Netcapital Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. THE FOLLOWING DISCUSSION OF OUR PLAN OF OPERATION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND RELATED NOTES TO THE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS ANNUAL REPORT. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL PERFORMANCE. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY THESE FORWARD-LOOKING STATEMENTS. Overview We are a fintech company that enables private companies to raise capital online and provides private equity investment opportunities to investors. Our consulting group, Netcapital Advisors, provides marketing and strategic advice and takes equity positions in select companies that we believe possess disruptive technologies. Our funding portal, Netcapital Funding Portal Inc., is registered with the SEC and is a member of the Financial Industry Regulatory Authority (FINRA), a registered national securities association. We sometimes take equity stakes in promising technology start-ups. We play an active role in growing these companies by providing strategic advice, technology consulting, and help with capital raising. We specialize in Reg CF offerings, under the provisions of Title III of the JOBS Act of 2012. We believe that new capital raising techniques, such as Reg CF, democratize capital raising, similar to the way that social networks democratize broadcast mechanisms that once belonged only to traditional media. We purchased Netcapital Funding Portal Inc., a registered Reg CF funding portal, effective November 5, 2020, and we changed the name of our company to Netcapital Inc. to reflect our commitment to help companies raise capital on the internet. Reg CF is one of three securities exemptions that enable online capital formation. Reg CF allows issuers to raise up to $5 million from accredited or non-accredited investors every 12 months. Our limited operating history and the uncertain nature of our future operations and the markets we address or intend to address make predictions of our future results of operations difficult. Our operations may never generate significant revenues, and we may not consistently achieve profitable operations. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and related notes to the financial statements included elsewhere in this Form 10-K. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. 11 Results of Operations Fiscal Year 2021 Compared to Fiscal Year 2020 Our revenues for fiscal 2021 increased by $2,967,445, or 169%, to $4,721,003 as compared to $1,753,558 reported for fiscal 2020. The increase in revenues is primarily attributable to our consulting services. We expanded our consulting business, which concentrates on providing assistance with capital raising, strategy, technology consulting and marketing. We also received additional revenues in fiscal 2021 from our funding portal, which we did not have in fiscal 2020. Our costs of revenues increased by $748,053, or 6,736%, to $759,158 in fiscal 2021, from $11,105 in fiscal 2020. The increase is primarily attributable to our increased revenues and the change in our strategy of how we accelerate the product development for the companies we invest in. Stock-based compensation increased by $324,359, or 91%, to $680,611 for fiscal 2021 from $356,252 reported in the prior fiscal year. The increase is primarily attributable to higher values of the price per share of our common stock in fiscal 2021, as compared to fiscal 2020. In addition, two new marketing consultants were hired in fiscal 2021that accounted for $147,654 in stock-based compensation. Consulting expense decreased by $96,020, or 94%, to $6,580 for fiscal 2021 from $102,600 reported in the prior fiscal year. The decrease is attributed to our increase in wages in fiscal 2021. Payroll and payroll related expenses increased to $3,117,075 in fiscal 2021. In fiscal 2020 compensation was paid through the issuance of common stock grants and cash payments to consultants. Payroll expense also increased in fiscal 2021 due to the acquisition of Netcapital Funding Portal Inc., which had approximately 20 employees. General and administrative expenses increased by $392,208, or 539%, to $464,955 for the year ended April 30, 2021, as compared to $72,747 for the prior fiscal year. The primary increase in expenses is attributable to legal costs of approximately $224,000 and software usage fees of $100,000. Interest expense increased by $68,454 to $87,333 for the year ended April 30, 2021, as compared to $18,879 for the prior fiscal year. Our debt balances increased significantly slightly in fiscal 2021 due to $4,271,600 in new borrowings during the year and an increase in the interest rate on our $1,000,000 secured loan, effective October 31, 2020, from 1.25% to 8%. In fiscal 2020 we incurred a loss on the sale of investments of $527,540. We sold equity we had earned in one of our consulting engagements primarily to take advantage of a realized loss for tax purposes. No realized gains or losses were recognized in fiscal 2021. In fiscal 2020 we incurred an impairment loss of $185,952, whereas no impairment losses were recognized in fiscal 2021. We monitor all our assets for any changes in observable prices from orderly transactions and we record an impairment expense when appropriate. Liquidity and Capital Resources As of April 30, 2021, we had cash and cash equivalents of $2,473,959 and negative working capital of $4,666,833 as compared to cash and cash equivalents of $11,206 and negative working capital of $1,057,581 as of April 30, 2020. We have been successful in raising capital by selling restricted common stock in private placements and by borrowing funds from the U.S. Small Business Administration. The negative working capital balance as of April 30, 2021 has been eliminated by converting approximately $5 million in current liabilities into shares of common stock at a price range of $9.00 to $9.74 per share. In addition to the settlement of $5 million in current liabilities, we anticipate a $1.8 million SBA loan will be forgiven this summer and we raised an additional $300,000 from the sale of shares of common stock in May 2021. We believe that our existing cash investment balances, and our anticipated cash flows from operations will be sufficient to meet our working capital and expenditure requirements for the next 12 months. Although we believe we have adequate sources of liquidity over the next 12 months, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity. Up to this point in time, we believe the pandemic has helped drive people to online investing, as we see regular monthly increases in users and dollars invested, and an increase in issuers seeking to use online fund-raising services in lieu of face-to-face meetings. 