ITEM
1. FINANCIAL STATEMENTS
Surna
Inc.
Condensed
Consolidated Balance Sheets
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
|
|
Unaudited
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
235,455
|
|
|
$
|
330,557
|
|
Accounts receivable (net of allowance for doubtful accounts of $85,000 and $40,873, respectively)
|
|
|
48,710
|
|
|
|
299,194
|
|
Notes receivable
|
|
|
187,218
|
|
|
|
207,218
|
|
Interest receivable
|
|
|
19,412
|
|
|
|
-
|
|
Inventory
|
|
|
916,486
|
|
|
|
1,261,802
|
|
Prepaid expenses
|
|
|
176,758
|
|
|
|
193,969
|
|
Total Current Assets
|
|
|
1,584,039
|
|
|
|
2,292,740
|
|
|
|
|
|
|
|
|
|
|
Noncurrent Assets
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
100,738
|
|
|
|
162,530
|
|
Intangible assets, net
|
|
|
665,723
|
|
|
|
647,464
|
|
Total Noncurrent Assets
|
|
|
766,461
|
|
|
|
809,994
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
2,350,500
|
|
|
$
|
3,102,734
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
1,223,296
|
|
|
$
|
2,066,803
|
|
Deferred revenue
|
|
|
1,420,974
|
|
|
|
986,445
|
|
Current portion long term debt
|
|
|
-
|
|
|
|
1,551
|
|
Amounts due shareholders
|
|
|
60,000
|
|
|
|
216,995
|
|
Accrued interest
|
|
|
2,263
|
|
|
|
-
|
|
Convertible promissory notes, net
|
|
|
2,272,694
|
|
|
|
1,227,761
|
|
Convertible accrued interest
|
|
|
467,074
|
|
|
|
201,257
|
|
Derivative liability on conversion feature
|
|
|
-
|
|
|
|
472,967
|
|
Derivative liability on warrants
|
|
|
287,406
|
|
|
|
139,192
|
|
Total Current Liabilities
|
|
|
5,733,707
|
|
|
|
5,312,971
|
|
|
|
|
|
|
|
|
|
|
Noncurrent Liabilities
|
|
|
|
|
|
|
|
|
Amounts due shareholders-long term
|
|
|
15,989
|
|
|
|
-
|
|
Convertible promissory notes, net
|
|
|
-
|
|
|
|
523,822
|
|
Convertible accrued interest
|
|
|
-
|
|
|
|
80,674
|
|
Vehicle loan
|
|
|
-
|
|
|
|
32,564
|
|
Total Noncurrent Liabilities
|
|
|
15,989
|
|
|
|
637,060
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES
|
|
|
5,749,696
|
|
|
|
5,950,031
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Preferred stock, $0.00001 par value; 150,000,000 shares authorized; 77,220,000 shares issued and outstanding
|
|
|
772
|
|
|
|
772
|
|
Common stock, $0.00001 par value; 350,000,000 shares authorized; 145,268,135 and 125,839,862 shares issued and outstanding, respectively
|
|
|
1,452
|
|
|
|
1,259
|
|
Paid in capital
|
|
|
9,780,598
|
|
|
|
8,214,271
|
|
Accumulated deficit
|
|
|
(13,182,018
|
)
|
|
|
(11,063,599
|
)
|
Total Shareholders’ Deficit
|
|
|
(3,399,196
|
)
|
|
|
(2,847,297
|
)
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT
|
|
$
|
2,350,500
|
|
|
$
|
3,102,734
|
|
The
accompanying notes are integral to the unaudited condensed consolidated financial statement.
Surna
Inc.
Condensed
Consolidated Statements of Operations and Comprehensive Loss
(Unaudited)
|
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Revenue
|
|
$
|
1,170,760
|
|
|
$
|
3,634,091
|
|
|
$
|
5,560,837
|
|
|
$
|
6,182,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
|
753,624
|
|
|
|
3,125,151
|
|
|
|
3,740,488
|
|
|
|
5,338,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
417,136
|
|
|
|
508,940
|
|
|
|
1,820,349
|
|
|
|
844,706
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising and marketing expenses
|
|
|
14,319
|
|
|
|
148,656
|
|
|
|
56,852
|
|
|
|
324,110
|
|
Product development costs
|
|
|
72,184
|
|
|
|
224,365
|
|
|
|
272,410
|
|
|
|
533,808
|
|
Selling, general and administrative expenses
|
|
|
567,512
|
|
|
|
676,325
|
|
|
|
1,662,183
|
|
|
|
2,097,513
|
|
Total operating expenses
|
|
|
654,015
|
|
|
|
1,049,346
|
|
|
|
1,991,445
|
|
|
|
2,955,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
(236,879
|
)
|
|
|
(540,406
|
)
|
|
|
(171,096
|
)
|
|
|
(2,110,725
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other income, net
|
|
|
10,576
|
|
|
|
-
|
|
|
|
19,060
|
|
|
|
-
|
|
Interest expense
|
|
|
(89,203
|
)
|
|
|
(78,938
|
)
|
|
|
(282,657
|
)
|
|
|
(367,497
|
)
|
Amortization of debt discount on convertible promissory notes
|
|
|
(291,000
|
)
|
|
|
(716,078
|
)
|
|
|
(1,335,429
|
)
|
|
|
(1,727,126
|
)
|
(Loss) gain on change in derivative liabilities
|
|
|
(62,000
|
)
|
|
|
-
|
|
|
|
(348,297
|
)
|
|
|
474,873
|
|
Total other (expense)
|
|
|
(431,627
|
)
|
|
|
(795,016
|
)
|
|
|
(1,947,323
|
)
|
|
|
(1,619,750
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before provision for income taxes
|
|
|
(668,506
|
)
|
|
|
(1,335,422
|
)
|
|
|
(2,118,419
|
)
|
|
|
(3,730,475
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(668,506
|
)
|
|
|
(1,335,422
|
)
|
|
|
(2,118,419
|
)
|
|
|
(3,730,475
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (expense)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Comprehensive loss
|
|
$
|
(668,506
|
)
|
|
$
|
(1,335,422
|
)
|
|
$
|
(2,118,419
|
)
|
|
$
|
(3,730,475
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share – basic and dilutive
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding, both basic and dilutive
|
|
|
145,268,135
|
|
|
|
146,816,336
|
|
|
|
139,684,359
|
|
|
|
145,943,222
|
|
The
accompanying notes are integral to the unaudited condensed consolidated financial statements.
Surna
Inc.
Condensed
Consolidated Statements of Changes in Shareholders’ Deficit
For the Nine Months Ended September 30, 2016
(Unaudited)
|
|
Preferred Stock
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
|
Amount
|
|
|
Number of Shares
|
|
|
Amount
|
|
|
Paid in Capital
|
|
|
Accumulated Deficit
|
|
|
Comprehensive Income (Loss)
|
|
|
Shareholders’ Deficit
|
|
Balance December 31, 2015
|
|
|
77,220,000
|
|
|
$
|
772
|
|
|
|
125,839,862
|
|
|
$
|
1,259
|
|
|
$
|
8,214,271
|
|
|
$
|
(11,063,599
|
)
|
|
$
|
-
|
|
|
$
|
(2,847,297
|
)
|
Common shares issued pursuant to conversion of debt and accrued interest, net of unamortized debt discount
|
|
|
-
|
|
|
|
-
|
|
|
|
17,888,828
|
|
|
|
179
|
|
|
|
888,905
|
|
|
|
-
|
|
|
|
-
|
|
|
|
889,084
|
|
Reclassification of derivative liability to equity pursuant to conversion of debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
673,050
|
|
|
|
-
|
|
|
|
-
|
|
|
|
673,050
|
|
Common shares issued to employees as compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
46,045
|
|
|
|
-
|
|
|
|
4,028
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,028
|
|
Issuance of common shares in connection with exercises of stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
1,493,400
|
|
|
|
14
|
|
|
|
344
|
|
|
|
-
|
|
|
|
-
|
|
|
|
358
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,118,419
|
)
|
|
|
-
|
|
|
|
(2,118,419
|
)
|
Balance September 30, 2016
|
|
|
77,220,000
|
|
|
$
|
772
|
|
|
|
145,268,135
|
|
|
$
|
1,452
|
|
|
$
|
9,780,598
|
|
|
$
|
(13,182,018
|
)
|
|
$
|
-
|
|
|
$
|
(3,399,196
|
)
|
The
accompanying notes are integral to the unaudited condensed consolidated financial statements.
Surna
Inc.
