Notes
to Consolidated Financial Statements
Note
1 – Description of Business
Surna
Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. The Company designs, engineers and manufactures
application-specific environmental control and air sanitation systems for commercial, state- and provincial-regulated indoor cannabis
cultivation facilities in the U.S. and Canada. Currently, the Company’s revenue stream is derived primarily from supplying
its products, services and technologies 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 sealed 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 other receivables in 2018 and included them in the Company’s presentation of other assets. These
reclassifications have been applied consistently to the periods presented and had no impact on net loss, total assets and liabilities,
or shareholders’ equity.
Use
of Estimates
Management
makes estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements and that affect the reported amounts of revenue and expenses during the
reporting period. The Company bases its estimates on historical experience and on various other assumptions that it believes to
be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Key estimates
include: allocation of transaction prices to performance obligations under contracts with customers, standalone selling prices,
timing of expected revenue recognition on remaining performance obligations under contracts with customers, valuation of 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. The Company
has not experienced any losses to date on depository accounts.
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 the Company’s review, it establishes
or adjusts the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2018 and
2017, the allowance for doubtful accounts was $119,022 and $105,267, respectively. If the financial condition of our customers
were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventory
Inventory
is stated at the lower of cost or market. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower
of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other
factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess,
obsolescence or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for
that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in
that newly established cost basis. As of December 31, 2018 and 2017, the allowance for excess and obsolete inventory was $295,347
and $323,384, respectively.
Property
and Equipment
Property
and equipment are stated at cost. For financial statement purposes, property and equipment are recorded at cost and depreciated
using the straight-line method over their estimated useful lives, which is generally five years. Leasehold improvements are amortized
on a straight-line basis over the lesser of their useful lives or the life of the lease. Upon sale or retirement of assets, the
cost and related accumulated depreciation and amortization are removed from the balance sheet and the resulting gain or loss is
reflected in operations. Maintenance and repairs are charged to operations as incurred.
Long-lived
tangible assets, including property and equipment, are reviewed for impairment whenever events or changes in business circumstances
indicate the carrying value of the assets may not be recoverable. When such an event occurs, management determines whether there
has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset’s carrying value.
If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash
flows or appraised value, depending on the nature of the asset. The Company has not identified any indicators of impairment during
the years ended December 31, 2018 and 2017.
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 determined that it has one reporting unit. The Company
completed this assessment as of December 31, 2018, 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, 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 Notes 10 and 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 Series 3 Warrants, which were subject to the exercise price reduction, qualified as
a derivative financial instrument. Accordingly, the Series 3 Warrants were marked to market at the end of each reporting period.
Any change in fair value during the period was recorded in as gain (loss) on change in derivative liabilities in the Company’s
consolidated statements of operations. 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, 2018
|
|
|
As
of December 31, 2017
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair
Value
|
|
|
Gain
(1)
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Fair
Value
|
|
|
Gain
(2)
|
|
Financial liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities - warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
21,403
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
410,880
|
|
|
$
|
410,880
|
|
|
$
|
66,934
|
|
Total financial
liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
21,403
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
410,880
|
|
|
$
|
410,880
|
|
|
$
|
66,934
|
|
|
(1)
The gain on change in derivative liabilities presented in the statements of operations for the year ended December 31, 2018
represents the gain on derivatives through the cashless exercise of all of the associated warrants during the first quarter
of 2018.
|
|
|
|
(2)
Represents the gain on change in derivative liabilities for the year ended December 31, 2017.
|
The
change in the balance of the warrant derivative liabilities during the year ended December 31, 2017 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.
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 twelve months of the balance sheet date.
Surna
Inc.
Notes
to Consolidated Financial Statements
Revenue
Recognition
On
January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606),
Revenue from Contracts
with Customers
and all the related amendments (“ASC 606” or the “new revenue standard”) to all contracts
and elected the modified retrospective method. The results for periods before 2018 were not adjusted for the new revenue standard
and the cumulative effect of the change in accounting was recognized through accumulated deficit at the date of adoption. The
comparative financial information presented has not been restated and continues to be reported under the accounting standards
in effect for those periods. The Company expects the impact of the adoption of the new revenue standard to be immaterial to its
net income (loss) on an ongoing basis.
The
cumulative effect of the changes made to the consolidated balance sheet for the adoption of the new revenue standard as of January
1, 2018 was as follows:
|
|
Balance
as of
December 31, 2017
|
|
|
Adjustments
Due to
ASC 606
|
|
|
Balance
as of
January 1, 2018
|
|
Balance Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Revenue
|
|
$
|
1,011,871
|
|
|
$
|
(56,912
|
)
|
|
$
|
954,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(19,254,911
|
)
|
|
$
|
56,912
|
|
|
$
|
(19,197,999
|
)
|
In
accordance with the new revenue standard’s requirements, the disclosure of the impact of adoption on the consolidated income
statements and balance sheets for the year ended December 31, 2018 was as follows:
|
|
For
the Year Ended December 31, 2018
|
|
|
|
As
Reported
|
|
|
Balances
Without
Adoption of ASC
606
|
|
|
Effect
of Change Higher/(Lower)
|
|
Income Statement
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
9,581,968
|
|
|
$
|
9,611,380
|
|
|
$
|
(29,412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,743,745
|
)
|
|
$
|
(4,714,333
|
)
|
|
$
|
29,412
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Revenue
|
|
$
|
641,798
|
|
|
$
|
669,298
|
|
|
$
|
(27,500
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(24,346,361
|
)
|
|
$
|
(24,373,861
|
)
|
|
$
|
(27,500
|
)
|
The
following table sets forth the Company’s revenue by source:
|
|
For
the Years Ended
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Equipment sales
|
|
$
|
8,288,102
|
|
|
$
|
6,255,150
|
|
Engineering and other services
|
|
|
1,040,764
|
|
|
|
588,849
|
|
Shipping and handling
|
|
|
243,072
|
|
|
|
238,908
|
|
Other revenue
|
|
|
10,030
|
|
|
|
127,334
|
|
Total revenue
|
|
$
|
9,581,968
|
|
|
$
|
7,210,241
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
The
Company accounts for sales taxes and other related taxes on a net basis, excluding such taxes from revenue.
Revenue
Recognition Accounting Policy Summary
The
Company accounts for revenue in accordance with the new revenue standard. Under the new revenue standard, a performance obligation
is a promise in a contract with a customer to transfer a distinct good or service to the customer. Most of the Company’s
contracts contain multiple performance obligations that include engineering and technical services as well as the delivery of
a diverse range of climate control system equipment and components, which can span multiple phases of a customer’s project
life-cycle from facility design and construction to equipment delivery and system installation and start-up. The Company does
not provide construction services or system installation services. Some of the Company’s contracts with customers contain
a single performance obligation, typically engineering only services contracts.
A
contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as,
the performance obligation is satisfied. When there are multiple performance obligations within a contract, the Company allocates
the transaction price to each performance obligation based on standalone selling price. The Company determines the standalone
selling price for each of the performance obligations at the inception of the contract and does not adjust the initial allocation
for future changes in any selling prices. When estimating the selling price, the Company uses various observable inputs. The best
observable input is the Company’s actual selling price for the same good or service, however, this input is generally not
available for the Company’s contracts containing multiple performance obligations. For engineering services, the Company
estimates the standalone selling price by reference to certain physical characteristics of the project, such as facility size
and mechanical systems involved, which are indicative of the scope and complexity of the mechanical engineering services to be
provided. For equipment sales, the standalone selling price is determined by forecasting the expected costs of the equipment and
then adding an appropriate margin, based on a range of acceptable margins established by management. Depending on the nature of
the performance obligations, the Company may use a combination of different methods and observable inputs if certain performance
obligations have highly variable or uncertain standalone selling prices. Once the selling prices are determined, the Company applies
the relative values to the total contract consideration and estimates the amount of the transaction price to be recognized as
each promise is fulfilled.
