Business context and reporting period
CleanSpark, Inc. filed this Form 10-Q for the quarter ended March 31, 2018, its second fiscal quarter of 2018, and reported six-month results for the period ended that date. The supplied metadata says “2017 Q2,” which does not match the filing. CleanSpark provides microgrid design, engineering, consulting and installation, supported by its mPulse and mVSO software. It said its focus in 2018 would be the CleanSpark business rather than gasification. Results are interim and are not necessarily indicative of full-year performance.
Financial results and liquidity
| Metric | Three months ended March 31, 2018 | Six months ended March 31, 2018 |
|---|---|---|
| Revenue | $120,265; down from $200,749 | $138,345; down from $284,633 |
| Gross profit | $42,988; prior year $26,135 | $54,600; prior year $92,045 |
| Gross margin | 35.7%; prior year 13.0% | 39.5%; prior year 32.4% |
| Operating expenses | $1,069,742; prior year $1,122,812 | $2,121,738; prior year $1,968,547 |
| Operating loss | $(1,026,754); prior year $(1,096,677) | $(2,067,138); prior year $(1,876,502) |
| Net loss | $(1,124,742); prior year $(1,201,274) | $(2,181,257); prior year $(2,006,838) |
| Basic loss per share | $(0.04) | $(0.07) |
Margins are calculated from reported revenue and cost of revenues. Six-month operating cash outflow was $653,164, versus $699,470 in the prior-year period; investing outflow was $142,311, versus $65,957; and financing inflow was $910,569, versus $567,304. Cash increased by $115,094 to $172,222.
At March 31, 2018, current assets were $1,076,307 and current liabilities were $1,259,208, a working-capital deficit of $182,901. Total assets were $20,780,671 and total liabilities were $1,559,208. Current and long-term loans were $277,457 and $300,000, respectively; convertible notes had a net carrying amount of $9,778, with a separate $248,950 derivative liability. Related-party balances included $210,712 due to related parties and a $177,433 related-party loan. Stockholders’ equity was $19,221,463. Common shares outstanding were 34,489,670 at quarter-end and 34,841,023 as of May 15, 2018.
Changes versus prior comparable periods
- Revenue declined approximately 40% for the quarter and 51% for the six-month period. Management attributed current-period revenue mainly to microgrid design and implementation work.
- Quarterly gross profit and margin improved, while six-month gross profit fell. Management cited reduced staff costs supporting internal projects and greater subcontractor use as factors in the six-month margin improvement.
- Quarterly net loss narrowed, but the six-month net loss increased, principally alongside higher total operating expenses, including payroll and product development.
- Cash was higher than at September 30, 2017, but the increase depended on financing, including notes, related-party borrowing, convertible debt and equity issuance.
Outlook, risks and unusual items
- Funding and going concern: Management said available cash was insufficient to fund operations at the current level for the next 12 months. The company had cumulative losses of $22.1 million, stated that substantial doubt existed about its ability to continue as a going concern, and planned to seek additional debt or equity financing. There is no assurance financing will be available on acceptable terms or at all.
- Pipeline and revenue uncertainty: Management cited more than $20 million of proposals in various negotiation stages and said it believed it was more likely than not to win many, but could not reliably estimate timing or revenue. Those prospective contracts were not reported revenue. Management said failure or delay could affect future revenue estimates and potentially lead to impairment charges on software or intangible assets.
- Contract and product plans: CleanSpark reported beginning work in February 2018 on a $900,000 Camp Pendleton microgrid contract. It planned an initial customer release of mPulse 2.0 and DNA 2.0 in fiscal Q3 2018; a limited beta had been offered. Operating expenses could rise as the company executes contracts and adds staff.
- Acquisition agreement after quarter-end: On May 2, 2018, CleanSpark agreed to acquire assets and assume certain liabilities of Pioneer Custom Electric Products; closing was expected before June 30, 2018. Consideration included 7 million shares valued by agreement at $5.6 million, two five-year warrants for 1 million shares each at $1.60 and $2.00 exercise prices, an 18-month note based on net current assets and liabilities, and an equipment lease. The transaction was not described as closed in the subsequent-event note.
- Debt and dilution: Certain current promissory notes carried maximum rates of 58.3% or 58.5%; other notes included 10%–15% rates. The March 2017 convertible note converts, at the holder’s option, at 70% of the lowest closing market price during the preceding 20 days, creating potential dilution. The company also had 8,030,552 warrants outstanding at March 31, 2018.
- Customer and supplier concentration: Daoust represented 45% and Cintas 16% of six-month sales. CED Greentech and Alltech Solar accounted for 49.2% and 41.3% of direct material costs, respectively.
- Controls and contingencies: Management concluded disclosure controls were ineffective due to material weaknesses in segregation of duties/risk assessment and written accounting and reporting procedures. Remediation depended partly on securing financing. The company reported no pending legal proceedings and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether CleanSpark can secure sufficient financing to meet the stated 12-month funding need and address its going-concern uncertainty.
- Whether the proposal pipeline converts into executed contracts, and the timing, margins and cash collection associated with those contracts.
- Whether the Pioneer transaction closed, the final assets and liabilities assumed, and its effect on shares outstanding, warrants, debt and liquidity.
- The terms, repayment status and potential dilution from convertible, high-interest and related-party borrowing, as well as outstanding warrants and options.
- Progress on mPulse 2.0/DNA 2.0 releases, software recoverability assumptions and any subsequent impairment charges.
- Whether management remediates the disclosed material weaknesses and improves financial reporting controls.