CleanSpark (CLSK) 10-Q2021 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

CleanSpark, Inc.

(Exact name of Registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days

[X] Yes [ ] No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 24,232,523 shares as of February 11, 2021.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Our consolidated financial statements included in this Form 10-Q are as follows:

This report on Form 10-Q for the quarter ended December 31, 2020, should be read in conjunction with the Company's annual report on Form 10-K for the year ended September 30, 2020, filed with the Securities and Exchange Commission (“SEC”) on December 17, 2020.

The accompanying consolidated financial statements and footnotes have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the SEC instructions to Form 10-Q. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the interim period ended December 31, 2020 are not necessarily indicative of the results that can be expected for the full year.

CLEANSPARK, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CLEANSPARK, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CLEANSPARK, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED) 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CLEANSPARK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited consolidated financial statements. 

CLEANSPARK, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.   ORGANIZATION AND LINE OF BUSINESS

Organization

The Company - CleanSpark, Inc.

CleanSpark, Inc. (“CleanSpark”, “we”, “our”, the "Company") was incorporated in the state of Nevada on October 15, 1987

under the name, SmartData Corporation. In October 2016, the Company changed its name to CleanSpark, Inc. in order to better reflect the Company’s brand identity.

The Company, through itself and its wholly-owned subsidiaries, has operated in the alternative energy sector since March 2014, and in the digital currency mining sector since December 2020.

Acquisitions Related to Subsidiaries and/or Assets of the Company

CleanSpark, LLC

On July 1, 2016, the Company entered into an Asset Purchase Agreement, as amended (the “Purchase Agreement”), with CleanSpark Holdings LLC, CleanSpark LLC, CleanSpark Technologies LLC and Specialized Energy Solutions, Inc. (together, the “Seller”). Pursuant to the Purchase Agreement, the Company acquired CleanSpark, LLC and all the assets related to the Seller and its line of business.

CleanSpark Critical Power Systems, Inc.

On January 22, 2019, CleanSpark entered into an agreement with Pioneer Critical Power, Inc., whereby it acquired certain intellectual property assets and client lists. As a result of the transaction Pioneer Critical Power Inc. became a wholly owned subsidiary of the Company. On February 1, 2019, Pioneer Critical Power, Inc. was renamed to CleanSpark Critical Power Systems, Inc.

p2klabs, Inc.

On January 31, 2020, the Company entered into a Stock Purchase Agreement with p2klabs, Inc (“p2k”), and its sole stockholder, whereby the Company purchased all of the issued and outstanding shares of p2k from its sole stockholder. As a result of the transaction, p2k became a wholly-owned subsidiary of the Company.

GridFabric, LLC

On August 31, 2020, the Company entered into a Membership Interest Purchase Agreement with GridFabric, LLC, (“GridFabric”), and its sole member, whereby the Company purchased all of the issued and outstanding membership units of GridFabric from its sole member. As a result of the transaction, GridFabric a wholly-owned subsidiary of the Company.

ATL Data Centers LLC

On December 9, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger”) with ATL Data Centers LLC (“ATL”), and its members whereby the Company purchased all of the issued and outstanding membership units of ATL from its members. As a result of the transaction, ATL became a wholly-owned subsidiary of the Company. (See Note 3 for details.) 

Lines of Business

Energy Business Segment

Through CleanSpark, LLC, the Company provides microgrid engineering, design and software solutions to military, commercial and residential customers. Our services consist of distributed energy microgrid system engineering and design, and project consulting services. The work is generally performed under fixed price bid contracts and negotiated price contracts.

Through CleanSpark Critical Power Systems, Inc., the Company provides custom hardware solutions for distributed energy systems that serve military and commercial residential properties. The equipment is generally sold under negotiated fixed price contracts.

Through GridFabric, the Company provides Open Automated Demand Response (“OpenADR”) and other middleware communication protocol software solutions to commercial and utility customers. 

Through ATL, the Company provides traditional data center services such as providing customers with rack space, power and equipment, and offers several cloud services including, virtual services, virtual storage, and data backup services.

Digital Agency Segment

Through p2kLabs, Inc., the Company provides design, software development, and other technology-based consulting services. The services provided are generally an hourly arrangement or fixed-fee project-based arrangements.

Digital Currency Mining Segment

Through ATL Data Centers, LLC, the Company mines digital assets, namely Bitcoin.

 2. SUMMARY OF SIGNIFICANT POLICIES

Basis of Presentation and Liquidity

The accompanying unaudited interim financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission, and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s most recent annual report on Form 10-K for the year ended September 30, 2020, filed with the SEC on December 17, 2020 (“Form 10-K”). In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim period presented in this quarterly report on Form 10-Q have been reflected herein. The results of operations for the interim period are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal period, as reported in the Form 10-K, have been omitted.

The Company has incurred losses for the past several years while it develops its infrastructure and its software platforms. As shown in the accompanying unaudited consolidated financial statements, the Company incurred net losses of $7,167,530 during the three months ended December 31, 2020. In response to these conditions, and to ensure the Company has sufficient capital for ongoing operations for a minimum of 12 months we have raised additional capital through the sale of equity securities pursuant to a registration statement on Form S-3. (See Note 12 for additional details.) As of December 31, 2020, the Company had working capital of $28,711,558.

 Principles of Consolidation

The accompanying consolidated financial statements include the accounts of CleanSpark, Inc., and its wholly owned operating subsidiaries, CleanSpark, LLC, CleanSpark, II, LLC, CleanSpark Critical Power Systems Inc., p2kLabs, Inc, GridFabric, LLC, and ATL Data Centers LLC. All material intercompany transactions have been eliminated upon consolidation of these entities.

Use of estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include estimates used to review the Company’s goodwill impairment, intangible assets acquired, impairments and estimations of long-lived assets, revenue recognition on percentage of completion type contracts,

allowances for uncollectible accounts, and the valuations of non-cash capital stock issuances.  The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions including, but not limited to, the ultimate impact that COVID-19 may have on the Company’s operations.

Revenue Recognition

We recognize revenue in accordance with generally accepted accounting principles as outlined in the Financial Accounting Standard Board's (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue From Contracts with Customers, which requires that five steps be followed in evaluating revenue recognition: (i) identify the contract with the customer; (ii) identity the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price; and (v) recognize revenue when or as the entity satisfied a performance obligation.

We did not have a cumulative impact as of October 1, 2019 due to the adoption of Topic 606.

Our accounting policy on revenue recognition by type of revenue is provided below. 

Engineering, Service & Installation or Construction Contracts

The Company recognizes engineering and construction contract revenue over time, as performance obligations are satisfied, due to the continuous transfer of control to the customer. Engineering and construction contracts are generally accounted for as a single unit of account (a single performance obligation) and are not segmented between types of services. The Company recognizes revenue based primarily on contract cost incurred to date compared to total estimated contract cost (an input method). The input method is the most faithful depiction of the Company’s performance because it directly measures the value of the services transferred to the customer. Customer-furnished materials, labor, and equipment and, in certain cases, subcontractor materials, labor, and equipment are included in revenue and cost of revenue when management believes that the Company is acting as a principal rather than as an agent (i.e., the Company integrates the materials, labor and equipment into the deliverables promised to the customer). Customer-furnished materials are only included in revenue and cost when the contract includes construction activity and the Company has visibility into the amount the customer is paying for the materials or there is a reasonable basis for estimating the amount. The Company recognizes revenue, but not profit, on certain uninstalled materials that are not specifically produced, fabricated, or constructed for a project. Revenue on these uninstalled materials is recognized when the cost is incurred (when control is transferred). Changes to total estimated contract cost or losses, if any, are recognized in the period in which they are determined as assessed at the contract level. Pre-contract costs are expensed as incurred unless they are expected to be recovered from the client. Project mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation being transferred to the client. Customer payments on engineering and construction contracts are typically due within 30 to 45 days of billing, depending on the contract.

For service contracts (including maintenance contracts) in which the Company has the right to consideration from the customer in an amount that corresponds directly with the value to the customer of the Company’s performance completed to date, revenue is recognized when services are performed and contractually billable. Service contracts that include multiple performance obligations are segmented between types of services. For contracts with multiple performance obligations, the Company allocates the transaction price to each performance obligation using an estimate of the stand-alone selling price of each distinct service in the contract. Revenue recognized on service contracts that have not been billed to clients is classified as a current asset under contract assets on the Consolidated Balance Sheets. Amounts billed to clients in excess of revenue recognized on service contracts to date are classified as a current liability under contract liabilities. Customer payments on service contracts are typically due within 30 days of billing, depending on the contract.

Revenues from Sale of Equipment

Performance Obligations Satisfied at a point in time.

We recognize revenue on agreements for non-customized equipment we sell on a standardized basis to the market at a point in time. We recognize revenue at the point in time that the customer obtains control of the good, which is generally upon shipment or when the customer has physical possession of the product depending on contract terms. We use proof of delivery for certain large equipment with more complex logistics, whereas the delivery of other equipment is estimated based on historical averages of in-transit periods (i.e., time between shipment and delivery). Generally, shipping costs are included in the price of equipment unless the customer requests a non-standard shipment. In situations where an alternative shipment arrangement has been made, the Company recognizes the shipping revenue upon customer receipt of the shipment.

In situations where arrangements include customer acceptance provisions based on seller or customer-specified objective criteria, we recognize revenue when we have concluded that the customer has control of the goods and that acceptance is likely to occur. We generally do not provide for anticipated losses on point in time transactions prior to transferring control of the equipment to the customer.

Our billing terms for these point in time equipment contracts vary and generally coincide with shipment to the customer; however, within certain businesses, we receive progress payments from customers for large equipment purchases, which is generally to reserve production slots with our manufacturing partners, which are recorded as contract liabilities.

Due to the customized nature of the equipment, the Company does not allow for customer returns.

Service Performance obligations satisfied over time.

