The following discussion of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this Quarterly Report) and the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2019 (our Annual Report). This section contains forward-looking statements that are based on our current expectations and reflect our plans, estimates, and anticipated future financial performance. These statements involve numerous risks and uncertainties. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in the sections entitled "Risk Factors" in Part II, Item 1A, and "Cautionary Note Regarding Forward-Looking Statements" included in this Quarterly Report.

Unless otherwise noted, (1) "Sunworks" refers to Sunworks, Inc., a Delaware corporation formerly known as Solar3D, Inc. (2) "Company," "we," "us," and "our," refer to the ongoing business operations of Sunworks and its Subsidiaries, whether conducted through Sunworks or a subsidiary of Sunworks, (3) "Subsidiaries" refers collectively to Sunworks United, Inc. (Sunworks United), MD Energy, Inc. (MD Energy) and Plan B Enterprises (Plan B).





Overview


We provide photovoltaic (PV) based power systems for the agricultural, commercial, industrial (ACI), public works, and residential markets in California, Nevada, Massachusetts, Oregon, New Jersey and Hawaii. We have direct sales and/or operations personnel in California, Massachusetts, and Oregon. Through our operating subsidiaries, we design, arrange financing, integrate, install, and manage systems ranging in size from 2kW (kilowatt) for residential projects to multi MW (megawatt) systems for larger ACI and public works projects. ACI installations have included installations at office buildings, manufacturing plants, warehouses, service stations, churches, and agricultural facilities such as farms, wineries, and dairies. Public works installations have included school districts, local municipalities, federal facilities and higher education institutions. We provide a full range of installation services to our solar energy customers including design, system engineering, procurement, permitting, construction, grid connection, warranty, system monitoring and maintenance.

Based upon our organizational structure and the way in which our operations are managed and evaluated, we currently operate in one segment.

For the three months ended March 31, 2020, approximately 69% of our 2020 revenue was from installations for the ACI and public works markets and approximately 31% of our revenue was from installations for the residential market.

For the three months ended March 31, 2019 approximately 58% of our revenue was from installations for the ACI and public works markets and approximately 42% of our revenue was from installations for the residential market.

At our Annual Meeting of Stockholders on August 7, 2019, our stockholders approved a reverse stock split of our issued and outstanding common stock at a ratio not less than 1-for-3 and not greater than 1-for-10. On August 29, 2019, our board of directors approved the reverse stock split at a ratio of 1-for-7 which went into effect at the open of trading on August 30, 2019. At the effective time of the reverse stock split, every seven shares of our issued and outstanding common stock were converted into one share of our issued and outstanding common stock. The authorized shares of 200,000,000 and the par value of $0.001 remain the same. All shares and related financial information in this Quarterly Report are retroactively stated to reflect this 1-for-7 reverse stock split.





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IMPACT OF COVID-19



The recent outbreak of COVID-19 has spread globally, including to the United States, which has resulted in significant governmental measures being implemented to control the spread of the virus, including quarantines, travel restrictions and business shutdowns. To assist readers in reviewing management's discussion and analysis of financial condition and results of operations, we provide the following discussion about the effects COVID-19 has had on the Company, what management expects the future impact to be, how we are responding to evolving circumstances and how we are planning for further COVID-19 uncertainties.

The California stay at home order has impacted our operations. We continue to serve customers based on our qualification as an "Essential Business" as defined by county agencies' "shelter-in-place" directives. As an Essential Business, our employees are allowed to leave their residences to continue working. We operate in the energy industry, which is identified as a critical infrastructure sector by the Federal Homeland Security Cybersecurity and Infrastructure Security Agency (CISA). Therefore, we are able to conduct business despite the California Department of Public Health's mandate that all individuals living in the State of California must stay at their place of residence. Although we are permitted to continue our operations as an Essential Business, COVID-19 and the "shelter-in-place" directives have materially disrupted the operations of the government, utility companies, various authorities having jurisdiction over our business and our customers. This disruption negatively impacts our ability to generate revenue on projects in backlog and causes many customers to delay decisions on new projects. As a result, we have implemented temporary cost and headcount reductions. Although we continue working with our reduced workforce, these cost savings are offset by an expected decline in revenues from the disruption impacting our customers.

Although we cannot predict the impact and severity of COVID-19 to our operations, these developments and measures have negatively affected our business already. We will continue to manage the impact through appropriate cost cutting measures. Of concern is how severely the COVID-19 outbreak could adversely impact our ability to source materials used in our operations or affect our ability to complete ongoing installations in a timely manner. It is also possible that any one of our key executives or other personnel could become incapacitated by COVID-19. COVID-19 has also caused a decline in demand for our products and services. To help offset the financial impact, we have received a loan under the Paycheck Protection Plan of $2,847 which we will utilize to return personnel to the field to focus on revenue generating activities and mitigating the impact COVID-19 has on our business.

As the situation around COVID-19 evolves, we are monitoring our business to ensure that our expenses are in line with expected cash generation. We have an internal team that evaluates the ongoing impact of COVID-19 on our business and is reacting to changes daily, as need arises. We are focused on the best possible outcome for the Company as we navigate through these uncertain times.





Critical Accounting Policies


Our 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 of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to impairment of property, plant and equipment, intangible assets, deferred tax assets, costs to complete projects, and fair value computation using the Black Scholes option pricing model. We base our estimates on historical experience and on various other assumptions, such as the trading value of our common stock and estimated future undiscounted cash flows, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.





Use of Estimates


The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include estimates used to review our goodwill, impairments and estimations of long-lived assets, revenue recognition on percentage of completion type contracts, allowances for uncollectible accounts, warranty reserves, inventory valuation, valuations of non-cash capital stock issuances and the valuation allowance on deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable in 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.





Revenue Recognition


Revenues and related costs on construction contracts are recognized as the performance obligations are satisfied over time in accordance with Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. Under ASC 606, revenue and associated profit will be recognized as the customer obtains control of the goods and services promised in the contract (i.e., performance obligations). The cost of uninstalled materials or equipment will generally be excluded from our recognition of profit, unless specifically produced or manufactured for a project, because such costs are not considered to be a measure of progress. All un-allocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, we will recognize the loss as it is determined.

Revisions in cost and profit estimates, during the course of the contract, are reflected in the accounting period in which the facts, which require the revision, become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.

Contract assets represent revenue recognized in excess of amounts invoiced to customers on contracts in progress. Contract liabilities represent amounts invoiced to customers in excess of revenue recognized on contracts in progress.





Leases


We determine if an arrangement is a lease at inception. Operating lease right-of-use assets (ROU assets) and short-term and long-term lease liabilities are included on the face of the condensed consolidated balance sheet. If we had finance lease ROU assets, such assets would be presented within other assets, and finance lease liabilities would be presented appropriately.





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ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are accounted for as a single lease component. For lease agreements with terms less than 12 months, we have elected the short-term lease measurement and recognition exemption, which recognizes such lease payments on a straight-line basis over the lease term.

Indefinite Lived Intangibles and Goodwill Assets

We account for business combinations under the acquisition method of accounting in accordance with ASC 805, Business Combinations, where the total purchase price is allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.

We test for indefinite lived intangibles and goodwill impairment in the fourth quarter of each year and whenever events or circumstances indicate that the carrying amount of the asset exceeds its fair value and may not be recoverable. In accordance with our policies, we performed a quantitative assessment of indefinite lived intangibles and goodwill at December 31, 2019. At December 31, 2019, we retained an independent valuation consulting firm to test for indefinite lived intangibles and goodwill impairment. Based on the valuation assessment, we determined that the carrying value of the assets did not exceed the fair value and, therefore, there was no impairment of assets. As a result of the events and circumstances resulting from the COVID-19 pandemic, we now expect our near-term revenue, profitability and cash flow to be lower than we anticipated in our previous review. Therefore, we performed another quantitative assessment of indefinite lived intangibles and goodwill at March 31, 2020. It was determined that the carrying value of goodwill exceeded its fair value at March 31, 2020 and, as a result, we recorded an impairment of $4,000. The primary driver of the $4,000 impairment at March 31, 2020 compared to no impairment at December 31, 2019, was lowered revenue projections for 2020 due to the impact of COVID-19, combined with the ATM sales in the first quarter of 2020, which resulted in a higher carrying value of the net assets of the Company.





Business Combinations



We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customer lists, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.





Stock-Based Compensation


We periodically issue stock options to employees and directors. We account for stock option grants issued and vesting to employees based on the authoritative guidance provided by the Financial Accounting Standards Board (FASB) whereas the value of the award is measured on the date of grant and recognized over the vesting period.

We account for stock grants issued to non-employees in accordance with the authoritative guidance of the FASB whereas the value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date.





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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2020 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2019

REVENUE AND COST OF GOODS SOLD

For the three months ended March 31, 2020, revenue increased 33.4% to $12,361 compared to $9,268 for the three months ended March 31, 2019. Cost of goods sold for the three months ended March 31, 2020 was $11,405, or 15.1% above the $9,912 reported for the three months ended March 31, 2019.

Increased revenue, along with lower cost of goods sold resulted in a gross profit of $956 for the quarter ended March 31, 2020. This compares to $(644) of gross loss for the three months ended March 31, 2019, or an improvement of $1,600. The gross margin was 7.7% for the three months ended March 31, 2020 compared to a negative gross margin of (6.9%) for the three months ended March 31, 2019. Approximately 69% of revenue for the three months ended March 31, 2020 was from installations for the ACI and public works markets compared to 58% of revenue for the three months ended March 31, 2019.

