urban-gro, Inc. - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _________.

Commission File Number: 001-39933

urban-gro, Inc.

(Exact name of registrant as specified in its charter)

(720) 390-3880

(Registrant’s telephone number, including area code)

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. 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 ☒ 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 ☒

The number of shares of the registrant’s only class of common stock outstanding as of November 4, 2022 was 10,611,592 shares.

urban-gro, Inc.

FORM 10-Q

For the Quarterly Period Ended September 30, 2022

INDEX

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements related to future events, challenges we may face, business strategy, future performance, future operations, backlog, financial position, estimated or projected revenues and losses, projected costs, prospects, plans and objectives of management. All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of words such as “seek,” “anticipate,” “plan,” “continue,” “estimate,” “expect,” “may,” “will,” “project,” “predict,” “potential,” “targeting,” “intend,” “could,” “might,” “should,” “believe,” “outlook” and variations of such words or their negative and similar expressions. Forward-looking statements should not be read as a guarantee of future performance or results, and may not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on management’s belief, based on currently available information, as to the outcome and timing of future events. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those expressed in such forward-looking statements. When evaluating forward-looking statements, you should consider the risk factors and other cautionary statements described in this Quarterly Report on Form 10-Q and under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. We believe the expectations reflected in the forward-looking statements contained in this report are reasonable, but no assurance can be given that these expectations will prove to be correct. Forward-looking statements should not be unduly relied upon. Important factors that could cause actual results or events to differ materially from those expressed in forward-looking statements include, but are not limited to:

These factors are not necessarily all of the important factors that could cause actual results or events to differ materially from those expressed in the forward-looking statements. Other unknown or unpredictable factors could also cause actual results or events to differ materially from those expressed in the forward-looking statements. Our future results will depend upon various other risks and uncertainties, including those described in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. All forward-looking statements attributable to us are qualified in their entirety by this cautionary statement. Forward-looking statements speak only as of the date hereof. We undertake no obligation to update or revise any forward-looking statements after the date on which any such statement is made, whether as a result of new information, future events or otherwise, except as required by law. You are advised, however, to consult any future disclosures we make on related subjects in future reports to the SEC.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

urban-gro, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

urban-gro, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

urban-gro, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

urban-gro, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

urban-gro, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATION, ACQUISITIONS, AND LIQUIDITY

Organization

urban-gro, Inc. (“we,” “us,” “our,” the “Company,” or “urban-gro”) is an integrated professional services and design-build firm. We offer value-added architectural, engineering, and construction management solutions to the Controlled Environment Agriculture (“CEA”), industrial, healthcare, and other commercial sectors. Innovation, collaboration, and a commitment to sustainability drive our team to provide exceptional customer experiences. To serve our horticulture clients, we engineer, design and manage the construction of indoor CEA facilities and then integrate complex environmental equipment systems into those facilities. Through this work, we create high-performance indoor cultivation facilities for our clients to grow specialty crops, including leafy greens, vegetables, herbs, and plant-based medicines. Our custom-tailored approach to design, construction, procurement, and equipment integration provides a single point of accountability across all aspects of indoor growing operations. We also help our clients achieve operational efficiency and economic advantages through a full spectrum of professional services and programs focused on facility optimization and environmental health which establish facilities that allow clients to manage, operate and perform at the highest level throughout their entire cultivation lifecycle once they are up and running. We also serve a broad range of commercial and governmental entities, providing them with planning, consulting, architectural, engineering and construction design-build services for their facilities. We aim to work with our clients from inception of their project in a way that provides value throughout the life of their facility. We are a trusted partner and advisor to our clients and offer a complete set of engineering and managed services complemented by a vetted suite of select cultivation equipment systems.

Acquisitions

Emerald

On April 29, 2022 (the “Emerald Closing Date”), the Company acquired all of the issued and outstanding capital stock (the “Emerald Acquisition”) of Emerald Construction Management, Inc. (“Emerald”) from its shareholders (collectively, the “Emerald Sellers”) through a forward merger into a wholly owned subsidiary of urban-gro, which has subsequently changed its name post-merger to Emerald Construction Management, Inc. The aggregate initial purchase price for the Emerald Acquisition was $7.8 million (the “Initial Emerald Purchase Price”), which represented $7.0 million in initial purchase price and an estimated $0.8 million in working capital adjustments.

