Hyperscale Data, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this quarterly report, the “Company,” “AAI,” “we,” “us” and “our” refer to Ault Alliance, Inc., a Delaware corporation. AAI is a diversified holding company pursuing growth by acquiring undervalued businesses and disruptive technologies with a global impact. Through our wholly and majority owned subsidiaries and strategic investments, we own and operate a data center at which we mine Bitcoin and offers colocation and hosting services for the emerging artificial intelligence ecosystems and other industries, and provides mission-critical products that support a diverse range of industries, including metaverse platform, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. In addition, we own and operate hotels and extend credit to select entrepreneurial businesses through a licensed lending subsidiary. Recent Events and Developments On January 23, 2023, we filed a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable preferred stock (“Series C Preferred Stock”) which, effective upon filing, eliminated the Series C Preferred Stock. On February 8, 2023, we entered into a Share Exchange Agreement (the “Agreement”) with BMI and the other signatories thereto. The Agreement provides that, subject to the terms and conditions set forth therein, BMI will acquire all of the outstanding shares of capital stock of our then subsidiary, BitNile.com, Inc. (“BitNile.com”), of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders (the “Minority Shareholders”), as well as Ault Iconic, (formerly Ault Media Group) and the securities of Earnity beneficially owned by BitNile.com (which represented approximately 19.9% of the outstanding equity securities of Earnity as of the date of the Agreement), in exchange for the following: (i) 8,637.5 shares of newly designated Series B Convertible Preferred Stock of BMI to be issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly designated Series C Convertible Preferred Stock of BMI to be issued to the to the Minority Shareholders (the “Series C Preferred,” and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series C Preferred each have a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred Stock to be issued by BMI of $100 million, and subject to adjustment, are convertible into an aggregate of 400 million shares of common stock of BMI (the “BMI Common Stock”), which represent and pursuant to the Agreement will represent approximately 92.4% of BMI’s outstanding BMI Common Stock on a fully-diluted basis as of the date of the Agreement. However, pending approval of the transaction by BMI’s shareholders and the Nasdaq Stock Market, the Preferred Stock is subject to a 19.9% beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from BMI in June of 2022. The Agreement provides that BMI will seek shareholder approval (the “Shareholder Approval”) following the closing. Pursuant to the Certificates of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of BMI Common Stock determined by dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of BMI Common Stock. The Conversion Price will be subject to certain adjustments, including potential downward adjustment if BMI closes a qualified financing resulting in at least $25 million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If BMI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the event of a liquidation, change of control event, dissolution or winding up of BMI, and will rank senior to all other capital stock of BMI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred was originally entitled to vote with the BMI Common Stock at a rate of 10 votes per share of Common Stock into which the Series B Preferred is convertible, but that provision was subsequently eliminated. Other than certain rights granted to the Company relating to amendments or waiver of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially identical. The Agreement closed on March 6, 2023. On March 28, 2023, we entered into a securities purchase agreement (the “Purchase Agreement”) with certain institutional investors (the “Investors”), pursuant to which we agreed to issue and sell, in a private placement, an aggregate of 100,000 shares of our preferred stock, with each such share having a stated value of $100.00 and consisting of (i) 83,000 shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”), (ii) 1,000 shares of Series F Convertible Preferred Stock (the “Series F Preferred Stock”) and (iii) 16,000 shares of Series G Convertible Preferred Stock (the “Series G Preferred Stock” and collectively, the “Preferred Shares”). The Preferred Shares will be convertible into shares of our common stock at the option of the holders and, in certain circumstances, by us. 1 Each share of Series E Preferred Stock and Series F Preferred Stock had a purchase price of $100.00, equal to each such share’s stated value. The purchase price of the Series E Preferred Stock and the Series F Preferred Stock was paid for by the Investors’ canceling outstanding secured promissory notes in the principal amount of $8.4 million, whereas the purchase price of the shares of Series G Preferred Stock consisted of accrued but unpaid interest on these notes, as well as for other good and valuable consideration. Each Preferred Share is convertible into shares of our common stock at a conversion price equal to 85% of the closing sale price of our common stock on the trading day prior to the date of conversion, subject to a floor price of $0.10. The Preferred Shares are convertible at the option of the holder at any time