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Acquisitions | 3 Months Ended
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Mar. 31, 2022
Acquisitions |
Acquisitions |
4. | Acquisitions
NetSapiens, Inc. Merger Agreement On June 1, 2021, the Company acquired 100% of the issued and outstanding shares of NetSapiens, Inc. (“NetSapiens”), a provider of a comprehensive suite of unified communications (UC), video conferencing, collaboration & contact center solutions to service providers, servicing over two million users around the globe. The aggregate purchase price was approximately $49.1 million, consisting of $10 million in cash, and approximately $39 million in common stock and stock options. In connection with the closing of the Merger, the Company issued 3,097,309 shares of the Company’s common stock valued at $5.47 per share for common stock consideration of approximately $16.9 million, and 4,482,328 options under the Crexendo, Inc. 2021 Equity Incentive Plan with an aggregate value of $22.1 million, net of the aggregate exercise price of $5.6 million.
(in thousands) |  | Initial Valuation |  |  | Adjustments |  | December 31, 2021 |
Consideration: |  |  |  |  |  |  |  |
Cash |  | $ | 10,000 |  |  |  |  | $ | 10,000 |
Common stock |  |  | 16,942 |  |  |  |  |  | 16,942 |
Stock options |  |  | 22,120 |  |  |  |  |  | 22,120 |
Total consideration |  | $ | 49,062 |  |  |  |  | $ | 49,062 |
The acquisition was accounted for under the acquisition method of accounting and the operating results of NetSapiens have been included in our consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by us was allocated to NetSapiens net tangible assets and intangible assets based on their estimated fair values as of the acquisition closing date. The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon our conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. Goodwill, which is non-deductible for tax purposes, represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is primarily attributable to the customer relationships, developed technology, and trademark and trade name of the acquired business and expected synergies at the time of the acquisition. We retained an independent third-party valuation firm to assist management in our valuation of the acquired assets and liabilities. The following table presents the final allocation of the purchase price for NetSapiens and adjustments made during the period ended December 31, 2021 (in thousands):
|  | Initial Valuation |  |  | Adjustments |  |  | December 31, 2021 |
Total purchase price |  | $ | 49,062 |  |  |  |  |  | $ | 49,062 |
Cash |  |  | 1,658 |  |  |  | 739 | (b) |  |  | 2,397 |
Accounts receivables |  |  | 846 |  |  |  | 107 | (f) |  |  | 953 |
Prepaid expenses |  |  | 57 |  |  |  |  |  |  |  | 57 |
Contract cost |  |  | - |  |  |  | 105 | (f) |  |  | 105 |
Other assets |  |  | 319 |  |  |  | 4 | (c) |  |  | 323 |
Property, plant & equipment |  |  | 62 |  |  |  | (2 | )(c) |  |  | 60 |
Right to use assets |  |  | 551 |  |  |  | 4 | (d) |  |  | 555 |
Deferred tax assets |  |  | 2,829 |  |  |  | (2,829 | )(g) |  |  | - |
Intangible assets acquired (FV) |  |  | 21,520 |  |  |  | (420 | )(a) |  |  | 21,100 |
Long-term trade receivables, net of current |  |  | - |  |  |  | 63 | (f) |  |  | 63 |
Other long-term assets |  |  | 84 |  |  |  | 5 | (c) |  |  | 89 |
Total identifiable assets |  |  | 27,926 |  |  |  |  |  |  |  | 25,702 |
Accounts payable |  |  | 438 |  |  |  | 69 | (c) |  |  | 507 |
Accrued expenses |  |  | 2,412 |  |  |  | 817 | (b)(c) |  |  | 3,229 |
Contract liability |  |  | 1,475 |  |  |  | 732 | (e)(f) |  |  | 2,207 |
Operating lease liability |  |  | 379 |  |  |  | 17 | (d) |  |  | 396 |
Direct financing liability |  |  | 17 |  |  |  | (17 | )(d) |  |  | - |
Contract liability, net of current portion |  |  | 629 |  |  |  | (629 | )(e) |  |  | - |
Direct financing liability, net of current portion |  |  | 29 |  |  |  | (29 | )(d) |  |  | - |
Operating lease liability, net of current portion |  |  | 219 |  |  |  | 30 | (d) |  |  | 249 |
Deferred tax liability |  |  | - |  |  |  | 5,033 | (g) |  |  | 5,033 |
Total liabilities assumed |  |  | 5,598 |  |  |  |  |  |  |  | 11,621 |
Total goodwill |  | $ | 26,734 |  |  |  | 8,247 |  |  | $ | 34,981 |
________________ (a) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the refinement of inputs used to calculate the fair value of the customer relationships, developed technology, and Trademarks and trade name intangible assets, with the assistance of an independent third-party valuation firm based on facts and circumstances that existed as of the acquisition date. The adjustment to customer relationships, developed technology, and addition of trademarks and trade name intangible assets was a decrease in the fair value of the intangible asset of $420,000, and an increase to goodwill of $420,000. As a result of the adjustments to the provisional amounts and estimated useful lives of intangible assets, during the fourth quarter the Company recognized $59,000 less amortization expense in cost of software solutions, $98,000 additional amortization expense in sales and marketing, and $37,000 additional amortization expense in general and administrative in the current period related to the effects that would have been recognized in previous quarters if the measurement period adjustment was recognized as of the date of acquisition. (b) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the