The Initial Emerald Purchase Price was payable as follows: $3.3 million in cash to the Emerald Sellers, net of satisfaction of Emerald’s outstanding debt of approximately $0.4 million; and 283,515 shares of the Company’s common stock valued at $2.5 million issued to the Emerald Sellers. The value of the shares of the Company’s common stock issued at closing was determined based upon the daily volume weighted average closing price (“VWAP”) of the Company’s common stock in the ten trading days prior to the signing date of the Emerald Acquisition Agreement.

The Emerald Sellers may earn up to $2.0 million of contingent consideration (the “Emerald Contingent Consideration”) based on the performance of Emerald during the 2-year period following the Emerald Closing Date. The Emerald Contingent Consideration is payable quarterly in shares of the Company’s common stock for a two-year period and will be equal to 35% of Emerald’s Quarterly Gross Profit (as defined in the Emerald Acquisition Agreement). The value of such shares will be determined based upon the VWAP of the Company’s common stock in the ten trading days prior to the end of the applicable quarter the Quarterly Gross Profit is calculated. The Company accounted for the acquisition of Emerald as follows:

 SCHEDULE OF INITIAL ACQUISITION OF TARGET COMPANIES

The following pro forma amounts reflect the Company’s results as if the acquisition of Emerald had occurred on January 1, 2021. These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results of the acquisition to reflect the additional amortization of intangibles.

 SCHEDULE OF SUPPLEMENTAL INFORMATION ON UNAUDITED PRO-FORMA BASIC OF ACQUISITION

Acquired goodwill from Emerald represents the value expected to arise from organic growth and an opportunity to expand into a well-established market for the Company.

2WR

On June 28, 2021, the Company’s wholly-owned subsidiary, urban-gro Architect Holdings, LLC (the “Buyer”), and the 2WRCO Shareholders, the 2WRGA Shareholders, the MJ12 Shareholders, and the 2WRMS Shareholders (collectively, the “2WR Sellers”), and Sam Andras, an individual entered into a Stock Purchase Agreement (the “2WR Purchase Agreement”), pursuant to which the Buyer would purchase all of the issued and outstanding capital stock of 2WR of Colorado, Inc., a Colorado corporation (“2WRCO”), 2WR of Georgia, Inc., a Georgia corporation (“2WRGA”), MJ12 Design Studio, Inc., a Colorado corporation (“MJ12”) (collectively, the “2WR Purchased Shares”) from the 2WR Sellers. In connection with the acquisition of the 2WR Purchased Shares, the Buyer entered into an affiliate relationship with 2WR of Mississippi, P.C., a Mississippi professional corporation (“2WRMS” and together with 2WRCO, 2WRGA and MJ12, the “2WR Entities”). The transaction closed on July 30, 2021. The aggregate initial purchase price for the 2WR Purchased Shares was $10.5 million (the “2WR Purchase Price”), which represented $9.1 million in purchase price and an estimated $1.4 million in working capital adjustments.

The 2WR Purchased Shares were payable as follows: $6.5 million in cash, net of the satisfaction of 2WR’s outstanding debt of $0.5 million; and 202,066 shares of the Company’s common stock valued at $2.0 million issued to the 2WR Sellers (the “2WR Closing Payment Shares”). The value of the shares of the Company’s common stock issued at closing was determined based upon the daily VWAP of the Company’s common stock in the ten trading days prior to the signing date of the 2WR Purchase Agreement.

The 2WR Purchase Agreement provides for additional earnout payments (“2WR Earnout Payments”) to the 2WR Sellers of up to an aggregate amount of $2.0 million, payable in cash or unregistered shares of the Company’s common stock in the Buyer’s sole discretion. The 2WR Earnout Payments are payable quarterly for a two-year period and will be equal to 20% of the 2WR Entities’ quarterly gross profit (as defined in the 2WR Purchase Agreement). The value of the 2WR Closing Payment Shares was determined based upon the VWAP of the Company’s common stock in the ten trading days prior to the issuance of such shares. If paid in shares, the value of 2WR Earnout Payments will be determined based upon the VWAP of the Company’s common stock in the ten trading days prior to the end of the applicable quarter. The Company accounted for the acquisition of the 2WR Entities as follows:

 SCHEDULE OF INITIAL ACQUISITION OF TARGET COMPANIES

The following pro forma amounts reflect the Company’s results as if the acquisition of the 2WR Entities had occurred on January 1, 2021. These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results of the acquisition to reflect the additional amortization of intangibles.

