Quarterly Report (10-q)

Date : 08/14/2018 @ 12:04PM
Source : Edgar (US Regulatory)
Stock : Surna Inc. (QB) (SRNA)
Quote : 0.026775  0.000575 (2.19%) @ 8:59PM

Quarterly Report (10-q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 000-54286

 

SURNA INC.

(Exact name of registrant as specified in its charter)

 

Nevada   27-3911608

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1780 55 th St., Suite C, Boulder, Colorado   80301
(Address of principal executive offices)   (Zip code)

 

(303) 993-5271

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days. YES [X] NO [  ]

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES [X] NO [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer, “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer [  ] Accelerated Filer [  ]
Non-accelerated Filer [  ] Smaller Reporting Company [X]
  Emerging Growth Company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]

 

As of August 13, 2018, the number of outstanding shares of common stock of the registrant was 222,471,602.

 

 

 

 

 

 

Surna Inc.

Quarterly Report on Form 10-Q

For The Three Months Ended June 30, 2018

 

Table of Contents

 

    Page
Cautionary Statement   ii
     
PART I — FINANCIAL INFORMATION  
     
Item 1. Financial Statements (Unaudited)  
     
Condensed Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017   F-1
     
Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017   F-2
     
Condensed Consolidated Statement of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2018   F-3
     
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017   F-4
     
Notes to the Condensed Consolidated Financial Statements   F-5
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   1
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   10
     
Item 4. Controls and Procedures   10
     
PART II — OTHER INFORMATION  
     
Item 1. Legal Proceedings   11
     
Item 1A. Risk Factors   11
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   11
     
Item 3. Defaults Upon Senior Securities   11
     
Item 4. Mine Safety Disclosures   11
     
Item 5. Other Information   12
     
Item 6. Exhibits   12
     
SIGNATURES   13
     
EXHIBIT INDEX   14

 

i

 

 

In this Quarterly Report on Form 10-Q, unless otherwise indicated, the “Company”, “we”, “us” or “our” refer to Surna Inc. and, where appropriate, its wholly owned subsidiary.

 

CAUTIONARY STATEMENT

 

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but are based on current management expectations that involve substantial risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements including, but not limited to, any projections of revenue, gross profit, earnings or loss, tax provisions, cash flows or other financial items; any statements of the plans, strategies or objectives of management for future operations; any statements regarding current or future macroeconomic or industry-specific trends or events and the impact of those trends and events on us or our financial performance; any statements regarding pending investigations, legal claims or tax disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing.

 

These forward-looking statements are subject to known and unknown risks, uncertainties, assumptions and other factors that could cause our actual results of operations, financial condition, liquidity, performance, prospects, opportunities, achievements or industry results, as well as those of the markets we serve or intend to serve, to differ materially from those expressed in, or suggested by, these forward-looking statements. These forward-looking statements are based on assumptions regarding our present and future business strategies and the environment in which we operate. Important factors that could cause those differences include, but are not limited to:

 

  our business prospects and the prospects of our existing and prospective customers;
     
  the inherent uncertainty of product development;
     
  regulatory, legislative and judicial developments, especially those related to changes in, and the enforcement of, cannabis laws;
     
  increasing competitive pressures in our industry;
     
  our relationships with our customers and suppliers;
     
  general economic conditions or conditions affecting demand for the products offered by us in the markets in which we operate, being less favorable than expected;
     
  changes in our business strategy or development plans, including our expected level of capital expenses and working capital;
     
  our ability to attract and retain qualified personnel;
     
  our ability to raise equity and debt capital to fund our growth strategy, including possible acquisitions;
     
  future revenue being lower than expected; and
     
  our intention not to pay dividends.

 

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in “Item 1A – Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, as updated from time to time in the Company’s filings with the U.S. Securities and Exchange Commission (the “SEC”). You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q. The forward-looking statements and projections contained in this Quarterly Report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the “Securities Act”).

 

ii

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Surna Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

 

    June 30, 2018     December 31, 2017  
ASSETS            
Current Assets                
Cash and cash equivalents   $ 1,628,880     $ 2,468,199  
Accounts receivable (net of allowance for doubtful accounts of $108,949 and $105,267, respectively)     229,950       422,589  
Other receivables     25,661       550  
Inventory, net     454,296       522,622  
Prepaid expenses     264,418       293,458  
Total Current Assets     2,603,205       3,707,418  
Noncurrent Assets                
Property and equipment, net     576,462       401,356  
Goodwill     631,064       631,064  
Intangible assets, net     37,529       37,985  
Deposits     51,000       51,000  
Total Noncurrent Assets     1,296,055       1,121,405  
                 
TOTAL ASSETS   $ 3,899,260     $ 4,828,823  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
                 
CURRENT LIABILITIES                
Accounts payable and accrued liabilities   $ 1,253,097     $ 1,969,263  
Deferred revenue     1,413,074       1,011,871  
Amounts due to shareholders     -       6,927  
Derivative liabilities     -       410,880  
Total Current Liabilities     2,666,171       3,398,941  
                 
NONCURRENT LIABILITIES                
Deferred rent     115,668       17,396  
Total Noncurrent Liabilities     115,668       17,396  
                 
TOTAL LIABILITIES     2,781,839       3,416,337  
                 
Commitments and Contingencies (Note 8)                
                 
SHAREHOLDERS’ EQUITY                
Preferred stock, $0.00001 par value; 150,000,000 shares authorized; 77,220,000 shares issued and outstanding     772       772  
Common stock, $0.00001 par value; 350,000,000 shares authorized; 221,471,602 and 206,248,522 shares issued and outstanding, respectively     2,215       2,062  
Additional paid in capital     24,001,891       20,664,563  
Accumulated deficit     (22,887,457 )     (19,254,911 )
Total Shareholders’ Equity     1,117,421       1,412,486  
                 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY   $ 3,899,260     $ 4,828,823  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F- 1

 

 

Surna Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

    For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
    2018     2017     2018     2017  
Revenue, net   $ 2,007,745     $ 1,741,893     $ 4,062,473     $ 3,334,985  
                                 
Cost of revenue     1,484,320       1,328,895       3,157,034       2,493,651  
                                 
Gross profit     523,425       412,998       905,439       841,334  
                                 
Operating expenses:                                
Advertising and marketing expenses     223,903       209,737       434,919       315,942  
Product development costs     56,917       96,294       132,089       190,083  
Selling, general and administrative expenses     1,659,862       1,303,611       3,660,778       2,121,571  
Total operating expenses     1,940,682       1,609,642       4,227,786       2,627,596  
                                 
Operating loss     (1,417,257 )     (1,196,644 )     (3,322,347 )     (1,786,262 )
                                 
Other income (expense):                                
Interest and other income, net     16,312       342       16,490       3,293  
Interest expense     -       (14,620 )     (35 )     (41,734 )
Amortization of debt discount on convertible promissory notes     -       (26,072 )     -       (53,120 )
Loss on extinguishment of debt     -       -       -       (415,000 )
Gain on change in fair value of derivative liabilities     -       163,714       21,403       218,714  
Total other income (expense)     16,312       123,364       37,858       (287,847 )
                                 
Loss before provision for income taxes     (1,400,945 )     (1,073,280 )     (3,284,489 )     (2,074,109 )
                                 
Income taxes     -       -       -       -  
                                 
Net loss   $ (1,400,945 )   $ (1,073,280 )   $ (3,284,489 )   $ (2,074,109 )
                                 
Loss per common share – basic and dilutive   $ (0.01 )   $ (0.01 )   $ (0.02 )   $ (0.01 )
                                 
Weighted average number of common shares outstanding, basic and dilutive     217,447,043       183,294,028       213,814,978       175,955,929  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F- 2

 

 

Surna Inc.

