Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements for the three months ended September 30, 2020, and the related notes thereto, which have been prepared in accordance with generally accepted accounting principles in the United States.
Forward-Looking Statements
This Quarterly Report on Form 10-Q including all exhibits hereto contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding future events or our future results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management. In some cases, forward-looking statements can be identified because they contain words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “likely,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or similar expressions and the negatives of those terms. Forward-looking statements are based on information available to our management as of the date of this Quarterly Report and our management’s good faith belief as of such date with respect to future events and are subject to a number of risks, uncertainties, and assumptions that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements, in particular the substantial risks and uncertainties related to the ongoing COVID-19 pandemic. Important factors that could cause such differences to include, but are not limited to:
| ● | our ability to sustain our revenue growth rate, to achieve or maintain profitability, and to effectively manage our anticipated growth; |
| ● | our short operating history makes it difficult to evaluate our business and future prospects; |
| ● | our dependence on the commercial success of our clients, the continued growth of the cannabis industry and the regulatory environment in which the cannabis industry operates |
| ● | our ability to attract new clients on a cost-effective basis and the extent to which existing clients renew and upgrade their subscriptions; |
| ● | the timing of our introduction of new solutions or updates to existing solutions; |
| ● | our ability to successfully diversify our solutions by developing or introducing new solutions or acquiring and integrating additional businesses, products, services, or content; |
| ● | our ability to respond to changes within the cannabis industry; |
| ● | the effects of adverse changes in, or the enforcement of, federal laws regarding our clients’ cannabis operations or our receipt of proceeds from such operations; |
| ● | our ability to manage unique risks and uncertainties related to government contracts; |
| ● | our ability to manage and protect our information technology systems; |
| ● | our ability to maintain and expand our strategic relationships with third parties; |
| ● | our ability to deliver our solutions to clients without disruption or delay; |
| ● | our exposure to liability from errors, delays, fraud, or system failures, which may not be covered by insurance; |
| ●
| our ability to expand our international reach; |
| ● | our ability to retain or recruit officers, key employees, and directors; |
| ● | our ability to raise additional capital or obtain financing in the future; |
| ● | our ability to successfully integrate acquired businesses with Akerna’s business within anticipated timelines and at their expected costs;
|
| ● | our ability to complete planned acquisitions on time or at all due to failure to obtain stockholder approval or governmental or regulatory clearances, or the failure to satisfy other conditions to completion, or the failure of completion for any other reason;
|
| ● | our response to adverse developments in the general market, business, economic, labor, regulatory, and political conditions, including worldwide demand for cannabis and the spot price and long-term contract price of cannabis; |
| ● | our response to competitive risks; |
| ● | our ability to protect our intellectual property; |
| ● | the market reaction to negative publicity regarding cannabis; |
| ● | our ability to manage the requirements of being a public company; |
| ● | our ability to service our convertible debt; |
| ● | our ability to effectively manage any disruptions to our business and/or any negative impact to our financial performance caused by the economic and social effects of the COVID-19 pandemic and measures taken in response; and
|
| ● | other factors discussed in other sections of this Quarterly Report on Form 10-Q, including the sections of this report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and under Part II, Item 1A. “Risk Factors” and in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission, or the SEC, on September 29, 2020, under Part I, Item 1A, “Risk Factors.” |
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated, or expected. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. We disclaim any obligation to revise subsequently any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. We qualify all the forward-looking statements contained in this Quarterly Report by the foregoing cautionary statements.
Business Overview
We are a leading provider of enterprise software solutions that enable regulatory compliance and inventory management. Our proprietary software platforms are adaptable for industries in which interfacing with government regulatory agencies for compliance purposes is required, or where the tracking of organic materials from seed or plant to end products is desired. Over ten years ago, we identified a need for organic material tracking and regulatory compliance software as a service, or SaaS, solutions in the growing cannabis and cannabidiol, or CBD, industry. We now seek to create the backbone on which the cannabis industry is built by providing an integrated ecosystem of applications and services that enables compliance, regulation and taxation. We develop products intended to help state-licensed businesses operate in compliance with applicable laws and to assist states in monitoring licensed businesses’ compliance with state regulations. We provide commercial software platforms to state and federally licensed businesses and our regulatory software platform to government regulatory agencies. Our integrated ecosystem provided additional integrations and add-ons that enhance the capabilities of our commercial software platforms. Although we have helped monitor legal compliance for more than $20 billion in cannabis sales to date, we do not handle any cannabis-related material, do not process cannabis sales transactions within the United States, and our revenue generation is not related to the type or amount of sales made by our clients, as revenues are generated by us on a fixed-fee based subscription model.
Executing upon the expansion strategy detailed by CEO Jessica Billingsley in 2019, we have acquired competitive brands Ample Organics, or Ample, on July 7, 2020 and Trellis Solutions, or Trellis, on April 10, 2020. These additions to the Akerna family of brands add two well-known seed-to-sale software options with reputable experience and significant market share. Ample Organics, the leading Health Canada approved software for Canadian Licensed Producers, or LPs, has majority market share in Canada, the only G7 country with federally legal cannabis. Trellis also brings a streamlined solution for Cultivators, Manufacturers, and Distributors, trusted by some of California’s largest brands.
Through the Akerna family companies, MJ Freeway, or MJF, Ample, and Trellis, we provide highly-versatile platforms that provide our clients with a central data management system for tracking regulated products – from seed to initial plant growth to the product to the final sale of the product to a patient or consumer – throughout the complete supply chain, using a global unique identifier method. Our platforms also provide clients with integrated security, transparency, and scalability capabilities. These capabilities allow our state-licensed clients to control inventory, operate efficiently in a fast-changing industry and comply with state, local, and federal (in countries such as Canada, Italy, Macedonia, and Colombia) regulation at all times, and allows our government regulatory clients to effectively and cost-efficiently monitor licensees and ensure commercial businesses are complying with their states’ regulations.
We generate revenue from software sales and by providing consulting services as follows:
| ● | Commercial Software Products – MJ Platform® is our SaaS offering for state and legally-licensed businesses. MJ Platform is an Enterprise Resource Planning, or ERP, compliance system specific to the cannabis industry, including state-legal marijuana, hemp, and CBD industry. MJ Platform is comprised of integrated modules designed to meet the regulations and inventory management needs of cannabis and hemp CBD cultivators, manufacturers, distributors, and retailers, but has applications in other industries.
The Ample suite of products includes AmpleOrganics, a seed-to-sale SaaS cannabis compliance offering for Canadian Licensed Producers; AmplePayments, a payment processing offering; AmpleCare, an API-first middleware solution that allows for the submission of both patient registration documents and medical documents in a secure electronic format to licensed producers using the AmpleOrganics seed-to-sale platform; and AmpleLearn, an education and training platform designed to educate and onboard personnel working within a licensed cannabis company.
Trellis’ seed-to-sale SaaS offering features inventory tracking to manage a licensee’s cannabis inventory from cultivation to extraction and sale. The Trellis product is designed to meet the needs of smaller licensees.
|
| ● | Government Regulatory Software Products – Leaf Data Systems is our SaaS product for government agencies. Leaf Data Systems is a compliance tracking system designed to give regulators visibility into the activity of licensed cannabis businesses in their jurisdictions. We are serving three clients for Leaf Data Systems, the Commonwealth of Pennsylvania, the State of Washington and the State of Utah. The Commonwealth of Pennsylvania and the State of Utah both require licensed cannabis operators to also use MJ Platform to report their compliance information. The State of Utah mandates the use of solo*TAGTM to provenance plants and products throughout the compliance supply chain. |
|
|
|
| ● | Consulting Services Contracts – We provide consulting services to cannabis industry operators interested in entering the cannabis industry and in integrating our platforms into their respective operations and systems. We consult with clients on a wide range of areas to help them successfully maintain compliance with state law. We work with clients to efficiently comply with state requirements in connection with the launch and operations of their cannabis businesses. Our management team and key personnel have broad experience gained from working with numerous cannabis operations. Our consulting team has experience in most aspects of cannabis operations in most verticals (e.g., cultivation, processing, distribution, manufacturing, and retail). Our service providers understand the intricacies of the varying regulations governing cannabis in each jurisdiction and, to the extent necessary, modify the professional services based on the jurisdiction. We provide project-focused consulting services to clients that are initiating or expanding their cannabis businesses or are interested in data consulting engagements with respect to the legal cannabis industry. Our advisory engagements include service offerings focused on compliance requirement assessments, readiness and best practices, compliance monitoring systems, application processes, inspection readiness, and business plan and compliance reviews. We typically provide our consulting services to clients in emerging markets that are seeking consultation on newly introduced licensing regimes and assistance with the regulatory compliant build-out of operations in newly legal states. |
|
|
|
| ●
| Business Intelligence and Data Analytics Products—Akerna Business Intelligence is an Infrastructure as a Service (IaS) tool which delivers supply chain analytics for the cannabis, hemp, and CBD industry. Last Call Analytics provides a subscription analytics tool for alcohol brands to analyze their retail sales analytics. |
We also resell a limited number of printers for printing compliance product labels and scales that are National Type Evaluation Program certified legal for trade. Revenue from these resale activities was 2% of total revenue in each of the three months ended September 30, 2020, and September 30, 2019. Beginning late in our fiscal year ended June 30, 2020, we entered into a revenue-sharing arrangement with a printer supplier, as a result, we expect our revenue and cost of sales related to this activity to decrease in the future. Following our acquisition of solo sciences, inc., or Solo, in January 2020, we sell a cannabis tracking technology that provides our clients with seed-to-sale-to-self data throughout a product’s life cycle.
We drive commercial software revenue growth by leveraging our reputation and we benefit from continued growth in the cannabis, hemp, and CBD industry. We believe we are well known in these industries and the brand recognition of our existing products, our ability to provide services in all areas of the seed-to-sale life cycle, and our wealth of relevant experience attracts operating cultivation, manufacturing, and dispensary clients who are seeking comprehensive services as well as attracting newly formed clients as they enter into existing markets or newly legalized markets. We also experience revenue growth in states and countries with an established market by providing a solution to operators seeking to vertically integrate and improve their business processes. We provide not only a vertically integrated solution across the cannabis, hemp, and CBD supply chain, but also provide a business intelligence capture, MJ Analytics, which provides operators with timely information about their business to allow them to run their businesses efficiently. This business intelligence capture is derived from the suite of services we provide and sets us apart from competitors.
Through our ecosystem strategy including acquisition, investment, and partnership strategies, we are creating the backbone on which the cannabis industry is built, enabling compliance, regulation, and taxation. With the Akerna family of companies, we are able to provide our new and existing clients with full transparency through the tracking of organic matter from seed-to-sale. We believe our integrated ecosystem creates further value by providing additional integrations and add-ons that enhance the capabilities and experience of our full client base. For example:
| ● | our integration with tier one ERP software providers supplying sophisticated accounting solutions that collect and store business transactions to satisfy external reporting requirements; |
| | |
| ● | our integration with over 85 partners to provide full-service solutions at all points in the cannabis business life cycle, including compliance, hardware, banking, accounting, online ordering, payment solutions, CRM and loyalty, delivery, and business analytics; |
|
|
|
| ● | our license with ZolTrain provides our MJ Platform clients with training modules to educate their staff and improve the patient /consumer experience by pairing education with product information both in person and through digital channels; |
|
|
|
| ●
| our Leaf Data Systems track-and-trace solution specifically customized for the State of Utah to include an electronic verification system and inventory control system, implements solo* TAGTM, the world’s first cryptographically-secure, cannabis product authentication system, exclusively for governments as an alternative to radio-frequency identification, or RFID, tracking; and
|
|
|
|
| ●
| MJ Analytics, a next-generation analytics platform that offers Enterprise-level data tools and provides users with unparalleled access and insight into the cannabis supply chain, from seed to sale. |
We use our years of experience, proprietary databases, and resources to identify trends and predict changes in the cannabis industry in order to evolve our products and better assist our clients in operating in compliance with the applicable laws of their jurisdictions and capitalizing on commercial opportunities within the applicable regulatory framework, with accuracy, efficiency, and geographic specificity. Following our July 2020 acquisition of Ample Organics, we have four data products: The MJ Analytics, or MJA; and Akerna Acumen Business Insights, which both leverage the extensive data captured in each of MJ Platform’s cultivation, E&I, distribution, and retail modules; AmpleData, which leverages data obtained through Canadian regulated retail channels; and Last Call Analytics, which provides retail sales analytics for alcohol brands. MJA gives MJ Platform clients access to aggregated data across their organization to keep track of emerging legal and commercial trends, allowing for informed actionable insights at various levels within the organization, including room, location, state, brand, and administration. MJ Platform allows users to align their operational data from three vantage points: in real-time, past trends, and predictive future. These proprietary databases assist users in making important decisions in real-time with respect to product monitoring, tracking, planning, and pricing.
