This Management's Discussion and Analysis of Financial Condition and Results of
Operations includes a number of forward-looking statements that reflect
Management's current views with respect to future events and financial
performance. You can identify these statements by forward-looking words such as
"may," "will," "expect," "anticipate," "believe," "estimate" and "continue," or
similar words. Those statements include statements regarding the intent, belief
or current expectations of us and members of our management team as well as the
assumptions on which such statements are based. Prospective investors are
cautioned that any such forward-looking statements are not guarantees of future
performance and involve risk and uncertainties, and that actual results may
differ materially from those contemplated by such forward-looking statements.
Readers are urged to carefully review and consider the various disclosures made
by us in this report and in our other reports filed with the Securities and
Exchange Commission. Important factors currently known to Management could cause
actual results to differ materially from those in forward-looking statements. We
undertake no obligation to update or revise forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or changes
in the future operating results over time. We believe that our assumptions are
based upon reasonable data derived from and known about our business and
operations. No assurances are made that actual results of operations or the
results of our future activities will not differ materially from our
assumptions. Factors that could cause differences include, but are not limited
to, expected market demand for our products, fluctuations in pricing for
materials, and competition.
Business Overview
We are focused on the research, design, development and manufacturing of
advanced, energy efficient indoor horticulture lighting, plant nutrient
products, and ancillary equipment. Our vision is to apply the latest advances in
high efficiency lighting and controls technology as well as effective
manufacturing techniques to deliver highly differentiated lighting and nutrient
products with clear benefits at competitive prices to the greenhouse and indoor
horticulture markets.
Our subsidiary, Solis Tek, Inc., a California corporation, was formed in June of
2010. Its operations consist of designing, developing and sourcing of a line of
Solis Tek Digital Ballasts intended for use in high intensity lighting systems
used for horticulture. An electrical ballast is a device intended to limit the
amount of current in an electric circuit. A familiar and widely used example is
the inductive ballast used in fluorescent lamps, which limits the current
through the tube, which would otherwise rise to destructive levels due to the
tube's negative resistance characteristic. Since the commencement of operations,
our product line has evolved from digital ballasts to a line of lighting
products including a line of specialty ballasts ranging from 400 watts to 1,000
watts with various features, our lamp products, a line of reflectors, high
intensity lighting accessories and a new line of LED lighting technologies.
Previously, we attempted to expand our operations in cannabis cultivation and
processing management services. In 2018, we acquired YLK Partners AZ, LLC, or
YLK Partners, an Arizona-based company to provide turn-key services for the
management, administration, and operation of a medical marijuana cultivation and
processing facility. YLK had a cultivation management services agreement with an
Arizona licensee. In 2019, we purchased real property in Phoenix, Arizona for
$3,500,000, which property held the approval and authorization for a Conditional
Use Permit, which allows the property to be used for the operation of a
cultivation and infusion facility, allowing for the cultivation, harvesting,
preparation, packaging and storing of medical cannabis, as well as extraction,
refinement, infusion, production, preparation, packaging, and storage of
manufactured and derivative oils, waxes, concentrates, edible and non-edible
products that contain cannabis. Later in 2019, we conveyed the property to our
lender in full settlement of the outstanding amounts we borrowed to acquire the
property. For various reasons, we decided to abandon the expanded business lines
and to re-focus on our core business of lights and nutrients.
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Known Trends and Uncertainties
In March 2020, the World Health Organization declared the outbreak of COVID-19 a
global pandemic. The responses by federal, state and local governments to
restrict public gatherings and travel rapidly grew to include stay-at-home
orders, school closures and mandatory restrictions on non-essential businesses
and services that has adversely affected workforces, economies, and financial
markets resulting in a significant economic downturn. In particular, on March
19, 2020, California Governor Gavin Newsom issued an executive order requiring
all California residents to stay home, making it the first state to impose that
strict mandate on all residents to counteract a looming surge of new infections.
The Company's executive offices are located in Upland, California. While we
currently believe we are an "essential" business, we have been following the
recommendations of local health authorities to minimize exposure risk for our
employees, including temporary closures of our offices and having employees work
remotely to the extent possible. The order, which has subsequently been modified
to provide for a gradual re-opening of businesses and travel, is to remain in
place until further notice. While California is currently in early stage 2 (out
of 4 stages) of re-opening, there is no known timeframe as to when California
may move to stage 3, and there remains a risk that California may regress.