Generally,
satisfaction occurs when control of the promised goods is transferred to the customer or as services are rendered or completed
in exchange for consideration in an amount for which the Company expects to be entitled. The Company recognizes revenue for the
sale of goods when control transfers to the customer, which primarily occurs at the time of shipment. The Company’s historical
rates of return are insignificant as a percentage of sales and, as a result, the Company does not record a reserve for returns
at the time the Company recognizes revenue. The Company has elected to exclude from the measurement of the transaction price all
taxes (e.g., sales, use, value added, and certain excise taxes) that are assessed by a governmental authority in connection with
a specific revenue-producing transaction and collected by the Company from the customer. Accordingly, the Company recognizes revenue
net of sales taxes. The revenue and cost for freight and shipping is recorded when control over the sale of goods passes to the
Company’s customers.
The
Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Performance
obligations are satisfied over-time if the customer receives the benefits as the Company performs work, if the customer controls
the asset as it is being produced, or if the product being produced for the customer has no alternative use and the Company has
a contractual right to payment. Revenue is recognized from this type of performance obligation as services are rendered based
on the percentage completion towards certain specified milestones.
The
Company offers assurance-type warranties for its products and products manufactured by others to meet specifications defined by
the contracts with customers and does not have any material separate performance obligations related to these warranties. The
Company maintains a warranty reserve based on historical warranty costs.
Other
Judgments and Assumptions
The
Company typically receives customer payments in advance of its performance of services or transfers of goods. Under the new revenue
standard, the Company is required to adjust the promised amount of consideration for a significant financing component to recognize
revenue at an amount that reflects the price that a customer would have paid for the promised goods or services if the customer
had paid cash for those goods or services when (or as) they transfer to the customer (that is, the cash selling price). Applying
the practical expedient in ASC 606-10-32-18, which the Company has elected, the Company does not adjust the promised amount of
consideration for the effects of a significant financing component since the Company expects, at contract inception, that the
period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or
service will be one year or less. Accordingly, the remaining performance obligations related to customer contracts does not consider
the effects of the time value of money.
Surna
Inc.
Notes
to Consolidated Financial Statements
Applying
the practical expedient in ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense
when incurred since the amortization period of the assets that the Company otherwise would have recognized is one year or less.
These costs include certain sales commissions and incentives, which are included in selling, general and administrative expenses,
and are payable only when associated revenue has been collected and earned by the Company. For sake of clarity, net revenues are
considered earned only after the service/product has been completed/shipped to the Company’s customer and the Company is
able to recognize such net revenue on its financial statement in accordance with generally accepted accounting principles.
Contract
Assets and Contract Liabilities
Contract
assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate
to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers
based on the terms established in its contracts.
Contract
assets include unbilled amounts where revenue recognized exceeds the amount billed to the customer and the right of payment is
conditional, subject to completing a milestone, such as a phase of a project. The Company typically does not have material amounts
of contract assets since revenue is recognized as control of goods are transferred or as services are performed. As of December
31, 2018 and 2017, the Company had no contract assets.
Contract
liabilities consist of advance payments in excess of revenue recognized. The Company’s contract liabilities are recorded
as a current liability in deferred revenue in the consolidated balance sheets since the timing of when the Company expects to
recognize revenue is generally less than one year. As of December 31, 2018 and 2017, deferred revenue, which was classified as
a current liability, was $641,798 and $1,011,871, respectively.
For
the year ended December 31, 2018, the Company recognized revenue of $876,350 related to the deferred revenue at January 1, 2018,
or 87%.
Remaining
Performance Obligations
Remaining
performance obligations, or backlog, represents the aggregate amount of the transaction price allocated to the remaining obligations
that the Company has not performed under its customer contracts. The Company has elected not to use the optional exemption in
ASC 606-10-50-14, which exempts an entity from such disclosures if a performance obligation is part of a contract with an original
expected duration of one year or less. Accordingly, the information disclosed about remaining performance obligations includes
all customer contracts, including those with an expected duration of one year or less.
Industry
uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of the
Company’s control, make it difficult for the Company to predict when it will recognize revenue on its remaining performance
obligations. There are risks that the Company may not realize the full contract value on customer projects in a timely manner
or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to
secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the
equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when the Company is able to
recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the
indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure
and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number
of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need
to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate
and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price
tag and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays
that are typical in completing any construction project.
Surna
Inc.
Notes
to Consolidated Financial Statements
As
of December 31, 2018, the Company’s remaining performance obligations, or backlog, was $8,529,000, of which $6,997,000,
or 82%, was attributable to customer contracts for which the Company has only received an initial advance payment to cover the
allocated value of the Company’s engineering services (“engineering only paid contracts”). There are enhanced
risks that the equipment portion of these engineering only paid contracts will not be completed or will be delayed, which could
occur if the customer is dissatisfied with the quality or timeliness of the Company’s engineering services or there is a
delay or abandonment of the project because of the customer’s inability to obtain project financing or licensing or other
reasons. After the customer has made an advance payment for a portion of the equipment to be delivered under the contract (“partial
equipment paid contracts”), the Company is typically better able to estimate the timing of revenue recognition since the
risks and delays associated with licensing, permitting and project funding are typically mitigated once the initial equipment
payment is received. There is significant uncertainty regarding the timing of the Company’s recognition of revenue on its
remaining performance obligations, and there is no certainty that these will result in actual revenues. The remaining performance
obligations expected to be recognized through 2021 are as follows:
|
|
2019
|
|
|
2020
|
|
|
2021
|
|
|
Total
|
|
Remaining performance obligations
related to engineering only paid contracts
|
|
$
|
4,164,000
|
|
|
$
|
198,000
|
|
|
$
|
2,635,000
|
|
|
$
|
6,997,000
|
|
Remaining performance
obligations related to partial equipment paid contracts
|
|
$
|
1,141,000
|
|
|
$
|
391,000
|
|
|
$
|
-
|
|
|
$
|
1,532,000
|
|
Total remaining
performance obligations
|
|
$
|
5,305,000
|
|
|
$
|
589,000
|
|
|
$
|
2,635,000
|
|
|
$
|
8,529,000
|
|
Product
Warranty
The
Company warrants the products that it manufactures for a warranty period equal to the lesser of 12 months from start-up or 18
months from shipment. The Company’s warranty provides for the repair, rework, or replacement of products (at the Company’s
option) that fail to perform within stated specification. The Company’s third-party suppliers also warrant their products
under similar terms, which are passed-through to the Company’s customers.
The
Company assesses the historical warranty claims on its manufactured products and, since 2016, warranty claims have been approximately
1% of annual revenue generated on these products. 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, 2018 and 2017, the Company had an accrued warranty
reserve amount of $144,822 and $105,122, respectively, which are included in accounts payable and accrued liabilities on the Company’s
consolidated balance sheets.