following our receipt of stockholder approval of the Reverse Split (as defined below). The private placement closed on March 30, 2023. On April 6, 2023, we issued a term note with a principal amount of $1.1 million, bearing an interest rate of 12% (the “Term Note”). The Term Note was issued at a discount, with net proceeds to us amounting to $1.0 million. The Term Note was scheduled to mature on June 5, 2023. We exercised the option to extend the maturity date by one month, by paying a $30,000 extension fee. Ault & Company guaranteed repayment of the Term Note. On May 1, 2023, we entered into a securities purchase agreement (the “Series C Agreement”) with Ault & Company, pursuant to which we agreed to sell to Ault & Company up to 40,000 shares of Series C convertible preferred stock and warrants to purchase up to 1.3 million shares of common stock for a total purchase price of up to $40 million. The consummation of the transactions contemplated by the Series C Agreement are subject to various customary closing conditions and the receipt of certain third party consents. In addition to customary closing conditions, the closing of the transaction is also conditioned upon the receipt by Ault & Company of financing in an amount sufficient to consummate the transaction, in whole or in part. The Series C Agreement contains customary termination provisions for Ault & Company under certain circumstances, and the Series C Agreement shall automatically terminate if the closing has not occurred prior to May 31, 2023, although such date may be extended by Ault & Company for a period of 90 days as set forth in the Series C Agreement. Our stockholders approved, at a special meeting of our stockholders called for such purpose, an amendment (the “Amendment”) to our certificate of incorporation to authorize a reverse split of our common stock (the “Reverse Split”). The Investors agreed in the Purchase Agreement to not transfer, offer, sell, contract to sell, hypothecate, pledge or otherwise dispose of the Preferred Shares until after the Reverse Split. Pursuant to the certificate of designation of the Series E Preferred Stock, the shares of Series E Preferred Stock have the right to vote on such Amendment on an as converted to common stock basis. In addition, pursuant to the certificate of designation of the Series F Preferred Stock, the shares of Series F Preferred Stock have the right to vote on such Amendment. Each Investor has separately agreed to vote the shares of the Series E Preferred Stock in favor of the Amendment and that the shares of the Series F Preferred Stock shall automatically be voted in a manner that “mirrors” the proportions on which the shares of our common stock and Series E Preferred Stock are voted on the Amendment. The Amendment requires the approval of the majority of the votes associated with our outstanding capital stock entitled to vote on the proposal. Because the Series F Preferred Stock will automatically and without further action of the purchaser be voted in a manner that “mirrors” the proportions on which the shares of common stock and Series E Preferred Stock are voted on the Reverse Split, abstentions by common stockholders will not have any effect on the votes cast by the holders of the Series F Preferred Stock. The Series G Preferred Stock does not carry any voting rights, except as required by law or expressly provided by its certificate of designation. On June 8, 2023, we entered into a loan agreement with Ault & Company as lender. The loan agreement provides for an unsecured, non-revolving credit facility in an aggregate principal amount of up to $10 million. All loans under the loan agreement are due within five business days after request by Ault & Company and Ault & Company is not obligated to make any further advances under the loan agreement after December 8, 2023. Advances under the loan agreement bear interest at the rate of 9.5% per annum and may be repaid at any time without penalty or premium. As of the date of this report, $4.7 million has been advanced under the loan agreement and not repaid. On June 9, 2023, we entered into an At-the-Market Issuance Sales Agreement with Ascendiant Capital Markets, LLC, as sales agent (“Ascendiant Capital”) to sell shares of our common stock having an aggregate offering price of up to $10,000,000 (the “Shares”) from time to time, through an “at the market offering” (the “2023 Common ATM Offering”). On July 12, 2023, we and Ascendiant Capital entered into an amendment to the At-The-Market issuance sales agreement to increase the size of the 2023 Common ATM Offering from $10.0 million to $20.0 million. Through August 14, 2023, we have sold an aggregate of 3.8 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $16.1 million. 