While this disruption is currently expected to be temporary, there is
considerable uncertainty around the duration. We are actively monitoring the
COVID-19 situation and its impact in the markets we serve. We are taking all
precautionary measures as directed by health authorities and local and national
governments. Due to continuing uncertainties regarding the ultimate scope and
trajectory of COVID-19's spread and evolution, it is impossible to predict the
total impact that the pandemic will have on our business. If public and private
entities continue to implement restrictive measures, the material adverse effect
on our business, results of operations, financial condition and cash flows could
persist.
On May 7, 2020, we were granted a loan (the "PPP loan") from Wells Fargo Bank in
the aggregate amount of $205,000, pursuant to the Paycheck Protection Program
(the "PPP") under the CARES Act. The PPP loan agreement is dated May 8, 2020,
matures on May 7, 2022, bears interest at a rate of 1% per annum, with the first
six months of interest deferred, and is unsecured and guaranteed by the U.S.
Small Business Administration. The loan term may be extended to May 7, 2025, if
mutually agreed to by us and lender. We applied ASC 470, Debt, to account for
the PPP loan. The PPP loan may be prepaid at any time prior to maturity with no
prepayment penalties. Funds from the PPP loan may only be used for qualifying
expenses as described in the CARES Act, including qualifying payroll costs,
qualifying group health care benefits, qualifying rent and debt obligations, and
qualifying utilities. We intend to use the entire loan amount for qualifying
expenses. Under the terms of the PPP, certain amounts of the loan may be
forgiven if they are used for qualifying expenses. We intend to apply for
forgiveness of the PPP loan with respect to these qualifying expenses, however,
we cannot assure that such forgiveness of any portion of the PPP loan will
occur. As for the potential loan forgiveness, once the PPP loan is, in part or
wholly, forgiven and a legal release is received, the liability would be reduced
by the amount forgiven and a gain on extinguishment would be recorded. The terms
of the PPP loan provide for customary events of default including, among other
things, payment defaults, breach of representations and warranties, and
insolvency events. We were in compliance with the terms of the PPP loan as of
September 30, 2020.
On June 7, 2020, we obtained an Economic Injury Disaster Loan from the United
States Small Business Administration in the amount of $150,000. Interest on the
loan is at the rate of 3.75% per year, and all loan payments are deferred for
twelve months, at which time the balance is payable in monthly installments of
$731 over a 30-year term. The loan is secured by all of our assets.
We continue to review and consider any available potential benefit under the
CARES Act for which we qualify. We cannot predict the manner in which such
benefits or any of the other benefits described herein will be allocated or
administered and we cannot assure you that we will be able to access such
benefits in a timely manner or at all. If the U.S. government or any other
governmental authority agrees to provide such aid under the CARES Act or any
other crisis relief assistance it may impose certain requirements on the
recipients of the aid, including restrictions on executive officer compensation,
dividends, prepayment of debt, limitations on debt and other similar
restrictions that will apply for a period of time after the aid is repaid or
redeemed in full.
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Results of Operations
Results of operations for the three months ended September 30, 2020 compared to
the three months ended September 30, 2019.
Revenue and Cost of Goods Sold
Revenue for the three months ended September 30, 2020 and 2019 was $397,000 and
$475,000, respectively, a decrease of $78,000, or 16%. The decrease was due to
two significant factors during three months ended September 30, 2020, as
compared to the prior year period. Those factors were: 1) a failed expansion of
operations into cannabis cultivation and processing management services, which
diverted resources and management attention; and 2) stagnation of the cannabis
industry in terms of new markets and granting of new cultivation licenses, which
resulted in few new companies obtaining licenses to legally grow cannabis, which
ultimately resulted in a lack of orders for our lights.
Cost of sales for the three months ended September 30, 2020 and 2019 was
$248,000 and $158,000, respectively. Gross profit for the three months ended
September 30, 2020 and 2019, was $149,000 and $317,000, respectively. As a
percentage of revenue, gross profit for the three months ended September 30,
2020 was 38%, compared to 67% for the three months ended September 30, 2019. The
decrease in gross profit and our gross margin percentage was primarily due to
our decrease in reserves for inventory obsolescence and change in product mix
sold.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses for the three months ended
September 30, 2020 and 2019 were $218,000 and $829,000, respectively, a decrease
of $611,000, or 74%. Our SG&A expenses decreased primarily due to reductions in
the number of employees, benefits, and professional fees.
Research and Development Expenses
Research and development ("R&D") expenses for the three months ended September
30, 2020 and 2019 was $25,000 and $37,000, respectively, a decrease of $12,000,
or 32%. The decrease in R&D expenses was primarily due to decreased royalty
expense.
Other Income and Expenses
Other income for the three months ended September 30, 2020 was $2,501,000, as
compared to other income of $540,000 for the three months ended September 30,
2019 The increase was due to the gain on settlement of legal judgments of
$2,417,000, offset by financing costs of $83,000, neither of which occurred in
the prior year period, offset by the difference in the change in fair value of
derivative liability of $384,000, and a decrease in interest expense of $10,000.
Net Income (Loss)
Our net income for the three months ended September 30, 2020 was $2,407,000, as
compared to a net loss $9,000 for the three months ended September 30, 2019. The
increase in net income was due primarily to the gain on settlement of legal
judgments, and the decrease in loss from operations.
Results of operations for the nine months ended September 30, 2020 compared to
the nine months ended September 30, 2019.
Revenue and Cost of Goods Sold
Revenue for the nine months ended September 30, 2020 and 2019 was $980,000 and
$1,895,000, respectively, a decrease of $915,000, or 48%. The decrease was due
to two significant factors during the nine months ended September 30, 2020, as
compared to the prior year period. Those factors were: 1) a failed expansion of
operations into cannabis cultivation and processing management services, which
diverted resources and management attention; and 2) stagnation of the cannabis
industry in terms of new markets and granting of new cultivation licenses, which
resulted in few new companies obtaining licenses to legally grow cannabis, which
ultimately resulted in a lack of orders for our lights.
20
Cost of sales for the nine months ended September 30, 2020 and 2019, was
$577,000 and $922,000, respectively. Gross profit for the nine months ended
September 30, 2020 and 2019, was $403,000 and $973,000, respectively. As a
percentage of revenue, gross profit for the nine months ended September 30, 2020
was 41%, compared to 51% for the nine months ended September 30, 2019. The
decrease in gross profit and our gross margin percentage was primarily due to
our decrease in reserves for inventory obsolescence and change in product mix
sold.
Selling, General and Administrative Expenses
SG&A expenses for the nine months ended September 30, 2020 and 2019 were
$839,000 and $3,096,000, respectively, a decrease of $2,257,000, or 73%. Our
SG&A expenses decreased primarily due to reductions in the number of employees,
benefits, and professional fees.
Research and Development Expenses
R&D expenses for the nine months ended September 30, 2020 and 2019 were $75,000
and $191,000, respectively, a decrease of $116,000, or 61%. The decrease in R&D
expenses was primarily due to decreased royalty expense.
Legal Judgment
On September 25, 2018, Matthew Geschke (the "Plaintiff") filed a breach of
contract case against us in the San Diego Superior Court of San Diego,
California. The Plaintiff claimed damages for breach of an employment contract
when we terminated the Plaintiff's employment agreement on February 22, 2018. On
June 26, 2020, the Plaintiff was awarded a default judgment against us in the
amount of $448,000.
Impairment of Right of Use (ROU") Asset
Impairment of ROU asset for the nine months ended September 30, 2020 was
$82,000. In March 2020, we determined that our ROU asset was impaired and
recorded an impairment charge accordingly. (See Note 5 to the accompanying
condensed consolidated financial statements). No similar activity occurred
during the prior year period.
Loss on Abandonment of Leasehold Improvements
Loss on abandonment of leasehold improvement for the nine months ended September
30, 2019 was $218,000. In February 2019, we terminated our Arizona facility
lease, thereby abandoning $218,000 of leasehold improvements during the nine
months ended September 30, 2019. No similar activity occurred during the current
year period.
Impairment of Intangible Assets
Impairment of intangible assets for the nine months ended September 30, 2019 was
$1,139,000. In June 2019, we determined that our intangible assets were impaired
and recorded an impairment charge accordingly. No similar activity occurred
during the current year period.
Other Income and Expenses
Other income for the nine months ended September 30, 2020 was $390,000, as
compared to other income of $1,590,000 for the nine months ended September 30,
2019. The decrease was due to the gain on settlement of legal judgments of
$2,417,000 during the nine months ended September 30, 2020, which did not occur
in the prior year period, offset by difference in the change in fair value of
derivative liability of $3,437,000, increased interest expense of $211,000 due
to our increased debt levels, and the decrease in financing costs of $31,000.
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Net Loss
Our net loss for the nine months ended September 30, 2020 and 2019 was $651,000
and $2,244,000, respectively. The decrease in net loss was due primarily to the
change in other income and expenses, and the decrease in loss from operations.
Liquidity and Capital Resources
Cash and Liquidity
Liquidity is the ability of a company to generate funds to support its current
and future operations, satisfy its obligations, and otherwise operate on an
ongoing basis. Significant factors in the management of liquidity are funds
generated by operations, levels of accounts receivable and accounts payable and
capital expenditures.
Cash Flows Used in Operating Activities
During the nine months ended September 30, 2020 and 2019, we used cash in
operating activities of $335,000 and $857,000, respectively. During the nine
months ended September 30, 2020, cash was primarily used to fund our net loss of
$651,000, partially offset by non-cash related items such as the settlement of
legal judgments, impairment of ROU asset, financing costs, and the change in the
fair value of derivative liabilities. Non-cash items during the nine months
ended September 30, 2020 in aggregate were $645,000. The remaining changes were
due to a $203,000 decrease in inventory accounts payable and accrued expenses,
and a $122,000 change in our remaining working capital accounts.
Cash Flows Used in Investing Activities
During the nine months ended September 30, 2020 and 2019, we used $0 and
$218,000, respectively, in cash from investing activities to purchase property
and equipment.
Cash Flows Provided by Financing Activities
During the nine months ended September 30, 2020 and 2019, we generated cash from
financing activities of $780,000 and $254,000, respectively. During the nine
months ended September 30, 2020, we received proceeds of $465,000, net of fees
of $35,000, from a secured convertible notes payable and $355,000 from loans
payable, offset by $40,000 of payments on our notes payable to related parties.
During the nine months ended September 30, 2019, we received $150,000 from the
issuance of a note payable to related party and $150,000 from a loan, and we
made payments on our loans payable totaling $46,000.
The accompanying condensed consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and the
settlement of liabilities and commitments in the normal course of business. As
reflected in the accompanying condensed consolidated financial statements,
during the nine months ended September 30, 2020, we incurred a net loss of
$651,000 and used cash in operations of $335,000 and had a shareholders' deficit
of $8,992,000 at September 30, 2020. These factors raise substantial doubt about
our ability to continue as a going concern within one year after the date of the
financial statements being issued. Our ability to continue as a going concern is
dependent upon our ability to raise additional funds and implement our business
plan. The financial statements do not include any adjustments that might be
necessary if we are unable to continue as a going concern. In addition, our
independent registered public accounting firm, in its report on our December 31,
2019 financial statements, has raised substantial doubt about our ability to
continue as a going concern.
At September 30, 2020, we had cash on hand in the amount of $549,000. Management
estimates that the current funds on hand will be sufficient to continue
operations through March 2021. Our continuation as a going concern is dependent
upon our ability to obtain necessary debt or equity financing to continue
operations until we begin generating positive cash flow. No assurance can be
given that any future financing will be available or, if available, that it will
be on terms that are satisfactory to us. Even if we are able to obtain
additional financing, it may contain undue restrictions on our operations, in
the case of debt financing or cause substantial dilution for our shareholders,
in case of equity financing.
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Historically, we have financed our operations primarily through private sales of
equity and convertible debt, a line of credit, loans from a third party
financial institutions, related parties, and operations. We anticipate that our
primary capital source will be from the issuance of notes payable or the
proceeds from the sale of our common stock. However, we may not generate
sufficient revenues from product sales in the future to achieve profitable
operations. If we are not able to achieve profitable operations at some point in
the future, we may have insufficient working capital to maintain our operations
as we presently intend to conduct them or to fund our expansion, marketing, and
product development plans. There can be no assurance that we will be able to
obtain such financing on acceptable terms, or at all.
Notes Payable to Related Parties
On May 9, 2016, we entered into note payable agreements with Alan Lien and Alvin
Hao, former officers and directors, to borrow $300,000 under each individual
note. Pursuant to the terms of each of these agreements, we borrowed $300,000
from each of Alan Lien and Alvin Hao. The notes accrue interest at a rate of 8%
per annum, are unsecured and were due on or before May 31, 2018. The notes are
currently past due. A total of $600,000 was due on the combined notes at
September 30, 2020 and December 31, 2019.
On May 8, 2019, we entered into a note agreement with the sister of Alvin Hao, a
former officer and director, to borrow $150,000. The loan accrues interest at 8%
per annum, are unsecured and due on November 8, 2019. The note is currently past
due. A total of $150,000 was due on the note at September 30, 2020 and December
31, 2019.
We entered into note agreements with the parents of Alan Lien, a former officer
and director. The loans accrue interest at 10% per annum, are unsecured and were
due on or before December 31, 2016. The loans are currently past due. A total of
$40,000 was due on the loans at each of September 30, 2020 and December 31,
2019.