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Cash Flows from Operating Activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,118,419
|
)
|
|
$
|
(3,730,475
|
)
|
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and intangible asset amortization expense
|
|
|
43,870
|
|
|
|
46,586
|
|
Amortization of debt discounts
|
|
|
1,335,429
|
|
|
|
1,727,126
|
|
Gain on change in derivative liability
|
|
|
348,297
|
|
|
|
(474,873
|
)
|
Employee compensation paid in stock
|
|
|
4,028
|
|
|
|
-
|
|
Provision for doubtful accounts
|
|
|
44,127
|
|
|
|
20,000
|
|
Loss on sale of assets other
|
|
|
1,117
|
|
|
|
-
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts and note receivable
|
|
|
186,945
|
|
|
|
(580,135
|
)
|
Inventory
|
|
|
345,316
|
|
|
|
(697,346
|
)
|
Prepaid expenses
|
|
|
17,211
|
|
|
|
(376,128
|
)
|
Accounts payable and accrued liabilities
|
|
|
(864,937
|
)
|
|
|
1,683,607
|
|
Deferred revenue
|
|
|
434,529
|
|
|
|
1,081,582
|
|
Accrued interest
|
|
|
282,657
|
|
|
|
2,925
|
|
Deferred compensation
|
|
|
(25,600
|
)
|
|
|
-
|
|
Cash provided by (used in) operating activities
|
|
|
34,570
|
|
|
|
(1,297,131
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities
|
|
|
|
|
|
|
|
|
Purchase of intangible assets
|
|
|
(22,380
|
)
|
|
|
-
|
|
Purchase of property and equipment
|
|
|
(15,126
|
)
|
|
|
(22,519
|
)
|
Proceeds from the sale of property and equipment
|
|
|
32,600
|
|
|
|
-
|
|
Cash disbursed for note receivable
|
|
|
(80,000
|
)
|
|
|
(135,000
|
)
|
Cash received on note receivable
|
|
|
100,000
|
|
|
|
-
|
|
Cash provided by (used in) investing activities
|
|
|
15,094
|
|
|
|
(157,519
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities
|
|
|
|
|
|
|
|
|
Proceeds from issuances of convertible promissory notes
|
|
|
-
|
|
|
|
1,859,850
|
|
Proceeds from exercises of stock options
|
|
|
358
|
|
|
|
-
|
|
Payments on loans
|
|
|
(34,115
|
)
|
|
|
(43,763
|
)
|
Payments on loans from shareholders
|
|
|
(111,009
|
)
|
|
|
-
|
|
Payments to related parties
|
|
|
-
|
|
|
|
(72,091
|
)
|
Cash (used in) provided by financing activities
|
|
|
(144,766
|
)
|
|
|
1,743,996
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash
|
|
|
(95,102
|
)
|
|
|
289,346
|
|
Cash, beginning of period
|
|
|
330,557
|
|
|
|
689,963
|
|
Cash, end of period
|
|
$
|
235,455
|
|
|
$
|
979,309
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
-
|
|
|
$
|
4,790
|
|
Income tax paid
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financial activities:
|
|
|
|
|
|
|
|
|
Conversions of promissory note balances to common stock
|
|
$
|
889,084
|
|
|
$
|
1,220,051
|
|
Derivative liability on convertible promissory notes and warrants
|
|
$
|
673,050
|
|
|
$
|
(1,324,283
|
)
|
Equipment issued in settlement of debt
|
|
$
|
2,500
|
|
|
$
|
-
|
|
Debt retirement former CEO
|
|
$
|
-
|
|
|
$
|
194,958
|
|
The
accompanying notes are integral to the unaudited condensed consolidated financial statements.
Surna
Inc.
Notes
to Unaudited Condensed Consolidated Financial Statements
September
30, 2016
NOTE
1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company:
Surna
Inc. (“Company” “we” “us” or “our”) incorporated in the State of Nevada on October
15, 2009. On March 26, 2014, we acquired Safari Resource Group, Inc. (“Safari”), a Nevada corporation, whereby we
became the sole surviving corporation after the acquisition of Safari. On July 25, 2014, we acquired 100% of the membership interest
in Hydro Innovations, LLC, a Colorado limited liability company (“Hydro”), pursuant to which Hydro became a wholly-owned
subsidiary of the Company.
We
engineer and manufacture innovative technology and products that address the energy and resource intensive nature of indoor cultivation.
Our focus lies in supplying industrial solutions to commercial indoor cannabis cultivation facilities. Our engineering team is
tasked with creating novel energy and resource efficient solutions, including our signature liquid-cooled climate control platform.
Our engineers continuously seek to create technologies that allow growers to easily meet the highly specific demands of a cannabis
cultivation environment through temperature, humidity, light, and process control. Our objective is to provide intelligent solutions
that improve the quality, control, and overall yield and efficiency of indoor cannabis cultivation. We are headquartered in Boulder,
Colorado.
The
Company’s operations exclude the production or sale of marijuana.
Financial
Statement Presentation:
The
accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting
principles in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X. Pursuant to these rules and regulations, certain information and note disclosures, normally
included in financial statements prepared in accordance with GAAP, have been condensed or omitted. GAAP requires management to
make estimates and assumptions that affect reported amounts and related disclosures. In the opinion of management, all adjustments
(consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for
the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the
fiscal year ending December 31, 2016. The balance sheet as of December 31, 2015 has been derived from the audited financial statements
at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. For
further information, refer to the consolidated financial statements and notes thereto contained in the Annual Report on Form 10-K
for the year ended December 31, 2015. The notes to the unaudited condensed consolidated financial statements are presented on
a continuing basis unless otherwise noted.
Basis
of Consolidation and Reclassifications:
The
condensed consolidated financial statements include the accounts of the Company and its controlled and wholly-owned subsidiary.
Intercompany transactions, profits, and balances are eliminated in consolidation.
Certain
reclassifications have been made to amounts in prior periods to conform to the current period presentation. All reclassifications
have been applied consistently to the periods presented. The reclassifications had no impact on net loss or total assets and liabilities.
Use
of Estimates:
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial
statements and that affect the reported amounts of revenues and expenses during the reporting period. We base our estimates on
historical experience and on various other assumptions that we believe 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 could differ from those estimates. In addition, any change in these estimates or their related assumptions
could have an adverse effect on our operating results. Key estimates include: valuation of derivative liabilities, valuation of
intangible assets, and valuation of deferred tax assets and liabilities.
Recent
Accounting Pronouncements:
In
August 2016, the accounting standard update related to the classification of certain cash receipts and cash payments was issued.
This standard update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice.
The amendments in this update are effective as of the first quarter of 2018; however, early adoption is permitted. We are currently
evaluating the impact that this standard update will have on our condensed consolidated financial statements.
In
June 2016, the standard update related to the measurement of credit losses on financial instruments was issued. This standard
update requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected.
This standard update is effective as of the first quarter of 2020; however, early adoption is permitted. We are currently evaluating
the impact that this standard update will have on our condensed consolidated financial statements.
In
May 2016, accounting guidance was issued to clarify the not yet effective revenue recognition guidance issued in May 2014. This
additional guidance does not change the core principle of the revenue recognition guidance issued in May 2014, rather, it provides
clarification of accounting for collections of sales taxes as well as recognition of revenue (i) associated with contract modifications,
(ii) for noncash consideration, and (iii) based on the collectability of the consideration from the customer. The guidance also
specifies when a contract should be considered “completed” for purposes of applying the transition guidance. The effective
date and transition requirements for this guidance are the same as the effective date and transition requirements for the guidance
previously issued in 2014, which is effective for interim and annual periods beginning on or after December 15, 2017. The Company
has not yet determined the impact that this new guidance will have on its consolidated financial statements.
In
April 2016, accounting guidance was issued pertaining to identifying performance obligations in contracts with customers and improving
the operability and understandability of licensing implementation guidance. The guidance is effective for interim and annual periods
beginning on or after December 15, 2017. The Company has not yet determined the impact of this new guidance on its condensed consolidated
financial statements.
In
March 2016, accounting guidance was issued to improve the accounting for employee stock-based payments. The guidance simplifies
accounting for stock-based award transactions specific to income tax consequences, the classification of awards as equity or liabilities,
and the classification of award payments on the statement of cash flows. The guidance is effective for interim and annual periods
beginning on or after December 15, 2016. The Company is currently assessing the impact that the adoption of this new guidance
will have on its condensed consolidated financial statements.
In
March 2016, accounting guidance was issued to clarify the application of previously issued revenue recognition guidance related
to whether an entity is a principal or an agent. More specifically, this new guidance clarifies that the analysis must focus on
whether the entity has control of the goods or services before they are transferred to the customer and provides additional guidance
about how to apply the control principle when services are provided and when goods or services are combined with other goods or
services. The guidance is effective for interim and annual periods beginning on or after December 15, 2017. The Company has not
yet determined the impact that this new guidance will have on its condensed consolidated financial statements.
In
March 2016, accounting guidance was issued pertaining to accounting for derivatives and hedging activity. The guidance amends
existing GAAP by clarifying that a change in the counterparty to a derivative instrument that has been designated as a hedging
instrument does not, in and of itself, require de-designation of that hedging relationship, provided that all other hedge accounting
criteria continue to be met. The amendment improves prior guidance by eliminating diversity in practice. The guidance is effective
for interim and annual periods beginning on or after December 15, 2016. The guidance may be applied prospectively or using a modified
retrospective approach to adjust retained earnings. The Company is currently evaluating the impact of this guidance on its condensed
consolidated financial statements.
In
March 2016, additional accounting guidance was issued pertaining to accounting for derivatives and hedging activity. The guidance
clarifies the steps required when assessing whether the economic characteristics and risks of call (put) options are clearly and
closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an
embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether
the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. The amendment
improves prior guidance by eliminating diversity in practice in assessing embedded contingent call (put) options in debt instruments.
The guidance is effective for interim and annual periods beginning on or after December 15, 2016. The Company is currently assessing
the impact that the adoption of this new guidance will have on its condensed consolidated financial statements.
In
February 2016, accounting guidance was issued pertaining to leases to increase transparency and comparability among organizations
by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.
The core principle of this guidance is that a lessee should recognize a liability to make lease payments (the lease liability)
and a right-of-use asset representing its right to use the underlying asset for the lease term. The guidance is effective for
interim and annual periods beginning on or after December 15, 2018. The Company is currently evaluating the impact that the adoption
of this new guidance will have on its condensed consolidated financial.
In
January 2016, accounting guidance was issued on the classification and measurement of financial assets and liabilities (equity
securities and financial liabilities) under the fair value option and the presentation and disclosure requirements for financial
instruments. The guidance modifies how an entity measures equity investments and presents changes in the fair value of financial
liabilities. Under the new guidance, an entity will have to measure at fair value those equity investments that do not result
in consolidation and are not accounted for under the equity method, and an entity will have to recognize any changes in fair value
in net income unless the investments qualify for the new practicality exception. That exception will apply to those equity investments
that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value under
the guidance, and, as such, these investments may be measured at cost. The guidance will be effective on January 1, 2018. The
Company is currently assessing the impact that the adoption of this new guidance will have on its condensed consolidated financial
statements.
We continually assess
any new accounting pronouncements to determine their applicability to us. Where it is determined that a new accounting pronouncement
affects our financial reporting, we undertake a study to determine the consequence of the change to our financial statements and
assure that there are proper controls in place to ascertain that our financial statements properly reflect the change. We have
evaluated all other GAAP issued through the date the condensed consolidated financials were issued and believe that the
adoption of these will not have a material impact on our condensed consolidated financial statements.
NOTE
2 - GOING CONCERN
The
accompanying unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue
as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.
In
the course of its development activities, the Company has sustained and continues to sustain losses. The Company cannot predict
if or when the Company will generate profits. The Company has a deficit in working capital of approximately $4,149,668 as of September
30, 2016. Additionally, the Company has generated cumulative net losses of approximately $13,182,018 during the period from inception
through September 30, 2016.
The
Company has not yet established an ongoing source of revenues sufficient to cover its operating costs and allow it to continue
as a going concern. The ability of the Company to continue as a going concern depends on it obtaining the adequate capital to
fund operating losses until it becomes profitable. Management plans to continue as a going concern to achieve a profitable level
of operations including generating cash through increased product sales, reducing planned expenditures, if necessary, and raising
capital from investors. While management plans to take the steps necessary to extend the time period over which the then-available
resources would be able to fund the operations, management cannot provide any assurances that the Company will be successful in
accomplishing any of its plans. Additionally, there can be no assurance that, if such efforts are successful, the terms and conditions
of such financing will be favorable. If the Company is unable to obtain adequate capital, it could be forced to cease operations.
During
the year ended December 31, 2015, we raised a total of approximately $1,781,000 in connection with issuances of three series of
convertible promissory notes. During the year ended December 31, 2014, we raised approximately $2,962,000 in connection with issuances
of two series of convertible promissory notes (“Notes”). The Notes become due and payable starting in November 2016
through February 2017. The Company has been in discussion with several investment firms and is evaluating the Company’s
options for additional funding. Also, the Compan
y has begun
negotiations with the
holders of the Notes to determine a mutual agreement to retire the Notes and amend associated warrants. As of the issuance of
these condensed consolidated financial statements, the Company has not entered into any agreements. The ability of the Company
to continue as a going concern is dependent upon its ability to successfully accomplish its plans and eventually secure other
sources of financing and attain profitable operations. The accompanying unaudited condensed consolidated financial statements
do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
NOTE
3 - NOTES RECEIVABLE
On April 26, 2016, the
Company entered into a non-binding letter of intent (“LOI”) to acquire substantially all of the assets of a third
party (“Seller”). Per the terms of the Agreement, Company and Seller endeavored to close the transaction before
August 31, 2016, which was extended to September 30, 2016 (“Exclusivity Period”). Although the Exclusivity
Period has terminated, the Company is still in the due diligence phase. During the Exclusivity Period, the Company was required
to provide the Seller a loan in the amount of $20,000 per month, up to a maximum of $80,000, which has been advanced as of September
30, 2016. The Company has changed its intent from acquiring the Company as a whole to acquiring certain assets and patents, which
don’t constitute a business, from the Seller.
NOTE
4 - CONVERTIBLE PROMISSORY NOTES
During
the first six months of 2016, approximately $890,000 of convertible promissory notes were converted into 17,888,828 shares of
the Company’s common stock. The remaining balance of our convertible promissory notes as of September 30, 2016 of approximately
$2,280,000 (after debt discounts of approximately $256,000) relates to our Convertible Series 2 issuance.
NOTE
5 - SUBSEQUENT EVENTS
There
have been no significant events occurring after September 30, 2016.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion
of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial
statements and the related notes included elsewhere in this Form 10-Q, which include additional information about our accounting
policies, practices, and the transactions underlying our financial results, as well as with our audited consolidated financial
statements included in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC. In addition
to our historical unaudited condensed consolidated financial information, the following discussion contains forward-looking statements
that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking
statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form
10-Q, particularly in Part II, Item 1A, “Risk Factors.”
Overview
Surna
develops, designs, and distributes cultivation technologies for controlled environment agriculture (“CEA”). The Company’s
customers include state-regulated cannabis cultivation facilities as well as traditional indoor agricultural facilities, including
organic herb and vegetable producers. Surna’s technologies include a comprehensive line of optimized lighting, environmental
control, air sanitation, and cultivation facilities. These technologies are designed to meet the specific environmental conditions
required for CEA and dramatically reduce energy and water consumption.
In
addition, Surna offers mechanical design services specific to hydronic cooling, including mechanical equipment and piping design.
Recent
Developments
In the six months preceding
September 30, 2016 we have been focused on further developing the fundamentals of our business. In 2015 we experienced manufacturing
related problems, as previously reported. In 2016 we have been heavily focused on ensuring that our products not only meet but
exceed customer expectations. We have focused on reducing costs, streamlining our operations, and ensuring our leadership role
in developing energy efficient products in the cannabis cultivation; whilst also ensuring that any residual problems have been
resolved. We believe we have built a strong team that will position the Company to be successful in the cannabis industry. Our
current and future revenue plan is dependent on the continued and increasing legality of the cannabis industry and our ability
to effectively market our indoor agriculture products to this key segment as well as expand our reach to other markets. As the
legal cannabis industry is still in its infancy, we also expect further revenues to be derived from existing markets as they age
and increase the sophistication of production.
On November 8, 2016,
eight states expanded the legalization of cannabis: 4 states initiated medicinal use and 4 states expanded use to incorporate
adult recreational – this included California, which in itself will increase availability to nearly 40 million people. This
massive expansion creates the need for cultivation technologies – like Surna’s climate controls and Hybrid Building
– to help the industry run efficiently and responsibly. As each state has a unique climate, growing environment and regulations,
we believe our expertise will be key for developing tailored solutions. To date, states have taken approximately 18 to 24 months
to implement rules and regulations, issue licenses and come online. However, it is possible the process may shorten for those
states that have medicinal and are simply expanding into adult recreational use. This remains to be seen. Regardless, during the
transition, we will establish our regional sales organization and continue to
invest in production, engineering and new technologies. Our focus for the remainder of 2016 and 2017 is on sales and execution.
Critical
Accounting Policies and Significant Judgments and Estimates
This discussion and analysis
of our financial condition and results of operations is based upon our interim unaudited condensed consolidated financial statements,
which have been prepared in conformity with accounting principles generally accepted in the United States. Certain accounting
policies are particularly important to the understanding of our financial position and results of operations and require
the application of significant judgment by our management or can be materially affected by changes from period to period in economic
factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In
applying these policies, management uses their judgment to determine the appropriate assumptions to be used in the determination
of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial
results, the terms of existing contracts, observance of trends in the industry, information provided by our customers, and information
available from other outside sources, as appropriate. For information regarding the Company’s critical accounting policies
as well as recent accounting pronouncements, see Note 1 to the consolidated financial statements.
Results
of Operations
The
following discussion should be read in conjunction with our condensed consolidated financial statements and the related notes
included in this form 10-Q
Comparison
of the Three Months Ended September 30, 2016 and 2015
Revenues
and Cost of Goods Sold
Revenue for the three months
ended September 30, 2016 was approximately $1,171,000 compared to $3,634,000 for the same period in 2015 (68% decrease). A significant
portion of our revenues for 2015 were derived from growers in the State of Nevada (legalized cannabis in 2014), which peaked in
the third quarter of 2015. As our sales quarter over quarter for 2016 have been declining, our contractual sales commitments have
been increasing. The sales amounts that we had under contract but not yet completed have increased quarter over quarter of 2016
from $1,662,000 (as of March 31, 2016), $2,310,000 (as of June 30, 2016) and $4,074,000 (as of September 30, 2016). Our contractual
sales commitments increased during the nine months ended September 30, 2016, due to our customers having experienced increased
delays in completing the construction of their facilities to accept their product. Our contractual sales cannot be canceled by
our customers. Initially our sales contracts were dependent upon our customers’ ability to secure, license and build their
growing facilities and thus our revenue recognition was dependent upon shipping and our customers’ ability to receive the
product. We have seen an increased delay in the time frames in which our customers have been able to receive the product, most
likely related to the increasing size of our projects. This factor has slowed our revenue recognition and increased our contractual
sales commitments. Beginning in October 2016, all of our sales contracts will be Freight On Board Shipping. This removes any dependencies
on our revenue recognition being tied to a customer’s ability to receive product.
Cost of revenue
has decreased by 76% from $3,125,000 for the three months ended September 30, 2015 to approximately $754,000 for the three
months ended September 30, 2016. The gross margin increased by 22% from 14% in 2015 to 36% 2016 due to (i) negotiation of favorable
pricing with key suppliers or sourcing new suppliers, (ii) a sales mix that consisted of high margin products and (iii) reduced
spend on installation projects as we no longer provide installation services.
Operating
expenses have decreased by 38% from $1,049,000 for the three months ended September 30, 2015 to approximately $654,000 for the
three months ended September 30, 2016. We have decreased advertising and marketing expenses by 90% from $149,000 for 2015 to $14,000
for 2016 due to a heavier emphasis on advertising in the prior year and a focus on reigning in costs in the current year. We decreased
product development costs by 68% from $224,000 in 2015 to $72,000 in 2016 due to the product life cycle of the Surna reflector
product, which has moved from development stage in the first quarter of 2015 to production stage in the first quarter of 2016.
Also in 2015, we were developing the Surna Hybrid Building, which is being launched to the market at the Marijuana Daily Conference
in November 2016. We decreased general and administrative expenses by 16% from $676,000 in 2015 to $568,000 in 2016 due to reductions
in personnel cost of approximately $55,000 as well as a focus on cost containment related other expense of approximately $69,000
which were offset with an increase of approximately $16,000 for travel expenses.
Other expenses have decreased
by 46% from $795,000 for the three months ended September 30, 2015 to approximately $432,000 for the three months ended
September 30, 2016. This is result of the decrease in interest expense and debt discount on convertible promissory notes, which
was a result of the conversion of certain convertible promissory notes converted in the first quarter and second quarter of 2016.
For
the three months ended September 30, 2016 and 2015, we had no federal taxable income due to utilization of net operating loss
carryforwards for the current quarter and operating losses in the second quarter of 2015.
Overall,
we realized a net loss of approximately $669,000 for the three months ended September 30, 2016 as compared to a net loss of approximately
$1,335,000 for the three months ended September 30, 2015.
Comparison
of the Nine Months Ended September 30, 2016 and 2015
Revenue
for the nine months ended September 30, 2016 was approximately $5,561,000 compared to $6,183,000 for the same period in 2015 (10%
decrease). A significant portion of our revenues for the nine months ended September 30, 2015 were derived from growers in the
State of Nevada (legalized cannabis in 2014), which peaked in the third quarter of 2015. As our sales quarter over quarter for
2016 have been declining, our contractual sales commitments have been increasing. The sales amounts that we had under contract
but not yet completed have increased quarter over quarter of 2016 from $1,662,000 (as of March 31, 2016), $2,310,000 (as of June
30, 2016) and $4,074,000 (as of September 30, 2016). Our contractual sales commitments have increased during the nine months ended
September 30, 2016, due to our customers having experienced increased delays in finalizing their facilities to accept their product.
Our contractual sales cannot be canceled by our customers. Initially our sales contracts were dependent upon our customers’
ability to secure, license and build their growing facilities and thus our revenue recognition was dependent upon shipping and
our customers’ ability to receive the product. We have seen an increased delay in the time frames in which our customers
have been able to receive the product, most likely related to the increasing size of our projects. This factor has slowed our
revenue recognition and increased our contractual sales commitments. Beginning in October 2016 , all of our sales contracts will
be Fright On Board Shipping. This removes any dependencies on our revenue recognition being tied to a customer’s ability
to receive product.
Cost of revenue
has decreased by 30% from $5,338,000 for the nine months ended September 30, 2015 to approximately $3,741,000 for the three
months ended September 30, 2016. Gross margin in 2016 increased by 19% from 14% in 2015 to to 33% in 2016 due to several factors
including: (i) a warranty charge of approximately $455,000 the Company recorded during the three month end June 30, 2016
for an estimated cost to replace a customer’s system (ii) offset by price increases that took effect late in the third quarter
of 2015, (ii) negotiation of favorable pricing with key suppliers or sourcing new suppliers, (iii) a sales mix that consisted
of high margin products and (iv) reduced spend on installation projects as we no longer provide installation services.
Operating expenses have
decreased by 33% from $2,955,000 for the nine months ended September 30, 2015 to approximately $1,991,000 for the nine months ended
September 30, 2016. Advertising and marketing expenses decreased by 82% from $324,000 for 2015 to $57,000 2016 due to a heavier
emphasis on advertising in the prior year and a focus on reigning in costs in the current year. Product development costs decreased
by 49% from $534,000 in 2015 to $272,000 in 2016 due to the product life cycle of the Surna reflector product, which has moved
from development stage in the first quarter of 2015 to production stage in the first quarter of 2016. Also in 2015, we were developing
the Surna Hybrid Building, which is being launched into the market at the at the Marijuana Daily Conference in November 2016. We
have decreased general and administrative expenses by 21% from $2,097,000 in 2015 to $1,662,000 in 2016 due to reductions in the
following expenses: personnel cost of approximately $102,000, travel expense of approximately $59,000, professional fees of approximately
$232,000 as well as a focus on cost containment related other expense of approximately of $105,000 which were offset with an increase
of approximately $64,000 for contract labor and sales expense.
We incurred net other
expenses of $1,947,000 for the nine months ended September 30, 2016 compared to $1,620,000 (a 20% increase) for the same period
in 2015. The increase in total other expense was due in part to loss on change in derivative liabilities and an increase in interest
expense, which were offset by a marginal decrease in amortization of debt discount on convertible promissory notes. The increase
of the market price for the Company’s common stock increased during the first and third quarters of 2016, which resulted
in a loss on change in derivatives of approximately $484,000, which was offset by an approximate gain of $135,000 during the second
quarter of 2016, as compared to an approximate gain of $475,000 for the same period in 2015.