SELLING AND MARKETING EXPENSES

For the three months ended March 31, 2020, selling and marketing (S&M) expenses were $657 compared to $782 for the three months ended March 31, 2019. As a percentage of revenue, S&M expenses were 5.3% of first quarter revenue in 2020 compared to 8.4% in the first quarter of 2019. First quarter S&M expenses were $125 less than the same period in the prior year. Most of the decrease resulted from a reduction in personnel in the sales and sales support functions, lower commission and promotional expenses and lower advertising expenses.

GENERAL AND ADMINISTRATIVE EXPENSES

Total general and administrative (G&A) expenses were $2,599 for the three months ended March 31, 2020, compared to $2,676 for the three months ended March 31, 2019. As a percentage of revenue, G&A expenses were 21.0% of first quarter revenue in 2020 compared to 28.9% in the first quarter of 2019. Headcount reductions between periods resulted in savings in salaries and employee benefits that were partially offset by increases in bad debt expense, vehicle insurance, transportation and recruiting. There is a continuing emphasis on improving talent and using technology to improve construction management systems and processes while at the same time reducing G&A expenses.

Operating expenses, including stock-based compensation, for 2020 are expected to decrease as we have made cuts in our headcount and other operating expenses due to COVID-19. The total impact on our financial statements related to COVID-19 is unknown as the pandemic continues evolve.





GOODWILL IMPAIRMENT


Goodwill impairment recorded for the three months ended March 31, 2020 and 2019 was $4,000 and $0, respectively. We retain an independent valuation consultant to perform a quantitative assessment of indefinite lived intangibles and goodwill at December 31, 2019 and March 31, 2020. In accordance with our policies, we performed a quantitative assessment of indefinite lived intangibles and goodwill at December 31, 2019, no impairment was found. As a result of the events and circumstances resulting from the COVID-19 pandemic, our outlook for revenue, profitability and cash flow have deteriorated. Therefore, we performed another quantitative assessment of indefinite lived intangibles and goodwill at March 31, 2020. It was determined that the carrying value of goodwill exceeded its fair value at March 31, 2020 and, as a result, we recorded an impairment of $4,000.

STOCK-BASED COMPENSATION EXPENSES

During the three months ended March 31, 2020 we incurred $98 in total non-cash stock-based compensation expense compared to $124 for the same period in the prior year.





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We entered into a restricted stock grant agreement with our Chief Executive Officer, Charles Cargile, in March 2017 (the March 2017 RSGA). All shares issuable under the March 2017 RSGA are valued as of the grant date at $10.50 per share. For the three months ended March 31, 2020 and 2019, stock-based compensation expense of $63 and $62, respectively, was recognized for the March 2017 RSGA. There will be no further stock-based compensation expense for the March 2017 RSGA. This grant was expensed on a straight-line basis over 36 months.

Stock-based compensation, excluding the March 2017 RSGA, related to employee and director options totaled $35 and $62 for the three months ended March 31, 2020 and 2019, respectively.

DEPRECIATION AND AMORTIZATION

Depreciation and Amortization expenses for the three months ended March 31, 2020 were $81 compared to $92 for the same period in the prior year. Depreciation and Amortization expenses decreased primarily due to the depreciable life of assets having been met since the 2014 - 2015 acquisitions of Solar United Network, MD Energy and Plan B.





OTHER EXPENSES (INCOME)



Other (income) expenses were $269 for the three months ended March 31, 2020, compared to $217 for the three months ended March 31, 2019. Interest expense for the three months ended March 31, 2020 was $259, primarily related to the interest paid for the $3.75 million promissory note issued to CrowdOut (the Senior Note) plus the amortization of both the $435 exit fee and the additional accelerated write-off of the issuance fees of $98, resulting from the $1,500 principal payment on the Senior Note. Both the exit fee accrual and the amortization of the issuance costs are shown as interest expense. Interest expense for the three months ended March 31, 2019 was $209 and was the result of CrowdOut interest plus interest on the acquisition debt for the MD Energy acquisition and for debt related to various equipment financings. See Note 5, "Loans Payable" for more information.





NET LOSS


The net loss for the three months ended March 31, 2020 was $6,748 compared to a net loss of $4,535 for the three months ended March 31, 2019.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Capital Resources

We had $5,471 in unrestricted cash at March 31, 2020, as compared to $3,154 at December 31, 2019. We believe that the aggregate of our existing cash and cash equivalents, in addition to funds generated in operations will be adequate for us to maintain sufficient liquidity and cash position for the next twelve months or more.

On April 28, 2020, we received a loan under the Paycheck Protection Plan of $2,847. Proceeds from the loan used to cover documented expenses related to payroll, rent and utilities during the 8-week period, subsequent to the cash being received by us are eligible to be forgiven. The forgiveness amount allows for not more than 25% of the forgiveness to be for non-payroll items and is subject to reduction if employees are terminated or wages are reduced. The remaining unforgiven amount of the loan bears interest at 1% per annum and matures on April 28, 2022. Initial principal payments are deferred for the first six months; however, interest still accrues during this time. There are no collateral requirements or prepayment penalties associated with the loan.

Currently, we cannot be certain of the type of additional future financing, terms and conditions or actual timing of any debt or equity financing. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing may involve agreements that include high interest costs and restrictive covenants. Continuing effects of the COVID-19 pandemic could have an adverse effect on our liquidity and cash. Additionally, the COVID-19 pandemic may adversely affect our ability to access future debt or equity financings. If we are unable to raise additional capital when required or on acceptable terms, we may have to adjust our cost structure and/or delay execution of projects in backlog.

At March 31, 2020, our working capital was a surplus of $3,117 compared to a working capital surplus of $1,460 at December 31, 2019.

The Loan Agreement for the Senior Note contains a subjective Event of Default clause based on CrowdOut determining, in the exercise of its reasonable discretion, that an event has occurred that would reasonably be expected to have a "Material Adverse Effect." If any Event of Default occurs and is continuing, CrowdOut reasonably determines that a "Material Adverse Effect" in our business has occurred, CrowdOut may declare that an Event of Default has occurred and the outstanding indebtedness to be immediately due. See Note 8, "Promissory Notes Payable" for more information regarding the Senior Note.

During the three months ended March 31, 2020, we had $3,609 of cash used in operating activities compared to $1,873 used in operating activities for same period in 2019. The cash used in operating activities was primarily the result of the current year net loss. The cash impact of the net loss was offset by collection of cash from accounts receivables and contract assets, reductions in inventory together with extension in accounts payable and accrued liabilities.





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Net cash used in investing activities for the three months ended March 31, 2020 and 2019 was insignificant.

Net cash provided by financing activities during the three months ended March 31, 2020 was $5,953. The cash was primarily used to pay $1,500 of principal on the Senior Note, offset the cash used in operating activities and to payoff the acquisition convertible promissory note and existing vehicle and equipment debt. Net cash received through the sale of our common stock pursuant to an At Market Issuance Sales Agreement we entered into with B. Riley FBR, Inc. (the ATM Agreement) totaled $7,736. We have sold the maximum amount allowed under the prospectus supplement we filed with the U.S. Securities and Exchange Commission (SEC) related to the ATM Agreement and no further shares will be sold under the ATM Agreement without us filing an additional prospectus supplement with the SEC. Our shelf registration statement on Form S-3 was filed in reliance on Instruction I.B.6. of Form S-3, which imposes a limitation on the maximum amount of securities that we may sell pursuant to the registration statement during any twelve-month period. At the time we sell securities pursuant to the registration statement, the amount of securities to be sold plus the amount of any securities we have sold during the prior twelve months in reliance on Instruction I.B.6. may not exceed one-third of the aggregate market value of our outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale as computed in accordance with Instruction I.B.6. At March 31, 2020, we did not have any additional availability under our existing S-3 under the 1/3 limitation calculations set forth in Instruction I.B.6 of Form S-3. Furthermore, Instruction I.B.6. of Form S-3 requires that the issuer have at least one class of common equity securities listed and registered on a national securities exchange. If we are not able to maintain compliance with applicable Nasdaq rules, we will no longer be able to rely upon that Instruction, which may negatively impact our ability to raise funds through an equity financing.

On March 13, 2020, we received a letter from The Nasdaq Stock Market LLC (Nasdaq) indicating that we have failed to comply with the minimum bid price requirement of Nasdaq Listing Rule 5550(a)(2). Nasdaq Listing Rule 5550(a)(2) requires that companies listed on the Nasdaq Capital Market maintain a minimum closing bid price of at least $1.00 per share. Under Nasdaq Listing Rule 5810(c)(3)(A), we have a 180-calendar-day grace period to regain compliance by meeting the continued listing standard. To regain compliance, our closing bid price must meet or exceed $1.00 per share for a minimum of ten consecutive business days during this grace period. Given the current extraordinary market conditions, Nasdaq has determined to toll the compliance periods for bid price and market value of publicly held shares requirements through June 30, 2020. Therefore, we will have until November 23, 2020 to regain compliance with the minimum bid price requirement. We are monitoring the bid price of our common stock and will consider options available to us to achieve compliance.

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, results of operations, liquidity, or capital expenditures.

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