CLEANSPARK, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC. Company Overview We are in the business of providing advanced energy software and control technology that enables a plug-and-play enterprise solution to modern energy challenges. Our services consist of intelligent energy monitoring and controls, microgrid design and engineering and consulting services. Our software allows energy users to obtain resiliency and economic optimization. Our software is uniquely capable of enabling a microgrid to be scaled to the user's specific needs and can be widely implemented across commercial, industrial, military and municipal deployment. We refer to the operations surrounding the above plug-and-play energy solution as our Distributed Energy Management Business (the “DER Business”). The main assets of our DER Business include our propriety software systems (“Systems”) and also our engineering and methodology trade secrets. The Distributed Energy Systems and microgrids that utilize our Systems are capable of providing secure, sustainable energy with significant cost savings for our energy customers. The Systems allow customers to design, engineer, construct and then efficiently manage renewable energy generation, storage and consumption. Integral to our business is our mPulse and mVSO software platforms (the “Platforms”). When the Platforms are implemented on a customer’s power system, they are able to control the distributed energy resources on site to provide secure, sustainable energy often at significant cost savings for our energy customers. The Platforms allows customers to efficiently manage renewable energy generation, other distributed energy generation technologies including energy generation assets, energy storage assets, and energy consumption assets. By having autonomous control over the distributed facets of energy usage and energy storage, customers are able to reduce their dependency on utilities, thereby keeping energy costs relatively constant over time. The overall aim is to transform energy consumers into energy producers by supplying power that anticipates their routine instead of interrupting it. Our Switchgear Acquisition As an energy technology company, part of our business model is to assess our technologies, product offerings and business direction and determine whether any strategic acquisitions would benefit us. In line with our focus, on January 22, 2019, we acquired the outstanding capital stock of Pioneer Critical Power, Inc., a Delaware corporation (“Pioneer”), which we have since renamed and redomiciled to the State of Nevada and changed the name to CleanSpark Critical Power Systems Inc. 4 Table of Contents As consideration for the transaction, we issued to its sole shareholder Pioneer Power Solutions, Inc. (“Pioneer Power”) a total of 175,000 shares of our common stock, a 5-year warrant to purchase 50,000 shares of our common stock at an exercise price of $16.00 per share and a 5-year warrant to purchase 50,000 shares of our common stock at an exercise price of $20.00 per share. The parties also signed additional agreements in connection with the transaction, as previously disclosed in our SEC filings, mainly requiring Pioneer Power to indemnify us in certain circumstances and restricting Pioneer Power from engaging in a competing business. We also signed a Contract Manufacturing Agreement, whereby Pioneer Power shall exclusively manufacture parallel switchgears, automatic transfer switches and related control and circuit protective equipment for us, for a period of eighteen months. We plan to utilize the new intellectual property we gained from the acquisition and the manufacturing agreement in place to enter into the switchgear equipment sales industry. We acquired executed contracts and purchase orders, which we expect will result in significant gross sales, as well as hired personnel to operate this new line of business. As a result of this transaction, the parties terminated a contemplated asset purchase arrangement previously disclosed in our SEC filings. Our acquisition of p2kLabs, Inc. As CleanSpark continues to drive towards profitability and further market and sell CleanSpark software and controls, our acquisition of p2kLabs, Inc. not only contributes additional revenues, but also adds depth to our team in sales, marketing, design and software development. We plan to maximize the value of our offering, internalize what would otherwise be expenses, and diversify our ability to better serve our valued clients. As consideration for the transaction, we issued to its sole shareholder, Amer Tadayon, a total of 95,699 shares of our common stock and paid $1,155,000 in cash. The parties also signed additional agreements in connection with the transaction, as previously disclosed in our SEC filings, mainly an employment agreement with Amer Tadayon. See note 3 for details. Nasdaq Listing On January 24, 2020, the Company was approved for