Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1 – General
Description
of Business
Surna
Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. The Company designs, engineers and sells cultivation
technologies for controlled environment agriculture including: (i) liquid-based process cooling systems and other climate control
systems, (ii) air handling equipment and systems, (iii) a full-service engineering package for designing and engineering commercial
scale thermodynamic systems specific to cannabis cultivation facilities, and (iv) automation and control devices, systems and
technologies used for environmental, lighting and climate control. Our customers include commercial, state- and provincial-regulated
cannabis growers in the U.S. and Canada as well as other international locations, including those growers building new facilities
and those expanding or retrofitting existing facilities. Currently, our revenue stream is derived primarily from supplying our
products, services and technologies to commercial indoor and hybrid sealed greenhouse facilities ranging from several thousand
to more than 100,000 square feet. Headquartered in Boulder, Colorado, we leverage our experience in this space to bring value-added
climate control solutions to our customers that help improve their overall crop quality and yield, optimize energy and water efficiency,
and satisfy the evolving state and local codes, permitting and regulatory requirements. Although our customers do, we neither
produce nor sell cannabis.
Financial
Statement Presentation
The
accompanying unaudited condensed consolidated financial statements of the Company 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 three months ended March 31, 2020 are not necessarily indicative of the results
that may be expected for the fiscal year ending December 31, 2020. The balance sheet as of December 31, 2019 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, 2019. The notes to the unaudited condensed consolidated financial
statements are presented on a going concern basis.
Basis
of Consolidation and Reclassifications
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.
Going
Concern
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. Since inception, the Company has financed its activities principally
through debt and equity financing, customer deposits and revenues from completed contracts. Management expects to incur additional
losses and cash outflows in the foreseeable future in connection with its operating activities. Management believes that the economic
dislocations in the overall economy, in the near term, will adversely impact our revenues, losses and cash flows. 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 2020 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 overall economy, 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 from 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.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Use
of Estimates
Management
makes 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: allocation of transaction prices to performance obligations under contracts with customers, standalone selling prices,
timing of expected revenue recognition on remaining performance obligations under contracts with customers, valuation of intangible
assets, valuation of equity-based compensation, valuation of deferred tax assets and liabilities, warranty accruals, accounts
receivable and inventory allowances, and legal contingencies.
Income
(Loss) Per Common Share
Basic
income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average
number of common shares outstanding during the period without consideration of common stock equivalents. Diluted net income (loss)
per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding and potentially
dilutive common stock equivalents, including stock options, warrants and restricted stock units and other equity-based awards,
except in cases where the effect of the common stock equivalents would be antidilutive. Potential common stock equivalents consist
of common stock issuable upon exercise of stock options and warrants and the vesting of restricted stock units using the treasury
method.
Goodwill
The
Company recorded goodwill in connection with its acquisition of Hydro Innovations, LLC in July 2014. Goodwill is reviewed for
impairment annually or more frequently when events or changes in circumstances indicate that fair value of the reporting unit
has been reduced to less than its carrying value. The Company performs a quantitative impairment test annually on December 31
by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting
unit exceeds its carrying amount, goodwill is considered not impaired. An impairment charge would be recognized for the amount
by which the carrying amount exceeds the reporting unit’s fair value. The Company determined that it has one reporting unit.
During
the three months ended March 31, 2020, the Company concluded that the projected impact of the COVID-19 pandemic on its sales,
contract completion and revenues in the near term, together with the volatility in its share price during the quarter represented
potential indicators of impairment. Accordingly, the Company performed an interim impairment analysis at March 31, 2020, and concluded
that no impairment relating to goodwill existed at March 31, 2020.
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 “revenue standard”) to all contracts
and elected the modified retrospective method.
Under
the 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.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
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 standalone selling price. When estimating the selling price, the
Company uses various observable inputs. The best observable input is the Company’s actual selling price for the same good
or service, however, this input is generally not available for the Company’s contracts containing multiple performance obligations.
