Notes
to Consolidated Financial Statements
Note
1 – Description of Business
Surna
Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. We design, engineer and sell environmental control
and other technologies for the Controlled Environment Agriculture (CEA) industry. The CEA industry is one of the fastest-growing
sectors of the United States’ economy. From leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens
harvested at the first true leaf stage), ethnic vegetables and small fruits (such as strawberries, blackberries and raspberries)
to bell peppers, cucumbers, tomatoes and cannabis and hemp, some producers grow crops indoors in response to market dynamics or
as part of their preferred farming practice. In service of the CEA industry, our principal technologies include: (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 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 CEA growers in the U.S. and Canada as well as other international locations. Customers are 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 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 or its related products.
Impact
of the COVID-19 Pandemic on Our Business
The
impact of the government and the business economic response to the COVID-19 pandemic has affected demand across the majority of
our markets and disrupted work on projects. The COVID-19 pandemic is expected to have continued adverse effects on our sales,
project implementation, operating margins, and working capital. As of the date of this filing, uncertainty continues to exist
concerning the magnitude and duration of the economic impact of the COVID-19 pandemic.
In
response to the COVID-19 pandemic and its changing conditions the Company reduced its operational expenses to conserve its cash
resources. Many expenses, including travel, marketing, headcount, work hours, and compensation were reduced, deferred, or eliminated
while still allowing us to meet our customer obligations and develop new business. As the fiscal year progressed and our sales
rebounded, and we were able to obtain additional funds through a forgivable bank loan, we restored our workforce and compensation.
Due
to the speed with which the COVID-19 pandemic developed and the resulting uncertainties, including the depth and duration of the
disruptions to customers and suppliers, its future effect on our business, on our results of operations, and on our financial
condition, cannot be predicted. We expect that the economic disruptions will continue to have an effect on our business over the
longer term. Despite this uncertainty, we continue to monitor costs and continue to take actions to reduce costs so as to mitigate
the impact of the COVID-19 pandemic to the best of our ability, although they may not be sufficient in the long-run for us to
avoid reduced sales, increased losses and reduced operating cash flows.
Refer
to Risk Factors, included in Part I, Item 1A of this Annual Report on Form 10-K above, for further discussion of the possible
impact of the COVID-19 pandemic on our business.
Note
2 – Basis of Presentation; Summary of Significant Accounting Policies
Financial
Statement Presentation
The
preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United
States of America (“GAAP”) requires management to make estimates and assumptions that affect reported amounts and
related disclosures.
As
further discussed in Note 3 Going Concern below, the accompanying consolidated financial statements have been prepared
on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has not generated sufficient revenue and has historically funded its operations through the sale of common
stock, the issuance of debt and the receipt of advance payments from customers. The Company is subject to risks, expenses and
uncertainties similar to those encountered by similarly situated companies.
Surna
Inc.
Notes
to Consolidated Financial Statements
Principles
of Consolidation
The
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
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 as it applies to impairment analysis, valuation of equity-based compensation, valuation of deferred tax assets and liabilities,
warranty accruals, inventory allowances, and legal contingencies.
Cash
and Cash Equivalents
All
highly liquid investments with original maturities of three months or less at the date of purchase are considered to be cash equivalents.
The Company may, from time to time, have deposits in financial institutions that exceed the federally insured amount. The Company
has not experienced any losses to date on depository accounts.
Accounts
Receivable and Allowance for Doubtful Accounts
Accounts
receivables are recorded at the invoiced amount or based on revenue earned for items not yet invoiced, and generally do not bear
interest. An allowance for doubtful accounts is established, as necessary, based on past experience and other factors, which,
in management’s judgment, deserve current recognition in estimating bad debts. Based on the Company’s review, it establishes
or adjusts the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2020, and
December 31, 2019, the allowance for doubtful accounts was $165,098 and $151,673, respectively. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may
be required.
Inventory
Inventory
is stated at the lower of cost or net realizable value. The inventory is valued based on a first-in, first-out (“FIFO”)
basis. Lower of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration
and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated
excess, obsolescence or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis
for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase
in that newly established cost basis. As of December 31, 2020, and December 31, 2019, the allowance for excess and obsolete
inventory was $93,045 and $71,376, respectively.
Property
and Equipment
Property
and equipment are stated at cost. For financial statement purposes, property and equipment are recorded at cost and depreciated
using the straight-line method over their estimated useful lives, which is generally five years. Leasehold improvements are amortized
on a straight-line basis over the lesser of their useful lives or the life of the lease. Upon sale or retirement of assets, the
cost and related accumulated depreciation and amortization are removed from the balance sheet and the resulting gain or loss is
reflected in operations. Maintenance and repairs are charged to operations as incurred.
Long-lived
Assets
Long-lived
tangible assets, including property and equipment, are reviewed for impairment whenever events or changes in business circumstances
indicate the carrying value of the assets may not be recoverable. When such an event occurs, management determines whether there
has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset’s carrying value.
If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash
flows or appraised value, depending on the nature of the asset. The Company has not identified any indicators of impairment during
the years ended December 31, 2020 and 2019.
Surna
Inc.
Notes
to Consolidated Financial Statements
Goodwill
and Intangible Assets
The
Company recorded goodwill in connection with its acquisition of Hydro in July 2014. Goodwill is reviewed for impairment annually
on December 31st 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 during the
fourth quarter 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. The Company completed this assessment as of December 31, 2020 and concluded that no impairment existed.
Separable
identifiable intangibles consist of intellectual property such as patents and trademarks, and capitalized website costs. Except
for trademarks, which are not amortized, the Company’s separable identifiable intangible assets are subject to amortization
on a straight-line basis over their estimated useful lives. Trademarks are tested annually for impairment. Separable identifiable
intangibles are also subject to evaluation for potential impairment if events or circumstances indicate the carrying value may
not be recoverable.
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.
A
financial asset 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.
Due
to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued
expenses, approximate fair value.
Derivative
Financial Instruments
The
Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify
as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument
is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported
in the statements of operations. For stock-based derivative financial instruments, the Company uses the Black-Scholes Option Pricing
Model (the “Black-Scholes Model”) to value the derivative instruments. The classification of derivative instruments,
including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period.
Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument could be required within twelve months of the balance sheet date. As of December 31, 2020,
and December 31, 2019, there were no derivative financial instruments.
Surna
Inc.
Notes
to Consolidated Financial Statements
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.
The
following table sets forth the Company’s revenue by source:
|
|
For
the Years Ended December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Equipment
and systems sales
|
|
$
|
7,730,371
|
|
|
$
|
13,692,863
|
|
Engineering
and other services
|
|
|
568,131
|
|
|
|
1,239,130
|
|
Shipping
and handling
|
|
|
215,770
|
|
|
|
292,461
|
|
Total
revenue
|
|
$
|
8,514,272
|
|
|
$
|
15,224,454
|
|
Revenue
Recognition Accounting Policy Summary
The
Company accounts for revenue in accordance with ASC 606. 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. 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 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 components 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 promise is fulfilled.
Generally,
satisfaction occurs when control of the promised goods is 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 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.
Surna
Inc.
Notes
to Consolidated Financial Statements
Other
Judgments and Assumptions
The
Company typically receives customer payments in advance of its performance of services or transfers of goods. 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.
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 December
31, 2020, and 2019, the Company had no contract assets.
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 consolidated balance sheets since the timing of when the Company expects to
recognize revenue is generally less than one year. As of December 31, 2020, and December 31, 2019, deferred revenue, which
was classified as a current liability, was $3,724,189 and $1,444,472, respectively.
For
the year ended December 31, 2020, the Company recognized revenue of $1,103,447 related to the deferred revenue at January 1, 2020,
or 76%. For the year ended December 31, 2019, the Company recognized revenue of $473,682 related to the deferred revenue at January
1, 2019, or 74%.
Remaining
Performance Obligations
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. Further, based on the current economic climate, the uncertainty regarding
the COVID-19 virus, and the Company’s recent cost cutting measures, there is no assurance that the Company will be able
to fulfill its backlog, and the Company may experience contract cancellations, project scope reductions and project delays.
Surna
Inc.
Notes
to Consolidated Financial Statements
As
of December 31, 2020, the Company’s remaining performance obligations, or backlog, was $8,448,000, of which $2,643,000,
or 31%, 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. The 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 December 31, 2020,
includes booked sales orders of $390,000 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.
The
remaining performance obligations expected to be recognized through 2022 are as follows:
|
|
2021
|
|
|
2022
|
|
|
Total
|
|
Remaining
performance obligations related to engineering only paid contracts
|
|
$
|
2,355,000
|
|
|
$
|
288,000
|
|
|
$
|
2,643,000
|
|
Remaining
performance obligations related to partial equipment paid contracts
|
|
|
5,703,000
|
|
|
|
102,000
|
|
|
$
|
5,805,000
|
|
Total
remaining performance obligations
|
|
$
|
8,058,000
|
|
|
$
|
390,000
|
|
|
$
|
8,448,000
|
|
Product
Warranty
The
Company warrants the products that it manufactures for a warranty period equal to the lesser of 12 months from start-up or 18
months from shipment. The Company’s warranty provides for the repair, rework, or replacement of products (at the Company’s
option) that fail to perform within stated specification. The Company’s third-party suppliers also warrant their products
under similar terms, which are passed through to the Company’s customers.
The
Company assesses the historical warranty claims on its manufactured products and, since 2016, warranty claims have been approximately
1% of annual revenue generated on these products. Based on the Company’s warranty policy, an accrual is established at 1%
of the trailing 18 months revenue. The Company continues to assess the need to record a warranty reserve at the time of sale based
on historical claims and other factors. As of December 31, 2020, and December 31, 2019, the Company had an accrued warranty
reserve amount of $173,365 and $185,234, respectively, which are included in accounts payable and accrued liabilities on the Company’s
consolidated balance sheets.
Cost
of Sales
Cost
of sales includes product costs (material, direct labor and overhead costs), shipping and handling expense, outside engineering
costs, engineering, project management and service salaries and benefits, client visits and warranty.
Concentrations
Three
customers accounted for 28%, 11% and 10% of the Company’s revenue for the year ended December 31, 2020. One customer accounted
for 44% of the Company’s revenue for the year ended December 31, 2019.
The
Company’s accounts receivable from two customers made up 48% and 38%, respectively, of the total balance as of December
31, 2020. The Company’s accounts receivable from three customers made up 59%, 16%, and 10%, respectively, of the total balance
as of December 31, 2019.
Three
suppliers accounted for 27%, 25% and 12% of the Company’s purchases of inventory for the year ended December 31, 2020, and
three suppliers accounted for 30%, 17% and 12% of the Company’s purchases of inventory for the year ended December 31, 2019.
Surna
Inc.
Notes
to Consolidated Financial Statements
Product
Development
The
Company expenses product development costs as incurred. Internal product development costs are expensed as incurred, and third-party
product developments costs are expensed when the contracted work has been performed or as milestone results have been achieved.
For the years ended December 31, 2020 and December 31, 2019, the Company incurred $390,229 and $521,044, respectively,
on product development.
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 consolidated financial statements
based on their grant date fair value. For awards subject to service conditions, compensation expense is recognized over the vesting
period on a straight-line basis. Awards subject to performance conditions are attributed separately for each vesting tranche of
the award and are recognized ratably from the service inception date to the vesting date for each tranche, based on the probability
of vesting. The probability of awards with future performance conditions is evaluated each reporting period and compensation expense
is adjusted based on the probability assessment.
Awards
are considered granted, and the service inception date begins, when mutual understanding of the key terms and conditions of the
award between the Company and the recipient has been established. For awards that provide discretion to adjust the amount of the
award, the service inception date for such awards could precede the grant date as a mutual understanding of the key terms and
conditions of the award between the Company and the recipient has not yet been established. For awards in which the service inception
date precedes the grant date, compensation cost is accrued beginning on the service inception date.
Subsequent
to December 31, 2020, the Company’s Board of Directors (the “Board”) approved annual incentive compensation
awards to certain employees payable in non-qualified stock options, based on the Company’s performance and each employee’s
contributions to such performance for the 2020 year. See Note 16. The non-qualified stock options were granted subsequent to December
31, 2020, were not subject to an additional service requirement and were immediately vested at the date of the grant. The final
amount of the annual incentive compensation award, and number of non-qualified stock options granted, were determined, and communicated
to the employee, subsequent to December 31, 2020. The estimated compensation expense of $128,434 related to the 2020 incentive
awards was accrued as of December 31, 2020. Since such incentive awards will be settled in non-qualified stock options, the accrued
compensation expense has been classified as a current liability until the number of non-qualified stock options is fixed pursuant
to a grant by the Board. At that time, the incentive award becomes equity-classified.
The
grant date fair value of stock options is based on 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
compensation costs (including expenses from the accrued compensation liabilities related to the annual incentive awards subsequently
settled in non-qualified stock options totaled $405,617 and $1,292,065 for the years ended December 31, 2020 and 2019, respectively.
Such share-based compensation costs are classified in the Company’s consolidated financial statements in the same manner
as if such compensation was paid in cash.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
following is a summary of such share-based compensation costs included in the Company’s consolidated statements of operations
for the years ended December 31, 2020 and 2019:
|
|
For
the Years Ended December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Share-based
compensation expense included in:
|
|
|
|
|
|
|
|
|
Cost
of revenue
|
|
$
|
31,006
|
|
|
$
|
91,081
|
|
Advertising
and marketing expenses
|
|
|
8,333
|
|
|
|
33,977
|
|
Product
development costs
|
|
|
21,882
|
|
|
|
45,330
|
|
Selling,
general and administrative expenses
|
|
|
344,396
|
|
|
|
1,121,677
|
|
Total
share-based compensation expense included in consolidated statement of operations
|
|
$
|
405,617
|
|
|
$
|
1,292,065
|
|
Income
Taxes
The
Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets
and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under
this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial
statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are
expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the
period that includes the enactment date.
The
Company recognizes deferred tax assets to the extent that the Company believes that these assets are more likely than not to be
realized. In making such a determination, the Company considers all available positive and negative evidence, including future
reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of
recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess
of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would
reduce the provision for income taxes.
The
Company records uncertain tax positions on the basis of a two-step process in which: (i) the Company determines whether it is
more likely than not that the tax positions will be sustained on the basis of the technical merits of the position, and (ii) for
those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax
benefit that is more likely than not to be realized upon ultimate settlement with the related tax authority.
Basic
and Diluted Net 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 periods when losses are reported 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. As of December 31, 2020, 29,213,500 potential common shares equivalents from warrants and options
were excluded from the diluted EPS calculations as their effect is 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.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
Company is subject to risks common to similarly-situated companies including, but not limited to, general economic conditions,
its customers’ operations and access to capital, and market and business disruptions including severe weather conditions,
natural disasters, health hazards, terrorist activities, financial crises, political crises or other major events, or the prospect
of these events, 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 have legalized medical and/or recreational cannabis, U.S. federal laws continue to
prohibit marijuana 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. See Note 3.
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.
Recently
Issued Accounting Pronouncements
In
August 2020, the FASB issued ASU 2020-06: “Accounting for Convertible Instruments and Contracts In An Entity’s
Own Equity” (“ASU 2020-06”) ASU 2020-04 simplifies the accounting for certain convertible instruments by
removing the separation models for convertible debt with a cash conversion feature and for convertible instruments with a beneficial
conversion feature. As a result, more convertible debt instruments will be reported as a single liability instrument with no separate
accounting for embedded conversion features. Additionally, ASU 2020-04 amends the diluted earnings per share calculation for convertible
instruments by requiring the use of the if-converted method. The treasury stock method is no longer available. Entities may adopt
the ASU 2020-04 using either a full or modified retrospective approach, and it is effective for interim and annual reporting periods
beginning after December 15, 2021. Early adoption is permitted for interim and annual reporting periods 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.
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 – Going Concern
The
accompanying 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 $1,759,000 for
the year ended December 31, 2020 and had an accumulated deficit of approximately $27,444,000 and a shareholders’ deficit
of approximately $1,334,000 as of December 31, 2020. Since inception, the Company has financed its activities principally through
debt and equity financing, advance payments from customers and revenues from completed contracts. 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 and situated companies, including general economic
conditions, its customers’ operations and prospects for and ability to obtain project financing, and market and business
disruptions, that include the outbreak of COVID-19, 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, 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 Consolidated Financial Statements
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. The Company’s ability to raise equity capital is also limited by the Company’s stock
price, and any such issuance could be highly dilutive to existing shareholders.
The
Company’s 2020 revenue of approximately $8,514,000 which represents a decrease of 44% over the prior year. The Company’s
revenue recognition on contracts continues to be unpredictable and inconsistent quarter-over-quarter, and the Company has incurred,
and expects to incur, additional operating expenses to support such growth. The Company generated approximately $818,000 in cash
flow from operating activities in 2020. However, as a result of the Company’s growth and its efforts to expand and upgrade
its products, the Company’s working capital deficit as of December 31, 2020 was approximately $2,220,000, compared to approximately
$1,437,000 as of December 31, 2019.
The
Company also will be affected by constraints on the availability of capital to its customers and prospects who have commenced,
or are contemplating, new or expanded cultivation facilities and the overall impact of the COVID-19 pandemic. The extent to which
COVID-19 will impact the Company’s business and financial results will depend on future developments, which are uncertain
and cannot be predicted. See Note 16. The duration and likelihood of operational success going forward resulting from the fiscal
year 2020 measures of adjusting the workforce reductions and cost-cutting measures are uncertain. If these actions do not meet
management’s expectations, or additional capital is not available, there is substantial doubt about the Company’s
ability to continue as a going concern for a period of one year from the issuance of these financial statements. Other factors
that will impact the Company’s ability to continue operations include the market demand for the Company’s products
and services, the ability to service its customers and prospects, potential contract cancellations, project scope reductions and
project delays, the Company’s ability to fulfill its backlog, the management of working capital, and the 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 twelve months. If the Company is unable to increase
revenues, or otherwise generate cash flows from operations, there is 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 consolidated financial statements
do not include any adjustment that might result from the outcome of this uncertainty.
Note
4 – 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. Consequently, financial information will not
be updated, and the disclosures required under the new lease standard will not be provided, for dates and periods prior to January
1, 2019.
The
new lease 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.
On
June 27, 2017, the Company entered into a lease for its manufacturing and office space (the “Facility Lease”), which
commenced September 29, 2017 and continues through August 31, 2022. The Company occupied its 12,700 square foot space for $12,967
per month until January 1, 2018. On January 2, 2018, the leased space was expanded to 18,600 square feet, and the monthly rental
rate increased to $18,979 until August 31, 2018. Beginning September 1, 2018 and 2019, the monthly rent increased to $19,549 and
$20,135, respectively. On each September 1 through the end of the lease, the monthly rent will increase by 3%. Pursuant to the
current lease, the Company made a security deposit of $51,000 on July 31, 2017. The deposit of $1,600 paid to the previous owner
of the property was forwarded to the current landlord. The Company has the option to renew the Facility Lease for an additional
five years.
During
2020, the Company entered into an agreement with its landlord to apply its rent deposit of $52,600 to rent payments due during
the period. The deposit required on the lease will be reduced to approximately $32,000 and will be payable in 12 monthly installments
from January through December of 2021. Further, the landlord also agreed to defer payment of fifty percent of the three months
of lease payments (base rent only) for the period July to September 2020. The deferred lease payments amount to approximately
$30,000 and will be payable in 12 monthly installments from January to December 2021.
Total
rent under the Facility 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. As of January 1, 2019, the remaining
deferred rent of $26,477 was reclassified to the operating lease liability under the new lease standard.
Surna
Inc.
Notes
to Consolidated Financial Statements
Upon
adoption of the new lease standard, 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 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.
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 non-lease component. For the Facility Lease, the Company has elected to exclude non-lease components from lease contract
consideration.
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 Year Ended
|
|
|
|
December
31, 2020
|
|
Operating
lease cost
|
|
$
|
216,889
|
|
Operating
cash outflow from operating lease
|
|
$
|
160,934
|
|
|
|
|
As
of
December
31, 2020
|
|
Operating
lease right-of-use assset
|
|
$
|
343,950
|
|
Operating
lease liability, current
|
|
$
|
266,105
|
|
Operating
lease liability, long-term
|
|
$
|
169,119
|
|
|
|
|
|
|
Remaining
lease term
|
|
|
1.7
years
|
|
Discount
rate
|
|
|
5.00
|
%
|
Future
annual minimum lease payments on the Facility Lease as of December 31, 2020 were as follows:
Years
ended December 31,
|
|
|
|
2021
|
|
|
281,864
|
|
2022
|
|
|
170,891
|
|
Total
minimum lease payments
|
|
|
452,755
|
|
Less
imputed interest
|
|
|
(17,531
|
)
|
Present
value of minimum lease payments
|
|
$
|
435,224
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
Note
5 – Inventory
Inventory
consisted of the following:
|
|
As
of December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Finished
goods
|
|
$
|
201,778
|
|
|
$
|
1,041,369
|
|
Work
in progress
|
|
|
4,231
|
|
|
|
3,851
|
|
Raw
materials
|
|
|
214,145
|
|
|
|
257,399
|
|
Allowance
for excess & obsolete inventory
|
|
|
(93,045
|
)
|
|
|
(71,376
|
)
|
Inventory,
net
|
|
$
|
327,109
|
|
|
$
|
1,231,243
|
|
Overhead
expenses of $17,974 and $31,831 were included in the inventory balance as of December 31, 2020 and 2019, respectively.
Note
6 – Property and Equipment
Property
and equipment consisted of the following:
|
|
As
of December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Furniture
and equipment
|
|
$
|
398,422
|
|
|
$
|
389,090
|
|
Vehicles
|
|
|
15,000
|
|
|
|
15,000
|
|
Leasehold
improvements
|
|
|
215,193
|
|
|
|
215,193
|
|
|
|
|
628,615
|
|
|
|
619,283
|
|
Accumulated
depreciation
|
|
|
(480,883
|
)
|
|
|
(361,360
|
)
|
Property
and equipment, net
|
|
$
|
147,732
|
|
|
$
|
257,923
|
|
Depreciation
expense amounted to $119,524 for the year ended December 31, 2020, of which $6,394 was allocated to cost of revenue. Depreciation
expense amounted to $157,860 for the year ended December 31, 2019, of which $7,010 was allocated to cost of revenue.
As
of December 31, 2018, the Company’s property and equipment, net included the gross cost of the equipment leased to a cultivation
company affiliated with one of the Co-founders of $176,042, and accumulated depreciation of $39,120. During the year ended December
31, 2019, the Company wrote-off the carrying value of the leased equipment. See Note 10.
Note
7 – Intangible Assets
Intangible
assets consisted of the following:
|
|
As
of December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Patents
|
|
$
|
8,110
|
|
|
$
|
12,234
|
|
Website
development costs
|
|
|
22,713
|
|
|
|
22,713
|
|
Trademarks
|
|
|
1,830
|
|
|
|
1,830
|
|
|
|
|
32,653
|
|
|
|
36,777
|
|
Accumulated
amortization
|
|
|
(25,426
|
)
|
|
|
(24,847
|
)
|
Intangible
assets, net
|
|
$
|
7,227
|
|
|
$
|
11,930
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
Patents
when issued are amortized over 14 years, and web site development costs are amortized over five years. Trademarks are not amortized
since they have an indefinite life. Amortization expense for intangibles amounted to $579 and $3,320 for the years ended December
31, 2020 and 2019, respectively. During the years ended December 31, 2020 and 2019, the Company wrote-off $4,124 and $7,778, respectively,
related to patents that had been abandoned.
Note
8 – Accounts Payable and Accrued Liabilities
Accounts
payable and accrued liabilities consisted of the following:
|
|
As
of December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Accounts
payable
|
|
$
|
918,639
|
|
|
$
|
1,299,015
|
|
Sales
commissions payable
|
|
|
48,263
|
|
|
|
69,532
|
|
Accrued
payroll liabilities
|
|
|
288,071
|
|
|
|
169,052
|
|
Product
warranty accrual
|
|
|
173,365
|
|
|
|
185,234
|
|
Other
accrued expenses
|
|
|
356,623
|
|
|
|
110,127
|
|
Total
|
|
$
|
1,784,961
|
|
|
$
|
1,832,959
|
|
Accounts
payable and other accrued expenses includes $402,651 relating to a one-time warranty issue experienced on three customers’
projects. The expenses related to parts and labor to repair units that had been delivered to these customers prior to year-end.
Since the issue is limited to these three projects and is not anticipated to reoccur in the future, we have made no adjustment
to the ongoing 1% warranty reserve that we accrue on all sales.
Note
9 – Note Payable and Accrued Interest
On
April 22, 2020, the Company entered into a note payable with its current bank in the principal amount of $554,000, for working
capital purposes.
The
loan amount was subject to interest at 1% and was initially due on April 20, 2022. Subsequently, the term of the loan was potentially
to be extended to April 20, 2025. The loan could be repaid in advance without penalty. The loan was also potentially forgivable
in full provided proceeds were used for payment of payroll expenses, rent, utilities and mortgage interest and certain other terms
and conditions were met. The loan had 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.
During
the year ended December 31, 2020, interest of $3,203 was accrued in respect of this note payable.
On
December 11, 2020, the Company received notice from the bank that its loan received on April 22, 2020, in the principal amount
of $554,000 and all accrued interest of $3,203, was fully forgiven. This gain on loan forgiveness was recorded as Other Income in the Statement of Operations during the year.
As
further discussed in Note 16 Subsequent Events below, on February 10, 2021, we received funding based on a loan agreement
entered into on February 5, 2021 with its current bank in the principal amount of $514,200 for working capital purposes. Consistent
with the loan provisions, the Company will use the proceeds to meet payroll and benefit expenses as well as for rent and utilities.
The loan amount bears interest at 1% and is due on February 5, 2026. The loan may be repaid in advance without penalty. 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.
Note
10 – Related Party Agreements and Transactions
Agreements
and Transaction with Company’s Co-Founders
The
following describes certain agreements and transactions between the Company and its co-founders (the “Co-founders”).
The Co-founders held various executive officer and director positions with the Company until May 2018. One of the Co-founders
also was a consultant to the Company until May 2018. The Co-founders are also shareholders of the Company. Based on information
available to the Company, the Co-founders did not own more than 10% of the Company’s outstanding common stock at any time
during 2019 or 2020.
Surna
Inc.
Notes
to Consolidated Financial Statements
Equipment,
Demonstration and Product Testing Agreement
In
May 2017, the Company entered into a three-year equipment, demonstration and product testing agreement with a licensed cannabis
cultivation company affiliated with one of the Co-founders. Under this agreement, the Company agreed to lease the cultivation
company certain cultivation equipment in exchange for a quarterly fee of $16,500, which was increased to $18,330 to reflect additional
leased equipment requested by the cultivation company (the “Lease Fee”). In consideration for access to the cultivation
facility to conduct demonstration tours and for the product testing and data to be provided by the cultivation company, the Company
agreed to pay the cultivation company a quarterly fee of $12,000 (the “Demo and Testing Fee”).
The
Company and the cultivation company each made their respective payments under this agreement through June 30, 2018. Thereafter,
the cultivation company failed to make any subsequent payments of the Lease Fee and, as a result, the Company did not pay the
Demo and Testing Fee. During the second quarter of 2019, the Company notified the cultivation company of its breach for non-payment
of the Lease Fee. In February 2020, the parties mutually agreed to terminate this agreement and release each other from all claims
related to this agreement, including any unpaid Lease Fees or Demo and Testing Fees. The Company also agreed to transfer the equipment
to the cultivation company for no additional consideration.
During
the year ended December 31, 2018, the Company recorded Demo and Testing Fees of $32,000 as operating expenses in the consolidated
statements of operations. During the year ended December 31, 2018, the Company also recorded Lease Fees of $48,880 as “Other
income, net” in the consolidated statements of operations. As of December 31, 2018, unpaid Lease Fees of $36,660 were included
in accounts receivable and unpaid Demo and Testing Fees of $24,000 were included in accounts payable.
During
the third quarter of 2019, the Company determined that it was unlikely that any further payment of Lease Fees would be paid by
the cultivation company, and the Company: (i) wrote off the balance of the accounts receivable related to unpaid Lease Fees, with
a corresponding charge to “Other income, net” in the consolidated statements of operations, (ii) reversed the accounts
payable related to the unpaid Demo and Testing Fees, with a corresponding credit to operating expenses, and (iii) wrote-off the
remaining carrying value of the leased equipment of $107,581, which was included in property and equipment on the Company’s
consolidated balance sheet. For the year ended December 31, 2019, the net impact of the foregoing items on the consolidated statements
of operations was a charge of $120,241.
Employment
Agreement
In
May 2018, the Company and one of the Co-founders entered into an employment agreement which provided for an initial base salary
of $150,000 per year and certain sales incentive. Pursuant to the employment agreement, the Company awarded 4,800,000 restricted
stock units (“RSUs”) to the Co-founder that vested at certain dates in the future, subject to the co-founder’s
continued employment. As of December 31, 2019: (i) the Company has issued 2,000,000 shares of common stock in settlement of vested
RSUs, (ii) 1,000,000 shares of common stock in settlement of RSUs that vested December 31, 2019 were issued subsequent to December
31, 2019, (iii) the parties mutually agreed to cancel 1,000,000 RSUs, and (iii) 800,000 RSUs vested on April 30, 2020, however,
the holder elected to cancel the RSUs.
Consulting
Agreement
As
further discussed in Note 16 Subsequent Events below, on January 7, 2021, the Company entered into a consulting agreement
with RSX Enterprises, Inc. (RSX), a company controlled by Mr. James R. Shipley, a director of the Company. RSX will provide consulting
services to the Company focused on product offerings, engineering requirements, key customer marketing outreach, and related matters,
as mutually determined by the Company and RSX. The Company will pay a monthly consulting fee of $6,500 for up to 50 hours per
month for the various consulting activities undertaken and provide for reimbursement of expenses. The term of the agreement is
set for three months. Any intellectual property developed by RSX will belong to the Company, and the contract provides for typical
indemnification obligations and confidentiality provisions.
Surna
Inc.
Notes
to Consolidated Financial Statements
Note
11 – 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 issued an interim award of approximately $10,000 in the Company’s favor and a finding against the former
employee. Effective June 9, 2020, the Arbitrator issued his final award in the Company’s favor in the Colorado arbitration.
The Arbitrator found against the former employee and awarded the Company costs of $33,985, with interest at 8% per year. Effective
July 22, 2020, the Colorado Court confirmed the Arbitration award and entered a final judgement in favor of the Company and against
the former employee. The Company pursued collection of this debt and has now collected the debt owed. This former employee is
continuing to pursue separate litigation against the Company for recovery of alleged consulting fees owed to him for the 2015
calendar year prior to his appointment as an executive officer of the Company. The Company strongly disputes the ongoing
litigation and in the remote event of an adverse outcome, the amount of any settlement loss for this case is not reasonably estimable
as of the date of the issuance of these financial statements.
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.
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
12 – Preferred and Common Stock
Preferred
Stock
As
of December 31, 2020, and 2019, there were 42,030,331 shares of Series A preferred stock, par value $0.00001 per share, issued
and outstanding. The holders of Series A preferred stock have one vote per share of Series A preferred stock equivalent to one
vote of the Company’s common stock. The Series A preferred stock ranks senior to the Company’s common stock. The holders
of shares of Series A preferred stock are not entitled to receive dividends and have no conversion or preemptive rights. Upon
liquidation, dissolution or winding up of the Company’s business, after payment to the holders of any senior securities,
the holders of Series A preferred stock are entitled to receive a preferential cash payment per share of Series A preferred stock
equal to the stated value of the preferred stock, prior to any payment to the holders of common stock.
Common
Stock
During
the year ended December 31, 2020, the Company did not issue any shares of its common stock in a private, non-registered transaction.
During
the year ended December 31, 2019, the Company did not issue any shares of its common stock in a private, non-registered transaction.
Surna
Inc.
Notes
to Consolidated Financial Statements
During
the year ended December 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 11
– Commitments and Contingencies, Litigation above.
|
During
the year ended December 31, 2019, the Company issued shares of its common stock under the Company’s 2017 Equity Plan as
follows:
|
●
|
197,370
shares of common stock were issued to independent directors in lieu of cash director fees;
|
|
|
|
|
●
|
789,474
shares of common stock were issued to independent directors as the 2019 equity retainer fee;
|
|
|
|
|
●
|
1,120,000
shares of common stock were issued to certain employees in settlement of vested restricted stock units; and
|
|
|
|
|
●
|
1,120,000
shares of common stock were issued to certain employees as a stock incentive bonus.
|
Note
13 – Outstanding Warrants
The
following table summarizes information with respect to outstanding warrants to purchase common stock during the years ended December
31, 2020 and 2019:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
Number
|
|
|
Exercise
|
|
|
Remaining
Life
|
|
|
Intrincic
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
In
Months
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2018
|
|
|
40,010,250
|
|
|
$
|
0.25
|
|
|
|
21
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(901,250
|
)
|
|
$
|
(0.66
|
)
|
|
|
-
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2019
|
|
|
39,109,000
|
|
|
$
|
0.24
|
|
|
|
9
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(31,546,500
|
)
|
|
$
|
(0.23
|
)
|
|
|
-
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2020
|
|
|
7,562,500
|
|
|
$
|
0.25
|
|
|
|
6
|
|
|
$
|
0
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
The
following table summarizes information about warrants outstanding at December 31, 2020.
|
|
|
|
|
|
Weighted
Average Life of
|
|
|
|
|
Warrants
|
|
|
Outstanding
Warrants
|
|
Exercise
price
|
|
|
Outstanding
|
|
|
In
Months
|
|
|
|
|
|
|
|
|
|
|
0.25
|
|
|
|
7,562,500
|
|
|
|
6
|
|
Series
2 Warrants
In
October 2014, the Company offered up to 60 investment units at a price per unit of $50,000. Each unit consisted of (i) 250,000
shares of the Company’s common stock, (ii) a $50,000 10% convertible promissory note (“Series 2 Convertible Note”),
and (iii) warrants for the purchase of 50,000 shares of the Company’s common stock (“Series 2 Warrants”). As
of December 31, 2018, Series 2 Warrants to purchase 901,250 shares of common stock were outstanding, all of which expired unexercised
during the year ended December 31, 2019.
Warrants
Issued to Investment Bank
Pursuant
to a certain agreement for services rendered in connection with the conversion of the Series 2 Convertible Notes, during the year
ended December 31, 2017, the Company issued to an investment bank or its designees a warrant (“Banker Warrant”) to
purchase, at an exercise price $0.35 per share, 500,000 shares of the Company’s common stock. The Banker Warrants were fully
vested on the date of issuance, were exercisable beginning December 20, 2017 and expired unexercised on June 20, 2020.
Q1
2017 Warrants
In
March 2017, the Company issued 16,781,250 investment units, for aggregate gross proceeds of $2,685,000, or $0.16 per unit. 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 (“Q1 2017 Warrants”); however, one investor declined receipt of the warrant to purchase 468,750 shares
of the Company’s common stock. Pursuant to the Q1 2017 Warrants, the holder thereof may at any time on or after six months
after the issuance date and on or prior to the close of business on the date that is the third anniversary of the issuance date,
purchase up to the number of shares of the Company’s common stock as set forth in the respective warrant. The exercise price
per share of the common stock under the Q1 2017 Warrants is $0.26, subject to customary adjustments as provided in the warrant.
Each Q1 2017 Warrant was callable at the Company’s option commencing six months from the issuance date, provided the closing
price of the Company’s common stock was $0.42 or greater for five consecutive trading days. Commencing at any time after
the date on which such call condition was satisfied, the Company had the right, upon 30 days’ notice to the holder, to redeem
the warrant shares at a price of $0.01 per warrant share. The holder could have exercised the warrant at any time (in whole or
in part) prior to the redemption date at the exercise price. These warrants expired unexercised in March 2020.
Q4
2017 Warrants
In
December 2017, the Company issued 14,734,000 investment units for aggregate proceeds of $1,768,080, or $0.12 per unit. 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 (“Q4 2017 Warrants”). The Q4 2017 Warrants had an exercise price of $0.20 per share, subject to customary
adjustments as provided in the warrant, and had a term of three years. The Q4 2017 Warrants were callable at the Company’s
option, provided the closing price of the Company’s common stock was $0.36 or greater for five consecutive trading days.
Commencing at any time after the date on which the call condition is satisfied, the Company had 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 could
not occur earlier than sixty-one (61) days following the date of the receipt of notice by the holder. The holder could exercise
the warrant at any time (in whole or in part) prior to the redemption date at the exercise price. These warrants expired unexercised
in December 2020.
Q2
2018 Warrants
In
June 2018, the Company completed a private placement offering of investment units, with each unit consisting of one share of the
Company’s common stock and one Q2 2018 Warrant. The Q2 2018 Warrants have an exercise price of $0.25 per share of the common
stock underlying each warrant, subject to customary adjustments as provided in the warrant. The Q2 2018 Warrants are exercisable
commencing July 1, 2018 until June 30, 2021. The Q2 2018 Warrants are callable at the Company’s option, beginning on July
1, 2019 until the expiration thereof on June 30, 2021, 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. 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 holder may exercise the warrant (in whole or in part)
prior to the redemption date at the exercise price. As of December 31, 2020, Q2 2018 Warrants to purchase 7,562,500 shares of
common stock were outstanding.
Surna
Inc.
Notes
to Consolidated Financial Statements
Note
14 – Equity Incentive Plan
On
August 1, 2017, the Board adopted and approved the Company’s 2017 Equity Incentive Plan (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. As of December 31, 2020, 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.
The
total unrecognized compensation expense for unvested non-qualified stock options at December 31, 2020 was $6,412, which will be
recognized over approximately 3 months.
Restricted
Stock Awards
As
of December 31, 2018, the Company had accrued fees owed to the Company’s independent directors totaling $15,000, which were
payable in equity. During the year ended December 31, 2019, the Company issued 197,370 shares of restricted stock, which were
fully vested at the time of the award, in settlement of these accrued fees.
During
the year ended December 31, 2019, the Company also awarded 789,474 shares of restricted stock under the 2017 Equity Plan to the
Company’s independent directors and consultants as an equity retainer fee for 2019. These restricted shares were fully vested
at the time of the award and the aggregate value attributable to these shares was $60,000, as calculated using the fair value
of the Company’s common stock on date the Board approved these awards.
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. The valuation assumptions used
to determine the fair value of each option award on the date of grant were: expected stock price volatility 114.97% - 122.48%;
expected term in 5 years and risk-free interest rate 0.2% - 2.37%.
Surna
Inc.
Notes
to Consolidated Financial Statements
Employee
and Consultant Options
A
summary of the non-qualified stock options granted to employees and consultants under the 2017 Equity Plan during the years ended
December 31, 2020 and 2019 are presented in the table below:
|
|
Number
of Options
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Term
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2018
|
|
|
10,560,000
|
|
|
$
|
0.104
|
|
|
|
8.4
|
|
|
$
|
-
|
|
Granted
|
|
|
2,000,000
|
|
|
$
|
0.080
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(2,408,333
|
)
|
|
$
|
0.116
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(16,667
|
)
|
|
$
|
0.105
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2019
|
|
|
10,135,000
|
|
|
$
|
0.096
|
|
|
|
7.7
|
|
|
$
|
-
|
|
Granted
|
|
|
6,616,900
|
|
|
$
|
0.070
|
|
|
|
10.0
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(2,500,900
|
)
|
|
$
|
0.101
|
|
|
|
4.3
|
|
|
|
|
|
Outstanding,
December 31, 2020
|
|
|
14,251,000
|
|
|
$
|
0.083
|
|
|
|
8.3
|
|
|
$
|
-
|
|
Exercisable,
December 31, 2020
|
|
|
14,251,000
|
|
|
$
|
0.083
|
|
|
|
8.3
|
|
|
$
|
-
|
|
A
summary of non-vested non-qualified stock options activity for employees and consultants under the 2017 Equity Plan for the years
ended December 31, 2020 and 2019 are presented in the table below: