Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our results of operations and financial condition should be read together with the financial statements and related notes and the other financial information included elsewhere in this Report. Such discussion and analysis reflects our historical results of operations and financial position. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" and "Cautionary Information about Forward-Looking Statements" and elsewhere in this Report. All share and per share amounts presented herein have been restated to reflect the implementation of the 1-for-6 reverse stock split as if it had occurred at the beginning of the earliest period presented.
OVERVIEW AND HISTORY – S EE "I TEM 1. B USINESS" FOR A FURTHER DESCRIPTION OF OUR H ISTORY AND B ACKGROUND
urban-gro is an integrated professional services and Design-Build firm. Our business focuses primarily on providing fee-based professional services, Design-Build solutions, as well as the value-added reselling and integration of equipment systems. We derive income from our ability to generate revenue from our clients through the billing of our employees’ time spent on client projects. We offer value-added architectural, engineering, systems procurement and integration, and construction solutions to customers operating in the CEA and Commercial sectors. In the CEA sector, our clients include operators and facilitators in both the cannabis and produce markets in the United States, Canada, and Europe. In the Commercial sector, we work with leading Food and Beverage CPG companies in the United States, and clients in other commercial sectors including light industrial, healthcare, higher education, laboratories, and hospitality. During 2021 and 2022, we made the following acquisitions:
• July 2021 - Three affiliated architecture design companies (the "2WR Entities")
• April 2022 - A construction Design-Build firm ("Emerald")
• October 2022 - An engineering firm ("DVO")
RESULTS OF OPERATIONS
Comparison of Results of Operations for the years ended December 31, 2023 and 2022
During the year ended December 31, 2023, we generated revenues of $71.5 million compared to revenues of $67.0 million during the year ended December 31, 2022, an increase of $4.5 million, or 7%. This increase in revenues is the net result of the following changes in individual revenue components:
• Construction design-build revenues increased $26.4 million, primarily due to significant organic growth within this group;
• Services revenue decreased $0.9 million, which was the result of a decrease in revenues in our existing business due to negative market conditions in the CEA sector;
• Equipment systems revenue decreased $20.7 million due to negative market conditions in the CEA sector and a reduction in capital equipment spending by customers; and
• Other revenue decreased $0.3 million.
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During the year ended December 31, 2023, cost of revenues was $61.3 million compared to $52.8 million during the year ended December 31, 2022, an increase of $8.4 million, or 16%. This increase is directly attributable to the increase in revenues indicated above.
Gross profit was $10.3 million (14% of revenue) during the year ended December 31, 2023, compared to $14.2 million (21% of revenue) during the year ended December 31, 2022. Gross profit as a percentage of revenues decreased overall due to increases in lower margin construction design-build revenue combined with decreases in higher margin equipment systems and services revenue.
Operating expenses increased by $0.1 million, or 0%, to $27.0 million for the year ended December 31, 2023 compared to $26.8 million for the year ended December 31, 2022. This increase was due to the net effects of the following:
• a $3.8 million increase in general and administrative expenses due to an increase in legal fees defending lawsuits, increases in the average number of personnel and increases in construction design-build revenue which increased business insurance and lease costs;
• a $3.3 million decrease in a one-time business development expense related to satisfying an equipment lighting issue encountered by a major customer; and
• a $0.4 million decrease in share based compensation due to a reduction in the number of employees who received grants in 2023 as compared to 2022.
Non-operating expense was $2.2 million for the year ended December 31, 2023, compared to $3.0 million for the year ended December 31, 2022, a decrease of $0.7 million. This decrease was primarily due to a $1.5 million loss on settlement and a $0.3 million impairment loss in 2023 compared to a $2.7 million impairment loss recorded in 2022.
As a result of the above, we incurred a net loss of $18.7 million for the year ended December 31, 2023, or a net loss per share of $1.66, compared to a net loss of $15.3 million for the year ended December 31, 2022, or a net loss per share of $1.44.
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NON-GAAP FINANCIAL MEASURES
The Company uses the supplemental financial measure of Adjusted Earnings before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") as a measure of our operating performance. Adjusted EBITDA is not calculated in accordance with U.S. GAAP and it is not a substitute for other measures prescribed by U.S. GAAP such as net income (loss), income (loss) from operations, and cash flows from operating activities. We define Adjusted EBITDA as net income (loss) attributable to urban-gro, Inc., determined in accordance with U.S. GAAP, excluding the effects of certain operating and non-operating expenses including, but not limited to, interest expense/income, income taxes/benefit, depreciation of tangible assets, amortization of intangible assets, impairment losses, unrealized exchange gains/losses, debt forgiveness and extinguishment, stock-based compensation expense, acquisition costs, and other nonrecurring expenses that we do not believe reflect our core operating performance.
Our Board and management team focus on Adjusted EBITDA as a key performance and compensation measure. We believe that Adjusted EBITDA assists us in comparing our operating performance over various reporting periods because it removes from our operating results the impact of items that our management believes do not reflect our core operating performance.
The following table reconciles net loss attributable to the Company to Adjusted EBITDA for the periods presented:
Years Ended December 31,
2023 2022
Net loss $ (18,681,061) $ (15,277,909)
Interest expense 271,686 54,579
Interest income (173,895) (329,012)
Federal and state income tax (provisions) (215,864) (322,092)
Federal and state income tax payments 185,910 16,253
Depreciation and amortization 1,636,667 1,483,065
EBITDA $ (16,976,557) $ (14,375,116)
Non-recurring legal fees 1,249,133 352,173
One-time employee expenses — 819,089
Contingent consideration - change in fair value 160,232 436,905
Contingent consideration - DVO acquisition 278,559 —
Reduction in force costs 346,725 —
One time business development expenses – 3,299,864
Impairment loss 258,492 2,660,934
Loss on settlement 1,500,000 –
Retention incentive 1,242,000 –
Stock-based compensation 2,199,046 2,571,785
Transaction costs 30,197 347,317
Adjusted EBITDA (non-GAAP) $ (9,712,173) $ (3,887,049)
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BACKLOG
Backlog is a financial measure that generally reflects the dollar value of revenue that the Company expects to realize in the future. Although backlog is not a term recognized under U.S GAAP, it is a common measure used by companies operating in our industries. We report backlog for the following revenue categories: (i) Equipment Systems; (ii) Construction Design-Build; and (iii) Services. We define backlog for Equipment Systems and Services as signed contracts, with Equipment Systems contracts generally requiring receipt of a customer deposit prior to being included in backlog. Construction Design-Build backlog is comprised of construction projects once the contract is awarded and to the extent we believe funding is probable. Our Construction Design/Build backlog consists of uncompleted work on contracts in progress and contracts for which we have executed a contract but have not commenced the work. For uncompleted work on contracts in progress, we include (i) executed change orders, (ii) pending change orders for which we expect to receive confirmation in the ordinary course of business, and (iii) claims that we have made against our customers for which we have determined we have a legal basis under existing contractual arrangements and as to which we consider collection to be probable.
Backlog for each of our revenue categories as of December 31, 2023 and December 31, 2022 is reflected in the following tables:
December 31, 2023
CEA Commercial Total Relative Percentage
(in millions)
Equipment systems
$ 1 $ — $ 1 1 %
Services $ 3 $ 4 $ 7 6 %
Construction design-build
$ 73 $ 29 $ 102 93 %
Total backlog
$ 77 $ 33 $ 110 100 %
Relative percentage 70 % 30 % 100 %
Note: Percentages may not add up due to rounding.
December 31, 2022
CEA Commercial Total Relative Percentage
(in millions)
Equipment systems
$ 5 $ — $ 5 6 %
Services $ 4 $ 2 $ 6 6 %
Construction design-build (1)
$ 67 $ 15 $ 82 88 %
Total backlog
$ 76 $ 17 $ 93 100 %
Relative percentage 82 % 18 % 100 %
Note: Percentages may not add up due to rounding.
(1) Construction design-build revenue and backlog relate to the operations of Emerald, which was acquired by the Company on April 29, 2022.
Historically, the majority of our Equipment Systems and Services backlog has been retired and converted into revenue within two quarters. At December 31, 2023, we expected approximately 57% of our Construction Design-Build backlog to be completed in the next 12 months. At December 31, 2023, three customers were each in excess of 10% of total backlog and in total they accounted for 74% of total backlog. At December 31, 2022, three customers were in excess of 10% of total backlog and in total they accounted for 81% of our total backlog.
Certain Construction Design-Build contracts contain options that are exercisable at the discretion of our customer to award additional work to us, without requiring us to go through an additional competitive bidding process. In addition, some customer contracts also contain task orders that are signed under master contracts pursuant to which we perform work only when the customer awards specific task orders to us.
Contracts in our Construction Design-Build backlog may be canceled or modified at the election of the customer. Many Construction Design-Build projects are added to our contract backlog and completed within the same fiscal year and therefore may not be reflected in our beginning or quarter-end Construction Design-Build backlog amounts.
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LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2023, we had negative working capital of $1.2 million, compared to positive working capital of $10.3 million as of December 31, 2022, a decrease of $11.5 million. This decrease in working capital was primarily due to a decrease in cash of $10.9 million (which is further detailed below) and the net effects of reductions in customer deposits of $2.0 million and prepaid expenses and other current assets of $1.4 million. The reductions in customer deposits and prepaid expenses and other current assets corresponds to a reduction in customer orders for equipment systems which is reflected in the reduction in equipment systems backlog from December 31, 2022 to December 31, 2023 outlined in Backlog above. Due to the acquisition of Emerald in 2022, the Company includes in working capital contract receivables and liabilities related to construction projects. These construction working capital balances are described in further detail in our consolidated financial statements, including the accompanying notes.