2 On June 26, 2023, we established a record date for our initial distribution of TurnOnGreen securities. Stockholders as of this date were entitled to 40 shares of TurnOnGreen common stock, along with warrants to purchase 40 shares of TurnOnGreen common stock (the “TurnOnGreen Securities”) for every share of our common stock they held on the record date. The initial distribution was finalized in July 2023. On July 24, 2023, we established a record date for our second partial distribution of TurnOnGreen Securities. Stockholders as of this date were entitled to 40 shares of TurnOnGreen Securities for every share of the Company’s common stock they held on the record date. The second distribution was finalized on August 7, 2023, whereby we relinquished control of voting interests of TurnOnGreen. We distributed 56.4 million TurnOnGreen Securities in the second distribution. On July 19, 2023 we along with certain of our subsidiaries entered into a First Amendment and Joinder to Loan and Guarantee Agreement (the “Amendment”) with the institutional investors pursuant to which the (i) Loan and Guarantee Agreement, dated November 7, 2022, entered into between us and the institutional investors (the “Loan Agreement”) and (ii) Security Agreement, dated November 7, 2022, entered into between the institutional investors and Sentinum (the “Security Agreement”) was amended. Pursuant to the Amendment, we borrowed an additional $8.8 million. The net proceeds of the additional loan amount were $7.5 million. Effective August 3, 2023, we and the Investors entered into an Exchange Agreement (the “Exchange Agreement”) pursuant to which the Investors exchanged all of their Preferred Shares as well as their demand notes (the “Demand Notes”) issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.8 million for two new 10% Secured OID Promissory Notes (the “Exchange Notes”), each with a principal face amount of $5.3 million, for an aggregate of amount owed of $10.5 million (the “Principal Amount”). We and Milton “Todd” Ault, III, our Executive Chairman, entered into guaranty agreements with the Investors guaranteeing repayment by Ault & Company, Inc., a related party (“Ault & Company”) of the Exchange Notes. Effective as of August 3, 2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, we issued a 10% demand promissory note in the principal face amount of $10.5 million (the “First A&C Demand Note”) to Ault & Company. Effective as of August 10, 2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. General As a holding company, our business objective is designed to increase stockholder value. Under the strategy we have adopted, we are focused on managing and financially supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize stockholder value. We anticipate returning value to stockholders after satisfying our debt obligations and working capital needs. From time to time, we engage in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary or partner company’s further growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner companies public through rights offerings and directed share subscription programs. We will continue to consider these (or similar) initiatives and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our stockholders. In recent years, we have provided capital and relevant expertise to fuel the growth of businesses in metaverse platform, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively involved, influencing development through board representation and management support. 3 We are a Delaware corporation with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and our website address is www.ault.com. Results of Operations Results of Operations for the Three Months Ended June 30, 2023 and 2022 The following table summarizes the results of our operations for the three months ended June 30, 2023 and 2022. For the Three Months Ended June 30, 2023 2022 Revenue $ 12,216,000 $ 7,577,000 Revenue, cryptocurrency mining 8,368,000 3,976,000 Revenue, hotel and real estate operations 4,709,000 4,870,000 Revenue, crane operations 12,590,000 - Revenue, lending and trading activities 9,525,000 943,000 Total revenue 47,408,000 17,366,000 Cost of revenue, products 9,036,000 5,044,000 Cost of revenue, cryptocurrency mining 9,726,000 4,453,000 Cost of revenue, hotel and real estate operations 3,120,000 2,872,000 Cost of revenue, hotel operations 7,641,000 - Cost of revenue, lending and trading activities - - Total cost of revenue 29,523,000 12,369,000 Gross profit 17,885,000 4,997,000 Total operating expenses 68,390,000 28,716,000 Loss from operations (50,505,000 ) (23,719,000 ) Other income (expense): Interest and other income 2,382,000 81,000 Interest expense (15,927,000 ) (2,031,000 ) Loss on extinguishment of debt (91,000 ) - Realized and unrealized (loss) gain on marketable securities (206,000 ) 198,000 Loss from investment in unconsolidated entity - (391,000 ) Loss on the sale of fixed assets (1,754,000 ) - Change in fair value of warrant liability 3,217,000 (6,000 ) Loss before income taxes (62,884,000 ) (25,868,000 ) Income tax provision 1,368,000 217,000 Net loss (64,252,000 ) (26,085,000 ) Net loss attributable to non-controlling interest 3,569,000 321,000 Net loss attributable to Ault Alliance, Inc. (60,683,000 ) (25,764,000 ) Preferred dividends (321,000 ) (44,000 ) Net loss available to common stockholders $ (61,004,000 ) $ (25,808,000 ) Comprehensive loss Net loss available to common stockholders $ (61,004,000 ) $ (25,808,000 ) Other comprehensive loss Foreign currency translation adjustment (520,000 ) (1,471,000 ) Other comprehensive loss (520,000 ) (1,471,000 ) Total comprehensive loss $ (61,524,000 ) $ (27,279,000 ) 4 Revenues Revenues by segment for the three months ended June 30, 2023 and 2022 were as follows: For the Three Months Ended June 30, Increase 2023 2022 (Decrease) % GIGA $ 8,740,000 $ 6,503,000 $ 2,237,000 34 % TurnOnGreen 724,000 1,062,000 (338,000 ) -32 % SMC 2,625,000 - 2,625,000 - Sentinum Revenue, cryptocurrency mining 8,368,000 3,976,000 4,392,000 110 % Revenue, commercial real estate leases 325,000 272,000 53,000 19 % AGREE 4,384,000 4,598,000 (214,000 ) -5 % Fintech: Revenue, lending and trading activities 9,525,000 943,000 8,582,000 910 % Other 45,000 12,000 33,000 275 % Energy 12,672,000 - 12,672,000 - Total revenue $ 47,408,000 $ 17,366,000 $ 30,042,000 173 % GIGA The $2.2 million increase in our GIGA