Concentrations
No
customers accounted for more than 10% of the Company’s revenue for the year ended December 31, 2018. Two customers accounted
for 12% and 11% of the Company’s revenue for the year ended December 31, 2017.
The
Company’s accounts receivable from three customers made up 17%, 12%, and 11%, respectively, of the total balance as of December
31, 2018. The Company’s accounts receivable from three customers made up 52%, 17%, and 17% of the total balance as of December
31, 2017.
One
supplier accounted for 39% of the Company’s purchases of inventory for the year ended December 31, 2018 and two suppliers
accounted for 35% and 10% of the Company’s purchases of inventory for the year ended December 31, 2017.
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, 2018 and 2017, the Company incurred $317,713 and $319,680, 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.
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 $2,029,430 and $2,139,865 for the years ended December 31, 2018 and
2017, 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, 2018 and 2017:
|
|
For
the Year Ended December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Share-based compensation expense included
in:
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
$
|
100,736
|
|
|
$
|
75,255
|
|
Advertising and marketing expenses
|
|
|
7,671
|
|
|
|
16,377
|
|
Product development costs
|
|
|
4,548
|
|
|
|
5,956
|
|
Selling, general
and administrative expenses
|
|
|
1,916,475
|
|
|
|
2,042,277
|
|
Total share-based
compensation expense included in consolidated statement of operations
|
|
$
|
2,029,430
|
|
|
$
|
2,139,865
|
|
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 marijuana in all its forms as well as its derivatives.
Any changes in the enforcement of U.S. federal laws may adversely affect the implementation of state and local cannabis laws and
regulations that permit medical or recreational cannabis and, correspondingly, may adversely impact the Company’s customers.
The Company’s success is also dependent upon its ability to raise additional capital and to successfully develop and market
its products. See Note 3.
Segment
Information
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by the Company’s senior management team in deciding how to allocate resources and in assessing performance. The
Company has one operating segment that is dedicated to the manufacture and sale of its products.
Recently
Issued Accounting Pronouncements
In
August 2018, the FASB issued ASU 2018-13,
Fair Value Measurement (Topic 820) — Disclosure Framework — Changes to
the Disclosure Requirements for Fair Value Measurement
, which modifies the disclosure requirements on fair value measurements
in
Topic 820
. The amendment will be effective for reporting periods beginning after December 15, 2019, and early adoption
is permitted. The Company is currently assessing the impact of the ASU on its consolidated results of operations, cash flows and
financial position.
In
June 2018, the FASB adopted ASU 2018-07,
Compensation — Stock Compensation (Topic 718) — Improvements to Nonemployee
Share-Based Payment Accounting
, which expands the scope of Topic 718 to include all share-based payment transactions for acquiring
goods and services from nonemployees. ASU 2018-07 specifies that
Topic 718
applies to all share-based payment transactions
in which the grantor acquires goods and services to be used or consumed in its own operations by issuing share-based payment awards.
ASU 2018-07 also clarifies that
Topic 718
does not apply to share-based payments used to effectively provide (1) financing
to the issuer, or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted
for under ASC 606. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within
those fiscal years, with early adoption permitted, but no earlier than the Company’s adoption of ASC 606. The Company 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.
Surna
Inc.
Notes
to Consolidated Financial Statements
In
June 2016, the FASB issued ASU 2016-13,
Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments
. ASU 2016-13 introduces an expected credit loss methodology for the impairment of financial assets
measured at amortized cost basis. This methodology reflects expected credit losses and requires consideration of a broader range
of reasonable and supportable information to inform credit loss estimates and replaces the probable, incurred loss model for those
assets. In November 2018, the FASB issued ASU 2018-19,
Codification Improvements to Topic 326, Financial Instruments –
Credit Losses,
which clarifies that receivables arising from operating leases are not within the scope of
Subtopic 326-20
,
but, instead, the impairment of receivables arising from operating leases are accounted for in accordance with
Topic 842, Leases
.
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 adopted ASU 2016-02,
Leases (Topic 842)
which amends the existing accounting standards for lease
accounting, including requiring lessees to recognize most leases on their balance sheet and to disclose key information about
leasing arrangements. Current GAAP does not require lessees to recognize assets and liabilities related to operating leases on
the balance sheet. In July 2018, the FASB issued ASU 2018-10,
Codification Improvements to Topic 842, Leases
and ASU 2018-11,
Targeted Improvements to Topic 842, Leases,
which make improvements and provide clarity to several aspects of the guidance
in ASC 842. The new standard establishes a right-of-use model (“ROU”) that requires a lessee to recognize a ROU asset
and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance
or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The
new standard is effective for the Company on January 1, 2019, with early adoption permitted. An entity may choose to use either:
(i) its effective date, or (ii) the beginning of the earliest comparative period presented in the financial statements as its
date of initial application. The Company has adopted the standard effective January 1, 2019 and has chosen to use the effective
date as the date of initial application. Consequently, financial information will not be updated, and the disclosures required
under the new standard will not be provided, for dates and periods prior to January 1, 2019. The new standard provides a number
of optional practical expedients in transition. The Company has elected to apply the “package of practical expedients”
which allow the Company to not reassess (i) whether existing or expired arrangements contain a lease, (ii) the lease classification
of existing or expired leases, or (iii) whether previous initial direct costs would qualify for capitalization under the new lease
standard. The Company has also elected to apply (i) the practical expedient which allows the Company to not separate lease and
non-lease components, and (ii) the short-term lease exemption for all leases with an original term of less than 12 months, for
purposes of applying the recognition and measurements requirements in the new standard. The adoption of the new standard is expected
to result in the recognition of additional lease liabilities of approximately $822,000, and ROU assets of approximately $688,000,
net of the deferred rent liability, as of January 1, 2019 related to the Company’s operating leases. The Company does not
expect that the new standard will have a material impact to the Company’s consolidated statement of operations or its consolidated
statement of cash flows.
Other
accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected
to have a material impact on the financial statements upon adoption. The Company does not discuss recent pronouncements that are
not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.
Note
3 – Going Concern
The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern,
which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The
Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $4,744,000 for
the year ended December 31, 2018, and had an accumulated deficit of approximately $24,346,000 as of December 31, 2018. 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. As of December
31, 2018, the Company has a working capital deficit of approximately $923,000.
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.
In
June 2018, the Company issued 7,562,500 investment units to accredited investors at a unit price of $0.16 for gross proceeds of
$1,210,000, with each unit consisting one share of common stock and a warrant to purchase one share of common stock. There can
be no assurance that the Company will be able to raise debt or equity financing in sufficient amounts, when and if needed, on
acceptable terms or at all. The Company’s ability to raise equity capital is also limited by the Company’s stock price,
and any such issuance could be highly dilutive to existing shareholders. Since November 2018, the Company has undertaken a number
of cost saving initiatives (including a workforce reduction) designed to preserve the Company’s limited cash resources.
While the Company’s 2018 revenue of approximately $9,582,000 represents an increase of almost 33% over the prior year, the
Company’s revenue recognition on contracts continues to be unpredictable and inconsistent quarter-over-quarter. In addition,
the Company’s efforts to expand and upgrade its products has resulted in additional working capital being allocated to equipment
purchases and increased inventory levels.
Surna
Inc.
Notes
to Consolidated Financial Statements
If
results of operations for 2019 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 twelve 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,
|
|
|
|
2018
|
|
|
2017
|
|
Finished goods
|
|
$
|
869,895
|
|
|
$
|
569,047
|
|
Work in progress
|
|
|
9,080
|
|
|
|
14,348
|
|
Raw materials
|
|
|
352,258
|
|
|
|
262,611
|
|
Allowance for
excess & obsolete inventory
|
|
|
(295,347
|
)
|
|
|
(323,384
|
)
|
Inventory, net
|
|
$
|
935,886
|
|
|
$
|
522,622
|
|
Overhead
expenses of $34,000 and $28,554 were included in the inventory balance as of December 31, 2018 and 2017, respectively.
Note
5 – Property and Equipment
Property
and equipment consisted of the following:
|
|
As
of December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Furniture and equipment
|
|
$
|
386,047
|
|
|
$
|
326,894
|
|
Equipment held for lease to related
party
|
|
|
176,042
|
|
|
|
159,806
|
|
Vehicles
|
|
|
15,000
|
|
|
|
15,000
|
|
Leasehold
improvements
|
|
|
215,193
|
|
|
|
33,257
|
|
|
|
|
792,282
|
|
|
|
534,957
|
|
Accumulated
depreciation
|
|
|
(271,961
|
)
|
|
|
(133,601
|
)
|
Property and
equipment, net
|
|
$
|
520,321
|
|
|
$
|
401,356
|
|
Depreciation
expense amounted to $158,683 for the year ended December 31, 2018, of which $7,940 was allocated to cost of revenue. Depreciation
expense amounted to $39,978 for the year ended December 31, 2017, of which $8,302 was allocated to cost of revenue.
Surna
Inc.
Notes
to Consolidated Financial Statements
As
of December 31, 2018, the Company has recorded $176,042 for the cost of the equipment located at the Sterling facility as leased
equipment under fixed assets and accumulated depreciation of $39,120. See Note 8.
Note
6 – Intangible Assets
Intangible
assets consisted of the following:
|
|
As
of December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Patents
|
|
$
|
20,012
|
|
|
$
|
29,952
|
|
Website development costs
|
|
|
22,713
|
|
|
|
22,713
|
|
Trademarks
|
|
|
1,830
|
|
|
|
1,830
|
|
|
|
|
44,555
|
|
|
|
54,495
|
|
Accumulated amortization
|
|
|
(21,527
|
)
|
|
|
(16,510
|
)
|
Intangible assets,
net
|
|
$
|
23,028
|
|
|
$
|
37,985
|
|
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 $5,017 and $4,887 for the years ended December
31, 2018 and 2017, respectively.
Note
7 – Accounts Payable and Accrued Liabilities
Accounts
payable and accrued liabilities consisted of the following:
|
|
As
of December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Accounts payable
|
|
$
|
1,278,678
|
|
|
$
|
1,159,975
|
|
Sales commissions payable
|
|
|
56,277
|
|
|
|
21,931
|
|
Accrued payroll liabilities
|
|
|
127,915
|
|
|
|
58,557
|
|
Product warranty accrual
|
|
|
144,822
|
|
|
|
105,122
|
|
Commercial dispute settlement
|
|
|
-
|
|
|
|
332,418
|
|
Other accrued
expenses
|
|
|
201,437
|
|
|
|
291,260
|
|
Total
|
|
$
|
1,809,129
|
|
|
$
|
1,969,263
|
|
Note
8 – Related Party Agreements and Transactions
Amounts
Due to Shareholders
In
July 2014, the Company issued a $250,000 unsecured promissory note (“Hydro Note”) to Stephen and Brandy Keen as part
of the purchase price of Hydro. Mr. Keen is a principal shareholder of the Company and was a former executive officer and director,
and was formerly a consultant to the Company (see below). Ms. Keen, the spouse of Mr. Keen, is also a principal shareholder of
the Company and previously served as an executive officer and director of the Company (see below). As of December 31, 2017, the
Hydro Note had a balance of $6,927, which was reflected on the Company’s consolidated balance sheet as a current liability.
During the year ended December 31, 2018, the balance of the Hydro Note was paid in full.
Stephen
Keen Consulting Agreement
In
May 2017, the Company’s Board of Directors (the “Board”) approved a three-year consulting agreement under which
Mr. Keen agreed to provide certain consulting services to the Company including research and development, new product design and
innovations, existing product enhancements and improvements, and other technology advancements with respect to the Company’s
business and products in exchange for an annual consulting fee of $30,000. Pursuant to the terms of the consulting agreement,
the Company recorded consulting fees of $10,000 and $20,000 payable to Mr. Keen during the years ended December 31, 2018 and 2017,
respectively. In May 2018, the Company and Mr. Keen entered into an agreement, which terminated the consulting agreement.
Surna
Inc.
Notes
to Consolidated Financial Statements
Sterling
Pharms Equipment Agreement
In
May 2017, the Board approved a three-year equipment, demonstration and product testing agreement between the Company and Sterling
Pharms, LLC (“Sterling”), an entity controlled by Mr. Keen, which operates a Colorado-licensed cannabis cultivation
facility. Under this agreement, the Company agreed to provide to Sterling certain lighting, environmental control, and air sanitation
equipment for use at the Sterling facility in exchange for a quarterly fee of $16,500. 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.
In
March 2018, the Company and Sterling entered into an amendment of the original agreement to include additional leased equipment
and to increase the quarterly fee payable to the Company to $18,330. The amendment of the original agreement also provided that,
upon expiration of the initial three-year term, either: (i) the leased equipment would be returned to the Company and the agreement
would terminate, (ii) Sterling could purchase the leased equipment at the agreed upon residual value of $81,827, or (iii) Sterling
and the Company could agree to an extension of the original agreement at mutually agreed to quarterly payments to and from the
parties.
After
giving effect to the amended quarterly equipment lease fees received from Sterling of $18,330 (the “Lease Fee”) and
the quarterly demonstration and testing fees paid to Sterling of $12,000 (the “Demo and Testing Fee”), the Company
will receive a net payment of $6,330 from Sterling each quarter.
Sterling
accepted delivery of the remaining leased equipment and completed installation of the equipment at its facility on May 1, 2018.
Accordingly, the term of this agreement, which commenced upon complete installation of the equipment, commenced May 1, 2018 and
will expire April 30, 2021.
The
Company is treating the equipment rental arrangement and related Lease Fee payment as an operating lease. Accordingly, the equipment
held for lease has been recorded as property and equipment on the balance sheets and is depreciated over the term of the lease.
The Lease Fee is recorded as “Interest and other income, net” in the consolidated statements of operations. For the
year ended December 31, 2018, the Company recorded Lease Fees of $48,880. As of December 31, 2018, Lease Fees of $36,660 were
included in accounts receivable as of December 31, 2018.
The
Company records the Demo and Testing Fee as operating expenses in the consolidated statements of operations. For the year ended
December 31, 2018, the Company recorded Demo and Testing Fees of $32,000. As of December 31, 2018, Demo and Testing Fees of $24,000
were included in accounts payable as of December 31, 2018.
Brandy
Keen Employment Agreement
In
May 2018, the Company and Ms. Keen entered into, an amended and restated employment agreement, which will expire on April 30,
2020 and provides for an annualized base salary of $150,000 and certain sales incentive.