12 Year over Year Changes Net cash used in operating activities amounted to $3,250,868 in fiscal 2021, as compared to net cash used in operating activities of $3,604 in fiscal 2020. In fiscal 2021, the primary uses of cash were an unrealized gain on equity securities of $2,571,494, non-cash revenue from the receipt of equity of $2,319,532 and an increase in accounts receivable of $1,417,257. These uses of cash were partially offset by net income of $1,469,660, stock-based compensation of $680,611, a change in deferred taxes of $613,000 and an increase in accounts payable and accrued expenses of $172,204. In fiscal 2020, the principal source of cash from operating activities was net income of $604,851, adjusted by stock-based compensation of $356,252, a loss on the sale of investments of $527,540 and asset impairment of $185,952. These sources of cash from operating activities were offset by investments of $1,538,980 because of non-cash contract revenue with major customers. In fiscal 2021, net cash provided by investing activities amounted to $242,025. Proceeds from the purchase of a subsidiary provided cash of $364,939, which was offset by a use of cash of $122,914 as an investment in an affiliate. There was no investing activity in fiscal 2019. Net cash provided by financing activities totaled $5,471,596. Proceeds from loans amounted to $4,271,600 and proceeds from stock subscriptions totaled $1,199,996. Net cash used in financial activities in fiscal 2020 consisted of principal payments on a related party note totaling $4,300. In fiscal 2021 and 2020, there were no expenditures for capital assets. We do not anticipate any capital expenditures in the next fiscal year. New Accounting Standards The new accounting pronouncements in Note 1 to our financial statements, which are included in this Report, are incorporated herein by reference thereto. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. The most significant estimates include: ● revenue recognition and estimating allowance for doubtful accounts; ● valuation of long-lived and indefinite-lived assets; and ● valuation of investments and identification of observable price changes. We continually evaluate our accounting policies and the estimates we use to prepare our financial statements. In general, the estimates are based on historical experience, on information from third party professionals and on various other sources and assumptions that are believed to be reasonable under the facts and circumstances at the time such estimates are made. Management considers an accounting estimate to be critical if: ● it requires assumptions to be made that were uncertain at the time the estimate was made; and ● changes in the estimate, or the use of different estimating methods, could have a material impact on our consolidated results of operations or financial condition. Actual results could differ from those estimates. Significant accounting policies are described in Note 1 to our financial statements, which are included in this Report. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. Certain of our accounting policies are deemed “critical”, as they require management's highest degree of judgment, estimates and assumptions. The following critical accounting policies are not intended to be a comprehensive list of all of our accounting policies or estimates: Revenue Recognition The Company recognizes service revenue from its consulting contracts and its game website using the five-step model as prescribed by ASC 606: • Identification of the contract, or contracts, with a customer; • Identification of the performance obligations in the contract; • Determination of the transaction price; • Allocation of the transaction price to the performance obligations in the contract; and • Recognition of revenue when or as, the Company satisfies a performance obligation. 13 Allowance for Doubtful Accounts In order to record the Company’s accounts receivable at their net realizable value, the Company must assess their collectability. A considerable amount of judgment is required in order to make this assessment, including an analysis of historical bad debts and other adjustments, a review of the aging of the Company’s receivables, and the current creditworthiness of the Company’s customers. Generally, when a customer account reaches a certain level of delinquency, the Company provides an allowance for the related amount receivable from the customer. The Company writes off the accounts receivable balance from a customer and the related allowance established when it believes it has exhausted all reasonable collection efforts. Accounts receivable of $1,356,932 and $0 were recorded at April 30, 2021 and 2020, respectively, and an allowance for doubtful accounts of $60,325 and $0 were recorded at April 30, 2021 and 2020, respectively. Impairment of Long-Lived Assets Financial Accounting Standards Board (“FASB”) authoritative guidance requires that certain assets be reviewed for impairment and, if impaired, remeasured at fair value whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Impairment loss estimates are primarily based upon management’s analysis and review of the carrying value of long-lived assets at each balance sheet date, utilizing an undiscounted future cash flow calculation. We recognized an impairment loss of $0 and $185,952 in fiscal 2021 and 2020, respectively, as we concluded the carrying amount of the equity that we owned in an early-stage company was not recoverable and we wrote down the value of our investment. Income Taxes We estimate the degree to which tax assets and loss carryforwards will result in a benefit based on expected profitability by tax jurisdiction. A valuation allowance for such tax assets and loss carryforwards is provided when it is determined that such assets will more likely than not go unused. If it becomes more likely than not that a tax asset or loss carry-forward will be used, the related valuation allowance on such assets is reversed. Based upon several profitable quarters over the past two years, and our ability to generate operating income of $1,147,222 and $624,433 in fiscal 2020 and 2019, respectively, and taxable income in both fiscal years, we reversed the valuation allowance from April 30, 2019 and recorded a current deferred tax asset as of April 30, 2020, and a deferred tax liability as of April 30, 2021. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Information About Market Risk We are not subject to fluctuations in interest rates, currency exchange rates or other financial market risks. We have not made any sales, purchases or commitments with foreign entities which would expose us to currency risks. 14 Item 7A. Quantitative and Qualitative Disclosures about Market Risk. We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide information under this item. Item 8. Financial Statements and Supplementary Data. Our Consolidated Financial Statements required by this Item are included herein, commencing on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable.