The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this annual report. Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" are forward-looking statements that are based on current expectations and involve various risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. Our financial statements are stated inUnited States Dollars ("$") and are prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP"). The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this prospectus. In this prospectus, unless otherwise specified, all dollar amounts are expressed inUnited States dollars and all references to "common shares" refer to the common shares in our capital stock.
Overview
DecisionPoint is a provider and integrator of mobility and wireless systems for business organizations. The Company designs, deploys and supports mobile computing systems that enable customers to access employers' data networks at various locations (i.e. the retail selling floor, nurse workstations, warehouse and distribution centers or on the road deliveries via enterprise-grade handheld computers, printers, tablets, and smart phones). The Company also integrates data capture equipment including bar code scanners and radio frequency identification (RFID) readers. 19
InDecember 2020 , we completed the acquisition ofExtenData Solutions, LLC , a privately held company with corporate headquarters inCentennial, CO. DecisionPoint acquired ExtenData to better serve its customers, deepen its expertise in manufacturing, transportation and logistics, and hospitality, and provide a stronger regional presence across theRocky Mountain and Southwest regions ofthe United States . InJanuary 2022 , we completed the acquisition ofAdvanced Mobile Group, LLC ("AMG"), a privately held company headquartered inDoylestown, Pennsylvania .DecisionPoint acquiredAdvanced Mobile Group to expandDecisionPoint's mobility-first enterprise solutions and service offerings and grow its capabilities in the mid-Atlantic region.Advanced Mobile Group is a regional leader providing services, hardware, software, integration, and wireless networking solutions, with deep experience in warehousing and distribution, manufacturing, mobile workforce automation, retailing, and healthcare segments, and 600 customers. The future impact of the COVID-19 pandemic on our business and results of operations is unknown and will depend on future developments, which fluctuate and are highly uncertain and cannot be predicted with confidence, including the duration and severity of the COVID-19 pandemic, the spread of the new variants of the virus, the effectiveness of vaccines and vaccination rates, and additional preventative and protective actions that governments, or we or our customers, may implement, which may result in an extended period of continued business disruption and reduced operations. While our overall business and revenue since the onset of the pandemic have not been materially adversely impacted, certain of our customers, particularly those in the retail sector, have been significantly impacted by COVID-19 and the pandemic has contributed to disruptions in supply chains and labor shortages across industries, and therefore our results of operations during 2021 are not necessarily indicative of results to be expected in 2022 in light of the uncertainties surrounding the impact of COVID-19 pandemic on many of our customers and suppliers. Although our results of operations were not materially adversely impacted, we have experienced supplier shipment delays due to a supply chain and logistic challenges resulting in delays in revenue recognition. In addition, general economic uncertainty and volatility arising from geopolitical events and concerns, inflation, rises in energy prices, changes in interest rates and general declines in capital spending in the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets we serve and whether our results of operations will be materially impacted.
Components of Results of Operations
Net sales reflect revenue from the sale of hardware, software, consumables and services (including hardware and software maintenance) to our clients, net of sales taxes.
Revenue is recognized when a customer obtains control of promised goods or
services under the terms of a contract and is measured as the amount of
consideration we expect to receive in exchange for transferring goods or
providing services. We do not have any material extended payment terms, as
payment is due at or shortly after the time of the sale. Sales, value-added and
other taxes collected concurrently with revenue producing activities are
excluded from revenue.
Cost of Sales, Sales and Marketing Expenses, and General and Administrative
Expenses
The following illustrates the primary costs classified in each major expense
category:
Cost of sales, include:
? Cost of goods sold for hardware, software and consumables;
? Cost of services, including maintenance;
? Markdowns of inventory; and
? Freight expenses.
Sales and marketing expenses, include:
? Sales salaries, benefits and commissions;
? Consulting; ? Marketing tools; ? Travel; and
? Marketing promotions and trade shows.
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General and administrative expenses, include:
? Corporate payroll and benefits; ? Depreciation and amortization; ? Rent; ? Utilities; and
? Other administrative costs such as maintenance of corporate offices, supplies,
legal, consulting, audit and tax preparation and other professional fees.
