Notes
to Consolidated Financial Statements
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,
light, 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 unique 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
preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United
States of America (“GAAP”) requires management to make estimates and assumptions that affect reported amounts and
related disclosures. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary
for a fair presentation have been included.
The
accompanying consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business. The Company has not generated sufficient revenue
and has funded its operating losses through the sale of common stock and the issuance of debt. The Company is subject to risks,
expenses and uncertainties similar to those encountered by similarly situated companies. See Note 3.
Basis
of Consolidation and Reclassifications
The
consolidated financial statements include the accounts of the Company and its controlled and wholly-owned subsidiary, Hydro Innovations,
LLC (“Hydro”). Intercompany transactions, profit, and balances are eliminated in consolidation.
The
Company has reclassified certain salaries related to marketing personnel from selling, general and administrative expense to advertising
and marketing expenses in 2016 to conform to the Company’s presentation of such marketing personnel salaries in 2017. These
reclassifications have been applied consistently to the periods presented and had no impact on net loss, total assets and liabilities,
or equity.
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.
Cash
and Cash Equivalents
All
highly liquid investments with original maturities of three months or less at the date of purchase are considered to be cash equivalents.
The Company may, from time to time, have deposits in financial institutions that exceed the federally insured amount.
Surna
Inc.
Notes
to Consolidated Financial Statements
Accounts
Receivable and Allowance for Doubtful Accounts
Accounts
receivables are recorded at the invoiced amount, or based on revenue earned for items not yet invoiced, and generally do
not bear interest. An allowance for doubtful accounts is established, as necessary, based on past experience and other factors,
which, in management’s judgment, deserve current recognition in estimating bad debts. Based on its review, the Company establishes
or adjusts the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2017 and
2016, the allowance for doubtful accounts was $105,267 and $91,000, respectively.
Inventory
Inventory
is stated at the lower of cost or market. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower
of cost or market is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments
to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolescence or impaired
inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for that inventory is established
and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost
basis. As of December 31, 2017 and 2016, the allowance for excess and obsolete inventory was $323,384 and $47,369, respectively.
Property
and Equipment
Property
and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation
are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings.
For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over
their estimated useful lives, which is generally five years. Leasehold improvements are amortized on a straight-line basis over
the lesser of their useful lives or the life of the lease. Upon sale or retirement of assets, the cost and related accumulated
depreciation and amortization are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance
and repairs are charged to operations as incurred.
Long-lived
tangible assets, including property and equipment, are reviewed for impairment whenever events or changes in business circumstances
indicate the carrying value of the assets may not be recoverable. When such an event occurs, management determines whether there
has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset’s carrying value.
If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash
flows or appraised value, depending on the nature of the asset. The Company has not identified any such impairment losses to date.
Goodwill
and Intangible Assets
The
Company recorded goodwill in connection with its acquisition of Hydro in July 2014. Goodwill is reviewed for impairment annually
or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to
less than its carrying value. The Company performs a quantitative impairment test annually during the fourth quarter by comparing
the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds
its carrying amount, goodwill is considered not impaired. An impairment charge would be recognized for the amount by which the
carrying amount exceeds the reporting unit’s fair value. The Company completed this assessment as of December 31, 2017,
and concluded that no impairment existed.
Separable
identifiable intangibles consist of intellectual property such as patents and trademarks, and capitalized website costs. Except
for trademarks which are not amortized, the Company’s separable identifiable intangible assets are subject to amortization
on a straight-line basis over their estimated useful lives. Separable identifiable intangibles are also subject to evaluation
for potential impairment if events or circumstances indicate the carrying value may not be recoverable.
Fair
Value Measurement
The
Company records its financial assets and liabilities at fair value. The accounting standard for fair value provides a framework
for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants at the reporting date. The accounting standard establishes a three-tier hierarchy, which
prioritizes the inputs used in the valuation methodologies in measuring fair value:
Surna
Inc.
Notes
to Consolidated Financial Statements
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 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.
As
of December 31, 2017 and 2016, the Company had outstanding warrants to purchase common stock that were issued in connection with
Series 3 convertible notes (“Series 3 Warrants”) that provided for a reduction in the exercise price of the warrants
in the event the Company issued common stock in a registered offering at a price below the exercise price. See Note 11. 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. See Note 11 for a discussion of the impact the derivative financial instruments had on the Company’s consolidated
financial statements and results of operations.
Financial
liabilities carried at fair value, measured on a recurring basis were as follows:
|
|
As
of December 31, 2017
|
|
|
As
of December 31, 2016
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair Value
|
|
|
Gain
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair Value
|
|
|
(Loss)
(1)
|
|
Financial
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities - conversion feature
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(200,083
|
)
|
Derivative
liabilities - warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
410,880
|
|
|
|
410,880
|
|
|
|
66,934
|
|
|
|
-
|
|
|
|
-
|
|
|
|
477,814
|
|
|
|
477,814
|
|
|
|
(338,622
|
)
|
Total
financial liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
410,880
|
|
|
$
|
410,880
|
|
|
$
|
66,934
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
477,814
|
|
|
$
|
477,814
|
|
|
$
|
(538,705
|
)
|
|
|
(1)
The loss on change in derivative liabilities of $538,705 presented in the statement of operations for the year ended December
31, 2016 also includes gains on derivatives associated with convertible promissory note balances outstanding at various dates
during the year ended December 31, 2016, which were converted to common stock prior to December 31, 2016.
|
The
change in the balance of the warrant derivative liabilities during the years ended December 31, 2017 and 2016 was calculated using
the Black-Scholes Option Pricing Model (the “Black-Scholes Model”), which is classified as gain (loss) on change in
warrant derivative liabilities in the consolidated statements of operations. The Black-Scholes Model does take into consideration
the Company’s stock price, historical volatility, and the risk-free interest rate, which do have observable Level 1 or Level
2 inputs.
During
the year ended December 31, 2016, the Company converted all of the Series 3 and 4 convertible promissory notes issued in 2015
into common stock, which gave rise to the fair value liabilities for the embedded conversion features. See Note 11. At conversion,
the balance of the derivative liability of $673,050 was credited to additional paid in capital in the consolidated balance sheet.
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. As of December 31, 2017, the Company concluded that no indicators of impairment
relating to intangible assets or goodwill existed and an interim test was not performed.
Surna
Inc.
Notes
to Consolidated Financial Statements
Due
to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued
expenses, approximate fair value.
Derivative
Financial Instruments
The
Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify
as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument
is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported
in the statements of operations. For stock-based derivative financial instruments, the Company uses the Black-Scholes Model to
value the derivative instruments. The classification of derivative instruments, including whether such instruments should be recorded
as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified
in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could
be required within 12 months of the balance sheet date.
The
Company determined that the Series 3 Warrants qualified as derivative financial instruments. Accordingly, the Series 3 Warrants
are derivative liabilities and are marked to market at the end of each reporting period. Any change in fair value during the period
is recorded in as gain (loss) on change in derivative liabilities in the Company’s consolidated statements of operations.
Revenue
Recognition
The
Company recognizes revenue from the sale of its manufactured products as well as from products manufactured by third-party suppliers,
which are typically drop-shipped to the Company’s customer. The principal markets for the Company’s products are the
U.S. and Canada. Revenue is recognized when products are shipped and title passes to the customer, provided that persuasive evidence
of an arrangement exists, the price is fixed or determinable, and collection of the resulting receivable is reasonably assured.
Sales of the Company’s products are not subject to regulatory requirements that vary from state to state. The Company generally
does not provide its customers with a contractual right of return. In certain cases, the Company provides engineering services
in connection with the sale of its products and recognizes revenue from such engineering services as the performance of such services
occur. Management believes that all relevant criteria and conditions are considered when recognizing revenue.
The
Company provides climate control equipment and engineering design services for the controlled environment agriculture industry
with contract terms typically less than one year. Advance payments received from customers are included in deferred revenue, a
component of current liabilities, until such time that all criteria are met, as noted above, and revenue is recognized.
Sales
arrangements sometimes involve delivering multiple elements, including engineering services and multiple items of equipment. In
these instances, revenue is assigned to each element based on vendor-specific objective evidence, third-party evidence or a management
estimate of the relative selling price. Revenue is recognized individually for delivered elements only if they have value to the
customer on a stand-alone basis and the performance of the undelivered items is probable and substantially in the Company’s
control, or the undelivered elements are inconsequential or perfunctory and there are no unsatisfied contingencies related to
payment. The majority of these deliverables are tangible products, such as equipment, with a relatively smaller portion attributable
to engineering services. The Company does not provide any separate maintenance. Generally, contract duration is less than one-year
and cancellation, termination or refund provisions apply only in the event of contract breach.