SCHEDULE OF SUPPLEMENTAL INFORMATION ON UNAUDITED PRO-FORMA BASIC OF ACQUISITION 

Acquired goodwill from the 2WR Entities represents the value expected to arise from organic growth and an opportunity to expand into a well-established market for the Company.

Liquidity and Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business within one year after the date the consolidated financial statements are available to be issued.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Condensed Consolidated Financial Statements

The Company has prepared the accompanying condensed consolidated financial statements pursuant to the rules and regulations of the SEC for condensed financial reporting. The condensed consolidated financial statements are unaudited and, in the Company’s opinion, include all adjustments, consisting of normal recurring adjustments and accruals necessary for a fair presentation of the Company’s condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive income (loss), condensed consolidated statements of shareholders’ equity (deficit) and condensed consolidated statements of cash flows for the periods presented. The results reported in these condensed consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted in accordance with regulations of the SEC. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

Significant Accounting Policies

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, 2021. During the nine months ended September 30, 2022, there were no material changes made to the Company’s significant accounting policies.

Use of Estimates

In preparing condensed consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of assets and liabilities at the date of the condensed consolidated financial statements and revenues and expenses during the reported period. Actual results could differ from those estimates. Significant estimates include: estimated revenues earned under construction design-build contracts; estimated useful lives and potential impairment of long-lived assets, intangibles and goodwill; inventory write offs; allowance for deferred tax assets; and allowance for bad debt.

Reclassification

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

Balance Sheet Classifications

The Company includes in current assets and liabilities the following amounts that are in connection with construction contracts that may extend beyond one year: contract assets and contract liabilities (including retainage invoiced to customers contingent upon anything other than the passage of time), capitalized costs to fulfill contracts, retainage payable to sub-contractors and accrued losses on uncompleted contracts. A one-year time period is used to classify all other current assets and liabilities when not otherwise prescribed by the applicable accounting principles.

Contract Assets and Liabilities

The timing of when the Company bills customers on long-term construction contracts is generally dependent upon agreed-upon contractual terms, which may include milestone billings based on the completion of certain phases of the work, or when services are provided. When as a result of contingencies, billings cannot occur until after the related revenue has been recognized, the result is unbilled revenue, which is included in contract assets. Additionally, the Company may receive advances or deposits from customers before revenue is recognized, the result is deferred revenue, which is included in contract liabilities.

Retainages subject to conditions other than the passage of time are included in contract assets and contract liabilities.

Contract assets represent revenues recognized in excess of amounts paid or payable (contract receivables) to the Company on uncompleted contracts. Contract liabilities represent the Company’s obligation to perform on uncompleted contracts with customers for which the Company has received payment or for which contract receivables are outstanding.

The following table provides information about contract assets and contract liabilities from contracts with customers as of September 30, 2022:

 SCHEDULE OF CONTRACT ASSETS AND LIABILITIES

NOTE 3 – RELATED PARTY TRANSACTIONS

Cloud 9 Support, LLC (“Cloud 9”) is an entity owned by James Lowe, a director of the Company. Cloud 9 purchases materials from the Company for use with its customers. Total sales to Cloud 9 from the Company were $13,383 and $99,556 during the nine months ended September 30, 2022, and 2021, respectively, and $1,571 and $5,349 during the three months ended September 30, 2022 and 2021, respectively. Outstanding receivables from Cloud 9 as of September 30, 2022 and December 31, 2021 totaled $5,623 and $6,797 respectively.

