Note 3 – Revenue
Financial Statement Impact of Adopting ASC 606, "Revenue from Contracts with Customers"
On July 1, 2020, we adopted ASC 606 using the modified retrospective transition method and applied this method to all contracts that were not complete as of the date of adoption. The reported results as of June 30, 2021 and December 31, 2020, and three and six months ended June 30, 2021 in the accompanying consolidated financial statements are presented under ASC 606, while prior period results have not been adjusted and are reported in accordance with historical accounting guidance in effect for those periods.
The most significant impacts of this standard relate to the timing of revenue recognition of fixed fees under our contracts, as well as the accounting for costs to obtain contracts. Under ASC 606, revenue recognition for subscription and implementation fees begins on the launch date and is recognized over time through the term of the contract. We then recognized the remaining balance of the fixed fees ratably over the remaining term of the contract. Additionally, under ASC 606, we now defer recognition of expense for sales commissions ("contract costs"). These contract costs are amortized to expense over the expected period of benefit. Before the adoption of ASC 606, we expensed these contract costs as incurred.
Revenue Recognition Policies for the three and six months ended June 30, 2020
We derive our revenues primarily from the following sources: software revenues, which are primarily comprised of subscription fees from government and commercial customers accessing our enterprise cloud computing services and from customers paying for additional support beyond the standard support that is included in the basic subscription fees; and consulting services provided to operators interested in integrating our platform into their respective operations, such services include: assessing compliance requirements, monitoring systems and readiness; assisting with the application process; and evaluating the operator’s inspection readiness and business plan.
We commence revenue recognition when there is persuasive evidence of an arrangement, the service has been or is being provided to the customer, the collection of the fees is reasonably assured, and the amount of fees to be paid by the customer is fixed or determinable.
Software Revenue
Software revenue primarily consists of subscription revenue that is recognized ratably over the term of the contract, beginning when access to the applicable software is provided to the customer. We typically invoice customers at the beginning of the term, in multi-year, annual, quarterly, or monthly installments. When a collection of fees occurs in advance of service delivery, revenue recognition is deferred until such services commence. Revenue for implementation fees is recognized ratably over the expected term of the contract, including expected renewals.
We include service level commitments to customers warranting certain levels of uptime reliability and performance and permitting those customers to receive credits if those levels are not met. In addition, customer contracts often include: specific obligations that require us to maintain the availability of the customer’s data through the service and that customer content is secured against unauthorized access or loss, and indemnity provisions whereby we indemnify customers from third-party claims asserted against them that result from our failure to maintain the availability of their content or securing the same from unauthorized access or loss. To date, we have not incurred any material costs as a result of such commitments. Any such credits or payments made to customers under these arrangements are recorded as a reduction of revenue.
Consulting Services Revenue
Consulting services revenue consists of contracts with fixed terms and fee structures based upon the volume and activity or fixed-price contracts for consulting and strategic services. When these services are not combined with subscription revenues as a single unit of account, as discussed below, these revenues are recognized as services are rendered and accepted by the customer.
Other Revenues
We sell solo*TAG’s and solo*CODEs to customers by the roll of printed labels or as a digital code that allows customers to directly print their packing. When customers active a solo*TAG or solo*CODE, we receive an activation fee, which is recognized upon activation by the customer. From time to time, we may purchase equipment for resale to customers. Such equipment is generally drop-shipped to our customers. We recognize revenue as these products are delivered.
Cost of Revenue
Cost of revenue consists primarily of costs related to providing subscription and other services to our customers, including employee compensation and related expenses for data center operations, customer support and professional services personnel, payments to outside technology service providers, security services, and other tools.
Deferred Revenue
Deferred revenue consists of payments received in advance of revenue recognition from subscription services. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, contract duration, and invoice frequency. Deferred revenue that will be recognized during the succeeding twelve-month period is recorded as deferred revenue, which is a current liability on the accompanying consolidated balance sheets.
Revenue Recognition Policies for the three and six months ended June 30, 2021
In accordance with ASC 606, revenue is recognized when a customer obtains the benefit of promised services, in an amount that reflects the consideration the Company expects to be entitled to receive in exchange for those services. In determining the amount of revenue to be recognized, the Company performs the following steps: (i) identification of the contract with a customer; (ii) identification of the promised services in the contract and determination of whether the promised services are performance obligations, including whether they are distinct in the context of the contract; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.
Disaggregation of Revenue
The Company derives the majority of its revenue from subscription fees paid for access to and usage of its SaaS solutions for a specified period of time, typically one year. In addition to subscription fees, contracts with customers may include implementation fees for launch assistance and training. Fixed subscription and implementation fees are billed in advance of the subscription term and are due in accordance with contract terms, which generally provide for payment within 30 days. The Company's contracts typically have a one-year term. The Company's contractual arrangements include performance, termination and cancellation provisions, but do not provide for refunds. Customers do not have the contractual right to take possession of the Company's software at any time.
Sales taxes collected from customers and remitted to government authorities are excluded from revenue.
The following table summarizes revenue disaggregation by product for the following periods (in thousands):
| For the Six Months Ended June 30, |
|
| 2021
|
| 2020 (1)
|
|
Government | $ | 1,638 | | $ | 2,472
|
|
Non-government | 7,283 | | 3,602
|
|
| $ | 8,921 | | $ | 6,074
|
|
| For the Six Months Ended June 30, |
|
| 2021
|
| 2020 (1)
|
|
United States | $ | 6,267 | | $ | 6,020
|
|
Canada | 2,654 | | 54
|
|
| $ | 8,921 | | $ | 6,074
|
|
(1) As noted above, prior periods have not been adjusted for the adoption of ASC 606 and are presented in accordance with historical accounting guidance in effect for those periods.
Software. Our software revenue is generated from subscriptions and services related to the use of our commercial software platforms, MJ Platform, Ample, Viridian, and Trellis, our government regulatory platform, Leaf Data Systems, and the sale of business intelligence, data analytics and other software related services. Software contracts are generally quarterly or annual contracts paid monthly, quarterly, or annually in advance of service and cancellable upon 30 or 90 days’ notice, 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. Amounts that have been invoiced are initially recorded as deferred revenue or contract liabilities. Subscription revenue is recognized on a straight-line basis over the service term of the arrangement beginning on the date that our solution is made available to the customer and ending at the expiration of the subscription term.
Consulting Services. Consulting services revenue is generated by providing solutions for operators in the pre-application of licensures 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.
Other Revenue. Our other revenue is derived primarily from point-of-sale hardware and other non-recurring revenue.
Contracts with Multiple Performance Obligations
Customers may elect to purchase a subscription to multiple modules, multiple modules with multiple service levels, or, for certain of the Company's solutions. We evaluate such contracts to determine whether the services to be provided are distinct and accordingly should be accounted for as separate performance obligations. If we determine that a contract has multiple performance obligations, the transaction price, which is the total price of the contract, is allocated to each performance obligation based on a relative standalone selling price method. We estimate standalone selling price based on observable prices in past transactions for which the product offering subject to the performance obligation has been sold separately. As the performance obligations are satisfied, revenue is recognized as discussed above in the product descriptions.
Transaction Price Allocated to Future Performance Obligation
ASC 606 provides certain practical expedients that limit the required disclosure of the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied. As the Company typically enters into contracts with customers for a twelve-month subscription term, substantially all of its performance obligations that have not yet been satisfied as of June 30, 2021 are part of a contract that has an original expected duration of one year or less. For contracts with an original expected duration of greater than one year, for which the practical expedient does not apply, the aggregate transaction price allocated to the unsatisfied performance obligations was $5.7 million as of June 30, 2020, of which $2.9 million is expected to be recognized as revenue over the next twelve months.
Deferred Revenue
Deferred revenue represents the unearned portion of subscription and implementation fees. Deferred revenue is recorded when cash payments are received in advance of performance. Deferred amounts are generally recognized within one year. Deferred revenue is included in the accompanying consolidated balance sheets under Total current liabilities, net of any long-term portion that is included in Other long-term liabilities.
The following table summarizes deferred revenue activity for the six months ended June 30, 2020 (in thousands):
| As of
December 31,
2020 | | Net additions | | Revenue recognized | | As of June 30, 2021 |
Deferred revenue | $ | 844 | | 3,362 | | (3,026 | ) | $ | 1,180 | |
Of the $8.9 million of revenue recognized in the six months ended June 30, 2021, $0.4 million was included in deferred revenue at December 31, 2020.
Costs to Obtain Contracts
In accordance with ASC 606, we now capitalize sales commissions that are directly related to obtaining customer contracts and that would not have been incurred if the contract had not been obtained. These costs are included in the accompanying consolidated balance sheets and are classified as Prepaid expenses and other current assets. Deferred contract costs are amortized to sales and marketing expense over the expected period of benefit, which we have determined to be one year based on the estimated customer relationship period.
The following table summarizes deferred contract cost activity for the six months ended June 30, 2021 (in thousand):
| As of
December 31,
2020 | | Additions | | Amortized costs (1) | | As of June 30, 2021 |
Deferred contract costs | $ | 228 | | 217 | | (242 | ) | $ | 203 | |
(1) Includes contract costs amortized to sales and marketing expense during the period.
The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements for the three and six months ended June 30, 2021, 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 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 accounting treatment of certain of our private warrants;
|
| ● | 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 March 31, 2021, 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
Akerna is a leading provider of enterprise software solutions within the cannabis industry. Cannabis businesses face significant complexity due to the stringent regulations and restrictions that shift based on regional, state, and national governing bodies. As the first to market more than ten years ago, Akerna’s family of software platforms enable regulatory compliance and inventory management across the entire supply chain. When the legal cannabis market started to grow, we identified a need for organic material tracking and regulatory compliance software as a service (SaaS) solution customized specifically for the unique needs of the industry. By providing an integrated ecosystem of applications and services that enables compliance, regulation, consumer safety and taxation, Akerna is building the technology backbone of the cannabis industry. While designed specifically for the unique needs of the cannabis market, our solutions are adaptable for other industries requiring government regulatory oversight, or where the tracking of organic materials from seed or plant to end products is desired.
Executing upon our expansion strategy, we acquire complementary cannabis brands to grow the scope of Akerna’s cannabis ecosystem. Throughout 2019, 2020, and 2021, we integrated five new brands into the Akerna product and service offering. Our first acquisition, solo sciences, was initiated in the fall of 2019, with the full acquisition completed in July 2020. We added Trellis Solutions to our portfolio on April 10, 2020 and finalized the acquisition of Ample Organics and Last Call Analytics on July 7, 2020. Most recently, in April 2021, we completed our acquisition of Viridian Sciences Inc., a cannabis business management software system built on SAP Business One. Through our growing family of companies, Akerna provides highly versatile platforms that equip our clients with a central data management system for tracking regulated products. Our solutions also provide clients with integrated security, transparency, and scalability capabilities, all while maintaining compliance with their governing regulations.
On the commercial side, our products help state-licensed businesses operate in compliance with applicable regional laws. Our integrated ecosystem provides integrations with third-party vendors and add-ons that enhance the capabilities of our commercial software platforms. On the regulatory side, we provide track and trace solutions that allow state governments to monitor compliance of licensed cannabis businesses. To date, our software has helped monitor the compliance of more than $20 billion in legal cannabis. While our software facilitates the success of legal cannabis businesses, we do not handle any cannabis-related material, do not process cannabis sales transactions within the United States, and our revenue is generated from a fixed-fee based subscription model and is not related to the type or amount of sales made by our clients.
We drive revenue growth through the development of our product line, our acquisitions and from continued expansion of the cannabis, hemp, and CBD industry. Businesses across the regulated cannabis industry use our solutions. 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 cultivation, manufacturing, and dispensary clients who are seeking comprehensive business optimization solutions. Our software solutions are designed to be scalable, and while mid-market and smaller customers have historically been our primary target segment, we are focused on extending our customer reach to address the needs of the emerging enterprise level operator. We believe these larger multi-state/multi-vertical operations represent significant long-term future growth opportunities as the cannabis industry continues to consolidate at a rapid rate. The sophistication of our platform accommodates the complexities of both multi-vertical and multi-state business needs, making us critical partners and allowing us to cultivate long-term, successful relationships with our clients.
Our platforms provide licensed businesses with a true enterprise solution for managing their inventory and compliance and allow government regulators to engage in accurate and real-time compliance monitoring. Key capabilities of our technology infrastructure include:
Seed-to-Sale Tracking allows the tracking of products from cultivation, through harvest and processing and manufacturing, to the monitoring of the final sale to the patient or consumer. Our traceability technology captures every step in an individual plant’s life, providing visibility into the supply chain from any measurement of finished product dispensed to a patient or customer, back to the plant it came from, and all activity, transportation, and transactions that happen in between. While we do not provide a point-of-sale processing, and never take, own, or handle any product or cash transaction, our platform does record all sales as part of state and jurisdictional compliance Track-and-Trace processes. The data gathered throughout all of these processes is captured, and provides the insights and information needed to run an efficient and streamlined cannabis business. Seed-to-Sale software operates in a complementary relationship with state-mandated Track-and-Trace systems, replicating the reporting functionality and eliminating the need for operators to duplicate their compliance data into two disparate systems. Track-and-Trace systems are designed solely for government regulators to maintain compliance and do not have the sophistication or functionality to provide cannabis business owners with the insights and tools for effective business management. Our seed-to-sale platforms integrate with the state Track-and-Trace compliance system, reporting in the mandated data along the supply chain while also providing business owners with the capabilities to make informed business decisions based on the fully overview of their operations.
Track-and-Trace is the compliance reporting system used by regulatory bodies in most states. In order to adhere to their state-specific compliance regulations, cannabis operators are required to enter specific data points along the supply chain into the state-mandated track-and-trace system. By doing so, regulators can track the movement of cannabis inventory through the full supply chain, even when it moves between facilities or operators. The aggregated view that Track-and-Trace software ensures that the end product being sold has been grown, harvested, processed, transferred and sold compliantly, and provides assurance of safety to consumers.
Single System Integration allows state-licensed clients to manage inventory, customer records, and staff in one tracking system. MJ Platform and Leaf Data Systems platforms can be fully integrated with one another to create a streamlined Seed-to-Sale/Track-and-Trace solution. Additionally, our platforms can also be integrated with systems of numerous third-party suppliers. We have certified integrations with world class accounting solutions, including Sage, SAP and Netsuite.
Anti-Counterfeiting Technology. Solo sciences provides next-generation anti-counterfeiting technology fused with a direct communication system between brands and consumers. The solo sciences mission is to build confidence and establish trust among consumers, while enabling retailers and distributors to close the loop with creators and producers.
Cannabis Market Insights are curated using the anonymized data aggregated through our Seed-to-Sale platform for key industry intelligence. With over $20 billion in cannabis sales tracked over the past 11 years, we have cultivated a substantial legal cannabis dataset across 30+ states and multiple countries. This data provides a detailed overview of key industry trends, giving us the ability to provide banks, investors, researchers, cannabis businesses, and non-cannabis businesses with cannabis market intelligence and comparison data.
Using our years of experience, proprietary databases, and resources to identify trends and predict changes in the cannabis industry we 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. We have worked with clients and governments across the globe to create customized solutions that fit their specific regulatory and commercially compliant needs. While the majority of our clients are in the United States and Canada, our solutions allow cannabis businesses to operate efficiently in this fast-changing industry and comply with state, local, and federal (in countries such as Canada, Italy, Macedonia, and Colombia). Akerna and our family of companies is well-positioned to provide compliance solutions for the expanding national and international legal cannabis market.
Financial Results of Operations
Revenue
We generate revenue from two primary sources: (1) software and (2) consulting services. Revenue from software comprised approximately 93% and 86% of our revenue for the six months ended June 30, 2021 and 2020, respectively. Revenue from consulting services comprised approximately 7% and 14% of our revenue for six months ended June 30, 2021 and 2020, respectively.
Software. Our software revenue is generated from subscriptions and services related to the use of our commercial software platforms, MJ Platform, Ample, Trellis and Viridian, our government regulatory platform, Leaf Data Systems, and the sale of business intelligence, data analytics and other software related services. Software contracts are generally quarterly or annual contracts paid monthly, quarterly, or annually in advance of service and cancellable upon 30 or 90 days’ notice, 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. Amounts that have been invoiced are initially recorded as deferred revenue or contract liabilities. Subscription revenue is recognized on a straight-line basis over the service term of the arrangement beginning on the date that our solution is made available to the customer and ending at the expiration of the subscription term.
Consulting Services. Consulting services revenue is generated by providing solutions for operators in the pre-application of licensures 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 grow over time as more states emerge with legalization reforms.
Other Revenue. Our other revenue is derived primarily from point-of-sale hardware and other non-recurring revenue.
Cost of Revenue and Operating Expenses
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 the direct cost method. This method requires the allocation of direct costs including support services and materials to the cost of revenue.
Product 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. Product development costs, other than software development expenses qualifying for capitalization, are expensed as incurred. Capitalized software development costs consist primarily of employee-related costs. We devote substantial resources to enhancing and maintaining our technology infrastructure, developing new and enhancing existing solutions, conducting quality assurance testing, and improving our core technology.
Sales and Marketing 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.
We defer the portion of sales commissions that is considered a cost of obtaining a new contract with a customer in accordance with the revenue recognition standard and amortize these deferred costs over the period of benefit, currently one year. We expense the remaining sales commissions as incurred. The rates at which sales commissions are earned varies depending on a variety of factors, including the nature of the sale (new, renewal, or add-on service offering), the type of service or solution sold, and the sales channel.
General and Administrative Expenses
Our general and administrative expenses include salaries and benefits and other costs of departments serving administrative functions, such as executives, finance and accounting, human resources, public relations and investor relations. In addition, general and administrative expense includes non-personnel costs, such as professional fees and other supporting corporate expenses not allocated to cost of revenue, product and development or sales and marketing.
Total Other (Income) Expense, Net
Total other (income) expense, net consists of interest income on cash and cash equivalents, quarterly remeasurement of the fair value of our convertible notes and derivative liability, foreign currency gains and losses, and other nonoperating gains and losses.
Critical Accounting Policies and Estimates
Our critical accounting policies are disclosed in our Transition Report on Form 10-K for the six-month period ended December 31, 2020. Since the date of the Transition Report, there have been no material changes to our critical accounting policies except for our accounting policies for warrants as disclosed in Note 8 to the condensed consolidated financial statements.
Results of Operations for the Six Months Ended June 30, 2021 Compared to Six Months Ended June 30, 2020
The following table highlights the various sources of revenues and expenses for the six months ended June 30, 2021, as compared to the six months ended June 30, 2020:
| Six Months Ended June 30, | | Change | |
| 2021 | | | 2020 | | Period over Period | |
Revenues: | | | | | | | | | |
Software | $ | 8,251,881 | | | $ | 5,196,043 | | $ | 3,055,838 | | | 59 | % |
Consulting | | 583,631 | | | | 823,584 | | | (239,953 | ) | | 29 | % |
Other | | 85,399 | | | | 54,557 | | | 30,842 | | | 57 | % |
Total revenue | | 8,920,911 | | | | 6,074,184 | | | 2,846,728 | | | 47 | % |
| | | | | | | | | | | | | |
Cost of revenues | | 3,368,547 | | | | 3,214,784 | | | 153,763 | | | 5 | % |
Gross profit | | 5,552,364 | | | | 2,859,400 | | | 2,692,964 | | | 94 | % |
Gross profit margin | | 62 | % | | | 47 | % | | | | | | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
| Product development: |
| 2,951,358
|
|
|
| 1,963,725 |
|
| 987,633 |
|
| 50 | % |
| Sales and marketing |
| 3,562,058 |
|
|
| 4,157,869 |
|
| (595,811
| ) |
| (14) | % |
General and administrative | | 6,228,943 | | | | 6,583,289 | | | (354,346 | ) | | 5 | % |
| Depreciation and amortization |
| 2,367,015 |
|
|
| 1,216,607 |
|
| 1,150,408 |
|
| 95 | % |
Total operating expenses | | 15,109,374 | | | | 13,921,490 | | | 1,187,884 | | | 9 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations | $ | (9,557,010 | ) | | $ | (11,062,090 | ) | $ | 1,505,080 | | | (14 | )% |
Software Revenue
Our total software revenue increased to $8.3 million for the six months ended June 30, 2021 from $5.2 million for the six months ended June 30, 2020, for an increase of $3.1 million, or 59%. Software revenue accounted for 93% and 86% of total revenue for the six months ended June 30, 2021 and 2020, respectively. The increase in software revenue during the six months ended June 30, 2021 was attributable to revenue generated from our acquisitions of Ample, Trellis and Viridian in the amounts of $2.2 million, $0.1 million, and $0.9 million, respectively. These increases were partially offset by a decrease of $0.9 million in software revenues generated from government clients which totaled $1.6 million and $2.5 million during the six months ended June 30, 2021 and 2020, respectively.
Consulting Revenue
Our consulting revenue was $0.6 million for the six months ended June 30, 2021 compared to $0.8 million for the six months ended June 30, 2020, a decrease of $0.2 million, or 29%. "This increase is primarily due to increased demand as the restrictions from COVID-19 are being lifted in various states we serve." 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 providing consulting services. However, many state ballot initiatives were passed for new medical or adult-use marijuana laws in the November 2020 elections. Despite the slowing of our consulting activity experienced during the pandemic, we expect increased demand for our services in the second half of calendar 2021.
Consulting revenue was 7% and 14% of total revenue for the six months ended June 30, 2021 and 2020, 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 percentage of consulting revenue over total revenue has varied from period to period depending on whether state legislation has expanded to allow new market entrants or growth of existing market participant operations.
Other Revenue
Other revenue includes retail/resale revenue, which was generated from point-of-sale hardware. Other revenue totaled less than $0.1 million for the six months ended June 30, 2021 and 2020 and was less than 1% of total revenue for the six months ended June 30, 2021 and 2020.
Cost of Revenue and Gross Profit
Our cost of revenue was $3.4 million, or 38% of total revenue, for the six months ended June 30, 2021 compared to $3.2 million, or 53% of total revenue, for the six months ended June 30, 2020.
The decrease in cost of revenue as a percentage of total revenue was primarily due to acquiring additional B2B customers, of which have a higher gross margin.
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 $0.9 million and $1.6 million during the six months ended June 30, 2021 and 2020, respectively. The decrease in the cost of government revenues incurred by us was due to a decrease in customer change order requests of our contracts with the state of Utah and Pennsylvania.
Operating Expenses
Product development expense was $3.0 million for the six months ended June 30, 2021, compared to $2.0 million for the six months ended June 30, 2020, an increase of $1.0 million, or 50%. Product development expense increased primarily as a result of the acquisitions of Ample and Viridian in the amount of $0.3 million and $0.1 million, respectively, as well as an increase in stock-based compensation expense of $0.3 million.
Sales and marketing expense was $3.6 million for the six months ended June 30, 2021, compared to $4.2 million for the six months ended June 30, 2020, a decrease of $0.6 million, or 14%. Sales and marketing decreased primarily due to a reduction in customer event spend due primarily to cancelling all in-person customer activities and events as a result of the COVID-19 pandemic.
General and administrative expense was $6.2 million for the six months ended June 30, 2021, compared to $6.6 million for the six months ended June 30, 2020, a decrease of $0.4 million, or 5%. This decrease was primarily due to $1.0 million in transactional costs and $2.2 million in acquisition related expenses that we incurred during the six months ended June 30, 2020 in connection with our acquisition of Ample and Trellis that were not recurring in 2021. During the six months ended June 30, 2021, we also had a slight decrease of $0.1 million in salaries and overhead as a direct result of cost-saving measures placed into service during 2020. Bad debt expense also decreased by $0.2 million during the six months ended June 30, 2021, as compared to 2020, due to our improvement in the overall quality of our revenue and client portfolio as well as enhancement of our sales and marketing team. Offsetting these decreases is a $2.4 million restructuring charge incurred during the six months ended June 30, 2021 related to a lease settlement agreement for relinquishing office space in Toronto and the related write off of leasehold improvements associated with the lease termination. .
Results of Operations for the Three Months Ended June 30, 2021 Compared to Three Months Ended June 30, 2020
The following table highlights the various sources of revenues and expenses for the three months ended June 30, 2021 as compared to the three months ended June 30, 2020:
| Three Months Ended June 30, | | Change | |
| 2021 | | | 2020 | | Period over Period | |
Revenues: | | | | | | | | | |
Software | $ | 4,456,728 | | | $ | 2,849,734 | | $ | 1,606,995 | | | 56 | % |
Consulting | | 410,884 | | | | 131,000 | | | 279,884 | | | 214 | % |
Other | | 39,275 | | | | 22,904 | | | 16,372 | | | 71 | % |
Total revenue | | 4,906,887 | | | | 3,003,638 | | | 1,903,249 | | | 63 | % |
| | | | | | | | | | | | | |
Cost of revenues | | 1,914,380 | | | | 1,818,565 | | | 95,815 | | | 5 | % |
Gross profit | | 2,992,507 | | | | 1,185,073 | | | 1,807,434 | | | 153 | % |
Gross profit margin | | 61 | % | | | 39 | % | | | | | | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Product development: | | 1,527,258 | | | | 1,088,938 | | | 438,320 | | | 40 | % |
| Sales and marketing |
| 1,826,143 |
|
|
| 2,117,118 |
|
| (290,975 | ) |
| (14) | % |
General and administrative | | 4,375,981 | | | | 3,126,027 | | | 1,249,954 | | | 40 | % |
| Depreciation and amortization |
| 1,314,132 |
|
|
| 1,036,378 |
|
| 277,754 |
|
| 27 | % |
Total operating expenses | | 9,043,514 | | | | 7,368,461 | | | 1,675,053 | | | 23 | % |
| | | | | | | | | | | | | |
Loss from operations | $ | (6,051,007 | ) | | $ | (6,183,388 | ) | $ | 132,381 | | | (2 | )% |
Software Revenue
Our total software revenue increased to $4.5 million for the three months ended June 30, 2021 from $2.8 million for the three months ended June 30, 2020, for an increase of $1.6 million, or 56%. Software revenue accounted for 91% and 95% of total revenue for the three months ended June 30, 2021 and 2020, respectively. The increase in software revenue during the three months ended June 30, 2021 was primarily attributable to revenue generated from our acquisition of Ample and Viridian in the amounts of $1.0 million and $1.0 million, respectively. These increases were partially offset by a decrease in software revenues generated from government clients which totaled $ 0.9 million and $1.4 million during the three months ended June 30, 2021 and 2020, respectively.
Consulting Revenue
Our consulting revenue was $0.4 million for the three months ended June 30, 2021 compared to $0.1 million for the three months ended June 30, 2020, an increase of $0.3 million, or 214%. This increase is primarily due to increased demand as the restrictions from COVID-19 are being lifted in various states we serve. While the pandemic overall has caused delays in providing consulting services to our customers, the impact was greater during the three months ended June 30, 2020 at the early stages of the pandemic. Despite the overall slowing of our consulting activity experienced during the pandemic, we expect increased demand for our services in the second half of calendar 2021, which we began to see in the three months ended June 30, 2021.
Consulting revenue was 8% and 3% of total revenue for the three months ended June 30, 2021 and 2020, 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 percentage of consulting revenue as a percentage of total revenue has varied from period to period depending on whether state legislation has expanded to allow new market entrants or growth of existing market participant operations.
Other Revenue
Other revenue includes retail/resale revenue, which was generated from point-of-sale hardware. Other revenue was less than $0.1 million for the three months ended June 30, 2021 and 2020 and comprised less than 1% of total revenue for the three months ended June 30, 2021 and 2020.
Cost of Revenue and Gross Profit
Our cost of revenue was $1.9 million, or 39% of total revenue, for the three months ended June 30, 2021 compared to $1.8 million, or 61% of total revenue, for the three months ended June 30, 2020.
The decrease in cost of revenue as a percentage of total revenue was primarily due acquiring additional B2B customers, of which have a higher gross margin.
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 $0.5 million and $0.9 million during the three months ended June 30, 2021 and 2020, respectively. The decrease in the cost of government revenues incurred by us was due to a decrease in customer change order requests of our contracts with the state of Utah and Pennsylvania
Operating Expenses
Product development expense was $1.5 million for the three months ended June 30, 2021, compared to $1.1 million for the three months ended June 30, 2020, an increase of $0.4 million, or 40%. Product development expense increased slightly as a result of the acquisitions of Ample and Viridian for a total of $0.2 million and $0.1 million, respectively, as well as a slight increase in stock-based compensation expense of $0.1 million, partially offset by reduced usage of third-party contractors associated with software development.
Sales and marketing expense was $1.8 million for the three months ended June 30, 2021, compared to $2.0 million for the three months ended June 30, 2020, a decrease of $0.2 million, or 14%. Sales and marketing decreased primarily due to a reduction in customer event spend and third-party consultants due primarily to cancelling all in-person customer activities and events as a result of the COVID-19 pandemic.
General and administrative expense was $4.4 million for the three months ended June 30, 2021, compared to $3.1 million for the three months ended June 30, 2020, an increase of $1.2 million, or 40%. This increase was primarily due to $2.4 million in lease termination costs we incurred during the three months ended June 30, 2021 in connection with terminating our office space in Toronto, partially offset by $1.0 million in transaction related costs we incurred during the three months ended June 30, 2020 in connection with our acquisition of Ample and Trellis.
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 expense, interest income 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:
| ●
| stock-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 and mergers that are required to be expensed as incurred in accordance with GAAP, because business combination and merger 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 non-recurring financing fees when we elect the fair value option to account for our debt instruments 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 charges, which includes costs to terminate a lease and the related writeoff of leasehold improvements and furniture, as we believe these costs are not representative of operating performance; |
| ● | 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; and |
| ●
| changes in the fair value of contingent consideration because these adjustments are not recurring across all periods and we believe these costs are not representative of operating performance. |
The reconciliation of net loss to EBITDA and Adjusted EBITDA is as follows:
|
| Six Months Ended June 30, |
|
| | 2021 | |
| 2020 |
|
Net loss | | $ | (12,562,954 | ) |
| $ | (10,669,494 | ) |
Adjustments: | | | | |
|
|
|
|
| Interest expense (income) |
|
| 937,504 | |
|
| (31,438 | ) |
| Change in fair value of convertible notes |
|
| 2,007,677 |
|
|
| (766,000 | ) |
| Change in fair value of derivative liability |
|
| 42,871 |
|
|
| 370,041 | |
| Income tax expense |
|
| 10,570 |
|
|
| 30,985 |
|
Depreciation and amortization | | | 2,367,015 | |
|
| 1,216,607 |
|
EBITDA | | $ | (7,197,317 | ) |
| $ | (9,849,299 | ) |
Stock-based compensation expense
| | | 1,024,715 | |
|
| 673,480 |
|
Business combination and merger related costs | | | 107,726 |
|
|
| 2,245,361 |
|
Non-recurring financing fees | | | 129,594 |
|
|
| 1,177,390 |
|
| Restructuring charges |
|
| 2,453,776 |
|
|
| — |
|
| Changes in fair value of contingent consideration |
|
| — |
|
|
| (998,000 | ) |
| Equity in losses of investee |
|
| 7,564 |
|
|
| 3,692 |
|
Adjusted EBITDA | | $
| (3,473,942 | ) |
| $ | (6,747,376 | ) |
|
| Three Months Ended June 30, |
|
| | 2021 | |
| 2020 |
|
Net loss | | $ | (6,105,251 | ) |
| $ | (6,061,107 | ) |
Adjustments: | | | | |
|
|
|
|
| Interest expense (income) |
|
| 163,124 | |
|
| 2,084 |
|
| Change in fair value of convertible notes |
|
| 16,405 |
|
|
| (766,000 | ) |
| Change in fair value of derivative liability |
|
| (133,125) |
|
|
| 606,958 | |
| Income tax expense |
|
| 4,300 |
|
|
| 30,985 |
|
Depreciation and amortization | | | 1,314,132 | |
|
| 1,036,378 |
|
EBITDA | | $ | (4,740,415 | ) |
| $ | (5,150,702 | ) |
Stock-based compensation expense
| | | 521,335 | |
|
| 371,532 |
|
Business combination and merger related costs | | | 63,735 |
|
|
| 1,026,929 |
|
Non-recurring financing fees | | | 111,761 |
|
|
| 1,177,390 |
|
| Restructuring charges |
|
| 2,406,589 |
|
|
| — |
|
| Changes in fair value of contingent consideration |
|
| — |
|
|
| (998,000 | ) |
| Equity in losses of investee |
|
| 3,782 |
|
|
| 3,692 |
|
Adjusted EBITDA | | $
| (1,633,213 | ) |
| $ | (3,569,159 | ) |
Liquidity and Capital Resources
Since our inception, we have incurred recurring operating losses, used cash from operations, and relied on capital raising transactions to continue ongoing operations. During the three and six months ended June 30, 2021, we incurred a loss from operations of $6.1 million and $9.6 million, respectively, and for the six months ended June 30, 2021, we used cash in operations of $3.7 million. As of June 30, 2021, we had cash of $11.8 million, excluding restricted cash, and working capital of $3.1 million. During the six months ended June 30, 2021, the Company incurred a number of one-time, non-recurring expenses of approximately $2.7 million. These expenses include business combination and merger related costs, restructuring charges, and other non-recurring charges. After considering all available evidence, we determined that, due to our current positive working capital, our ability to repay our senior secured convertible note with shares of our common stock, and our initiatives to reduce operating expenditures, that we have sufficient working capital to sustain operations for a period of at least twelve months from the date that our June 30, 2021 financial statements were issued.
In the event the Company requires additional liquidity, the Company believes it 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.
On July 23, 2021, we entered into an Equity Distribution Agreement with Oppenheimer & Co. Inc. and A.G.P./Alliance Global Partners. Pursuant to the terms of the Agreement, we may offer and sell from time to time, up to $25 million of shares of our common stock. While no assurance can be provided that we will be able to raise capital under such program, we intend to use the net proceeds from the sale of our shares of common stock, if any, for general corporate purposes, including working capital, marketing, product development, capital expenditures and merger and acquisition activities.
Cash Flows
Our cash and restricted cash balances were $12.3 million and $24.7 million as of June 30, 2021 and 2020, respectively. Cash flow information for the six months ended June 30, 2021 and 2020 is as follows:
| | Six Months Ended
June 30, | |
| | 2021 | | | 2020 | |
Cash (used in) provided by: | | | | | | |
Operating activities | | $ | (3,715,198) | | | $ | (8,587,734 | ) |
Investing activities | | | (2,004,609) | | | | (2,024,545 | ) |
Financing activities | | | (333,847) | | | | 15,987,210 | |
| Effect of change in exchange rates on cash and restricted cash |
|
| (124) | |
|
| — |
|
Net decrease in cash and restricted cash | | $ | (6,053,778) | | | $ | 5,374,931 | |
Sources and Uses of Cash for the Six months ended June 30, 2021 and 2020
Net cash used in operating activities decreased to $3.7 million during the six months ended June 30, 2021, from $8.6 million during the six months ended June 30, 2020, a decrease of $4.9 million. The decrease in cash used in operating activities was primarily due to improvements in cash flows from working capital changes.
Net cash used in investing activities totaled $2.0 million during the six months ended June 30, 2021, as a result of amounts invested in the development of our software products. Net cash used by investing activities during the six months ended June 30, 2020, was $2.0 million as a result of acquisitions and investment in software products.
Net cash used in financing activities totaled $0.3 million during the six months ended June 30, 2021 and represents cash paid for the value of shares withheld for tax withholdings on restricted stock units that vested. Our net cash provided by financing activities was $16.0 million for the six months ended June 30, 2020 as a result of proceeds from debt issuance.
Warrant Liability and Financial Statement Revisions
As discussed in Note 8 to the accompanying financial statements, we determined that our Private Warrants, previously recorded in stockholders’ equity, were not properly classified as derivative liabilities, which resulted in primarily the overstatement of net losses attributable to Akerna’s shareholders for each of the reporting periods identified in that note. We assessed the materiality of these errors on prior periods’ financial statements and concluded that the errors were not material to any prior annual or interim periods, but the cumulative adjustments necessary to correct the errors would be material if we recorded the corrections in the period in which the errors were identified. In accordance with GAAP, we are revising the prior periods’ financial statements when they are next issued.
As a result of the revisions to prior period financial statements, certain items discussed in “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our previously filed Form 10-KT for the six-month transition period ended December 31, 2020 have been revised. Our net loss for the year ended June 30, 2019 was revised from $12,403,215 to $14,419,027. Our net loss for the year ended June 30, 2020 was revised from $15,534,345 to $13,572,311. Our net loss for the six-month period ended December 31, 2020 was revised from $16,957,334 to $16,210,482. In each case, the revision was due solely to the inclusion of the fair value of derivative liability for the Private Warrants. The revisions had no impact on revenue, gross profit, operating expenses or losses from operations.
Not applicable.
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 June 30, 2021 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 June 30, 2021, 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
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. Pursuant to our management’s review of disclosure controls and procedures and internal control over financial reporting, management determined that the following material weaknesses in our internal control over financial reporting and prevented management from determining that our disclosure controls and procedures and internal control over financial reporting 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. |
On April 12, 2021, the staff of the SEC (the “SEC Staff”) issued a public statement entitled “Staff Statement on Accounting and Reporting Considerations for Warrants issued by Special Purpose Acquisition Companies (“SPACs”)” (the “SEC Staff Statement”). In the SEC Staff Statement, the SEC Staff expressed its view that certain terms and conditions common to SPAC warrants may require the warrants to be classified as liabilities on the SPAC’s balance sheet as opposed to equity. In light of the SEC Staff Statement, the Company’s management reevaluated the terms of the Public Warrants and Private Warrants and determined that the Private Warrants should be classified as liabilities measured at fair value upon issuance, with subsequent changes in fair value reported in earnings each reporting period. As a result of this reevaluation, management identified a new material weakness in our internal control over financial reporting during Q2 2021, prior to the filing of the Q1 2021 Form 10-Q, related to our improper evaluation of accounting for complex instruments.
Remediation:
We have hired additional experienced resources to fill accounting functions and expects to add further resources, including those to assist in evaluating the appropriate accounting for complex financial instruments. 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 contracted an outside consultant to assist in determining the appropriate accounting for complex instruments.
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.
Notwithstanding the material weakness, management has concluded that the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows in conformity with GAAP.
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.