segment revenue for the three months ended June 30, 2023 included $0.7 million attributable to our acquisition of Giga-tronics Incorporated on September 8, 2022. Continued conflicts and tensions worldwide are driving defense-related investments in force protection technologies at GIGA across the United States, UK, Europe, Asia, and the Middle East. Additionally, demand for key electronics solutions, particularly for customers in medicine and telecommunications, accelerated in the three months ended June 30, 2023, as businesses rebound in the post-pandemic COVID-19 economy. TurnOnGreen TurnOnGreen revenues were down $0.3 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022 due to a large project in 2022 that was cancelled. SMC SMC revenues increased by $2.6 million due to the acquisition of SMC in June 2022. Sentinum Revenues from Sentinum’s cryptocurrency mining operations increased $4.4 million as we increased our cryptocurrency mining activities from the prior period, partially offset by lower Bitcoin prices and an increase in Bitcoin mining difficulty level in the current year period. AGREE AGREE’s revenues decreased by $0.2 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022, due to interruptions in business operations as the properties were being renovated through the end of April 2023. 5 Fintech Revenues from our lending and trading activities were $9.5 million due to significant realized gains for the three months ended June 30, 2023 from our investment portfolio. During the three months ended June 30, 2022, Ault Lending generated income from appreciation of investments in marketable securities as well as shares of common stock underlying equity securities issued to Ault Lending in certain financing transactions. Revenue from lending and trading activities for the three months ended June 30, 2023 included an approximate $0.9 million unrealized gain from our investment in Alzamend. Under its business model, Ault Lending also generates revenue through origination fees charged to borrowers and interest generated from each loan. Revenues from our trading activities for the three months ended June 30, 2023 included net gains on equity securities, including unrealized gains and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic earnings. Energy Energy revenues increased by $12.7 million for the three months ended June 30, 2023, due to the acquisition of the Circle 8 crane operations in December 2022. Gross Margins Gross margins increased to 38% for the three months ended June 30, 2023, compared to 29% for the three months ended June 30, 2022. Our gross margins of 38% recognized during the three months ended June 30, 2023 benefited from favorable margins from our lending and trading activities and were impacted by negative margins from our Sentinum cryptocurrency mining segment due to the decline in the price of Bitcoin coupled with an increase in Bitcoin mining difficulty level. Excluding the effects of margin from our lending and trading activities and cryptocurrency mining operations, our adjusted gross margins for the three months ended June 30, 2023 and 2022 would have been 33% and 36%, respectively. Research and Development Research and development expenses increased by $1.1 million for the three months ended June 30, 2023, due to expenditures related to development work on the BMI metaverse platform. Selling and Marketing Selling and marketing expenses were $9.6 million for the three months ended June 30, 2023, compared to $7.0 million for the three months ended June 30, 2022, an increase of $2.6 million, or 37%. The increase was the result of $3.6 million higher advertising and promotion costs related to BMI’s metaverse platform, partially offset by a $1.4 million decline in employee related costs and consulting expenses. The increase is also attributable to $0.4 million increases in sales and marketing costs from SMC, which was acquired in June 2022 and $0.2 million from GIGA, which was acquired in September 2022. General and Administrative General and administrative expenses were $21.3 million for the three months ended June 30, 2023, compared to $19.0 million for the three months ended June 30, 2022, an increase of $2.3 million, or 12%. General and administrative expenses increased from the comparative prior period, mainly due to increases from new acquisitions: · general and administrative costs of $3.4 million from Circle 8, which was acquired in December 2022; · general and administrative costs of $3.0 million from BMI, which was acquired in March 2023; · general and administrative costs of $2.9 million from SMC, which was acquired in June 2022; · general and administrative costs of $2.3 million from GIGA, which was acquired in September 2022; and · general and administrative costs of $0.6 million from AVLP, which was acquired in June 2022. 