Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1 – Description of Business
Surna
Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. The Company develops innovative technologies
and products that monitor, control and or address the energy and resource intensive nature of indoor cannabis cultivation. Currently,
the Company’s revenue stream is derived primarily from supplying industrial technology and products to commercial indoor
cannabis cultivation facilities. Headquartered in Boulder, Colorado, the Company’s engineering and technical team provides
solutions that allow growers to meet the unique demands of a cannabis cultivation environment through precise temperature, humidity,
and process controls, energy and water efficiency, and satisfaction of the evolving code and regulatory requirements being imposed
at the state and local levels. The Company’s objective is to leverage its experience in this space in order to bring value-added
climate control solutions to its customers that help improve their overall crop quality and yield as well as optimize the resource
efficiency of their controlled environment (i.e,. indoor and greenhouses) cultivation facilities. The Company is not involved
in the production or sale of cannabis.
Note
2 – Basis of Presentation; Summary of Significant Accounting Policies
Financial
Statement Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles
generally accepted in the United States of America (“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. 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 six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for
the fiscal year ending December 31, 2018. The balance sheet as of December 31, 2017 has been derived from the audited financial
statements at that date, but does not include all 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, 2017. The notes to the unaudited condensed consolidated financial statements are presented
on a going concern basis unless otherwise noted.
Basis
of Presentation
The
accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going
concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The
Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $3,284,000 for
the six months ended June 30, 2018, and had an accumulated deficit of approximately $22,887,000 as of June 30, 2018. Since inception,
the Company has financed its activities principally through debt and equity financing and customer deposits. Management expects
to incur additional losses and cash outflows in the foreseeable future in connection with its operating activities.
The
Company is subject to a number of risks similar to those of other similar stage companies, including dependence on key individuals,
successful development, marketing and branding of products; uncertainty of product development and generation of revenues; dependence
on outside sources of financing; risks associated with research and development; dependence on third-party suppliers and collaborators;
protection of intellectual property; and competition with larger, better-capitalized companies. Ultimately, the attainment of
profitable operations is dependent on future events, including obtaining adequate financing to fulfill its development activities
and generating a level of revenues adequate to support the Company’s cost structure.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
There
can be no assurance that the Company will be able to raise debt or equity financing in sufficient amounts, when and if needed,
on acceptable terms or at all. If results of operations for 2018 do not meet management’s expectations, or additional capital
is not available, management believes it has the ability to reduce certain expenditures. The precise amount and timing of the
funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand
for the Company’s products and services, the quality of product development efforts, management of working capital, and
continuation of normal payment terms and conditions for purchase of the Company’s products. The Company believes its cash
balances and cash flow from operations will be insufficient to fund its operations for the next 12 months. If the Company is unable
to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then the Company will
need to raise additional funding to continue as a going concern.
The
foregoing factors raise substantial doubt about the Company’s ability to continue as a going concern for a period of one
year from the date the financial statements are issued. These condensed consolidated financial statements do not include any adjustment
that might result from the outcome of this uncertainty.
Basis
of Consolidation
The
condensed consolidated financial statements include the accounts of the Company and its controlled and wholly-owned subsidiary,
Hydro Innovations, LLC (“Hydro”). Intercompany transactions, profit, and balances are eliminated in consolidation.
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 revenue and expenses during the reporting period. The Company bases its estimates
on historical experience and on various other assumptions that it believes 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. Key estimates include: valuation of derivative liabilities,
valuation of intangible assets, valuation of equity-based compensation, valuation of deferred tax assets and liabilities, warranty
accruals, inventory allowances, and legal contingencies.
Fair
Value Measurement
The
Company records its financial assets and liabilities at fair value. The accounting standard for fair value provides a framework
for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants at the reporting date. The accounting standard establishes a three-tier hierarchy, which
prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level
1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level
2 - inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset
or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level
3 - inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value.
On
a Recurring Basis
A
financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level of input
that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to
the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or
liability.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
During
the third quarter of 2015, the Company issued convertible notes (the “Notes”) to three accredited investors in the
aggregate original principal amount of $711,000, together with warrants to purchase up to an aggregate of 2,625,000 shares of
the Company’s common stock (the “Warrants”). The Warrants, which were outstanding as of December 31, 2017, provided
for a reduction in the exercise price in the event the Company issued common stock in a registered offering at a price below the
exercise price. In such event, the exercise price under the Warrants would be reduced to the price of the common stock in the
dilutive issuance. The Company determined that these outstanding Warrants subject to the exercise price reduction qualified as
a derivative financial instrument.
During
the first quarter of 2018, all of the outstanding Warrants were exercised on a cashless basis, and the Company extinguished the
derivative liability of approximately $389,000 and recorded an increase in additional paid-in capital of the same amount. The
gain on change in derivative liabilities presented in the statements of operations for the six months ended June 30, 2018 represents
the gain on derivatives through the date of the cashless exercise of these warrants.
Financial
liabilities carried at fair value, measured on a recurring basis were as follows:
|
|
|
As
of June 30, 2018
|
|
|
As
of December 31, 2017
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair
Value
|
|
|
Gain
(1)
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair
Value
|
|
|
Gain
(2)
|
|
|
Financial
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities - warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
21,403
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
410,880
|
|
|
$
|
410,880
|
|
|
$
|
66,934
|
|
|
Total
financial liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
21,403
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
410,880
|
|
|
$
|
410,880
|
|
|
$
|
66,934
|
|
|
|
(1)
The gain on change in derivative liabilities presented in the statements of operations for the six months ended June 30, 2018
represents the gain on derivatives through the cashless exercise of all of the associated warrants during the first quarter
of 2018.
|
|
|
|
|
|
(2)
Represents the gain on change in derivative liabilities for the twelve months ended December 31, 2017.
|
The
change in the balance of the warrant derivative liabilities during the first quarter of 2018 was calculated based on the closing
price of the Company’s common stock on the settlement date and the net shares issued under the Warrants, which is classified
as a gain on change in derivative liabilities in the condensed consolidated statements of operations.
On
a Non-Recurring Basis
Intangible
assets that are amortized are evaluated for recoverability whenever adverse effects or changes in circumstances indicate that
the carrying value may not be recoverable. The recoverability test consists of comparing the undiscounted projected cash flows
with the carrying amount. Should the carrying amount exceed undiscounted projected cash flows, an impairment loss would be recognized
to the extent the carrying amount exceeds fair value.
For
the Company’s indefinite-lived goodwill, the impairment test consists of comparing the fair value, determined using the
market value method, with its carrying amount. An impairment loss would be recognized for the carrying amount in excess of its
fair value. The Company concluded that no impairment relating to intangible assets or goodwill existed at June 30, 2018.
Due
to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued
expenses, approximate fair value.