We enter into long-term product service agreements with our customers primarily within our microgrid segment. These agreements require us to provide preventative maintenance, and standby support services that include certain levels of assurance regarding system performance throughout the contract periods; these contracts will generally range from 1 to 10 years. We account for items that are integral to the maintenance of the equipment as part of our service-related performance obligation, unless the customer has a substantive right to make a separate purchasing decision (e.g., equipment upgrade). Contract modifications that extend or revise contract terms are not uncommon and generally result in our recognizing the impact of the revised terms prospectively over the remaining life of the modified contract (i.e., effectively like a new contract). Revenues are recognized for these arrangements on a straight-line basis consistent with the nature, timing and extent of our services, which primarily relate to routine maintenance and as needed product repairs. Our billing terms for these contracts vary, but we generally invoice periodically as services are provided.

Contract assets represent revenue recognized in excess of amounts billed and include unbilled receivables (typically for cost reimbursable contracts) of $0 and contract work in progress (typically for fixed-price contracts) of $906 and $4,103 as of December 31, 2020 and September 30, 2020, respectively. Unbilled receivables, which represent an unconditional right to payment subject only to the passage of time, are reclassified to accounts receivable when they are billed under the terms of the contract. Advances that are payments on account of contract assets of $0 and $0 as of December 31, 2020 and September 30, 2020, respectively, have been deducted from contract assets. Contract liabilities represent amounts billed to clients in excess of revenue recognized to date. The Company recorded $63,603 and $64,108 in contract liabilities as of December 31, 2020 and September 30, 2020, respectively.

Revenues from software 

The Company derives its software revenue from both subscription fees from customers for access to its (i) energy software offerings and software license sales and (ii) support services. Revenues from software licenses are generally recognized upfront when the software is made available to the customer, and revenues from the related support is generally recognized ratably over the contract term. The Company’s policy is to exclude sales and other indirect taxes when measuring the transaction price of its subscription agreements.

The Company’s subscription agreements generally have monthly or annual contractual terms. Revenue is recognized ratably over the related contractual term beginning on the date that the platform is made available to a customer. Access to the platform represents a series of distinct services as the Company continually provides access to, and fulfills its obligation to the end customer over the subscription term. The series of distinct services represents a single performance obligation that is satisfied over time.

Revenues from design, software development and other technology-based consulting services

For service contracts performed under Master Services Agreements (“MSA”) and accompanying Statement(s) of Work (“SOW”), revenue is recognized based on the performance obligation(s) outlined in the SOW which is typically hours worked or specific deliverable milestones. In the case of a milestone-based SOW, the Company recognizes revenue as each deliverable is signed off by the customer.

Revenues from data center services

The Company provides data services such as providing its customers with rack space, power and equipment, and cloud services such as virtual services, virtual storage, and data backup services, generally based on monthly services provided at a defined price included in the contracts. The performance obligations are the services provided to a customer for the month based on the contract. The transaction price is the price agreed with the customer for the monthly services provided and the revenues are recognized monthly based on the services rendered for the month.

Revenues from digital currency mining

The Company has entered into a digital asset mining pool to provide computing power to the mining pool.  Providing computing power is the only performance obligation in the Company’s contracts with pool operators. When the Company successfully places a block (by being the first to solve an algorithm) and the Company receives confirmation of the consideration it will receive, at which time revenue is recognized. The transaction consideration the Company receives is noncash consideration, which the Company measures at fair value on the date received.  The consideration is dependent on the number of digital assets mined on any given day. digital Fair value of the digital currency award received is determined using the spot price of the related digital currency at the time of receipt.

There is currently no specific definitive guidance under GAAP or alternative accounting framework for the accounting for digital currencies recognized as revenue or held, and management has exercised significant judgment in determining the appropriate accounting treatment. In the event authoritative guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect on the Company’s consolidated financial position and results from operations.

Variable Consideration

The nature of the Company’s contracts gives rise to several types of variable consideration, including claims and unpriced change orders, awards and incentive fees, and liquidated damages and penalties. The Company recognizes revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Company estimates the amount of revenue to be recognized on variable consideration using the expected value (i.e., the sum of a probability-weighted amount) or the most likely amount method, whichever is expected to better predict the amount. Factors considered in determining whether revenue associated with claims (including change orders in dispute and unapproved change orders in regard to both scope and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim, (b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies in the Company’s performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed, and (d) evidence supporting the claim is objective and verifiable. If the requirements for recognizing revenue for claims or unapproved change orders are met, revenue is recorded only when the costs associated with the claims or unapproved change orders have been incurred. Back charges to suppliers or subcontractors are recognized as a reduction of cost when it is determined that recovery of such cost is probable, and the amounts can be reliably estimated. Disputed back charges are recognized when the same requirements described above for claims accounting have been satisfied.

The Company generally provides limited warranties for work performed under its engineering and construction contracts. The warranty periods typically extend for a limited duration following substantial completion of the Company’s work on a project. Historically, warranty claims have not resulted in material costs incurred.

Practical Expedients

If the Company has a right to consideration from a customer in an amount that corresponds directly with the value of the Company’s performance completed to date (a service contract in which the Company bills a fixed amount for each hour of service provided), the Company recognizes revenue in the amount to which it has a right to invoice for services performed.

The Company does not adjust the contract price for the effects of a significant financing component if the Company expects, at contract inception, that the period between when the Company transfers a service to a customer and when the customer pays for that service will be one year or less.

The Company has made an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by governmental authorities that are collected by the Company from its customers (use taxes, value added taxes, some excise taxes).

For the three months ended December 31, 2020 and 2019, the Company reported revenues of $2,257,570 and $976,824, respectively.

Cash and cash equivalents

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments and short-term debt instruments with original maturities of three months or less to be cash equivalents. There was $25,631,913 and $3,126,202 in cash and no cash equivalents as of December 31, 2020 and September 30, 2020, respectively.

Digital Currency

Digital currencies are included in current assets in the consolidated balance sheets. Digital currencies are recorded at cost less impairment. Digital currencies held are accounted for as intangible assets with indefinite useful lives. An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the digital currency at the time its fair value is being measured. In testing for impairment, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required to perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment losses is not permitted.

Digital currencies awarded to the Company through its mining activities are included within operating activities on the accompanying consolidated statements of cash flows. The sales of digital currencies are included within investing activities in the accompanying consolidated statements of cash flows and any realized gains or losses from such sales are included in other income (expense) in the consolidated statements of operations. The Company accounts for its gains or losses in accordance with the first in first out (FIFO) method of accounting.  

The following table presents the activities of the digital currencies for the three months ended December 31, 2020:

Digital currencies at December 31, 2020:

Accounts receivable

Accounts receivable is comprised of uncollateralized customer obligations due under normal trade terms. The Company performs ongoing credit evaluation of its customers and management closely monitors outstanding receivables based on

factors surrounding the credit risk of specific customers, historical trends, and other information. The carrying amount of accounts receivable is reviewed periodically for collectability. If management determines that collection is unlikely, an allowance that reflects management’s best estimate of the amounts that will not be collected is recorded. Accounts receivable are presented net of an allowance for doubtful accounts of $42,970 and $42,970 at December 31, 2020, and September 30, 2020, respectively.

Retention receivable is the amount withheld by a customer until a contract is completed. Retention receivables of $0 and $615 were included in the balance of trade accounts receivable as of December 31, 2020 and September 30, 2020, respectively.

Investment securities

Investment securities include debt securities and equity securities. Debt securities are classified as available for sale (“AFS”) and are reported as an asset in the Consolidated Balance Sheet at their estimated fair value. As the fair values of AFS debt securities change, the changes are reported net of income tax as an element of OCI, except for other-than-temporarily-impaired securities. When AFS debt securities are sold, the unrealized gains or losses are reclassified from OCI to non-interest income. Securities classified as AFS are securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, decline in credit quality, and regulatory capital considerations.

Interest income is recognized based on the coupon rate and increased by accretion of discounts earned or decreased by the amortization of premiums paid over the contractual life of the security.

For individual debt securities where the Company either intends to sell the security or more likely than not will not recover all of its amortized cost, the OTTI is recognized in earnings equal to the entire difference between the security's cost basis and its fair value at the balance sheet date. For individual debt securities for which a credit loss has been recognized in earnings, interest accruals and amortization and accretion of premiums and discounts are suspended when the credit loss is recognized. Interest received after accruals have been suspended is recognized in income on a cash basis.

The Company holds investments in both publicly held and privately held equity securities. However, as described in Note 1, the Company primarily operates in the alternative energy sector and in the digital currency mining sector, and thus, it is not in the business of investing in securities.

Privately held equity securities are recorded at cost and adjusted for observable transactions for same or similar investments of the issuer (referred to as the measurement alternative) or impairment. All gains and losses on privately held equity securities, realized or unrealized, are recorded through gains or losses on equity securities on the consolidated statement of operations.

Publicly held equity securities are based on fair value accounting with unrealized gains or losses resulting from changes in fair value reflected as unrealized gains or losses on equity securities in our consolidated statements of operations.

Concentration Risk

At times throughout the year, the Company may maintain cash balances in certain bank accounts in excess of FDIC limits. As of December 31, 2020, the cash balance in excess of the FDIC limits was $25,379,232. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk in these accounts. The Company had certain customers whose revenue individually represented 10% or more of the Company’s total revenue. (See Note 16 for details.)

Warranty Liability

The Company establishes warranty liability reserves to provide for estimated future expenses as a result of installation and product defects, product recalls, and litigation incidental to the Company’s business. Liability estimates are determined based on management’s judgment, considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions with the Company’s general counsel and outside counsel retained to handle specific product liability cases. The Company’s manufacturers and service providers currently provide substantial warranties between ten to twenty-five years with full reimbursement to replace and install replacement parts. Warranty costs and associated liabilities were $0 and $0 at December 31, 2020 and September 30, 2020, respectively.

Stock-based compensation

The Company follows the guidelines in FASB Codification Topic ASC 718-10 “Compensation-Stock Compensation,” which requires companies to measure the cost of employee and non-employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period. The Company may issue compensatory shares for services including, but not limited to, executive, management, accounting, operations, corporate communication, financial and administrative consulting services.