listing on the Nasdaq Capital Market (“Nasdaq”). Our Contractual Joint Venture CleanSpark entered into an agreement with partners to procure, distribute and supply Personal Protective Equipment (PPE) for hospitals and frontline medical personnel. The agreement is effective until December 31, 2020, unless otherwise extended by mutual consent. The Company contributed capital in the amount of $660,000 on April 6, 2020 to assist with the procurement of these products, with the potential for additional monies to be lent by the Company to the contractual joint venture, upon mutual consent if necessary. Under the agreement, the Company will receive $0.20 per unit for each mask sold and a mutually agreeable amount for other types of PPE’s sold through the use of its funds. Such proceeds are distributed to the Company as soon as commercially reasonable after receipt from such customer or at the Company’s option reinvested for additional purchases. 5 Table of Contents CleanSpark recognized and received $20,000 in other income from this agreement for the period ended June 30, 2020. See note 5 for details. On July 7, 2020, the Company received its $660,000 in initial capital from the JV. The Company plans to continue to evaluate opportunities under the JV and will continue to provide capital for the procurement of PPE under this agreement as future opportunities continue to arise. Results of operations for the three months ended June 30, 2020 and 2019 Revenues Revenues increased to $3,438,674 during the three months ended June 30, 2020, as compared with $1,222,736 in revenues for the same period ended 2019 primarily due to revenue from our switchgear products and mPulse sales. Gross Profit Our cost of revenues was $2,893,939 for the three months ended June 30, 2020, resulting in gross profit of $544,735, as compared with cost of revenues of $1,006,144 for the three months ended June 30, 2019, resulting in gross profit of $216,592. Our cost of revenues for the three months ended June 30, 2020 was mainly the result of manufacturing, hardware, and service expenses. Cost of goods sold increased to $2,751,964 for the three months ended June 30, 2020, from $914,220 for the same period ended 2019. Our product sale expense consisted mainly of the cost of contract manufacturing for our switchgear products and hardware costs. Our cost of services increased to 141,975 for the three months ended June 30, 2020, from $91,924 for the same period ended 2019. Our service, software and related revenues expenses for the three months ended June 30, 2020, and 2019 consisted mainly of allocated payroll costs of employees and consultants and subcontractors for services rendered from our acquisition of p2k and installation of solar panels and energy storage. Operating Expenses We had operating expenses of $2,688,334 for the three months ended June 30, 2020, as compared with $2,693,290 for the three months ended June 30, 2019. Professional fees decreased to $709,367 for the three months ended June 30, 2020, from $1,296,993 for the same period ended June 30, 2019. Our professional fees expenses for the three months ended June 30, 2020 consisted mainly of officers and directors’ consulting fees of $105,500, consulting fees of $434,236, and accounting, audit and review fees of $25,900 and stock-based compensation of $143,731. Our professional fees expenses for the three months ended June 30, 2019 consisted mainly of officers’ consulting fees of $375,500, consulting fees of $436,653, and audit and review fees of $11,000 and stock-based compensation of $431,721. Professional fees decreased in 2020 mainly as a result of decreased stock-based compensation and officers and directors’ consulting fees. Payroll expenses increased to $996,555 for the three months ended June 30, 2020, from $211,129 for the same period ended 2019. Our payroll expenses for the three months ended June 30, 2020 consisted mainly of salary and wages expense of $967,355 and employee stock-based compensation of $29,200. Our payroll expenses for the three months ended June 30, 2019 consisted mainly of salary and wages expense of $209,879 and employee stock-based compensation of $1,250. General and administrative fees increased to $279,045 for the three months ended June 30, 2020, from $222,167 for the same period ended 2019. Our general and administrative expenses for the three months ended June 30, 2020 consisted mainly of marketing expenses of $32,322, rent expenses of $34,445, insurance expenses of $65,833, dues and subscriptions of $61,675 and office expense of $6,267. Our general and administrative expenses for the three months ended June 30, 2019 consisted mainly of travel expenses of $32,994, rent expenses of $17,575, insurance expenses of $36,626, dues and subscriptions of $37,093 and office expense of $17,391. 