Flash Sports & Media Holdings, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included herein. See also “Forward Looking Statements” on pages 3 - 4 of this Report.

OVERVIEW AND HISTORY

urban-gro is an integrated professional services and design-build firm. Our business focuses primarily on providing fee-based knowledge-based services as well as the value-added reselling of equipment. We derive income from our ability to generate revenue from our clients through the billing of our employees’ time spent on client projects. We offer value-added architectural, engineering, systems procurement and integration, and construction design-build solutions to customers operating in the controlled environment agriculture (“CEA”) and industrial and other commercial (“Commercial”) sectors. In the CEA sector, our clients include operators and facilitators in both the cannabis and produce markets in the United States, Canada, and Europe. In the Commercial sector, we work with leading food and beverage commercial packaged goods (“CPG”) companies in the United States, and clients in other commercial sectors including healthcare, higher education, and hospitality. During 2022 and 2021, we made the following acquisitions:

• October 2022 - An engineering firm (“DVO”)
• April 2022 - A construction design-build firm (“Emerald”)
• July 2021 - Three affiliated architecture design companies (the “2WR Entities”)

RESULTS OF OPERATIONS

Comparison of Results of Operations for the three months ended September 30, 2023 and 2022

During the three months ended September 30, 2023, we generated revenues of $20.9 million compared to revenues of $12.4 million during the three months ended September 30, 2022, an increase of $8.6 million, or 69%. This increase in revenues is the net result of the following changes in individual revenue components:

• Equipment systems revenue decreased $0.8 million due to negative market conditions in the CEA sector and a reduction in capital equipment spending by customers;
• Services revenue was flat, which was the result of a decrease in revenues in our existing business due to negative market conditions in the CEA sector offset by an increase in revenues from the DVO acquisition;
• Construction design-build revenue increased $9.4 million, primarily due to significant organic growth of our construction design-build revenue; and
• Other revenues decreased $0.1 million.

During the three months ended September 30, 2023, cost of revenues was $18.1 million compared to $9.8 million during the three months ended September 30, 2022, an increase of $8.3 million, or 85%. This increase is directly attributable to the overall increase in revenues indicated above and was further impacted by the change in individual revenue components.

Gross profit was $2.9 million (14% of revenues) during the three months ended September 30, 2023, compared to $2.6 million (21% of revenue) during the three months ended September 30, 2022. The overall gross profit as a percentage of revenues decreased primarily due to an increase in lower margin construction design-build revenue.

Operating expenses decreased by $3.5 million, or 37%, to $6.0 million for the three months ended September 30, 2023, compared to $9.5 million for the three months ended September 30, 2022. This overall decrease in operating expenses was the result of the net effects of the following:

• a $0.8 million decrease in general and administrative operating expenses due to the offsetting effects of (i) decreases in salary and personnel related costs, (ii) increased legal expenses and (iii) implementation of an incentive retention plan in 2023 that, at its inception, was expected to result in total expense of $1.3 million in 2023 ($0.5 million in the first quarter, $0.2 million in the second quarter, $0.3 million in the third quarter and $0.3 million in the fourth quarter);
• a $0.6 million increase in stock-based compensation expense, due to the three months ended September 30, 2022 expense including a reduction for unvested stock grants for employees who were no longer employed by the Company; and
• a $3.3 million decrease in a one-time business development expense related to satisfying a lighting issue encountered by a major customer.

Non-operating expense was $0.3 million for the three months ended September 30, 2023, compared to non-operating expense of $1.8 million for the three months ended September 30, 2022, a change of $1.5 million. This change was primarily due to a $1.7 million impairment loss recorded in the three months ended September 30, 2022.

As a result of the above, we incurred a net loss of $3.4 million for the three months ended September 30, 2023, or a net loss per share of $0.29, compared to a net loss of $8.7 million for the three months ended September 30, 2022, or a net loss per share of $0.81.

Comparison of Results of Operations for the nine months ended September 30, 2023 and 2022

During the nine months ended September 30, 2023, we generated revenues of $56.5 million compared to revenues of $49.7 million during the nine months ended September 30, 2022, an increase of $6.8 million, or 14%. This increase in revenues is the net result of the following changes in individual revenue components:

• Equipment systems revenue decreased $20.4 million due to negative market conditions in the CEA sector and a reduction in capital equipment spending by customers;
• Services revenue decreased $0.1 million which was the net result of a decrease in our existing business due to negative market conditions in the CEA sector offset by increased revenues in the commercial sectors resulting from our expanded business development efforts outside of the CEA market;
• Construction design-build revenue increased $27.8 million, due to significant organic growth of our construction design-build revenue in addition to the Emerald acquisition being included in our operating results for nine months in 2023 and only five months in 2022; and
• Other revenues decreased $0.4 million.