For engineering services, the Company estimates the standalone selling price by reference to certain physical characteristics
of the project, such as facility size and mechanical systems involved, which are indicative of the scope and complexity of the
mechanical engineering services to be provided. For equipment sales, the standalone selling price is determined by forecasting
the expected costs of the equipment and then adding an appropriate margin, based on a range of acceptable margins established
by management. Depending on the nature of the performance obligations, the Company may use a combination of different methods
and observable inputs if certain performance obligations have highly variable or uncertain standalone selling prices. Once the
selling prices are determined, the Company applies the relative values to the total contract consideration and estimates the amount
of the transaction price to be recognized as each performance obligation is fulfilled.
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 has elected to exclude from the
measurement of the transaction price all taxes (e.g., sales, use, value added, and certain excise taxes) that are assessed by
a governmental authority in connection with a specific revenue-producing transaction and collected by the Company from the customer.
Accordingly, the Company 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.
The
Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Revenue
is recognized from this type of performance obligation as services are rendered based on the percentage completion towards certain
specified milestones.
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.
Applying
the practical expedient in ASC 606-10-32-18, which the Company has elected, the Company does not adjust the promised amount of
consideration for the effects of a significant financing component since the Company expects, at contract inception, that the
period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or
service will be one year or less. Accordingly, the remaining performance obligations related to customer contracts does not consider
the effects of the time value of money.
Applying
the practical expedient in ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense
when incurred since 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, which are included in selling, general and administrative expenses,
and are payable only when associated revenue has been collected and earned by the Company.
The
Company does not have material amounts of contract assets since revenue is recognized as control of goods is transferred or as
services are performed. Contract liabilities consist of advance payments and deferred revenue.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
For
the three months ended March 31, 2020, the Company recognized revenue of $859,705 related to the deferred revenue at January 1,
2020. For the three months ended March 31, 2019, the Company recognized revenue of $393,756 related to the deferred revenue at
January 1, 2019.
Remaining
performance obligations, or backlog, represents the aggregate amount of the transaction price allocated to the remaining obligations
that the Company has not performed under its customer contracts. The Company has elected not to use the optional exemption in
ASC 606-10-50-14, which exempts an entity from such disclosures if a performance obligation is part of a contract with an original
expected duration of one year or less. Accordingly, the information disclosed about remaining performance obligations includes
all customer contracts, including those with an expected duration of one year or less.
Industry
uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of the
Company’s control, make it difficult for the Company to predict when it will recognize revenue on its remaining performance
obligations. There are risks that the Company may not realize the full contract value on customer projects in a timely manner
or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to
secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the
equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when the Company is able to
recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the
indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure
and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number
of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need
to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate
and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price
tag and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays
that are typical in completing any construction project.
As
of March 31, 2020, the Company’s remaining performance obligations, or backlog, was $8,875,000, of which $6,292,000, or
71%, was attributable to customer contracts for which the Company has only received an initial advance payment to cover the allocated
value of the Company’s engineering services (“engineering only paid contracts”). There is the risk that the
equipment portion of these engineering only paid contracts will not be completed or will be delayed. These reasons include the
customer being dissatisfied with the quality or timeliness of the Company’s engineering services, delay or abandonment of
the project because of the customer’s inability to obtain project financing or licensing, or other reasons such as a challenging
business climate including an overall post-Covid-19 economic downturn, or change in business direction. After the customer has
made an advance payment for a portion of the equipment to be delivered under the contract (“partial equipment paid contracts”),
the Company is typically better able to estimate the timing of revenue recognition since the risks and delays associated with
licensing, permitting and project funding are typically mitigated once the initial equipment payment is received. There is significant
uncertainty regarding the timing of the Company’s recognition of revenue on its remaining performance obligations, and there
is no certainty that these will result in actual revenues. The backlog at March 31, 2020, includes booked sales orders of $975,000
from several customers that the Company does not expect to be realized until 2022, if at all. Given the present economic uncertainty
arising from the impact of the novel coronavirus COVID-19, the Company believes that several of its current contracts may be delayed
or canceled in the short term.