6 Table of Contents Product development expense decreased to $0 for the three months ended June 30, 2020, from $344,871 for the same period ended 2019. Our product development expenses for the three months ended June 30, 2020 and 2019 consisted mainly of amortization of capitalized software. Depreciation and amortization expense increased to $703,367 for the three months ended June 30, 2020, from $618,130 for the same period ended 2019. We expect that our operating expenses will increase in future quarters as we further implement our business plan. As we execute on customer contracts we may be required to hire and compensate additional personnel and support increased operational costs. Other income (expenses) Other income/(expenses) increased to ($6,407,702) for the three months ended June 30, 2020, from ($1,495,213) for the same period ended June 30, 2019. Our other income/(expenses) for the three months ended June 30, 2020 consisted mainly of an unrealized loss on equity securities of ($80,500), derivative gain of $719,294 and interest expense of ($7,066,496). Our other expenses for the three months ended June 30, 2019 consisted of interest expense of ($1,495,213). Net Loss We recorded a net loss of $8,551,301 for the three months ended June 30, 2020, as compared with a net loss of $3,971,911 for the same period ended June 30, 2019. Results of operations for the nine months ended June 30, 2020 and 2019 Revenues Revenues increased to $8,073,781 during the nine months ended June 30, 2020, as compared with $2,209,542 in revenues for the same period ended 2019 primarily due to revenue from our switchgear products and mPulse sales. Gross Profit Our cost of revenues was $6,730,906 for the nine months ended June 30, 2020, resulting in gross profit of $1,342,875, as compared with cost of revenues of $1,821,488 for the nine months ended June 30, 2019, resulting in gross profit of $388,054. Our cost of revenues for the nine months ended June 30, 2020 was mainly the result of product sale and service, software and related revenues expenses. Cost of goods sold increased to $6,458,086 for the nine months ended June 30, 2020, from $1,245,102 for the same period ended 2019. Our product sale expense for the nine months ended June 30, 2020 consisted mainly of the cost of contract manufacturing for our switchgear products. Cost of services decreased to $272,820 for the nine months ended June 30, 2020, from $576,386 for the same period ended 2019. Our service, software and related revenues expenses for the nine months ended June 30, 2020, and 2019 consisted mainly of allocated payroll costs of employees and consultants and subcontractors for services rendered from our acquisition of p2k and installation of solar panels and energy storage. Operating Expenses We had operating expenses of $8,749,987 for the nine months ended June 30, 2020, as compared with $7,192,344 for the nine months ended June 30, 2019. 7 Table of Contents Professional fees increased to $3,231,945 for the nine months ended June 30, 2020, from $3,719,269 for the same period ended June 30, 2019. Our professional fees expenses for the nine months ended June 30, 2020 consisted mainly of officers and directors’ consulting fees of $571,654, consulting fees of $1,233,008, legal fees of $332,020 and accounting, audit and review fees of $120,060 and stock-based compensation of $975,143. Our professional fees expenses for the nine months ended June 30, 2019 consisted mainly of officers’ consulting fees of $848,489, consulting fees of $1,071,107, legal fees of $146,682, and audit and review fees of $95,349 and stock-based compensation of $1,540,503. Professional fees increased in 2019 mainly as a result of increased stock-based compensation and other consulting related to increased business development efforts and audit and legal fees in connection with our SEC reporting obligations. Payroll expenses increased to $2,692,474 for the nine months ended June 30, 2020, from $684,650 for the same period ended 2019. Our payroll expenses for the nine months ended June 30, 2020 consisted mainly of salary and wages expense of $2,606,586 and employee stock-based compensation of $85,888. Our payroll expenses for the nine months ended June 30, 2019 consisted mainly of salary and wages expense of $508,400 and employee stock-based compensation of $176,250. General and administrative fees increased to $820,837 for the nine months ended June 30, 2020, from $478,564 for the same period ended 2019. Our general and administrative expenses for the nine months ended June 30, 2020 consisted mainly of marketing expenses of $108,869, travel expenses of $80,648, rent expenses of $82,904, insurance expenses of $159,519, dues and subscriptions of $230,713 and office expense of $27,467. Our general and administrative expenses for the nine months ended June 30, 2019 consisted mainly of travel expenses of $60,028, rent expenses of $52,378, insurance expenses of $79,939, dues and subscriptions of $136,092 and office expense of $30,116. Product development expense decreased to $0 for