During the nine months ended September 30, 2023, cost of revenues was $48.0 million compared to $38.7 million during the nine months ended September 30, 2022, an increase of $9.3 million, or 24%. This increase is directly attributable to the change in individual revenue components driven by a decrease in higher margin equipment systems revenue as well as an increase in lower margin construction design-build revenue.

Gross profit was $8.6 million (15% of revenues) during the nine months ended September 30, 2023, compared to $11.0 million (22% of revenue) during the nine months ended September 30, 2022. The overall gross profit as a percentage of revenues decreased primarily due to an increase in lower margin construction design-build revenue as well as a decrease in higher margin equipment systems revenue. The decrease in services gross profit for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022 is primarily attributable to better time tracking on service projects due to system upgrades implemented in the first quarter of 2023.

Operating expenses decreased by $0.1 million, or 0%, to $20.6 million for the nine months ended September 30, 2023, compared to $20.7 million for the nine months ended September 30, 2022. This overall decrease in operating expenses was the result of the net effects of the following:

• a $3.2 million increase in general and administrative operating expenses due to (i) increases in salary and personnel related costs attributable to the acquisitions of the DVO and Emerald entities, (ii) increased legal expenses and (iii) implementation of an incentive retention plan in 2023 that, at its inception, was expected to result in total expense of $1.3 million in 2023 ($0.5 million in the first quarter, $0.2 million in the second quarter, $0.3 million in the third quarter and $0.3 million in the fourth quarter); and
• a $3.3 million decrease in in a one-time business development expense related to satisfying a lighting issue encountered by a major customer.

Non-operating expense was $2.1 million for the nine months ended September 30, 2023, compared to non-operating expense of $1.7 million for the nine months ended September 30, 2022, an increase of $0.4 million.

As a result of the above, we incurred a net loss of $14.0 million for the nine months ended September 30, 2023, or a net loss per share of $1.29, compared to a net loss of $11.1 million for the nine months ended September 30, 2022, or a net loss per share of $1.05.

NON-GAAP FINANCIAL MEASURES

The Company uses the supplemental financial measure of Adjusted Earnings before Interest, Taxes, Depreciation and Amortization (“Adjusted EBITDA”) as a measure of our operating performance. Adjusted EBITDA is not calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and it is not a substitute for other measures prescribed by GAAP such as net income (loss), income (loss) from operations, and cash flows from operating activities. We define Adjusted EBITDA as net income (loss) attributable to urban-gro, Inc., determined in accordance with GAAP, excluding the effects of certain operating and non-operating expenses including, but not limited to, interest expense/income, income taxes/benefit, depreciation of tangible assets, amortization of intangible assets, impairment of investments, foreign exchange gains and losses, debt forgiveness and extinguishment, stock-based compensation expense, and non-recurring legal and acquisition costs, that we do not believe reflect our core operating performance.

Our Board and management team focus on Adjusted EBITDA as a key performance and compensation measure. We believe that Adjusted EBITDA assists us in comparing our operating performance over various reporting periods because it removes from our operating results the impact of items that our management believes do not reflect our core operating performance.

The following table reconciles net income (loss) attributable to the Company to Adjusted EBITDA for the periods presented:

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BACKLOG

Backlog is a financial measure that generally reflects the dollar value of revenue that the Company expects to realize in the future. Although backlog is not a term recognized under generally accepted accounting principles in the United States (“GAAP”), it is a common measure used by companies operating in our industries. We report backlog for the following revenue categories: (i) Equipment Systems; (ii) Services; and (iii) Construction design-build. We define backlog for Equipment Systems and Services as signed contracts, with Equipment Systems contracts generally requiring receipt of a customer deposit. Construction design-build backlog is comprised of construction projects once the contract is awarded and to the extent we believe funding is probable. Our Construction design-build backlog consists of uncompleted work on contracts in progress and contracts for which we have executed a contract but have not commenced the work. For uncompleted work on contracts in progress, we include (i) executed change orders, (ii) pending change orders for which we expect to receive confirmation in the ordinary course of business, and (iii) claims that we have made against our customers for which we have determined we have a legal basis under existing contractual arrangements and as to which we consider collection to be probable.