Pursuant
to the employment agreement, the Board approved an award of 4,800,000 restricted stock units (“RSUs”) to Ms. Keen
under the Company’s 2017 Equity Incentive Plan, as may be modified and amended by the Company from time to time (the “2017
Equity Plan”), that vest as follows: (i) 1,000,000 RSUs vested on June 30, 2018, subject to her continued employment through
the vesting date, (ii) 1,000,000 RSUs vested on December 31, 2018, subject to her continued employment through the vesting date,
(iii) 1,000,000 RSUs will vest on June 30, 2019, subject to her continued employment through the vesting date, (iv) 1,000,000
RSUs will vest on December 31, 2019, subject to her continued employment through the vesting date, and (v) 800,000 RSUs will vest
on April 30, 2020, subject to her continued employment through the vesting date. The employment agreement provides that the foregoing
RSUs would continue to vest if Ms. Keen’s employment is terminated by the Company without cause.
In
connection with the employment agreement, Ms. Keen agreed to extend the post-termination restrictive period from one year to two
years from the date of termination or expiration.
In
connection with the foregoing transactions, Ms. Keen resigned as an executive officer and director of the Company effective May
10, 2018.
Surna
Inc.
Notes
to Consolidated Financial Statements
Company
Purchase of Common Stock from Stephen and Brandy Keen
In
May 2018, the Company and the Keens entered into a stock repurchase agreement, pursuant to which the Company agreed to repurchase
from the Keens certain shares of the Company’s common stock, subject to the closing of a private placement offering to accredited
investors of the Company’s common stock, which occurred during the second quarter of 2018. In June 2018, the Company closed
the transaction under the stock repurchase agreement and repurchased 3,125,000 shares of the Company’s common stock from
the Keens for a total purchase price of $400,000. See Note 13.
Company
Purchase of Preferred Stock from Stephen and Brandy Keen
In
May 2018, the Company and the Keens entered into a preferred stock option agreement under which the Company had the right, but
not the obligation, to acquire all 35,189,669 shares of preferred stock owned by the Keens (the “Preferred Stock”)
on or before April 30, 2020. Pursuant to the preferred stock option agreement, upon exercise of the option by the Company, the
Company agreed to issue one share of the Company’s common stock for each 1,000 shares of Preferred Stock purchased by the
Company. As consideration for the Keens’ grant of the option, the Company paid them $5,000. The Company exercised this option
and, in December 2018, completed the repurchase by the Preferred Stock and issued 35,190 shares of the Company’s common
stock to the Keens. See Note 13.
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 year ended December 31, 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
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, a “Conversion Agreement” and together, the “Conversion 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 Conversion Agreement was privately negotiated so the terms vary.
Pursuant
to the Conversion 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 Conversion 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.
Pursuant
to the Conversion 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
following table summarizes the Series 2 Convertible Note activity for the year ended December 31, 2017:
|
|
Series
2
Convertible
Notes
|
|
Balance January 1, 2017
|
|
$
|
780,000
|
|
Conversions
|
|
|
(510,000
|
)
|
Repayments
|
|
|
(270,000
|
)
|
Balance December 31, 2017
|
|
$
|
-
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
The
Company accounted for the Conversion 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. The following details the calculation
of the loss on extinguishment of the Series 2 Convertible Notes for the year ended December 31, 2017:
|
|
For
the Year Ended
December 31, 2017
|
|
Carrying amount of
debt
|
|
|
|
|
Principal converted
|
|
$
|
510,000
|
|
Accrued interest converted
|
|
|
134,553
|
|
Unamortized debt
discount
|
|
|
(5,398
|
)
|
Total carrying
amount of debt
|
|
|
639,155
|
|
Reacquisition price of debt
|
|
|
|
|
Fair value of shares of common stock issued
|
|
|
995,155
|
|
Warrant modification value
|
|
|
59,000
|
|
Total reacquisition price of debt
|
|
|
1,054,155
|
|
Loss
on extinguishment of debt
|
|
$
|
(415,000
|
)
|
During
the year ended December 31, 2017, the amortization expense related to the debt discount was $13,160.
As
of December 31, 2018, Series 2 Warrants to purchase 901,250 shares of common stock were outstanding, all of which expired unexercised
in the first quarter of 2019.
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 Series 3 Warrants to purchase up to an aggregate of 2,625,000 shares
of the Company’s common stock, 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. 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.
The
Series 3 Warrants had a five-year term and an exercise price of $0.25 per share, subject to adjustment. The Series 3 Warrants
were exercisable 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. As of December 31, 2017, Series 3 Warrants to purchase 2,625,000
shares of common stock were outstanding. During the year ended December 31, 2018, the Company issued 1,168,540 shares of its restricted
common stock upon the cashless exercise of the Series 3 Warrants.
Note
11 – Derivative Liabilities
The
Company determined that the Series 3 Warrants qualified as derivative financial instruments. Accordingly, the Series 3 Warrants
were derivative liabilities and were marked to market at the end of each reporting period. The change in fair value during the
year ended December 31, 2018 was recorded as gain on change in derivative liabilities in the Company’s consolidated statements
of operations.
During
the year ended December 31, 2018, all of the outstanding Series 3 Warrants were exercised on a cashless basis and the Company
extinguished the derivative liability of approximately $389,000 and recorded an increase in additional paid-in capital of the
same amount. The gain on change in derivative liabilities presented in the statement of operations for the year ended December
31, 2018 represents the gain on derivatives through the date of the cashless exercise of the Warrants.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
following table sets forth movement in the derivative liability related to the Series 3 Warrants:
Balance January 1, 2017
|
|
$
|
477,814
|
|
(Gain) on change
in derivative liability, net
|
|
|
(66,934
|
)
|
Balance December 31, 2017
|
|
|
410,880
|
|
Gain on change
in derivative liability, net
|
|
|
(21,403
|
)
|
Balance prior to exercise of associated
warrants
|
|
|
389,477
|
|
Extinguishment
of derivative liability on cashless exercise of associated warrants
|
|
|
(389,477
|
)
|
Balance December 31, 2018
|
|
$
|
-
|
|
Note
12 – Commitments and Contingencies
Litigation
There
are 6,750,000 restricted stock units that have not been settled due to the failure of the recipient to pay the required withholding
taxes based on the value of the underlying shares at the time of vesting. The Company has commenced litigation against the recipient
to have these restricted stock units canceled.
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.
Building
Lease
The
Company had a lease agreement for its manufacturing and office space consisting of approximately 18,000 square feet, 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 this 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 18,000 square foot 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 increased to $19,549. On each September 1 through the end of the
lease, the monthly rent will increase by 3%. Pursuant to the current lease, the Company made a security deposit of $51,000 on
July 31, 2017 and received a $100,000 tenant allowance for leasehold improvements. Rent expense under the building leases amounted
to $239,107 and $218,926 for the years ended December 31, 2018 and 2017, respectively.
The
following is a schedule by years of the minimum future lease payments on the building lease as of December 31, 2018.
Year
Ended December 31,
|
|
|
|
2019
|
|
$
|
236,926
|
|
2020
|
|
|
244,034
|
|
2021
|
|
|
251,355
|
|
2022
|
|
|
170,888
|
|
Total future
minimum lease payments
|
|
$
|
903,203
|
|
Total
rent under the current building lease is charged to expense over the term of the lease on a straight-line basis, resulting in
the same monthly rent expense throughout the lease. The difference between the rent expense amount and the actual rent paid is
recorded to deferred rent on the Company’s consolidated balance sheets.
Surna
Inc.