NOTE 4 – PREPAYMENTS AND OTHER ASSETS

Prepayments and other assets are comprised of prepayments paid to vendors to initiate orders and prepaid services and fees. The prepaid balances are summarized as follows:

 SCHEDULE OF PREPAID BALANCES

NOTE 5 – INVESTMENTS

The components of investments are summarized as follows:

 SCHEDULE OF COST METHOD INVESTMENTS

Edyza

The Company has a strategic investment in Edyza, Inc. (“Edyza”), a hardware and software technology company that enables dense sensor networks in agriculture, healthcare, and other environments that require precise micro-climate monitoring. The Company measures this investment at cost, less any impairment changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer.

During the three months ended September 30, 2022, the Company has fully impaired this investment. The Company notes that the intent and ability to retain its investment for a period of time sufficient to allow for any anticipated recovery has passed, causing an “other than temporary loss.” The Company will continue to monitor any future changes to this impairment and seek to recover any remaining value of its 19.5% ownership. The loss recorded in the three and nine months ended September 30, 2022 was $1.7 million.

XS Financial

On October 30, 2021, the Company’s wholly-owned subsidiary UGFS, LLC, a Colorado limited liability company (“UGFS”), participated in a convertible note offering of Xtraction Services, Inc., a/k/a XS Financial Inc. (CSE: XSF) (OTCQB: XSHLF) (“XSF”), a specialty finance company providing CAPEX financing solutions, including equipment leasing, to Controlled Environment Agriculture (CEA) companies in the United States. UGFS invested $2,500,000 of a total $43,500,000 raised by XSF. The investment is convertible into equity and incurs 9.50% interest payable in cash (8.0%) and payment-in-kind Notes (“PIK”) (1.5%) prior to any Nasdaq listing and 8.0% interest after any listing, pursuant to the Note Purchase Agreement. The debt matures on October 28, 2023, with a one-year option to extend the maturity date at the option of XSF. In addition, UGFS received 1,250,000 warrants with a CAD$0.45 exercise price pursuant to the Warrant instrument. No value was attributed to the warrants at the time of the investment in XFS.

NOTE 6 – GOODWILL & INTANGIBLE ASSETS

Goodwill

The Company has recorded goodwill in conjunction with the acquisitions it has completed. The goodwill balances as of September 30, 2022 and December 31, 2021 were $12,127,124 and $7,992,121, respectively. Goodwill is not amortized. There is no goodwill for income tax purposes. The Company did not record any impairment charges related to goodwill for the periods ended September 30, 2022 and 2021.

Intangible Assets Other Than Goodwill

Intangible assets as of September 30, 2022 and December 31, 2021 consisted of the following:

 SCHEDULE OF FINITE-LIVED INTANGIBLE ASSETS

The estimated future amortization expense for intangible assets subject to amortization as of September 30, 2022, is summarized below:

 SCHEDULE OF FUTURE AMORTIZATION EXPENSES OF INTANGIBLE ASSETS

Amortization expense for intangible assets for the nine months ended September 30, 2022 and 2021 was $773,063 and $101,727, respectively. Amortization expense for intangible assets for the three months ended September 30, 2022 and 2021 was $304,339 and $101,149, respectively.

NOTE 7 – ACCRUED EXPENSES

Accrued expenses are summarized as follows:

 SCHEDULE OF ACCRUED EXPENSES

NOTE 8 – RISKS AND UNCERTAINTIES

Concentration Risk

The table below shows customers who account for 10% or more of the Company’s total revenues and 10% or more of the Company’s accounts receivable for the periods presented:

Customers exceeding 10% of revenue:

 SCHEDULES OF CONCENTRATION OF RISK

Customers exceeding 10% of accounts receivable:

The table below shows vendors who account for 10% or more of the Company’s total purchases and 10% or more of the Company’s accounts payable for the periods presented:

Vendors exceeding 10% of purchases:

Vendors exceeding 10% of accounts payable:

*Amounts less than 10%

Foreign Exchange Risk

Although the Company’s revenues and expenses are expected to be predominantly denominated in United States dollars, the Company may be exposed to currency exchange fluctuations. Recent events in the global financial markets have been coupled with increased volatility in the currency markets. Fluctuations in the exchange rate between the U.S. dollar, the Canadian dollar, the Euro, and the currency of other regions in which the Company may operate may have a material adverse effect on the Company’s business, financial condition and operating results. The Company may, in the future, establish a program to hedge a portion of the Company’s foreign currency exposure with the objective of minimizing the impact of adverse foreign currency exchange movements. However, even if the Company develops a hedging program, there can be no assurance that it will effectively mitigate currency risks.