Revenue
Recognition
On
January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606),
Revenue from Contracts
with Customers
and all the related amendments (“ASC 606” or the “new revenue standard”) to all contracts
and elected the modified retrospective method. The results for periods before 2018 were not adjusted for the new revenue standard
and the cumulative effect of the change in accounting was recognized through accumulated deficit at the date of adoption. The
comparative financial information presented has not been restated and continues to be reported under the accounting standards
in effect for those periods. The Company expects the impact of the adoption of the new revenue standard to be immaterial to its
net income (loss) on an ongoing basis.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
cumulative effect of the changes made to the condensed consolidated balance sheet for the adoption of the new revenue standard
as of January 1, 2018 was as follows:
|
|
|
Balance
as of December 31, 2017
|
|
|
Adjustments
Due to ASC 606
|
|
|
Balance
as of
January 1, 2018
|
|
|
Balance
Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
Revenue
|
|
$
|
1,011,871
|
|
|
$
|
(56,912
|
)
|
|
$
|
954,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
deficit
|
|
$
|
(19,254,911
|
)
|
|
$
|
56,912
|
|
|
$
|
(19,197,999
|
)
|
In
accordance with the new revenue standard’s requirements, the disclosure of the impact of adoption on the condensed consolidated
income statements and balance sheets for the three and six months ended June 30, 2018 (including insignificant true-up adjustments
related to the first quarter of 2018 which have been reflected in the three months ended June 30, 2018) was as follows:
|
|
|
For
the Three Months Ended
June
30, 2018
|
|
|
For
the Six Months Ended
June
30, 2018
|
|
|
|
|
As
Reported
|
|
|
Balances
Without Adoption of ASC 606
|
|
|
Effect
of Change Higher/(Lower)
|
|
|
As
Reported
|
|
|
Balances
Without Adoption of ASC 606
|
|
|
Effect
of Change Higher/(Lower)
|
|
|
Income
Statement
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
2,007,745
|
|
|
$
|
2,024,685
|
|
|
$
|
(16,940
|
)
|
|
$
|
4,062,473
|
|
|
$
|
4,061,973
|
|
|
$
|
500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(1,400,945
|
)
|
|
$
|
(1,384,005
|
)
|
|
$
|
16,940
|
|
|
$
|
(3,284,489
|
)
|
|
$
|
(3,284,989
|
)
|
|
$
|
(500
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
Revenue
|
|
$
|
1,413,074
|
|
|
$
|
1,470,486
|
|
|
$
|
(57,412
|
)
|
|
$
|
1,413,074
|
|
|
$
|
1,470,486
|
|
|
$
|
(57,412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
deficit
|
|
$
|
(22,887,457
|
)
|
|
$
|
(22,944,869
|
)
|
|
$
|
(57,412
|
)
|
|
$
|
(22,887,457
|
)
|
|
$
|
(22,944,869
|
)
|
|
$
|
(57,412
|
)
|
Revenue
Recognition Accounting Policy Summary
The
Company accounts for revenue in accordance with the new revenue standard. Under the new revenue standard, a performance obligation
is a promise in a contract with a customer to transfer a distinct good or service to the customer. Most of the Company’s
contracts contain multiple performance obligations that include engineering and technical services as well as the delivery of
a diverse range of climate control system equipment and components, which can span multiple phases of a customer’s project
life-cycle from facility design and construction to equipment delivery and system installation and start-up. The Company does
not provide construction services or system installation services. Some of the Company’s contracts with customers contain
a single performance obligation, typically engineering only services contracts. A contract’s transaction price is allocated
to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there
are multiple performance obligations within a contract, the Company allocates the transaction price to each performance obligation
based on its standalone selling price.
Generally,
satisfaction occurs when control of the promised goods are transferred to the customer or as services are rendered or completed
in exchange for consideration in an amount for which the Company expects to be entitled. The Company recognizes revenue for the
sale of goods when control transfers to the customer, which primarily occurs at the time of shipment. The Company’s historical
rates of return are insignificant as a percentage of sales and, as a result, the Company does not record a reserve for returns
at the time the Company recognizes revenue. The Company also recognizes revenue net of sales taxes. The revenue and cost for freight
and shipping is recorded when control over the sale of goods passes to the Company’s customers.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Performance
obligations are satisfied over-time if the customer receives the benefits as the Company performs work, if the customer controls
the asset as it is being produced, or if the product being produced for the customer has no alternative use and the Company has
a contractual right to payment. Revenue is recognized from this type of performance obligation as services are rendered based
on the percentage completion towards certain specified milestones.
During
the course of a customer’s project, the Company may deploy one of its engineers or technicians to the customer’s facility,
as requested by the customer, to provide technical guidance either prior to, during, or after, the installation of the climate
control system by a third-party contractor. Typically, one of these customer site visits is dedicated to testing that the Company’s
equipment has been properly assembled and installed by the installation contractor and assuring the equipment is operating within
the agreed specifications, which is commonly referred to as commissioning. The Company charges the customer a per diem fee for
these customer site visits, which are generally optional, and are not related to any other performance obligation. The Company
has determined that these customer site visits are separate performance obligations as they are considered distinct and the customer
benefits from these visits on their own. As separate performance obligations, the revenue related to these customer site visits
will be recognized at a point in time when the services are provided to the customer.
The
Company offers assurance-type warranties for its products and products manufactured by others to meet specifications defined by
the contracts with customers, and does not have any material separate performance obligations related to these warranties. The
Company maintains a warranty reserve based on historical warranty costs.
Other
Judgments and Assumptions
The
Company applies the practical expedient in ASC 606-10-50-14 and does not disclose information about remaining performance obligations
that have original expected durations of one year or less. Applying the practical expedient in ASC 340-40-25-4, the Company recognizes
the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company
otherwise would have recognized is one year or less. These costs include certain sales commissions and incentives and are included
in selling, general and administrative expenses. ASC 606-10-32-18 allows the Company to not adjust the amount of consideration
to be received in a contract for any significant financing component if the Company expect to receive payment within twelve months
of transfer of control of goods or services. The Company has elected this expedient as it expects all consideration to be received
in one year or less at contract inception. The Company has also elected not to provide the remaining performance obligations disclosures
related to service contracts in accordance with the practical expedient in ASC 606-10-55-18. The Company recognizes revenue in
the amount to which the entity has a right to invoice and has adopted this election to not provide the remaining performance obligations
related to service contracts.
Contract
Assets and Contract Liabilities
Contract
assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate
to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers
based on the terms established in its contracts.
Contract
assets include unbilled amounts where revenue recognized exceeds the amount billed to the customer and the right of payment is
conditional, subject to completing a milestone, such as a phase of a project. The Company typically does not have material amounts
of contract assets since revenue is recognized as control of goods are transferred or as services are performed. As of June 30,
2018 and December 31, 2017, the Company has no contract assets.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Contract
liabilities consist of advance payments in excess of revenue recognized. The Company’s contract liabilities are recorded
as a current liability in Deferred Revenue in the condensed consolidated balance sheet since the timing of when the Company expects
to recognize revenue is generally less than one year. As of June 30, 2018 and December 31, 2017, the deferred revenue, which was
classified as a current liability, was $1,413,074 and $1,011,871, respectively.
For
the three and six months ended June 30, 2018, the Company recognized revenue of $41,731 and $867,814, respectively, related to
the deferred revenue at January 1, 2018.
Accounting
for Share-Based Compensation
The
Company recognizes the cost resulting from all share-based compensation arrangements, including stock options, restricted stock
awards and restricted stock units that the Company grants under its equity incentive plan in its condensed consolidated financial
statements based on their grant date fair value. The expense is recognized over the requisite service period or performance period
of the award. Awards with a graded vesting period based on service are expensed on a straight-line basis for the entire award.
Awards with performance-based vesting conditions, which require the achievement of a specific company financial performance goal
at the end of the performance period and required service period, are recognized over the performance period. Each reporting period,
the Company reassesses the probability of achieving the respective performance goal. If the goals are not expected to be met,
no compensation cost is recognized and any previously recognized amount recorded is reversed. If the award contains market-based
vesting conditions, the compensation cost is based on the grant date fair value and expected achievement of market condition and
is not subsequently reversed if it is later determined that the condition is not likely to be met or is expected to be lower than
initially expected.
The
grant date fair value of stock options is based on the Black-Scholes Option Pricing Model (the “Black-Scholes Model”).
The Black-Scholes Model requires judgmental assumptions including volatility and expected term, both based on historical experience.
The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected term of the option.
The
grant date fair value of restricted stock and restricted stock units is based on the closing price of the underlying stock on
the date of the grant.
The
Company has elected to reduce share-based compensation expense for forfeitures as the forfeitures occur since the Company does
not have historical data or other factors to appropriately estimate the expected employee terminations and to evaluate whether
particular groups of employees have significantly different forfeiture expectations.
Share-based
awards granted to non-employees are recorded at the fair value of the consideration received or the fair value of the equity issued,
whichever can be more readily measured, on the measurement date and are subject to periodic adjustment as the underlying share-based
awards vest.
Share-based
compensation paid to employees, directors and non-employees totaled $1,493,260 and $391,969 for the six months ended June 30,
2018 and 2017, respectively.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Share-based
compensation expenses are classified in the condensed consolidated financial statements in the same manner as if such compensation
was paid in cash. The following is a summary of share-based compensation costs included in the condensed consolidated statements
of operations for the three and six months ended June 30, 2018 and 2017, respectively:
|
|
|
For
the Three Months Ended June 30,
|
|
|
For
the Six Months Ended June 30,
|
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
Share-based
compensation expense included in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenue
|
|
$
|
37,792
|
|
|
$
|
-
|
|
|
$
|
79,063
|
|
|
$
|
-
|
|
|
Advertising
and marketing expenses
|
|
|
2,273
|
|
|
|
-
|
|
|
|
3,125
|
|
|
|
-
|
|
|
Product
development costs
|
|
|
1,137
|
|
|
|
-
|
|
|
|
2,274
|
|
|
|
-
|
|
|
Selling,
general and administrative expenses
|
|
|
811,437
|
|
|
|
261,900
|
|
|
|
1,408,798
|
|
|
|
391,969
|
|
|
Total
share-based compensation expense included in consolidated statement of operations
|
|
$
|
852,639
|
|
|
$
|
261,900
|
|
|
$
|
1,493,260
|
|
|
$
|
391,969
|
|
Basic
and Diluted Net Loss per Common Share
Basic
net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during
the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during
the period, adjusted for the dilutive effect of common stock equivalents. In periods when losses are reported, the weighted-average
number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.
Commitments
and Contingencies
In
the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out
of its business, that cover a wide range of matters, including, among others, customer disputes, government investigations and
tax matters. An accrual for a loss contingency is recognized when it is probable that an asset had been impaired or a liability
had been incurred and the amount of loss can be reasonably estimated.
Other
Risks and Uncertainties
To
achieve profitable operations, the Company must successfully develop, manufacture and market its products. There can be no assurance
that any such products can be developed or manufactured at an acceptable cost and with appropriate performance characteristics,
or that such products will be successfully marketed. These factors could have a material adverse effect upon the Company’s
financial results, financial position, and future cash flows.
The
Company is subject to risks common to similarly-situated companies including, but not limited to, new technological innovations,
dependence on key personnel, protection of proprietary technology, compliance with government regulations, uncertainty of market
acceptance of products, product liability, and the need to obtain additional financing. As a supplier of services and equipment
to cannabis cultivators, the Company is also subject to risks related to the cannabis industry. Although certain states and parts
of Canada, where the Company sells its products, have legalized medical and/or recreational cannabis, U.S. federal laws continue
to prohibit cannabis in all its forms as well as its derivatives. Any changes in the enforcement of U.S. federal laws may adversely
affect the implementation of state and local cannabis laws and regulations that permit medical or recreational cannabis and, correspondingly,
may adversely impact the Company’s customers. The Company’s success is also dependent upon its ability to raise additional
capital and to successfully develop and market its products.
Segment
Information
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by the Company’s senior management team in deciding how to allocate resources and in assessing performance. The
Company has one operating segment that is dedicated to the manufacture and sale of its products.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Recent
Accounting Pronouncements
In
June 2018, the Financial Accounting Standards Board (“FASB”) adopted ASU 2018-07, “Compensation — Stock
Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of Topic
718 to include all share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 specifies
that Topic 718 applies to all share-based payment transactions in which the grantor acquires goods and services to be used or
consumed in its own operations by issuing share-based payment awards. ASU 2018-07 also clarifies that Topic 718 does not apply
to share-based payments used to effectively provide (1) financing to the issuer, or (2) awards granted in conjunction with selling
goods or services to customers as part of a contract accounted for under ASC 606. ASU 2018-07 is effective for fiscal years beginning
after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted, but no earlier than
the Company’s adoption of ASC 606. The Company is currently evaluating the effect that adopting this new accounting guidance
will have on its consolidated results of operations, cash flows and financial position.
In
February 2016, the FASB adopted ASU 2016-02,
Leases
(Topic 842) which requires companies leasing assets to recognize on
their balance sheet 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 on contracts longer than one year. The lessee is permitted to make an accounting policy
election to not recognize lease assets and lease liabilities for short-term leases. How leases are recorded on the balance sheet
represents a significant change from previous GAAP guidance in Topic 840. ASU 2016-02 maintains a distinction between finance
leases and operating leases similar to the distinction under previous lease guidance for capital leases and operating leases.
In July 2018, FASB issued ASU 2018-10,
Codification Improvements to Topic 842, Leases
. This amendment provides improvements
that clarify specific aspects of the guidance in ASU 2016-02. In July 2018, FASB also issued ASU 2018-11,
Targeted Improvements
to Topic 842, Leases
. This amendment provides entities with an additional (and optional) transition method to adopt the new
leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and
recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently,
an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases
standard will continue to be in accordance with current GAAP (Topic 840, Leases). ASU 2016-02 is effective for fiscal periods
beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating the effect that adopting
this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.
Other
accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected
to have a material impact on the financial statements upon adoption. The Company does not discuss recent pronouncements that are
not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.
Note
3 – Inventory
Inventory
consisted of the following:
|
|
|
June
30, 2018
|
|
|
December
31, 2017
|
|
|
Finished
goods
|
|
$
|
500,958
|
|
|
$
|
569,047
|
|
|
Work
in progress
|
|
|
38,922
|
|
|
|
14,348
|
|
|
Raw
materials
|
|
|
233,799
|
|
|
|
262,611
|
|
|
Allowance
for excess & obsolete inventory
|
|
|
(319,383
|
)
|
|
|
(323,384
|
)
|
|
Inventory,
net
|
|
$
|
454,296
|
|
|
$
|
522,622
|
|
Overhead
expenses of $34,356 and $28,554 were included in the inventory balance as of June 30, 2018 and December 31, 2017, respectively.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
4 – Property and Equipment
Property
and equipment consisted of the following:
|
|
|
June
30,
2018
|
|
|
December
31, 2017
|
|
|
Furniture
and equipment
|
|
$
|
372,380
|
|
|
$
|
326,894
|
|
|
Equipment
held for lease to related party
|
|
|
176,043
|
|
|
|
159,806
|
|
|
Vehicles
|
|
|
15,000
|
|
|
|
15,000
|
|
|
Leasehold
improvements
|
|
|
215,193
|
|
|
|
33,257
|
|
|
|
|
|
778,616
|
|
|
|
534,957
|
|
|
Accumulated
depreciation
|
|
|
(202,154
|
)
|
|
|
(133,601
|
)
|
|
Property
and equipment, net
|
|
$
|
576,462
|
|
|
$
|
401,356
|
|
Note
5 – Accounts Payable and Accrued Liabilities
Accounts
payable and accrued liabilities consisted of the following:
|
|
|
June
30, 2018
|
|
|
December
31, 2017
|
|
|
Accounts
payable
|
|
$
|
790,564
|
|
|
$
|
1,159,975
|
|
|
Sales
commissions payable
|
|
|
46,513
|
|
|
|
21,931
|
|
|
Accrued
payroll liabilities
|
|
|
74,819
|
|
|
|
58,557
|
|
|
Product
warranty accrual
|
|
|
112,840
|
|
|
|
105,122
|
|
|
Commercial
dispute settlement
|
|
|
-
|
|
|
|
332,418
|
|
|
Other
accrued expenses
|
|
|
228,361
|
|
|
|
291,260
|
|
|
Total
|
|
$
|
1,253,097
|
|
|
$
|
1,969,263
|
|
Note
6 – Related Party Agreements and Transactions
Amounts
Due to Shareholders
In
July of 2014, the Company issued a $250,000 unsecured promissory note (“Hydro Note”) to Stephen and Brandy Keen as
part of the purchase price of Hydro. Mr. Keen is a principal shareholder of the Company and was a former executive officer and
director, and was formerly a consultant to the Company (see below). Ms. Keen, the spouse of Mr. Keen, is also a principal shareholder
of the Company and previously served as an executive officer and director of the Company (see below). As of December 31, 2017,
the Hydro Note had a balance of $6,927, which was reflected on the balance sheet as a current liability. During the six months
ended June 30, 2018, the balance of the Hydro Note was paid in full.
Stephen
Keen Consulting Agreement
On
May 10, 2017, the Board of Directors (the “Board”) approved a three-year consulting agreement (the “Consulting
Agreement”) under which Mr. Keen agreed to provide certain consulting services to the Company including research and development,
new product design and innovations, existing product enhancements and improvements, and other technology advancements with respect
to the Company’s business and products in exchange for an annual consulting fee of $30,000. Pursuant to the terms of the
Consulting Agreement, the Company recorded consulting fees of $2,500 and $10,000 payable to Stephen Keen during the three and
six months ended June 30, 2018, respectively. On May 29, 2018, the Company and Mr. Keen entered into, a Termination Agreement
which terminated the Consulting Agreement effective May 31, 2018 (the “Termination Agreement”).
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Sterling
Pharms Equipment Agreement
On
May 10, 2017, the Board approved a three-year equipment, demonstration and product testing agreement between the Company and Sterling
Pharms, LLC (“Sterling”), an entity controlled by Mr. Keen, which operates a Colorado-regulated cannabis cultivation
facility. Under this agreement, the Company agreed to provide to Sterling certain lighting, environmental control, and air sanitation
equipment for use at the Sterling facility in exchange for a quarterly fee of $16,500 from Sterling. Also, under this agreement,
Sterling agreed to allow the Company and its existing and prospective customers to have access to the Sterling facility for demonstration
tours in a working environment, which the Company believes will assist it in the sale of its products. Sterling also agreed to
monitor, test and evaluate the Company’s products installed at the Sterling facility and to collect data and provide feedback
to the Company on the energy and operational efficiency and efficacy of the installed products, which the Company intends to use
to improve, enhance and develop new or additional product features, innovations and technologies. In consideration for access
to the Sterling facility to conduct demonstration tours and for the product testing and data to be provided by Sterling, the Company
will pay Sterling a quarterly fee of $12,000.
On
March 22, 2018, the Company and Sterling entered into an amendment of the original agreement to include additional leased equipment
and to increase the quarterly fee payable to the Company to $18,330. The amendment of the original agreement also provided that,
upon expiration of the initial three-year term, either: (i) the leased equipment would be returned to the Company and the agreement
would terminate, (ii) Sterling could purchase the leased equipment at the agreed upon residual value of $81,827, or (iii) Sterling
and the Company could agree to an extension of the original agreement at mutually agreed to quarterly payments to and from the
parties.
After
giving effect to the amended quarterly equipment lease fees received from Sterling of $18,330 (the “Lease Fee”) and
the quarterly demonstration and testing fees paid to Sterling of $12,000 (the “Demo and Testing Fee”), the Company
will receive a net payment of $6,330 from Sterling each quarter.
Sterling
accepted delivery of the remaining leased equipment and completed installation of the equipment at its facility on May 1, 2018.
Accordingly, the term of this agreement, which commenced upon complete installation of the equipment, commenced May 1, 2018 and
will expire April 30, 2021.
The
Company is treating the equipment rental arrangement and related Lease Fee payment as an operating lease. Accordingly, the equipment
held for lease has been recorded as property and equipment on the balance sheets and will be depreciated over the term of the
lease. The Lease Fee will be recorded as “Interest and other income, net” in the condensed consolidated statements
of operations. For the three and six months ended June 30, 2018, the Company recorded Lease Fees of $12,220 and $12,220, respectively.
The
Company will record the Demo and Testing Fee as operating expenses in the condensed consolidated statements of operations. For
the three and six months ended June 30, 2018, the Company recorded Demo and Testing Fees of $8,000 and $8,000, respectively.
Brandy
Keen Employment Agreement
On
May 29, 2018, the Company and Ms. Keen entered into, an amended and restated employment agreement (the “Employment Agreement”),
pursuant to which, among other things, (i) Ms. Keen’s position will remain as Senior Technical Advisor reporting to the
Director of Sales; (ii) the term of Ms. Keen’s employment will expire on April 30, 2020, (iii) through April 30, 2019, Ms.
Keen will be a full-time employee of the Company and will reside in the Boulder, Colorado area, (iv) beginning May 1, 2019 through
April 30, 2020, Ms. Keen will become a part-time employee and will be expected to work a minimum of 30 hours per work, (v) beginning
May 1, 2019, Ms. Keen may relocate her residence and will only be expected to attend significant trade shows, major customer meetings,
or meetings at the Boulder office from time to time, (vi) Ms. Keen’s current base salary of $150,000 and her sales incentive
would remain in full force and effect through April 30, 2019, and (vii) beginning May 1, 2019, Ms. Keen’s annualized salary
will become $75,000 and she will no longer receive any sales incentives and, except as set forth in the Employment Agreement,
Ms. Keen would not be eligible for any other bonus or incentive compensation during the term of her employment.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Pursuant
to the Employment Agreement, the Board approved an award of 4,800,000 restricted stock units (“RSUs”) to Ms. Keen
under the Company’s 2017 Equity Incentive Plan, as may be modified and amended by the Company from time to time (the “2017
Equity Plan”), that vest as follows: (i) 1,000,000 RSUs vested on June 30, 2018, subject to her continued employment through
the vesting date, (ii) 1,000,000 RSUs vest on December 31, 2018, subject to her continued employment through the vesting date,
(iii) 1,000,000 RSUs vest on June 30, 2019, subject to her continued employment through the vesting date, (iv) 1,000,000 RSUs
vest on December 31, 2019, subject to her continued employment through the vesting date, and (v) 800,000 RSUs vest on April 30,
2020, subject to her continued employment through the vesting date. The Employment Agreement provides that the foregoing RSUs
would continue to vest if Ms. Keen’s employment is terminated by the Company without cause.
In
consideration of the new consideration being provided to Ms. Keen under the Employment Agreement, the post-termination restrictive
covenants under her existing employment agreement were amended to extend the restrictive period from one year to two years from
the date of termination or expiration.
In
connection with the foregoing transactions, Ms. Keen resigned as an executive officer and director of the Company effective May
10, 2018.
Company
Purchase of Common Stock from Stephen and Brandy Keen
On
May 29, 2018, the Company and the Keens entered into a Stock Repurchase Agreement (the “Stock Repurchase Agreement”),
pursuant to which the Company agreed to repurchase from the Keens shares of the Company’s common stock at the Repurchase
Price per Share (as defined below) for a total repurchase price of $400,000 (“Repurchased Shares”). The Company’s
obligation to repurchase the Repurchased Shares was contingent on the closing of a private placement offering to accredited investors
of the Company’s common stock, which occurred during the second quarter of 2018. The Repurchase Price per Share was $0.128,
which was equal to 80% of the $0.16 unit price paid by investors in the private placement offering to reflect the estimated value
of the warrant included in the unit. On June 19, 2018, the Company closed the transaction under the Stock Repurchase Agreement
and repurchased 3,125,000 shares of the Company’s common stock from the Keens. See Note 9.
Company
Option to Purchase of Preferred Stock from Stephen and Brandy Keen
On
May 29, 2018, the Company and the Keens entered into a Preferred Stock Option Agreement under which the Company has the right,
but not the obligation, to acquire all 35,189,669 shares of preferred stock owned by the Keens (the “Preferred Stock”).
Pursuant to the Preferred Stock Option Agreement, upon exercise of the option by the Company, the Company will issue one share
of common stock for each 1,000 shares of Preferred Stock purchased by the Company. The common stock issued upon exercise will
be restricted shares. The option will expire on April 30, 2020. As consideration for the Keens’ grant of the option, the
Company paid them $5,000. See Note 9.
Note
7 – Derivative Liabilities
The
Company determined that the Warrants qualified as derivative financial instruments. Accordingly, the Warrants were recorded as
derivative liabilities and were marked to market at the end of each reporting period. Any change in fair value during the period
was recorded as gain (loss) on change in derivative liabilities in the condensed consolidated statements of operations.
During
the first quarter of 2018, all of the outstanding Warrants were exercised on a cashless basis and the Company extinguished the
derivative liability of $389,000 and recorded an increase in additional paid-in capital of the same amount. The gain on change
in derivative liabilities presented in the statements of operations for the three and six months ended June 30, 2018 of $0 and
$21,403, respectively, represent the gain on derivatives through the date of the cashless exercise of the Warrants.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
following table sets forth movement in the derivative liability related to the Warrants:
|
Balance
December 31, 2017
|
|
$
|
410,880
|
|
|
Gain
on change in derivative liability, net
|
|
|
(21,403
|
)
|
|
Balance
prior to exercise of associated warrants
|
|
|
389,477
|
|
|
Extinguishment
of derivative liability on cashless exercise of associated warrants
|
|
|
(389,477
|
)
|
|
Balance
June 30, 2018
|
|
$
|
-
|
|
Note
8 – Commitments and Contingencies
Litigation
From
time to time, in the normal course of its operations, the Company is subject to litigation matters and claims. Litigation can
be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to
predict and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold.
The Company expenses legal fees as incurred. The Company records a liability for contingent losses when it is both probable that
a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter,
if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of
operations.
Internal
Revenue Service Penalties
The
Company has been penalized by the Internal Revenue Service (“IRS”) for failure to file its Foreign Form 5471, Information
Return of U.S. Persons with Respect to Certain Foreign Corporations, for the years 2011, 2012 and 2014 on a timely basis. The
penalties and interest approximate $115,000. The Company’s request that the penalties be abated for reasonable cause was
denied by the IRS in September 2017. The Company has appealed the IRS’s denial based on statutory grounds under Revenue
Procedure 92-70, which provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations.
Persons complying with this revenue procedure are deemed to satisfy their Form 5471 filing obligations with respect to dormant
foreign corporations and are not subject to penalties related to the failure to timely file a complete Form 5471 and to timely
furnish information requested thereon. The IRS has notified the Company that it has referred the appeal to a regional appeals
office for handling, and the Company has not yet received any response from the appeals office. The Company believes it has complied
with the summary filing procedures for filing Form 5471 under Revenue Procedure 92-70 and the likelihood of abatement is more
likely than not. As a result, no amounts have been accrued for this contingency as of June 30, 2018 and December 31, 2017. However,
there can be no assurance of any abatement until the IRS acts upon the appeal.
Building
Lease
The
Company has a lease agreement for its manufacturing and office space consisting of approximately 18,600 square feet, which commenced
on September 29, 2017 and continues through August 31, 2022. The monthly rental rate of $18,979 will continue until August 31,
2018. Beginning September 1, 2018, the monthly rent will increase by 3% each year through the end of the lease. The Company made
a security deposit of $51,000 and received a $100,000 tenant allowance for leasehold improvements.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
following is a schedule by years of the minimum future lease payments on the building lease as of June 30, 2018.
|
Year
Ended December 31,
|
|
|
|
|
2018
|
|
$
|
116,151
|
|
|
2019
|
|
|
236,926
|
|
|
2020
|
|
|
244,034
|
|
|
2021
|
|
|
251,355
|
|
|
2022
|
|
|
170,888
|
|
|
Total
future minimum lease payments
|
|
$
|
1,019,354
|
|
Total
rent under the building lease is charged to expense over the term of the lease on a straight-line basis, resulting in the same
monthly rent expense throughout the lease. The difference between the rent expense amount and the actual rent paid is recorded
to deferred rent on the condensed consolidated balance sheets.
The
Company recorded to deferred rent a credit for the tenant improvements paid for or reimbursed by the landlord during the three
and six months ended June 30, 2018. Depreciation of the leasehold improvements and amortization of the credit have been determined
based on a straight-line basis over the remaining term of the lease. The amortization of the credit for the tenant improvement
allowance will result in a corresponding reduction in rent expense over the term of the lease.
Other
Commitments
In
the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors,
business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the
Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement
claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain
of its officers and employees that will require the Company to, among other things, indemnify them against certain liabilities
that may arise by reason of their status or service as directors, officers, or employees. The Company maintains director and officer
insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and certain of its officers
and employees, and former officers, directors, and employees of acquired companies, in certain circumstances.
Note
9 – Non-compensatory Equity Transactions
Private
Placement Offering
During
the second quarter of 2018, the Company completed a private placement offering of investment units (the “Units”),
at a price of $0.16 per Unit, with certain accredited investors. Each Unit consisted of one share of the Company’s common
stock and one warrant for the purchase of one share of the Company’s common stock. The Company issued a total of 7,562,500
Units for aggregate proceeds of $1,210,000. No commissions or fees were paid in connection with the offering, and the proceeds
will be used for working capital and general corporate purposes, after $400,000 from the proceeds was used to repurchase shares
of common stock from the Keens.
The
warrants have an exercise price of $0.25 per share of the common stock underlying each warrant, subject to adjustment as provided
in the warrant. The warrants are exercisable commencing July 1, 2018 until June 30, 2021. The warrant may be exercised only for
cash.
Each
warrant is callable at the Company’s option, beginning on July 1, 2019 until the expiration date of the warrant, provided
the closing price of the Company’s common stock is $0.40 (subject to adjustment as provided in the warrant) or greater for
five consecutive trading days (the “Call Condition”). Commencing at any time after the date on which the Call Condition
is satisfied, the Company has the right, upon notice to the holders, to redeem the shares of common stock underlying each warrant
at a price of $0.01 per share, but such redemption may not occur earlier than sixty-one (61) days following the date of the receipt
of notice by the holder (the “Redemption Date”). The holder may exercise the warrant (in whole or in part) prior to
the Redemption Date at the Exercise Price.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Other
Equity Issuances
During
the six months ended June 30, 2018, the Company issued shares of its restricted common stock as follows:
|
|
●
|
100,000
shares upon the exercise of certain warrants by an investor and payment of the exercise price of $15,000;
|
|
|
|
|
|
|
●
|
1,498,325
shares upon the exercise of certain warrants by a former director on a cashless exercise basis;
|
|
|
|
|
|
|
●
|
1,168,540
shares upon exercise of certain warrants by investors on a cashless exercise basis;
|
|
|
|
|
|
|
●
|
800,000
shares in connection with the settlement of a commercial dispute;
|
|
|
|
|
|
|
●
|
273,675
shares to consultants as compensation for services rendered; and
|
|
|
|
|
|
|
●
|
31,562
shares to certain employees under a sales incentive plan.
|
Common
Stock Repurchase
On
June 19, 2018, the Company repurchased 3,125,000 shares of the Company’s common stock from the Keens for a repurchase price
of $400,000. See Note 6. Following the repurchase, the Company retired these shares and returned them to unauthorized and unissued
shares. The Company recorded the purchase price for the repurchased shares as a reduction to common stock at par value with the
remainder of the purchase price reflected as an increase to accumulated deficit.
Purchase
of Preferred Stock Option
On
May 29, 2018, the Company acquired an option to purchase 35,189,669 shares of preferred stock owned by the Keens. The Company
paid the Keens $5,000 for this option. See Note 6. The Company recorded the purchase price for the option as an increase to accumulated
deficit.
Note
10 – Equity Incentive Plan
On
August 1, 2017, the Board adopted and approved the 2017 Equity Plan in order to attract, motivate, retain, and reward high-quality
executives and other employees, officers, directors, consultants, and other persons who provide services to the Company by enabling
such persons to acquire an equity interest in the Company. Under the 2017 Equity Plan, the Board (or the compensation committee
of the Board, if one is established) may award stock options, stock appreciation rights (“SARs”), restricted stock
awards (“RSAs”), restricted stock unit awards (“RSUs”), shares granted as a bonus or in lieu of another
award, and other stock-based performance awards. The 2017 Equity Plan allocates 50,000,000 shares of the Company’s common
stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. If any shares subject to an award
are forfeited, expire, or otherwise terminate without issuance of such shares, the shares will, to the extent of such forfeiture,
expiration, or termination, again be available for awards under the 2017 Equity Plan.
As
of June 30, 2018, the Company has granted, under the 2017 Equity Plan, awards in the form of RSAs for services rendered by independent
directors and consultants, non-qualified stock options, RSUs and stock bonus awards totaling 39,588,972 shares. Of these total
awards, as of June 30, 2018, (i) awards related to 4,345,000 shares have been forfeited or expired, (ii) 9,533,972 shares have
been issued on settlement of vested awards, and (iii) awards related to 25,710,000 remain outstanding. During the six months ended
June 30, 2018, the Company issued shares of its common stock under the 2017 Equity Plan in settlement of certain vested awards
as follows:
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
|
|
●
|
4,050,000
shares to certain employees and independent directors in settlement of vested restricted stock units;
|
|
|
|
|
|
|
●
|
1,560,000
shares pursuant to special incentive stock bonuses earned by the CEO and another employee for the period ended December 31,
2017;
|
|
|
|
|
|
|
●
|
119,820
shares of common stock to independent directors in lieu of cash director fees of $30,000 related to the fourth quarter of
2017 and the first quarter of 2018;
|
|
|
|
|
|
|
●
|
158,658
shares to a consultant as compensation for services rendered in lieu of cash fees of $44,900 for the period November 1, 2017
to February 13, 2018;
|
|
|
|
|
|
|
●
|
1,000,000
shares to a consultant as bonus compensation for services rendered; and
|
|
|
|
|
|
|
●
|
25,000
shares upon exercise of non-qualified stock options by a former employee upon payment of the exercise price of $3,375.
|
The
total unrecognized compensation expense for unvested non-qualified stock options, RSUs and stock bonus awards at June 30, 2018
was $1,103,770, which will be recognized over approximately 2.0 years. This unrecognized compensation expense does not include
the potential future compensation expense related to non-qualified stock options and RSUs which are subject to vesting based on
the achievement of $18,000,000 in revenue for 2018 and $25,000,000 in revenue for 2019 (the “Performance-based Awards”).
As of June 30, 2018 and the grant date, the Company has determined that the likelihood of performance levels being obtained is
remote; therefore, no expense was recognized. The unrecognized compensation expense with respect to these Performance-based Awards
at June 30, 2018 was $1,251,973.
Non-Qualified
Stock Options
The
Company uses the Black-Scholes Model to determine the fair value of options granted. Option-pricing models require the input of
highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. Changes
in the subjective input assumptions can materially affect the fair value estimate. The expected stock price volatility assumptions
are based on the historical volatility of the Company’s common stock over periods that are similar to the expected terms
of grants and other relevant factors. The Company derives the expected term based on an average of the contract term and the vesting
period taking into consideration the vesting schedules and future employee behavior with regard to option exercise. The risk-free
interest rate is based on U.S. Treasury yields for a maturity approximating the expected term calculated at the date of grant.
The Company has never paid any cash dividends on its common stock and the Company has no intention to pay a dividend at this time;
therefore, the Company assumes that no dividends will be paid over the expected terms of option awards.
The
Company determines the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected
stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant
dates. As such, the Company may use different assumptions for options granted throughout the year. During the six months ended
June 30, 2018, the valuation assumptions used to determine the fair value of each option award on the date of grant were: expected
stock price volatility 118.90%; expected term in years 7.5 and risk-free interest rate 2.77%.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
A
summary of the non-qualified stock options granted to employees under the 2017 Equity Plan as of June 30, 2018, and changes during
the six months then ended, are presented in the table below:
|
|
|
Number
of Options
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Term
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2017
|
|
|
10,235,000
|
|
|
$
|
0.121
|
|
|
|
8.7
|
|
|
$
|
1,218,375
|
|
|
Granted
|
|
|
1,000,000
|
|
|
$
|
0.283
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(25,000
|
)
|
|
$
|
0.135
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(1,116,666
|
)
|
|
$
|
0.122
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(33,334
|
)
|
|
|
0.135
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
June 30, 2018
|
|
|
10,060,000
|
|
|
$
|
0.137
|
|
|
|
8.3
|
|
|
$
|
333,800
|
|
|
Exercisable,
June 30, 2018
|
|
|
1,826,674
|
|
|
$
|
0.124
|
|
|
|
3.9
|
|
|
$
|
83,884
|
|
|
Outstanding
vested and expected to vest, June 30, 2018
|
|
|
2,760,000
|
|
|
$
|
0.127
|
|
|
|
5.7
|
|
|
$
|
120,050
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performance
options based on 2018 and 2019 revenue thresholds - uncertain vesting as of June 30, 2018
|
|
|
7,300,000
|
|
|
$
|
0.141
|
|
|
|
9.2
|
|
|
$
|
213,750
|
|
A
summary of non-vested non-qualified stock options granted to employees
under the
2017 Equity
Plan
as of June 30, 2018, and any changes during the six months then ended, are presented in the
table below:
|
|
|
Number
of Options
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested,
December 31, 2017
|
|
|
8,349,992
|
|
|
$
|
0.107
|
|
|
$
|
1,000,499
|
|
|
Granted
|
|
|
1,000,000
|
|
|
$
|
0.257
|
|
|
|
|
|
|
Vested
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Forfeited
|
|
|
(1,116,666
|
)
|
|
$
|
0.109
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Nonvested,
June 30, 2018
|
|
|
8,233,326
|
|
|
$
|
0.125
|
|
|
$
|
249,916
|
|
During
the six months ended June 30, 2018, the Company recorded $27,978 as compensation expense related to vested options issued to employees,
net of forfeitures. As of June 30, 2018, total unrecognized share-based compensation related to unvested options was $970,611,
of which $54,338 was related to time-based vesting and $916,273 was related to performance-based vesting.
As
of June 30, 2018, the Company had granted non-qualified options to purchase 10,250,000 shares which were performance-based, of
which 1,950,000 were forfeited due to the failure to satisfy the 2017 revenue and bookings performance thresholds and 1,000,000
were forfeited due to employee terminations. Of the remaining non-qualified options to purchase 7,300,000 shares which are performance-based,
the Company has determined that the likelihood of the 2018 and 2019 performance thresholds being satisfied is remote as of the
date of grant and June 30, 2018; therefore, no expense was recognized. As of June 30, 2018, the performance-based non-qualified
stock options include: (i) 2,950,000 options that vest if the Company achieves 2018 revenue of $18,000,000, and (ii) 4,350,000
options that vest if the Company achieves 2019 revenue of $25,000,000.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
A
summary of the non-qualified stock options granted to the directors under the 2017 Equity Plan as of June 30, 2018, and changes
during the six months then ended, are presented in the table below:
|
|
|
Number
of Options
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Term
|
|
|
Aggregate
Intrinsic Value ($000)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2017
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.6
|
|
|
$
|
94,500
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Forfeited/Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
June 30, 2018
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.1
|
|
|
$
|
31,500
|
|
|
Exerciseable,
June 30, 2018
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.1
|
|
|
$
|
31,500
|
|
|
Outstanding
vested, June 30, 2018
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.1
|
|
|
$
|
31,500
|
|
A
summary of non-vested non-qualified stock options granted to directors
under the
2017 Equity
Plan
as of June 30, 2018, and any changes during the six months then ended, are presented in the
table below:
|
|
|
Number
of Options
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested,
December 31, 2017
|
|
|
450,000
|
|
|
$
|
0.123
|
|
|
$
|
52,470
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Vested
|
|
|
(450,000
|
)
|
|
$
|
0.123
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Nonvested,
June 30, 2018
|
|
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
During
the six months ended June 30, 2018, the Company recorded $12,205 as compensation expense related to vested options issued to directors.
As of June 30, 2018, total unrecognized share-based compensation related to unvested options was $0.
Restricted
Stock Units
A
summary of the RSUs awarded to employees, directors and consultants under the 2017 Equity Plan as June 30, 2018, and changes during
the six months then ended, are presented in the table below:
|
|
|
Number
of Units
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2017
|
|
|
13,800,000
|
|
|
$
|
0.122
|
|
|
$
|
3,312,000
|
|
|
Granted
|
|
|
5,000,000
|
|
|
$
|
0.188
|
|
|
|
|
|
|
Vested
and settled with share issuance
1
|
|
|
(5,050,000
|
)
|
|
$
|
0.141
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Outstanding,
June 30, 2018
|
|
|
13,750,000
|
|
|
$
|
0.139
|
|
|
$
|
2,337,500
|
|
|
Expected
to vest as of June 30, 2018
|
|
|
10,750,000
|
|
|
$
|
0.146
|
|
|
$
|
1,827,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018/2019
Performance Units - uncertain vesting
|
|
|
3,000,000
|
|
|
$
|
0.112
|
|
|
$
|
510,000
|
|
1
Includes
1,000,000 RSUs which were vested and to be settled with issued shares as of June 30, 2018.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
During
the six months ended June 30, 2018, the Company recorded $796,874 as compensation expense related to vested RSUs issued to employees,
directors and consultants. As of June 30, 2018, total unrecognized share-based compensation related to unvested RSUs was $1,080,982,
of which $745,282 was related to time-based vesting and $335,700 was related to performance-based vesting. The total intrinsic
value of RSUs vested and settled or to be settled with share issuance was $1,577,100 for the six months ended June 30, 2018, based
on the closing price of the Company’s stock on the vesting date.
As
of June 30, 2018, the Company had granted 3,000,000 RSUs to the CEO which were performance-based. The Company has determined that
the likelihood of the performance thresholds being satisfied is remote as of the date of grant and June 30, 2018; therefore, no
expense was recognized. As of June 30, 2018, the performance-based RSUs include: (i) 1,500,000 RSUs that vest if the Company achieves
2018 revenue of $18,000,000, and (ii) 1,500,000 options that vest if the Company achieves 2019 revenue of $25,000,000.
Incentive
Stock Bonus Awards
Incentive
stock bonuses awarded pursuant to certain employment agreements are treated as vesting over each award’s service period
based on the fair value of the award at the time of grant. Even though the awards are subject to Board approval, the awards are
treated as vesting over each service period based on the employee performance standards for such awards included in the employment
agreements. Since the awards are denominated in shares of common stock, the fair value of the vested award is charged to additional
paid-in capital. In the event the Board does not approve these incentive stock bonus awards or the employee terminates employment,
the Company would reverse any previously recognized compensation costs related to these awards.
A
summary of the incentive stock bonus awards granted to employees under the 2017 Equity Plan as June 30, 2018, and changes during
the six months then ended, are presented in the table below:
|
|
|
Number
of Shares
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested,
December 31, 2017
|
|
|
7,040,000
|
|
|
$
|
0.113
|
|
|
$
|
1,689,600
|
|
|
Awarded
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Vested
|
|
|
(1,560,000
|
)
|
|
$
|
0.112
|
|
|
|
|
|
|
Forfeited
|
|
|
(200,000
|
)
|
|
$
|
0.121
|
|
|
|
|
|
|
Unvested,
June 30, 2018
|
|
|
5,280,000
|
|
|
$
|
0.113
|
|
|
$
|
897,600
|
|
During
the six months ended June 30, 2018, the Company recorded $277,566 as compensation expense related to vested stock bonus awards
issued to employees, net of forfeitures related to employee terminations. As of June 30, 2018, total unrecognized share-based
compensation related to unvested stock bonus awards was $304,150.
Note
11 – Income Taxes
As
of December 31, 2017, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $10,848,000,
which will expire, if not utilized, in the years 2034 through 2037. Pursuant to Section 382 of the Internal Revenue Code of 1986,
as amended, use of the Company’s NOLs carryforwards may be limited in the event of cumulative changes in ownership of more
than 50% within a three-year period.
The
Company must assess the likelihood that its net deferred tax assets (including NOLs) will be recovered from future taxable income,
and to the extent the Company believes that recovery is not likely, the Company establishes a valuation allowance. Management’s
judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any
valuation allowance recorded against the net deferred tax assets. The Company recorded a full valuation allowance as of December
31, 2017 and June 30, 2018. Based on the available evidence, the Company believes it is more likely than not that it will not
be able to utilize its net deferred tax assets (including NOLs) in the foreseeable future.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
12 – Subsequent Events
The
Company has evaluated all subsequent events through August 14, 2018, the date the financial statements were available to be issued.
The following events occurred after June 30, 2018.
Appointment
of Chief Financial Officer
On
July 9, 2018, the Board appointed a new Chief Financial Officer (“CFO”) and Treasurer, which positions had been previously
vacant. In connection with this appointment, the Company and the new CFO entered into an employment agreement that will continue
until June 30, 2020. Under the employment agreement, the new CFO is eligible to receive an aggregate of 4,000,000 shares of the
Company’s common stock, as determined by the Board in its sole discretion, as follows: (i) for the six-month period ended
December 31, 2018, the new CFO will be eligible to receive a special bonus of 1,000,000 shares of the Company’s common stock,
provided the Board has determined that his performance has been average or better for such period, and (ii) for each of the six-month
periods ended June 30, 2019, December 31, 2019 and June 30, 2020, the new CFO will be eligible to receive a special bonus of 1,000,000
shares of the Company’s common stock, provided the Board has determined that he has achieved certain benchmarks and milestones
as mutually agreed to by him and the Board in advance of each such period.
Equity-related
Transactions
On
July 13, 2018, the Company issued 1,000,000 shares to Brandy Keen in settlement of RSUs that vested on June 30, 2018. See Note
6.
On
August 2, 2018, the Board approved the following:
|
|
●
|
The
issuance of 105,634 shares of common stock to independent directors in lieu of cash director fees of $15,000 related to the
second quarter of 2018;
|
|
|
|
|
|
|
●
|
The
issuance of 560,000 shares pursuant to special incentive stock bonuses earned by an employee for the six-month period ended
June 30, 2018, subject to the remittance of required withholding taxes by the recipient; and
|
|
|
|
|
|
|
●
|
The
grant to a new employee of 120,000 RSUs that vest on the six-month anniversary of employment.
|