CLEANSPARK, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22 Table of Contents Forward-Looking Statements The following discussion of our financial condition and results of operations for the years ended September 30, 2020 and 2019 should be read in conjunction with our consolidated financial statements and the notes to those statements that are included elsewhere in this Annual Report on Form 10-K. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. We use words such as “anticipate”, “estimate”, “plan”, “project”, “continuing”, “ongoing”, “expect”, “believe”, “intend”, “may”, “will”, “should”, “could”, and similar expressions to identify forward-looking statements. Results of Operations for the Year Ended September 30, 2020 and 2019 Revenues We earned $10,028,701 in revenues during the year ended September 30, 2020, as compared with $4,532,782 in revenues for the year ended September 30, 2019. For the year ended September 30, 2020 and 2019 our revenue was derived from of the sale of equipment, design, engineering and services revenue. This income from our Energy segment is the result of contracts to sell switchgear equipment, perform engineering design, and provide software for distributed energy and microgrid systems. For the year ended September 30, 2020, we also generated services revenue from our January 2020 acquisition of p2kLabs, Inc. We hope to generate more significant revenue from customers through the sale and licensing of our Software platforms and services in the future. However, we are unable to estimate with any degree of certainty the amount of future revenues, from existing or future software contracts. Also, we do not anticipate earning significant revenues from our Gasifier business until such time that we have fully developed our technology and are able to market our products. Gross Profit Our cost of revenues were $7,907,849 for the year ended September 30, 2020 resulting in gross profit of $2,120,852, as compared with cost of revenues of $3,861,086 for the year ended September 30, 2019 resulting in gross profits of $671,696. Our cost of revenues in 2020 was mainly the result of contract manufacturing expense, hardware materials, subcontractors and direct labor expense. Contract manufacturing expense increased to $6,704,075 for the year ended September 30, 2020, from $3,220,480 for the year ended 2019. Our manufacturing expense consisted of the cost of contract manufacturing of switchgear equipment. Hardware material expenses increased to $824,665 for the year ended September 30, 2020, from $125,782 for the year ended 2019. Our materials expense for the years ended September 30, 2020 and 2019 consisted mainly of the cost of energy storage. Direct labor decreased to $4,029 for the year ended September 30, 2020, from $86,125 for the year ended 2019. Our direct labor expenses for the year ended September 30, 2020 consisted mainly of allocated payroll costs of employees and consultants. Subcontractor expenses decreased to $325,232 for the year ended September 30, 2020, from $366,523 for the year ended 2019. Our subcontractor expenses for the year ended September 30, 2019 consisted mainly of fees charged by subcontractors for services delivery and installation of energy assets. 23 Table of Contents Operating Expenses We had operating expenses of $17,263,968 for the year ended September 30, 2020, as compared with $17,285,541 for the year ended September 30, 2019. Professional fees increased to $6,521,016 for the year ended September 30, 2020 from $4,829,038 for the same period ended September 30, 2019. Our professional fees expenses for the year ended September 30, 2020 consisted mainly of consulting fees of $607,392 paid to management of the Company, stock-based compensation for consulting of $2,265,194, sales consulting of $278,547, legal fees of $1,472,421, investor relations and external marketing consulting of $725,347, director fees of $442,000, consulting for software and engineering of $82,031, accounting and tax fees of $186,969 and audit and review fees of $135,060. Our professional fees expenses for the year ended September 30, 2019 consisted mainly of consulting fees of $1,032,076 paid to management of the Company, stock-based compensation for consulting of $1,735,693, sales consulting of $202,963, legal fees of $220,163, investor relations consulting of $1,253,903, consulting for public relations of $52,740, consulting for software and engineering of $15,680 and audit and review fees of $141,349. Payroll expenses increased to $6,813,641 for the year ended September 30, 2020 from $1,267,403 for the same period ended September 30, 2019. Our payroll expenses for the year ended September 30, 2020 consisted mainly of salary and wages expense of $4,293,558 and employee and officer stock-based compensation and related bonuses of $2,520,083. Our payroll expenses for the year ended September 30, 2019 consisted mainly of salary and wages expense of $1,010,054 and employee and officer stock-based compensation of $257,349. General and administrative fees increased to $1,093,062 for the year ended September 30, 2020 from $917,298 for the same period ended September 30, 2019. Our general and administrative expenses for the year ended September 30, 2020 consisted mainly of travel expenses of $82,407, rent expenses of $117,223 insurance expenses of $232,043, dues and subscriptions of $362,887, marketing related expenses of $153,091, and bad debt expense of $36,924. Our general and administrative expenses for the year ended September 30, 2019 consisted mainly of travel expenses of $95,151, rent expenses of $76,220 insurance expenses of $123,499, dues and subscriptions of $184,402, marketing related expenses of $95,690, and bad debt expense of $258,255. Product development expense decreased to $163,918 for the year ended September 30, 2020 from $1,453,635 for the same period ended September 30, 2019. Our product development expenses for the year ended September 30, 2020 consisted of amortization of capitalized software of $163,91 8. Our product development expenses for the year ended September 30, 2019 consisted of amortization of capitalized software of $1,453,635. Depreciation and amortization expense increased to $2,672,331 for the year ended September 30, 2020 from $1,902,981 for the same period ended September 30, 2019. No impairment expenses were recorded for the year ended September 30, 2020 and $6,915,186 for the same period ended September 30, 2019. Other Income/Expenses We had net other expenses of $8,203,027 for the year ended September 30, 2020, compared with other expenses of $9,503,087 for the year ended September 30, 2019. Our other income/expenses for the year ended September 30, 2020 consisted mainly of other income of 20,000, unrealized gains on equity security and derivative security of $116,868 and $2,115,269 respectively, and interest expense of $10,449,946. Our other expenses for the year ended September 30, 2019 consisted mainly of loss on settlement of debts of $19,425, and interest expense of $9,483,662. Net Loss Net loss for the year ended September 30, 2020 was $23,346,143 compared to net loss of $26,116,932 for the year ended September 30, 2019. 