NOTE 9 – STOCK-BASED COMPENSATION

Stock-based compensation expense for the nine months ended September 30, 2022, and 2021 was $1,860,767 and $1,096,441, respectively, based on the vesting schedule of the stock grants and options. Stock-based compensation expense for the three months ended September 30, 2022 and 2021 was $96,767 and $506,034, respectively, based on the vesting schedule of the stock grants and options. No cash flow effects are anticipated for stock grants.

The following schedule shows stock grant activity for the nine months ended September 30, 2022:

 SCHEDULE OF STOCK GRANT ACTIVITY

As of September 30, 2022, the Company has $2.3 million in unrecognized stock-based compensation expense related to these stock grants.

The following schedule shows stock option activity for the nine months ended September 30, 2022.

 SCHEDULE OF STOCK GRANT VESTING PERIODS

The fair value of the options is calculated using the Black-Scholes pricing model based on the market value of the underlying common stock at the valuation measurement date of $10.48, the remaining contractual term of the options of 10 years, risk-free interest rate of 1.61% and expected volatility of the price of the underlying common stock of 100%.

As of September 30, 2022, the Company has $0.3 million in unrecognized stock-based compensation expense related to these stock options. The aggregate intrinsic value of the options outstanding and exercisable at September 30, 2022 is $0.

NOTE 10 – SHAREHOLDERS’ EQUITY

On May 24, 2021, the Board of Directors authorized a stock repurchase program to purchase up to $5.0 million of the currently outstanding shares of the Company’s common stock, over a period of 12 months through open market purchases, in compliance with Rule 10b-18 under the Securities Exchange Act of 1934. On January 18, 2022, the Board of Directors authorized a $2.0 million increase to the stock repurchase program, to a total of $7.0 million. On February 2, 2022, the Board of Directors authorized an additional $1.5 million increase to the stock repurchase, to a total of $8.5 million. On September 12, 2022, the Board of Directors authorized an additional $2 million increase to the stock repurchase, to a total of $10.5 million.

During the nine months ended September 30, 2022, the Company repurchased 482,211 shares of common stock at an average price per share of $8.20, for a total price of $4.0 million under this program. During the three months ended September 30, 2022, the Company repurchased 63,123 shares of common stock at an average price per share of $2.90, for a total price of $0.2 million. During the nine months ended September 30, 2021, the company repurchased 421,024 shares of common stock at an average price per share of $9.33, for a total price of $4.0 million. During the three months ended September 30, 2021, the Company repurchased 368,129 shares of common stock at an average price per share of $9.31, for a total of $3.4 million. In total, the Company has repurchased 987,126 shares of common stock at an average of $8.78 per share, for a total price of $8.7 million, under this program.

In February 2021, the Company repurchased 350,000 shares of common stock with an average price per share of $8.50, for a total of $3.0 million, outside of any stock repurchase or publicly announced program.

NOTE 11 – WARRANTS

The following table shows warrant activity for the nine months ended September 30, 2022.

 SCHEDULE OF WARRANT ACTIVITY

The weighted-average life of the warrants is 2.10 years. The aggregate intrinsic value of the warrants outstanding and exercisable as of September 30, 2022 is $0.

NOTE 12 – BUSINESS DEVELOPMENT

During 2021, the Company purchased lights from one of its international vendors to fulfill an order for a major customer. Subsequent to the sale, delivery and installation of the lights, the customer noted the lights were not performing as the manufacturer had stipulated. The Company performed tests of the lights and confirmed the performance metrics did not meet the manufacturer’s specifications. The Company worked with the customer to determine a lighting solution of replacement lights, sourced from the vendor, that would meet their needs. The customer has been a key customer to the Company and the Company expects to continue to do significant business with the customer in the future. In order to immediately satisfy the customer in this matter, during the third quarter of 2022, the Company agreed to supply the replacement lighting solution to the customer at the Company’s expense while the Company continues to work with the vendor to resolve the original defective lighting issue, including, claims for reimbursement of the expense.