6 The increases above were partially offset by the following decreases in general and administrative expenses: · $5.0 million lower performance bonus related to realized gains on trading activities; · $1.2 million lower corporate legal fees; · $1.0 million lower corporate bonuses; · $0.8 million lower general and administrative expenses at AGREE; · $0.7 million lower corporate consulting fees; · $0.7 million lower corporate audit fees; and · $0.5 million lower corporate board of directors fees. Impairment of AVLP Goodwill and Intangible Assets Goodwill We test the recorded amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the goodwill exceeds its carried value. We performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators of impairment related to certain unforeseen business developments and changes in financial projections. The valuation of the AVLP reporting unit was determined using a market and income approach methodology of valuation. The income approach was based on the projected cash flows discounted to their present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions regarding AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach utilized the guideline public company method. The results of the quantitative test indicated the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying value of the goodwill. As a result, the entire $18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment charge during the three months ended June 30, 2023. Intangible Assets Due to indicators of impairment, AVLP intangible assets were tested for impairment as of June 30, 2023. Based on internally developed forecasts of undiscounted expected future cash flows, it was determined that the carrying amount of the assets were not recoverable and, based on an assessment of the fair value of the assets, impairment of $17.0 million was recognized as a non-cash impairment charge during the three months ended June 30, 2023. The tradenames and patents/developed technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of 18% for patents and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present value using a discount factor of 25.7%. Impairment of Mined Cryptocurrency Impairment of mined cryptocurrency for the three months ended June 30, 2023 and 2022 was $0.1 million and $2.0 million, respectively. Impairment losses are attributable to the volatility of the Bitcoin market as market price of Bitcoin drops below our carrying value within the respective periods. The impairment of mined cryptocurrency for the three months ended June 30, 2023 is lower than the comparable prior year period as the average amount of digital currency held decreased during the three months ended June 30, 2023 as we generally sold our mined digital currency the next business day. Interest and Other Income Interest and other income was $2.4 million for the three months ended June 30, 2023, compared to $0.1 million for the three months ended June 30, 2022. The increase in interest and other income is primarily due to higher interest rates resulting in higher income from ADRT’s cash and marketable securities held in the trust account. Interest Expense Interest expense was $15.9 million for the three months ended June 30, 2023, compared to $2.0 million for the three months ended June 30, 2022. The $15.9 million interest expense for the three months ended June 30, 2023 included amortization of debt discount of $7.2 million, forbearance and extension fees of $6.2 million and contractual interest of $2.5 million. The $2.0 million interest expense for the three months ended June 30, 2022 included amortization of debt discount of $32,000 and contractual interest of $2.0 million. Loss on Extinguishment of Debt Loss on extinguishment of debt was $0.1 million for the three months ended June 30, 2023, compared to $0 for the three months ended June 30, 2022. Loss From Investment in Unconsolidated Entity Loss from investment in unconsolidated entity was $0 for the three months ended June 30, 2023, compared to $0.4 million for the three months ended June 30, 2022, representing our share of losses from our equity method investment in AVLP prior to the June 1, 2022 acquisition. 7 Results of Operations for the Six Months Ended June 30, 2023 and 2022 The following table summarizes the results of our operations for the six months ended June 30, 2023 and 2022. For the Six Months Ended June 30, 2023 2022 Revenue $ 25,647,000 $ 15,958,000 Revenue, cryptocurrency mining 15,715,000 7,524,000 Revenue, hotel and real estate operations 7,410,000 7,846,000 Revenue, crane operations 25,236,000 - Revenue, lending and trading activities 4,586,000 18,864,000 Total revenue 78,594,000 50,192,000 Cost of revenue, products 18,823,000 10,792,000 Cost of revenue, cryptocurrency mining 17,829,000 6,950,000 Cost of revenue, hotel and real estate operations 5,808,000 5,121,000 Cost of revenue, hotel operations 15,029,000 - Cost of revenue, lending and trading activities 1,180,000 - Total cost of revenue 58,669,000 22,863,000 Gross profit 19,925,000 27,329,000 Total operating expenses 101,848,000 50,018,000 Loss from operations (81,923,000 ) (22,689,000 ) Other income (expense): Interest and other income 3,579,000 530,000 Interest expense (29,657,000 ) (31,855,000 ) Loss on extinguishment of debt (154,000 ) - Realized and unrealized (loss) gain on marketable securities (244,000 ) 307,000 Loss from investment in unconsolidated entity - (924,000 ) Impairment of equity securities (9,555,000 ) - Gain on the sale of fixed assets 2,761,000 - Change in fair value of warrant liability 3,217,000 (24,000 ) Loss before income taxes (111,976,000 ) (54,655,000 ) Income tax provision 1,105,000 217,000 Net loss (113,081,000 ) (54,872,000 ) Net loss attributable to non-controlling interest 3,752,000 336,000 Net loss attributable to Ault Alliance, Inc. (109,329,000 ) (54,536,000 ) Preferred dividends (550,000 ) (49,000 ) Net loss available to common stockholders $ (109,879,000 ) $ (54,585,000 ) Comprehensive loss Net loss available to common stockholders $ (109,879,000 ) $ (54,585,000 ) Other comprehensive loss Foreign currency translation adjustment (350,000 ) (1,758,000 ) Other comprehensive loss (350,000 ) (1,758,000 ) Total comprehensive loss $ (110,229,000 ) $ (56,343,000 ) Revenues Revenues by segment for the six months ended June 30, 