As of December 31, 2023, we had cash of $1.1 million, which represented a decrease of $10.9 million from $12.0 million as of December 31, 2022. Changes in cash during 2023 and 2022 are discussed below.
On December 13, 2023, UG Construction, Inc, ("UG Construction"), a wholly owned subsidiary of the Company, entered into an interest only asset based revolving loan agreement ("the Line of Credit") with Gemini Finance Corp. ("Lender") pursuant to which Lender extended to UG Construction the Line of Credit in an amount not to exceed $10.0 million to be used to assist UG Construction and the Company with cash management. Lender will consider requests under the Line of Credit, which Lender may accept or reject in its discretion, until September 12, 2024 ("the Initial Term"), subject to an automatic extension for an additional nine-,month term until May 12, 2025. provided that UG Construction is in compliance with all the terms of the applicable loan documents and Lender has not sent a written notice of non-renewal at least 60 days prior to expiration of the Initial Term. The Line of Credit contains standard events of default and representations and warranties by UG Construction and the Lender and the Company has entered into a Continuing Guaranty pursuant to which the Company will guarantee repayment of the loans associated with the Line of Credit (the “Guaranty Agreement”). Loans made under the Line of Credit earns interest at a monthly rate of one and seventy-five hundredths percent (1.75%). As of December 31, 2023, we had borrowed $2.5 million under the Line of Credit.
Operating Activities:
Net cash used in operating activities was $11.2 million during the year ended December 31, 2023. This use of cash was the net effect of the net loss of $18.7 million, offset by non-cash expenses of $4.8 million, and a reduction in net operating assets and liabilities of $2.7 million. The $2.7 million reduction in net operating assets and liabilities was due to the net effects of a $23.4 million increase in accounts payable, contract liabilities and accrued expenses, a $2.2 million decrease in prepayments and other assets, offset by an $19.2 million increase in accounts receivable and a decrease in contract assets, customer deposits, operating lease liability, and contingent consideration of $3.6 million.
Net cash used in operating activities was $12.6 million during the year ended December 31, 2022. This use of cash was the net effect of the net loss of $15.3 million, offset by non-cash expenses of $6.9 million, and a decrease in net operating assets and liabilities of $4.2 million. The $4.2 million decrease in net operating assets and liabilities was primarily due to the net effects of a $2.5 million increase in accounts receivable, a $10.8 million increase in customer deposits, offset by a $1.1 million increase in accounts payable and accrued expenses, and an $8.4 million increase in prepayments and other assets.
Investing Activities:
Net cash provided by investing activities was $1.7 million for the year ended December 31, 2023, primarily from the sale of our investment in XS Financial for $2.3 million offset by the acquisition of property, plant and equipment of $0.6 million. We had no material commitments for capital expenditures as of December 31, 2023.
Net cash used in investing activities was $4.5 million for the year ended December 31, 2022. This use of cash was due to $3.9 million from the acquisition of the DVO Entities and $0.6 million for the purchase of fixed assets.
Financing Activities:
Net cash used by financing activities was $1.4 million for the year ended December 31, 2023. Cash used from financing activities during the year ended December 31, 2023 primarily relates to cash provided by our line of credit and other financing agreements of $3.0 million offset by $3.8 million of payments made on the promissory note related to the DVO acquisition and $0.7 million of payments made for the contingent consideration and finance lease.
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Net cash used by financing activities was $5.5 million for the year ended December 31, 2022. This decrease in cash primarily relates to $4.4 million used in the repurchase of common stock and $1.0 million paid for acquisition related contingent consideration.
Material Cash Requirements:
Our material cash requirements include payments on the promissory note associated with the DVO acquisition and operating lease payments. These obligations are described in detail in our consolidated financial statements, including the accompanying notes.
INFLATION
Inflation has resulted in increased costs for our customers. In addition, the U.S. Government has responded to inflation by raising interest rates, which has increased the cost of capital for our customers. We believe this has resulted in some customers delaying projects, reducing the scope of projects or potentially canceling projects, as well as increased costs of our operations, which has negatively impacted the results of our operations during the year ended December 31, 2023. We maintain strategies to mitigate the impact of higher material, energy and commodity costs, including cost reduction, alternative sourcing strategies, and passing along cost increase to customers, which may offset only a portion of the adverse impact. We believe the current inflationary environment has negatively impacted our customers which has led to delays in our customers starting projects, which in turn has delayed our customers from signing contracts with us.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Please refer to Note 2 – Summary of Significant Accounting Policies set forth immediately following the signature page of this Report for more information on our significant accounting policies.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Please refer to Recently Issued Accounting Pronouncements in Note 2 – Summary of Significant Accounting Policies set forth immediately following the signature page of this Report for information on new authoritative accounting guidance.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to provide this information.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial information required by this Item are set forth immediately following the signature page and are incorporated herein by reference.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.