Notes
to Consolidated Financial Statements
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
On
May 29, 2018, the Company acquired an option to purchase 35,189,669 shares of preferred stock owned by the Keens. The Company
paid the Keens $5,000 for this option. The Company exercised this option and, in December 2018, completed the repurchase by these
shares of preferred stock and issued 35,190 shares of the Company’s common stock to the Keens. The Company recorded the
purchase price for the repurchased shares as a reduction to preferred stock at par value with the remainder of the purchase price
reflected as an increase to accumulated deficit.
As
of December 31, 2018 and 2017, there were 42,030,331 and 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, 2018, the Company issued shares of its restricted common stock as follows:
|
●
|
100,000
shares upon the exercise of certain warrants by an investor and payment of the exercise price of $15,000;
|
|
|
|
|
●
|
1,498,325
shares upon the exercise of certain warrants by a former director on a cashless exercise basis;
|
|
|
|
|
●
|
1,168,540
shares upon exercise of certain warrants by investors on a cashless exercise basis;
|
|
|
|
|
●
|
800,000
shares in connection with the settlement of a commercial dispute;
|
|
|
|
|
●
|
273,675
shares to consultants as compensation for services rendered;
|
|
|
|
|
●
|
31,562
shares to certain employees under a sales incentive plan;
|
|
|
|
|
●
|
7,562,500
shares of common stock were issued to accredited investors in a unit offering completed in June 2018 (see Note 14); and
|
|
|
|
|
●
|
35,190
shares of common stock were issued to the Keens in December 2018 in connection with the Company’s exercise of the preferred
stock option (see Note 8).
|
Surna
Inc.
Notes
to Consolidated Financial Statements
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 of common stock 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 a unit offering completed in March 2017 (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 a unit offering completed in December 2017 (see Note 14).
|
During
the year ended December 31, 2018, the Company also issued shares of its common stock under the 2017 Equity Plan as follows:
|
●
|
345,454
shares of common stock were issued to independent directors in lieu of cash director fees;
|
|
|
|
|
●
|
5,447,368
shares of common stock were issued to certain employees and independent directors in settlement of vested restricted stock
units;
|
|
|
|
|
●
|
3,420,000
shares of common stock were issued to certain employees as a stock incentive bonus;
|
|
|
|
|
●
|
1,158,658
shares of common stock were issued to a consultant as compensation for services rendered in lieu of cash fees and a bonus
fee; and
|
|
|
|
|
●
|
25,000
shares of common stock were issued to a former employee upon exercise of certain non-qualified stock options.
|
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;
|
|
|
|
|
●
|
1,200,000
shares of common stock 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 of common stock were issued to a consultant as compensation for services rendered in lieu of cash fees.
|
In
June 2018, the Company repurchased 3,125,000 shares of the Company’s common stock from the Keens for a repurchase price
of $400,000. See Note 8. Following the repurchase, the Company retired these shares and returned them to unauthorized and unissued
shares. The Company recorded the purchase price for the repurchased shares as a reduction to common stock at par value with the
remainder of the purchase price reflected as an increase to accumulated deficit.
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.
Surna
Inc.
Notes
to Consolidated Financial Statements
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.
In
December 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.
In
June 2018, the Company completed a private placement offering of investment units, at a price of $0.16 per unit, with certain
accredited investors. Each unit consisted of one share of the Company’s common stock and one warrant for the purchase of
one share of the Company’s common stock (the “Q2 2018 Warrants”). The Company issued a total of 7,562,500 units
for aggregate proceeds of $1,210,000, with $400,000 from the proceeds used to repurchase shares of common stock from the Keens.
The
Q2 2018 Warrants have an exercise price of $0.25 per share of the common stock underlying each warrant, subject to customary adjustments
as provided in the warrant. The Q2 2018 Warrants are exercisable commencing July 1, 2018 until June 30, 2021. The Q2 2018 Warrants
are callable at the Company’s option, beginning on July 1, 2019 until the expiration thereof on June 30, 2021, provided
the closing price of the Company’s common stock is $0.40 (subject to adjustment as provided in the warrant) or greater for
five consecutive trading days. Commencing at any time after the date on which the call condition is satisfied, the Company has
the right, upon notice to the holders, to redeem the shares of common stock underlying each warrant at a price of $0.01 per share,
but such redemption may not occur earlier than sixty-one (61) days following the date of the receipt of notice by the holder.
The holder may exercise the warrant (in whole or in part) prior to the redemption date at the exercise price.
As
of December 31, 2018, Q1 2017 Warrants to purchase 16,312,500 shares of common stock, the Q4 2017 Warrants to purchase 14,734,000
shares of common stock and the Q2 2018 Warrants to purchase 7,562,500 shares of common stock are outstanding.
Note
15 – Warrants Issued as Compensation for Services
Warrants
Issued to Former Director
Pursuant
to certain letter agreements, 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%. The former director exercised the Warrants on a cashless basis during 2018.
Surna
Inc.
Notes
to Consolidated Financial Statements
Warrants
Issued to Investment Bank
Pursuant
to a certain agreement for services rendered in connection with the conversion of the Series 2 Convertible Notes, during the year
ended December 31, 2017, the Company issued to an investment bank or its designees a warrant (“Banker Warrant”) to
purchase, at an exercise price $0.35 per share, 500,000 shares of the Company’s common stock 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%.
As of December 31, 2018, the Banker Warrant is outstanding.
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 a former executive officer, 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 former executive officer
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 former executive officer to complete a private placement of the Company’s common stock. The
former executive officer thereupon delivered a purported notice of exercise of the options to the Company just prior to the expiration
of the options. Prior to the Company’s acceptance of the notice of exercise and issuances of these shares in response thereto,
in May 2017, the former executive officer and the principal shareholders entered into a rescission agreement to nullify the March
2017 assignment transaction. Pursuant to their terms, these options have expired.
In
March 2017, another former executive officer 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, 2018 and 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, January 1, 2017
|
|
|
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
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
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, 2018, the Company
has granted, under the 2017 Equity Plan, awards in the form of RSAs for services rendered by independent directors and consultants,
non-qualified stock options, RSUs and stock bonus awards.
The
total unrecognized compensation expense for unvested non-qualified stock options, RSUs and stock bonus awards at December 31,
2018 was $702,169, which will be recognized over approximately 2.0 years. This unrecognized compensation expense does not include
the potential future compensation expense related to non-qualified stock options which are subject to vesting based on certain
revenue thresholds for 2019 being satisfied (the “Performance-based Awards”). As of December 31, 2018 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, 2018 was $245,553.
Restricted
Stock Awards
During
the year ended December 31, 2017, the Company awarded 2,420,494 shares of restricted stock under the 2017 Equity Plan in consideration
of services rendered to the Company by certain employees, independent directors and consultants. These restricted shares were
fully vested at the time of the award and the aggregate value attributable to these shares was $304,035, as calculated using the
fair value of the Company’s common stock on date the Board approved these awards. As of December 31, 2017, the independent
directors and a consultant were owed cash fees of $27,750 which were paid in the form of fully vested restricted shares in February
2018.
During
the year ended December 31, 2018, the Company awarded 1,406,055 shares of restricted stock under the 2017 Equity Plan in consideration
of services rendered to the Company by certain independent directors and consultants. These restricted shares were fully vested
at the time of the award and the aggregate value attributable to these shares was $301,650, as calculated using the fair value
of the Company’s common stock on date the Board approved these awards. As of December 31, 2018, the independent directors
were owed cash fees of $15,000 which were paid in the form of fully vested restricted shares in January 2019.