The
Company typically charges its customers for shipping and handling, which is included in revenue. Shipping and handling costs are
reported within cost of revenue in the consolidated statements of operations.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
following table sets forth the Company’s revenue by source:
|
|
2017
|
|
|
2016
|
|
Equipment
|
|
$
|
6,255,150
|
|
|
$
|
6,787,348
|
|
Engineering services
|
|
|
588,849
|
|
|
|
537,020
|
|
Shipping and handling
|
|
|
238,908
|
|
|
|
207,650
|
|
Other revenue
|
|
|
127,334
|
|
|
|
47,845
|
|
Total revenue
|
|
$
|
7,210,241
|
|
|
$
|
7,579,863
|
|
The
Company accounts for sales taxes and other related taxes on a net basis, excluding such taxes from revenue.
Product
Warranty
The
Company warrants the products that it manufactures for a warranty period equal to the lesser of 12 months from start-up or 18
months from shipment. The Company’s warranty provides for the repair, rework, or replacement of products (at the Company’s
option) that fail to perform within stated specification. The Company’s third-party suppliers also warrant their products
under similar terms, which are passed-through to the Company’s customers.
The
Company assesses the historical warranty claims on its manufactured products and, since 2016, warranty claims have been approximately
1% of annual revenue generated on these products. The Company continues to assess the need to record a warranty reserve at the
time of sale based on historical claims and other factors. As of December 31, 2017 and 2016, the Company had an accrued warranty
reserve amount of $105,122 and $85,000, respectively, which are included in accounts payable and accrued liabilities on
the Company’s consolidated balance sheets.
Concentrations
Two
customers accounted for 12% and 11% of the Company’s revenue for the year ended December 31, 2017. Two customers accounted
for 14% and 10% of the Company’s revenue for the year ended December 31, 2016.
The
Company’s accounts receivable from three customers made up 52%, 17% and 17%, respectively, of the total balance as of December
31, 2017. The Company’s accounts receivable from two customers made up 39% and 29% of the total balance as of December 31,
2016.
Two
suppliers accounted for 35% and 10% of the Company’s purchases of inventory for the year ended December 31, 2017 and 41%
and 10% of the Company’s purchases of inventory for the year ended December 31, 2016.
Product
Development
The
Company expenses product development costs as incurred. Internal product development costs are expensed as incurred, and third-party
product developments costs are expensed when the contracted work has been performed or as milestone results have been achieved.
For the years ended December 31, 2017 and 2016, the Company incurred $319,680 and $349,062, respectively, on product development.
Accounting
for Share-Based Compensation
The
Company recognizes the cost resulting from all share-based compensation arrangements, including stock options, restricted stock
awards and restricted stock units that the Company grants under its equity incentive plan in its consolidated financial statements
based on their grant date fair value. 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.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
grant date fair value of stock options is based on the Black-Scholes Model. The Black-Scholes Model requires judgmental assumptions
including volatility and expected term, both based on historical experience. The risk-free interest rate is based on U.S. Treasury
interest rates whose term is consistent with the expected term of the option.
The
grant date fair value of restricted stock and restricted stock units is based on the closing price of the underlying stock on
the date of the grant.
Share-based
compensation expense is reduced 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 their fair value on the measurement date and are subject to periodic adjustment
as the underlying share-based awards vest.
Share-based
payments to employees, directors and non-employees totaled $2,139,865 and $4,386 for the years ended December 31, 2017 and 2016,
respectively.
Share-based
compensation costs are classified in the Company’s consolidated financial statements in the same manner as if such compensation
was paid in cash. The following is a summary of share-based compensation costs included in the Company’s consolidated statements
of operations for the years ended December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Share-based compensation expense included
in:
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
$
|
75,255
|
|
|
$
|
-
|
|
Advertising and marketing expenses
|
|
|
16,377
|
|
|
|
-
|
|
Product development costs
|
|
|
5,956
|
|
|
|
-
|
|
Selling, general
and administrative expenses
|
|
|
2,042,277
|
|
|
|
4,386
|
|
Total share-based
compensation expense included in consolidated statement of operations
|
|
$
|
2,139,865
|
|
|
$
|
4,386
|
|
Income
Taxes
The
Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets
and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under
this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial
statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are
expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the
period that includes the enactment date.
The
Company recognizes deferred tax assets to the extent that the Company believes that these assets are more likely than not to be
realized. In making such a determination, the Company considers all available positive and negative evidence, including future
reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of
recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess
of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would
reduce the provision for income taxes.
The
Company records uncertain tax positions on the basis of a two-step process in which: (i) the Company determines whether it is
more likely than not that the tax positions will be sustained on the basis of the technical merits of the position, and (ii) for
those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax
benefit that is more likely than not to be realized upon ultimate settlement with the related tax authority.
Surna
Inc.
Notes
to Consolidated Financial Statements
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 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. See Note 3.
Segment
Information
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by the Company’s senior management team in deciding how to allocate resources and in assessing performance. The
Company has one operating segment that is dedicated to the manufacture and sale of its products.
Recently
Adopted Accounting Pronouncements
On
January 1, 2017, the Financial Accounting Standards Board (“FASB”) adopted Accounting Standards Update
(“ASU”) 2016-09,
Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
.
As required by the standard, excess tax benefits and deficiencies recognized on share-based compensation expense are recorded
in the consolidated statement of comprehensive income as a component of income tax expense. Previously, these amounts were recorded
as a component of additional paid-in capital on the consolidated balance sheet. The Company elected to apply the change in presentation
to the consolidated statement of cash flows prospectively to classify excess tax benefits as an operating activity rather than
a financing activity. Upon adoption, the Company determined that it did not have previously unrecognized excess tax benefits to
be recognized on a modified retrospective transition method as an adjustment to retained earnings. The Company will continue to
classify cash paid related to shares withheld to satisfy tax-withholding requirements as a financing activity, as required by
the standard. The Company made a policy election to account for forfeitures as they occur, rather than estimating the expected
forfeitures over the course of the vesting period. ASU 2016-09 also requires that excess tax benefits and deficiencies be prospectively
excluded from assumed future proceeds in the calculation of diluted weighted average shares when calculating diluted earnings
per share utilizing the treasury stock method. The Company applied this change prospectively, and it did not have a material impact
on the Company’s consolidated financial statements.
During
the first quarter of 2017, the Company early adopted ASU 2017-04,
Intangibles – Goodwill and Other: Simplifying the Test
for Goodwill Impairment (Topic 350)
, which simplifies the goodwill impairment test by eliminating step 2, which is the step
requiring companies to perform a hypothetical purchase price allocation to measure goodwill. Instead, under the new standard,
impairment will be measured using the difference between the fair value of a reporting unit with its carrying amount. Any impairment
charge will be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, taking into
consideration income tax effects from any deductible goodwill on the carrying amount of the reporting unit. This standard was
applied prospectively. The adoption did not have a material effect on the Company’s consolidated financial statements or
related disclosures.
Surna
Inc.
Notes
to Consolidated Financial Statements
In
July 2015, the FASB issued ASU 2015-11,
Inventory (Topic 330)
-
Simplifying the Measurement of Inventory,
which
simplifies the subsequent measurement of inventories by replacing the lower of cost or market test with a lower of cost and net
realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out
(LIFO) and the retail inventory method. The guidance in the ASU is effective for fiscal years beginning after December 15, 2016
and early adoption is permitted. The Company adopted the ASU in the first quarter of fiscal 2017. The adoption of the ASU in the
first quarter of fiscal 2017 did not impact the Company’s financial position or results of operations.
Recently
Issued Accounting Pronouncements
In
July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2017-11,
(Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite
Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling
Interests with a Scope Exception
. The new standard applies to issuers of financial instruments with down-round features. A
down-round provision is a term in an equity-linked financial instrument (i.e. a freestanding warrant contract or an equity conversion
feature embedded within a host debt or equity contract) that triggers a downward adjustment to the instrument’s strike price
(or conversion price) if equity shares are issued at a lower price (or equity-linked financial instruments are issued at a lower
strike price) than the instrument’s then-current strike price. The purpose of the feature is typically to protect the instrument’s
counterparty from future issuances of equity shares at a more favorable price. The ASU amends (1) the classification of such instruments
as liabilities or equity by revising the certain guidance relative to evaluating if they must be accounted for as derivative instruments
and (2) the guidance on recognition and measurement of freestanding equity-classified instruments. This ASU is effective January
1, 2019, with early adoption permitted. The Company is currently evaluating the impact of this new accounting guidance on its
consolidated results of operations and financial condition.
In
May 2017, the FASB issued ASU No. 2017-09,
Compensation – Stock Compensation (Topic 718) – Scope of Modification
Accounting
, to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification.
Under the new standard, modification is required only if the fair value, the vesting conditions, or the classification of an award
as equity or liability changes as a result of the change in terms or conditions. The amendments are effective for all entities
for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and will be applied
prospectively. Early adoption is permitted. The Company does not believe the adoption of this new accounting guidance will have
a material impact on its consolidated results of operations, cash flows and financial position.
In
June 2016, the FASB issued ASU 2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
. The amendments within ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP
with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable
information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including
interim periods within those fiscal years. Entities may early adopt the amendments within this ASU but not prior to the fiscal
years beginning after December 15, 2018, including the interim periods within those fiscal years. 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 issued 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.
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.
In
May 2014, the FASB issued ASU 2014-09 (Topic 606),
Revenue from Contracts with Customers
. The new revenue recognition standard
supersedes all existing revenue recognition guidance. Under ASU 2014-09, an entity must recognize revenue relating to contracts
with customers that depicts the transfer of promised goods or services to customers in an amount reflecting the consideration
to which the entity expects to be entitled in exchange for such goods or services. In order to meet this requirement, the entity
must apply the following steps: (i) identify the contracts with the customers; (ii) identify performance obligations in the contracts;
(iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations per the contracts; and
(v) recognize revenue when (or as) the entity satisfies a performance obligation. Additionally, disclosures required for revenue
recognition will include qualitative and quantitative information about contracts with customers, significant judgments and changes
in judgments, and assets recognized from costs to obtain or fulfill a contract. This guidance is effective for the Company beginning
in the first quarter of 2018.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
new guidance allows for two transition methods in application: (i) retrospective to each prior reporting period presented, or
(ii) prospective with the cumulative effect of adoption recognized on January 1, 2018, also known as the modified retrospective
approach. The Company intends to adopt the standard using the modified retrospective approach, which will result in an adjustment
to accumulated deficit for the cumulative effect of applying this guidance to contracts in process as of the adoption date. Under
this approach, prior financial statements presented will not be restated. This guidance requires additional disclosures of the
amount by which each financial statement line item affected in the current reporting period during 2018 as compared to the guidance
that was in effect before the change, and an explanation of the reasons for the significant changes.
The
Company is finalizing implementation activities in accordance with the planned effective date. These activities are focused on
the review of significant customer contracts and the design and implementation of relevant internal controls. The Company believes
that the new standard will not materially change the timing of revenue recognition. The Company also believes that this new guidance
will not have a material impact on its consolidated results of operations, cash flows and financial position.
Note
3 – Going Concern
The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern,
which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The
Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $4,919,000 for
the year ended December 31, 2017, and had an accumulated deficit of approximately $19,255,000 as of December 31, 2017. Since inception,
the Company has financed its activities principally through debt and equity financing. Management expects to incur additional
losses and cash outflows in the foreseeable future in connection with development of 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, 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. To support the Company’s financial
performance, management undertook several initiatives during 2017, including:
|
●
|
In
the first quarter of 2017, the Company converted promissory notes with an original principal amount of $510,000, together
with accrued interest of $134,553, in exchange for 5,001,554 shares of the Company’s common stock;
|
|
|
|
|
●
|
In
the second quarter of 2017, the Company amended certain promissory notes, each in the original principal amount of $268,750,
to provide for the conversion of such notes into 2,800,000 shares, or 5,600,000 shares in the aggregate;
|
|
|
|
|
●
|
In
the first quarter of 2017, the Company also issued 16,781,250 investment units to accredited investors for gross proceeds
of $2,685,000, with each unit consisting one share of common stock and a warrant to purchase one share of common stock (the
“Q1 2017 Unit Offering”); and
|
|
|
|
|
●
|
In
the fourth quarter of 2017, the Company issued 14,734,000 investment units to accredited investors for gross proceeds of $1,768,000,
with each unit consisting one share of common stock and a warrant to purchase one share of common stock (the “Q4 2017
Unit Offering”).
|
The
warrants issued under the Q1 2017 Unit Offering and the Q4 2017 Unit Offering have an exercise price of $0.26 and $0.20 per share,
respectively, and are callable at the Company’s option under conditions. Depending on the market price of the Company’s
common stock, these warrants may provide an additional source of capital if they are exercised by the holder. As of January 29,
2018, the call conditions with respect to the warrants issued under the Q4 2017 Unit Offering were satisfied, however, the Company
has not yet elected to call such warrants.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
Company also adopted the 2017 Equity Incentive Plan (the “2017 Equity Plan”) which allows the Company to grant equity-based
awards to attract, motivate, retain, and reward employees, directors and consultants, while permitting the Company preserve its
cash resources.
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 consolidated financial statements do not include any adjustment
that might result from the outcome of this uncertainty.
Note
4 – Inventory
Inventory
consisted of the following:
|
|
As
of December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Finished goods
|
|
$
|
569,047
|
|
|
$
|
591,564
|
|
Work in progress
|
|
|
14,348
|
|
|
|
16,518
|
|
Raw materials
|
|
|
262,611
|
|
|
|
187,192
|
|
Allowance for
excess & obsolete inventory
|
|
|
(323,384
|
)
|
|
|
(47,369
|
)
|
Inventory, net
|
|
$
|
522,622
|
|
|
$
|
747,905
|
|
Overhead
expenses of $28,554 and $26,764 were included in the inventory balance as of December 31, 2017 and 2016, respectively.
Note
5 – Property and Equipment
Property
and equipment consisted of the following:
|
|
As
of December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Furniture and equipment
|
|
$
|
326,894
|
|
|
$
|
171,709
|
|
Equipment held for lease to related
party
|
|
|
159,806
|
|
|
|
-
|
|
Molds
|
|
|
-
|
|
|
|
31,063
|
|
Vehicles
|
|
|
15,000
|
|
|
|
15,000
|
|
Leasehold
Improvements
|
|
|
33,257
|
|
|
|
38,101
|
|
|
|
|
534,957
|
|
|
|
255,873
|
|
Accumulated
depreciation
|
|
|
(133,601
|
)
|
|
|
(162,308
|
)
|
Property and
equipment, net
|
|
$
|
401,356
|
|
|
$
|
93,565
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
Depreciation
expense amounted to $39,978 for the year ended December 31, 2017, of which $8,302 was allocated to cost of revenue. Depreciation
expense amounted to $47,773 for the year ended December 31, 2016, of which $8,349 was allocated to cost of revenue and inventory.
As
of December 31, 2017, the Company has recorded $159,806 for the cost of the equipment located at the Sterling facility as leased
equipment under fixed assets. See Note 8.
Note
6 – Intangible Assets
Intangible
assets consisted of the following:
|
|
As
of December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Patents
|
|
$
|
29,952
|
|
|
$
|
24,192
|
|
Website development costs
|
|
|
22,713
|
|
|
|
22,713
|
|
Trademarks
|
|
|
1,830
|
|
|
|
1,099
|
|
|
|
|
54,495
|
|
|
|
48,004
|
|
Accumulated amortization
|
|
|
(16,510
|
)
|
|
|
(11,623
|
)
|
Intangible assets,
net
|
|
$
|
37,985
|
|
|
$
|
36,381
|
|
Patents
when issued are amortized over 14 years, and web site development costs are amortized over five years. Trademarks are not amortized
since they have an indefinite life. Amortization expense for intangibles amounted to $4,887 and $5,311 for the years ended December
31, 2017 and 2016, respectively.
Note
7 – Accounts Payable and Accrued Liabilities
Accounts
payable and accrued liabilities consisted of the following:
|
|
As
of December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Accounts payable
|
|
$
|
1,159,975
|
|
|
$
|
1,020,224
|
|
Sales commissions payable
|
|
|
21,931
|
|
|
|
40,736
|
|
Sales tax payable
|
|
|
8,750
|
|
|
|
23,631
|
|
Accrued payroll liabilities
|
|
|
58,557
|
|
|
|
43,573
|
|
Product warranty accrual
|
|
|
105,122
|
|
|
|
85,000
|
|
Commercial dispute settlement
|
|
|
332,418
|
|
|
|
-
|
|
Other accrued expenses
|
|
|
282,510
|
|
|
|
124,689
|
|
Total
|
|
$
|
1,969,263
|
|
|
$
|
1,337,853
|
|
As
of December 31, 2017, the Company reclassified $322,776 from previously recorded deferred revenue and recorded a loss of $9,642
in connection with the settlement of a commercial dispute. See Note 18.
Note
8 – 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. Stephen Keen is a principal shareholder of the Company and was a former executive officer
and director, and is now a consultant to the Company (see below). Brandy Keen, the wife of Stephen Keen, is also a principal shareholder
of the Company and has been, and currently serves as, an executive officer and director of the Company. On April 15, 2016, the
Keens and the Company entered into an amendment to the original Hydro Note under which the Company made a payment of $100,000
in April 2016, which resulted in the reduction of the outstanding balance from $194,514 to $94,514. Additionally, pursuant to
the amendment, the Company was not obligated to make further payments until July 2016, at which time, the Company would resume
monthly payments equal to $5,000 per month until the Hydro Note was paid in full. As part of the amendment, the parties also agreed
that the Hydro Note no longer had to be paid in full by July 18, 2016 and that no default had occurred. The interest rate is 6%
per annum. As of December 31, 2017, the Hydro Note had a balance of $6,927, which is reflected on the balance sheet as a current
liability. As of December 31, 2016, the Hydro Note had a balance of $69,383, of which $57,398 and $11,985 were reflected on the
Company’s consolidated balance sheet as a current and long-term liability, respectively. Subsequent to December 31, 2017,
the balance of the Hydro Note was paid in full.
Surna
Inc.
Notes
to Consolidated Financial Statements
As
of December 31, 2015, there was a deferred compensation balance of $25,600 due to Stephen and Brandy Keen, which was paid in full
during 2016.
Stephen
Keen Consulting Agreement
On
May 10, 2017, the Board approved a three-year consulting agreement between the Company and Stephen Keen, a principal shareholder
of the Company and a former executive officer and director. Under the consulting agreement, Stephen Keen will 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. The consulting agreement also includes certain activity restrictions which prohibit Stephen
Keen from competing with the Company. In connection with the execution of this consulting agreement, Stephen Keen’s employment
with the Company ceased as of April 28, 2017 and he resigned as a director of the Company on May 10, 2017. Pursuant to the terms
of this consulting agreement, the Company recorded consulting fees of $20,000 payable to Stephen Keen during 2017.
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 Stephen Keen, which operates a Colorado-regulated cannabis cultivation
facility currently under construction. 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. 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.
As
of December 31, 2017, Sterling Pharms had accepted substantially all the equipment under this agreement, but is in the process
of completing the installation of the equipment. Pursuant to the terms of this agreement, the respective payments will begin upon
the delivery and installation of the equipment. As of December 31, 2017, the Company has recorded $159,806 for the cost of the
equipment located at the Sterling facility as equipment held for lease to related party in fixed assets. Upon commencement of
the respective payments under this agreement, the Company intends to record the $16,500 quarterly fee for use of the equipment
as other income and to depreciate the cost of the leased equipment over the term of this agreement. The Company’s quarterly
fee payable to Sterling will be charged equally between marketing and product development expense.
During
the fourth quarter of 2017, the Company and Sterling agreed to revise the equipment schedule to the original agreement to include
additional equipment purchased by the Company at a cost of $23,580.
Subsequent
to December 31, 2017, at the request of Sterling, the Company purchased additional equipment at a cost of $7,687 to be included
in the equipment schedule to the original agreement. On March 22, 2018, the Company and Sterling entered into an amendment of
the original agreement to include the additional leased equipment as discussed above 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. See Note 18.
Surna
Inc.
Notes
to Consolidated Financial Statements
Separately,
Sterling purchased equipment from the Company unrelated to this agreement for $78,310, which represented the Company’s cost.
Note
9 – Promissory Notes
On
February 9, 2017, the Company entered into a securities purchase agreement with two accredited investors pursuant to which the
Company issued promissory notes in the aggregate original principal amount of $537,500. In addition, each investor received 125,000
shares, an aggregate of 250,000 shares, of the Company’s common stock. The notes were unsecured, had an interest rate of
6%, per annum and were originally due and payable, with all accrued interest, on November 9, 2017. The total proceeds were approximately
$500,000 with an original issue discount of approximately $37,500. The Company allocated the cash proceeds amount between the
debt and shares issued on a relative fair value basis. Based on relative fair value, the Company allocated approximately $461,000
and $39,000 to the promissory notes and the shares of common stock, respectively. The original issue discount of $37,500 and fair
value of the shares issued of $39,000 were amortized and expensed over the life of the loans.
On
August 8, 2017, the Company executed an amendment (the “Amendment”) with the holders of the promissory notes, each
in the original principal amount of $268,750. The Amendment provided for each of the holder’s notes to convert its principal
into 2,800,000 shares, or 5,600,000 shares in the aggregate, of the Company’s common stock, at a price per share of approximately
$0.096. The Company’s closing share price on August 7, 2017 was $0.135. In connection with this Amendment, the holders also
agreed to surrender to the Company the portion of the promissory notes representing the accrued interest as the consideration
for this Amendment, which approximated $15,900 in total. The transactions contemplated by the Amendment closed on August 22, 2017.
The
Company has accounted for the Amendment as debt extinguishment whereby the difference between the reacquisition price of the debt
and the net carrying amount of the extinguished debt was recognized as a loss during the third quarter of 2017. The following
details the calculation of the loss on extinguishment of the notes payable:
Carrying amount of debt
|
|
|
|
Principal converted
|
|
$
|
537,500
|
|
Accrued interest converted
|
|
|
15,904
|
|
Unamortized debt
discount
|
|
|
(25,832
|
)
|
Total carrying
amount of debt
|
|
|
527,572
|
|
Reacquisition price of debt
|
|
|
|
|
Fair value of shares of common
stock issued
|
|
|
756,000
|
|
Loss
on extinguishment of debt
|
|
$
|
(228,428
|
)
|
During
the year ended December 31, 2017, the amortization expense related to the debt discount was $49,997.
Surna
Inc.
Notes
to Consolidated Financial Statements
Note
10 – Convertible Notes
The
following table summarizes the convertible promissory notes for the years ended December 31, 2017 and 2016:
|
|
Series
2
|
|
|
Series
3
|
|
|
Series
4
|
|
|
Total
|
|
Balance January 1, 2016
|
|
$
|
2,536,250
|
|
|
$
|
711,000
|
|
|
$
|
103,273
|
|
|
$
|
3,350,523
|
|
Additions
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Conversions
|
|
|
(1,756,250
|
)
|
|
|
(711,000
|
)
|
|
|
(103,273
|
)
|
|
|
(2,570,523
|
)
|
Balance December 31, 2016
|
|
$
|
780,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
780,000
|
|
Discounts and
deferred finance charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18,560
|
)
|
Convertible notes payable, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
761,440
|
|
Less current portion - December
31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
761,440
|
|
Long-term portion - December 31,
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance January 1, 2017
|
|
$
|
780,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
780,000
|
|
Conversions
|
|
|
(510,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(510,000
|
)
|
Repayments
|
|
|
(270,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(270,000
|
)
|
Balance December 31, 2017
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Series
2 Convertible Notes
In
October 2014, the Company offered up to 60 investment units at a price per unit of $50,000. Each unit consisted of (i) 250,000
shares of the Company’s common stock, (ii) a $50,000 10% convertible promissory note (“Series 2 Convertible Note”),
and (iii) warrants for the purchase of 50,000 shares of the Company’s common stock (Series 2 Warrants”). The Series
2 Convertible Notes: (i) were unsecured, (ii) accrued interest at the rate of 10% per annum, and (iii) if not converted, were
due and payable two years from the date of issuance. The Series 2 Convertible Notes were convertible after 360 days from the issuance
date, at the investor’s option, into a number of shares of the Company’s common stock that was determined by dividing
the amount to be converted by the $0.60 conversion price. Additionally, the entire principal amount under the Series 2 Convertible
Notes would be automatically converted into common stock at a conversion price equal to the greater of $0.50 per share or 75%
of the public offering price per share, without any action by the investor, on the earlier of: (x) the date on which the Company
closed on a financing transaction involving the sale of the Company’s common stock at a price of no less than $2.00 per
share with gross proceeds to the Company of no less than $5,000,000, or (y) the date which is three days after the common stock
traded at a volume-weighted-average-price (“VWAP”) of at least $2.00 per share for a period of 10 consecutive trading
days. The Company raised $2,536,250 from the sale of these investment units.
The
gross proceeds from the sale of the Series 2 Convertible Notes were recorded net of a discount related to the conversion feature
of the embedded conversion option and the fair value of the Series 2 Warrants, each of which were calculated pursuant to the Black-Scholes
Model. The fair value of conversion feature and the Series 2 Warrants were recorded as a reduction to the Series 2 Convertible
Notes payable and were charged to operations as interest expense in accordance with the effective interest method within the term
of the Series 2 Convertible Notes. Transaction costs were apportioned to Series 2 Convertible Notes payable, common stock, Series
2 Warrants and derivative liabilities. The portion of transaction costs attributed to the conversion feature, warrants and common
stock were immediately expensed, because the derivative liabilities are accounted for at fair value through the statement of operations.
During
the year ended December 31, 2016 and the first quarter of 2017, the Company entered into note conversion and warrant amendment
agreements (each, an “Agreement” and together, the “Agreements”) to: (i) amend the Series 2 Convertible
Notes to reduce the conversion price and simultaneously cause the conversion of the outstanding amount under such Series 2 Convertible
Notes into shares of the Company’s common stock, and (ii) reduce the exercise price of the Series 2 Warrants. Each Agreement
has been privately negotiated so the terms vary.
Pursuant
to the Agreements, the Series 2 Convertible Notes were amended to reflect a reduced conversion price per share between $0.09 and
$0.22. Additionally, pursuant to the Agreements, the Series 2 Warrants were amended to reflect a reduced exercise price per share
between $0.30 and $0.35, except for one Series 2 Warrant to reflect a reduced exercise price of $0.15 per share. The term of one
Series 2 Warrant was also extended.
Surna
Inc.
Notes
to Consolidated Financial Statements
Pursuant
to the Agreements, during the year ended December 31, 2016, the Company converted Series 2 Convertible Notes with an aggregate
outstanding principal amount of $1,756,250, together with accrued interest of $399,063, in exchange for the issuance of 15,253,089
shares of the Company’s common stock. The exercise price of the Series 2 Warrants related to these converted notes was also
reduced.
Pursuant
to the Agreements, in the first quarter of 2017, the Company converted Series 2 Convertible Notes with an aggregate outstanding
principal amount of $510,000, together with accrued interest of $134,553, in exchange for the issuance of 5,001,554 shares of
the Company’s common stock. The exercise price of the Series 2 Warrants related to these converted notes was also reduced.
In
the first quarter of 2017, the Company also made payments of $314,150 to settle Series 2 Convertible Notes in the principal amount
of $270,000, together with accrued interest of $44,150. As of December 31, 2017, the Company had no Series 2 Convertible Notes
outstanding.
The
Company has accounted for the Agreements as debt extinguishment whereby the difference between the reacquisition price of the
debt and the net carrying amount of the extinguished debt was recognized as a loss during for the years ended December 31, 2017
and 2016. The following details the calculation of the loss on extinguishment of the Series 2 Convertible Notes:
|
|
For
the Year ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Carrying amount of
debt
|
|
|
|
|
|
|
|
|
Principal
converted
|
|
$
|
510,000
|
|
|
$
|
1,756,250
|
|
Accrued interest
converted
|
|
|
134,553
|
|
|
|
399,063
|
|
Unamortized
debt discount
|
|
|
(5,398
|
)
|
|
|
(51,208
|
)
|
Total
carrying amount of debt
|
|
|
639,155
|
|
|
|
2,104,105
|
|
Reacquisition price of debt
|
|
|
|
|
|
|
|
|
Fair value of shares of common stock
issued
|
|
|
995,155
|
|
|
|
2,346,240
|
|
Warrant modification
value
|
|
|
59,000
|
|
|
|
96,106
|
|
Total reacquisition
price of debt
|
|
|
1,054,155
|
|
|
|
2,442,346
|
|
Loss
on extinguishment of debt
|
|
$
|
(415,000
|
)
|
|
$
|
(338,241
|
)
|
During
the year ended December 31, 2017, the amortization expense related to the debt discount was $13,160.
As
of December 31, 2017, Series 2 Warrants to purchase 2,536,250 shares of common stock are outstanding. The exercise price varies
from a low of $0.15 to a high of $3.00 per share, with a weighted average exercise price of $0.45 per share.
Series
3 Convertible Notes
During
the third quarter of 2015, the Company entered into Securities Purchase Agreements with three accredited investors (each a “Purchaser”
and together the “Purchasers”), pursuant to which the Company sold and the Purchasers purchased convertible notes
(“Series 3 Convertible Notes”) with a one-year term in the aggregate original principal amount of $711,000, with an
aggregate original issue discount of $61,000, together with warrants to purchase up to an aggregate of 2,625,000 shares of the
Company’s common stock (“Series 3 Warrants”), for aggregate cash proceeds of $656,250. The Series 3 Convertible
Notes accrued interest a rate of 10% per annum, expect for Series 3 Convertible Notes in the principal amount of $106,000 which
had an interest rate of 11% per annum.
The
conversion price of the Series 3 Convertible Notes was equal to 80% of the lowest trading price of the Company’s common
stock as reported on the OTCQB for the 15 trading days prior to conversion. The Company determined that the Series 3 Convertible
Notes had an embedded conversion option that qualified for derivative accounting and bifurcation under ASC 815-40 and, as a result,
the Company recognized the fair value of the embedded conversion feature as a derivative liability upon issuance of the Series
3 Convertible Notes.
The
Series 3 Warrants have a five-year term and an exercise price of $0.25 per share, subject to adjustment. The Series 3 Warrants
may be exercised on a cashless basis. The Series 3 Warrants also provide 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 case, the exercise price under
the warrants would be reduced to the price of the common stock in the registered offering. The Company determined that this exercise
price reduction qualified as a derivative financial instrument.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
gross proceeds from the sale of the Series 3 Convertible Notes were recorded net of a discount related to the conversion feature
of the embedded conversion option and the fair value of the Series 3 Warrants, each of which were calculated pursuant to the Black-Scholes
Model. The fair value of conversion feature and the Series 3 Warrants were recorded as a reduction to the Series 3 Convertible
Notes payable and were charged to operations as interest expense in accordance with the effective interest method within the term
of the Series 3 Convertible Notes. Transaction costs were apportioned to Series 3 Convertible Notes payable, Series 3 Warrants
and derivative liabilities. The portion of transaction costs attributed to the conversion feature, warrants and common stock were
immediately expensed, because the derivative liabilities are accounted for at fair value through the statement of operations.
Upon
issuance of the Series 3 Convertible Notes, the Company determined a fair value of $1,023,881 for the derivative liabilities,
with the fair value of the warrants determined to be $246,020 and the fair value of the conversion feature determined to be $777,861.
The aggregate debt discount was amortized over the term of the Series 3 Convertible Notes.
During
the year ended December 31, 2016, the Company issued 15,598,870 shares of its common stock in connection with the conversion the
Series 3 Convertible Notes in the principal amount of $711,000 and accrued interest of $72,128.
As
of December 31, 2017, Series 3 Warrants to purchase 2,625,000 shares of common stock are outstanding.
Series
4 Convertible Note
On
December 18, 2015, the Company and the noteholder agreed to amend a certain secured promissory note issued in July 2015 which,
at the time of the amendment, had an outstanding principal balance of $100,273 together with accrued interest of $3,046. Pursuant
to the amendment, the maturity date was extended to from December 22, 2015 to April 30, 2016 and a conversion was added allowing
for conversion into shares of the Company’s common stock, at any time following the amendment, at a conversion price equal
to 70% of the lowest trading price of the Company’s common stock as reported on the OTCQB for the 20 trading days prior
to conversion (“Series 4 Convertible Note”).
The
Series 4 Convertible Note had an embedded conversion option that qualified for derivative accounting and bifurcation under GAAP.
The Company recognized the fair value of the embedded conversion feature as a derivative liability at the time of amendment. Since
the present value of the cash flows under the new debt instrument was at least ten percent different from the present value of
the remaining cash flows under the terms of the original debt instrument, the Company accounted for the amendment as a debt extinguishment.
During
the year ended December 31, 2016, the Company issued 2,289,958 shares of its common stock in connection with the conversion the
Series 4 Convertible Notes in the principal amount of $103,319 and accrued interest of $2,637.
Note
11 – Derivative Liabilities
The
Company determined that the Series 3 Warrants qualified as derivative financial instruments. Accordingly, the Series 3 Warrants
are derivative liabilities and are marked to market at the end of each reporting period. Any change in fair value during the period
is recorded in as gain (loss) on change in derivative liabilities in the Company’s consolidated statements of operations.
The
following table sets forth movement in the derivative liability related to the Series 3 Warrants:
Balance December 31, 2015
|
|
$
|
139,192
|
|
Loss on change
in derivative liability, net
|
|
|
338,622
|
|
Balance December 31, 2016
|
|
|
477,814
|
|
(Gain) on change
in derivative liability, net
|
|
|
(66,934
|
)
|
Balance December 31, 2017
|
|
$
|
410,880
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
During
the year ended December 31, 2016, the Company also had a loss on change in derivative liabilities of $200,083 associated with
certain convertible promissory note balances outstanding at various dates during the year ended December 31, 2016, which were
converted to common stock prior to December 31, 2016.
Note
12 – 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. 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 needs additional time to respond to the Company’s appeal, which response
is not expected until April 2018. 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 high. However, there can be no assurance of any abatement until
the IRS acts upon the appeal. See Note 17.
Building
Lease
The
Company had a lease agreement for its manufacturing and office space consisting of approximately 18,000 square feet during 2016,
which expired April 1, 2017. As the parties negotiated a new lease agreement in connection with the sale of the property to a
new landlord, the parties extended the then current lease until September 29, 2017. On June 27, 2017, the Company executed a new
lease, which commenced September 29, 2017 and continues through August 31, 2022. The Company occupied its same leased space for
$12,967 per month until January 1, 2018. On January 2, 2018, the leased space was expanded and the monthly rental rate increased
to $18,979 until August 31, 2018. Beginning September 1, 2018, the monthly rent will increase by 3% each year through the end
of the lease. Pursuant to the new lease, the Company made a security deposit of $51,000 on July 31, 2017 and is entitled to a
$100,000 tenant allowance for leasehold improvements. The Company has recorded leasehold improvements in progress of $7,285 as
of December 31, 2017, none of which had been reimbursed by the landlord under the tenant improvement allowance as of December
31, 2017. During the first quarter of 2016, the Company also rented additional space under a short-term lease. Rent expense under
these leases amounted to $218,926 and $210,957 for the years ended December 31, 2017 and 2016, respectively.
The
following is a schedule by years of the minimum future lease payments on the new building lease as of December 31, 2017.
Year
Ended December 31,
|
|
|
|
2018
|
|
$
|
230,025
|
|
2019
|
|
|
236,926
|
|
2020
|
|
|
244,034
|
|
2021
|
|
|
251,355
|
|
2022
|
|
|
170,888
|
|
Total future
minimum lease payments
|
|
$
|
1,133,228
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
Total
rent under the new 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 Company’s consolidated balance sheets.
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
13 – Preferred and Common Stock
Preferred
Stock
As
of December 31, 2017 and 2016, there were 77,220,000 shares of Series A preferred stock, par value $0.00001 per share, issued
and outstanding. The holders of Series A preferred stock have one vote per share of Series A preferred stock equivalent to one
vote of the Company’s common stock. The Series A preferred stock ranks senior to the Company’s common stock. The holders
of shares of Series A Preferred Stock are not entitled to receive dividends and have no conversion or preemptive rights. Upon
liquidation, dissolution or winding up of the Company’s business, after payment to the holders of any senior securities,
the holders of Series A preferred stock are entitled to receive a preferential cash payment per share of Series A preferred stock
equal to the stated value of the preferred stock, prior to any payment to the holders of common stock.
Common
Stock
During
the year ended December 31, 2017, the Company issued restricted shares of its common stock as follows:
|
●
|
5,001,554
shares of common stock were issued upon conversion of Series 2 Convertible Notes with a principal amount of $510,000, together
with accrued interest (see Note 10);
|
|
|
|
|
●
|
40,000
shares of common stock were issued to an employee as compensation;
|
|
|
|
|
●
|
250,000
shares were issued to two investors in connection with the Company’s issuance of certain promissory notes;
|
|
|
|
|
●
|
16,781,250
shares of common stock were issued to accredited investors in the Q1 2017 Unit Offering (see Note 14);
|
|
|
|
|
●
|
5,600,000
shares of common stock were issued to two investors upon conversion of certain promissory notes (see Note 9);
|
|
|
|
|
●
|
700,000
shares of common stock were issued to an independent director as an equity retention payment; and
|
|
|
|
|
●
|
14,734,000
shares of common stock were issued to accredited investors in the Q4 2017 Unit Offering (see Note 14).
|
During
the year ended December 31, 2017, the Company also issued shares of its common stock under the 2017 Equity Plan as follows:
|
●
|
216,009
shares of common stock were issued to independent directors in lieu of cash director fees;
|
|
|
|
|
●
|
600,000
shares of common stock were issued to a director as compensation for services prior to becoming a director;
|
Surna
Inc.
Notes
to Consolidated Financial Statements
|
●
|
1,200,000
shares were issued to an employee in connection with the execution of an employment agreement with the Company;
|
|
|
|
|
●
|
200,000
shares of common stock were issued to a consultant in settlement of vested restricted stock units; and
|
|
|
|
|
●
|
404,485
shares were issued to a consultant as compensation for services rendered in lieu of cash fees.
|
During
the year ended December 31, 2016, the Company issued restricted shares of its common stock as follows:
|
●
|
46,045
shares of common stock were issued to employees as compensation;
|
|
|
|
|
●
|
1,493,400
shares of common stock were issued upon the exercise of stock options;
|
|
|
|
|
●
|
15,253,089
shares of common stock were issued upon conversion of Series 2 Convertible Notes with a principal amount of $1,756,250 (see
Note 10); and
|
|
|
|
|
●
|
17,888,828
shares of common stock were issued upon conversion of the Series 3 and 4 Convertible Notes (see Note 10).
|
Note
14 – Unit Offerings
In
March 2017, the Company entered into a securities purchase agreement with certain accredited investors. The Company issued an
aggregate of 16,781,250 investment units, for aggregate gross proceeds of $2,685,000, or $0.16 per unit. Each unit consisted of
one share of the Company’s common stock and one warrant for the purchase of one share of the Company’s common stock
(“Q1 2017 Warrants”); however, one investor declined receipt of the warrant to purchase 468,750 shares of the Company’s
common stock.
Pursuant
to the Q1 2017 Warrants, the holder thereof may at any time on or after six months after the issuance date and on or prior to
the close of business on the date that is the third anniversary of the issuance date, purchase up to the number of shares of the
Company’s common stock as set forth in the respective warrant. The exercise price per share of the common stock under the
Q1 2017 Warrants is $0.26, subject to customary adjustments as provided in the warrant. Each Q1 2017 Warrant is callable at the
Company’s option commencing six months from the issuance date, provided the closing price of the Company’s common
stock is $0.42 or greater for five consecutive trading days. Commencing at any time after the date on which such call condition
is satisfied, the Company has the right, upon 30 days’ notice to the holder, to redeem the warrant shares at a price of
$0.01 per warrant share. The holder may exercise the warrant at any time (in whole or in part) prior to the redemption date at
the exercise price.
On
December 12, 2017, the Company completed a private placement offering of investment units, at a price of $0.12 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 (“Q4 2017 Warrants”). The Company issued a total of 14,734,000 units
for aggregate proceeds of $1,768,080.
The
Q4 2017 Warrants have an exercise price of $0.20 per share, subject to customary adjustments as provided in the warrant, and have
a term of three years. The Q4 2017 Warrants are callable at the Company’s option, provided the closing price of the Company’s
common stock is $0.36 or greater for five consecutive trading days. Commencing at any time after the date on which the call condition
is satisfied, the Company has the right, upon notice to the holders, to redeem the shares of common stock underlying each warrant
at a price of $0.01 per share, but such redemption may not occur earlier than sixty-one (61) days following the date of the receipt
of notice by the holder. The holder may exercise the warrant at any time (in whole or in part) prior to the redemption date at
the exercise price. The call condition with respect to the Q4 2017 Warrants was satisfied on January 29, 2018, however, the Company
has not elected to call such warrants.
As
of December 31, 2017, Q1 2017 Warrants to purchase 16,312,500 shares of common stock and Q4 2017 Warrants to purchase 14,734,000
shares of common stock are outstanding.
Surna
Inc.
Notes
to Consolidated Financial Statements
Note
15 – Equity Issued as Compensation for Services
Warrants
Issued to Former Director
Pursuant
to certain letter agreements dated May 26, 2017 and June 16, 2017, and in connection with the resignation of a former director,
the Company agreed to issue the former director three individual warrants to purchase: (i) 900,000 shares (“Warrant 1”),
(ii) 460,525 shares (“Warrant 2”), and (iii) 460,525 shares (“Warrant 3”) (collectively, the “Warrants”)
of the Company’s common stock for a period of five years. Warrant 1 was granted on June 20, 2017, is fully vested, and can
be exercised beginning December 21, 2017 at an exercise price of $0.114 per share with the option for a cashless exercise. Warrants
2 and 3 were granted on June 20, 2017, are fully vested, and can be exercised beginning December 21, 2017 at an exercise price
of $0.0005 per share with the option for a cashless exercise. The Company recorded $189,592 of compensation expense for the fair
value of the Warrants on the grant date. The fair value of the Warrants at the date of grant was determined using the Black-Scholes
Model. The assumptions used in the Black-Scholes Model were the term of the Warrants of 5 years, volatility rate of 119.96%, quarterly
dividends 0%, and a risk-free interest rate of 1.77%.
Warrants
Issued to Investment Bank
Pursuant
to a certain agreement dated June 19, 2017, for services rendered in connection with the conversion of the Original Notes, the
Company issued to an investment bank or its designees a warrant (“Banker Warrant”) to purchase, at an exercise price
$0.35 per share, 500,000 shares of the Company’s common stock for a period of three years. The Banker Warrants were fully
vested on the date of issuance and may be exercised beginning December 20, 2017. The Company recorded $30,687 of expense for the
fair value of the Banker Warrant on the date of issuance. The fair value of the Banker Warrants at date of issuance was determined
using the Black-Scholes Model. The assumptions used in the Black-Scholes Model were term of the Banker Warrant of 3 years, volatility
rate of 120.02%, rate of quarterly dividends 0% and a risk-free interest rate of 1.52%.
Common
Shares Issued to Employee
During
the first quarter of 2017, the Company issued to an employee 40,000 shares of common stock which were valued at $8,840 on the
date of issuance. These shares were fully vested on the date of issuance and immediately expensed.
Common
Shares Issued to Director
Pursuant
to an agreement dated March 7, 2017, the Company issued to its Chairman of the Board (the “Chairman”) 700,000 shares
of common stock as an equity retention award. These shares were valued, using the closing price for the Company’s common
stock, as of the date of ratification for total value of $121,450, which was immediately expensed as compensation.
Note
16 – Equity Incentive Plans
2014
Stock Ownership Plan
As
of December 31, 2016, the Company had non-qualified stock options to purchase 6,177,600 shares of the Company’s common stock,
with an exercise price of $0.00024, outstanding under the 2014 Stock Ownership Plan of Safari Resource Group, Inc. (the “2014
Stock Plan”). Upon the adoption of the Company’s 2017 Equity Incentive Plan (the “2017 Equity Plan”),
there will be no further awards under the 2014 Stock Plan.
In
March 2017, in a private transaction, certain principal shareholders of the Company, assigned to the Previous CEO, non-qualified
stock options to purchase 3,088,800 shares of the Company’s common stock outstanding under the 2014 Stock Plan. The principal
shareholders informed the Company that they agreed to assign these options as an incentive (i) for the Previous CEO to complete
the negotiations with the Company’s convertible noteholders to convert their notes into shares of the Company’s common
stock, and (ii) for the Previous CEO to complete a private placement of the Company’s common stock. The Previous CEO thereupon
delivered a purported notice of exercise of the options to the Company just prior to the expiration of the options. The Company
erroneously reported in its Form 10-K for the year ended December 31, 2016 that the common stock underlying these options had
been issued during the three months ended March 31, 2017. Prior to the Company’s acceptance of the notice of exercise and
issuances of these shares in response thereto, in May 2017, the Previous CEO and the principal shareholders entered into a rescission
agreement to nullify the March 2017 assignment transaction. Pursuant to their terms, these options have expired.
Surna
Inc.
Notes
to Consolidated Financial Statements
In
March 2017, a former CEO of the Company, holding non-qualified options to 3,088,800 shares of the Company’s common stock
outstanding under the 2014 Stock Plan, requested to exercise options with respect to 3,000,000 shares at an exercise price of
$0.00024 per share.
The Board did not approve the request for the issuance of the common stock underlying
these exercised options and, as a result, the Company has treated these options as expired.
As
of December 31, 2017, there are no options outstanding under the 2014 Stock Plan.
The
following table summarizes certain details regarding the options under the 2014 Stock Plan are set forth in the table below:
|
|
Number
of Options
|
|
|
Weighted-
Average
Exercise
Price
|
|
|
Weighted-
Average
Remaining
Contractual
Term (in years)
|
|
|
Aggregate
Intrinsic
Value of
Outstanding
Options
|
|
Outstanding, December 31, 2016
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
|
|
0.2
|
|
|
$
|
1,155,211
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Expired
|
|
|
(6,177,600
|
)
|
|
$
|
0.00024
|
|
|
|
-
|
|
|
|
|
|
Outstanding, December
31, 2017
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and exercisable,
December 31, 2017
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
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. As of December 31, 2017, the Company
has granted, under the 2017 Equity Plan, awards in the form of RSAs for services rendered by independent directors and consultants,
non-qualified stock options, RSUs and stock bonus awards.
The
total unrecognized compensation expense for unvested non-qualified stock options, RSUs and stock bonus awards at December 31,
2017 was $1,311,109, which will be recognized over approximately 2.25 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
certain revenue thresholds for 2018 and 2019 being satisfied (the “Performance-based Awards”). As of December 31,
2017 and the grant date, the Company has determined that the likelihood of performance levels being obtained is remote. The unrecognized
compensation expense with respect to these Performance-based Awards at December 31, 2017 was $1,102,780.
Restricted
Stock Awards
On
August 8, 2017, the Company’s current Chief Executive Officer (the “CEO”) was awarded 600,000 shares of restricted
stock under the 2017 Equity Plan in consideration of services rendered to the Company prior to his appointment as a director.
These restricted shares were fully vested at the time of the award and the value attributable to these shares, which were issued
in August 2017, was $84,000 as calculated using the fair value of the Company’s common stock on August 7, 2017.
On
August 8, 2017, the Company awarded 111,113 restricted shares under the 2017 Equity Plan to independent directors in lieu of the
payment of cash fees earned during the second quarter of 2017. The quarterly director fees are paid 50% in cash and 50% in shares
of the Company’s common stock, with the number of shares determined based on the closing price of the common stock on the
date of issuance. These restricted shares were fully vested at the time of the award. The value attributable to these shares,
which were issued in August 2017, was $15,000 as calculated using the fair value of the Company’s common stock on August
7, 2017.
Surna
Inc.
Notes
to Consolidated Financial Statements
On
August 8, 2017, the Company awarded 260,778 restricted shares under the 2017 Equity Plan to a consultant who provided corporate
and financial services to the Company. These restricted shares were awarded in lieu of cash fees earned for the April, May, June
and July 2017 and were fully vested at the time of the award. The value attributable to these shares, which were issued in August
2017, was $35,205 as calculated using the fair value of the Company’s common stock on August 7, 2017.
On
September 6, 2017, the Company awarded 1,200,000 restricted shares under the 2017 Equity Plan to an employee as compensation.
These restricted shares were fully vested at the time of the award. The value attributable to these shares, which were issued
in October 2017, was $134,280 as calculated using the fair value of the Company’s common stock on September 6, 2017.
On
November 7, 2017, the Company awarded 104,896 restricted shares under the 2017 Equity Plan to independent directors in lieu of
the payment of cash fees earned during the third quarter of 2017. These restricted shares were fully vested at the time of the
award. The value attributable to these shares, which were issued in November 2017, was $15,000 as calculated using the fair value
of the Company’s common stock on November 6, 2017. As of December 31, 2017, the independent directors are owed cash fees
of $15,000 which were paid in the form of fully vested restricted shares in February 2018. See Note 18.
On
November 7, 2017, the Company awarded 143,707 restricted shares under the 2017 Equity Plan to a consultant who provided corporate
and financial services to the Company. These restricted shares were awarded in lieu of cash fees earned in August September and
October 2017 and were fully vested at the time of the award. The value attributable to these shares, which were issued in November
2017, was $20,550 as calculated using the fair value of the Company’s common stock on November 6, 2017, which is equivalent
to the value of the services provided. As of December 31, 2017, the consultant is owed cash fees of $12,750 which were paid in
the form of fully vested restricted shares in February 2018. See Note 18.
Non-Qualified
Stock Options
On
August 8, 2017, the Board granted to certain independent directors non-qualified stock options, under the 2017 Equity Plan, to
purchase a total of 1,800,000 shares of the Company’s common stock at an exercise price of $0.135 per share for a period
of ten years. These options vest 50% on date of grant and the remaining 50% on March 1, 2018, provided they are still serving
as a director on such date. On August 17, 2017, one of these independent directors was appointed the CEO and, in consideration
of the grant of the restricted stock units and the eligibility for the special bonus, the CEO agreed to terminate and cancel the
non-qualified stock options to purchase 900,000 shares of the Company’s common stock previously granted to him.
During
2017, the Board granted to certain employees non-qualified stock options, under the 2017 Equity Plan, to purchase a total of 12,530,000
shares of the Company’s common stock at an exercise price equal to the closing market price of the Company’s common
stock on the day before the grant. The terms of the options are summarized as follows:
|
(a)
|
Non-qualified
stock options to purchase 1,805,000 shares at an exercise price of $0.135 per share granted to certain employees on August
8, 2017, which vest based on the employee’s continued service over 2.4 years, as follows: (i) 661,672 options will vest
if the employee remains employed at various dates during 2017, (ii) 571,665 options will vest if the employee remains employed
at various dates during 2018, and (iii) 571,663 options will vest if the employee remains employed at various dates during
2019, and have a term of 10 years. As of December 31, 2017, non-qualified stock options to purchase 60,000 shares expired
unexercised, and non-qualified options to purchase 285,000 shares were forfeited due to employee terminations.
|
|
|
|
|
(b)
|
Non-qualified
stock options to purchase 1,300,000 shares at an exercise price of $0.121 per share granted to a former employee on August
17, 2017, which were fully vested on the grant date and have a term of three years.
|
|
|
|
|
(c)
|
Non-qualified
stock options to purchase 1,200,000 shares at an exercise price of $0.135 per share granted to certain employees on August
8, 2017, which vest based on the employee’s continued service and subject to the following performance thresholds: (i)
400,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively, for
the year end December 31, 2017, (ii) 400,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and (iii)
400,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As of December
31, 2017, non-qualified stock options to purchase 400,000 shares were forfeited due to the failure to achieve the 2017 performance
thresholds.
|
|
|
|
|
(d)
|
Non-qualified
stock options to purchase 4,050,000 shares at an exercise price of $0.121 per share granted to certain employees on August
17, 2017, which vest based on the employee’s continued service and subject to the following performance thresholds:
(i) 800,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively,
for the year end December 31, 2017, (ii) 1,300,000 options will vest if the Company achieves 2018 revenue of $18,000,000,
and (iii) 1,950,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As
of December 31, 2017, non-qualified stock options to purchase 800,000 shares were forfeited due to the failure to achieve
the 2017 performance thresholds.
|
Surna
Inc.
Notes
to Consolidated Financial Statements
|
(e)
|
Non-qualified
stock options to purchase 4,000,000 shares at an exercise price of $0.112 per share granted to an employee on September 6,
2017, which vest based on the employee’s continued service and subject to the following performance thresholds: (i)
750,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively, for
the year end December 31, 2017, (ii) 1,250,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and
(iii) 2,000,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As of
December 31, 2017, non-qualified stock options to purchase 750,000 shares were forfeited due to the failure to achieve the
2017 performance thresholds.
|
|
|
|
|
(f)
|
Non-qualified
stock options to purchase 175,000 shares at an exercise price of $0.105 per share granted to certain employees on October
10, 2017, which vest based on the employee’s continued service over 2.25 years, as follows: (i) 58,336 options will
vest if the employee remains employed during 2017, (ii) 58,332 options will vest if the employee remains employed during 2018,
and (iii) 58,332 options will vest if the employee remains employed during 2019, and have a term of 10 years.
|
The
Company uses the
Black-Scholes
Model to determine the fair value of options granted. Option-pricing
models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected
term of options. Changes in the subjective input assumptions can materially affect the fair value estimate. The expected stock
price volatility assumptions are based on the historical volatility of the Company’s common stock over periods that are
similar to the expected terms of grants and other relevant factors. The Company derives the expected term based on an average
of the contract term and the vesting period taking into consideration the vesting schedules and future employee behavior with
regard to option exercise. The risk-free interest rate is based on U.S. Treasury yields for a maturity approximating the expected
term calculated at the date of grant. The Company has never paid any cash dividends on its common stock and the Company has no
intention to pay a dividend at this time; therefore, the Company assumes that no dividends will be paid over the expected terms
of option awards.
The
Company determines the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected
stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant
dates. As such, the Company may use different assumptions for options granted throughout the year. The valuation assumptions used
to determine the fair value of each option award on the date of grant were: expected stock price volatility 115.82% - 118.20%;
expected term in years 1.5 - 7.5 and risk-free interest rate 1.32% - 2.18%.
A
summary of the non-qualified stock options granted to employees under the
2017
Equity Plan
as of December 31, 2017, and changes during the year 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, 2016
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
12,530,000
|
|
|
$
|
0.121
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(2,235,000
|
)
|
|
|
0.122
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(60,000
|
)
|
|
|
0.135
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2017
|
|
|
10,235,000
|
|
|
|
0.121
|
|
|
|
8.7
|
|
|
$
|
1,218,375
|
|
Exercisable
,
December 31, 2017
|
|
|
1,885,008
|
|
|
|
0.124
|
|
|
|
4.5
|
|
|
$
|
217,876
|
|
Outstanding vested
and expected to vest, December 31, 2017
|
|
|
2,935,000
|
|
|
|
0.127
|
|
|
|
6.4
|
|
|
$
|
331,625
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performance options
based on 2018 and 2019 revenue thresholds - uncertain vesting as of December 31, 2017
|
|
|
7,300,000
|
|
|
|
0.119
|
|
|
|
9.7
|
|
|
$
|
886,750
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
A
summary of non-vested non-qualified stock options granted to employees
under the
2017 Equity
Plan
as of December 31, 2017, and any changes during the year then ended, are presented in the table
below:
|
|
Number
of
Options
|
|
|
Weighted
Average
Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2016
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
12,530,000
|
|
|
$
|
0.103
|
|
|
|
|
|
Vested
|
|
|
(1,885,008
|
)
|
|
$
|
0.082
|
|
|
|
|
|
Forfeited
|
|
|
(2,235,000
|
)
|
|
$
|
0.109
|
|
|
|
|
|
Expired
|
|
|
(60,000
|
)
|
|
$
|
0.122
|
|
|
|
|
|
Nonvested, December 31, 2017
|
|
|
8,349,992
|
|
|
$
|
0.107
|
|
|
$
|
1,000,499
|
|
During
the year ended December 31, 2017, the Company has recorded $189,536 as compensation expense related to vested options issued to
employees, net of forfeitures. As of December 31, 2017, total unrecognized share-based compensation related to unvested options
was $863,610, of which $96,530 was related to time-based vesting and $767,080 was related to performance-based vesting.
As
of December 31, 2017, the Company had granted non-qualified options to purchase 9,250,000 shares which were performance-based.
At December 31, 2017, non-qualified options to purchase 1,950,000 shares were forfeited due to the failure to satisfy the 2017
performance thresholds. 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 performance thresholds being satisfied is remote as of the date of grant and December
31, 2017; therefore, no expense was recognized.
A
summary of the non-qualified stock options granted to the directors under the
2017
Equity Plan
as of December 31, 2017, and changes during the year 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, 2016
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Granted
|
|
|
1,800,000
|
|
|
|
0.135
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited/Cancelled
|
|
|
(900,000
|
)
|
|
|
0.135
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding, December
31, 2017
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.6
|
|
|
$
|
94,500
|
|
Exercisable
,
December 31, 2017
|
|
|
450,000
|
|
|
$
|
0.135
|
|
|
|
9.6
|
|
|
$
|
47,250
|
|
Outstanding
vested and expected to vest, December 31, 2017
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
9.6
|
|
|
$
|
94,500
|
|