delayed settlement of pre-acquisition liabilities resulted in an increase in opening balance sheet cash and accrued liabilities of $739,000, with no impact on goodwill. (c) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to revisions to our estimates for various assets acquired and liabilities assumed resulting in an increase of $9,000 to assets acquired and a increase in liabilities assumed of $147,000 and an increase to goodwill of $140,000. (d) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the adoption of ASC 842, resulting in the reclassification of direct financing lease liabilities as operating lease liabilities, and an increase of $4,000 to the right to use assets balance and an increase of $1,000 to the operating lease liability and a decrease to goodwill of $3,000. (e) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to revisions to our preliminary estimate of contract liabilities, net of current portion, which were determined to be current liabilities and have been reclassified as current contract liabilities with no impact on goodwill. (f) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the retroactive adoption of ASC 606, resulting in the recording of contract cost of $105,000, an increase to current and long-term accounts receivables of $170,000, an increase in contract liabilities of $103,000 and a decrease to goodwill of $172,000. (g) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to recording of a valuation allowance on the deferred tax assets of $2,829,000, and recording a deferred tax liability of $5,033,000 for the intangible assets acquired and a increase to goodwill of $7,862,000. The fair values of the customer relationships, developed technology, and trademark and trade name were established based upon the income approach. The income approach relies on an estimation of the present value of the future monetary benefits expected to flow to the owner of an asset during its remaining economic life. This approach requires a projection of the cash flow that the asset is expected to generate in the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate that accounts for the time value of money and the degree of risk inherent in the asset. The income approach may take the form of a “relief from royalty” methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending on the specific asset under consideration. The customer relationships were valued using the multi-period excess earnings method. The Inherent in the multi-period excess earnings method is the recognition that, in most cases, all of the assets of the business, both tangible and intangible, contribute to the generation of the cash flow of the business and the net cash flows attributable to the subject asset must recognize the support of the other assets which contribute to the realization of the cash flows. This future cash flow was then discounted using an estimated required rate of return for the asset to determine the present value of the future cash flows attributable to the asset. The key assumptions used in valuing the customer relationships, developed technology, and trademarks and trade names acquired are as follows: weighted average cost of capital of 11.0%, tax rate of 25.0%, and estimated economic life of 16 years. The developed technology and trademarks and trade name were valued using the relief from royalty methodology. The relief-from-royalty method was used to value the developed technology and trademarks and trade name acquired from NetSapiens. The relief-from-royalty method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be required to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the completed technology. The market-derived royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the developed technology are as follows: royalty rate of 7%, discount rate of 11.0%, tax rate of 25% and estimated average economic life of 6 years. The key assumptions used in valuing the existing trademarks are as follows: royalty rate of 1.0%, discount rate of 11.0%, tax rate of 25% and estimated average economic life of 4 years. The following unaudited pro forma information presents our consolidated results of operations as if NetSapiens, Inc. had been included in our consolidated results since January 1, 2020:
|  | For the Three Months Ended March 31, (Unaudited, in thousands) |
|  | 2022 |  |  | 2021 |
Revenues |  | $ | 8,158 |  |  | $ | 8,353 |
Net loss |  |  | (1,220 | ) |  |  | (1,591 | )
Earnings per share |  | $ | (0.05 | ) |  | $ | (0.07 | )
The unaudited pro forma financial information is presented for informational purposes only, and may not necessarily reflect the Company’s future results of operations or what the results of operations would have been had the Company owned and operated NetSapiens, Inc. as of January 1, 2020. Acquisition related expenses incurred by us in connection with the NetSapiens acquisition of $970,000 for the year ended December 31, 2021, are recorded within general and administrative expenses in our consolidated statements of operations. Centric Telecom, Inc. Business Acquisition On January 14, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period. The fair value of the common stock issued as consideration was determined based on the closing market price of the Company’s common stock on the date of the acquisition of $7.42. The aggregate purchase price is subject to customary upward or downward adjustments for Centric Telecom’s net working capital.
(in thousands) |  | Initial Valuation |  |  | Adjustments |  | December 31, 2021 |
Consideration: |  |  |  |  |  |  |  |
Cash |  | $ | 2,163 |  |  |  |  | $ | 2,163 |
Common stock |  |  | 346 |  |  |  |  |  | 346 |
Contingent consideration |  |  | 746 |  |  |  |  |  | 746 |
Total consideration |  | $ | 3,255 |  |  |  |  | $ | 3,255 |
The acquisition was accounted for under the acquisition method of accounting and the operating results of Centric Telecom have been included in our consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by us was allocated to Centric Telecom’s net tangible assets and intangible assets based on their estimated fair values as of the acquisition closing date. The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon our conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. Goodwill, which is non-deductible for tax purposes, represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is primarily attributable to the customer relationships of the acquired business and expected synergies at the time of the acquisition. We retained an independent third-party valuation firm to assist management in our valuation of the acquired assets and liabilities. The following table presents the final allocation of the purchase price for Centric Telecom and adjustments made during the period ended December 31, 2021 (in thousands):
|  | Initial Valuation |  |  | Adjustments |  |  | December 31, 2021 |
Total purchase price |  | $ | 3,255 |  |  |  |  |  | $ | 3,255 |
Cash |  |  | 7 |  |  |  |  |  |  | 7 |
Accounts receivables |  |  | 122 |  |  |  |  |  |  | 122 |
Prepaid expenses |  |  | 4 |  |  |  |  |  |  | 4 |
Inventory |  |  | 12 |  |  |  |  |  |  | 12 |
Other assets |  |  | 12 |  |  |  |  |  |  | 12 |
Property, plant & equipment |  |  | 57 |  |  |  |  |  |  | 57 |
Right to use assets |  |  | 134 |  |  |  |  |  |  | 134 |
Intangible assets acquired (FV) |  |  | 2,238 |  |  |  | (38 | )(a) |  |  | 2,200 |
Other long-term assets |  |  | 44 |  |  |  |  |  |  |  | 44 |
Total identifiable assets |  |  | 2,630 |  |  |  |  |  |  |  | 2,592 |
Accounts payable |  |  | 26 |  |  |  |  |  |  |  | 26 |
Accrued expenses |  |  | 187 |  |  |  | 8 | (b) |  |  | 195 |
Contract liability |  |  | 147 |  |  |  |  |  |  |  | 147 |
Operating lease liability |  |  | 118 |  |  |  | 16 | (c) |  |  | 134 |
Direct financing liability |  |  | 20 |  |  |  |  |  |  |  | 20 |
Deferred tax liability |  |  | - |  |  |  | 534 | (d) |  |  | 534 |
Total liabilities assumed |  |  | 498 |  |  |  |  |  |  |  | 1,056 |
Total goodwill |  | $ | 1,123 |  |  |  | 596 |  |  | $ | 1,719 |
_______________ (a) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the refinement of inputs used to calculate the fair value of the customer relationships intangible asset, with the assistance of an independent third-party valuation firm based on facts and circumstances that existed as of the acquisition date. The adjustment to customer relationships intangible asset was a decrease in the fair value of the intangible asset of $38,000, and an increase to goodwill of $38,000. As a result of the adjustments to the provisional amounts and estimated useful lives of intangible assets, during the fourth quarter the Company recognized $16,000 less amortization expense in sales and marketing in the current period related to the effects that would have been recognized in previous quarters if the measurement period adjustment was recognized as of the date of acquisition. (b) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to recording of pre-acquisition liabilities and resulted in an increase to accrued liabilities of $8,000 and an increase to goodwill of $8,000. (c) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due to the adoption of ASC 842, resulting in an increase of $16,000 to the operating lease liability and an increase to goodwill of $16,000. (d) During the fourth quarter of 2021, we identified measurement period adjustments related to preliminary fair value estimates. The measurement period adjustments were due recording a deferred tax liability of $534,000 for the intangible assets acquired and an increase to goodwill of $534,000. The fair values of the customer relationships were established based upon the income approach. The income approach relies on an estimation of the present value of the future monetary benefits expected to flow to the owner of an asset during its remaining economic life. This approach requires a projection of the cash flow that the asset is expected to generate in the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate that accounts for the time value of money and the degree of risk inherent in the asset. The income approach may take the form of a “relief from royalty” methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending on the specific asset under consideration. The customer relationships were valued using the multi-period excess earnings method. The Inherent in the multi-period excess earnings method is the recognition that, in most cases, all of the assets of the business, both tangible and intangible, contribute to the generation of the cash flow of the business and the net cash flows attributable to the subject asset must recognize the support of the other assets which contribute to the realization of the cash flows. This future cash flow was then discounted using an estimated required rate of return for the asset to determine the present value of the future cash flows attributable to the asset. The key assumptions used in valuing the customer relationships acquired are as follows: weighted average cost of capital of 14.0%, tax rate of 25.0%, and estimated economic life of 15 years. Acquisition related expenses incurred by us in connection with the Centric Telecom acquisition of $67,000 for the year ended December 31, 2021, are recorded within general and administrative expenses in our consolidated statements of operations.

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