Backlog for each of our revenue categories as of September 30, 2023, and December 31, 2022, is reflected in the following tables:

(in millions)

(in millions)

Historically, the majority of our Equipment Systems and Services backlog has been retired and converted into revenue within two quarters. As of September 30, 2023, we expected approximately 50% of our Construction design-build backlog to be completed in the next 12 months. As of September 30, 2023, and December 31, 2022, one customer accounted for 50% and 46% of total backlog, respectively.

Certain Construction design-build contracts contain options that are exercisable at the discretion of our customer to award additional work to us, without requiring us to go through an additional competitive bidding process. In addition, some customer contracts also contain task orders that are signed under master contracts pursuant to which we perform work only when the customer awards specific task orders to us.

Contracts in our Construction design-build backlog may be canceled or modified at the election of the customer. Many Construction design-build projects are added to our contract backlog and completed within the same fiscal year and therefore may not be reflected in our beginning or quarter-end Construction design-build backlog amounts.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2023, we had working capital of $2.8 million, compared to working capital of $10.3 million as of December 31, 2022, a decrease of $7.5 million. This decrease in working capital was primarily due to the net effects of the following:

• an increase in accounts payable, accrued expenses, and contract liabilities of $13.8 million;
• a decrease in cash and prepaid expenses and other assets of $8.1 million;
• an increase of accounts receivable, net and contract receivables of $8.3 million; and
• a decrease in customer deposits, contingent consideration, and promissory note of $6.1 million.

The increase in accounts payable is associated with the increase in costs incurred on construction design-build projects, including costs incurred near the end of the third quarter of 2023. Certain of these contracts were tied to customers where we had previously agreed upon project billing timelines and we were unable to bill for these projects until after September 30, 2023. This resulted in an increase in contract receivables as of September 30, 2023. The decrease in customer deposits and associated decrease in vendor prepayments are tied to the ongoing softness in the CEA sector. We are continually evaluating alternatives to increase our working capital including securing non-dilutive debt financing arrangements.

As of September 30, 2023, we had cash of $4.8 million, which represented a decrease of $7.2 million from December 31, 2022, due to the following changes during the nine months ended September 30, 2023:

• Net cash used in operating activities was $6.5 million. This use of cash is the net effect of the net loss of $14.0 million, offset by non-cash expenses of $3.8 million and cash provided by the net changes in operating assets and liabilities of $3.6 million. See the condensed consolidated statements of cash flows for further details on the non-cash expenses and net changes in operating assets and liabilities;
• Net cash provided by investing activities was $1.9 million, primarily from the sale of our investment in XS Financial offset by the acquisition of property, plant and equipment. We have no material commitments for capital expenditures as of September 30, 2023; and
• Net cash used in financing activities was $2.6 million, primarily due to payments made on the promissory note related to the DVO acquisition.

INFLATION

Inflation has resulted in increased costs for our customers. In addition, the U.S. Government has responded to inflation by raising interest rates, which has increased the cost of capital for our customers. We believe this has resulted in some customers delaying projects, reducing the scope of projects or potentially canceling projects, as well as increased costs of our operations, which has negatively impacted the results of our operations during the three and nine month periods ended September 30, 2023. We maintain strategies to mitigate the impact of higher material, energy and commodity costs, including cost reduction, alternative sourcing strategies, and passing along cost increase to customers, which may offset only a portion of the adverse impact.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under 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. For a detailed discussion about the Company’s significant accounting policies, refer to Note 2 - Summary of Significant Accounting Policies, in the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. During the nine months ended September 30, 2023, there were no material changes made to the Company’s significant accounting policies.

OFF-BALANCE SHEET ARRANGEMENTS

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.

DISCLOSURE CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Report.

These controls are designed to ensure that information required to be disclosed in the reports we file or submit pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our CEO and CFO to allow timely decisions regarding required disclosure.

Based on this evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of September 30, 2023, at reasonable assurance levels.

We believe that our financial statements presented in this Form 10-Q fairly present, in all material respects, our financial position, results of operations, and cash flows for all periods presented herein.

Inherent Limitations

Our management team, including our CEO and CFO, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of any system of controls 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 under all potential future conditions. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdown can occur because of simple errors or mistakes. In particular, many of our current processes rely upon manual reviews and processes to ensure that neither human error nor system weakness has resulted in erroneous reporting of financial data.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the nine months ended September 30, 2023, which were identified in conjunction with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information under this item.