2023 and 2022 were as follows: For the Six Months Ended June 30, Increase 2023 2022 (Decrease) % GIGA $ 17,448,000 $ 13,748,000 $ 3,700,000 27 % TurnOnGreen 1,600,000 2,191,000 (591,000 ) -27 % SMC 6,008,000 - 6,008,000 — Sentinum Revenue, cryptocurrency mining 15,715,000 7,524,000 8,191,000 109 % Revenue, commercial real estate leases 783,000 550,000 233,000 42 % AGREE 6,627,000 7,296,000 (669,000 ) -9 % Fintech: Revenue, lending and trading activities 4,586,000 18,864,000 (14,278,000 ) -76 % Other 45,000 19,000 26,000 137 % Energy 25,782,000 - 25,782,000 — Total revenue $ 78,594,000 $ 50,192,000 $ 28,402,000 57 % 8 GIGA The $3.7 million increase in our GIGA segment revenue for the six months ended June 30, 2023 included $1.1 million attributable to our acquisition of Giga-tronics Incorporated on September 8, 2022. Continued conflicts and tensions worldwide are driving defense-related investments in force protection technologies at GIGA across the United States, UK, Europe, Asia, and the Middle East. Additionally, demand for key electronics solutions, particularly for customers in medicine and telecommunications, accelerated in the six months ended June 30, 2023, as businesses rebound in the post-pandemic COVID-19 economy. TurnOnGreen TurnOnGreen revenues were down $0.6 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022 due to a large project in 2022 that was cancelled. SMC SMC revenues increased by $6.0 million due to the acquisition of SMC in June 2022. Sentinum Revenues from Sentinum’s cryptocurrency mining operations increased $8.2 million as we increased our cryptocurrency mining activities from the prior period, partially offset by lower Bitcoin prices and an increase in Bitcoin mining difficulty level in the current year period. AGREE AGREE’s revenues decreased by $0.7 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022, due to interruptions in business operations as the properties were being renovated during the six months ended June 30, 2023. The renovations were completed in April 2023 . Fintech Revenues from our lending and trading activities were $4.6 million due to realized gains for the six months ended June 30, 2023 from our investment portfolio. During the six months ended June 30, 2022, Ault Lending generated income from appreciation of investments in marketable securities as well as shares of common stock underlying equity securities issued to Ault Lending in certain financing transactions. Revenue from lending and trading activities for the six months ended June 30, 2023 included an approximate $0.6 million unrealized loss from our investment in Alzamend. Under its business model, Ault Lending also generates revenue through origination fees charged to borrowers and interest generated from each loan. Revenues from our trading activities for the six months ended June 30, 2023 included net losses on equity securities, including unrealized gains and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic earnings. 9 Energy Energy revenues increased by $25.8 million for the six months ended June 30, 2023, due to the acquisition of the Circle 8 crane operations in December 2022. Gross Margins Gross margins decreased to 25% for the six months ended June 30, 2023, compared to 54% for the six months ended June 30, 2022. Our gross margins of 25% recognized during the six months ended June 30, 2023 were impacted by negative margins from our Sentinum cryptocurrency mining segment due to the decline in the price of Bitcoin coupled with an increase in Bitcoin mining difficulty level, offset by favorable margins from our lending and trading activities. Excluding the effects of margin from our lending and trading activities and cryptocurrency mining operations, our adjusted gross margins for the six months ended June 30, 2023 and 2022 would have been 33% and 36%, respectively. Research and Development Research and development expenses increased by $2.2 million for the six months ended June 30, 2023, primarily due to expenditures related to development work on the BMI metaverse platform. Selling and Marketing Selling and marketing expenses were $18.4 million for the six months ended June 30, 2023, compared to $13.5 million for the six months ended June 30, 2022, an increase of $4.9 million, or 36%. The increase was the result of $5.3 million higher advertising and promotion costs related to BMI’s metaverse platform, partially offset by a $1.8 million decline in employee related costs and consulting expenses. The increase is also attributable to $1.3 million increases in sales and marketing costs from SMC, which was acquired in June 2022 and $0.5 million from GIGA, which was acquired in September 2022. General and Administrative General and administrative expenses were $44.0 million for the six months ended June 30, 2023, compared to $32.7 million for the six months ended June 30, 2022, an increase of $11.3 million, or 34%. General and administrative expenses increased from the comparative prior period, mainly due to increases from new acquisitions: · general and administrative costs of $6.4 million from Circle 8, which was acquired in December 2022; · general and administrative costs of $5.1 million from SMC, which was acquired in June 2022; · general and administrative costs of $3.5 million from GIGA, which was acquired in September 2022; · general and administrative costs of $3.0 million from BMI, which was acquired in March 2023; and · general and administrative costs of $1.2 million from AVLP, which was acquired in June 2022. The increases above were partially offset by the following decreases in general and administrative expenses: · $4.2 million lower performance bonus related to realized gains on trading activities; · $2.2 million lower corporate legal fees; and · $1.5 million lower general and administrative expenses at AGREE. 