Results of Operations The following table summarizes key components of our results of operations for the periods indicated, both in dollars and as a percentage of our net sales
(in
thousands):
Year Ended
December 31,
2021 2020
Income Statement Data:
Net sales $ 65,943 $ 63,360
Cost of sales 50,639 48,542
Gross profit 15,304 14,818
Sales and marketing expenses 7,354 5,587
General and administrative expenses 7,552 5,203
Total operating expenses 14,906 10,790
Operating income 398 4,028
Interest expense (79 ) (319 )
Gain on extinguishment of debt 1,211 -
Other income - 213
Income before income taxes 1,530 3,922
Income tax expense (116 ) (1,061 )
Net income attributable to common shareholders $ 1,414 $ 2,861
Percentage of Net Sales :
Net sales 100.0 % 100.0 %
Cost of sales 76.8 % 76.6 %
Gross profit 23.2 % 23.4 %
Sales and marketing expenses 11.2 % 8.8 %
General and administrative expenses 11.5 % 8.2 %
Total operating expenses 22.6 % 17.0 %
Operating income 0.6 % 6.4 %
Interest expense -0.1 % -0.5 %
Gain on extinguishment of debt 1.8 % 0.0 %
Other income 0.0 % 0.3 %
Income before income taxes 2.3 % 6.2 %
Income tax expense -0.2 % -1.7 %
Net income attributable to common shareholders 2.1 % 4.5 %
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Results of Operations for the Year Ended December 31, 2021 compared to the Year
Ended December 31, 2020
Net sales
Year Ended
December 31, Dollar Percent
2021 2020 Change Change
(dollars in thousands)
Hardware and software $ 44,355 $ 47,416 $ (3,061 ) -6.5 %
Consumables 6,125 3,257 2,868 88.1 %
Services 15,463 12,687 2,776 21.9 %
$ 65,943 $ 63,360 $ 2,583 4.1 %
Net sales increased by 4.1%, or $2.6 million , for the year ended December 31,
2021 compared to the year ended December 31, 2020 . The increase in net sales was
primarily driven by a $11.0 million increase in overall net sales associated
with sales by ExtenData that we acquired in December 2020 (and, thus, there were
not corresponding sales by ExtenData included in our results of operations for
2020), partially offset by a decrease in hardware and software sales in the
retail sector due to significant equipment upgrades (and resulting purchases of
our products and services) that occurred in 2020 from one of our largest
customers (without a corresponding significant upgrade by that customer in
2021), as well as supply chain issues impacting product availability in 2021.
Significant customer equipment upgrades occur periodically and the related net
sales, and the timing of those net sales, are difficult to estimate with a high
degree of certainty.
Cost of sales
Year Ended
December 31, Dollar Percent
2021 2020 Change Change
(dollars in thousands)
Hardware and software $ 35,573 $ 37,986 $ (2,413 ) -6.4 %
Consumables 4,370 2,143 2,227 103.9 %
Services 10,696 8,413 2,283 27.1 %
$ 50,639 $ 48,542 $ 2,097 4.3 %
Cost of sales increased by 4.3%, or $2.1 million during the year ended December
31, 2021 as compared to the year ended December 31, 2020 primarily due a $7.9
million increase in overall cost of sales associated with cost of sales of
ExtenData that we acquired in December 2020 (and, thus, there were not
corresponding cost of sales for ExtenData included in our results of operations
for the comparable period in 2020), partially offset by lower hardware and
software costs associated with significant equipment upgrades that occurred
in
the prior year.
Gross profit
Year Ended
December 31,
2021 2020
(dollars in thousands)
Gross profit:
Hardware and software $ 8,782 $ 9,430
Consumables 1,755 1,114
Services 4,767 4,274
Total gross profit $ 15,304 $ 14,818
Gross profit percentage:
Hardware and software 19.8 % 19.9 %
Consumables 28.7 % 34.2 %
Services 30.8 % 33.7 %
Total gross profit percentage 23.2 % 23.4 %
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Gross profit increased$0.5 million for the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 , primarily as a result of higher sales volume and the other impacts noted above. The decrease in gross profit margin for consumables was partly due to lower consumables margins associated with customers of ExtenData that we acquired inDecember 2020 . The decrease in gross profit margin for services was attributed to higher fixed personnel costs in connection with our increased service offerings. Sales and marketing expenses Year Ended December 31, Dollar Percent 2021 2020 Change Change (dollars in thousands) Sales and marketing expenses$ 7,354 $ 5,587 $ 1,767 31.6 % As a percentage of sales 11.2 % 8.8 % - 2.4 %
Sales and marketing expenses increased$1.8 million , or 31.6%, for the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 due to increased expenses for ExtenData operations that was acquired inDecember 2020 (and, thus, there were not corresponding expenses for ExtenData included in our results of operations for 2020). As a percentage of sales, sales and marketing expenses increased 240 basis points primarily as a result of higher marketing personnel costs and sales integration costs.
General and administrative expenses
Year Ended
December 31, Dollar Percent
2021 2020 Change Change
(dollars in thousands)
General and administrative expenses$ 7,552 $ 5,203 $ 2,349
45.1 % As a percentage of sales 11.5 % 8.2 % - 3.2 % General and administrative expenses increased$2.3 million , or 45.1%, for the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 . The increase in costs was primarily due to a$1.5 million increase in expenses associated with the acquisition of ExtenData inDecember 2020 (and, thus, there were not corresponding expenses for ExtenData included in our results of operations for 2020), director and executive compensation and benefits, and an increase in legal and compliance costs. As a percentage of sales, general and administrative costs increased 320 basis points due to higher compensation, legal and compliance costs.
Interest expense. The decrease in interest expense to
year was due to a decrease in average debt balances as compared to 2020.
Gain on extinguishment of debt. We recorded a gain on extinguishment of debt of$1.2 million in the first quarter of 2021 in connection with the forgiveness of the PPP Loans by theUS Small Business Administration ("SBA"). Income tax expense. Income tax expense was approximately$0.1 million and$1.1 million for the year endedDecember 31, 2021 andDecember 31, 2020 , respectively. The lower income tax rate this year is primarily associated with the tax exemption for the gain on extinguishment of debt recognized in the first quarter of 2021.
Net income. Net income was
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Liquidity and Capital Resources
As ofDecember 31, 2021 , our principal sources of liquidity were cash totaling$2.6 million and$9.0 million of availability under our line of credit. In recent years, we have financed our operations primarily through cash generated from operating activities, borrowings from term loans and our line of credit. We have historically generated operating losses and negative cash flows from operating activities as reflected in our accumulated deficit. We have generated operating income for each of the years endedDecember 31, 2018 throughDecember 31, 2021 . Based on our recent trends and our current projections, we expect to generate cash from operations for the year endingDecember 31, 2022 . Given our projections, combined with our existing cash and credit facilities, we believe the Company has sufficient liquidity for at least the next 12 months. Our ability to continue to meet our cash requirements will depend on, among other things, the effect of COVID-19 onU.S. and global economic activity, continuing disruptions in supply chains and labor shortages across industry sectors caused by the COVID-19 pandemic, our ability to achieve anticipated levels of revenues and cash flow from operations, our ability to manage costs and working capital successfully and the continued availability of financing, if needed. We cannot provide any assurance that our assumptions used to estimate our liquidity requirements will remain accurate due to, among other things, the unpredictability of the COVID-19 global pandemic and its effect on the Company and its customers and suppliers. Consequently, the duration of the pandemic and our estimates on the severity of the impact on our future earnings and cash flows could change and have a material impact on our results of operations and financial condition. In the event of a sustained market deterioration, and declines in net sales, we may need additional liquidity, which would require us to evaluate available alternatives and take appropriate actions. We cannot provide any assurance that we will be able to obtain any additional sources of financing or liquidity on acceptable terms, or at all.
Working Capital (Deficit)
December 31, December 31, Increase/
2021 2020 (Decrease)
(in thousands)
Current assets $ 19,334 $ 21,138 $ (1,804 )
Current liabilities 18,352 21,777 (3,425 )
Working capital (deficit) 982 (639 ) 1,621
The improvement in working capital is primarily due to timing of payments of
accounts payable and the payoff during 2021 of the outstanding line of credit
balance of $1.2 million at December 31, 2020 .