During the three months ended and at September 30, 2022, the Company delivered $1.3 million of replacement lighting equipment and accrued an additional $2.0 million of expense for the remaining order total for shipments delivered in October 2022. The total business development expense recorded in the three months ended September 30, 2022 was $3.3 million. This expense is a one-time expense. 

NOTE 13 – INCOME TAXES

The Company has experienced losses for both book and tax purposes since inception. The deferred income tax benefit for the three and nine month periods ended September 30, 2022 relates to the reduction in the deferred tax liability associated with the amortization of the intangible assets from the acquisitions of the Emerald and 2WR Entities.

NOTE 14 – SUBSEQUENT EVENTS

The Company has evaluated events and transaction occurring subsequent to September 30, 2022 up to the date of this filing of these condensed consolidated financial statements. These statements contain all necessary adjustments and disclosures resulting from that evaluation.

On October 10, 2022, the Company signed a binding term sheet to acquire substantially all of the operating assets of Dawson Van Orden, Inc. (“DVO”), an engineering firm with significant experience in indoor CEA, for a total purchase consideration of up to $7.3 million. The asset acquisition of DVO was completed on October 31, 2022 by urban-gro Engineering, Inc., d/b/a DVO, a wholly owned subsidiary of the Company. The Company funded the $7.3 million purchase price, which includes a contingent consideration of up to $1.1 million paid in cash or equity at the Company’s discretion, with $1.3 million in cash, a promissory note of $3.8 million to be paid out over four quarters, and $1.1 million of its common stock at a pre-set price of $4 per share.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 page 3 of this Report.

Overview and History

urban-gro, Inc. (“we,” “us,” “our,” the “Company,” or “urban-gro”) is an integrated professional services and design-build firm. We offer value-added architectural, engineering, and construction management solutions to the Controlled Environment Agriculture (“CEA”), industrial, healthcare, and other commercial sectors. Innovation, collaboration, and a commitment to sustainability drive our team to provide exceptional customer experiences.

On October 31, 2022, we acquired substantially all of the operating assets of Dawson Van Order, Inc, an engineering firm. On April 29, 2022, we acquired Emerald Construction Management, a general contracting and construction management firm. On July 30, 2021, we acquired three architecture design firms (2WR Colorado, Inc, 2WR Georgia, Inc. and MJ12 Design Studios, Inc., collectively the “2WR Entities”) from their shareholders. The 2WR Entities were under common ownership and management. We design and build high performance facilities in several sectors. Within the CEA sector, we design these facilities and while building them, we then integrate complex environmental equipment systems into them. Through this work, we create high-performance indoor cultivation facilities for our clients to grow specialty crops, including leafy greens, vegetables, herbs, and plant-based medicines. Our custom-tailored approach to design, procurement, and equipment integration provides a single point of accountability across all aspects of indoor growing operations. We also help our clients achieve operational efficiency and economic advantages through a full spectrum of professional services and programs focused on facility optimization and environmental health which establish facilities that allow clients to manage, operate and perform at the highest level throughout their entire cultivation lifecycle once they are up and running.

We aim to work with our clients in all sectors from inception of their project in a way that provides value throughout the life of their facility. We are a trusted partner and advisor to our clients and offer a complete set of design, engineering, construction management, and managed services. Within the CEA sector, this is complemented by a vetted suite of select cultivation equipment systems. We provide these services in a turnkey fashion, operating as a single point of responsibility for our clients, or they can pick and choose from the variety of services we offer. Outlined below is an example of a complete project that demonstrate how we provide value to our clients

Our indoor commercial cultivation solution offers an integrated suite of services and equipment systems that generally fall within the following categories:

Historically, the majority of our clients are commercial CEA cultivators. However, through our acquisitions we have seen our client base across the industrial, healthcare, and other commercial sectors grow as well. We believe one of the key points of our differentiation that clients value is the depth of experience of our employees and our Company. We currently employ approximately 140 individuals, inclusive of the DVO acquisition. Approximately two-thirds of our employees are considered experts in their areas of focus, and our team includes Designers (Architects, Interior Designers, Cultivation Space Planners), Professional Engineers (Mechanical, Electrical, Plumbing), Engineers (Controls, and Agricultural), Construction Managers (superintendents, supervisors, project managers) and individuals with Masters Degrees in Plant Science, Horticulture, and Business Administration. As a company, we have worked on 1000s of projects and well over 500 projects at indoor CEA facilities and believe that the experience of our team and Company provides clients with the confidence that will proactively keep them from making common costly mistakes during the build out process that impacts operational stages. Our expertise translates into clients saving time, money, and resources through expertise that they can leverage without having to add headcount to their own operations. We provide this experience in addition to offering a platform of the highest quality equipment systems that can be integrated holistically into our clients’ facilities.

Results of Operations

Comparison of Results of Operations for the three months ended September 30, 2022 and 2021

During the three months ended September 30, 2022, we generated revenues of $12.4 million compared to revenues of $18.3 million during the three months ended September 30, 2021, a decrease of $5.9 million, or 32%. This decrease in revenues is a result of the following changes in individual revenue components:

During the three months ended September 30, 2022, cost of revenues was $9.8 million compared to $14.0 million during the three months ended September 30, 2021, a decrease of $4.2 million, or 30%. This decrease is directly attributable to the overall decrease in revenues indicated above.

Gross profit was $2.6 million (21% of revenues) during the three months ended September 30, 2022, compared to $4.2 million (23% of revenue) during the three months ended September 30, 2021. Gross profit as a percentage of revenues decreased primarily due to an increase in lower margin Construction design-build revenue offset by an increase in higher margin services revenue. Margins on equipment systems revenues did not materially impact the change in the overall gross profit percentages.

Operating expenses increased by $5.3 million, or 126%, to $9.5 million for the three months ended September 30, 2022 compared to $4.2 million for the three months ended September 30, 2021. This was due to a one-time $3.3 million increase in business development costs as well as a $2.2 million increase in general and administrative operating expenses in part due to an increase in salary, marketing, and travel expenses attributable to the acquisitions of the 2WR Entities and Emerald, a $0.4 million decrease in stock-based compensation expense, primarily due to the elimination of unvested stock grants for employees no longer employed by the Company, and a $0.2 million increase in intangible asset amortization due solely to the acquisitions of the 2WR Entities and Emerald.

Non-operating expense was $1.8 million for the three months ended September 30, 2022, compared to non-operating expenses of $0.0 million for the three months ended September 30, 2021, an increase of $1.8 million. This was primarily due to a $1.7 million loss from the impairment of the Edyza investment.

Deferred income tax benefit increased by $0.1 million due to the acquisitions of the 2WR Entities and Emerald.

As a result of the above, we incurred a net loss of $8.7 million for the three months ended September 30, 2022, or a net loss per share of ($0.81), compared to net income of $0.1 million for the three months ended September 30, 2021, or a fully diluted net income per share of $0.0.

Comparison of Results of Operations for the nine months ended September 30, 2022 and 2021

During the nine months ended September 30, 2022, we generated revenues of $49.7 million compared to revenues of $43.2 million during the nine months ended September 30, 2021, an increase of $6.5 million, or 15%. This increase in revenues is a result of the following changes in individual revenue components:

During the nine months ended September 30, 2022, cost of revenues was $38.7 million compared to $33.3 million during the nine months ended September 30, 2021, an increase of $5.4 million, or 16%. This increase is directly attributable to the increase in revenues indicated above.

Gross profit was $11.0 million (22% of revenues) during the nine months ended September 30, 2022 compared to $9.8 million (23% of revenue) during the nine months ended September 30, 2021. Gross profit as a percentage of revenues decreased primarily due to an increase in lower margin construction design-build revenues offset by an increase in higher margin services revenues. Margins on equipment systems revenues did not materially impact the change in the overall gross profit percentages.

Operating expenses increased by $11.3 million, or 121%, to $20.7 million for the nine months ended September 30, 2022 compared to $9.4 million for the nine months ended September 30, 2021. This was due to a one-time $3.3 million increase in business development costs as well as a $6.5 million increase in general and administrative expenses, mainly due to an increase in salary, marketing, and travel expenses, in part related to the acquisitions of the 2WR Entities and Emerald, a $0.8 million increase in stock-based compensation expense, primarily due to an increase in the number of total employees included under the plan, and a $0.7 million increase in intangible asset amortization from the acquisitions of Emerald and the 2WR Entities.

Non-operating expense was $1.7 million for the nine months ended September 30, 2022, compared to non-operating expense of $0.7 million for the nine months ended September 30, 2021, a change of $1.0 million. Interest expense decreased by $0.3 million in the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, due to the elimination of debt. Interest income increased by $0.2 million due to the interest earned on the XS Financial investment. The Company recorded a $1.7 million loss from the write-down of the Edyza investment in the nine months ended September 30, 2022. For the nine months ended September 30, 2021, the Company incurred a $1.0 million gain from the forgiveness of the PPP Loan, a $0.8 million loss on the extinguishment of debt, and $0.6 million in interest expense related to the conversion of debt to equity at a discount to the offering price.

Deferred income tax benefit increased by $0.3 million due to the acquisitions of the 2WR Entities and Emerald.

As a result of the above, we incurred a net loss of $11.1 million for the nine months ended September 30, 2022, or a net loss per share of ($1.05), compared to a net loss of $0.3 million for the nine months ended September 30, 2021, or a net loss per share of ($0.03).

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, unrealized exchange 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 of directors 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:

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) Construction Design-Build; and (iii) Services. We define backlog for Equipment Systems and Services as signed contracts, with Equipment Systems contracts generally requiring a 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.

Our backlog as of September 30, 2022, June 30, 2022, March 31, 2022, and December 31, 2021 for each of our revenue categories is reflected in the following table (in millions of $):

(1) - Construction Design-Build revenue and backlog relate to the operations of Emerald which was acquired by the Company on April 29, 2022.

Historically, the majority of our Equipment Systems and Services backlog has been retired and converted into revenue within two quarters. At September 30, 2022, we expected approximately 70% of our Construction Design-Build backlog to be completed in the next 12 months. At September 30, 2022, one customer accounted for 63% of total backlog.

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, 2022, we had cash of $18.6 million, which represented a decrease of $16.0 million from December 31, 2021 due to the following changes during the nine months ended September 30, 2022:

Inflation

Although our operations are influenced by general economic conditions, we do not believe that inflation had a material effect on our results of operations during the nine months ended September 30, 2022.

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, 2021. During the nine months ended September 30, 2022, 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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are a smaller reporting company and are not required to provide the information under this Item pursuant to Regulation S-K.

ITEM 4. CONTROLS AND PROCEDURES.

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, 2022, 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 error or mistake. 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, 2022, 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.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we become involved in or are threatened with legal disputes. While most of these disputes are not likely to have a material effect on our business, financial condition, or operations, the following matters are deemed by the Company to be material either due to the costs of litigation or the potential negative impacts to the Company should these matters not be resolved in our favor:

ITEM 1A. RISK FACTORS

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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Stock Repurchase Program

The following table summarizes purchases by us of our common stock during the three months ended September 30, 2022:

Unregistered Shares Issued in Connection with the Emerald and 2WR Acquisitions

On April 29, 2022, the Company issued 283,515 shares of the Company’s common stock valued at $2.5 million as part of the Initial Purchase Price of the Emerald Acquisition as more fully described in Note 1 to the Unaudited Condensed Consolidated Financial Statements above.

On June 28, 2021, the Company issued 202,066 shares of the Company’s common stock valued at $2.0 million as part of the initial consideration paid pursuant to the 2WR Purchase Agreement as more fully described in Note 1 to the Unaudited Condensed Consolidated Financial Statements above.

The foregoing issuances of restricted shares of common stock were issued under Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated thereunder. The Company believes the issuance of the foregoing restricted shares was exempt from registration as a privately negotiated, isolated, non-recurring transaction not involving a public solicitation. No commissions were paid regarding the share issuances, and the share certificates were issued with a Rule 144 restrictive legend.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURE

Not Applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 10 2022.