Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
References in this section to “we,” “us,” "our" or “the Company” refer to Phunware, Inc. References to “management” or “management team” refer to our officers and directors.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto appearing elsewhere in this Annual Report on Form 10-K. As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those discussed in the section titled “ Risk Factors ” and elsewhere in this Annual Report.
Certain figures, such as interest rates and other percentages, included in this section have been rounded for ease of presentation. Percentage figures included in this section have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage amounts in this section may vary slightly from those obtained by performing the same calculations using the figures in our consolidated financial statements or in the associated text. Certain other amounts that appear in this section may similarly not sum due to rounding.
Key Events and Recent Developments
In October 2022, Alan S. Knitowski, our Chief Executive Officer, submitted notice of resignation to the Company effective December 27, 2022.
In November 2022, we entered into an employment agreement with Russell Buyse to serve as our Chief Executive Officer effective December 28, 2022. Our board of directors also appointed Mr. Buyse to serve as a Class III director until the 2024 annual meeting of stockholders. Mr. Buyse filled the vacancy on our board of directors created by the resignation of Randall Crowder, which occurred in September 2022.
In addition, in January 2023, we announced that we had entered into a separation agreement with Luan Dang, our Chief Technology Officer.
Overview
Phunware, Inc. offers a fully integrated software platform that equips companies with the products, solutions and services necessary to engage, manage and monetize their mobile application portfolios globally at scale. Our MaaS platform provides the entire mobile lifecycle of applications, media and data in one login through one procurement relationship. Our offerings include:
• Enterprise mobile software development kits (SDKs) including content management, location-based services, marketing automation, business intelligence and analytics, alerts, notifications and messaging, audience engagement and audience monetization;
• Integration of our SDK licenses into existing applications maintained by our customers, as well as custom application development and support services;
• Cloud-based vertical solutions, which are off-the-shelf, iOS- and Android-based mobile application portfolios, solutions and services that address: the patient experience for healthcare, the shopper experience for retail, the fan experience for sports, the traveler experience for aviation, the luxury resident experience for real estate, the luxury guest experience for hospitality, the student experience for education and the generic user experience for all other verticals and applications; and
• Application transactions for mobile audience building, user acquisition, application discovery, audience engagement and monetization, including our engagement-driven digital asset PhunToken.
We also offer and sell pre-packaged and custom high-end personal computer systems for gaming, streaming and cryptocurrency mining enthusiasts.
We intend to continue investing for long-term growth. We have invested and expect to continue investing in the expansion of our ability to market, sell and provide our current and future products and services to customers globally. We also expect to continue investing in the development and improvement of new and existing products and services to address customers' needs. We currently do not expect to be profitable in the near future.
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Key Business Metrics
Our management regularly monitors certain financial measures to track the progress of our business against internal goals and targets. We believe that the most important of these measures include backlog and deferred revenue.
Backlog and Deferred Revenue. Backlog represents future amounts to be invoiced under our current software subscription and services customer agreements. At any point in the contract term, there can be amounts that we have not yet been contractually able to invoice. Until such time as these amounts are invoiced, they are not recorded in revenue, deferred revenue, accounts receivable or elsewhere in our consolidated financial statements, and are considered by us to be backlog. We expect backlog to fluctuate up or down from period to period for several reasons, including the timing and duration of customer contracts, varying billing cycles and the timing and duration of customer renewals. We reasonably expect approximately 40% of our backlog as of December 31, 2022 will be invoiced during the subsequent 12-month period, primarily due to the fact that our contracts are typically one to three years in length.
In addition, our deferred revenue consists of amounts that have been invoiced but have not yet been recognized as revenues as of the end of a reporting period. Together, the sum of deferred revenue and backlog represents the total billed and unbilled contract value yet to be recognized in revenue, and provides visibility into future revenue streams.
The following table sets forth our backlog and deferred revenue:
December 31,
2022 2021
(in thousands)
Backlog $ 3,824 $ 3,316
Deferred revenue 4,178 5,272
Total backlog and deferred revenue $ 8,002 $ 8,588
For further information regarding our deferred revenue balances, refer to Note 4 “ Revenue ” of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Non-GAAP Financial Measures
Adjusted Gross Profit, Adjusted Gross Margin and Adjusted EBITDA
We report our financial results in accordance with GAAP. We also use certain non-GAAP financial measures that fall within the meaning ascribed in SEC Regulation G and Regulation S-K Item 10(e), which may provide users of the financial information with additional meaningful comparison to prior period results. Our non-GAAP financial measures include adjusted gross profit, adjusted gross margin and adjusted earnings before interest, taxes, depreciation and amortization ("EBITDA") (our "non-GAAP financial measures"). Management uses these measures (i) to compare operating performance on a consistent basis, (ii) to calculate incentive compensation for our employees, (iii) for planning purposes including the preparation of our internal annual operating budget and (iv) to evaluate the performance and effectiveness of operational strategies.
Our non-GAAP financial measures should be considered in addition to, not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. They are not measurements of our financial performance under GAAP and should not be considered as alternatives to revenue or net loss, as applicable, or any other performance measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other businesses. Our non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of our operating results as reported under GAAP. Some of these limitations include:
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• Non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period;
• Our non-GAAP financial measures do not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of ongoing operations; and
• Other companies in our industry may calculate our non-GAAP financial measures differently than we do, limiting their usefulness as comparative measures.
We compensate for these limitations to our non-GAAP financial measures by relying primarily on our GAAP results and using our non-GAAP financial measures only for supplemental purposes. Our non-GAAP financial measures include adjustments for items that may not occur in future periods. However, we believe these adjustments are appropriate because the amounts recognized can vary significantly from period to period, do not directly relate to the ongoing operations of our business and complicate comparisons of our internal operating results and operating results of other peer companies over time. For example, it is useful to exclude non-cash, stock-based compensation expenses because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations and these expenses can vary significantly across periods due to timing of new stock-based awards. We may also exclude certain discrete, unusual, one-time, or non-cash costs in order to facilitate a more useful period-over-period comparison of our financial performance. Each of the normal recurring adjustments and other adjustments described in this paragraph help management with a measure of our operating performance over time by removing items that are not related to day-to-day operations or are non-cash expenses.
The following table sets forth the non-GAAP financial measures we monitor.
Year Ended December 31,
2022 2021
(in thousands, except percentages)
Adjusted gross profit (1)
$ 5,286 $ 4,670
Adjusted gross margin (1)
24.3 % 43.9 %
Adjusted EBITDA (2)
$ (23,480) $ (11,662)
(1) Adjusted gross profit and adjusted gross margin are non-GAAP financial measures. We believe that adjusted gross profit and adjusted gross margin provide supplemental information with respect to gross profit and gross margin regarding ongoing performance. We define adjusted gross profit as net revenues less cost of revenue, adjusted to exclude one-time revenue adjustments, stock-based compensation and amortization of intangible assets. We define adjusted gross margin as adjusted gross profit as a percentage of net revenues.
(2) Adjusted EBITDA is a non-GAAP financial measure. We believe adjusted EBITDA provides helpful information with respect to operating performance as viewed by management, including a view of our business that is not dependent on (i) the impact of our capitalization structure and (ii) items that are not part of day-to-day operations. We define adjusted EBITDA as net loss plus (i) interest expense, (ii) income tax expense (benefit), (iii) depreciation, (iv) amortization, and further adjusted for (v) one-time adjustments and (vi) stock-based compensation expense.
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Reconciliation of Non-GAAP Financial Measures
The following tables set forth a reconciliation of the most directly comparable GAAP financial measure to each of the non-GAAP financial measures discussed above.
Year Ended December 31,
2022 2021
(in thousands, except percentages)
Gross profit $ 5,076 $ 3,613
Add back: Amortization of intangibles — 7
Add back: Stock-based compensation 210 1,050
Adjusted gross profit $ 5,286 $ 4,670
Adjusted gross margin 24.3 % 43.9 %
Year Ended December 31,
2022 2021
(in thousands)
Net loss $ (50,894) $ (53,522)
Add back: Depreciation and amortization 739 240
Add back: Interest expense 2,406 4,481
Add back (Less): Income tax expense (benefit) 4 (426)
EBITDA (47,745) (49,227)
Add back: Stock-based compensation 3,009 4,941
Add back: Loss on extinguishment of debt — 7,952
Add back: Impairment of digital assets 22,911 9,383
Add back: Impairment of goodwill 2,061 —
Less (Add back): Fair value adjustment for warrant liabilities (3,349) 18,139
Less: Gain on forgiveness of Paycheck Protection Program loan — (2,850)
Less: Gain on sale of digital assets (367) —
Adjusted EBITDA $ (23,480) $ (11,662)
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Components of Results of Operations
Revenue and Gross Profit
There are a number of factors that impact the revenue and margin profile of the product, service and technology offerings we provide, including, but not limited to, solution and technology complexity, technical expertise requiring the combination of products and types of services provided, as well as other elements that may be specific to a particular client solution.
Platform Revenue and Gross Profit
Our platform revenue consists of software subscriptions, application development services and support, application transactions (which are comprised of in-app advertising) and PhunToken sales.
Subscription revenue is derived from software license fees, which comprise subscription fees from customers licensing our Software Development Kits (SDKs), that includes accessing the MaaS platform. Subscription revenue from SDK licenses gives the customer the right to access our MaaS platform.
Application development revenue is derived from development services around designing and building new applications or enhancing existing applications. Support revenue is comprised of support and maintenance fees of customer applications, software updates and technical support for application development services for a support term. From time to time, we may also provide professional services by outsourcing employees’ time and materials to customers.
We generate application transaction revenue by charging advertisers to deliver advertisements (ads) to users of mobile connected devices. Depending on the specific terms of each advertising contract, we generally recognize revenue based on the activity of mobile users viewing these ads. Fees from advertisers are commonly based on the number of ads delivered or views, clicks or actions by users on mobile advertisements delivered, and we recognize revenue at the time the user views, clicks or otherwise acts on the ad. We sell ads through several offerings: cost per thousand impressions and cost per click. During 2021, we announced the commencement of PhunToken sales. PhunToken is designed to reward consumers for their activity, such as watching branded videos, completing surveys and visiting points of interest. We recognize revenue related to PhunToken at time of delivery to a customer's ethereum-based wallet.
Platform gross profit is equal to subscriptions and services revenue less the cost of personnel and related costs for our support and professional services employees, external consultants, stock-based compensation and allocated overhead. Costs associated with our development and project management teams are generally recognized as incurred. Costs directly attributable to the development or support of applications relating to subscription customers are included in cost of sales, whereas costs related to the ongoing development and maintenance of Phunware’s MaaS platform are expensed in research and development. Furthermore, gross profit related to application transactions is equal to application transaction revenue less cost of revenue associated with application transactions, which is impacted by the cost of advertising traffic we pay to our suppliers, the amount of traffic which we can purchase from those suppliers and ethereum blockchain fees paid to deliver PhunToken.
As a result, platform gross profit may fluctuate from period to period.
Hardware Revenue and Gross Profit
We acquired Lyte in October 2021. Revenue from Lyte is primarily derived from the sale of high-performance personal computers. Lyte computers are sold with a variety of pre-packaged solutions, as well as customizable solutions selected by our customers. A majority of Lyte's customers pay us via credit card payments, which is managed through a third party processor. We recognize revenue at the time a completed unit ships from our facility.
Hardware gross profit is equal to hardware revenue less the costs associated with the assembly of computers. Hardware gross profit is impacted by the costs that we pay for parts incorporated into a Lyte computer system, as well as labor costs of our employees directly attributable to building computer systems and shipping. Demand may exceed available supply at times, which may hamper our ability to deliver computer systems timely and may increase the costs at which we can obtain inventory needed for computer builds. Customizable solutions we offer our customers may also vary from time to time. As a result, computer hardware revenue and gross profit may fluctuate from period to period. Although we plan to invest in Lyte for future growth, we may experience revenue and gross profit fluctuations as a result of seasonality.
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Gross Margin
Gross margin measures gross profit as a percentage of revenue. Gross margin is generally impacted by the same factors that affect changes in the mix of platform and hardware revenue.
Operating Expenses
Our operating expenses include sales and marketing expenses, general and administrative expenses, research and development expenses, depreciation and amortization of acquired intangible assets. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation and, in sales and marketing expense, commissions. Legal settlements pertaining to litigation brought as a result of the Company's operations is also included in operating expenses.
Sales and Marketing Expense. Sales and marketing expense is comprised of compensation, commission expense, variable incentive pay and benefits related to sales personnel, along with travel expenses, other employee related costs, including stock-based compensation and expenses related to marketing programs and promotional activities. Our sales and marketing expense may increase in absolute dollars as we increase our sales and marketing organizations as we plan to increase revenue but may fluctuate as a percentage of our total revenue from period to period.
General and Administrative Expense. General and administrative expense is comprised of compensation and benefits of administrative personnel, including variable incentive pay and stock-based compensation, bad debt expenses and other administrative costs such as facilities expenses, professional fees and travel expenses. We expect to incur additional general and administrative expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and listing standards of Nasdaq, additional insurance expenses, investor relations activities and other administrative and professional services. We also expect to increase the size of our general and administrative function to support the growth of our business. As a result, our general and administrative expenses may increase in absolute dollars but may fluctuate as a percentage of our total revenue from period to period.