Condensed Consolidated Statement of Changes in Shareholders’ Equity

For the Six Months Ended June 30, 2018

(Unaudited)

 

    Preferred Stock     Common Stock                    
    Number of Shares     Amount     Number of Shares     Number of Shares to be Issued     Amount     Additional Paid in Capital     Accumulated Deficit     Shareholders’ Equity  
Balance December 31, 2017     77,220,000     $ 772       206,248,522       -     $ 2,062     $ 20,664,563     $ (19,254,911 )     1,412,486  
Cumulative effect of changes due to adoption of ASC 606 revenue recognition     -       -       -       -       -       -       56,912       56,912  
Adjusted balance January 1, 2018 to reflect adoption of ASC 606     77,220,000     $ 772       206,248,522       -     $ 2,062     $ 20,664,563     $ (19,197,999 )   $ 1,469,398  
Extinguishment of derivative liability upon exercise of investor warrants     -       -       -       -       -       389,477       -       389,477  
Common shares issued on cashless exercise of former director and investor warrants     -       -       2,666,865       -       26       (26 )     -       -  
Common shares issued on exercise of investor warrants and employee options     -       -       125,000       -       1       18,374       -       18,375  
Common shares issued or to be issued on settlement of restricted stock units and award of stock bonuses     -       -       5,610,000       1,000,000       56       (56 )     -       -  
Common shares issued as compensation for services     -       -       1,583,715       -       17       378,619       -       378,636  
Common shares issued in settlement agreement     -       -       800,000       -       8       226,392       -       226,400  
Fair value of vested restricted stock units awarded to employees and directors     -       -       -       -       -       796,874       -       796,874  
Fair value of vested stock options granted to employees     -       -       -       -       -       40,184       -       40,184  
Fair value of vested incentive stock bonuses awarded to employees     -       -       -       -       -       277,566       -       277,566  
Common shares issued for cash, net     -       -       7,562,500       -       76       1,209,924       -       1,210,000  
Repurchase of common shares from related party     -       -       (3,125,000 )     -       (31 )     -       (399,969 )     (400,000 )
Purchase of option to repurchase preferred stock from related party     -       -       -       -       -       -       (5,000 )     (5,000 )
Net loss     -       -       -       -       -       -       (3,284,489 )     (3,284,489 )
Balance June 30, 2018     77,220,000     $ 772       221,471,602       1,000,000     $ 2,215     $ 24,001,891     $ (22,887,457 )   $ 1,117,421  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F- 3

 

 

Surna Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

    For the Six Months Ended
June 30,
 
    2018     2017  
Cash Flows From Operating Activities:                
Net loss   $ (3,284,489 )   $ (2,074,109 )
Adjustments to reconcile net loss to net cash used in operating activities:                
Depreciation and intangible asset amortization expense     71,061       23,042  
Amortization of debt discounts     -       32,957  
Amortization of original issue discount on notes payable     -       20,163  
Gain on change in derivative liabilities     (21,403 )     (218,715 )
Compensation paid in equity     1,493,260       391,969  
Provision for doubtful accounts     3,682       -  
Provision for excess and obsolete inventory     (4,001 )     -  
Loss on extinguishment of debt     -       415,000  
                 
Changes in operating assets and liabilities:                
Accounts and other receivable     163,846       (101,530 )
Inventory     72,327       164,312  
Prepaid expenses     29,040       (87,595 )
Accounts payable and accrued liabilities     (491,075 )     188,320  
Deferred revenue     458,115       (724,463 )
Accrued interest     -       (9,602 )
Deferred rent     (1,728 )     -  
Net cash used in operating activities     (1,511,365 )     (1,980,251 )
                 
Cash Flows From Investing Activities                
Capitalization of intangible assets     (1,550 )     (19,431 )
Purchases of property and equipment     (226,615 )     (5,832 )
Proceeds from payment of tenant improvement allowance     100,000       -  
Cash disbursed for equipment held for lease     (16,237 )     -  
Payments received on note receivable     -       157,218  
Net cash (used in) provided by investing activities     (144,402 )     131,955  
                 
Cash Flows From Financing Activities                
Cash proceeds from sale of common stock and warrants     1,210,000       2,685,000  
Payments on convertible notes payable     -       (270,000 )
Proceeds from issuance of notes payable     -       500,000  
Proceeds from exercises of stock options     3,375       -  
Proceeds from exercise of investor warrants     15,000       -  
Repurchase of common shares from related party     (400,000 )     -  
Purchase of option to repurchase preferred stock from related party     (5,000 )     -  
Payments on loans from shareholders     (6,927 )     (33,178 )
Net cash provided by financing activities     816,448       2,881,822  
                 
Net (decrease) increase in cash     (839,319 )     1,033,526  
Cash, beginning of period     2,468,199       319,546  
Cash, end of period   $ 1,628,880     $ 1,353,072  
                 
Supplemental cash flow information:                
Interest paid   $ 35     $ -  
                 
Non-cash investing and financial activities:                
Conversions of promissory notes and accrued interest to common stock   $ -     $ 639,155  
Equity issued in settlement   $ 226,400     $ -  
Extinguishment of derivative liability on cashless exercise of warrants   $ 389,477     $ -  
Unpaid purchases of equipment and other assets   $ 1,309     $ -  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

F- 4

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 1 – Description of Business

 

Surna Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. The Company develops innovative technologies and products that monitor, control and or address the energy and resource intensive nature of indoor cannabis cultivation. Currently, the Company’s revenue stream is derived primarily from supplying industrial technology and products to commercial indoor cannabis cultivation facilities. Headquartered in Boulder, Colorado, the Company’s engineering and technical team provides solutions that allow growers to meet the unique demands of a cannabis cultivation environment through precise temperature, humidity, and process controls, energy and water efficiency, and satisfaction of the evolving code and regulatory requirements being imposed at the state and local levels. The Company’s objective is to leverage its experience in this space in order to bring value-added climate control solutions to its customers that help improve their overall crop quality and yield as well as optimize the resource efficiency of their controlled environment (i.e,. indoor and greenhouses) cultivation facilities. The Company is not involved in the production or sale of cannabis.

 

Note 2 – Basis of Presentation; Summary of Significant Accounting Policies

 

Financial Statement Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Pursuant to these rules and regulations, certain information and note disclosures, normally included in financial statements prepared in accordance with GAAP, have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018. The balance sheet as of December 31, 2017 has been derived from the audited financial statements at that date, but does not include all the information and footnotes required by GAAP for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2017. The notes to the unaudited condensed consolidated financial statements are presented on a going concern basis unless otherwise noted.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $3,284,000 for the six months ended June 30, 2018, and had an accumulated deficit of approximately $22,887,000 as of June 30, 2018. Since inception, the Company has financed its activities principally through debt and equity financing and customer deposits. Management expects to incur additional losses and cash outflows in the foreseeable future in connection with its operating activities.

 

The Company is subject to a number of risks similar to those of other similar stage companies, including dependence on key individuals, successful development, marketing and branding of products; uncertainty of product development and generation of revenues; dependence on outside sources of financing; risks associated with research and development; dependence on third-party suppliers and collaborators; protection of intellectual property; and competition with larger, better-capitalized companies. Ultimately, the attainment of profitable operations is dependent on future events, including obtaining adequate financing to fulfill its development activities and generating a level of revenues adequate to support the Company’s cost structure.

 

F- 5

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

There can be no assurance that the Company will be able to raise debt or equity financing in sufficient amounts, when and if needed, on acceptable terms or at all. If results of operations for 2018 do not meet management’s expectations, or additional capital is not available, management believes it has the ability to reduce certain expenditures. The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for the Company’s products and services, the quality of product development efforts, management of working capital, and continuation of normal payment terms and conditions for purchase of the Company’s products. The Company believes its cash balances and cash flow from operations will be insufficient to fund its operations for the next 12 months. If the Company is unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then the Company will need to raise additional funding to continue as a going concern.

 

The foregoing factors raise substantial doubt about the Company’s ability to continue as a going concern for a period of one year from the date the financial statements are issued. These condensed consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

Basis of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company and its controlled and wholly-owned subsidiary, Hydro Innovations, LLC (“Hydro”). Intercompany transactions, profit, and balances are eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and that affect the reported amounts of revenue and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Key estimates include: valuation of derivative liabilities, valuation of intangible assets, valuation of equity-based compensation, valuation of deferred tax assets and liabilities, warranty accruals, inventory allowances, and legal contingencies.

 

Fair Value Measurement

 

The Company records its financial assets and liabilities at fair value. The accounting standard for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting standard establishes a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

Level 1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

Level 2 - inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

 

Level 3 - inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value.

 

On a Recurring Basis

 

A financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

 

F- 6

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

During the third quarter of 2015, the Company issued convertible notes (the “Notes”) to three accredited investors in the aggregate original principal amount of $711,000, together with warrants to purchase up to an aggregate of 2,625,000 shares of the Company’s common stock (the “Warrants”). The Warrants, which were outstanding as of December 31, 2017, provided for a reduction in the exercise price in the event the Company issued common stock in a registered offering at a price below the exercise price. In such event, the exercise price under the Warrants would be reduced to the price of the common stock in the dilutive issuance. The Company determined that these outstanding Warrants subject to the exercise price reduction qualified as a derivative financial instrument.

 

During the first quarter of 2018, all of the outstanding Warrants were exercised on a cashless basis, and the Company extinguished the derivative liability of approximately $389,000 and recorded an increase in additional paid-in capital of the same amount. The gain on change in derivative liabilities presented in the statements of operations for the six months ended June 30, 2018 represents the gain on derivatives through the date of the cashless exercise of these warrants.

 

Financial liabilities carried at fair value, measured on a recurring basis were as follows:

 

    As of June 30, 2018     As of December 31, 2017  
    Level 1     Level 2     Level 3     Fair Value     Gain (1)     Level 1     Level 2     Level 3     Fair Value     Gain (2)  
Financial liabilities:                                                                                
Derivative liabilities - warrants   $ -     $ -     $ -     $ -     $ 21,403     $ -     $ -     $ 410,880     $ 410,880     $ 66,934  
Total financial liabilities   $ -     $ -     $ -     $ -     $ 21,403     $ -     $ -     $ 410,880     $ 410,880     $ 66,934  

 

 

  (1) The gain on change in derivative liabilities presented in the statements of operations for the six months ended June 30, 2018 represents the gain on derivatives through the cashless exercise of all of the associated warrants during the first quarter of 2018.  
   
  (2) Represents the gain on change in derivative liabilities for the twelve months ended December 31, 2017.

 

The change in the balance of the warrant derivative liabilities during the first quarter of 2018 was calculated based on the closing price of the Company’s common stock on the settlement date and the net shares issued under the Warrants, which is classified as a gain on change in derivative liabilities in the condensed consolidated statements of operations.

 

On a Non-Recurring Basis

 

Intangible assets that are amortized are evaluated for recoverability whenever adverse effects or changes in circumstances indicate that the carrying value may not be recoverable. The recoverability test consists of comparing the undiscounted projected cash flows with the carrying amount. Should the carrying amount exceed undiscounted projected cash flows, an impairment loss would be recognized to the extent the carrying amount exceeds fair value.

 

For the Company’s indefinite-lived goodwill, the impairment test consists of comparing the fair value, determined using the market value method, with its carrying amount. An impairment loss would be recognized for the carrying amount in excess of its fair value. The Company concluded that no impairment relating to intangible assets or goodwill existed at June 30, 2018.

 

Due to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximate fair value.

 

Revenue Recognition

 

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606), Revenue from Contracts with Customers and all the related amendments (“ASC 606” or the “new revenue standard”) to all contracts and elected the modified retrospective method. The results for periods before 2018 were not adjusted for the new revenue standard and the cumulative effect of the change in accounting was recognized through accumulated deficit at the date of adoption. The comparative financial information presented has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company expects the impact of the adoption of the new revenue standard to be immaterial to its net income (loss) on an ongoing basis.

 

F- 7

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

The cumulative effect of the changes made to the condensed consolidated balance sheet for the adoption of the new revenue standard as of January 1, 2018 was as follows:

 

    Balance as of December 31, 2017     Adjustments Due to ASC 606     Balance as of
January 1, 2018
 
Balance Sheet                        
                         
Liabilities                        
Deferred Revenue   $ 1,011,871     $ (56,912 )   $ 954,959  
                         
Shareholders’ Equity                        
Accumulated deficit   $ (19,254,911 )   $ 56,912     $ (19,197,999 )

 

In accordance with the new revenue standard’s requirements, the disclosure of the impact of adoption on the condensed consolidated income statements and balance sheets for the three and six months ended June 30, 2018 (including insignificant true-up adjustments related to the first quarter of 2018 which have been reflected in the three months ended June 30, 2018) was as follows:

 

   

For the Three Months Ended

June 30, 2018

   

For the Six Months Ended

June 30, 2018

 
    As Reported     Balances Without Adoption of ASC 606     Effect of Change Higher/(Lower)     As Reported     Balances Without Adoption of ASC 606     Effect of Change Higher/(Lower)  
Income Statement                                                
Revenues                                                
Revenues   $ 2,007,745     $ 2,024,685     $ (16,940 )   $ 4,062,473     $ 4,061,973     $ 500  
                                                 
Net loss   $ (1,400,945 )   $ (1,384,005 )   $ 16,940     $ (3,284,489 )   $ (3,284,989 )   $ (500 )
                                                 
Balance Sheet                                                
Liabilities                                                
Deferred Revenue   $ 1,413,074     $ 1,470,486     $ (57,412 )   $ 1,413,074     $ 1,470,486     $ (57,412 )
                                                 
Shareholders’ Equity                                                
Accumulated deficit   $ (22,887,457 )   $ (22,944,869 )   $ (57,412 )   $ (22,887,457 )   $ (22,944,869 )   $ (57,412 )

 

Revenue Recognition Accounting Policy Summary

 

The Company accounts for revenue in accordance with the new revenue standard. Under the new revenue standard, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Most of the Company’s contracts contain multiple performance obligations that include engineering and technical services as well as the delivery of a diverse range of climate control system equipment and components, which can span multiple phases of a customer’s project life-cycle from facility design and construction to equipment delivery and system installation and start-up. The Company does not provide construction services or system installation services. Some of the Company’s contracts with customers contain a single performance obligation, typically engineering only services contracts. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, the Company allocates the transaction price to each performance obligation based on its standalone selling price.

 

Generally, satisfaction occurs when control of the promised goods are transferred to the customer or as services are rendered or completed in exchange for consideration in an amount for which the Company expects to be entitled. The Company recognizes revenue for the sale of goods when control transfers to the customer, which primarily occurs at the time of shipment. The Company’s historical rates of return are insignificant as a percentage of sales and, as a result, the Company does not record a reserve for returns at the time the Company recognizes revenue. The Company also recognizes revenue net of sales taxes. The revenue and cost for freight and shipping is recorded when control over the sale of goods passes to the Company’s customers.

 

F- 8

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

The Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Performance obligations are satisfied over-time if the customer receives the benefits as the Company performs work, if the customer controls the asset as it is being produced, or if the product being produced for the customer has no alternative use and the Company has a contractual right to payment. Revenue is recognized from this type of performance obligation as services are rendered based on the percentage completion towards certain specified milestones.

 

During the course of a customer’s project, the Company may deploy one of its engineers or technicians to the customer’s facility, as requested by the customer, to provide technical guidance either prior to, during, or after, the installation of the climate control system by a third-party contractor. Typically, one of these customer site visits is dedicated to testing that the Company’s equipment has been properly assembled and installed by the installation contractor and assuring the equipment is operating within the agreed specifications, which is commonly referred to as commissioning. The Company charges the customer a per diem fee for these customer site visits, which are generally optional, and are not related to any other performance obligation. The Company has determined that these customer site visits are separate performance obligations as they are considered distinct and the customer benefits from these visits on their own. As separate performance obligations, the revenue related to these customer site visits will be recognized at a point in time when the services are provided to the customer.

 

The Company offers assurance-type warranties for its products and products manufactured by others to meet specifications defined by the contracts with customers, and does not have any material separate performance obligations related to these warranties. The Company maintains a warranty reserve based on historical warranty costs.

 

Other Judgments and Assumptions

 

The Company applies the practical expedient in ASC 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less. Applying the practical expedient in ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs include certain sales commissions and incentives and are included in selling, general and administrative expenses. ASC 606-10-32-18 allows the Company to not adjust the amount of consideration to be received in a contract for any significant financing component if the Company expect to receive payment within twelve months of transfer of control of goods or services. The Company has elected this expedient as it expects all consideration to be received in one year or less at contract inception. The Company has also elected not to provide the remaining performance obligations disclosures related to service contracts in accordance with the practical expedient in ASC 606-10-55-18. The Company recognizes revenue in the amount to which the entity has a right to invoice and has adopted this election to not provide the remaining performance obligations related to service contracts.

 

Contract Assets and Contract Liabilities

 

Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers based on the terms established in its contracts.

 

Contract assets include unbilled amounts where revenue recognized exceeds the amount billed to the customer and the right of payment is conditional, subject to completing a milestone, such as a phase of a project. The Company typically does not have material amounts of contract assets since revenue is recognized as control of goods are transferred or as services are performed. As of June 30, 2018 and December 31, 2017, the Company has no contract assets.

 

F- 9

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Contract liabilities consist of advance payments in excess of revenue recognized. The Company’s contract liabilities are recorded as a current liability in Deferred Revenue in the condensed consolidated balance sheet since the timing of when the Company expects to recognize revenue is generally less than one year. As of June 30, 2018 and December 31, 2017, the deferred revenue, which was classified as a current liability, was $1,413,074 and $1,011,871, respectively.

 

For the three and six months ended June 30, 2018, the Company recognized revenue of $41,731 and $867,814, respectively, related to the deferred revenue at January 1, 2018.

 

Accounting for Share-Based Compensation

 

The Company recognizes the cost resulting from all share-based compensation arrangements, including stock options, restricted stock awards and restricted stock units that the Company grants under its equity incentive plan in its condensed consolidated financial statements based on their grant date fair value. The expense is recognized over the requisite service period or performance period of the award. Awards with a graded vesting period based on service are expensed on a straight-line basis for the entire award. Awards with performance-based vesting conditions, which require the achievement of a specific company financial performance goal at the end of the performance period and required service period, are recognized over the performance period. Each reporting period, the Company reassesses the probability of achieving the respective performance goal. If the goals are not expected to be met, no compensation cost is recognized and any previously recognized amount recorded is reversed. If the award contains market-based vesting conditions, the compensation cost is based on the grant date fair value and expected achievement of market condition and is not subsequently reversed if it is later determined that the condition is not likely to be met or is expected to be lower than initially expected.

 

The grant date fair value of stock options is based on the Black-Scholes Option Pricing Model (the “Black-Scholes Model”). The Black-Scholes Model requires judgmental assumptions including volatility and expected term, both based on historical experience. The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected term of the option.

 

The grant date fair value of restricted stock and restricted stock units is based on the closing price of the underlying stock on the date of the grant.

 

The Company has elected to reduce share-based compensation expense for forfeitures as the forfeitures occur since the Company does not have historical data or other factors to appropriately estimate the expected employee terminations and to evaluate whether particular groups of employees have significantly different forfeiture expectations.

 

Share-based awards granted to non-employees are recorded at the fair value of the consideration received or the fair value of the equity issued, whichever can be more readily measured, on the measurement date and are subject to periodic adjustment as the underlying share-based awards vest.

 

Share-based compensation paid to employees, directors and non-employees totaled $1,493,260 and $391,969 for the six months ended June 30, 2018 and 2017, respectively.

 

F- 10

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Share-based compensation expenses are classified in the condensed consolidated financial statements in the same manner as if such compensation was paid in cash. The following is a summary of share-based compensation costs included in the condensed consolidated statements of operations for the three and six months ended June 30, 2018 and 2017, respectively:

 

    For the Three Months Ended June 30,     For the Six Months Ended June 30,  
    2018     2017     2018     2017  
Share-based compensation expense included in:                                
Cost of revenue   $ 37,792     $ -     $ 79,063     $ -  
Advertising and marketing expenses     2,273       -       3,125       -  
Product development costs     1,137       -       2,274       -  
Selling, general and administrative expenses     811,437       261,900       1,408,798       391,969  
Total share-based compensation expense included in consolidated statement of operations   $ 852,639     $ 261,900     $ 1,493,260     $ 391,969  

 

Basic and Diluted Net Loss per Common Share

 

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents. In periods when losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.

 

Commitments and Contingencies

 

In the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, customer disputes, government investigations and tax matters. An accrual for a loss contingency is recognized when it is probable that an asset had been impaired or a liability had been incurred and the amount of loss can be reasonably estimated.

 

Other Risks and Uncertainties

 

To achieve profitable operations, the Company must successfully develop, manufacture and market its products. There can be no assurance that any such products can be developed or manufactured at an acceptable cost and with appropriate performance characteristics, or that such products will be successfully marketed. These factors could have a material adverse effect upon the Company’s financial results, financial position, and future cash flows.

 

The Company is subject to risks common to similarly-situated companies including, but not limited to, new technological innovations, dependence on key personnel, protection of proprietary technology, compliance with government regulations, uncertainty of market acceptance of products, product liability, and the need to obtain additional financing. As a supplier of services and equipment to cannabis cultivators, the Company is also subject to risks related to the cannabis industry. Although certain states and parts of Canada, where the Company sells its products, have legalized medical and/or recreational cannabis, U.S. federal laws continue to prohibit cannabis in all its forms as well as its derivatives. Any changes in the enforcement of U.S. federal laws may adversely affect the implementation of state and local cannabis laws and regulations that permit medical or recreational cannabis and, correspondingly, may adversely impact the Company’s customers. The Company’s success is also dependent upon its ability to raise additional capital and to successfully develop and market its products.

 

Segment Information

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s senior management team in deciding how to allocate resources and in assessing performance. The Company has one operating segment that is dedicated to the manufacture and sale of its products.

 

F- 11

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Recent Accounting Pronouncements

 

In June 2018, the Financial Accounting Standards Board (“FASB”) adopted ASU 2018-07, “Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of Topic 718 to include all share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 specifies that Topic 718 applies to all share-based payment transactions in which the grantor acquires goods and services to be used or consumed in its own operations by issuing share-based payment awards. ASU 2018-07 also clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer, or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under ASC 606. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted, but no earlier than the Company’s adoption of ASC 606. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.

 

In February 2016, the FASB adopted ASU 2016-02, Leases (Topic 842) which requires companies leasing assets to recognize on their balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on contracts longer than one year. The lessee is permitted to make an accounting policy election to not recognize lease assets and lease liabilities for short-term leases. How leases are recorded on the balance sheet represents a significant change from previous GAAP guidance in Topic 840. ASU 2016-02 maintains a distinction between finance leases and operating leases similar to the distinction under previous lease guidance for capital leases and operating leases. In July 2018, FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases . This amendment provides improvements that clarify specific aspects of the guidance in ASU 2016-02. In July 2018, FASB also issued ASU 2018-11, Targeted Improvements to Topic 842, Leases . This amendment provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). ASU 2016-02 is effective for fiscal periods beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.

 

Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.

 

Note 3 – Inventory

 

Inventory consisted of the following:

 

    June 30, 2018     December 31, 2017  
Finished goods   $ 500,958     $ 569,047  
Work in progress     38,922       14,348  
Raw materials     233,799       262,611  
Allowance for excess & obsolete inventory     (319,383 )     (323,384 )
Inventory, net   $ 454,296     $ 522,622  

 

Overhead expenses of $34,356 and $28,554 were included in the inventory balance as of June 30, 2018 and December 31, 2017, respectively.

 

F- 12

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 4 – Property and Equipment

 

Property and equipment consisted of the following:

 

   

June 30, 2018

    December 31, 2017  
Furniture and equipment   $ 372,380     $ 326,894  
Equipment held for lease to related party     176,043       159,806  
Vehicles     15,000       15,000  
Leasehold improvements     215,193       33,257  
      778,616       534,957  
Accumulated depreciation     (202,154 )     (133,601 )
Property and equipment, net   $ 576,462     $ 401,356  

 

Note 5 – Accounts Payable and Accrued Liabilities

 

Accounts payable and accrued liabilities consisted of the following:

 

    June 30, 2018     December 31, 2017  
Accounts payable   $ 790,564     $ 1,159,975  
Sales commissions payable     46,513       21,931  
Accrued payroll liabilities     74,819       58,557  
Product warranty accrual     112,840       105,122  
Commercial dispute settlement     -       332,418  
Other accrued expenses     228,361       291,260  
Total   $ 1,253,097     $ 1,969,263  

 

Note 6 – Related Party Agreements and Transactions

 

Amounts Due to Shareholders

 

In July of 2014, the Company issued a $250,000 unsecured promissory note (“Hydro Note”) to Stephen and Brandy Keen as part of the purchase price of Hydro. Mr. Keen is a principal shareholder of the Company and was a former executive officer and director, and was formerly a consultant to the Company (see below). Ms. Keen, the spouse of Mr. Keen, is also a principal shareholder of the Company and previously served as an executive officer and director of the Company (see below). As of December 31, 2017, the Hydro Note had a balance of $6,927, which was reflected on the balance sheet as a current liability. During the six months ended June 30, 2018, the balance of the Hydro Note was paid in full.

 

Stephen Keen Consulting Agreement

 

On May 10, 2017, the Board of Directors (the “Board”) approved a three-year consulting agreement (the “Consulting Agreement”) under which Mr. Keen agreed to provide certain consulting services to the Company including research and development, new product design and innovations, existing product enhancements and improvements, and other technology advancements with respect to the Company’s business and products in exchange for an annual consulting fee of $30,000. Pursuant to the terms of the Consulting Agreement, the Company recorded consulting fees of $2,500 and $10,000 payable to Stephen Keen during the three and six months ended June 30, 2018, respectively. On May 29, 2018, the Company and Mr. Keen entered into, a Termination Agreement which terminated the Consulting Agreement effective May 31, 2018 (the “Termination Agreement”).

 

F- 13

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Sterling Pharms Equipment Agreement

 

On May 10, 2017, the Board approved a three-year equipment, demonstration and product testing agreement between the Company and Sterling Pharms, LLC (“Sterling”), an entity controlled by Mr. Keen, which operates a Colorado-regulated cannabis cultivation facility. Under this agreement, the Company agreed to provide to Sterling certain lighting, environmental control, and air sanitation equipment for use at the Sterling facility in exchange for a quarterly fee of $16,500 from Sterling. Also, under this agreement, Sterling agreed to allow the Company and its existing and prospective customers to have access to the Sterling facility for demonstration tours in a working environment, which the Company believes will assist it in the sale of its products. Sterling also agreed to monitor, test and evaluate the Company’s products installed at the Sterling facility and to collect data and provide feedback to the Company on the energy and operational efficiency and efficacy of the installed products, which the Company intends to use to improve, enhance and develop new or additional product features, innovations and technologies. In consideration for access to the Sterling facility to conduct demonstration tours and for the product testing and data to be provided by Sterling, the Company will pay Sterling a quarterly fee of $12,000.

 

On March 22, 2018, the Company and Sterling entered into an amendment of the original agreement to include additional leased equipment and to increase the quarterly fee payable to the Company to $18,330. The amendment of the original agreement also provided that, upon expiration of the initial three-year term, either: (i) the leased equipment would be returned to the Company and the agreement would terminate, (ii) Sterling could purchase the leased equipment at the agreed upon residual value of $81,827, or (iii) Sterling and the Company could agree to an extension of the original agreement at mutually agreed to quarterly payments to and from the parties.

 

After giving effect to the amended quarterly equipment lease fees received from Sterling of $18,330 (the “Lease Fee”) and the quarterly demonstration and testing fees paid to Sterling of $12,000 (the “Demo and Testing Fee”), the Company will receive a net payment of $6,330 from Sterling each quarter.

 

Sterling accepted delivery of the remaining leased equipment and completed installation of the equipment at its facility on May 1, 2018. Accordingly, the term of this agreement, which commenced upon complete installation of the equipment, commenced May 1, 2018 and will expire April 30, 2021.

 

The Company is treating the equipment rental arrangement and related Lease Fee payment as an operating lease. Accordingly, the equipment held for lease has been recorded as property and equipment on the balance sheets and will be depreciated over the term of the lease. The Lease Fee will be recorded as “Interest and other income, net” in the condensed consolidated statements of operations. For the three and six months ended June 30, 2018, the Company recorded Lease Fees of $12,220 and $12,220, respectively.

 

The Company will record the Demo and Testing Fee as operating expenses in the condensed consolidated statements of operations. For the three and six months ended June 30, 2018, the Company recorded Demo and Testing Fees of $8,000 and $8,000, respectively.

 

Brandy Keen Employment Agreement

 

On May 29, 2018, the Company and Ms. Keen entered into, an amended and restated employment agreement (the “Employment Agreement”), pursuant to which, among other things, (i) Ms. Keen’s position will remain as Senior Technical Advisor reporting to the Director of Sales; (ii) the term of Ms. Keen’s employment will expire on April 30, 2020, (iii) through April 30, 2019, Ms. Keen will be a full-time employee of the Company and will reside in the Boulder, Colorado area, (iv) beginning May 1, 2019 through April 30, 2020, Ms. Keen will become a part-time employee and will be expected to work a minimum of 30 hours per work, (v) beginning May 1, 2019, Ms. Keen may relocate her residence and will only be expected to attend significant trade shows, major customer meetings, or meetings at the Boulder office from time to time, (vi) Ms. Keen’s current base salary of $150,000 and her sales incentive would remain in full force and effect through April 30, 2019, and (vii) beginning May 1, 2019, Ms. Keen’s annualized salary will become $75,000 and she will no longer receive any sales incentives and, except as set forth in the Employment Agreement, Ms. Keen would not be eligible for any other bonus or incentive compensation during the term of her employment.

 

F- 14

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Pursuant to the Employment Agreement, the Board approved an award of 4,800,000 restricted stock units (“RSUs”) to Ms. Keen under the Company’s 2017 Equity Incentive Plan, as may be modified and amended by the Company from time to time (the “2017 Equity Plan”), that vest as follows: (i) 1,000,000 RSUs vested on June 30, 2018, subject to her continued employment through the vesting date, (ii) 1,000,000 RSUs vest on December 31, 2018, subject to her continued employment through the vesting date, (iii) 1,000,000 RSUs vest on June 30, 2019, subject to her continued employment through the vesting date, (iv) 1,000,000 RSUs vest on December 31, 2019, subject to her continued employment through the vesting date, and (v) 800,000 RSUs vest on April 30, 2020, subject to her continued employment through the vesting date. The Employment Agreement provides that the foregoing RSUs would continue to vest if Ms. Keen’s employment is terminated by the Company without cause.

 

In consideration of the new consideration being provided to Ms. Keen under the Employment Agreement, the post-termination restrictive covenants under her existing employment agreement were amended to extend the restrictive period from one year to two years from the date of termination or expiration.

 

In connection with the foregoing transactions, Ms. Keen resigned as an executive officer and director of the Company effective May 10, 2018.

 

Company Purchase of Common Stock from Stephen and Brandy Keen

 

On May 29, 2018, the Company and the Keens entered into a Stock Repurchase Agreement (the “Stock Repurchase Agreement”), pursuant to which the Company agreed to repurchase from the Keens shares of the Company’s common stock at the Repurchase Price per Share (as defined below) for a total repurchase price of $400,000 (“Repurchased Shares”). The Company’s obligation to repurchase the Repurchased Shares was contingent on the closing of a private placement offering to accredited investors of the Company’s common stock, which occurred during the second quarter of 2018. The Repurchase Price per Share was $0.128, which was equal to 80% of the $0.16 unit price paid by investors in the private placement offering to reflect the estimated value of the warrant included in the unit. On June 19, 2018, the Company closed the transaction under the Stock Repurchase Agreement and repurchased 3,125,000 shares of the Company’s common stock from the Keens. See Note 9.

 

Company Option to Purchase of Preferred Stock from Stephen and Brandy Keen

 

On May 29, 2018, the Company and the Keens entered into a Preferred Stock Option Agreement under which the Company has the right, but not the obligation, to acquire all 35,189,669 shares of preferred stock owned by the Keens (the “Preferred Stock”). Pursuant to the Preferred Stock Option Agreement, upon exercise of the option by the Company, the Company will issue one share of common stock for each 1,000 shares of Preferred Stock purchased by the Company. The common stock issued upon exercise will be restricted shares. The option will expire on April 30, 2020. As consideration for the Keens’ grant of the option, the Company paid them $5,000. See Note 9.

 

Note 7 – Derivative Liabilities

 

The Company determined that the Warrants qualified as derivative financial instruments. Accordingly, the Warrants were recorded as derivative liabilities and were marked to market at the end of each reporting period. Any change in fair value during the period was recorded as gain (loss) on change in derivative liabilities in the condensed consolidated statements of operations.

 

During the first quarter of 2018, all of the outstanding Warrants were exercised on a cashless basis and the Company extinguished the derivative liability of $389,000 and recorded an increase in additional paid-in capital of the same amount. The gain on change in derivative liabilities presented in the statements of operations for the three and six months ended June 30, 2018 of $0 and $21,403, respectively, represent the gain on derivatives through the date of the cashless exercise of the Warrants.

 

F- 15

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following table sets forth movement in the derivative liability related to the Warrants:

 

Balance December 31, 2017   $ 410,880  
Gain on change in derivative liability, net     (21,403 )
Balance prior to exercise of associated warrants     389,477  
Extinguishment of derivative liability on cashless exercise of associated warrants     (389,477 )
Balance June 30, 2018   $ -  

 

Note 8 – Commitments and Contingencies

 

Litigation

 

From time to time, in the normal course of its operations, the Company is subject to litigation matters and claims. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a liability for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.

 

Internal Revenue Service Penalties

 

The Company has been penalized by the Internal Revenue Service (“IRS”) for failure to file its Foreign Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for the years 2011, 2012 and 2014 on a timely basis. The penalties and interest approximate $115,000. The Company’s request that the penalties be abated for reasonable cause was denied by the IRS in September 2017. The Company has appealed the IRS’s denial based on statutory grounds under Revenue Procedure 92-70, which provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations. Persons complying with this revenue procedure are deemed to satisfy their Form 5471 filing obligations with respect to dormant foreign corporations and are not subject to penalties related to the failure to timely file a complete Form 5471 and to timely furnish information requested thereon. The IRS has notified the Company that it has referred the appeal to a regional appeals office for handling, and the Company has not yet received any response from the appeals office. The Company believes it has complied with the summary filing procedures for filing Form 5471 under Revenue Procedure 92-70 and the likelihood of abatement is more likely than not. As a result, no amounts have been accrued for this contingency as of June 30, 2018 and December 31, 2017. However, there can be no assurance of any abatement until the IRS acts upon the appeal.

 

Building Lease

 

The Company has a lease agreement for its manufacturing and office space consisting of approximately 18,600 square feet, which commenced on September 29, 2017 and continues through August 31, 2022. The monthly rental rate of $18,979 will continue until August 31, 2018. Beginning September 1, 2018, the monthly rent will increase by 3% each year through the end of the lease. The Company made a security deposit of $51,000 and received a $100,000 tenant allowance for leasehold improvements.

 

F- 16

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following is a schedule by years of the minimum future lease payments on the building lease as of June 30, 2018.

 

Year Ended December 31,      
2018   $ 116,151  
2019     236,926  
2020     244,034  
2021     251,355  
2022     170,888  
Total future minimum lease payments   $ 1,019,354  

 

Total rent under the building lease is charged to expense over the term of the lease on a straight-line basis, resulting in the same monthly rent expense throughout the lease. The difference between the rent expense amount and the actual rent paid is recorded to deferred rent on the condensed consolidated balance sheets.

 

The Company recorded to deferred rent a credit for the tenant improvements paid for or reimbursed by the landlord during the three and six months ended June 30, 2018. Depreciation of the leasehold improvements and amortization of the credit have been determined based on a straight-line basis over the remaining term of the lease. The amortization of the credit for the tenant improvement allowance will result in a corresponding reduction in rent expense over the term of the lease.

 

Other Commitments

 

In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers and employees that will require the Company to, among other things, indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers, or employees. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and certain of its officers and employees, and former officers, directors, and employees of acquired companies, in certain circumstances.

 

Note 9 – Non-compensatory Equity Transactions

 

Private Placement Offering

 

During the second quarter of 2018, the Company completed a private placement offering of investment units (the “Units”), at a price of $0.16 per Unit, with certain accredited investors. Each Unit consisted of one share of the Company’s common stock and one warrant for the purchase of one share of the Company’s common stock. The Company issued a total of 7,562,500 Units for aggregate proceeds of $1,210,000. No commissions or fees were paid in connection with the offering, and the proceeds will be used for working capital and general corporate purposes, after $400,000 from the proceeds was used to repurchase shares of common stock from the Keens.

 

The warrants have an exercise price of $0.25 per share of the common stock underlying each warrant, subject to adjustment as provided in the warrant. The warrants are exercisable commencing July 1, 2018 until June 30, 2021. The warrant may be exercised only for cash.

 

Each warrant is callable at the Company’s option, beginning on July 1, 2019 until the expiration date of the warrant, provided the closing price of the Company’s common stock is $0.40 (subject to adjustment as provided in the warrant) or greater for five consecutive trading days (the “Call Condition”). Commencing at any time after the date on which the Call Condition is satisfied, the Company has the right, upon notice to the holders, to redeem the shares of common stock underlying each warrant at a price of $0.01 per share, but such redemption may not occur earlier than sixty-one (61) days following the date of the receipt of notice by the holder (the “Redemption Date”). The holder may exercise the warrant (in whole or in part) prior to the Redemption Date at the Exercise Price.

 

F- 17

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Other Equity Issuances

 

During the six months ended June 30, 2018, the Company issued shares of its restricted common stock as follows:

 

  100,000 shares upon the exercise of certain warrants by an investor and payment of the exercise price of $15,000;
     
  1,498,325 shares upon the exercise of certain warrants by a former director on a cashless exercise basis;
     
  1,168,540 shares upon exercise of certain warrants by investors on a cashless exercise basis;
     
  800,000 shares in connection with the settlement of a commercial dispute;
     
  273,675 shares to consultants as compensation for services rendered; and
     
  31,562 shares to certain employees under a sales incentive plan.

 

Common Stock Repurchase

 

On June 19, 2018, the Company repurchased 3,125,000 shares of the Company’s common stock from the Keens for a repurchase price of $400,000. See Note 6. Following the repurchase, the Company retired these shares and returned them to unauthorized and unissued shares. The Company recorded the purchase price for the repurchased shares as a reduction to common stock at par value with the remainder of the purchase price reflected as an increase to accumulated deficit.

 

Purchase of Preferred Stock Option

 

On May 29, 2018, the Company acquired an option to purchase 35,189,669 shares of preferred stock owned by the Keens. The Company paid the Keens $5,000 for this option. See Note 6. The Company recorded the purchase price for the option as an increase to accumulated deficit.

 

Note 10 – Equity Incentive Plan

 

On August 1, 2017, the Board adopted and approved the 2017 Equity Plan in order to attract, motivate, retain, and reward high-quality executives and other employees, officers, directors, consultants, and other persons who provide services to the Company by enabling such persons to acquire an equity interest in the Company. Under the 2017 Equity Plan, the Board (or the compensation committee of the Board, if one is established) may award stock options, stock appreciation rights (“SARs”), restricted stock awards (“RSAs”), restricted stock unit awards (“RSUs”), shares granted as a bonus or in lieu of another award, and other stock-based performance awards. The 2017 Equity Plan allocates 50,000,000 shares of the Company’s common stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. If any shares subject to an award are forfeited, expire, or otherwise terminate without issuance of such shares, the shares will, to the extent of such forfeiture, expiration, or termination, again be available for awards under the 2017 Equity Plan.

 

As of June 30, 2018, the Company has granted, under the 2017 Equity Plan, awards in the form of RSAs for services rendered by independent directors and consultants, non-qualified stock options, RSUs and stock bonus awards totaling 39,588,972 shares. Of these total awards, as of June 30, 2018, (i) awards related to 4,345,000 shares have been forfeited or expired, (ii) 9,533,972 shares have been issued on settlement of vested awards, and (iii) awards related to 25,710,000 remain outstanding. During the six months ended June 30, 2018, the Company issued shares of its common stock under the 2017 Equity Plan in settlement of certain vested awards as follows:

 

F- 18

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

  4,050,000 shares to certain employees and independent directors in settlement of vested restricted stock units;
     
  1,560,000 shares pursuant to special incentive stock bonuses earned by the CEO and another employee for the period ended December 31, 2017;
     
  119,820 shares of common stock to independent directors in lieu of cash director fees of $30,000 related to the fourth quarter of 2017 and the first quarter of 2018;
     
  158,658 shares to a consultant as compensation for services rendered in lieu of cash fees of $44,900 for the period November 1, 2017 to February 13, 2018;
     
  1,000,000 shares to a consultant as bonus compensation for services rendered; and
     
  25,000 shares upon exercise of non-qualified stock options by a former employee upon payment of the exercise price of $3,375.

 

The total unrecognized compensation expense for unvested non-qualified stock options, RSUs and stock bonus awards at June 30, 2018 was $1,103,770, which will be recognized over approximately 2.0 years. This unrecognized compensation expense does not include the potential future compensation expense related to non-qualified stock options and RSUs which are subject to vesting based on the achievement of $18,000,000 in revenue for 2018 and $25,000,000 in revenue for 2019 (the “Performance-based Awards”). As of June 30, 2018 and the grant date, the Company has determined that the likelihood of performance levels being obtained is remote; therefore, no expense was recognized. The unrecognized compensation expense with respect to these Performance-based Awards at June 30, 2018 was $1,251,973.

 

Non-Qualified Stock Options

 

The Company uses the Black-Scholes Model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. Changes in the subjective input assumptions can materially affect the fair value estimate. The expected stock price volatility assumptions are based on the historical volatility of the Company’s common stock over periods that are similar to the expected terms of grants and other relevant factors. The Company derives the expected term based on an average of the contract term and the vesting period taking into consideration the vesting schedules and future employee behavior with regard to option exercise. The risk-free interest rate is based on U.S. Treasury yields for a maturity approximating the expected term calculated at the date of grant. The Company has never paid any cash dividends on its common stock and the Company has no intention to pay a dividend at this time; therefore, the Company assumes that no dividends will be paid over the expected terms of option awards.

 

The Company determines the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant dates. As such, the Company may use different assumptions for options granted throughout the year. During the six months ended June 30, 2018, the valuation assumptions used to determine the fair value of each option award on the date of grant were: expected stock price volatility 118.90%; expected term in years 7.5 and risk-free interest rate 2.77%.

 

F- 19

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

A summary of the non-qualified stock options granted to employees under the 2017 Equity Plan as of June 30, 2018, and changes during the six months then ended, are presented in the table below:

 

    Number of Options     Weighted Average Exercise Price     Weighted Average Remaining Contractual Term     Aggregate Intrinsic Value  
                         
Outstanding, December 31, 2017     10,235,000     $ 0.121       8.7     $ 1,218,375  
Granted     1,000,000     $ 0.283                  
Exercised     (25,000 )   $ 0.135                  
Forfeited     (1,116,666 )   $ 0.122                  
Expired     (33,334 )     0.135                  
Outstanding, June 30, 2018     10,060,000     $ 0.137       8.3     $ 333,800  
Exercisable, June 30, 2018     1,826,674     $ 0.124       3.9     $ 83,884  
Outstanding vested and expected to vest, June 30, 2018     2,760,000     $ 0.127       5.7     $ 120,050  
                                 
Performance options based on 2018 and 2019 revenue thresholds - uncertain vesting as of June 30, 2018     7,300,000     $ 0.141       9.2     $ 213,750  

 

A summary of non-vested non-qualified stock options granted to employees under the 2017 Equity Plan as of June 30, 2018, and any changes during the six months then ended, are presented in the table below:

 

  Number of Options     Weighted Average Grant-Date Fair Value     Aggregate Intrinsic Value  
                       
Nonvested, December 31, 2017     8,349,992     $ 0.107     $ 1,000,499  
Granted     1,000,000     $ 0.257          
Vested     -       -          
Forfeited     (1,116,666 )   $ 0.109          
Expired     -       -          
Nonvested, June 30, 2018     8,233,326     $ 0.125     $ 249,916  

 

During the six months ended June 30, 2018, the Company recorded $27,978 as compensation expense related to vested options issued to employees, net of forfeitures. As of June 30, 2018, total unrecognized share-based compensation related to unvested options was $970,611, of which $54,338 was related to time-based vesting and $916,273 was related to performance-based vesting.

 

As of June 30, 2018, the Company had granted non-qualified options to purchase 10,250,000 shares which were performance-based, of which 1,950,000 were forfeited due to the failure to satisfy the 2017 revenue and bookings performance thresholds and 1,000,000 were forfeited due to employee terminations. Of the remaining non-qualified options to purchase 7,300,000 shares which are performance-based, the Company has determined that the likelihood of the 2018 and 2019 performance thresholds being satisfied is remote as of the date of grant and June 30, 2018; therefore, no expense was recognized. As of June 30, 2018, the performance-based non-qualified stock options include: (i) 2,950,000 options that vest if the Company achieves 2018 revenue of $18,000,000, and (ii) 4,350,000 options that vest if the Company achieves 2019 revenue of $25,000,000.

 

F- 20

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

A summary of the non-qualified stock options granted to the directors under the 2017 Equity Plan as of June 30, 2018, and changes during the six months then ended, are presented in the table below:

 

    Number of Options     Weighted Average Exercise Price     Weighted Average Remaining Contractual Term     Aggregate Intrinsic Value ($000)  
                         
Outstanding, December 31, 2017     900,000     $ 0.135       9.6     $ 94,500  
Granted     -       -                  
Exercised     -       -                  
Forfeited/Cancelled     -       -                  
Expired     -       -                  
Outstanding, June 30, 2018     900,000     $ 0.135       9.1     $ 31,500  
Exerciseable, June 30, 2018     900,000     $ 0.135       9.1     $ 31,500  
Outstanding vested, June 30, 2018     900,000     $ 0.135       9.1     $ 31,500  

 

A summary of non-vested non-qualified stock options granted to directors under the 2017 Equity Plan as of June 30, 2018, and any changes during the six months then ended, are presented in the table below:

 

    Number of Options     Weighted Average Grant-Date Fair Value     Aggregate Intrinsic Value  
                   
Nonvested, December 31, 2017     450,000     $ 0.123     $ 52,470  
Granted     -       -          
Vested     (450,000 )   $ 0.123          
Forfeited     -       -          
Expired     -       -          
Nonvested, June 30, 2018     -       -     $ -  

 

During the six months ended June 30, 2018, the Company recorded $12,205 as compensation expense related to vested options issued to directors. As of June 30, 2018, total unrecognized share-based compensation related to unvested options was $0.

 

Restricted Stock Units

 

A summary of the RSUs awarded to employees, directors and consultants under the 2017 Equity Plan as June 30, 2018, and changes during the six months then ended, are presented in the table below:

 

  Number of Units     Weighted Average Grant-Date Fair Value     Aggregate Intrinsic Value  
                 
Outstanding, December 31, 2017     13,800,000     $ 0.122     $ 3,312,000  
Granted     5,000,000     $ 0.188          
Vested and settled with share issuance 1     (5,050,000 )   $ 0.141          
Forfeited     -       -          
Outstanding, June 30, 2018     13,750,000     $ 0.139     $ 2,337,500  
Expected to vest as of June 30, 2018     10,750,000     $ 0.146     $ 1,827,500  
                         
2018/2019 Performance Units - uncertain vesting     3,000,000     $ 0.112     $ 510,000  

 

1 Includes 1,000,000 RSUs which were vested and to be settled with issued shares as of June 30, 2018.

 

F- 21

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

During the six months ended June 30, 2018, the Company recorded $796,874 as compensation expense related to vested RSUs issued to employees, directors and consultants. As of June 30, 2018, total unrecognized share-based compensation related to unvested RSUs was $1,080,982, of which $745,282 was related to time-based vesting and $335,700 was related to performance-based vesting. The total intrinsic value of RSUs vested and settled or to be settled with share issuance was $1,577,100 for the six months ended June 30, 2018, based on the closing price of the Company’s stock on the vesting date.

 

As of June 30, 2018, the Company had granted 3,000,000 RSUs to the CEO which were performance-based. The Company has determined that the likelihood of the performance thresholds being satisfied is remote as of the date of grant and June 30, 2018; therefore, no expense was recognized. As of June 30, 2018, the performance-based RSUs include: (i) 1,500,000 RSUs that vest if the Company achieves 2018 revenue of $18,000,000, and (ii) 1,500,000 options that vest if the Company achieves 2019 revenue of $25,000,000.

 

Incentive Stock Bonus Awards

 

Incentive stock bonuses awarded pursuant to certain employment agreements are treated as vesting over each award’s service period based on the fair value of the award at the time of grant. Even though the awards are subject to Board approval, the awards are treated as vesting over each service period based on the employee performance standards for such awards included in the employment agreements. Since the awards are denominated in shares of common stock, the fair value of the vested award is charged to additional paid-in capital. In the event the Board does not approve these incentive stock bonus awards or the employee terminates employment, the Company would reverse any previously recognized compensation costs related to these awards.

 

A summary of the incentive stock bonus awards granted to employees under the 2017 Equity Plan as June 30, 2018, and changes during the six months then ended, are presented in the table below:

 

  Number of Shares     Weighted Average Grant-Date Fair Value     Aggregate Intrinsic Value  
                       
Unvested, December 31, 2017     7,040,000     $ 0.113     $ 1,689,600  
Awarded     -       -          
Vested     (1,560,000 )   $ 0.112          
Forfeited     (200,000 )   $ 0.121          
Unvested, June 30, 2018     5,280,000     $ 0.113     $ 897,600  

 

During the six months ended June 30, 2018, the Company recorded $277,566 as compensation expense related to vested stock bonus awards issued to employees, net of forfeitures related to employee terminations. As of June 30, 2018, total unrecognized share-based compensation related to unvested stock bonus awards was $304,150.

 

Note 11 – Income Taxes

 

As of December 31, 2017, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $10,848,000, which will expire, if not utilized, in the years 2034 through 2037. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, use of the Company’s NOLs carryforwards may be limited in the event of cumulative changes in ownership of more than 50% within a three-year period.