Earnings (loss) per share

The Company reports earnings (loss) per share in accordance with Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 260-10 “Earnings Per Share,” which provides for calculation of “basic” and “diluted” earnings per share. Basic earnings per share includes no dilution and is computed by dividing net income or loss available to common stockholders by the weighted average common shares outstanding the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity. The calculation of diluted net loss per share gives effect to common stock equivalents; however, potential common shares are excluded if their effect is anti-dilutive. As of December 31, 2020, there are 1,562,092 shares issuable upon exercise of outstanding options and warrants which have been excluded as anti-dilutive.

Property and equipment

Property and equipment are stated at cost. Depreciation is calculated on a straight-line basis over the estimated useful life of the asset as follows:

Long-lived Assets

In accordance with the Financial Accounting Standards Board ("FASB") Accounts Standard Codification (ASC) ASC 360-10, "Property, Plant and Equipment," the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances that may suggest impairment. The Company recognizes impairment when the sum of the expected undiscounted future cash flow is less than the carrying amount of the asset. Impairment losses, if any, are measured as the excess of the carrying amount of the asset over its estimated fair value. For the three months ended December 31, 2020 and 2019, the Company did not record an impairment expense.

Intangible Assets and Goodwill

The Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, “Business Combinations,” where the total purchase price is allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed, and revisions to preliminary estimates. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.

The Company reviews its indefinite lived intangibles and goodwill for impairment annually or whenever events or circumstances indicate that the carrying amount of the asset exceeds its fair value and may not be recoverable. In accordance with its policies, the Company performed an assessment of indefinite lived intangibles and goodwill and determined there was no impairment for the three months ended December 31, 2020 and 2019.

Software Development Costs

The Company capitalizes software development costs under guidance of ASC 985-20 “Costs of Software to be Sold, Leased or Marketed” for our mPulse platform and under ASC 350-40 “Internal Use Software” for our mVSO, Canvas & Plaid products. Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products. Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product requires both technical design documentation and infrastructure design documentation, or the completed and tested product design and a working model. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established, and the evaluation is performed on a product-by-product basis. For products where proven technology exists, this may occur early in the development cycle. Prior to a product's release, if and when we believe capitalized costs are not recoverable, we expense the amounts as part of "Product development." Capitalized costs for products that are cancelled or are expected to be abandoned are charged to "Product development" in the period of cancellation. Amounts related to software development, such as product enhancements to existing features, which are not capitalized are charged immediately to "Product development."

Commencing upon a product's release, capitalized software development costs are amortized to "Cost of revenues—software amortization" based on the ratio of current revenues to total projected revenues for the specific product, generally resulting in an amortization period of seven years for our current product offerings. In recognition of the uncertainties involved in estimating future revenue, amortization will never be less than straight-line amortization of the products remaining estimated economic life.

We evaluate the future recoverability of capitalized software development costs on a quarterly basis. For products that have been released in prior periods, the primary evaluation criterion is the actual performance of the software platform to which the costs relate. For products that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific products to which the costs relate. Criteria used to evaluate expected product performance include: historical performance of comparable products developed with comparable technology, market performance of comparable software, orders for the product prior to its release, pending contracts, and general market conditions.

Significant management judgments and estimates are utilized in assessing the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than the originally forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of expenses for any period if matters resolve in a manner that is inconsistent with management's expectations. If an impairment occurs, the reduced amount of the capitalized software costs that have been written down to the net realizable value at the close of each annual fiscal period will be considered the cost for subsequent accounting purposes.

Fair value of financial instruments and derivative asset

The carrying value of cash, accounts payable and accrued expenses, and debt (See Notes 8 and 9) approximate their fair values because of the short-term nature of these instruments. Management believes the Company is not exposed to significant interest or credit risks arising from these financial instruments. The carrying amount of the Company’s long-term debt is also stated at fair value of $531,169 since the stated rate of interest approximates market rates.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company utilizes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.

The following table presents the Company’s financial instruments that are measured and recorded at fair value on the Company’s balance sheets on a recurring basis, and their level within the fair value hierarchy as of December 31, 2020 and September 30, 2020, respectively:

Fair value measured at December 31, 2020

Fair value measured at September 30, 2020

The below table presents the change in the fair value of the derivative asset and investment in debt security during the three months ended December 31, 2020:

Reclassifications

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations or net assets of the Company.

Segment Reporting

Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding the method to allocate resources and assess performance. The Company currently has three reportable segments for financial reporting purposes.

Recently issued accounting pronouncements 

In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," which allows for the capitalization of certain implementation costs incurred in a hosting arrangement that is a service contract. ASU 2018-15 allows for either retrospective adoption or prospective adoption to all implementation costs incurred after the date of adoption. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019. The new standard did not have a material impact on the Company’s results of operations or cash flows.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The purpose of the standard is to improve the overall usefulness of fair value disclosures to financial statement users and reduce unnecessary costs to companies when preparing the disclosures. ASU 2018-13 is effective for for fiscal years beginning after December 15, 2019 and requires the application of the prospective method of transition (for only the most recent interim or annual period presented in the initial fiscal year of adoption) to the new disclosure requirements for (1) changes in unrealized gains and losses included in other comprehensive income and (2) the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 also requires prospective application to any modifications to disclosures made because of the change to the requirements for the narrative description of measurement uncertainty. The effects of all other amendments made by ASU 2018-13 must be applied retrospectively to all periods presented. The new standard did not have a material impact on the Company’s results of operations or cash flows.

In January 2017, the FASB issued guidance within ASU 2017-04, Intangibles-Goodwill and Other. The amendments in ASU 2017-04 simplify the subsequent measurement of goodwill by comparing the fair value of a reporting unit with its carrying amount. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. The new standard did not have a material impact on the Company’s results of operations or cash flows.

In June 2016, the FASB issued guidance within ASU 2016-13, Financial Instruments – Credit Losses. The amendments in ASU 2016-13 require assets measured at amortized cost and establishes an allowance of credit losses for available for sale debt securities. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022. We are currently evaluating the impact the adoption of this new standard will have on our financial position and results of operations.

The Company has evaluated all other recent accounting pronouncements and believes that none of them will have a material effect on the Company's financial position, results of operations or cash flows.

3. ACQUISITIONS

ATL DATA CENTERS, LLC

On December 9, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger”) with ATL Data Centers LLC (“ATL”) and its members.

At the closing, ATL became a wholly-owned subsidiary of the Company. In exchange, the Company issued 1,618,285 shares

of restricted common stock based on the average closing price of the Company’s common stock (as reflected on Nasdaq.com) for the five trading days including and immediately preceding the closing date of $11.988 per share, to the selling members of ATL, of which: (i) 642,309 shares were fully earned on closing, and (ii) an additional 975,976 shares issued to escrow and subject to holdback pending satisfaction of certain future milestones, with all such shares subject to a lock up of no less than 180 days and a leak out of no more than 10% of the average daily trading value of the prior 30 days.

The consideration remitted in connection with the Merger is subject to adjustment based on post-closing adjustments to closing cash, indebtedness, and transaction expenses of ATL within 90 days of closing. The Company also assumed approximately $6.9 million in debts of ATL at closing. As part of the transaction costs, the Company issued 41,708 shares of common stock for an aggregate value of $545,916 to the broker.

The Company accounted for the acquisition of ATL as an acquisition of a business under ASC 805.

The Company determined the fair value of the consideration given to the selling members of ATL in connection with the transaction in accordance with ASC 820 was as follows:

The total purchase price was allocated to identifiable assets deemed acquired, and liabilities assumed, based on their estimated fair values as indicated below. The business combination accounting is not yet final and the amounts assigned to the assets acquired and the liabilities assumed are provisional. Therefore, this may result in future adjustments to the provisional amounts as new information is obtained about the facts and circumstances that existed at the acquisition date.

The strategic contract relates to supply of a critical input to our digital currency mining business. The other assets and liabilities assumed includes $5.475 million in digital currency mining equipment and notes payable related to this equipment, which was settled by the Company during the current quarter ended December 31, 2020.

The following is the unaudited pro forma information assuming the acquisition of GridFabric, p2k Labs, and ATL occurred on October 1, 2019:

The unaudited pro forma consolidated financial results have been prepared for illustrative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on the first day of the earliest period presented, or of future results of the consolidated entities. The unaudited pro forma consolidated financial information does not reflect any operating efficiencies and cost savings that may be realized from the integration of the acquisition. All transitions that would be considered inter-company transactions for proforma purposes have been eliminated.

P2K LABS, INC

On January 31, 2020, the Company, entered into an Agreement with p2k, and its sole stockholder, Amer Tadayon, whereby the Company purchased all of the issued and outstanding shares of p2k in exchange for an aggregate purchase price of cash and equity of $1,688,935. The transaction closed simultaneously upon the execution of the Agreement by the parties on January 31, 2020.

As a result of the transaction, p2k is now a wholly-owned subsidiary of the Company.

Pursuant to the terms of the Agreement, the purchase price was as follows:

The Company accounted for the acquisition of p2k as an acquisition of a business under ASC 805.

The Company determined the fair value of the consideration given to the Seller in connection with the Transaction in accordance with ASC 820 was as follows:

The total purchase price was allocated to identifiable assets deemed acquired, and liabilities assumed, of the Company’s acquisition of p2k, based on their estimated fair values as indicated below.

GRIDFABRIC, LLC

On August 31, 2020, the Company entered into a Membership Interest Purchase Agreement (the “Agreement”) with GridFabric, LLC, (“GridFabric”), and its sole member, Dupont Hale Holdings, LLC (“Seller”), whereby the Company purchased all of the issued and outstanding membership units of GridFabric from the Seller (the “Transaction”) in exchange for an aggregate purchase price of cash and stock of up to $1,400,000 (the “Purchase Price”). The Transaction closed simultaneously with execution on August 31, 2020. As a result of the Transaction, GridFabric, an OpenADR software solutions provider, is now a wholly-owned subsidiary of the Company.