Line of Credit
OnJuly 30, 2021 , we entered into a Loan and Security Agreement (the "Loan Agreement") withMUFG Union Bank, National Association . The Loan Agreement provides for a revolving line of credit of up to$9.0 million with our obligations being secured by a security interest in substantially all of our assets. Loans extended to us under the Loan Agreement are scheduled to mature onJuly 31, 2024 . The availability under the line of credit is not determined by a borrowing base calculation on our existing accounts receivable balance and currently bears interest at 2.75%.
As of
no outstanding borrowings under the line of credit.
PPP Loans
OnApril 20, 2020 andMay 4, 2020 , we received$740,000 and$471,000 , respectively, in proceeds from loans from Pacific Western Business Finance ("PWBF"), which were granted pursuant to the Paycheck Protection Program of the Coronavirus Aid Relief and Economic Security Act (collectively, the "PPP Loans"). We used the entire PPP Loan proceeds for qualifying expenses. InDecember 2020 , we applied for loan forgiveness, including principal and accrued interest as permitted by the CARES Act. In February andMarch 2021 , we received forgiveness of the PPP Loans in whole, including all accrued interest to date. 24 EIDL Promissory Note OnAugust 27, 2020 , we received$150,000 in connection with a promissory note from the SBA under the Economic Injury Disaster Loan ("EIDL") program pursuant to the CARES Act. Under the terms of the EIDL promissory note, interest accrues on the outstanding principal at an interest rate of 3.75% per annum and with a term of 30 years with equal monthly payments of principal and interest of$731 beginning onAugust 27, 2021 .
Impact of CARES Act on Company Liquidity
OnMarch 27, 2020 , formerPresident Trump signed into law the CARES Act which, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property.
ExtenData Solutions, LLC Acquisition
InDecember 2020 , we acquired 100% of the issued and outstanding membership interests ofExtenData Solutions, LLC ("ExtenData"). ExtenData is focused on enterprise mobility solutions and provides software product development, mobile computing, identification and wireless tracking solutions. The consideration we paid was comprised of$4.4 million in cash and an estimated earn-out obligation of$0.6 million , subject to the financial performance of ExtenData following the closing of the acquisition. As a result of the acquisition, ExtenData became a wholly owned subsidiary of the Company. The operating results for ExtenData have been consolidated into our results of operations beginningDecember 5, 2020 . Cash Flow Analysis Year EndedDecember 31, 2021 2020 (in thousands)
Net cash provided by operating activities
Net used in investing activities
(541 ) (3,502 )
Net cash used in financing activities (1,229 ) (1,309 )
Net increase (decrease) in cash
$ 582 $ (615 ) Operating Activities
Net cash provided by operating activities decreased to$2.4 million for the year endedDecember 31, 2021 from$4.2 million for the year endedDecember 31, 2020 . The decrease was primarily due to lower net income.
Investing Activities
Net cash used in investing activities was$0.5 million for the year endedDecember 31, 2021 which is comprised of cash payments delivered in the first quarter of 2021 in connection with the acquisition of ExtenData and purchases of capital expenditures of property and equipment. Net cash used in investing activities was$3.5 million for the year endedDecember 31, 2020 which is comprised of cash paid for the acquisition of ExtenData of$3.4 million and$0.1 million in purchases of capital expenditures of property and equipment.
Financing Activities
Net cash used in financing activities was$1.2 million for the year endedDecember 31, 2021 which primarily comprised of payments on the line of credit. Net cash used in financing activities was$1.3 million for the year endedDecember 31, 2020 which comprised of the repayment of debt, partially offset by proceeds of long-term debt. 25
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that may have a current or future
material effect on our financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources.