For
the nine months ended September 30, 2016 and 2015, we had no federal taxable income due to utilization of net operating loss carryforwards
for the each of period.
Overall,
we realized a net loss of approximately $2,118,000 for the nine months ended September 30, 2016 as compared to a net loss of approximately
$3,731,000 for the nine months ended September 30, 2015, which is a 43% reduction in our net loss.
Liquidity
and Capital Resources
The
following summarizes our cash flows:
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Cash provided by (used in) operating activities
|
|
$
|
35,000
|
|
|
$
|
(1,297,000
|
)
|
Cash flows provided by (used in) investing activities
|
|
|
15,000
|
|
|
|
(158,000
|
)
|
Cash flows (used in) provided by financing activities
|
|
|
(145,000
|
)
|
|
|
1,744,000
|
|
Net change in cash
|
|
$
|
(95,000
|
)
|
|
$
|
289,000
|
|
We
have never reported net income. We incurred net losses for the nine months ended September 30, 2016 and 2015 and have an accumulated
deficit of approximately $13,182,000 as of September 30, 2016. We had working capital deficits (current liabilities exceed current
assets) of approximately $4,149,000 and $3,020,000 as of September 30, 2016 and December 31, 2015, respectively. We have not been
able to generate sufficient cash from operating activities to fund our ongoing operations. Since our inception, we have raised
capital through private sales of common stock and debt securities. Our future success is dependent upon our ability to achieve
profitable operations and generate cash from operating activities. There is no guarantee that we will be able to generate enough
revenue and/or raise capital to support our operations. As of September 30, 2016 and December 31, 2015, we had a cash balance
of approximately $235,000 and $331,000, respectively.
Cash
Requirements
Our
ability to fund our growth and meet our obligations on a timely basis is dependent on our ability to match our available financial
resources to our growth strategy, which includes acquisitions for cash or a combination of cash and debt. The decisions we make
with regard to acquisitions drive the level of capital required and the level of our financial obligations. Management has determined
the Company’s September 30, 2016 cash balance of approximately $235,000 will not be sufficient to fund the Company’s
operations over the next twelve months. Based on management’s estimate for operational cash requirements and without modifications
to our existing payment obligations, which including, among other things, the upcoming payments for the convertible promissory
notes maturing from October 31, 2016 through the end of the quarter ending March 31, 2017, or receipt of additional funding, we
will require additional capital to continue our operations beyond December 2016. We are currently negotiating with holders of
notes which are maturing with a goal of converting the notes into equity and reducing the exercise prices of associated warrants.
As of the filing of this Form 10-Q, we have not finalized any negotiation and there is no assurance we will be able to successfully
negotiate these conversions and avoid default on the notes.
If
we are unable to generate cash flow from operations, adjustment to our payment arrangements or from successfully raising sufficient
additional capital through future debt and equity financings or strategic and collaborative ventures with potential partners,
we would likely have to reduce the size and scope of our operations. Our officers and shareholders have not made any written or
oral agreement to provide us additional financing. There can be no assurance that we will be able to continue to raise capital
on terms and conditions that are deemed acceptable to us.
Operating
Activities
Cash
provided by operations for the nine months ended September 30, 2016 was approximately $35,000 compared to cash used in operations
of approximately $1,297,000 for the same period in 2015.
The fluctuation was due to the reduction in the recorded net loss
and collection of our accounts receivable and maintaining lowering levels of inventory, which have been offset with the use of
cash to lower our accounts payable balance.
Investing
Activities
Cash
provided by investing activities for the nine months ended September 30, 2016 was approximately $15,000 compared to cash used
by investing activities of approximately $158,000 for the period in 2015. This fluctuation reflects the $135,000 of cash loaned
to a company in 2015 and the $100,000 cash receipt against the note receivable from Agrisoft in 2016. Also, in 2016 we loaned
approximately $80,000 in connection with a potential acquisition.
Financing
Activities
Cash used in financing
activities for the nine months ended September 30, 2016 was approximately $145,000 compared to cash provided by financing activities
of approximately $1,744,000 for the same period in 2015. No debt was issued in 2016 period compared to the $1,860,000 off
convertible promissory note issuances in the comparable prior in 2015. During the 2016 period, we paid of a vehicle loan in the
amount of approximately $34,000 and payments of approximately $111,000 on outstanding promissory notes.
Inflation
In
the opinion of management, inflation has not and will not have a material effect on our operations in the immediate future. Management
will continue to monitor inflation and evaluate the possible future effects of inflation on our business and operations.
Contractual
Payment Obligations
We
have obligations under notes payable and an irrevocable operating lease. As of September 30, 2016, these contractual obligations
totaled approximately $3,112,000.
Off-Balance
Sheet Arrangements
There
are no 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
that is material to investors.