Pursuant to the terms of the Agreement, the Purchase Price was as follows:

The Shares were issued at a fair market value of $9.46 per share. The Earn-Out Shares are accounted for as contingent consideration and the number of shares to be issued will be determined based on the closing price of the Company’s common stock on the date such milestone event occurs.

The Agreement contains standard representations, warranties, covenants, indemnification and other terms customary in similar transactions.

In connection with the transaction, the Company also entered into employment relationships and non-compete agreements with GridFabric’s key employees for a period of 36 months and plans to issue future equity compensation to said employees, subject to approval of the Company’s board of directors.

The Company accounted for the acquisition of GridFabric as an acquisition of a business under ASC 805.

The Company determined the fair value of the consideration given to the Seller in connection with the Transaction in accordance with ASC 820 was as follows:

The total purchase price of the Company’s acquisition of GridFabric was allocated to identifiable assets deemed acquired, and liabilities assumed, based on their estimated fair values as indicated below.

4. INVESTMENT IN INTERNATIONAL LAND ALLIANCE

International Land Alliance, Inc.

On November 5, 2019, the Company entered into a binding Memorandum of Understanding (the “MOU”) with International Land Alliance, Inc., a Wyoming corporation (“ILAL”), in order to lay a foundational framework where the Company will deploy its energy solutions products and services to ILAL, its energy projects, and its customers.

In connection with the MOU, and in order to support the power and energy needs of ILAL’s development and construction of certain projects, the Company entered into a Securities Purchase Agreement, dated as of November 6, 2019, with ILAL (the “ILAL SPA”).

Pursuant to the terms of the ILAL SPA, ILAL sold, and the Company purchased 1,000 shares of Series B Preferred Stock (the “Preferred Stock”) of ILAL for an aggregate purchase price of US $500,000 (the “Stock Transaction”), less certain expenses and fees. The Company also received 350,000 shares (“commitment shares”) of ILAL’s common stock. The Preferred Stock will accrue cumulative in-kind accruals at a rate of 12% per annum and may increase upon the occurrence of certain events. The Preferred Stock is now convertible into common stock at a variable rate as calculated under the agreement terms.

The commitment shares are recorded at fair value as of December 31, 2020 of $136,500.

The Preferred Stock is recorded as an AFS debt security and is reported at its estimated fair value as of December 31, 2020. The Company identified a derivative instrument in accordance with ASC Topic No. 815 due to the variable conversion feature. Topic No. 815 requires the Company to account for the conversion feature on its balance sheet at fair value and account for changes in fair value as a derivative gain or loss.

The Black-Scholes model utilized the following inputs to value the derivative asset at the date in which the derivative asset was determined through December 31, 2020.

5. CAPITALIZED SOFTWARE

Capitalized software consists of the following as of December 31, 2020 and September 30, 2020:

Capitalized software amortization recorded as cost of revenues and product development expense for the three months ended December 31, 2020 and 2019 was $39,286 and $39,286, respectively.  

6. INTANGIBLE ASSETS

The Company amortizes intangible assets with finite lives over their estimated useful lives, which range between two and twenty years as follows:

Intangible assets consist of the following as of December 31, 2020 and September 30, 2020:

Amortization expense for the three months ended December 31, 2020 and 2019 was $867,205, including $12,683 recorded to cost of revenues, and $613,115, respectively.

The Company expects to record amortization expense of intangible assets over the next 5 years and thereafter as follows:

7. FIXED ASSETS

Fixed assets consist of the following as of December 31, 2020 and September 30, 2020:

Depreciation expense for the three months ended December 31, 2020 and 2019 was $223,907 and $13,662, respectively.

8. LOANS

Long term

Promissory Notes

On May 7, 2020, the Company applied for a loan from Celtic Bank Corporation, as lender, pursuant to the Paycheck Protection Program of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) as administered by the U.S. Small Business Administration (the "SBA"). On May 15, 2020, the loan was approved and the Company received the proceeds from the loan in the amount of $531,169 (the “PPP Loan”). The PPP Loan, which took the form of a promissory note issued by the Company (the “PPP Note”) matures on May 7, 2022 and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments, less the amount of any potential forgiveness (discussed below), will commence on June 7, 2021.

The PPP Note provides for customary events of default, including, among others, those relating to failure to make payments thereunder. The Company may prepay the principal of the PPP Loan at any time without incurring any prepayment penalties. The PPP Loan is non-recourse against any individual shareholder, except to the extent that such party uses the loan proceeds for an unauthorized purpose. All or a portion of the PPP Loan may be forgiven by the SBA and lender upon application by the Company beginning 8 weeks after loan approval and upon documentation of expenditures in accordance with the SBA requirements. Under the CARES Act, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during the eight-week period beginning on the date of loan approval. For purposes of the CARES Act, payroll costs exclude compensation of an individual employee in excess of $100,000, prorated annually. Not more than 25% of the forgiven amount may be for non-payroll costs. Forgiveness is reduced if full-time headcount declines, or if salaries and wages for employees with salaries of $100,000 or less annually are reduced by more than 25%. In the event the PPP Loan, or any portion thereof, is forgiven pursuant to the CARES Act, the amount forgiven is applied to outstanding principal.

Paycheck Protection Program Flexibility Act of 2020 (the “PPP Flexibility Act”), enacted on June 5, 2020, amended the Paycheck Protection Program, among others, as follows: (i) extended the covered period from 8 weeks to 24 weeks from the date the PPP Loan is originated, during which PPP funds needed to be expended in order to be forgiven. A borrower may submit a loan forgiveness application any time on or before the maturity date of the loan – including before the end of the covered period – if the borrower has used all of the loan proceeds for which the borrower is requesting forgiveness, (ii) at least 60% of PPP funds must be spent on payroll costs, with the remaining 40% available to spend on other eligible expenses, (iii) payments are deferred until the date on which the amount of forgiveness determined is remitted to the lender. If a borrower fails to seek forgiveness within 10 months after the last day of its covered period, then payments will begin on the date that is 10 months after the last day of the covered period. In addition, the PPP Flexibility Act modified the CARES Act by increasing the maturity date for loans made after the effective date from two years, to a minimum maturity of five years from the date on which the borrower applies for loan forgiveness. Existing PPP loans made before the new legislation retain their original two-year term, but may be renegotiated between a lender and a borrower to match the 5-year term permitted under the PPP Flexibility Act.

Company intends to apply for loan forgiveness within the required timeframe. No assurance is provided that the Company will obtain forgiveness of the PPP Loan in whole or in part.

The Company recorded interest expense of $3,987 and $0 for the three months ended December 31, 2020 and 2019, respectively.

9. CONVERTIBLE NOTES PAYABLE 

Short-Term convertible notes

Securities Purchase Agreement – December 31, 2018 

On December 31, 2018, the Company entered into a Securities Purchase Agreement (the “SPA”) with an otherwise unaffiliated third-party institutional investor (the “Investor”), pursuant to which the Company issued to the Investor a Senior Secured Redeemable Convertible Debenture (the “Debenture”) in the aggregate face value of $5,250,000. The note was secured by all assets of the Company. The Debenture has a maturity date of two years from the issuance date and the Company agreed to pay compounded interest on the unpaid principal balance of the Debenture at the rate equal to 7.5% per annum. Interest is payable on the date the applicable principal is converted or on maturity. The interest must be paid in cash and, in certain circumstances, may be paid in shares of common stock.

The transactions described above closed on December 31, 2018. In connection with the issuance of the Debenture and pursuant to the terms of the SPA, the Company issued to the Investor 10,000 shares of common stock and a Common Stock Purchase Warrant to acquire up to 308,333 shares of common stock for a term of three years (the “Warrant”) on a cash-only basis at an exercise price of $20.00 per share with respect to 125,000 Warrant Shares, $25.00 with respect to 100,000 Warrant Shares, $50.00 with respect to 50,000 Warrant Shares and $75.00 with respect to 33,333 Warrant Shares. The warrants and shares issued were fair valued and a debt discount of $4,995,000 was recorded as a result of the issuance of the warrants and shares and the recognition of a beneficial conversion feature on the Debenture. The Company also paid a $5,000 due diligence fee prior to receiving the funding which was also recorded as a debt discount.

Pursuant to the terms of the SPA, the Investor agreed to tender to the Company the sum of $5,000,000, of which the Company received the full amount as of the closing.

Prior to the maturity date, provided that no trigger event has occurred, the Company will have the right at any time upon 30 trading days’ prior written notice, in its sole and absolute discretion, to redeem all or any portion of the Debenture then outstanding by paying to the Investor an amount equal to 140% of the of the portion of the Debenture being redeemed.

The Investor may convert the Debenture into shares of the Company’s common stock at a conversion price equal to 95% of the mathematical average of the 5 lowest individual daily volume weighted average prices of the common stock, less $0.50 per share, during the period beginning on the issuance date and ending on the maturity date subject to certain floor price restrictions. In the event certain equity conditions exist, the Company may require that the Investor convert the Debenture. In no event shall the Debenture be allowed to affect a conversion if such conversion, along with all other shares of Company common stock beneficially owned by the Investor and its affiliates would exceed 4.99% of the outstanding shares of the common stock of the Company.

While the Debenture is outstanding, if triggering events occur, the conversion rate may be decreased by 10% and the interest rate increased by 10% for each triggering event which may result in the issuance of additional shares.

On March 4, March 13, and May 1, 2020 the Company entered into amendments (the “Amendments”) with the Investor.

The Amendments amended the SPA and Debenture, as follows:

As of September 30, 2020, the Debenture was fully converted into shares of the Company’s common stock.

The aggregate debt discount has been accreted and charged to interest expenses as a financing expense in the amount of $0 and $157,379 during the three months ended December 31, 2020 and 2019, respectively.

Securities Purchase Agreement – April 17, 2019

On April 17, 2019, the Company entered into a Securities Purchase Agreement (the “Agreement”) with an otherwise unaffiliated third-party institutional investor (the “Investor”), pursuant to which the Company agreed to issue to the Investor a $10,750,000 face value Senior Secured Redeemable Convertible Promissory Note (the “Note”) with a 7.5% original issue discount, 215 shares of our Series B Preferred Stock with a 7.5% original issue discount, a Common Stock Purchase Warrant (the “Warrant”) on a cash-only basis to acquire up to 230,000 shares (the “Warrant Shares”) of our common stock and 125,000 shares of our Common Stock. The aggregate purchase price for the Note, the Series B Preferred Stock the Warrant and the Common Stock is $20,000,000. The Note was secured by all assets of the Company.

Pursuant to the first closing of the Agreement, which occurred on April 18, 2019, the Investor agreed to tender to the Company the sum of $10,000,000, for the Note, the Common Stock and the Warrant. No additional closings to sell the preferred stock have occurred and the Series B preferred stock was removed under the amendments to the Agreement discussed below.

The Note has a maturity date of two years from the issuance date and the Company has agreed to pay compounded interest on the unpaid principal balance of the Note at the rate equal 7.5% per annum. Interest is payable on the date the applicable principal is converted or on maturity. The interest must be paid in cash and, in certain circumstances, may be paid in shares of common stock.

Prior to the maturity date, provided that no trigger event has occurred, the Company will have the right at any time upon 30 trading days’ prior written notice, in its sole and absolute discretion, to redeem all or any portion of the Note then outstanding by paying to the Investor an amount equal to 145% of the of the portion of the Note being redeemed.

The Investor may convert the Note into shares of the Company’s common stock at a conversion price equal to 90% of the mathematical average of the 5 lowest individual daily volume weighted average prices of the common stock, less $0.75 per share, during the period beginning on the issuance date and ending on the maturity date subject to certain floor price restrictions. In the event certain equity conditions exist, the Company may require that the Investor convert the Note. In no event shall the Note be allowed to effect a conversion if such conversion, along with all other shares of Company common stock beneficially owned by the Investor and its affiliates would exceed 4.99% of the outstanding shares of the common stock of the Company.

While the Note is outstanding if triggering events occur the conversion rate may be decreased by 10% and the interest rate increased by 10% for each triggering event which may result in the issuance of additional shares.

On March 4, March 13, and May 1, 2020 the Company entered into amendments (the “Amendments”) with the Investor.

The Amendments amended the Agreement and Note, as follows:

As of September 30, 2020, the Note was fully converted into shares of the Company’s common stock.

The aggregate debt discount has been accreted and charged to interest expenses as a financing expense in the amount of $0 and $1,354,795 during the three months ended December 31, 2020 and 2019, respectively.

10. LEASES

Effective October 1, 2019, the Company accounts for its leases under ASC 842, which requires lessees to recognize lease assets and liabilities arising from operating leases on the balance sheet. The Company adopted the new lease guidance using the modified retrospective approach and elected the transition option issued under ASU 2018-11, Leases (Topic 842) Targeted Improvements, allowing entities to continue to apply the legacy guidance in ASC 840, Leases, to prior periods, including disclosure requirements. Accordingly, prior period financial results and disclosures have not been adjusted.

The Company has operating leases under which it leases its branch offices, corporate headquarters and data center, one of which is with a related party. As of December 31, 2020, the Company's operating lease right of use asset and operating lease liability totaled $865,441 and $865,441, respectively. A weighted average discount rate of 10% was used in the measurement of the right of use asset and lease liability. As the rate implicit in the lease is not readily determinable, the Company's incremental collateralized borrowing rate is used to determine the present value of lease payments. This rate gives consideration to the applicable Company collateralized borrowing rates and is based on the information available at the commencement date. The Company has elected to apply the short-term lease measurement and recognition exemption to leases with an initial term of 12 months or less; therefore, these leases are not recorded on the Company’s Consolidated Balance Sheet, but rather, lease expense is recognized over the lease term on a straight-line basis.

The Company's operating leases have remaining lease terms between one year to two years, with a weighted average lease term of 1.39 years at December 31, 2020. Some leases include multiple year renewal options. The Company’s decision to exercise these renewal options is based on an assessment of its current business needs and market factors at the time of the renewal. Currently, the Company has no leases for which the option to renew is reasonably certain and therefore, options to renew were not factored into the calculation of its right of use asset and lease liability as of December 31, 2020. These operating leases also have a weighted average discount rate of 10% at December 31, 2020.

The following is a schedule of the Company's operating lease liabilities by contractual maturity as of December 31, 2020:

Total operating lease costs of $117,223 and $21,318 for the three months ended December 31, 2020 and 2019, respectively, were included as part of administrative expense.

The Company has financing leases in relation to the equipment used at its data center. The following is a schedule of the Company’s financing lease liabilities by contractual maturity as of December 31, 2020:

These financing leases have a weighted average lease term of 3.02 years and a weighted average discount rate of 8.6% at December 31, 2020.

11. RELATED PARTY TRANSACTIONS 

Zachary Bradford – Chief Executive Officer and Director

During the three months ended December 31, 2020, the Company paid Blue Chip Accounting, LLC (“Blue Chip”) $30,000 for accounting, tax, administrative services and reimbursement for office supplies. Blue Chip is 50% beneficially owned by Mr. Bradford. None of the services were associated with work performed by Mr. Bradford. The services consisted of bookkeeping, accounting, and administrative support assistance. The Company also sub-leases office space from Blue Chip (see Note 15 for additional details). During the three months ended December 31, 2020, $4,575 was paid to Blue Chip for rent.

Matthew Schultz - Chairman of the Board

The Company entered into an agreement on November 15, 2019 with an organization to provide general investor relations and consulting services that Mr. Schultz is affiliated with. The Company paid the organization $27,000 in fees plus $85,150 in expense reimbursements for the three months ended December 31, 2019. The agreement was terminated in March 2020.

12. STOCKHOLDERS EQUITY

Overview

The Company’s authorized capital stock consists of 35,000,000 shares of common stock and 10,000,000 shares of preferred stock, par value $0.001 per share. As of December 31, 2020, there were 24,070,531 shares of common stock issued and outstanding and 1,750,000 shares of preferred stock issued and outstanding.

On December 5, 2019, the Company’s Board of Directors approved a reverse stock split of the Company’s common stock, par value $0.001 per share. On December 10, 2019, the Financial Industry Regulatory Authority (“FINRA”) approved the Company’s 1:10 reverse stock split of the Company’s common stock. The reverse stock split took effect on December 11, 2019. Unless otherwise noted, impacted amounts and share information in the consolidated financial statements and notes thereto as of and for the interim period ended December 31, 2019 and fiscal year ended September 30, 2020, have been adjusted for the stock split as if such stock split occurred on the first day of the first period presented. 

Amendment to Articles of Incorporation

On October 4, 2019, pursuant to Article IV of our Articles of Incorporation, our Board of Directors voted to increase the number of shares of preferred stock designated as Series A Preferred Stock from one million (1,000,000) shares to two million (2,000,000) shares, par value $0.001.

Under the Certificate of Designation, holders of Series A Preferred Stock will be entitled to quarterly dividends on 2% of our earnings before interest, taxes and amortization. The dividends are payable in cash or common stock. The holders will also have a liquidation preference on the state value of $0.02 per share plus any accumulated but unpaid dividends. The holders are further entitled to have us redeem their Series A Preferred Stock for three shares of common stock in the event of a change of control and they are entitled to vote together with the holders of our common stock on all matters submitted to shareholders at a rate of forty-five (45) votes for each share held.

The rights of the holders of Series A Preferred Stock are defined in the relevant Amendment to the Certificate of Designation filed with the Nevada Secretary of State on October 9, 2019.

On October 2, 2020, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Nevada Secretary of State to increase its authorized shares of common stock to 35,000,000.

On October 7, 2020, the Company executed that certain first amendment to 2017 Equity Incentive Plan to increase its option pool from 300,000 to 1,500,000 shares of common stock (the “Plan Amendment”).

Certificate of Preferred Stock Designation

On April 16, 2019, pursuant to Article IV of our Articles of Incorporation, the Company’s Board of Directors voted to designate a class of preferred stock entitled Series B Preferred Stock, consisting of up to one hundred thousand (100,000) shares, par value $0.001. Shares of the Series B Preferred Stock were never issued and on March 6, 2020, the Company withdrew the Certificate of Designation for the Series B Preferred Stock. At the time of withdrawal, no shares of Series B Preferred Stock were issued and outstanding.

Common Stock issuances during the three months ended December 31, 2020

The Company issued 4,444,445 shares of the Company’s common stock in connection with its underwritten equity offering at a price of $9.00 per share for net proceeds of $37.05 million.

The Company issued 236,000 shares of common stock as settlement of accrued bonus compensation related to the year ended September 30, 2020. The fair value of these shares is $1.9 million and was fully expensed for in the prior year. The Company also issued 222,249 shares of common stock for the current year and the fair value of these shares is $546 thousand and has been fully expensed during the three months ended December 31, 2020.

The Company issued 1,618,285 shares of common stock in relation to the acquisition of ATL Data Centers LLC (See Note 3 for additional details.)

The Company issued 43,188 shares of common stock for services rendered for a total fair value of $561 thousand and has been fully expenses during the three months ended December 31, 2020.

The Company issued 115,385 shares of common stock in relation to the exercise of stock options and warrants. (See Notes 13 and 14 for additional details.)

Common Stock issuances during the three months ended December 31, 2019

The Company issued 187,100 shares in accordance with the terms of the convertible debt agreement due to the decrease in stock price.

The Company issued 2,000 shares for services rendered to an independent consultant.

The Company issued 793 shares for stock split true up due to rounding.

Series A Preferred Stock issuances during the three months ended December 31, 2019

On October 4, 2019, the Company authorized the issuance of a total of seven hundred and fifty thousand (750,000) shares of its designated Series A Preferred Stock to three members of its board of directors for services rendered.  A fair value of $0.02 per share was determined by the Company. Director fees of $15,000 was recorded as a result of the stock issued.