The
remaining performance obligations expected to be recognized through 2022 are as follows:
|
|
2020
|
|
|
2021
|
|
|
2022
|
|
|
Total
|
|
Remaining performance obligations related to engineering only paid contracts
|
|
$
|
3,694,000
|
|
|
$
|
2,151,000
|
|
|
$
|
447,000
|
|
|
$
|
6,292,000
|
|
Remaining performance obligations related to partial equipment paid contracts
|
|
|
1,841,000
|
|
|
|
214,000
|
|
|
|
528,000
|
|
|
|
2,583,000
|
|
Total remaining performance obligations
|
|
$
|
5,535,000
|
|
|
$
|
2,365,000
|
|
|
$
|
975,000
|
|
|
$
|
8,875,000
|
|
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
following table sets forth the Company’s revenue by source:
|
|
For the Three Months Ended March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Equipment and systems sales
|
|
$
|
1,606,946
|
|
|
$
|
1,492,530
|
|
Engineering and other services
|
|
|
131,591
|
|
|
|
222,409
|
|
Shipping and handling
|
|
|
71,388
|
|
|
|
56,291
|
|
Total revenue
|
|
$
|
1,809,925
|
|
|
$
|
1,771,230
|
|
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 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 three months ended
March 31, 2020, the valuation assumptions used to determine the fair value of each option award on the date of grant were: expected
stock price volatility ranged from 121.91% to 122.48%; expected term in years 5 and risk-free interest rate ranged from 1.38%
to 1.67%.
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.
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 expanded 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 the Company’s fiscal year beginning
January 1, 2019. While the Company grants stock options to nonemployees, the adoption of ASU 2018-07 has not had a material impact
on its consolidated results of operations, cash flows and financial position.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
The
following is a summary of share-based compensation expenses included in the condensed consolidated statements of operations for
the three months ended March 31, 2020 and 2019:
|
|
For the Three Months Ended March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Share-based compensation costs included in:
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
$
|
8,558
|
|
|
$
|
2,362
|
|
Advertising and marketing expenses
|
|
|
2,912
|
|
|
|
840
|
|
Product development costs
|
|
|
6,545
|
|
|
|
420
|
|
Selling, general and administrative expenses
|
|
|
172,874
|
|
|
|
352,109
|
|
Total share-based compensation expense included in consolidated statement of operations
|
|
$
|
190,889
|
|
|
$
|
355,731
|
|
Included
in the $190,889 expense for the three months ended March 31, 2020, is an accrual for $36,463 in respect of the 2020 Annual Employee
Incentive Compensation Plan.
Concentrations
Four
customers accounted for 17%, 16%, 10% and 10% of the Company’s revenue for the three March 31, 2020. For the three months
ended March 31, 2019, three customers accounted for 26%, 15% and 12% of the Company’s revenue.
Three
customers accounted for 59%, 18% and 15% of the Company’s accounts receivable for the three months ended March 31, 2020.
For the three months ended March 31, 2019, three customers accounted for 24%, 22% and 10% of the Company’s accounts receivable.
Recently
Issued Accounting Pronouncements
In
March 2020, the FAS issued ASU No. 2020-04 “Reference Reform (Topic 848) Facilitation of the Effects of Reference Rate
Reform on Financial Reporting” (“ASU 2020-04”). ASU 2020-04 provides optional guidance for a limited period
of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.
The amendments are effective for the Company as of March 12, 2020 through December 31, 2022. The Company does not expect this
ASU to have a material impact on its consolidated results of operations, cash flows and financial position.
In
January 2020, the FASB issued ASU No. 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method
and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic
323, and Topic 815 (a consensus of the Emerging Issues Task Force). This update clarifies whether an entity should consider
observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying
the measurement alternative and how to account for certain forward contracts and purchased options to purchase securities. For
public entities, this guidance is effective for fiscal years beginning after December 15, 2020. The Company does not expect this
ASU to have a material impact on its consolidated results of operations, cash flows and financial position.
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes, which
simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments
also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance.
ASU 2019-12 is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. The Company does not
expect this ASU to have a material impact on its consolidated results of operations, cash flows and financial position.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
In
August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to
the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements on fair value measurements
in Topic 820. The amendment will be effective for reporting periods beginning after December 15, 2019, and early adoption is permitted.
The adoption of this ASU has not had a material impact on the Company’s consolidated results of operations, cash flows and
financial position.
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments. ASU 2016-13 replaces the incurred loss impairment methodology with a methodology that reflects expected
credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.
For trade and other receivables, loans and other financial instruments, the Company will be required to use a forward-looking
expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable.
In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit
Losses, which clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20,
but, instead, the impairment of receivables arising from operating leases are accounted for in accordance with Topic 842, Leases.
In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit
Losses, to clarify, correct errors in, or improve the codification of Topic 326 and make the codification easier to understand
and easier to apply by eliminating inconsistencies and providing clarifications. ASU 2016-13 is effective for fiscal years beginning
after December 15, 2019. Entities may early adopt the amendments within this ASU but not prior to the fiscal years beginning after
December 15, 2018. The adoption of this ASU has not had a material impact on the Company’s 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
2 – Leases
In
February 2016 the FASB issued ASU 2016-02, Leases (Topic 842)(“ASC 842” or the “new lease standard”).
The Company adopted ASC 842 as of January 1, 2019, using the effective date method.
The
new standard provides a number of optional practical expedients in transition. The Company has elected to apply the “package
of practical expedients” which allow the Company to not reassess: (i) whether existing or expired arrangements contain a
lease, (ii) the lease classification of existing or expired leases, or (iii) whether previous initial direct costs would qualify
for capitalization under the new lease standard. The Company has also elected to apply the short-term lease exemption for all
leases with an original term of less than 12 months, for purposes of applying the recognition and measurements requirements in
the new lease standard.
Upon
adoption, the Company recognized its lease for manufacturing and office space (the “Facility Lease”) on the balance
sheet as an operating lease right-of-use asset in the amount of $714,416 and as a lease liability of $822,374. The Facility Lease
commenced September 29, 2017 and continues through August 31, 2022. The Company has the option to renew the Facility Lease for
an additional five years. However, the renewal option to extend the Facility Lease is not included in the right-of-use asset or
lease liability as the option is not reasonably certain of exercise. The Company regularly evaluates the renewal option and when
it is reasonably certain of exercise, the Company will include the renewal period in its lease term.
Beginning
September 1, 2018, and each subsequent September 1 during the term, the monthly rent under the Facility Lease will increase by
3%. Total rent under the current 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 operating lease liability on the Company’s condensed consolidated balance sheets.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Under
the Facility Lease, the landlord agreed to pay the Company or the Company’s contractors for tenant improvements made by
the Company not to exceed $100,000, which were used for normal tenant improvements. The Company determined that these improvements
were not specialized and could be utilized by a subsequent tenant and, as such, the improvements were considered assets of the
lessor. As of January 1, 2019, the unamortized amount of tenant improvement allowance of $81,481 was treated as a reduction in
measuring the right-of-use asset.
Under
the Facility Lease, the Company pays the actual amounts for property taxes and insurance, excludes such payments from lease contract
consideration, and records such payments as incurred. The Company also pays the landlord for common area maintenance, which is
considered a nonlease component. For the Facility Lease, the Company has not elected the accounting policy to include both the
lease and nonlease components as a single component and account for it as the lease.
In
determining the right-of-use asset and lease liability, the Company applied a discount rate to the minimum lease payments under
the Facility Lease. ASC 842 requires the Company to use the rate of interest that the Company would have to pay to borrow on a
collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Since the discount
rate is not implicit in the lease agreement, we utilized an estimated incremental borrowing rate provided by the Company’s
depository bank.
The
lease cost, cash flows and other information related to the Facility Lease were as follows:
|
|
For the Three Months Ended
March 31,
2020
|
|
|
|
|
|
Operating lease cost
|
|
$
|
54,222
|
|
Operating cash outflow from operating lease
|
|
$
|
60,406
|
|
|
|
As of March 31, 2020
|
|
Operating lease right-of-use assset
|
|
$
|
487,467
|
|
Operating lease liability, current
|
|
$
|
222,397
|
|
Operating lease liability, long-term
|
|
$
|
346,806
|
|
|
|
|
|
|
Remaining lease term
|
|
|
2.4 years
|
|
Discount rate
|
|
|
5.00
|
%
|
Future
annual minimum lease payments on the Facility Lease as of March 31, 2020 were as follows:
2020 (excluding the three months ended March 31, 2020)
|
|
$
|
183,633
|
|
2021
|
|
|
251,360
|
|
2022
|
|
|
170,891
|
|
Total minimum lease payments
|
|
|
605,884
|
|
Less imputed interest
|
|
|
(36,681
|
)
|
Present value of minimum lease payments
|
|
$
|
569,203
|
|
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
3 – Inventory
Inventory
consisted of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Finished goods
|
|
$
|
947,864
|
|
|
$
|
1,041,369
|
|
Work in progress
|
|
|
7,516
|
|
|
|
3,851
|
|
Raw materials
|
|
|
418,518
|
|
|
|
257,399
|
|
Allowance for excess & obsolete inventory
|
|
|
(59,719
|
)
|
|
|
(71,376
|
)
|
Inventory, net
|
|
$
|
1,314,179
|
|
|
$
|
1,231,243
|
|
Overhead
expenses of $19,570 and $31,831 were included in the inventory balance as of March 31, 2020, and December 31, 2019, respectively.
Advance payments on inventory
purchases are recorded in prepaid expenses until title for such inventory passes to the Company. Prepaid expenses included $86,000
and $164,000 in advance payments for inventory for the periods ended March 31, 2020, and December 31, 2019, respectively.
Note
4 – Property and Equipment
Property
and equipment consisted of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Furniture and equipment
|
|
$
|
400,096
|
|
|
$
|
389,090
|
|
Vehicles
|
|
|
15,000
|
|
|
|
15,000
|
|
Leasehold improvements
|
|
|
215,193
|
|
|
|
215,193
|
|
|
|
|
630,289
|
|
|
|
619,283
|
|
Accumulated depreciation
|
|
|
(391,950
|
)
|
|
|
(361,360
|
)
|
Property and equipment, net
|
|
$
|
238,339
|
|
|
$
|
257,923
|
|
Depreciation expense
was $30,591 and $31,311 for the three months ended March 31, 2020, and December 31, 2019, respectively. In both periods,
$1,402 was allocated to cost of sales and $350 was allocated to inventory with the remainder recorded as selling,
general and administrative expense.
Note
5 – Accounts Payable and Accrued Liabilities
Accounts
payable and accrued liabilities consisted of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Accounts payable
|
|
$
|
1,660,452
|
|
|
$
|
1,299,015
|
|
Sales commissions payable
|
|
|
19,490
|
|
|
|
69,532
|
|
Accrued payroll liabilities
|
|
|
171,258
|
|
|
|
169,052
|
|
Product warranty accrual
|
|
|
188,837
|
|
|
|
185,234
|
|
Other accrued expenses
|
|
|
93,217
|
|
|
|
110,127
|
|
Total
|
|
$
|
2,133,254
|
|
|
$
|
1,832,959
|
|
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
6 – Commitments and Contingencies
Litigation
As
of December 31, 2019, there were 6,750,000 restricted stock units that had not been settled due to a dispute with a former employee
over the required withholding taxes to be paid to the Company for remittance to the appropriate tax authorities. The Company commenced
an arbitration action against the former employee regarding the dispute. The former employee also made claims in the arbitration
action against the Company for unpaid wages. As stated in a pleading in the arbitration, on March 9, 2020, the Company issued
the former employee 6,750,000 shares of the Company’s common stock in settlement of these restricted stock units after taking
measures to mitigate the Company’s exposure to penalties and liability for the failure to properly withhold income taxes.
The Arbitrator has issued an interim award of approximately $10,000 in the Company’s favor and finding against the former
employee. The recipient continues to pursue separate litigation against the Company for recovery of alleged consulting fees owed
for the 2015 calendar year prior to the recipient’s appointment as an executive officer of the Company and discovery is
ongoing in this case. As further discussed in Note 9. Subsequent Events below, effective June 9, 2020, the Arbitrator issued
his final award in the Company’s favor. The Arbitrator found against the former employee and awarded the Company costs of
$33,985, with interest at 8% per year. The Company will now lodge the judgment with the State court so that it can collect upon
this debt.
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.
Leases
The
Company has a lease agreement for its manufacturing and office space. See Note 2.
Other
Commitments
In
the ordinary course of business, the Company enters into commitments to purchase inventory and may also 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
7 – Equity Incentive Plan
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”), the Board of Directors (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.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
During
the three months ended March 31, 2020, the Company issued shares of its common stock under the 2017 Equity Plan as follows:
|
●
|
1,000,000
shares to an employee in settlement of certain RSUs that vested December 31, 2019;
|
|
|
|
|
●
|
560,000
shares pursuant to a special incentive stock bonus approved by the Board for the period ended December 31, 2019; and
|
|
|
|
|
●
|
6,750,000
shares in settlement of restricted stock units to a former employee after taking measures to mitigate the Company’s
exposure to penalties and liability for the failure to properly withhold income taxes.as further discussed in Note 6 –
Commitments and Contingencies, Litigation above.
|
As
of March 31, 2020, awards related to 22,951,900 shares remain outstanding.
The
total unrecognized compensation expense for unvested non-qualified stock options and RSUs at March 31, 2020, was $89,571, which
will be recognized over approximately 9 months.
Non-Qualified
Stock Options
A
summary of the non-qualified stock options granted to employees and consultants under the 2017 Equity Plan during the three months
ended March 31, 2020, are presented in the table below:
|
|
Number of Options
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Term
|
|
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2019
|
|
|
10,135,000
|
|
|
$
|
0.096
|
|
|
|
7.7
|
|
|
$
|
-
|
|
Granted
|
|
|
6,616,900
|
|
|
$
|
0.070
|
|
|
|
10.0
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, March 31, 2020
|
|
|
16,751,900
|
|
|
$
|
0.086
|
|
|
|
8.4
|
|
|
$
|
-
|
|
Exercisable, March 31, 2020
|
|
|
13,751,900
|
|
|
$
|
0.087
|
|
|
|
8.2
|
|
|
$
|
-
|
|
Outstanding vested and expected to vest, March 31, 2020
|
|
|
16,751,900
|
|
|
$
|
0.086
|
|
|
|
8.4
|
|
|
$
|
-
|
|
A
summary of non-vested non-qualified stock options activity for employees and consultants under the 2017 Equity Plan for the three
months ended March 31, 2020, are presented in the table below:
|
|
|
Number of Options
|
|
|
Weighted Average Grant-Date Fair Value
|
|
|
Aggregate Intrinsic Value
|
|
|
Grant-Date Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2019
|
|
|
|
2,000,000
|
|
|
$
|
0.075
|
|
|
$
|
-
|
|
|
$
|
149,534
|
|
Granted
|
|
|
|
6,616,900
|
|
|
$
|
0.059
|
|
|
|
|
|
|
$
|
387,199
|
|
Vested
|
|
|
|
(5,616,900
|
)
|
|
$
|
0.058
|
|
|
|
|
|
|
$
|
328,472
|
|
Forfeited
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, March 31, 2020
|
|
|
|
3,000,000
|
|
|
$
|
0.069
|
|
|
$
|
-
|
|
|
$
|
208,262
|
|
For
the three months ended March 31, 2020 and 2019, the Company recorded $106,288 and $172,778 as compensation expense related to
vested options issued to employees and consultants, net of forfeitures, respectively.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
A
summary of the non-qualified stock options granted to directors under the 2017 Equity Plan during the three months ended March
31, 2020, 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, 2019
|
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
7.6
|
|
|
$
|
-
|
|
Granted
|
|
|
|
4,500,000
|
|
|
$
|
0.070
|
|
|
|
10.0
|
|
|
|
|
|
Exercised
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited/Cancelled
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, March 31, 2020
|
|
|
|
5,400,000
|
|
|
$
|
0.081
|
|
|
|
9.4
|
|
|
$
|
-
|
|
Exerciseable, March 31, 2020
|
|
|
|
5,400,000
|
|
|
$
|
0.081
|
|
|
|
9.4
|
|
|
$
|
-
|
|
A
summary of non-vested non-qualified stock options activity for directors under the 2017 Equity Plan for the three months ended
March 31, 2020, are presented in the table below:
|
|
|
Number of Options
|
|
|
Weighted Average Grant-Date Fair Value
|
|
|
Aggregate Intrinsic Value
|
|
|
Grant-Date Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2019
|
|
|
|
-
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
Granted
|
|
|
|
4,500,000
|
|
|
$
|
0.059
|
|
|
|
|
|
|
$
|
263,250
|
|
Vested
|
|
|
|
(4,500,000
|
)
|
|
$
|
0.059
|
|
|
|
|
|
|
$
|
263,250
|
|
Forfeited
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, March 31, 2020
|
|
|
|
-
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
During
the three months ended March 31, 2020 and 2019, the Company incurred $29,266 and $0, respectively, as compensation expense related
to 500,000 and 0 vested options, respectively, issued to directors.
As
further discussed in Note 9. Subsequent Events below, effective June 24, 2020, the Company issued 2 million non-qualified
stock options under the 2017 Equity Plan to newly appointed directors. The options will vest 50% upon grant and 50% on April 1,
2021, if the Director remains on the Board up to that time. The options have a term of 5 years and have an exercise price equal
to the closing price of the Company’s common stock on The OTC Markets on the day immediately preceding the grant date.
Restricted
Stock Units
A
summary of the RSUs awarded to employees, directors and consultants under the 2017 Equity Plan during the three months ended March
31, 2020, are presented in the table below:
|
|
Number of Units
|
|
|
Weighted Average Grant-Date Fair Value
|
|
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2019
|
|
|
7,550,000
|
|
|
$
|
0.128
|
|
|
$
|
528,500
|
|
Granted
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Vested and settled with share issuance
|
|
|
(6,750,000
|
)
|
|
$
|
0.121
|
|
|
|
|
|
Forfeited/canceled
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding, March 31, 2020
|
|
|
800,000
|
|
|
$
|
0.184
|
|
|
$
|
25,200
|
|
For
the three months ended March 31, 2020 and 2019, the Company recorded $18,872 and $92,755, respectively, as compensation expense
related to vested RSUs issued to employees, directors and consultants. The total intrinsic value of RSUs vested and settled with
share issuance was $70,000 for the three months ended March 31, 2020.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
As
further disclosed in Note 9 – Subsequent Events below, the remaining 800,000 RSUs vested effective April 30, 2020.
However, the holder of the RSUs elected not to exercise them and accordingly they have lapsed, unexercised.