Secured Convertible Notes Payable
On May 10, 2018, we issued a secured debenture (the "2018 Note") to YA II PN in
the principal amount of $1,500,000 with interest at 8% per annum (18% on
default) and due on June 30, 2020, and provide a conversion right, in which the
principal amount of the 2018 Note, together with any accrued but unpaid
interest, could be converted into our common stock at a conversion price at 75%
of the lowest volume weighted average price (VWAP) of our common stock during
the 10 trading days immediately preceding the conversion date. A total of
$1,758,000, including accrued interest, was due on the 2018 Note as of September
30, 2020. The 2018 Note is past due.
On October 29, 2019, we issued a convertible secured debenture (the "2019 Note")
to YA II PN in the principal amount of $275,000 with interest at 10% per annum
(15% on default) and due on April 29, 2020. The 2019 Note provides a conversion
right, in which the principal amount of the Note, together with any accrued but
unpaid interest, could be converted into our common stock at a conversion price
at 75% of the lowest volume weighted average price (VWAP) of our common stock
during the 10 trading days immediately preceding the conversion date. A total of
$300,000, including accrued interest, was due on the 2019 Note as of September
30, 2020. The 2019 Note is past due.
On February 13, 2020, we issued a secured convertible debenture (the "2020
Note") in the principal amount of $150,000 with interest at 10% per annum (15%
on default) and due on August 10, 2021. The 2020 Note provides a conversion
right, in which any portion of the principal amount of the 2020 Note, together
with any accrued but unpaid interest, may be converted into our common stock at
a conversion price equal to 75% of the lowest VWAP of our common stock during
the ten (10) trading days immediately preceding the date of conversion, subject
to adjustment. A total of $160,000, including accrued interest, was due on the
2020 Note as of September 30, 2020.
On September 23, 2020, we issued a secured convertible debenture (the "September
2020 Note") in the principal amount of $350,000 with interest at 10% per annum
(15% on default) and due on March 23, 2021. The September 2020 Note provides a
conversion right, in which any portion of the principal amount of the September
2020 Note, together with any accrued but unpaid interest, may be converted into
our common stock at a conversion price equal to 75% of the lowest VWAP of our
common stock during the ten (10) trading days immediately preceding the date of
conversion, subject to adjustment. A total of $351,000, including accrued
interest, was due on the September 2020 Note as of September 30, 2020.
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Term Loans
On May 21, 2019, we entered into a loan agreement with Celtic Bank in the
principal amount of $150,000 (the "Celtic Loan") with interest at 40.44% per
annum and due on May 21, 2020. The loan was guaranteed by Alvin Hao, one of our
former officers. We have made principal payment of $126,000, leaving a total of
$24,000 due on the term loan as of September 30, 2020. The Celtic Loan is past
due.
On May 8, 2020, we obtained a Paycheck Protection Program loan in the amount of
$205,000 pursuant to the Coronavirus Aid, Relief, and Economic Security Act (the
"CARES Act"). Interest on the loan is at the rate of 1% per year, and all loan
payments are deferred for six months, at which time the balance is payable in 18
monthly installments if not forgiven in accordance with the CARES Act and the
terms of the promissory note we executed in connection with the loan.
On June 7, 2020, we obtained an Economic Injury Disaster Loan from the United
States Small Business Administration in the amount of $150,000. Interest on the
loan is at the rate of 3.75% per year, and all loan payments are deferred for
twelve months, at which time the balance is payable in monthly installments of
$731 over a 30 year term. The loan is secured by all of our assets.
Critical Accounting Policies
The Securities and Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of 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 and may change in
subsequent periods. Not all of the accounting policies require management to
make difficult, subjective or complex judgments or estimates. However, the
following policies could be deemed to be critical within the SEC definition.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on our assessment of the
collectability of customer accounts. We regularly review the allowance by
considering factors such as historical experience, the age of the accounts
receivable balances, credit quality, economic conditions that may affect a
customer's ability to pay and expected default frequency rates. Trade
receivables are written off at the point when they are considered uncollectible.
Inventories
We provide inventory reserves based on excess and obsolete inventories
determined primarily by future demand forecasts. The write down amount is
measured as the difference between the cost of the inventory and market based
upon assumptions about future demand and charged to the provision for inventory,
which is a component of cost of sales. At the point of the loss recognition, a
new, lower cost basis for that inventory is established, and subsequent changes
in facts and circumstances do not result in the restoration or increase in that
newly established cost basis.
Recent Accounting Pronouncements
See Note 2 of the condensed consolidated financial statements for management's
discussion of recent accounting pronouncements.
Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to
have a current or future effect on our financial condition, revenues, and
results of operations, liquidity or capital expenditures.
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