Stock Issuances
InFebruary 2021 , common stock purchase warrants issued by us inSeptember 2016 were fully exercised by all of the holders on a cashless basis. As a result of the cashless exercise, 303,008 shares of common stock were issued. During the year endedDecember 31, 2021 , certain employees and directors exercised vested stock options through a cashless exercise. The options exercised were net settled in satisfaction of the exercise price. The exercised options, utilizing a cashless exercise, are summarized in the following table: Weighted Employee Average Shares Shares Weighted Share-Based Options Exercise Net Settled Withheld for Net Shares Average Tax exercised Price for Exercise Taxes Issued Share Price Withholding
151,441$ 1.88 77,954 7,225 66,232$ 3.67 $ 24,662
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements that have been prepared in accordance with generally accepted accounting principles inthe United States of America ("US GAAP"). This preparation requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. US GAAP provides the framework from which to make these estimates, assumption and disclosures. We choose accounting policies within US GAAP that management believes are appropriate to accurately and fairly report our operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. While there are a number of significant accounting policies affecting our financial statements, we believe the following critical accounting policies involve the most complex, difficult and subjective estimates and judgments:
Revenue Recognition
We determine revenue recognition through the following steps: (1) identification
of the contract with a customer; (2) identification of the performance
obligations in the contract; (3) determination of the transaction price; (4)
allocation of the transaction price to the performance obligations in the
contract; and (5) recognition of revenue when, or as, a performance obligation
is satisfied.
We combine contracts with the same customer into a single contract for
accounting purposes when the contracts are entered into at or near the same time
and the contracts are negotiated as a single commercial package, consideration
in one contract depends on the other contract, or the services are considered a
single performance obligation. If an arrangement involves multiple performance
obligations, the items are analyzed to determine the separate units of
accounting (that is, are they distinct and are they distinct in the context of
the customer contract). The total contract transaction price is allocated to the
identified performance obligations based upon the relative standalone selling
prices of the performance obligations. The standalone selling price is based on
an observable price for services sold to other comparable customers, when
available, or an estimated selling price using a cost plus margin approach. We
estimate the amount of total contract consideration we expect to receive for
variable arrangements by determining the most likely amount we expect to earn
from the arrangement based on the expected quantities of services we expect to
provide, and the contractual pricing based on those quantities. We only include
some or a portion of variable consideration in the transaction price when it is
probable that a significant reversal in the amount of cumulative revenue
recognized will not occur or when the uncertainty associated with the variable
consideration is subsequently resolved. We consider the sensitivity of the
estimate, our relationship and experience with our client and variable services
being performed, the range of possible revenue amounts and the magnitude of the
variable consideration to the overall arrangement.
26
As discussed in more detail below, revenue is recognized when a customer obtains
control of promised goods or services under the terms of a contract and is
measured as the amount of consideration, we expect to receive in exchange for
transferring goods or providing services. We do not have any material extended
payment terms, as payment is due at or shortly after the time of the sale.
Sales, value-added and other taxes collected concurrently with revenue producing
activities are excluded from revenue.
We recognize contract assets or unbilled receivables related to revenue
recognized for services completed but not yet invoiced to our clients. Unbilled
receivables are recorded when we have an unconditional right to contract
consideration. A contract liability is recognized as deferred revenue when we
invoice clients, or receive customer cash payments, in advance of performing the
related services under the terms of a contract. Remaining performance
obligations represent the transaction price allocated to the performance
obligations that are unsatisfied as of the end of each reporting period.
Deferred revenue is recognized as revenue when we have satisfied the related
performance obligation.
Hardware, consumables and software products - We recognize product revenue at
the point in time when a client takes control of the hardware and/or software,
which typically occurs when title and risk of loss have passed to the client.
Our selling terms and conditions reflect that F.O.B 'dock' contractual terms
establish that control is transferred from us at the point in time when the
product is shipped to the customer.
Revenues from software license sales are recognized as a single performance
obligation on a gross basis as we are acting as a principal in these
transactions at the point the software license is delivered to the customer.
Generally, software licenses are sold with accompanying third-party delivered
software assurance, which allows customers to upgrade, at no additional cost, to
the latest technology if new capabilities are introduced during the period that
the software assurance is in effect. We determined that the accompanying
third-party delivered software assurance is critical or essential to the core
functionality of the software licensor because we do not sell the software
license and standard warranty on a standalone basis (which indicates that the
customer cannot benefit from the software license and standard warranty on its
own), the software license and the standard warranty are not separately
identifiable, the software license assurance warranty are inputs of a combined
item in the contract, the assurance warranty and software license are highly
interdependent and interrelated because the core functionality of the license is
dependent on the assurance warranty, and our promise to provide the assurance
warranty that is necessary for the software license to continue to provide
significant benefit to the customer. As a result, the software license and the
accompanying third party delivered software assurance are recognized as a single
performance obligation.