24 Table of Contents Liquidity and Capital Resources For the year ended September 30, 2020, our primary sources of liquidity came from existing cash, and proceeds from a securities purchase agreement. On October 6, 2020 , the Company completed a share offering which resulted in net cash proceeds of approximately $37,000,000. Based on our current plans and business conditions, we believe that existing cash and cash generated from operations will be sufficient to satisfy our anticipated cash requirements until the Company reaches profitability, and we are not aware of any trends or demands, commitments, events or uncertainties that are reasonably likely to result in a decrease in liquidity of our assets. However, 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. If cash generated from operations is insufficient to satisfy our capital requirements, we may open a revolving line of credit with a bank, or we may have to sell additional equity or debt securities or obtain credit facilities. In the event such financing is needed in the future, there can be no assurance that such financing will be available to us, or, if available, that it will be in amounts and on terms acceptable to us. If cash flows from operations became insufficient to continue operations at the current level, and if no additional financing was obtained, our business, operating results and financial condition would be adversely affected. As of September 30, 2020, we had total current assets of $8,251,858, consisting of cash, accounts receivable, contract assets and prepaid expenses and other current assets, and total assets in the amount of $22,340,063. Our total current liabilities as of September 30, 2019 were $5,382,529. We had a working capital surplus of $2,869,329 as of September 30, 2020. Operating activities used $6,642,734 in cash for the year ended September 30, 2019, as compared with $5,697,989 for the same period ended September 30, 2019. Our net loss of $23,346,143 was the main component of our negative operating cash flow for the year ended September 30, 2020, offset mainly by amortization of debt discount of $9,010,547, depreciation and amortization of $2,672,331, shares issued as interest of $2,050,000, amortization of capitalized software of $163,918 and stock-based compensation of $2,053,232. Our net loss of $26,116,932 was the main component of our negative operating cash flow for the year ended September 30, 2019, offset mainly by impairment expense of $6,915,186, depreciation and amortization of $1,902,981, shares issued as interest of $1,400,000, amortization of capitalized software of $1,453,635 and stock-based compensation of $1,993,043. Cash flows used by investing activities during the year ended September 30, 2020 was $2,383,623, as compared with $673,953 for the year ended September 30, 2019. Our acquisitions of p2kLabs & GridFabric of $1,513,802, investments in the capitalized software of $84,924, purchase of fixed assets of $34,897 and the investment in debt and equity securities of $750,000 were the main components of our negative investing cash flow for the year ended September 30, 2020. Our investment in the capitalized software of $569,042, purchase of fixed assets of $102,761 and the purchase of intangible assets of $2,150 were the main components of our negative investing cash flow for the year ended September 30, 2019. Cash flows provided by financing activities during the year ended September 30, 2020 amounted to $4,313,702, as compared with $13,798,022 for the year ended September 30, 2019. Our positive cash flows from financing activities for the year ended September 30, 2020 consisted of $4,000,000 in proceeds from the sale of common stock, $531,169 in proceeds from promissory notes off-set by repayments of $217,467 on promissory notes. Our positive cash flows from financing activities for the year ended September 30, 2019 consisted of $361,800 in proceeds from the sale of common stock, 14,995,000 in proceeds from convertible notes and $75,030 from related party debts off-set by repayments of $625,344 on promissory notes repayments of $457,820 on related party debt, and repayments of $555,000 on convertible debts. Known Trends or Uncertainties Although we have not seen any significant reduction in revenues to date, we have seen some consolidation in our industry during economic downturns. These consolidations have not had a negative effect on our total sales; however, should consolidations and downsizing in the industry continue to occur, those events could adversely impact our revenues and earnings going forward. As discussed in the Risk Factors section of this Annual Report on Form 10-K, the world has been affected due to the COVID-19 pandemic. Until the pandemic has passed, there remains uncertainty as to the effect of COVID-19 on our business in both the short and long-term. 25 Table of Contents We believe that the need for improved productivity in the research and development activities directed toward developing new products and/or software will continue to result in increasing adoption of energy solution tools such as those we produce. New product and/or software developments in the energy business segment could result in increased revenues and earnings if they are accepted by our markets; however, there can be no assurances that new products and/or software will result in significant improvements to revenues or earnings. For competitive reasons, we do not disclose all of our new product development activities. Our continued quest for acquisitions could result in a significant change to revenues and earnings if one or more such acquisitions are completed. The potential for growth in new markets is uncertain. We will continue to explore these opportunities until such time as we either generate sales or determine that resources would be more efficiently used elsewhere. Inflation We have not been affected materially by inflation during the periods presented, and no material effect is expected in the near future. Recently Issued Accounting Pronouncements 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. 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 ASU 2016-02, "Leases" ("ASC 842"). The guidance requires lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model and the new revenue recognition standard. Existing sale-leaseback guidance, including guidance for real estate, is replaced with a new model applicable to both lessees and lessors. ASC 842 is effective for fiscal years beginning after December 15, 2018. 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. 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. 26 Table of Contents Our accounting policies are discussed in detail in the footnotes to our financial statements included in this 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. Off Balance Sheet Arrangements As of September 30, 2020, there were no off balance sheet arrangements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk As a smaller reporting company, we are not required to provide the information required by this Item.