the nine months ended June 30, 2020, from $1,034,612 for the same period ended 2019. Our product development expenses for the nine months ended June 30, 2020 and 2019 consisted mainly of amortization of capitalized software. Depreciation and amortization expense increased to $2,004,731 for the nine months ended June 30, 2020, from $1,275,249 for the same period ended 2019. We expect that our operating expenses will increase in future quarters as we further implement our business plan. As we execute on customer contracts we may be required to hire and compensate additional personnel and support increased operational costs. Other income (Expenses) Other income/(expenses) increased to ($8,875,541) for the nine months ended June 30, 2020, from ($7,215,712) for the same period ended June 30, 2019. Our other income/(expenses) for the nine months ended June 30, 2020 consisted mainly of an unrealized gain on equity securities of $78,368, derivative gain of $1,544,185 and interest expense of ($10,518,094). Our other expenses for the nine months ended June 30, 2019 consisted of interest expense of ($7,196,287), and loss on settlement of debt of (19,425). Net Loss We recorded a net loss of $16,282,653 for the nine months ended June 30, 2020, as compared with a net loss of $14,020,002 for the same period ended June 30, 2019. Liquidity and Capital Resources As of June 30, 2020, we had total current assets of $7,220,044, consisting of cash, accounts receivable, and prepaid expenses and other current assets, and total assets in the amount of $20,628,304. Our total current and total liabilities as of June 30, 2020 were $1,588,880 and $2,270,049, respectively. We had working capital of $5,631,164 as of June 30, 2020. 8 Table of Contents Operating activities used $3,679,081 in cash for the nine months ended June 30, 2020, as compared with $5,792,028 for the same period ended June 30, 2019. Our net loss of $16,282,653 was the main component of our negative operating cash flow for the nine months ended June 30, 2020, offset mainly by unrealized gain on equity security of ($78,368), gain on derivative asset of ($1,544,185), depreciation and amortization of $2,004,731, amortization of capitalized software of $121,582, amortization of debt discounts of $9,022,759, accounts payable of $2,347,566, and stock-based compensation of $1,171,632. Our net loss of $14,020,002 was the main component of our negative operating cash flow for the nine months ended June 30, 2019, offset mainly by loss on settlement of debt of $19,425, depreciation and amortization of $1,275,249, amortization of capitalized software of $1,034,612, amortization of debt discounts of $5,674,800, stock based compensation of $1,716,753 and an increase in accounts payable of $1,653,821. Cash flows used by investing activities during the nine months ended June 30, 2020 was $2,667,702, as compared with $598,763 for the same period ended June 30, 2019. Our acquisition of p2kLabs, Inc. of $1,141,990, investment in International Land Alliance and other equity securities of $750,000, investment in Contractual Joint Venture of $660,000, and purchase of fixed assets of $30,787 were the main components of our negative investing cash flow for the nine months ended June 30, 2020. Our investment in the capitalized software of $569,043 and purchase of fixed assets of $27,570 were the main components of our negative investing cash flow for the nine months ended June 30, 2019. Cash flows provided by financing activities during the nine months ended June 30, 2020 amounted to $463,702, as compared with $13,994,092 for the nine months ended June 30, 2019. Our cash flows from financing activities for the nine months ended June 30, 2020 consisted of repayments of ($67,467) on promissory note and proceeds from promissory notes of $531,169. Our positive cash flows from financing activities for the nine months ended June 30, 2019 consisted of $361,800 in proceeds from the sale of common stock, $14,995,000 in net proceeds from convertible notes and $75,030 from related party debts off-set by repayments of $507,876 on promissory note, repayments of $555,000 on convertible debts and repayments of $457,820 on related party debts. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of our sales and marketing, the timing of new product introductions and the continuing market acceptance of our products and services. Management believes that the Company has sufficient liquidity to satisfy its anticipated cash requirements for the next twelve months. However, there can be no assurance that our operations will become profitable or that external sources of financing, including the issuance of debt and/or equity securities, will be available at times and on terms acceptable to us, or at all. The Company’s management prepares budgets and monitors the financial results of the Company as a tool to align liquidity needs to the recurring business requirements. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise monies on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected. Off Balance Sheet Arrangements As of June 30, 2020, there were no off-balance sheet arrangements. Recently Issued Accounting Pronouncements In June 2018, the FASB issued ASU 2018-07, "Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting," which modifies the accounting for share-based payment awards issued to nonemployees to largely align it with the accounting for share-based payment awards issued to employees. ASU 2018-07 is effective for us for annual periods beginning October 1, 2019. The new standard did not have a material impact on the Company’s results of operations or cash flows. 9 Table of Contents In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," which allows for the capitalization of certain implementation costs incurred in a hosting arrangement that is a service contract. ASU 2018-15 allows for either retrospective adoption or prospective adoption to all implementation costs incurred after the date of adoption. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019. We are currently evaluating the impact the adoption of this new standard will have on our financial position and results of operations. In February 2016, the FASB issued guidance within ASU 2016-02, Leases . The amendments in ASU 2016-02 to Topic 842, Leases , require lessees to recognize the lease assets and lease liabilities arising from operating leases in the statement of financial position. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The Company adopted the amendments to Topic 842 on October 1, 2019 using the modified retrospective approach. The Company elected the transition option issued under ASU 2018-11, Leases (Topic 842) Targeted Improvements , which allows entities to continue to apply the legacy guidance in ASC 840, Leases , to prior periods, including disclosure requirements. Accordingly, prior period financial results and disclosures have not been adjusted. The Company also elected to apply the package of practical expedients permitting entities to forgo reassessment of: 1) expired or existing contracts that may contain leases; 2) lease classification of expired or existing leases; and 3) initial direct costs for any existing leases. The Company has also elected to apply the short term lease measurement and recognition exemption to leases with an initial term of 12 months or less. The most significant impact of the new standard on the Company’s Consolidated Financial Statements was the recognition of a right of use asset and lease liability for operating leases for which the Company is the lessee. Upon adoption of this guidance, on October 1, 2019, the Company recorded a Right of use asset and corresponding lease liability of $85,280 and $85,280, respectively, on the Consolidated Balance Sheet. No cumulative effect adjustment to retained earnings resulted from adoption of this guidance. The new standard did not have a material impact on the Company’s results of operations or cash flows. In January 2017, the FASB issued guidance within ASU 2017-04, Intangibles-Goodwill and Other. The amendments in ASU 2017-04 simplify the subsequent measurement of goodwill by comparing the fair value of a reporting unit with its carrying amount. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. We are currently evaluating the impact the adoption of this new standard will have on our financial position and results of operations. In June 2016, the FASB issued guidance within ASU 2016-13, Financial Instruments – Credit Losses. The amendments in ASU 2016-13 require assets measured at amortized cost and establishes an allowance of credit losses for available for sale debt securities. ASU 2016-13 is effective for fiscal years beginning after December 15, 2020. We are currently evaluating the impact the adoption of this new standard will have on our financial position and results of operations. The Company has evaluated all other recent accounting pronouncements, and believes that none of them will have a material effect on the Company's financial position, results of operations or cash flows. Critical Accounting Policies In December 2001, the SEC requested that all registrants list their most “critical accounting polices” in the Management Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our accounting policies are discussed in detail in the footnotes to our financial statements included in our Annual Report on Form 10-K for the year ended September 30, 2019, however we consider our critical accounting policies to be those related to revenue recognition, long-lived assets, accounts receivable, fair value of financial instruments, cash and cash equivalents, accounts receivable, warranty liability and stock-based compensation. 10 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable to a “smaller reporting company” as defined in Item 10(f)(1) of Regulation S-K.