10 Impairment of AVLP Goodwill and Intangible Assets Goodwill We test the recorded amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the goodwill exceeds its carried value. We performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators of impairment related to certain unforeseen business developments and changes in financial projections. The valuation of the AVLP reporting unit was determined using a market and income approach methodology of valuation. The income approach was based on the projected cash flows discounted to their present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions regarding AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach utilized the guideline public company method. The results of the quantitative test indicated the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying value of the goodwill. As a result, the entire $18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment charge during the six months ended June 30, 2023. Intangible Assets Due to indicators of impairment, AVLP intangible assets were tested for impairment as of June 30, 2023. Based on internally developed forecasts of undiscounted expected future cash flows, it was determined that the carrying amount of the assets were not recoverable and, based on an assessment of the fair value of the assets, impairment of $17.0 million was recognized as a non-cash impairment charge during the six months ended June 30, 2023. The tradenames and patents/developed technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of 18% for patents and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present value using a discount factor of 25.7%. Impairment of Mined Cryptocurrency Impairment of mined cryptocurrency for the six months ended June 30, 2023 and 2022 was $0.3 million and $2.4 million, respectively. Impairment losses are attributable to the volatility of the Bitcoin market as market price of Bitcoin drops below our carrying value within the respective periods. The impairment of mined cryptocurrency for the six months ended June 30, 2023 is lower than the comparable prior year period as the average amount of digital currency held decreased during the first half of 2023 as we generally sold our mined digital currency the next business day. 11 Interest and Other Income Interest and other income was $3.6 million for the six months ended June 30, 2023, compared to $0.5 million for the six months ended June 30, 2022. The increase in interest and other income is primarily due to higher interest rates resulting in higher income from ADRT’s cash and marketable securities held in the trust account. Interest Expense Interest expense was $29.7 million for the six months ended June 30, 2023, compared to $31.9 million for the six months ended June 30, 2022. The $29.7 million interest expense for the six months ended June 30, 2023 included amortization of debt discount of $16.2 million, forbearance and extension fees of $7.5 million and contractual interest of $5.9 million. The $29.8 million interest expense for the six months ended June 30, 2022 related primarily to amortization of debt discount of $26.3 million from the issuance of warrants, a non-cash charge, and original issue discount, in connection with the $66.0 million of senior notes issued in December 2021, which were fully paid in March 2022. Loss on Extinguishment of Debt Loss on extinguishment of debt was $0.2 million for the six months ended June 30, 2023, compared to $0 for the six months ended June 30, 2022. Loss From Investment in Unconsolidated Entity Loss from investment in unconsolidated entity was $0 for the six months ended June 30, 2023, compared to $0.9 million for the six months ended June 30, 2022, representing our share of losses from our equity method investment in AVLP prior to the June 1, 2022 acquisition. Impairment of Equity Securities Cumulative downward adjustments for impairments for our equity securities without readily determinable fair values held at June 30, 2023 were $9.6 million. Liquidity and Capital Resources On June 30, 2023, we had cash and cash equivalents of $19.7 million (excluding restricted cash of $1.1 million), compared to cash and cash equivalents of $10.5 million (excluding restricted cash of $3.6 million) at December 31, 2022. The increase in cash and cash equivalents was primarily due cash provided by operating activities and cash provided by financing activities related to the sale of common and preferred stock, as well as proceeds from convertible notes partially offset by the payment of debt, purchases of property and equipment and investments in equity securities. Net cash provided by operating activities totaled $12.9 million for the six months ended June 30, 2023, compared to $19.4 million for the six months ended June 30, 2022. Cash provided by operating activities for the six months ended June 30, 2023 included $41.2 million net cash provided by marketable securities from trading activities related to the operations of Ault Lending and $15.0 million proceeds from the sale of cryptocurrencies from our Sentinum Bitcoin mining operations, partially offset by operating losses and changes in working capital. Net cash used in investing activities was $21.8 million for the six months ended June 30, 2023, compared to $87.1 million for the six months ended June 30, 2022, which included $72.8 million of capital expenditures, primarily for Bitcoin mining equipment. Net cash used in investing activities for the six months ended June 30, 2023 was primarily related to capital expenditures and the purchase of equity securities, partially offset by proceeds from the sale of fixed assets of $4.5 million. 12 Net cash provided by financing activities was $12.8 million for the six months ended June 30, 2023, compared to net cash provided by financing activities of $75.5 million for the six months ended June 30, 2022, and primarily reflects the following transactions: · 2022 Common ATM Offering – During the six months ended June 30, 2023, we sold an aggregate of 0.1 million shares of common stock pursuant to the 2022 Common ATM Offering for gross proceeds of $4.2 million and effective March 17, 2023, the 2022 Common ATM Offering was terminated; · 2022 Preferred ATM Offering – During the six months ended June 30, 2023, we sold an aggregate of 162,175 shares of Series D Preferred Stock pursuant to the 2022 Preferred ATM Offering for net proceeds of $3.0 million and effective June 16, 2023, the 2022 Preferred ATM Offering was terminated; · 2023 Common ATM Offering –On June 9, 2023, we entered into the 2023 Common ATM Offering with Ascendiant Capital. During the six months ended June 30, 2023, we sold an aggregate of 0.1 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $0.8 million; · $34.1 million payments on notes payable, partially offset by $30.7 million proceeds from notes payable; and · $7.8 million proceeds from convertible notes payable, partially offset by $0.4 million payments on convertible notes payable. Financing Transactions Subsequent to June 30, 2023 Financing transactions subsequent to June 30, 2023 included the following: 2023 Common ATM Offering During the period between July 1, 2023 through August 14, 2023, we sold an aggregate of 3.9 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $15.6 million. Amendment to 8.5% Secured Promissory Notes On July 19, 2023, we and certain of our subsidiaries entered into an amendment agreement with the institutional investors and increased the principal balance of the secured promissory notes by an additional $8.8 million. The net proceeds to us from the amendment agreement were $7.5 million. Advances under Ault & Company Loan Agreement Subsequent to June 30, 2023, $3.9 million has been advanced by Ault & Company to us under the loan agreement entered into June 8, 2023. Exchange of Preferred Shares for Secured Debt and Assignment of Secured Note Effective August 3, 2023, we and the Investors entered into the Exchange Agreement pursuant to which the Investors exchanged all of their Preferred Shares as well as their Demand Notes issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.9 million for the Exchange Notes, each with a principal face amount of approximately $5.3 million, for an aggregate of amount owed of $10.5 million. We and Milton “Todd” Ault, III, our Executive Chairman issued entered into guaranty agreements with the Investors guaranteeing Ault & Company’s repayment of the Exchange Notes. Effective as of August 3, 2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, we issued the First A&C Demand Note to Ault & Company. 13 Assignment of Term Note Effective as of August 10, 2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us , we issued a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. Critical Accounting Policies Variable Interest Entities The accounting guidance requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a Variable Interest Entity (“VIE”); to eliminate the solely quantitative approach previously required for determining the primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide readers of financial statements with more transparent information about an enterprise’s involvement in a VIE. For VIEs, the Company assesses whether it is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. The Company evaluates its business relationships with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, Consolidation. The Company consolidates VIEs in which it is considered to be the primary beneficiary. Entities are considered to be the primary beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken together, most significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns from the VIE that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an entity involves the consideration of various factors including the form of its ownership interest, its representation in the entity’s governance, the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the rights of the other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the joint venture, if applicable. Business Combination We allocate the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. Acquired customer relations, technology, trade names and know how are recognized at fair value. The purchase price allocation process requires management to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets. Direct transaction costs associated with the business combination are expensed as incurred. The allocation of the consideration transferred in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date. We include the results of operations of the business that we have acquired in our consolidated results prospectively from the date of acquisition. If the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquire is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss. 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable for a smaller reporting company.