13. STOCK WARRANTS

The following is a summary of stock warrant activity during the three months ended December 31, 2020.

During the three months ended December 31, 2020, a total of 31,096 shares of the Company’s common stock were issued in connection with the exercise of warrants at exercise prices ranging from $3.63 and $8.00.

On December 31, 2020, a total of 73,906 shares of the Company’s common stock were issued in connection with the cashless exercise of 76,200 common stock warrants at an exercise price of $0.83.

As of December 31, 2020, the outstanding warrants have a weighted average remaining term of was 1.50 years and an intrinsic value of $11,130,019.

As of December 31, 2020, there are warrants exercisable to purchase 1,191,769 shares of common stock in the Company and 18,571 unvested warrants outstanding that cannot be exercised until vesting conditions are met. 993,699 of the warrants require a cash investment to exercise as follows, 2,500 require a cash investment of $8.00 per share, 449,865 require a cash investment of $15.00 per share, 125,000 require a cash investment of $20.00 per share, 103,000 require a cash investment of $25.00 per share, 200,000 require an investment of $35.00 per share, 10,000 require an investment of $40.00 per share, 60,000 require an investment of $50.00 per share, 38,333 require a cash investment of $75.00 per share and 5,000 require a cash investment of $100.00 per share. 198,070 of the outstanding warrants contain provisions allowing a cashless exercise at their respective exercise prices.

 14. STOCK OPTIONS

The Company sponsors a stock-based incentive compensation plan known as the 2017 Incentive Plan (the “Plan”), which was established by the Board of Directors of the Company on June 19, 2017. On October 7, 2020, the Company executed a first amendment to thePlan to increase its share pool from 300,000 to 1,500,000 shares of common stock. As of December 31, 2020, there were 553,190 shares available for issuance under the Plan.

The Plan allows the Company to grant incentive stock options, non-qualified stock options, stock appreciation right, or restricted stock. The incentive stock options are exercisable for up to ten years, at an option price per share not less than the fair market value on the date the option is granted. The incentive stock options are limited to persons who are regular full-time employees of the Company at the date of the grant of the option. Non-qualified options may be granted to any person, including, but not limited to, employees, independent agents, consultants and attorneys, who the Company’s Board believes have contributed, or will contribute, to the success of the Company. Non-qualified options may be issued at option prices of less than fair market value on the date of grant and may be exercisable for up to ten years from date of grant. The option vesting schedule for options granted is determined by the Board of Directors at the time of the grant. The Plan provides for accelerated vesting of unvested options if there is a change in control, as defined in the Plan.

The following is a summary of stock option activity during the three months ended December 31, 2020.

As of December 31, 2020, there are options exercisable to purchase 388,895 shares of common stock in the Company. As of December 31, 2020, the outstanding options have a weighted average remaining term of was 2.60 years and an intrinsic value of $11,800,257.

Option activity for the three months ended December 31, 2020

During the three months ended December 31, 2020, the Company issued 291,500 options to purchase shares of common stock to employees. The shares were granted at quoted market prices ranging from $8.07 to $12.48. The options were valued at issuance using the Black Scholes model and stock compensation expense of $385,883 was recorded as a result of the issuances, with the balance of $953,126 offset against bonuses accrued in the prior year

The Black-Scholes model utilized the following inputs to value the options granted during the three months ended December 31, 2020:

As of December 31, 2020, the Company expects to recognize $1,040,030 of stock-based compensation for the non-vested outstanding options over a weighted-average period of 1.01 years.

Option activity for the three months ended December 31, 2019

During the three months ended December 31, 2019, the Company issued 136,697 options to purchase shares of common stock to employees, the shares were granted at quoted market prices ranging from $4.50 to $8.50. The options were valued at issuance using the Black Scholes model and stock compensation expense of $478,022 was recorded as a result of the issuances.

The Black-Scholes model utilized the following inputs to value the options granted during the three months ended December 31, 2019:

15. COMMITMENTS AND CONTINGENCIES

Office leases

Utah Corporate Office

On November 22, 2019, the Company entered into a lease to relocate the corporate office to 1185 South 1800 West, Suite 3, Woods Cross, UT 84047. The agreement calls for the Company to make payments of $2,300 in base rent per month through February 28, 2021. The lease term is on an annual basis beginning on March 1, 2020.

San Diego Office

On May 15, 2018, the Company executed a 37 month lease agreement, which commenced on July 1, 2018 at 4360 Viewridge Avenue, Suite C, San Diego, California. The agreement calls for the Company to make payments of $4,057 in base rent per month through July 31, 2021 subject to an annual 3% rent escalation.  

Las Vegas Offices

On January 2, 2020, the Company entered into a sublease agreement with Blue Chip for office space at 8475 S. Eastern Ave., Suite 200, Las Vegas, NV 89123. The agreement calls for the Company to make monthly payments of $1,575 in base rent through January 1, 2021. The lease term is on an annual basis beginning January 2, 2020.

The Company assumed p2k’s lease agreement entered into on October 17, 2017 at 7955 W. Badura Ave., Suite 1040, Las Vegas, NV 89113. The agreement calls for $1,801 in base rent through October 31, 2020. The lease expired on October 31, 2020. The Company did not renew this lease.

Atlanta Offices

The Company assumed ATL’s lease agreement entered into on June 6, 2020 at 2380 Godby Road, Atlanta GA 30349. The agreement calls for $52,958 in base rent through June 4, 2022.

Contractual contingencies

On April 6, 2020, the Company entered into a joint venture agreement with a third party to procure, distribute, and supply Personal Protective Equipment (PPE) for hospitals and frontline medical personnel. The agreement expired on December 31, 2020.

Contingent consideration

On August 31, 2020, the Company acquired GridFabric. Pursuant to the terms of the purchase agreement, additional shares of the Company’s common stock valued at up to $750,000 will be issuable if GridFabric achieves certain revenue and product release milestones.

Legal contingencies

From time to time we may be subject to litigation. Risks associated with legal liability are difficult to assess and quantify, and their existence and magnitude can remain unknown for significant periods of time. We have acquired liability insurance to reduce such risk exposure to the Company. Despite the measures taken, such policies may not cover future litigation, or the damages claimed may exceed our coverage which could result in continent liabilities.

For a description of our material pending legal proceedings, please see Part II, Item I of this Quarterly Report on Form 10Q.

16. MAJOR CUSTOMERS AND VENDORS

For the three months ended December 31, 2020 and 2019, the Company had the following customers that represented more than 10% of our sales.

For the three months ended December 31, 2020 and 2019, the Company had the following suppliers that represented more than 10% of our direct material costs. Internally developed product costs and labor for services rendered are excluded from the calculation.

17. SEGMENT REPORTING

We disclose segment information that is consistent with the way in which management operates and views the business. Our operating structure contains the following reportable segments:   

Energy Segment – Consisting of our CleanSpark, LLC, CleanSpark Critical Power Systems, Inc., and GridFabric, LLC lines of business, this segment provides services, equipment, and software to the energy industry.

Digital Agency Segment – p2kLabs, Inc. provides design, software development, and other technology-based consulting services.

Digital Currency Mining Segment – Consisting of ATL Data Centers, LLC, this segment mines digital assets, namely Bitcoin.

SEGMENT REPORTING - Segmnent Reporting Assets

18. SUBSEQUENT EVENTS

On January 7, 2021, the Company issued 26,000 shares of Common Stock in connection with employee Common Stock Option exercises at exercise prices ranging from $4.65-$10.00 per share. The Company received $150,262 in consideration as a result of these exercises.

On January 8, 2021, the Company issued 10,000 shares of Common Stock in connection with a Common Stock warrant exercise at an exercise price of $15.00 per share. The Company received $150,000 in consideration as a result of the exercise.

On January 11, 2021, the Company issued 125,000 shares of Common Stock in connection with a Common Stock warrant exercise at an exercise price of $20.00 per share. The Company received $2,500,000 in consideration as a result of the exercise.

On January 15, 2021, the Company issued 300 shares of Common Stock in connection with a Common Stock warrant exercise at an exercise price of $3.36 per share. The Company received $1,008 in consideration as a result of the exercise.

On January 31, 2021, the Company issued 423 shares of Common Stock in connection with an employee Common Stock Option exercise at an exercise price of $24.40 per share. The Company received $10,321 in consideration as a result of the exercise.

On February 9, 2021, the Company issued 268 shares of Common Stock in connection with the cashless exercise of 300 Common Stock warrants at an exercise price of $3.36 per share.

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements 

Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.

Company Overview

We are in the business of providing advanced software and controls technology solutions to solve modern energy challenges. We have a suite of software solutions that provide end-to-end microgrid energy modeling, energy market communications, and energy management solutions. Our offerings consist of intelligent energy monitoring and controls, intelligent microgrid design software, middleware communications protocols for the energy industry, energy system engineering, and software consulting services.

The software platforms (the “Platforms”) which are integral to our business are summarized as follows:

The Platforms are designed to allow customers to design, build, and operate distributed energy systems and microgrids which efficiently manage energy generation assets, energy storage assets, and energy consumption assets. Our software products enable users to implement software solutions to execute on these strategies. These strategies are generally targeted to operate distributed energy assets in a manner that provides resiliency and economic optimization and/or revenue generation through wholesale market activities.

We also own patented gasification technologies. Our technology converts any organic material into SynGas, which can be used as fuel for a variety of applications and as feedstock for the generation of DME (Di-Methyl Ether). As previously disclosed, we plan to continue to focus on our other product offerings, as opposed to expending significant efforts on the Gasifier side of the business.

Distributed Energy Management and Microgrid Industry

Integral to our business is our Distributed Energy Management Business (the “DER Business”). The main assets of our DER Business include our propriety software systems (“Systems”) and also our engineering and methodology trade secrets. The Distributed Energy systems and microgrids that utilize our Systems are capable of providing secure, sustainable energy with significant cost savings for its energy customers. The Systems allows customers to design, engineer, and then efficiently communicate with and manage renewable energy generation, storage and consumption. By having autonomous control over the multiple facets of energy usage and storage, customers are able to reduce their dependency on utilities, thereby keeping energy costs relatively constant over time. The overall aim is to transform energy consumers into intelligent energy producers by supplying and managing power in a manner that anticipates their routine instead of interrupting it.