Financial Results of Operations
Revenue
Our software revenue is derived from our commercial software platforms, MJ Platform®, Ample and Trellis, our data analytics offerings, our SaaS ERP offerings for state-licensed businesses, and our government regulatory platform, Leaf Data Systems, our track-and-trace product for government agencies. Commercial software contracts are generally annual contracts paid monthly in advance of service and cancellable upon 30 days’ notice after the first year, although we do have some multi-year commercial software contracts. Leaf Data Systems contracts are generally multi-year contracts payable annually or quarterly in advance of service. Commercial software and Leaf Data Systems contracts generally may only be terminated early for breach of contract as defined in the respective agreements.
Consulting services revenue growth is driven by numerous factors. In new emerging states, we provide solutions for operators in the pre-application for licensure and pre-operational phases of development. These services include application and business plan preparation as they seek licenses to be granted. Consulting projects completed during the pre-application phase generally solidify us as the software vendor of choice for subsequent operational phases once the operator is granted the license. As a result, our consulting revenue is driven as new emerging states pass legislation, and as our client-operators gain licenses. Accordingly, we expect our consulting services to continue to grow as more states emerge with legalization reforms.
Our other revenue is derived primarily from the sale of business intelligence and data analytics products, point of sale hardware and labels, including solo*TAG™ and solo*CODE™.
Cost of Revenue
Our cost of revenue is derived from direct costs associated with operating our commercial and government regulatory software platforms and providing consulting services. The cost of revenue for our commercial and government regulatory platforms relates primarily to hosting and infrastructure costs and subcontractor expenses incurred in connection with certain government contracts. Consulting cost of revenue relates primarily to our employees’ and consultants’ salaries and other related compensation expenses. We record the cost of revenue using on the direct cost method. This method requires the allocation of direct costs including support services and materials to the cost of revenue.
Product and Development Expenses
Our product development expenses include salaries and benefits, nearshore contractor expenses, technology expenses, and other overhead related to the ongoing maintenance of our commercial and government regulatory software platforms and planning for new software development, that does not qualify for capitalization.
Selling, General and Administrative Expenses
Sales and marketing expense is primarily salaries and related expenses, including commissions, for our sales, marketing, and client service staff. We also categorize payments to partners and marketing programs as sales and marketing expenses. Marketing programs consist of advertising, events, such as trade shows, corporate communications, brand building, and product marketing activities. We plan to continue to invest in marketing and sales by expanding our domestic and international selling and marketing activities, building brand awareness, attracting new clients, and sponsoring additional marketing events. The timing of these marketing events will affect our marketing costs in a particular quarter.
Critical Accounting Policies and Estimates
Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended June 30, 2020. Since the date of the Annual Report, there have been no material changes to our critical accounting policies.
Results of Operations for the Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019
The following table highlights the various sources of revenues and expenses for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019:
| Three Months Ended September 30, | | Change | |
| 2020 | | | 2019 | | Period over Period | |
Revenues: | | | | | | | | | |
Software | $ | 3,154,442 | | | $ | 2,254,480 | | $ | 899,962 | | | 40 | % |
Consulting | | 331,080 | | | | 831,363 | | | (500,283 | ) | | (60 | %) |
Other | | 228,482 | | | | 107,047 | | | 121,435 | | | 113 | % |
Total revenue | | 3,714,004 | | | | 3,192,890 | | | 521,114 | | | 16 | % |
| | | | | | | | | | | | | |
Cost of revenues | | 1,739,937 | | | | 1,379,701 | | | 360,236 | | | 26 | % |
Gross profit | | 1,974,067 | | | | 1,813,189 | | | 160,878 | | | 9 | % |
Gross profit margin | | 53% |
| | | 57% | | | | | | | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Product development: | | 1,758,826 | | | | 610,902 | | | 1,147,924 | | | 188 | % |
Sales and marketing |
| 2,097,502 |
|
|
| 1,841,514 |
|
| 255,988 |
|
| 14 | % |
General and administrative | | 2,470,187 | | | | 1,742,301 | | | 727,886 | | | 42 | % |
Depreciation and amortization |
| 1,171,022 |
|
|
| 17,899 |
|
| 1,153,123 |
|
| nm |
|
Total operating expenses | | 7,497,537 | | | | 4,212,616 | | | 3,284,921 | | | 78 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations | $ | (5,523,470 | ) | | $ | (2,399,427 | ) | $ | (3,124,043 | ) | | 130 | % |
nm – percentage change not meaningful
Total Revenue
Total revenue increased to $3.7 million for the three months ended September 30, 2020 from $3.2 million for the three months ended September 30, 2019, an increase of $0.5 million, or 16%. The increase in total revenue compared to the fiscal three months ended September 30, 2019 was driven primarily by our growth achieved following our acquisition of Ample, partially offset by a decrease in consulting revenue, discussed below.
Software Revenue
Our total software revenue increased to $3.2 million for the fiscal three months ended September 30, 2020 from $2.3 million for the three months ended September 30, 2019, for an increase of $0.9 million, or 40%. Software revenue accounted for 85% and 71% of total revenue for the three months ended September 30, 2020 and 2019, respectively. The increase in software revenue during the three months ended September 30, 2020 was primarily driven by our acquisition of Ample.
Software revenues generated from government clients totaled $0.9 million and $1.1 million during the three months ended September 30, 2020 and 2019, respectively. Leaf Data Systems revenue decreased for the three months ended September 30, 2020 compared to 2019 primarily as a result of a decrease in the volume of change orders. Change orders represent out-of-scope functionality modifications requested by the client. Revenues earned from these change orders are recognized upon acceptance and delivery of the requested modifications. As a result, revenues from change orders vary and may be impacted by the timing of entering into agreements and the number of requested change orders in any given period.
Consulting Revenue
Our consulting revenue includes revenue generated from consulting services delivered to prospective and current cannabis, hemp and CBD businesses and business operators. Our consulting revenue was $0.3 million for the three months ended September 30, 2020 compared to $0.8 million for the three months ended September 30, 2019, a decrease of $0.5 million, or 60%. This decrease is mainly due to the impact of COVID-19. Consulting services are correlated to state legalizations and other regulatory expansion activity. As a result, individual year-over-year comparisons experienced variability depending on the timing of recent legislative changes. During the COVID-19 pandemic and resulting shut-down, state legislatures have turned their focus to the pandemic and tabled work on cannabis legislation, which resulted in delays in our providing consulting services during the first quarter of fiscal 2020. However, many state ballot initiatives were passed for new medical or adult-use marijuana laws in the November 2020 elections. We expect, despite the slowing of our consulting activity experienced during the pandemic, we will see increased demand for our services following the November 2020 elections.
Consulting revenue was 9% and 26% of total revenue for the three months ended September 30, 2020 and 2019, respectively. Due to the nature of consulting revenue, our dependence on emerging market activity as well as the ongoing pandemic as a driver of demand, the quarters in which we recognize consulting revenue has varied from year to year depending on whether state legislation has expanded to allow new market entrants or growth of existing market participant operations.
Other Revenue
Other revenue includes our business intelligence and data analytics revenue, retail/resale revenue, which was generated from point of sale hardware, and revenue generated by the sale of solo*TAGsTM, solo*CODEsTM and the related activation fees. Other revenue increased to $0.2 million for the three months ended September 30, 2020 from $0.1 million for the three months ended September 30, 2019 due to the acquisition of Ample. Other revenue was 6% and 3% of total revenue for the three months ended September 30, 2020 and 2019. We have entered into a revenue-sharing agreement with a printer supplier, whereby our clients will acquire hardware from the supplier and the supplier will share a percentage of revenue generated by our clients with us. In accordance with GAAP, we may only recognize the portion of the revenue that the supplier shares with us pursuant to the new arrangement, as a result, we expect both revenue and cost of sales to decrease in the future, with minimal effect on gross margin.
Cost of Revenue and Gross Profit
Our cost of revenue increased to $1.7 million for the three months ended September 30, 2020 from $1.4 million for the three months ended September 30, 2019, an increase of 26%. This increase was primarily due to the addition of a subcontractor supporting our Leaf Data Systems contract with Utah, an increase in subcontractor costs to support our contract with Pennsylvania, and an increase in the cost of hosting, software and applications as a result of our increased usage fees for cloud service providers to support the growth in commercial software platform subscriptions and government regulatory platform contracts. We also incurred higher direct labor costs associated with providing our consulting services of $0.2 million.
Because the applications and services available through the Leaf Data Systems are provided through relationships with third-party service providers at higher costs than those from our commercial software platform contracts, the gross profit margins from the government contracts are generally lower than those from our commercial software clients. Total costs of government revenues incurred by us, which are included in the cost of revenues on the statement of operations, were $0.8 million and $0.7 million during the three months ended September 30, 2020 and 2019, respectively. The increase in the cost of government revenues incurred by us was due to the additional customer requests of our contracts with the state of Utah and Pennsylvania, and a higher volume of ongoing support and maintenance services provided by subcontractors in connection with the contracts with Pennsylvania and Washington.
Operating Expenses
The following table presents operating expense line items for the three months ended September 30, 2020 and 2019 and the period-over-period dollar and percentage changes for those line items:
| Three Months Ended September 30, | | Change | |
| 2020 | | 2019 | | Period over Period | |
Operating expenses: | | | | | | | | |
Salary expenses, excluding Solo, Trellis, and Ample | $ | 884,016 | | $ | 317,377 | | $ | 566,639 | | | 179 | % |
Product development of Solo, Trellis, and Ample |
| 592,740 |
|
| — |
|
| 253,292 |
|
| nm |
|
Other product development | | 282,070 | | | — | | | 592,740 | | | nm | |
Product development | | 1,758,826 | | | 610,902 | | | 1,147,924 | | | 188 | % |
Percentage of revenue | | 47% | | | 19% | | | | | | | |
| | | | | | | | | | | | |
Sales and marketing, excluding Solo, Trellis, and Ample | | 1,700,930 | | | 1,841,514 | | | (140,584 | ) | | (8 | %) |
Sales and marketing of Solo, Trellis, and Ample |
| 396,572 |
|
| — |
|
| 396,572 |
|
| nm |
|
Sales and marketing |
| 2,097,502 |
|
| 1,841,514 |
|
| 255,988 |
|
| 14 | % |
Percentage of revenue
| | 56% |
|
| 58% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative salaries, excluding Solo, Trellis, and Ample | | 646,530 | | | 445,647 | | | 200,883 | | | 45 | % |
Transaction related costs |
| 951,865 |
|
| 142,437 |
|
| 809,428 |
|
| nm |
|
Change in fair value of contingent consideration | | (389,000 | ) | | — | | | (389,000 | ) | | nm | |
Bad debt expense | | 12,450 | | | 252,809 | | | (240,359 | ) | | (95 | %) |
Restructuring costs |
| 68,190 |
|
| — |
|
| 68,190 |
|
| nm |
|
General and administrative expenses of Solo, Trellis, and Ample |
| 330,538 |
|
| — |
|
| 330,538 |
|
| nm |
|
General and administrative stock-based compensation |
| 346,059 |
|
| 41,542 |
|
| 304,517 |
|
| 733 | %) |
Other general and administrative |
| 503,555 |
|
| 859,866 |
|
| (356,311 | ) |
| (41 | %) |
General and administrative | | 2,470,187 | | | 1,742,301 | | | 727,886 | | | 42 | % |
Percentage of revenue | | 67% | | | 55% | | | | | | | |
| | | | | | | | | | | | |
Total operating expenses | $ | 7,497,537 | | $ | 4,212,616 | | $ | 3,284,921 | | | 78 | % |
Percentage of revenue | | 202% | | | 132% | | | | | | | |
nm – percentage change not meaningful
Our operating expenses increased to $7.5 million for the three months ended September 30, 2020, from $4.2 million for the three months ended September 30, 2019, an increase of $3.3 million, or 78%. The increased level of operating expenses for the three months ended September 30, 2020, was the result of investments made in personnel, technology and other infrastructure as we continue to position ourselves for growth both organically and through strategic acquisitions, and transactional costs associated with acquisitions and financing activities.
Product development expenses increased to $1.8 million for the three months ended September 30, 2020, from $0.6 million for the three months ended September 30, 2019, an increase of $1.2 million, or 188%. Salary expense for product development functions increased by $0.6 million, primarily due to the reduced usage of third party contractors associated with software development. Our acquisitions also contributed to the increase in product development spend for the three months ended September 30, 2020.
Sales and marketing expenses increased $0.3 million during the three months ended September 30, 2020, as compared to September 30, 2019, primarily as a result of our acquisitions.
General and administrative expenses increased to $2.5 million for the three months ended September 30, 2020, from $1.7 million for the three months ended September 30, 2019, an increase of $0.7 million, or 42%. This increase was primarily due to transactional costs we are required to expense as incurred and an increase in other general and administrative costs. During the three months ended September 30, 2020, we incurred legal and other costs totaling $1.0 million primarily in connection with our acquisition of Ample. We also recognized a $0.4 million reduction in the estimated fair value of contingent consideration paid for our acquisition of Solo in July 2020. Bad debt expense decreased by $0.2 million, during the three months ended September 30, 2020, as compared to 2019, due to our improvement in the overall quality of our revenue and client portfolio, enhancement of our sales and marketing team has resulted in a steady decline in the number and amount of delinquent accounts resulting in bad debt expense since the three months ended September 30, 2019. During the three months ended September 30, 2020, we have an additional $0.3 million in general and administrative expenses associated with Solo, Trellis, and Ample compared to the three months ended September 30, 2019. Other general and administrative expenses decreased by $0.4 million, most notably due to lower technology costs as compared to the three months ended September 30, 2019.
Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool, and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP.
Investors are cautioned that there are material limitations associated with the use of non-GAAP financial measures as an analytical tool. Other companies, including companies in our industry, may calculate similarly titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. We attempt to compensate for these limitations by providing specific information regarding the GAAP items excluded from these non-GAAP financial measures.
Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures and not rely on any single financial measure to evaluate our business.
EBITDA and Adjusted EBITDA
We believe that EBITDA and Adjusted EBITDA, when considered with the financial statements determined in accordance with GAAP, are helpful to investors in understanding our performance and allows for comparison of our performance and credit strength to our peers. EBITDA and Adjusted EBITDA should not be considered alternatives to net loss as determined in accordance with GAAP as indicators of our performance or liquidity.
We define EBITDA as net loss before interest income and expense and changes in fair value of convertible notes, provision for income taxes, depreciation and amortization. We calculate Adjusted EBITDA as EBITDA further adjusted to exclude the effects of the following items for the reasons set forth below:
| ●
| share-based compensation expense, because this represents a non-cash charge and our mix of cash and share-based compensation may differ from other companies, which effects the comparability of results of operations and liquidity; |
| ● | cost incurred in connection with business combinations that are required to be expensed as incurred in accordance with GAAP, because business combination related costs are specific to the complexity and size of the underlying transactions as well as the frequency of our acquisition activity these costs are not reflective of our ongoing operations; |
| ● | costs incurred in connection with debt issuance when we elect the fair value option to account for the debt instrument because if we had not elected the fair value option such costs would be recognized as an adjustment to the effective interest and excluded from EBITDA; |
| ● | restructuring costs because we believe these costs are not representative of operating performance; and |
| ●
| equity in earnings (losses) of investees because our share of the operations of investees is not representative of our own operating performance and may not be monetized for a number of years. |
The reconciliation of net loss to EBITDA and Adjusted EBITDA for the three months ended September 30, 2020and 2019 is as follows:
| | 2020 | |
| 2019 |
|
Net loss | | $ | (4,750,691 | ) |
| $ | (2,326,332 | ) |
Adjustments: | | | | |
|
|
|
|
Interest (income) expense and change in fair value of convertible notes | | | (774,313 | ) |
|
| (73,382 | ) |
Depreciation and amortization | | | 1,171,022 | |
|
| 17,899 |
|
EBITDA | | $ | (4,353,982 | ) |
| $ | (2,381,815 | ) |
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
| | | 681,419 | |
|
| 161,165 |
|
Business combination and merger related costs | | | 951,865 |
|
|
| — |
|
Debt issuance costs related to fair value option debt instruments | | | 43,167 |
|
|
| — |
|
Restructuring charges |
|
| 68,190 |
|
|
| — |
|
Changes in fair value of contingent consideration |
|
| (389,000
| ) |
|
| — |
|
Equity in losses of investee |
|
| 1,534 |
|
|
| — |
|
Adjusted EBITDA | | $
| (2,996,807 | ) |
| $ | (2,220,650 | ) |
Liquidity and Capital Resources
Since our inception, we have incurred recurring operating losses, used cash in operations, and relied on capital raising transactions to continue ongoing operations. During the three months ended September 30, 2020, we incurred a loss from operations of $5.5 million and used cash in operations of $4.2 million. As of September 30, 2020, we had cash of $14.3 million, excluding restricted cash, and working capital of $0.9 million.
During the quarter ended September 30, 2020, the Company incurred a number of one-time, non-recurring expenses of approximately $1.1 million. These expenses include business combination expenses, restructuring, and other non-recurring charges. Additionally, on October 30, 2020, we closed on the public offering of 5 million shares of common stock with proceeds of approximately $11.0 million net of offering costs, which will be used for general corporate purposes. During the three months ended September 30, 2020, we implemented a number of cost reduction initiatives reducing costs and identifying cost savings that we expect to result in annual savings of an additional $3.0 million to $4.0 million. As a result, we expect that our current working capital is sufficient to fund our operations and commitments for a period of at least twelve months from the date these financial statements are issued.
In the event the Company requires additional liquidity, the Company can further reduce or defer expenses. More specifically, the Company could implement certain discretionary cost reduction initiatives relating to our spending on employee travel and entertainment, consulting costs and marketing expenses, negotiate deferred salary arrangements, furlough employees or reduce headcount or negotiate extensions of payments of rent and utilities. The Company also believes it has access to capital through future debt or equity offerings and could be successful in renegotiating the maturity dates or conversion option relating to its current outstanding notes payable, although no assurance can be provided that we would be successful in these efforts. Further, the potential continues to exist that our $2 million PPP loan could be forgiven. Management will continue to evaluate our liquidity and capital resources.
Cash Flows
Our cash and restricted cash balances were $14.8 million and $24.7 million as of September 30, 2020 and 2019, respectively. Cash flow information for the three months ended September 30, 2020, and 2019 is as follows:
| | Three Months Ended September 30, | |
| | 2020 | | | 2019 | |
Cash provided by (used in): | | | | | | |
Operating activities | | $ | (4,181,159 | ) | | $ | (3,142,174 | ) |
Investing activities | | | (5,704,806 | ) | | | (519,739 | ) |
Financing activities | | | (12,668 | ) | | | 4,242,454 | |
Net change in cash and restricted cash | | $ | (9,898,633 | ) | | $ | 580,541 | |
Sources and Uses of Cash for the three months ended September 30, 2020 and 2019
Net cash used in operating activities increased to $4.2 million during the three months ended September 30, 2020, from $3.1 million during the three months ended September 30, 2019, an increase of $1.0 million. The increase in cash used in operating activities was primarily driven by the increase in net loss from operations of $3.1 million described above, partially offset by the effect of the timing of cash received from clients relative to when we recognize revenue.
Net cash used in investing activities totaled $5.7 million during the three months ended September 30, 2020, as a result of net cash paid as consideration for the Ample acquisition and amounts invested in the development of our software products. Net cash used by investing activities during the three months ended September 30, 2019, was $0.5 million as a result of amounts invested in the development of our software products.
Net cash used in financing activities totaled $13,000 during the three months ended September 30, 2020 and represents cash paid in connection with our common stock offering that closed on October 30, 2020. Net cash provided by financing activities totaled $4.2 million and represents the proceeds from the exercise of warrants.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is processed, recorded, summarized, and reported within the time periods specified in the Security and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
We have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of September 30, 2020 with the participation, and under the supervision, of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2020, our disclosure controls and procedures were ineffective in ensuring that: (i) information required to be disclosed by us in reports that we file or submit to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and (ii) material information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for accurate and timely decisions regarding required disclosure.
Material Weaknesses
Pursuant to our management’s review of disclosure controls and procedures, management determined that the following material weaknesses existed in our internal control over financial reporting and prevented management from determining that our disclosure controls and procedures were effective as of the end of the period covered by this report:
| 1) | We lacked formally documented system policies and procedures to demonstrate that our system of internal control over financial reporting is designed effectively, including a lack of documentation surrounding our information technology policies and procedures. |
| 2) | We lacked documentation necessary to demonstrate the controls in place are operating effectively, including controls related to the enforcement of segregation of duties in key areas of financial reporting. |
| 3) | We did not have controls in place to ensure that we prepared complete and accurate financial statements in a timely manner in accordance with GAAP. |
Remediation:
We have hired additional experienced resources to fill accounting functions and expects to add further resources. In addition, we have identified upgraded IT, accounting and finance systems, which we expect will automate critical control functions and improve operational effectiveness and efficiencies.
We have contracted an outside consultant to assist in the overall evaluation and documentation of the design and operating effectiveness of our internal controls over financial reporting.
We believe these actions will remediate the control weaknesses. However, the weaknesses will not be considered fully remediated until the applicable controls operate for a sufficient period of time for management to test the results for operating effectiveness. Once implemented, we intend to continue periodic testing and reporting of the internal controls to ensure continuity of compliance.
Changes in Internal Control over Financial Reporting
During the most recently completed fiscal quarter, there have been changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, as described above in our remediation efforts.
Inherent Limitations on Effectiveness of Controls
Management recognizes that a control system, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.