Financial Gravity Companies, Inc.: Form 10-Q for the period ended Mar 31, 2021

Forward-Looking Statements

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand its historical results of operations during the periods presented and its financial condition. This MD&A should be read in conjunction with its financial statements and the accompanying notes and contains forward-looking statements that involve risks and uncertainties and assumptions that could cause its actual results to differ materially from management’s expectations. See the sections entitled “Forward-Looking Statements” and “Risk Factors” included in this Form 10-Q for the six months ended March 31, 2021.

Plan of Operations

Financial Gravity is a parent company of best of breed financial services companies including brokerage, wealth management, estate planning, family office services, risk management, business and personal tax planning, business consulting, and financial advisor services. Financial Gravity's mission is to synergistically bring together companies that create symbiotic advantages to each other in order to bring a complete financial experience to the clients that we serve.

Financial Gravity’s Subsidiaries:

Forta Financial Group, Inc.

Forta was acquired effective May 21, 2020 and is a securities broker dealer, a registered investment advisor and a licensed insurance agency. Forta is a registered broker-dealer with the Securities and Exchange Commission (''SEC") and with the Financial Industry Regulatory Authority ("FINRA"). Forta is also a member of the Securities Investor Protection Corporation ("SIPC"). The Company's securities activities is limited to introducing and forwarding securities on a fully disclosed basis to a carrying broker-dealer. The Company as a matter of policy does not hold funds or securities for customers or owe money or securities to customers. Pursuant to Rule 15c3-1 of the Securities Exchange Act of 1934, Forta is required to maintain minimum net capital of $100,000 and ratio of aggregate indebtedness to net capital shall not exceed 15 to 1. On March 31, 2021, the Forta’s net capital was $292,930 and the aggregate indebtedness to net capital was 67.46%. The Company is exempt from certain provisions of Rule 15c3-3 of the Securities Exchange Act of 1934. Such exemption is in accordance with paragraph (k) (2) (ii) of the Rule.

Sofos Investments, Inc. (formerly Financial Gravity Wealth, Inc.)

After saving thousands in taxes, clients are happy to trust us with the management of their wealth, especially when treated to a different wealth management experience. Sofos is a Registered Investment Advisory firm. An RIA is an advisor or firm engaged in financial planning and wealth management business and is registered either with the Securities and Exchange Commission “SEC” or state securities authorities. An RIA has a fiduciary duty to his or her clients, which means that he or she has a fundamental obligation to provide suitable investment advice and always act in the clients’ best interests.

MPath Advisor Resources, LLC (formerly Financial Gravity Business, LLC) (“MPath”) MPath is an insurance marketing organization and provides insurance products and services to insurance agents or agencies.

Tax Master Network, LLC

Tax Master Network “TMN” was a key acquisition in fiscal year 2016. TMN supports over 300 CPA and Enrolled Agent professionals, training them to add crucial tax planning services to support clients. Not only did this acquisition bring high-end tax planning to Financial Gravity, but the TMN customer base adds significant business development opportunities for Forta and Sofos. The Company developed the Certified Tax Master® for this group and rolled out new client systems in mid-2016. TMN also provides tax services through its “Tax Blueprint®” system which identifies several strategies for lowering the client's taxes.

Results of Operations for the three and six months ended March 31, 2021 compared to the three and six months ended March 31, 2020

Revenues

For the three months ended March 31, 2021, revenue increased $1,064,989 to $1,681,995 from $616,680 for the three months ended March 31, 2020. The principal components of the increase in revenue are: revenue of approximately $754,000 from Forta, increased investment management revenue from Sofos of approximately $150,000, and from Mpath of approximately $166,000, as compared to the three months ended March 31, 2020.

For the six months ended March 31, 2021, revenue increased $2,080,917 to $3.389,673 from $1,308,755 for the six months ended March 31, 2020. The principal components of the increase in revenue are: revenue of approximately $1,500,000 from Forta, increased investment management revenue from Sofos of approximately $150,000, and increased revenue from TMN of approximately 180,000, and from Mpath of approximately $325,000, offset by decreased revenue at Financial Gravity Tax of approximately $70,000 as compared to the six months ended March 31, 2020.

Operating Expenses

Cost of services activity increased $8,038 to $22,683 for the three months ended March 31, 2021 from $14,646 for the three months ended March 31, 2020. The three month increase consists of Forta clearing house charges of $13,386, offset by reduction of credit card processing costs, resulting from the disposal of the tax business, of $5,349. Cost of services activity increased $31,573 to $58,230 for the six months ended March 31, 2021 from $26,657 for the six months ended March 31, 2020. The six month increase is principally due to Forta clearing house charges of $27,398 and a Sofos customer settlement of $11,073. The cost of services is credit card processing fees and Forta cost of brokerage services.

Professional services expenses include legal expense, professional fees, and business consulting. Professional services expenses increased $26,428 to $97,074 for the three months ended March 31, 2021 from $70,646 for the three months ended March 31, 2020 This increase is primarily due to an increase in legal fees and accounting arising from Forta operations. Professional services expenses increased $42,825 to $229,804 for the six months ended March 31, 2021 from $186,979 for the six months ended March 31, 2020 This increase is primarily due to an increase in legal fees and accounting arising from Forta operations.

Depreciation and amortization expenses include depreciation on fixed assets and amortization of definite lived intangibles. Depreciation and amortization expenses increased $10,388 to $32,174 for the three months ended March 31, 2021 from $21,785 for the three months ended March 31, 2020. The increase is due to acceleration of depreciation of certain assets. Depreciation and amortization expenses increased $19,697 to $67,504 for the six months ended March 31, 2021 from $47,807 for the six months ended March 31, 2020. The increase is due to acceleration of depreciation of certain assets

General and administrative expenses increased $138,965 to $221,398 for the three months ended March 31, 2021 from $85,903 for the three months ended March 31, 2020. The increase is primarily due to inclusion of Forta's expenses of approximately $148,000 for the period General and administrative expenses increased $376,353 to $558,165 for the six months ended March 31, 2021 from $181,812 for the six months ended March 31, 2020. The increase is primarily due to inclusion of Forta's expenses of approximately $380,000 for the period.

Marketing expenses decreased slightly by $1,238 to $12,234 for the three months ended March 31, 2021 from $13,472 for the three months ended March 31, 2020 Marketing expenses decreased slightly by $1,805 to $32,780 for the six months ended March 31, 2021 from $34,585 for the six months ended March 31, 2020. The decreases are due to the Company shutting down some previous marketing channels, while new channels have yet to be identified and implemented.

Compensation expenses increased $830,475 to $1,400,684 for the three months ended March 31, 2021 from $570,209 for the three months ended March 31, 2020. The increase was principally due to inclusion of Forta's compensation expense (approximately $612,000), increase in Mpath's compensation expense (approximately $35,000) and increases of compensation expenses at Company (approximately $100,000) and an increase at TMN and Sofos (approximately $50,000). Compensation expenses increased $1,586,446 to $2,735,466 for the six months ended March 31, 2021 from $1,149,020 for the six months ended March 31, 2020. The increase was principally due to inclusion of Forta's compensation expense (approximately $1,240,000), increase in Mpath's compensation expense (approximately $80,000) and increases of compensation expenses at Company (approximately $190,000) and an increase at TMN and Sofos (approximately $75,000).

The Company experienced an decrease in its net loss of $55,525 to a net loss of $103,786 for the three months ended March 31, 2021 from a net loss of $162,107 for the three months ended March 31, 2020. The Company experienced an increase in its net loss of $126,759 to a net loss of $298,147 for the six months ended March 31, 2021 from a net loss of $171,352 for the six months ended March 31, 2020. The changes are primarily attributable to the reasons noted above.

Significant Accounting Policies

Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements. These policies are contained in Note 1 to the consolidated financial statements.

Use of Estimates and Assumptions.

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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Revenue Recognition and Accounts Receivable.

The Company derives its revenues primarily from six components: Investment Management Fees, Brokerage Commissions, Tax Master Network subscriptions, Tax Operating System subscriptions, Financial Advisor subscriptions, Tax BluePrint sales, and Insurance Sales.

Sofos Investments, Inc. generates investment management fees for services provided by the Company. Investment management fees include fees earned from assets under management by providing professional services to manage client investments. Investment management fees are calculated as a percentage of assets under management for the period. Investment management fees are Revenue is recognized as earned, at the end of each period. Fees are withdrawn from investor assets monthly, in arrears.

Commission revenue is derived from the sale of securities, annuities and premiums on life insurance policies. The revenue is recognized when commissions are earned from the sale of securities, and when it is determined that insurance products are sold. Commissions are received after products are sold, issued or in force.

Revenue represents gross billings less discounts, and are net of sales taxes, as applicable. Amounts invoiced for work not yet completed are shown as deferred revenue in the accompanying consolidated balance sheets.

Tax Master Network has five levels of services that are charged and collected on a month-to-month subscription basis. None of these programs come with a long-term commitment or contract, and there is no up-front payment beyond the monthly subscription fee. Cancellations are processed within the month requested and memberships are closed at the end of the period for which the most recent payment was made. Members are not entitled to refunds for unused memberships. Any subscription fees paid for a future period are deferred in the financial statements. TMN also sells Tax Blueprint®. These are tax planning strategies guides, to save customers taxes through the implementation of the recommended tax strategies. After an initial assessment, the customers pay half of the year one tax savings. Revenue is deferred until the customer reviews and accepts the final Tax Blueprint® document and returns an executed delivery agreement. Subscription income is billed to client credit card monthly, on the monthly anniversary of client sign-up. Tax BluePrint sales are billed to the client after a preliminary assessment and client approval to move forward. Revenue has been recognized in 2021 in the amount of $76,470, that was included in the contract liability at the beginning of the at the end of 2020.

Services income is recognized as consulting and other professional services are performed by the Company. Income is recognized as services are delivered.

Commission revenue is derived from the sale of premiums on life insurance policies held by third parties. The revenue is recognized as received from the insurer, issuer.

Revenue represents gross billings less discounts, net of sales tax, as applicable. Amounts invoiced for work not yet completed are shown as deferred revenue in the accompanying consolidated balance sheets.

In the normal course of business, the Company extends credit on an unsecured basis to its customers, substantially all of whom are located in the United States of America. The Company does not believe that it is exposed to any significant risk of loss on accounts receivable.

Stock-Based Compensation.

The Company recognizes the fair value of stock-based compensation awards as wages in the accompanying statements of operations for employee grants, commissions for non-employee grants, and stock appreciation rights grants, on a straight-line basis over the vesting period, using the Black-Scholes option pricing model, which is based on risk-free rate of 0.59%, dividend yield of 0%, expected life of 10 years and volatility of 35% to 40% in 2020. SAR awards are new this year and are being treated as a liability award while the options are being treated as equity awards. While the fair value of the options are based on the Black Scholes assumptions included here, the SAR awards are based on assumptions at period end and are treated as liability awards. Forfeitures are recorded as they occur.

Liquidity and Capital Resources

As of March 31, 2021, the Company had cash and cash equivalents of $626,685. The increase of $143,831 in cash and cash equivalents from September 30, 2020 was due to net cash used in operating activities of $258,061 and net cash used in investing activities of $2,176, and net cash provided from financing activities of $404,068.

As shown below, at March 31, 2021, our contractual cash obligations totaled approximately $1,440,762, all of which consisted of debt principal.

Maturities by years

26

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the Company will need to manage additional asset units under contract and/or additional financing to fully implement its business plan, including continued growth and establishment of a stronger brand.

For the six months ended March 31, 2021, the Company reported $3,389,673 in revenue, a net loss of $298,147, an increase in cash used in operations of $258,061, and an accumulated deficit of $7,288,936. These operating results raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties.

On May 8, 2020, the Company received a PPP loan in the amount of $283,345. Additionally, on May 15, 2020, Forta received a PPP loan in the amount of $377,700 and $422,900 in February of 2021. PPP loans bear a fixed interest rate of 1% over a two-year term, are guaranteed by the federal government, and do not require collateral. The loans may be forgiven, in part or whole, if the proceeds are used to retain and pay employees and for other qualifying expenditures. The Company expects that the full proceeds of the PPP loans will be eligible for forgiveness, which would result in an increase in capital of $1,083,945.

Company’s plans for expansion include attracting additional clients through marketing efforts with its current and future brokerage, investment management and insurance agent representatives, as well as increasing the TMN membership and the investment advisory activity of the members to increase assets under management and Company’s revenue. Future growth plans will include efforts to increase advisory headcount through recruiting of individuals advisors and groups of advisors. There is no guaranty that the Company will achieve these objectives.

Off Balance Sheet Transactions and Related Matters

Other than operating leases discussed in Note 4 to the consolidated financial statements, there are no off-balance sheet transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources of the Company.

Interest Rate Risk. Our business is leveraged and, accordingly, is sensitive to fluctuations in interest rates. Any significant increase in interest rates could have a material adverse effect on our financial condition and ability to continue as a going concern.

Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2020. The term “disclosure controls and procedures,” as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost benefit relationship of possible controls and procedures. Based on its evaluation, management concluded as of March 31, 2021 that its disclosure controls and procedures were not effective because of material weaknesses in our internal control over financial reporting, described below in Management’s Report on Internal Control Over Financial Reporting. Notwithstanding the identified material weaknesses, management believes the financial statements included in this Form 10-Q fairly represent in all material respects our financial condition, results of operations and cash flows at and for the periods presented in accordance with U.S. GAAP.

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Responsibility, estimates and judgments by management are required to assess the expected benefits and related costs of control procedures. The objectives of internal control include providing management with reasonable, but not absolute, assurance that assets are safeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordance with management’s authorization and recorded properly to permit the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States. The Company’s Chief Executive Officer and Chief Financial Officer assessed the effectiveness of its internal control over financial reporting as of March 31, 2021. In making this assessment, its management used the criteria based on the framework in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2021, its internal control over financial reporting was not effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with US generally accepted accounting principles. The Company’s Chief Executive Officer and Chief Financial Officer reviewed the results of their assessment with its board of directors.

Based on its evaluation under this framework, management concluded that its internal control over financial reporting was not effective as of the evaluation date due to the factors stated below.

• Insufficient Resources: The Company has inadequate number of personnel with requisite expertise in the key functional areas of finance and accounting to be able to have appropriately designed and operating entity level controls including risk assessment; information and communication; monitoring; and financial reporting.
• Inadequate Segregation of Duties: The Company has inadequate number of personnel to properly segregate duties to implement control procedures.

Inherent Limitations on Effectiveness of Controls

Internal control over financial reporting has inherent limitations which include but is not limited to the use of independent professionals for advice and guidance, interpretation of existing and/or changing rules and principles, segregation of management duties, scale of organization, and personnel factors. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis, however these inherent limitations are known features of the financial reporting process and it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

No changes in Internal Control over Financial Reporting has been made since fiscal year end 2020.

Forta has 16 pending FINRA claims that arise from the sale to clients of alternative investments (REITs, Business Development Loan Funds, and Oil and Gas securities). These income generating investments did not do as well as the stock markets, and the performance has lagged the market. While the exposure on these cases would not be material, the costs of defense for legal fees may be substantial. Company is evaluating the impact upon operations of the expenses.

In December 2020, a novel strain of coronavirus, referred to as COVID-19, was reported to have surfaced in Wuhan, China. Since then, COVID-19 has spread to other countries, including the United States. In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. Further, the President of the United States declared the COVID-19 pandemic a national emergency. States in which we operate declared states of emergency related to the spread of COVID-19 and issued executive orders directing individuals to stay at their place of residence for an indefinite period of time.

The financial markets demonstrated significant volatility in reaction to the virus outbreak. There has been considerable strain on companies in many sectors of the economy. Investors suffered significant decreases in the value of their investment portfolios, and the economy has significantly shut down. It is unclear when the economy will start up again, and the lingering effects are not known. During periods of high volatility and uncertainty many investors choose to stop ongoing investment activity and sit on the sidelines until the markets become more stable.

The Company’s revenues are adversely affected when investors reduce their investment activities. In addition, part of Company’s revenues is based upon the value of assets under management. If the investment portfolios of clients decrease in value, the fees charged for investment advice also decreases.

The Company could be affected by lack of access to its offices, although that seems to have had little short-term impact as employees have succeeded in maintaining productivity while working remotely. The long-term effects, however, may present significant issues.

Any significant shutdown of the economy for a sustained period will affect the Company’s revenue which could lead to losses.