Around the world, the aging grid is becoming unstable and unreliable due to increases in loads and lack of new large-scale generation facilities. This inherent instability is compounded by the push to integrate a growing number and variety of renewable but intermittent energy generation assets and advanced technologies into outdated electrical grid systems. Simultaneously, defense installations, industrial complexes, communities, campuses and other aggregators across the world are turning to virtual power plants and microgrids as a means to decrease their reliance from the grid, reduce utility costs, utilize cleaner power, and enhance energy security and surety.

The convergence of these factors is creating significant opportunities in the power supply optimization and energy management industry. Efficiently operating and managing the distributed energy management systems and microgrids of tomorrow, while maximizing the use of sustainable energy to produce affordable, stable, predictable and reliable power on a large scale, is a significant opportunity that early-movers can leverage to capture a large share of this emerging global industry.

A microgrid is comprised of any number of energy generation, energy storage, and smart distribution assets that serve a single or multiple loads, both connected to the utility grid and separate from the utility grid “islanded”. In the past, distributed energy management systems and microgrids have consisted of off-grid generators organized with controls to provide power where utility lines cannot run. Today, modern distributed energy management systems and microgrids integrate renewable energy generation systems (REGS) with advanced energy storage devices and interoperate with the local utility grid. Advanced autonomous cyber-secure microgrids controls relay information between intelligent hardware and servers to make decisions in real-time that deliver optimum power where it is needed, when it is needed.

Our mPulse software suite is an integrated distributed energy management control platform that seamlessly integrates and controls all forms of energy generation with energy storage devices to provide energy security in real time free of cyber threats to service facility loads. DER systems are able to interoperate with the local utility grid and bring users the ability to choose when to buy or sell power to and from the utility grid. mPulse suite is an ideal DER system for commercial, industrial, defense, campus and residential users and ranges in size from 4KW to 100MW and beyond.

mPulse Software Suite

mPulse is a modular platform that provides intelligent control of a microgrid based on a systems operational goals, energy assets, and forecasted energy load and generation. mPulse performs high-frequency calculations, threshold-based alarming, execution of domain-specific business rules, internal and external health monitoring, historical data persistence, and system-to-operator notifications. The modular design increases system flexibility and extensibility. In addition, the deployment of the mPulse system follows a security-conscious posture by deploying hardware-based firewalls as well as encryption across communication channels. mPulse allows configuration for site-specific equipment and operation and provides a clean, informative user interface to allow customers to monitor and analyze the data streams that describe how their microgrid is operating.

mPulse supports our innovative fractal approach to microgrid design, which enables multiple microgrids on a single site to interact in a number of different ways, including as peers, in a parent-child relationship, and in parallel or completely disconnected. Each grid can have different operational objectives, and those operational objectives can change over time. Any microgrid can be islanded from the rest of the microgrid as well as the larger utility grid. The mPulse software can control the workflow required in both the islanding steps as well as the reconnecting steps of this maneuver and coordinate connected equipment such that connections are only made when it is safe to do so.

Microgrid Value Stream Optimizer (mVSO)

The Microgrid Value Stream Optimizer (mVSO) software platform provides a robust distributed energy and microgrid system modeling solution. mVSO takes utility rate data and load data for a customer site and helps automate the sizing and analysis of potential microgrid solutions as well as providing a financial analysis around each grid configuration. mVSO uses historical data to generate projected energy performance of generation assets and models how storage responds to varying operational modes and command logics based upon predicted generation and load curves. mVSO analyzes multiple equipment combinations and operational situations to determine the optimal configuration for a site based on the financial and economic results, equipment outlay, utility cost savings, etc., to arrive at payback and IRR values. This ultimately provides the user with data to design a distributed energy and/or microgrid system that will meet the customers’ performance benchmarks. The system also provides users with business development and proposal generation tools to more efficiently present the results to end-customers.

Critical power switchgear and hardware solutions – CleanSpark Critical Power Systems, Inc.

Through the Company’s wholly-owned subsidiary, CleanSpark Critical Power Systems, Inc., we provide parallel switchgear, automatic transfer switches, and related control and circuit protective equipment solutions for commercial, industrial, defense, campus, and residential users. We utilize Pioneer Power Solutions, Inc. for contract manufacturing of our parallel switchgear, automatic transfer switches, and related control and circuit protective equipment.

OpenADR and communication protocol software solutions – GridFabric

Through the Company’s wholly-owned subsidiary, GridFabric, LLC, we offer OpenADR solutions to commercial and utility customers. GridFabric provides middleware software solutions for utilities and IoT (Internet of Things) products that manage energy loads. OpenADR 2.0b is now the basis for the standard to be developed by the International Electrotechnical Commission. GridFabric's core products are Canvas and Plaid. 

Canvas

Canvas is an OpenADR 2.0b Virtual Top Node ('VTN') built for testing and managing Virtual End Nodes ('VENs') that are piloting and running load shifting programs. Canvas is offered to customers in the Cloud as a SaaS solution or as a licensed software.

Plaid

Plaid is a licensed software solution that allows any internet connected product that uses energy (i.e. Solar, Storage & Inverters, Demand Response, EV Charging, Lighting, Industrial controls, Building Management Systems, etc.)   to add load shifting capabilities by translating load shifting protocols into their existing APIs. Companies that implement Plaid through GridFabric get a Certified OpenADR 2.0b Virtual End Node (VEN) upon completion of the implementation process.

Digital Agency Segment – p2kLabs

Through the Company’s wholly-owned subsidiary, p2kLabs, Inc., we provide a suite of digital services from creative design to technical development for products and services through the entire product/service lifecycle. P2k is made up of “labs” whereas each lab contains its own unique offering including design, marketing/digital content, engineering & SalesForce development, and strategy services.

Legacy Gasifier Business

Our Gasification technologies and prototype will need to undergo further additional testing to further establish its commercial capability of producing large volumes of clean, renewable energy from any carbon compound (Municipal Solid Waste (MSW), Coal, Sewage Sludge) into clean Synthesis Gas(“SynGas”). Our prototype Gasifier is still under development and a commercially viable Gasifier is not expected to be sellable until we expend additional resources on its testing and development. A third-party consulting firm has independently tested the Gasifer's performance and certified the results of its performance. 

Upon completion of the testing, an initial white paper was published outlining the results and suggested improvements for commercialization. We anticipate that the investment to complete these improvements would be between approximately $500,000. Upon completion of the improvements, we would be required to conduct an extended test run with an independent third party to verify the results needed to prove its commercial viability, at which time we could begin to actively market our Gasifier units.

Bitcoin mining and Data Center business

Through its wholly-owned subsidiary, ATL Data Centers LLC, CleanSpark owns and operates a data center that provides customers with traditional on-site and cloud-based data center services. The Company also owns and operates a fleet of Bitcoin miners producing over 200 PH/s. Mining capacity is expected to increase to over 300 PH/s in early 2021. CleanSpark plans to apply its energy technologies to these divisions with a goal of mining bitcoins at the lowest energy prices in the United States.

Results of operations for the three months ended December 31, 2020 and 2019

Revenues

Revenues increased to $2,257,570 during the three months ended December 31, 2020, as compared with $976,824 in revenues for the same period ended 2019 primarily due to revenues from our digital agency and digital currency mining segments. 

Gross Profit

Our cost of revenues was $1,332,890 for the three months ended December 31, 2020, resulting in gross profit of $924,680, as compared with cost of revenues of $882,721 for the three months ended December 31, 2019, resulting in gross profit of $94,103.

The increase in our cost of revenues for the three months ended December 31, 2020 was mainly the result of an increase in manufacturing and hardware expenses.

Product sale revenue costs increased to $1,014,931 for the three months ended December 31, 2020, from $784,574 for the same period ended 2019. The increase in our product sale expense consisted mainly as a result of an increase in the cost of contract manufacturing for our switchgear products and hardware costs. 

Our cost of services increased to 148,913 for the three months ended December 31, 2020, from $98,147 for the same period ended 2019. The increase in our service, software, and related revenues expenses for the three months ended December 31, 2020, and 2019 consisted mainly as a result of an increase in the cost of allocated payroll costs of employees and consultants and subcontractors for services rendered through our digital agency services and installation of solar panels and energy storage. 

Our cost of mining and data center revenue increased to $169,046 for the three months ended December 31, 2020 from $0 for the same period ended 2019. The increase in these costs consisted mainly as a result of an increase in the utility costs and labor for data center services rendered.

Operating Expenses

We had operating expenses of $7,094,778 for the three months ended December 31, 2020, as compared with $3,085,564 for the three months ended December 31, 2019.

Professional fees increased to $1,712,723 for the three months ended December 31, 2020, from $1,516,587 for the same period ended December 31, 2019. Our professional fees expenses for the three months ended December 31, 2020 consisted mainly of legal fees of $1,230,362, consulting fees of $226,450, external marketing fees of $120,838, and accounting, audit and review fees of $97,350. Our professional fees expenses for the three months ended December 31, 2019 consisted mainly of officers and directors’ consulting fees of $150,000, consulting fees of $62,818, and accounting, audit and review fees of $71,655 and stock-based compensation of $586,181.  Professional fees increased in 2020 mainly as a result of increased legal fees.

Payroll expenses increased to $3,314,201 for the three months ended December 31, 2020, from $711,539 for the same period ended 2019. Our payroll expenses for the three months ended December 31, 2020 consisted mainly of salary and wages expense of $2,382,161 and employee stock-based compensation of $932,040. The increase in our payroll expenses for the three months ended December 31, 2019 consisted mainly as a result of an increase in salary and wages expense of $680,551 and employee stock-based compensation of $30,988.

General and administrative fees increased to $950,139 for the three months ended December 31, 2020, from $230,661 for the same period ended 2019. The increase in our general and administrative expenses for the three months ended December 31, 2020 consisted mainly as a result of an increase in our marketing expenses of 555,429, dues and subscriptions of $171,992, insurance expenses of $72,159, and rent expenses of $30,393. Our general and administrative expenses for the three months ended December 31, 2019 consisted mainly of travel expenses of $31,585, rent expenses of $21,318, insurance expenses of $42,901, dues and subscriptions of $51,367 and office expense of $10,445.

Product development expense was $39,286 for the three months ended December 31, 2020, and $39,287 for the same period ended 2019. Our product development expenses for the three months ended December 31, 2020 and 2019 consisted mainly of amortization of capitalized software. 

Depreciation and amortization expense increased to $1,078,429 for the three months ended December 31, 2020, from $587,490 for the same period ended 2019 mainly due to the depreciation expense related to the equipment used in the data center and digital currency miners.

We expect that our operating expenses will increase in future quarters as we further implement our business plan. As we execute on customer contracts we may be required to hire and compensate additional personnel and support increased operational costs.

Other income (expenses)

Other income/(expenses) decreased to ($997,432) for the three months ended December 31, 2020, from $1,075,207 for the same period ended December 31, 2019. Our other income/(expenses) for the three months ended December 31, 2020 consisted mainly of a realized gain on sales of digital currency of $49,918, net interest income of $46,644, an unrealized loss on equity securities of ($73,500), and derivative loss of ($1,020,494). Our other income/(expenses) for the three months ended December 31, 2019 consisted mainly of an unrealized gain on equity security of $368,868, derivative income of $2,266,654 and interest expense of ($1,560,315).

Net Loss

We recorded a net loss of $7,167,530 for the three months ended December 31, 2020, as compared with a net loss of $1,916,254 for the same period ended December 31, 2019 mainly due to increase in payroll expenses, general and administrative expenses, and depreciation and amortization expenses.

Liquidity and Capital Resources

As of December 31, 2020, we had total current assets of $33,306,373, consisting of cash, digital currency, accounts receivable, and prepaid expenses and other current assets, and total assets in the amount of $78,172,736. Our total current and total liabilities as of December 31, 2020 were $4,594,815 and $6,137,646 respectively. We had working capital of $28,711,558 as of December 31, 2020.

Operating Activities

Operating activities used $6,833,578 in cash for the three months ended December 31, 2020, as compared with $885,386 for the same period ended December 31, 2019. Our net loss of $7,167,530 was the main component of our negative operating cash flow for the three months ended December 31, 2020, offset mainly by stock based compensation of $4,350,643 unrealized loss on equity security of $73,500, loss on derivative asset of $1,020,494, depreciation and amortization of $1,078,429, and amortization of capitalized software of $39,286. Other components of our negative operating cash flow are the changes in operating assets and liabilities including prepaid expenses and other current assets of ($2,329,318), accounts payable of ($2,366,531), digital currency of ($733,410), accounts receivable of ($463,199), and inventory of ($276,750). Our net loss of $1,916,254 was the main component of our negative operating cash flow for the three months ended December 31, 2019, offset mainly by unrealized gain on equity security of ($368,868), gain on derivative asset of ($2,266,654), depreciation and amortization of $626,777, amortization of capitalized software of $39,286, amortization of debt discounts of $1,512,174, and stock-based compensation of $636,269. 

Investing Activities

Investing activities used $(2,427,972) during the three months ended December 31, 2020, as compared with ($509,447) for the same period ended December 31, 2019. Our sale of digital currencies of $375,887, acquisition of ATL Data Centers, LLC of $45,783, investment in infrastructure development of $(2,830,560), and purchase of fixed assets of ($19,082) were the main components of our investing cash flow for the three months ended December 31, 2020. Our investment in International Land Alliance of $(500,000) and purchase of fixed assets of $(9,447) were the main components of our negative investing cash flow for the three months ended December 31, 2019.

Financing Activities

Cash flows received/(used) in financing activities during the three months ended December 31, 2020 amounted to $31,767,261, as compared with ($67,467) for the three months ended December 31, 2019. Our cash flows from financing activities for the three months ended December 31, 2020 consisted of repayments of ($5,475,000) on promissory notes, proceeds from exercise of warrants of $192,656, and proceeds from underwritten offering of $37,049,605. Our negative cash flows from financing activities for the three months ended December 31, 2019 consisted of repayments of $(67,467) on promissory notes. 

Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of our sales and marketing, the timing of new product introductions and the continuing market acceptance of our products and services.

Management believes that the Company has sufficient liquidity to satisfy its anticipated cash requirements for the next twelve months. However, there can be no assurance that our operations will become profitable or that external sources of financing, including the issuance of debt and/or equity securities, will be available at times and on terms acceptable to us, or at all.  The Company’s management prepares budgets and monitors the financial results of the Company as a tool to align liquidity needs to the recurring business requirements.    

We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise monies on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

Off Balance Sheet Arrangements

As of December 31, 2020, there were no off-balance sheet arrangements.

Recently Issued Accounting Pronouncements

The Company has evaluated all recent accounting pronouncements and believes that none of them will have a material effect on the Company's financial position, results of operations or cash flows.

Critical Accounting Policies

In December 2001, the SEC requested that all registrants list their most “critical accounting polices” in the Management Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Our accounting policies are discussed in detail in the footnotes to our financial statements included in our Annual Report on Form 10-K for the year ended September 30, 2020. However, we consider our critical accounting policies to be those related to revenue recognition, long-lived assets, accounts receivable, fair value of financial instruments, cash and cash equivalents, accounts receivable, warranty liability and stock-based compensation.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable to a “smaller reporting company” as defined in Item 10(f)(1) of Regulation S-K.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic and current reports that we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Limitation on Effectiveness of Controls

The design of any control system 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 its stated goals. The inherent limitations in any control system include the realities that judgments related to decision-making can be faulty, and that reduced effectiveness in controls can occur because of simple errors or mistakes. Due to the inherent limitations in a cost-effective control system, misstatements due to error may occur and may not be detected.

Disclosure Controls and Procedures

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2020. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2020, our disclosure controls and procedures were not effective due to our recently acquired entity (i.e., ATL Data Centers LLC) in the process of adopting our internal controls and procedures.

Changes in Internal Control over Financial Reporting

Other than remediation actions related to a previous material weakness in our internal controls, there has been no change in our internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business.

CleanSpark, Inc. v. Discover Growth Fund, LLC

On August 5, 2020, the Company filed a verified complaint (the “Complaint”) in the Supreme Court of the State of New York against Discover Growth Fund, LLC (“Investor”). Among other things, the Complaint seeks: declaratory relief against Investor in response to Investor’s claim that a Form 8-K filed by the Company in relation to a July 20, 2020 securities purchase agreement needed pre-approval by Investor prior to filing, and injunctive relief in response to conversion notices sent by Investor claiming trigger events and defaults arising out of the failure to obtain the Form 8-K pre-approval.

The case was subsequently removed to the United States District Court for the Southern District of New York, which then determined that the parties’ agreements required a JAMS arbitrator sitting in the U.S. Virgin Islands to resolve the parties’ dispute over which of their agreements’ competing forum selection clauses was controlling, and that therefore the Court’s personal jurisdiction over Investor had not been established.

While the New York action was pending, Investor filed a demand for arbitration with JAMS in the U.S. Virgin Islands, alleging breach of the Securities Purchase Agreement dated December 31, 2018, and the Purchase Agreement dated April 17, 2019 between Investor and the Company (the “Arbitration”) and seeking issuance of additional shares of the Company. The Company then filed a response to Investor’s claims, denying Investor’s claims and asserting counterclaims against Investor, and also filed for emergency injunctive relief in the Arbitration seeking, among other things, an order enjoining Investor from continuing to pursue certain remedies based on the allegations in the Arbitration between Investor and the Company.

On September 21, 2020, the arbitrator granted the Company’s motion for emergency interim relief in the Arbitration. The arbitrator issued his interim award on September 22, 2020, (the “Interim Award”), which restrains Investor from: (i) proceeding with an asset sale or taking any actions in furtherance of the asset sale; (ii) pursuing any remedies in connection with the purported trigger events, conversion notices, notices of default, or sale notices that Investor issued; (iii) claiming or issuing any additional trigger events, conversion notices, delivery notices, notices of default, or sale notices pursuant to the debenture, note, or prior securities purchase agreements between the parties that relate to or arise out of the facts and allegations at issue in the Arbitration; and (iv) pursuing any other remedies that relate to or arise out of the facts and allegations at issue in the Arbitration.

Following the Interim Award, the Company completed an underwritten public offering with HC Wainwright (the “Offering”). In connection with the Offering, the Company provided notice to Investor of the Offering in compliance with a right of first refusal provision (the “ROFR”) in the parties’ agreements with the Company. Investor responded to the notice claiming that the notice was not sufficient and the ROFR was not satisfied by the notice and, as a result, proceeding with the Offering constituted a trigger event under the parties’ prior securities purchase agreements. Investor included the preceding allegations regarding the ROFR in its statement of claim in the Arbitration, and they are now at issue in that proceeding. The Company forcefully denies those claims.

Although the ultimate outcome of this matter cannot be determined with certainty, the Company believes that the claims raised by Investor in and related to the Arbitration are completely without merit, and the Company intends to both defend itself vigorously and to vigorously prosecute its counterclaims. Additionally, the Company believes that it has fully complied with its obligations under the right of first refusal and public disclosure review provisions of the parties’ prior securities purchase agreements.

Notwithstanding the merits of Investor’s claims, however, the Arbitration may distract the Company and cost the Company’s management time, effort and expense to defend against the claims and threats made by Investor. Notwithstanding the Company’s belief that it has complied with all of its obligations under the parties’ agreements, no assurance can be given as to the outcome of the Arbitration, and in the event the Company does not prevail in such action, the Company, its business, financial condition and results of operations would be materially and adversely affected.

Bishins v. CleanSpark, Inc. et al.