Research and Development Expense. Research and development expenses consist primarily of employee compensation costs and overhead allocation. We believe that continued investment in our platform is important for our growth. As a result, our research and development expenses may increase in absolute dollars as our business grows but may fluctuate as a percentage of revenue from period to period.
Impairment of Goodwill. Goodwill impairment consists of non-cash impairment charges related to goodwill. We review goodwill for impairment annually on October 1 and more frequently if events or changes in circumstances indicate an impairment may exist. If the carrying value of the reporting unit continues to exceed its fair value, the fair value of the Company’s goodwill is calculated and an impairment charge equal to the excess is recorded.
Interest Expense
Interest expense includes interest related to our outstanding debt, including amortization of discounts and deferred issuance costs.
Refer to Note 8 " Debt " of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for more information on debt offerings.
We also may seek additional debt financings to fund the expansion of our business or to finance strategic acquisitions in the future, which may have an impact on our interest expense.
Income Tax Expense
We are subject to U.S. Federal income taxes, state income taxes net of federal income tax effect and nondeductible expenses. Our effective tax rate will vary depending on permanent non-deductible expenses and other factors.
Refer to Note 14 " Income Taxes " of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.
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Results of Operations
Comparison of Fiscal Years Ended December 31, 2022 and 2021
Net Revenue
Year Ended December 31, Change
(in thousands, except percentages) 2022 2021 Amount %
Net Revenue
Platform revenue $ 6,521 $ 7,548 $ (1,027) (13.6) %
Hardware revenue 15,273 3,095 12,178 393.5 %
Total revenue $ 21,794 $ 10,643 $ 11,151 104.8 %
Platform revenue as percentage of total revenue 29.9 % 70.9 %
Hardware revenue as percentage of total revenue 70.1 % 29.1 %
Total revenue increased $11.2 million, or 104.8%, in the year ended December 31, 2022 compared to the corresponding period in 2021.
Platform revenue decreased $1.0 million, or (13.6)% as a result of a $1.5 million decrease of development, licensing and support services provided to two customers, one of which whose contract has expired. These decreases were minimally offset by an increase in PhunToken revenue of $0.5 million.
Computer hardware revenue increased by $12.2 million, which was the result of the acquisition of Lyte in October 2021.
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Cost of Revenue, Gross Profit and Gross Margin
Year Ended December 31, Change
(in thousands, except percentages) 2022 2021 Amount %
Cost of Revenue
Platform revenue $ 3,012 $ 4,013 $ (1,001) (24.9) %
Hardware revenue 13,706 3,017 10,689 354.3 %
Total cost of revenue $ 16,718 $ 7,030 $ 9,688 137.8 %
Gross Profit
Platform revenue $ 3,509 $ 3,535 $ (26) (0.7) %
Hardware revenue 1,567 78 1,489 1,909.0 %
Total gross profit $ 5,076 $ 3,613 $ 1,463 40.5 %
Gross Margin
Platform revenue 53.8 % 46.8 %
Hardware revenue 10.3 % 2.5 %
Total gross margin 23.3 % 33.9 %
Total gross profit increased $1.5 million, or 40.5%, in the year ended December 31, 2022, compared to the corresponding period of 2021 primarily due to revenue items discussed above. The decrease in platform revenue noted above was offset by a decrease of $0.8 million of stock-based compensation.
Increase in platform gross margin is the result of higher PhunToken revenue in 2022, as compared to 2021. Increase in Lyte gross margin is the result of operational efficiencies captured as we integrated Lyte during 2022. Total gross margin percentage decreased primarily due to product mix between platform and hardware revenue, as Lyte comprised of larger percentage of our revenue mix in 2022, as compared to 2021.
Operating Expenses
Year Ended December 31, Change
(in thousands, except percentages) 2022 2021 Amount %
Operating expenses
Sales and marketing $ 6,814 $ 3,022 $ 3,792 125.5 %
General and administrative 19,554 13,256 6,298 47.5 %
Research and development 6,149 4,179 1,970 47.1 %
Impairment of goodwill 2,061 — 2,061 100.0 %
Total operating expenses $ 34,578 $ 20,457 $ 14,121 69.0 %
Sales and Marketing
Sales and marketing expense increased $3.8 million, or 125.5% for the year ended December 31, 2022 compared to the corresponding period of 2021, primarily due to an increase of $3.1 million of marketing related expenditures mostly related to Lyte and PhunToken. Other increases of $0.9 million of employee compensation costs were due to higher headcount. These increases were minimally offset by the decrease in stock-based compensation of $0.3 million.
General and Administrative
General and administrative expense increased $6.3 million, or 47.5%, for the year ended December 31, 2022 compared to the corresponding period of 2021, as a result of an increase of $1.8 million in legal fees attributable to legal matters more fully described under the subheading " Litigation" in Note 10, " Commitments and Contingencies " of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. We also experienced an increase of $1.2 million in payroll costs, as a result of an higher headcount in our general and administrative function and employee retention credit received during 2021. Increases in these payroll-related items were partially offset by a decrease in accruals for employee bonuses. Other increases are the result of $0.8 million of facility expenses for new corporate office space
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in Austin, Texas and the Lyte warehouse facility, $0.6 million in audit and other professional services, $0.6 million in bad debt recoveries and accounts payable settlements that occurred in 2021, $0.6 million in other general and administrative expenses, $0.4 million related to amortization of trade name related to the Lyte acquisition and a $0.3 million increase in credit card processing fees for Lyte.
Research and Development
Research and development expense increased $2.0 million, or 47.1% for the year ended December 31, 2022, compared to the corresponding period of 2021, primarily resulting from increased headcount dedicated to research and development projects. This increase was minimally offset by in decrease in stock-based compensation.
Impairment of Goodwill
We recorded an impairment of goodwill of $2.1 million related to the Lyte operating segment of our business for the year ended December 31, 2022. Refer to Note 6 " Goodwill " of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further discussion on our goodwill impairment.
Other income (expense)
Year Ended December 31,
(in thousands, except percentages) 2022 2021
Other income (expense)
Interest expense $ (2,406) $ (4,481)
Loss on extinguishment of debt — (7,952)
Impairment of digital assets (22,911) (9,383)
Fair value adjustment for warrant liabilities 3,349 (18,139)
Gain on forgiveness of Paycheck Protection Program ("PPP") loan — 2,850
Other income, net 580 1
Total other expense $ (21,388) $ (37,104)
During 2022, we recorded other expense of $21.4 million, which primarily consisted of impairment charges related to our digital asset holdings. Refer to Note 2, " Summary of Significant Accounting Policies " of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further discussion regarding our digital asset holdings. We also recorded interest expense related to our 2021 Promissory Note and 2022 Promissory Note (defined elsewhere herein) and accretion of debt discounts thereunder. These expenses were offset by a gain related to the change in the fair value of our warrants issued in connection with our 2020 Convertible Notes. Reference is made to Note 8 " Debt " of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further discussion on our debt holdings.
During 2021, we recorded other expense related to a fair value adjustment of the warrants issued in connection with our 2020 Convertible Notes, which included a fair value adjustment related to a partial exercise of the warrant. We also recorded interest expense and losses on extinguishment of debt related to payments and the payoff of our 2020 Convertible Notes. These expenses were partially offset by the gain on forgiveness of our Paycheck Protection Program loan.
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Liquidity and Capital Resources
As of December 31, 2022, we held total cash of $2.0 million, all of which was held in the United States. We have a history of operating losses and negative operating cash flows. As we continue to focus on growing our revenues, we expect these trends to continue into the foreseeable future.
We may, if needed, sell our digital asset holdings for cash to fund our ongoing operations. As of December 31, 2022, we held 605 bitcoins and 400 ethereum, of which consist of the majority of the digital assets recorded on our balance sheet. The digital asset market historically has been characterized by significant volatility in its price, limited liquidity and trading volumes compared to sovereign currencies markets, relative anonymity, a developing regulatory landscape, susceptibility to market abuse and manipulation, and various other risks inherent in its entirely electronic, virtual form and decentralized network. During times of instability in the digital asset market, we may not be able to sell our digital asset holdings at reasonable prices, or at all. As a result, our digital assets are less liquid than our existing cash and cash equivalents and may not be able to serve as a source of liquidity for us to the same extent as cash and cash equivalents.
On February 1, 2022, we filed a registration statement on Form S-3, which was subsequently declared effective by the SEC on February 9, 2022, pursuant to which we may issue up to $200 million in common stock, preferred stock, warrants and units. Contained therein, was a prospectus supplement in which we may sell up to $100 million of our common stock in an “at the market" offering pursuant to an At Market Issuance Sales Agreement we entered into with H.C. Wainwright & Co., LLC on January 31, 2022. As of December 31, 2022, 2,623,460 shares of our common stock have been sold for aggregate cash proceeds of $4.6 million, net of transaction costs of $0.1 million. We also incurred additional transaction costs paid outside of closing of $0.2 million.
On July 6, 2022, we entered into a note purchase agreement and completed the sale of an unsecured promissory note with an original principal amount of $12.8 million in a private placement (the "2022 Promissory Note"). After deducting all transaction fees paid by us at closing, net cash proceeds to us at closing were $11.8 million. No interest will accrue on the 2022 Promissory Note unless and until the occurrence of an event of default (as defined in the 2022 Promissory Note). Beginning on November 1, 2022 and on the same day of each month thereafter until the promissory note is paid in full, we are required to make monthly amortization payments in the amount of $1.6 million until the maturity date of July 1, 2022, which is subject to adjustment for any payment deferrals we elect. We may prepay any or all outstanding balance of the 2022 Promissory Note earlier than it is due with a prepayment premium of 110%. The prepayment premium also applies to the monthly amortization payments. On March 15, 2023, we entered into a waiver agreement with the holder of our 2022 Promissory Note, waiving the Payment Deferral Conditions, as defined in the 2022 Promissory Note. For agreeing to waive the Payment Deferral Conditions, we agreed to compensate the noteholder an amount equal to 5% of the outstanding balance immediately before entering into the waiver agreement. In connection therewith, we elected to defer the monthly payments under the 2022 Promissory Note for the months of April, May, June and July 2023. As a result of our election to defer the monthly payments, the outstanding balance of the 2022 Promissory Note will be increased by 1.85% on the first day of each month beginning on April 1, 2023 and concluding on July 1, 2023. The waiver fee and the additional principal will be paid in connection with our monthly installment payments once the deferral period concludes. Beginning on August 1, 2023 and on the same day of each month thereafter, we will be required to pay to the noteholder the new monthly amortization payment in the amount of $1,769 until the new maturity date of November 1, 2023.
Our expectation to generate operating losses and negative operating cash flows in the future and the need for additional funding to support our planned operations, raise substantial doubt regarding our ability to continue as a going concern. Management believes that our existing cash and liquidation of some, or all, of our digital asset holdings are not sufficient to satisfy our operating cash needs for the year after the filing of this Annual Report on Form 10-K, and substantial doubt exists about our ability to continue as a going concern for a period of at one year following the filing date of this Annual Report on Form 10-K.
Additional plans may include selling shares of our common stock in our "at the market" offering, and as of the date of this Annual Report on Form 10-K, a total of $95.4 million may be sold pursuant to the sales agreement. We may also issue shares of our common stock, preferred stock, warrants and units in other offerings pursuant to our effective registration statement.
Our future capital requirements will depend on many factors, including our pace of growth, subscription renewal activity, the timing and extent of spend to support development efforts, the pace at which we can scale Lyte, the expansion of sales and marketing activities and the market acceptance of our products and services. We believe that it is likely we will in the future enter into arrangements to acquire or invest in complementary businesses, technologies and intellectual property rights. We may be required to seek additional equity or debt financings, or issue securities under our effective registration statement described above. In the event that additional financing is required from outside sources, we may not be able to raise it on terms
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acceptable to us, or at all. If we are unable to raise additional capital when desired and/or on acceptable terms, our business, operating results and financial condition could be adversely affected.
The accompanying consolidated financial statements have been prepared assuming we will continue to operate as a going concern, which contemplates the realization of assets and settlement of liabilities in the ordinary course of business.
The following table summarizes our cash flows for the periods presented:
Year Ended December 31,
(in thousands, except percentages) 2022 2021
Consolidated statement of cash flows
Net cash used in operating activities $ (26,827) $ (22,514)
Net cash used in investing activities (2,287) (46,385)
Net cash provided by financing activities 8,055 88,019
Operating Activities
Our primary source of cash from operating activities is receipts sales for our various product and service offerings as further described elsewhere in this Annual Report. Our primary uses of cash from operating activities are payments to employees for compensation and related expenses, publishers and other vendors for the purchase of digital media inventory and related costs, vendors for costs of inventory related to the assembly of Lyte computers, sales and marketing expenses and general operating expenses.
We utilized $26.8 million of cash from operating activities during 2022 resulting from a net loss of $50.9 million. The net loss included non-cash charges of $27.1 million, primarily consisting of the change in fair value of warrants, impairment of digital assets, impairment of goodwill, amortization of debt issuance costs primarily related to our 2022 Promissory Note, as well as stock-based compensation. In addition, certain changes in our operating assets and liabilities resulted in significant cash (decreases) as follows: $(0.1) million from a decrease in accounts payable, accrued expenses and an installment payments to Uber related to the settlement of our lawsuit, as well as $(2.9) million from other working capital changes, primarily related to a decrease in deferred revenue and lease liability payments.
We utilized $22.5 million of cash from operating activities during 2021 resulting from a net loss of $53.5 million. The net loss included non-cash charges of $40.0 million, primarily consisting of the change in fair value of warrants, impairment of digital assets, the loss on the extinguishment and amortization of debt issuance costs related to our 2020 Convertible Notes, as well as stock-based compensation. In addition, certain changes in our operating assets and liabilities resulted in significant cash (decreases) as follows: $(5.7) million from a decrease in accounts payable, accrued expenses and an installment payments to Uber related to the settlement of our lawsuit, as well as $(3.3) million from other working capital changes, primarily related to a decrease in post-acquisition deferred revenue and inventory purchases.
Investing Activities
Our investing activities during 2022 consisted of the purchase of digital assets and cash payments for the acquisition of Lyte. This was partially offset by proceeds from the sale of digital assets.
Our investing activities during 2021 consisted of the purchase of digital assets and the acquisition of Lyte.
Financing Activities
Our financing activities during 2022 consisted of proceeds from equity financings and debt borrowings offset by payments on debt. We acquired $8.1 million of cash from financing activities resulting primarily from $11.8 million in proceeds from our 2022 Promissory Note and $4.3 million in proceeds from the sale of our common stock. These sources of financings were partially offset by $8.1 million of payments on debt.
Our financing activities during 2021 consisted of proceeds from equity financings and debt borrowings offset by payments on debt. We acquired $88.0 million of cash from financing activities resulting primarily from $94.7 million in proceeds from the sale of our common stock, $14.7 million in proceeds from our Series B Convertible Note and 2021 Promissory Note and $4.6 million from a partial exercise of a warrant held by the holder of our 2020 Convertible Notes. These
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sources of financing were partially offset by $26.2 million of payments on debt, a majority of which related to payments on the 2020 Convertible Notes.
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Contractual Obligations
We lease various office facilities, including our corporate headquarters in Austin, Texas, our Lyte warehouse facility in Round Rock, Texas, as well as offices in California and Florida, under non-cancellable operating lease agreements that expire through 2027. The terms of the lease agreements provide for rental payments on a graduated basis. We recognize rent expense on a straight-line basis over the lease periods. Rent expense under operating leases totaled $1.1 million and $0.8 million for the years ended December 31, 2022 and 2021, respectfully.
The following table sets forth our contractual obligations as of December 31, 2022 (in thousands):
Payments due by period
Contractual obligations Total Less than
1 year
1-3
years
3-5
years
More than
5 years
Operating lease obligations $ 4,782 $ 1,296 $ 2,234 $ 1,252 $ —
Off-Balance Sheet Arrangements
During the years ended December 31, 2022 and 2021, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K, such as the use of unconsolidated subsidiaries, structured finance, special purpose entities or variable interest entities.
Indemnification Agreements
In the ordinary course of business, we provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, solutions to be provided by the Company or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with directors and certain current and former officers and employees that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of, or are related to, their status or service as directors, officers or employees.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with GAAP. 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, as well as the reported revenues generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are set forth below. For further information on all significant accounting policies, refer to Note 2 “ Summary of Significant Accounting Policies ” of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Revenue
We derive our revenue primarily from MaaS subscription fees, application development and support fees, as well as revenue from the sale of high-performance personal computer systems. Revenue is recognized when control of these products or services are transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services. Our revenue recognition policy follows guidance from Accounting Standards Codification ("ASC") No. 606, Revenue from Contracts with Customers (Topic 606) .
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We determine revenue recognition through the following five-step framework:
• Identification of the contract, or contracts, with a customer;
• Identification of the performance obligations in the contract or contracts;
• Determination of the transaction price;
• Allocation of the transaction price to the performance obligations in the contract; and
• Recognition of revenue when, or as, we satisfy a performance obligation.
Our software subscription and services contracts often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a customer contract consists of licensing, application development and support services, we consider these separate performance obligations, which would require an allocation of consideration. For contracts with multiple performance obligations, the contract price is allocated to separate performance obligations on a relative standalone basis for which significant judgment is required. Judgment is required to determine whether a software license is considered distinct and accounted for separately, or not distinct and accounted for together with the software support and services and recognized over time.
Digital Assets
We account for our digital assets as indefinite-lived intangible assets in accordance with ASC 350, Intangibles—Goodwill and Other . We have ownership of and control over our digital assets and we may use third-party custodial services or self-custody solutions to secure them. The digital assets are initially recorded at cost and are subsequently remeasured, net of any impairment losses incurred since acquisition.
We determine the fair value of our digital assets on a nonrecurring basis in accordance with ASC 820, Fair Value Measurement , based on quoted prices on the active exchange(s) that we have determined is the principal market for bitcoin and ethereum (Level 1 inputs). We perform an analysis each quarter to identify whether events or changes in circumstances, principally decreases in the quoted prices on active exchanges, indicate that it is more likely than not that our digital assets are impaired. In determining if an impairment has occurred, we consider the lowest intra-day market price quoted on an active exchange since acquiring the respective digital asset. If the then current carrying value of a digital asset exceeds the fair value, an impairment loss has occurred with respect to those digital assets in the amount equal to the difference between their carrying values and the fair value.
The impaired digital assets are written down to their fair value at the time of impairment and this new cost basis will not be adjusted upward for any subsequent increase in fair value. Gains are not recorded until realized upon sale. In determining the gain or loss to be recognized upon sale, we calculate the difference between the sales price and carrying value of the digital assets sold immediately prior to sale. Impairment losses and gains or losses on sales are recognized within other expense in our consolidated statements of operations and comprehensive loss.
Goodwill
We review goodwill for impairment annually during the fourth quarter or more frequently if events or changes in circumstances would more-likely-than-not reduce the fair value of a reporting unit below its carrying value. As of December 31, 2022, we identified an impairment related to our Lyte computer division of approximately $2.1 million. Refer to Note 6 " Goodwill " of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further discussion on our goodwill impairment.
Derivative Liabilities
When the Company issues warrants, it evaluates the proper balance sheet classification of the warrant to determine whether the warrant should be classified as equity or as a derivative liability on the consolidated balance sheet. In accordance with ASC 815-40, Derivatives and Hedging - Contracts in the Entity’s Own Equity (“ASC 815-40”), we classify a warrant as equity if it is indexed to our equity and several specific conditions for equity classification are met. A warrant is not considered indexed to our equity, in general, when it contains certain types of exercise contingencies or adjustments to exercise price. If a warrant is not indexed to our equity or it has net cash settlement that results in the warrants to be accounted for under ASC 480, Distinguishing Liabilities from Equity , or ASC 815-40, it is classified as a derivative liability which is carried on the consolidated balance sheet at fair value with any changes in its fair value recognized currently in the statement of operations. As
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of December 31, 2022 and 2021, we had a warrant that was classified as a liability and other warrants that were classified as equity.
We used a Black-Scholes option-pricing model to value the warrant classified as a liability at inception and subsequent valuation dates. Furthermore, the holder partially exercised its warrant for 2,060,000 shares of our common stock, in October 2021, which resulted in a revaluation of the warrant at the time of exercise. The initial and subsequent valuations of the warrant require significant judgment. For the assumptions used to value at warrant as of December 31, 2022, refer to Note 8 “ Debt ” of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Business Combination
We account for business combinations using the acquisition method of accounting as prescribed in ASC 805, " Business Combinations (Topic 805)." We record the assets acquired, liabilities assumed and acquisition-related contingent consideration at fair value on the date of acquisition. The difference between the purchase price, including any contingent consideration, and the fair value of net assets acquired is recorded as goodwill. We may adjust the preliminary purchase price and purchase price allocation, as necessary, during the measurement period of up to one year after the acquisition closing date as we obtain more information as to facts and circumstances that impact the determination of fair value at the acquisition date. Any change in fair value of acquisition-related contingent consideration resulting from events after the acquisition date is recognized in earnings. Acquisition-related costs are recognized separately from the acquisition and are expensed as incurred.
Recent Accounting Standards
Recent accounting standards applicable to our business are described under the subheading " Recently Adopted Accounting Policies " in Note 2 " Summary of Significant Accounting Policies " of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are a “smaller reporting company” as defined by Rule 12b-2 of the Exchange Act, and as such, we are not required to provide the information required under this Item.
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