 

The Company must assess the likelihood that its net deferred tax assets (including NOLs) will be recovered from future taxable income, and to the extent the Company believes that recovery is not likely, the Company establishes a valuation allowance. Management’s judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against the net deferred tax assets. The Company recorded a full valuation allowance as of December 31, 2017 and June 30, 2018. Based on the available evidence, the Company believes it is more likely than not that it will not be able to utilize its net deferred tax assets (including NOLs) in the foreseeable future.

 

F- 22

 

 

Surna Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 12 – Subsequent Events

 

The Company has evaluated all subsequent events through August 14, 2018, the date the financial statements were available to be issued. The following events occurred after June 30, 2018.

 

Appointment of Chief Financial Officer

 

On July 9, 2018, the Board appointed a new Chief Financial Officer (“CFO”) and Treasurer, which positions had been previously vacant. In connection with this appointment, the Company and the new CFO entered into an employment agreement that will continue until June 30, 2020. Under the employment agreement, the new CFO is eligible to receive an aggregate of 4,000,000 shares of the Company’s common stock, as determined by the Board in its sole discretion, as follows: (i) for the six-month period ended December 31, 2018, the new CFO will be eligible to receive a special bonus of 1,000,000 shares of the Company’s common stock, provided the Board has determined that his performance has been average or better for such period, and (ii) for each of the six-month periods ended June 30, 2019, December 31, 2019 and June 30, 2020, the new CFO will be eligible to receive a special bonus of 1,000,000 shares of the Company’s common stock, provided the Board has determined that he has achieved certain benchmarks and milestones as mutually agreed to by him and the Board in advance of each such period.

 

Equity-related Transactions

 

On July 13, 2018, the Company issued 1,000,000 shares to Brandy Keen in settlement of RSUs that vested on June 30, 2018. See Note 6.

 

On August 2, 2018, the Board approved the following:

 

  The issuance of 105,634 shares of common stock to independent directors in lieu of cash director fees of $15,000 related to the second quarter of 2018;
     
  The issuance of 560,000 shares pursuant to special incentive stock bonuses earned by an employee for the six-month period ended June 30, 2018, subject to the remittance of required withholding taxes by the recipient; and
     
  The grant to a new employee of 120,000 RSUs that vest on the six-month anniversary of employment.

 

F- 23

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report, which include additional information about our accounting policies, practices, and the transactions underlying our financial results, as well as with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC. In addition to historical information, the following discussion and other parts of this Quarterly Report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under “Cautionary Statements and Projections” appearing elsewhere herein and the risks and uncertainties described or identified in “Item 1A – Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, as updated from time to time in the Company’s filings with the SEC, and Part II, Item 1A of this Quarterly Report entitled “Risk Factors.”

 

Non-GAAP Financial Measures

 

To supplement our financial results on U.S. generally accepted accounting principles (“GAAP”) basis, we use the non-GAAP measures including net bookings and backlog, as well as other significant non-cash expenses such as stock-based compensation and certain debt-related expenses. We believe these non-GAAP measures are helpful in understanding our past performance and are intended to aid in evaluating our potential future results. The presentation of these non-GAAP measures should be considered in addition to our GAAP results and are not intended to be considered in isolation or as a substitute for financial information prepared or presented in accordance with GAAP. We believe these non-GAAP financial measures reflect an additional way to view aspects of our operations that, when viewed with our GAAP results, provide a more complete understanding of factors and trends affecting our business.

 

Overview

 

We design, engineer and manufacture application-specific environmental control and air sanitation systems for commercial, state- and provincial-regulated indoor cannabis cultivation facilities in the U.S. and Canada. Our engineering and technical team provides energy and water efficient solutions that allow growers to meet the unique demands of a cannabis cultivation environment through precise temperature, humidity, and process controls and to satisfy the evolving code and regulatory requirements being imposed at the state and local levels.

 

Headquartered in Boulder, Colorado, we leverage our experience in this space in order to bring value-added climate control solutions to our customers that help improve their overall crop quality and yield as well as optimize the resource efficiency of their controlled environment (i.e., indoor and greenhouses) cultivation facilities. We have been involved in consulting, equipment sales and/or full-scale design for over 700 grow facilities since 2006 making us a trusted resource for indoor environmental design and control management for the cannabis industry.

 

Our customers have included small cultivation operations to licensed commercial facilities ranging from several thousand to more than 100,000 square feet. We have sold our equipment and systems throughout the U.S. and Canada as well as internationally in South Africa, Switzerland and the United Kingdom. Our revenue stream is derived primarily from supplying mechanical engineering services and climate and environmental control equipment to commercial indoor cannabis grow facilities in North America. We also sell equipment to smaller cultivators who can purchase either directly from us, or from our authorized wholesalers or retailers. Though our customers do, we neither produce nor sell cannabis.

 

Shares of our common stock are traded on the OTCMarkets under the ticker symbol “SRNA.”

 

Cannabis Market

 

The demand for our climate control and air sanitation systems, including system design and engineering, proprietary equipment, and third-party manufactured equipment, is primarily influenced by the construction of new cannabis cultivation facilities in the U.S. and Canada. Due to continued uncertainty of the cannabis industry following the U.S. Justice Department’s announcement of its opposition to legalized cannabis in early 2017, and the January 4, 2018 rescission of the Cole Memo, we believe there may be an interim decrease in the development and financing of new cannabis cultivation facilities. However, this possible market effect is expected to be mitigated by California’s legalization of recreational cannabis use, and Canada’s recent federal legalization of cannabis.

 

1

 

 

Recent and anticipated regulatory changes involving medicinal and/or recreational cannabis use in various jurisdictions, such as California and Canada, tend to be a leading indicator for the granting of licenses for new facility construction. As more new cultivation facilities become licensed, we in turn have an expanded set of potential customers that might buy our climate control systems.

 

For 2018, we are pursuing customers seeking to build larger indoor cannabis cultivation facilities in all regulated markets, with special focus in California and Canada. In Canada, medicinal use of cannabis is federally legal, and the Canadian federal government recently legalized recreational use effective October 2018. On June 26, 2018, Oklahoma voters approved a medical cannabis ballot initiative. We also believe that Michigan will offer opportunities in 2018 as the state attempts to move to a recreational use regulated market, with the second-largest medical cannabis patient base in the U.S. In November 2018, voters in Michigan will consider an initiative legalizing and regulating recreational use of cannabis. Utah voters will also decide on a medical cannabis ballot measure in November 2018.

 

During the three months ended June 30, 2018, we entered into sales orders for 12 projects, each with a sales value over $100,000, which we refer to as commercial-scale projects. These commercial-scale projects represented aggregate net bookings of $4,145,000 for the three months ended June 30, 2018. For the six months ended June 30, 2018, we entered into sales orders for 23 commercial-scale projects with aggregate net bookings of $8,584,000. This compares to 21 commercial-scale projects representing aggregate net bookings of $6,749,000 for the year ended December 31, 2017. The California and Canadian markets each showed signs of strength for us through the first half of 2018, and we expect this trend to continue through the remainder of 2018. The following table sets forth our net bookings of commercial-scale projects for each cohort period presented (meaning, the commercial-scale contracts executed during each period for which we received an initial deposit, adjusted for any change orders or cancellations for that cohort group to date) by country/state.

 

   

For the Six Months Ended

June 30, 2018

     

For the Year Ended

December 31, 2017

 
    Number of New Commercial-Scale Projects     Total Commercial-Scale Project Net Bookings     Average Commercial-Scale Project Net Bookings       Number of New Commercial-Scale Projects     Total Commercial-Scale Project Net Bookings     Average Commercial-Scale Project Net Bookings  
Canada     6     $ 2,125,613     $ 354,269         7     $ 3,302,917     $ 471,845  
California     7     $ 2,063,184     $ 294,741         1     $ 262,336     $ 262,336  
Colorado     -     $ -     $ -         3     $ 421,948     $ 140,649  
Arizona     -     $ -     $ -         3     $ 785,547     $ 261,849  
Oregon     1     $ 370,898     $ 370,898         2     $ 403,365     $ 201,682  
Washington     3     $ 1,844,277     $ 614,759         1     $ 170,976     $ 170,976  
Massachusetts     1     $ 594,748   $ 594,748         -     $ -     $ -  
Ohio     1     $ 135,860     $ 135,860         -     $ -     $ -  
Alaska     -     $ -     $ -         1     $ 297,500     $ 297,500  
Rhode Island     -     $ -     $ -         1     $ 227,680     $ 227,680  
Nevada     -     $ -     $ -         1     $ 556,950     $ 556,950  
Texas     -     $ -     $ -         1     $ 319,557     $ 319,557  
Michigan