We leverage drop-ship shipments with many of our partners and suppliers to
deliver hardware and consumable products to our clients without having to
physically hold the inventory at our warehouses, thereby increasing efficiency
and reducing costs. We recognize revenue for drop-ship arrangements on a gross
basis as the principal in the transaction when the product is received by the
client because we control the product prior to transfer to the client. We also
assume primary responsibility for the fulfillment in the arrangement, we assume
inventory risk if the product is returned by the client, we set the price of the
product charged to the client, we assume credit risk for nonpayment by our
customer, and we work closely with clients to determine their hardware
specifications.
Services - We provide services which include consulting, staging, deployment,
installation, repair and customer specified software customization. The
arrangement is based on either a time and material basis or a fixed fee. For our
time and materials service contracts, we recognize revenues as those services
are provided and consumed, as this is the best output measure of how the
services are transferred to the customer. Fixed fee contracts are recognized in
the period in which the services are performed or delivered using a proportional
performance service model. Revenue is recognized on a gross basis in the period
in which the services are performed or delivered.
Maintenance services - We sell certain Original Equipment Manufacturer ("OEM")
hardware and software maintenance support arrangements to our clients. We also
offer an internal maintenance agreement related to hardware. These contracts are
support service agreements for the hardware and/or software products that were
acquired from us and others. Although these are third-party support agreements
for maintenance on the specific hardware and/or software products, our internal
help desk and systems engineers assist customers by providing technical
assistance on the source of or how to fix the problem. In addition, we also
provide a turn back feature, deploying replacements as needed while we manage
the return and reverse logistics of the product back to the OEM. Revenue related
to service contracts is recognized ratably over the term of the agreement,
generally over one to three years.
27
We act as the principal in the transaction as the primary obligor for
fulfillment in the arrangement, we set the price of the service charged to the
customer, and we assume credit risk for the amounts invoiced. In addition, we
manage back-end warranties, service contracts and repairs for multiple products
and suppliers. We leverage our knowledge base of mobility best practices by
consolidating multiple suppliers' supplier's maintenance requirements under a
single point in contact through us. Our internal support team assists our
customers first by performing an initial technical triage to determine the
source of the problem including, but not limited to, physical damage and
software issues and whether they can be handled remotely by the client or
returned for repair. Further, we receive the returned products, confirm that the
equipment is operational or not, either repair or refurbish the equipment
internally or return it to the manufacturer directly to repair. We then obtain
the product turn back from the manufacturer and either send it back out to a
specific customer location or place in a customer's spare pool. As a result, we
recognize the revenue on a gross basis.
We defer costs to acquire contracts, including commissions, incentives and
payroll taxes if they are incremental and recoverable costs of obtaining a
customer contract with a term exceeding one year. Deferred contract costs are
amortized to sales and marketing expense over the contract term, generally over
one to three years. We have elected to recognize the incremental costs of
obtaining a contract with a term of less than one year as a selling expense when
incurred. We include deferred contract acquisition costs in "Prepaid expenses
and other current assets" in the consolidated balance sheets.
Intangible Assets and Long-lived Assets
We evaluate our intangible and long-lived assets for impairment when events or circumstances arise that indicate intangible and long-lived assets may be impaired. Indicators of impairment include, but are not limited to, a significant deterioration in overall economic conditions, a decline in the market capitalization, the loss of significant business, or other significant adverse changes in industry or market conditions. Intangible assets with finite useful lives are amortized over their respective estimated useful lives using an accelerated method to their estimated residual values, if any. Our intangible assets consist of customer lists, customer relationships and trade names.
Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired.Goodwill is not amortized but tested for impairment at least annually and whenever events or changes in circumstance indicate that carrying values may not be recoverable. We assess the impairment of goodwill annually at each year-end and if indicators of impairment are present.
Factors that we consider important that could trigger an impairment assessment
include, but not limited to, the following:
? significant under-performance relative to historical and projected operating
results;
? significant changes in the manner of use of the acquired assets or business
strategy; and ? significant negative industry or general economic trends.
When performing the impairment review, we determine the carrying amount of a
reporting unit by assigning assets and liabilities, including the existing
goodwill, to each reporting unit. To evaluate whether goodwill is impaired, we
compare the estimated fair value of each reporting unit to which the goodwill is
assigned to the reporting unit's carrying amount. If the carrying amount of a
reporting unit exceeds its fair value, the amount of the impairment loss will be
recognized as the difference of the estimated fair value and the carrying value
of the reporting unit under the new accounting standard.
28
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue and expense growth rates, capital expenditures and the depreciation and amortization related to capital expenditures, changes in working capital, discount rates, risk-adjusted discount rates, future economic and market conditions and the determination of appropriate comparable companies. Due to the inherent uncertainty involved in making these estimates, actual future results related to assumed variables could differ from these estimates.
Business Combinations
We utilize the acquisition method of accounting for business combinations and allocate the purchase price of an acquisition to the various tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. We primarily establish fair value using the income approach based upon a discounted cash flow model. The income approach requires the use of many assumptions and estimates including future revenues and expenses, as well as discount factors and income tax rates. Other estimates include:
? Estimated step-ups or write-downs for fixed assets and inventory;
? Estimated fair values of intangible assets; and
? Estimated liabilities assumed from the target
While we use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business acquisition date, these estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the purchase price allocation period, which is generally no more than one year from the business acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Business combinations also require us to estimate the useful life of certain intangible assets that we acquire and this estimate requires significant judgment.
Share-Based Compensation
We account for share-based compensation in accordance with the provisions of ASC
Topic 718 "Compensation - Stock Compensation". Under ASC 718, share-based
compensation cost is measured at the grant date, based on the calculated fair
value of the award, and is recognized as an expense over the requisite service
period (generally the vesting period of the equity grant).
Share-based compensation expense recognized during the period is based on the
value of the portion of stock-based payment awards that is ultimately expected
to vest during the period. Given that stock-based compensation expense
recognized in the accompanying consolidated statements of income and
comprehensive income is based on awards ultimately expected to vest. We account
for forfeitures as they occur, rather than estimate expected forfeitures.
Compensation cost for stock awards, which from time to time may include
restricted stock units ("RSUs"), is measured at the fair value on the grant date
and recognized as expense, net of estimated forfeitures, over the related
service period. The fair value of stock awards is based on the estimated fair
value of our common stock on the grant date.
The estimated fair value of common stock option awards is calculated using the
Black-Scholes option pricing model. The Black-Scholes model requires subjective
assumptions regarding future stock price volatility and expected time to
exercise, along with assumptions about the risk-free interest rate and expected
dividends, all of which affect the estimated fair values of our common stock
option awards. Given a lack of historical stock option exercises, the expected
term of options granted is calculated as the average of the weighted vesting
period and the contractual expiration date of the option. This calculation is
based on a method permitted by the Securities and Exchange Commission in
instances where the vesting and exercise terms of options granted meet certain
conditions and where limited historical exercise data is available. The expected
volatility is based on the historical volatility of the common stock of
comparable public companies that operate in similar industries as us.
29
The risk-free rate selected to value any particular grant is based on the U.S.
Treasury rate that corresponds to the expected term of the grant effective as of
the date of the grant. The expected dividend assumption is based on our history
and management's expectation regarding dividend payouts.
Compensation expense for common stock option awards with graded vesting
schedules is recognized on a straight-line basis over the requisite service
period for the last separately vesting portion of the award, provided that the
accumulated cost recognized as of any date at least equals the value of the
vested portion of the award.
If there are any modifications or cancellations of the underlying vested or
unvested stock-based awards, we may be required to accelerate, increase or
cancel any remaining unearned stock-based compensation expense, or record
additional expense for vested stock-based awards. Future stock-based
compensation expense and unearned stock- based compensation may increase to the
extent that we grant additional common stock options or other stock-based
awards.
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