Note
8 – Income Taxes
As
of March 31, 2020, the Company had U.S. federal and state net operating losses (“NOLs”) of approximately $17,293,000,
which will expire, if not utilized, in the years 2034 through 2037, however, NOLs generated subsequent to December 31, 2017 do
not expire but may only be used against taxable income to 80%. However, in response to the novel coronavirus COVID-19, the Coronavirus
Aid, Relief, and Economic Security Act temporarily repealed the 80% limitation for NOLs arising in 2018, 2019 and 2020. 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 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 March 31, 2020,
and December 31, 2019. 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 in the foreseeable future.
Note
9 – Subsequent Events
In
accordance with ASC 855, Subsequent Events, the Company has evaluated all subsequent events through June 24, 2020,
the date the financial statements were available to be issued. No material subsequent events occurred after March 31, 2020, other
than as set out below:
On
April 22, 2020, the Company entered into a loan with its current bank in the principal amount of $554,000, for working capital
purposes. Following the receipt of these loan funds, the Company reinstated all staff who previously had been placed on furlough.
Staff receiving salaries of $100,000 per year or less were restored to their full salaries. All executives, including the CEO,
had their compensation reduced to the greater of $100,000 per year or 75% of their previous salary level. The Company re-engaged
its staff so as to be able to fulfill its current customer contracts and any new sales orders and to continue its marketing and
selling efforts. The loan amount bears interest at 1% and was initially due on April 20, 2022. Subsequently, the term of the loan
may now potentially be extended to April 20, 2025. The loan may be repaid in advance without penalty. The loan is also potentially
forgivable in full provided proceeds are used for payment of payroll expenses, rent, utilities and mortgage interest and certain
other terms and conditions are met. The loan has typical default provisions, including for change of ownership, general lender
insecurity as to repayment, non-payment of amounts due, defaults on other debt instruments, insolvency, dissolution or termination
of the business as a going concern and bankruptcy.
Effective
April 30, 2020, 800,000 restrictive stock units became fully vested. However, the holder of the RSUs elected not exercise them
and accordingly these RSUs have lapsed, unexercised as further disclosed in Note 7 – Equity Incentive Plan – Restrictive
Stock Units above.
Revenue
recognition on contracts continues to be unpredictable and inconsistent quarter-over-quarter, however, current indications are
that many of the Company’s existing contracts will be subject to substantial delays, at least in the short term, due to
the economic disruption caused by the impact of the COVID-19 pandemic. The full extent of the disruption cannot be accurately
forecast at this time.
Surna
Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Effective
June 1, 2020, the Company received notification that an existing customer contract with an outstanding balance of work to be performed
of $1,984,051 had been terminated as the customer has permanently ceased operations due to lack of funding for the project. As
of March 31, 2020, there was an existing accounts receivable balance due to the Company of $81,008 in respect of engineering work
already performed under this contract. No provision had been made in respect of this balance of accounts receivable as of March
31, 2020, as there had been no indication at that time that there would be any difficulty in collecting these funds. Consequently,
the full balance of $81,008 has been written off as uncollectible effective June 1, 2020.
Effective
June 8, 2020, the Company furloughed several employees and implemented further 25% salary reductions for all remaining salaried
employees. All hourly employees were moved to part-time status.
Effective
June 9, 2020, the Arbitrator ruled in the action against a former employee regarding a dispute over the issuance of 6,750,000
restricted stock units and unpaid wages issued his final award in the Company’s favor. The Arbitrator found against the
former employee and awarded the Company costs of $33,985, with interest at 8% per year. The Company will now lodge the judgment
with the State court so that it can collect upon this debt.
Effective
June 24, 2020, the Company appointed two new independent directors, Randy Shipley and Nick Etten, and Mr. McDonald was appointed
Chairman of the Board. The Company issued 2 million non-qualified stock options under the 2017 Equity Plan to the newly appointed
directors. The options will vest 50% upon grant and 50% on April 1, 2021, if the Director remains on the Board up to that time.
The options have a term of 5 years and have an exercise price equal to the closing price of the Company’s common stock on
The OTC Markets on the day immediately preceding the grant date.