Non-Qualified
Stock Options
The
Company uses the Black-Scholes Model to determine the fair value of options granted. Option-pricing models require the input of
highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. Changes
in the subjective input assumptions can materially affect the fair value estimate. The expected stock price volatility assumptions
are based on the historical volatility of the Company’s common stock over periods that are similar to the expected terms
of grants and other relevant factors. The Company derives the expected term based on an average of the contract term and the vesting
period taking into consideration the vesting schedules and future employee behavior with regard to option exercise. The risk-free
interest rate is based on U.S. Treasury yields for a maturity approximating the expected term calculated at the date of grant.
The Company has never paid any cash dividends on its common stock and the Company has no intention to pay a dividend at this time;
therefore, the Company assumes that no dividends will be paid over the expected terms of option awards.
The
Company determines the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected
stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant
dates. As such, the Company may use different assumptions for options granted throughout the year. The valuation assumptions used
to determine the fair value of each option award on the date of grant were: expected stock price volatility 114.32% - 118.90%;
expected term in years 1.5 - 7.5 and risk-free interest rate 1.32% - 2.87%.
Surna
Inc.
Notes
to Consolidated Financial Statements
A
summary of the non-qualified stock options granted to employees under the 2017 Equity Plan during the years ended December 31,
2018 and 2017 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
|
|
Granted
|
|
|
6,500,000
|
|
|
$
|
0.118
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(25,000
|
)
|
|
$
|
0.135
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(6,083,332
|
)
|
|
$
|
0.147
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(66,668
|
)
|
|
$
|
0.135
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2018
|
|
|
10,560,000
|
|
|
$
|
0.104
|
|
|
|
8.4
|
|
|
$
|
-
|
|
Exercisable, December 31, 2018
|
|
|
3,226,671
|
|
|
$
|
0.114
|
|
|
|
6.1
|
|
|
$
|
-
|
|
Outstanding vested and expected to vest,
December 31, 2018
|
|
|
8,160,000
|
|
|
$
|
0.101
|
|
|
|
8.3
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performance options based on 2019 revenue
thresholds - uncertain vesting as of December 31, 2018
|
|
|
2,400,000
|
|
|
$
|
0.116
|
|
|
|
8.7
|
|
|
$
|
-
|
|
A
summary of non-vested non-qualified stock options activity for employees under the 2017 Equity Plan for the years ended December
31, 2018 and 2017 are presented in the table below:
|
|
Number
of Options
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
|
Grant-Date
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2016
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
12,530,000
|
|
|
$
|
0.103
|
|
|
|
|
|
|
$
|
1,296,504
|
|
Vested
|
|
|
(1,885,008
|
)
|
|
$
|
0.082
|
|
|
|
|
|
|
$
|
153,981
|
|
Forfeited
|
|
|
(2,235,000
|
)
|
|
$
|
0.109
|
|
|
|
|
|
|
$
|
243,359
|
|
Expired
|
|
|
(60,000
|
)
|
|
$
|
0.122
|
|
|
|
|
|
|
$
|
7,310
|
|
Nonvested, December 31, 2017
|
|
|
8,349,992
|
|
|
$
|
0.107
|
|
|
$
|
1,000,499
|
|
|
$
|
891,855
|
|
Granted
|
|
|
6,500,000
|
|
|
$
|
0.102
|
|
|
|
|
|
|
$
|
663,569
|
|
Vested
|
|
|
(1,433,331
|
)
|
|
$
|
0.088
|
|
|
|
|
|
|
$
|
125,988
|
|
Forfeited
|
|
|
(6,083,332
|
)
|
|
$
|
0.132
|
|
|
|
|
|
|
$
|
800,680
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
$
|
-
|
|
Nonvested, December 31, 2018
|
|
|
7,333,329
|
|
|
$
|
0.086
|
|
|
$
|
-
|
|
|
$
|
628,756
|
|
For
the years ended December 31, 2018 and 2017, the Company recorded $148,013 and $189,536 as compensation expense related to vested
options issued to employees, net of forfeitures, respectively. As of December 31, 2018, total unrecognized share-based compensation
related to unvested options was $578,486, of which $332,933 was related to time-based vesting and $245,553 was related to performance-based
vesting.
As
of December 31, 2018, the Company had granted non-qualified options to purchase 10,250,000 shares which were performance-based.
At December 31, 2018, non-qualified options to purchase 3,600,000 shares were forfeited due to the failure to satisfy the 2017
and 2018 revenue-based performance thresholds and 4,250,000 shares were forfeited due to employee terminations. Of the remaining
non-qualified options to purchase 2,400,000 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, 2018; therefore, no expense was
recognized.
Surna
Inc.
Notes
to Consolidated Financial Statements
A
summary of the non-qualified stock options granted to directors under the 2017 Equity Plan during the years ended December 31,
2018 and 2017 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
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited/Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2018
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
8.6
|
|
|
$
|
-
|
|
Exerciseable, December 31, 2018
|
|
|
900,000
|
|
|
$
|
0.135
|
|
|
|
8.6
|
|
|
$
|
-
|
|
A
summary of non-vested non-qualified stock options activity for directors under the 2017 Equity Plan for the years ended December
31, 2018 and 2017 are presented in the table below:
|
|
Number
of Options
|
|
|
Weighted
Average Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2016
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
1,800,000
|
|
|
$
|
0.123
|
|
|
|
|
|
Vested
|
|
|
(450,000
|
)
|
|
$
|
0.123
|
|
|
|
|
|
Forfeited
|
|
|
(900,000
|
)
|
|
$
|
0.123
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2017
|
|
|
450,000
|
|
|
$
|
0.123
|
|
|
$
|
52,470
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Vested
|
|
|
(450,000
|
)
|
|
$
|
0.123
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Nonvested, December 31, 2018
|
|
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
For
the years ended December 31, 2018 and 2017, the Company recorded $12,205 and $166,187 as compensation expense related to vested
options issued to directors, respectively. As of December 31, 2018, there was no unrecognized share-based compensation related
to unvested options issued to directors.
Surna
Inc.
Notes
to Consolidated Financial Statements
Restricted
Stock Units
A
summary of the RSUs awarded to employees, directors and consultants under the 2017 Equity Plan during the years ended December
31, 2018 and 2017 are presented in the table below:
|
|
Number
of Units
|
|
|
Weighted
Average Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2016
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
14,000,000
|
|
|
$
|
0.122
|
|
|
|
|
|
Vested and settled
with share issuance
|
|
|
(200,000
|
)
|
|
$
|
0.103
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2017
|
|
|
13,800,000
|
|
|
$
|
0.122
|
|
|
$
|
3,312,000
|
|
Granted
|
|
|
5,514,736
|
|
|
$
|
0.185
|
|
|
|
|
|
Vested
and settled with share issuance
1
|
|
|
(6,447,368
|
)
|
|
$
|
0.153
|
|
|
|
|
|
Forfeited
|
|
|
(3,000,000
|
)
|
|
$
|
0.112
|
|
|
|
|
|
Outstanding, December 31, 2018
|
|
|
9,867,368
|
|
|
$
|
0.140
|
|
|
$
|
730,185
|
|
Vested but not settled as of December 31, 2018
2
|
|
|
6,750,000
|
|
|
$
|
0.121
|
|
|
$
|
499,500
|
|
Expected to vest as of December 31, 2018
|
|
|
3,117,368
|
|
|
$
|
0.181
|
|
|
$
|
230,685
|
|
|
1
Includes
1,000,000 RSUs that were vested as of December 31, 2018 and settled with the issuance of 1,000,000 shares of common stock
in January 2019.
|
|
|
|
2
These
RSUs have not been settled due to the failure of the recipient to pay the required withholding taxes based on the value of
the underlying shares at the time of vesting. The Company has commenced litigation against the recipient to have these RSUs
canceled.
|
For
the years ended December 31, 2018 and 2017, the Company recorded $1,295,368 and $765,055 as compensation expense related to vested
RSUs issued to employees, directors and consultants. As of December 31, 2018, total unrecognized share-based compensation related
to unvested RSUs was $325,027, all of which was related to time-based vesting. The total intrinsic value of RSUs vested and settled
with share issuance was $1,289,500 and $20,499 for the years ended December 31, 2018 and 2017, excluding the intrinsic value of
$1,035,750 related to RSUs, which the Company is seeking to cancel, that vested in 2018 but have not been settled due to the recipient’s
failure to pay required withholding taxes.
During
2018, 3,000,000 RSUs granted to a former executive officer and subject to performance-based vesting were forfeited due to termination
of employment. The Company had not recognized any expense related to these RSUs prior to forfeiture since the likelihood of the
performance thresholds being satisfied was determined to be remote.
Incentive
Stock Bonuses
The
Company has entered into certain “at-will” employment agreements with certain employees. Under these agreements, the
employees are eligible to receive special incentive stock bonuses, provided the Board has determined, in its sole discretion,
that the employee’s performance has been average or better for the applicable special bonus period. This special stock incentive
bonus is payable only if the employee continues in the employment of the Company.
For
accounting purposes, the Company treats these special incentive stock bonuses as vesting over each bonus’s service period
based on the fair value of the award at the time of grant. Even though these bonuses are subject to Board approval, the awards
are vested over each service period because it is more likely than not that the Board will approve the award based on the “average
or better” employee performance standard. Since the awards are denominated in shares of common stock, the fair value of
the vested bonus is charged to additional paid-in capital.
Surna
Inc.
Notes
to Consolidated Financial Statements
A
summary of the incentive stock bonus awards granted to employees under the 2017 Equity Plan during the years ended December 31,
2018 and 2017 are presented in the table below:
|
|
Number
of Shares
|
|
|
Weighted
Average Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
Unvested, December 31, 2016
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
Awarded
|
|
|
8,600,000
|
|
|
$
|
0.113
|
|
|
|
|
|
Vested
|
|
|
(1,560,000
|
)
|
|
$
|
0.113
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Unvested, December 31, 2017
|
|
|
7,040,000
|
|
|
$
|
0.113
|
|
|
$
|
1,689,600
|
|
Awarded
|
|
|
4,000,000
|
|
|
$
|
0.170
|
|
|
|
|
|
Vested
|
|
|
(1,860,000
|
)
|
|
$
|
0.113
|
|
|
|
|
|
Forfeited
|
|
|
(7,500,000
|
)
|
|
$
|
0.144
|
|
|
|
|
|
Unvested, December 31, 2018
|
|
|
1,680,000
|
|
|
$
|
0.112
|
|
|
$
|
124,320
|
|
For
the years ended December 31, 2018 and 2017, the Company recorded $165,208 and $364,483 as compensation expense related to vested
stock bonus awards issued to employees, net of forfeitures of $404,689 and $0, respectively. As of December 31, 2018, total unrecognized
share-based compensation related to unvested stock bonus awards was $44,209. During the year ended December 31, 2018, the Company
issued 3,420,000 shares in payment of the vested stock bonus awards approved by the Board which had a total intrinsic value of
$624,520. Subsequent to December 31, 2018, the Company issued 560,000 shares in payment of the vested stock bonus awards approved
by the Board which had a total intrinsic value of $42,560. See Note 18.
Note
17 – Income Taxes
On
December 22, 2017, the Tax Cuts and Jobs Act was enacted into law. This U.S. tax reform contains several key provisions including
the reduction of the U.S. federal corporate income tax rate to 21% effective January 1, 2018 as well as a variety of other changes
including the limitation of the tax deductibility of interest expense, acceleration of expensing of certain business assets, and
reductions in the amount of executive pay that could qualify as a tax deduction. As a result of the change in the corporate tax
rate, the Company remeasured its deferred tax assets as of December 31, 2017 based on the rate at which they are expected to reverse
in the future, and recorded a reduction in net deferred tax assets of $1,177,000 in the fourth quarter of 2017, which is fully
offset by the corresponding reduction in the valuation allowance of the same amount.
For
financial reporting purposes, the provision for income taxes consisted of the following components:
|
|
2018
|
|
|
2017
|
|
Current taxes:
|
|
|
|
|
|
|
|
|
U.S. Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
U.S. State
|
|
|
-
|
|
|
|
-
|
|
International
|
|
|
-
|
|
|
|
-
|
|
Current taxes
|
|
|
-
|
|
|
|
-
|
|
Deferred taxes:
|
|
|
|
|
|
|
|
|
U.S. Federal
|
|
|
-
|
|
|
|
-
|
|
U.S. State
|
|
|
-
|
|
|
|
-
|
|
International
|
|
|
-
|
|
|
|
-
|
|
Deferred
taxes
|
|
|
-
|
|
|
|
-
|
|
Provision for
income taxes, net
|
|
$
|
-
|
|
|
$
|
-
|
|
Surna
Inc.
Notes
to Consolidated Financial Statements
The
differences between income taxes expected at the U.S. federal statutory income tax rate and the reported provision for income
taxes are summarized as follows:
|
|
2018
|
|
|
2017
|
|
Expected income tax benefit
at the federal statutory rate
|
|
$
|
(996,000
|
)
|
|
$
|
(1,535,000
|
)
|
State taxes, net
of federal benefits
|
|
|
(187,000
|
)
|
|
|
(109,000
|
)
|
Permanent differences
|
|
|
105,000
|
|
|
|
225,000
|
|
Tax return to provision
true-up adjustments
|
|
|
49,000
|
|
|
|
-
|
|
Adjustment to net
operating loss
|
|
|
(87,000
|
)
|
|
|
-
|
|
Other, net
|
|
|
(1,000
|
)
|
|
|
(8,000
|
)
|
Change due to U.S.
tax reform
|
|
|
-
|
|
|
|
1,177,000
|
|
Change
in valuation allowance
|
|
|
1,117,000
|
|
|
|
250,000
|
|
Reported income
tax (benefit) expense
|
|
$
|
-
|
|
|
$
|
-
|
|
The
components of the net deferred tax assets as of December 31, 2018 and 2017 are as follows:
|
|
2018
|
|
|
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net
operating losses
|
|
$
|
3,899,000
|
|
|
$
|
2,706,000
|
|
Equity compensation
|
|
|
321,000
|
|
|
|
274,000
|
|
Other
deferred tax assets
|
|
|
188,000
|
|
|
|
263,000
|
|
Total deferred
tax assets
|
|
|
4,408,000
|
|
|
|
3,243,000
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Other
deferred tax liabilities
|
|
|
(48,000
|
)
|
|
|
-
|
|
Total deferred
tax liabilities
|
|
|
(48,000
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets before valuation
allowance
|
|
|
4,360,000
|
|
|
|
3,243,000
|
|
Less valuation
allowance
|
|
|
(4,360,000
|
)
|
|
|
(3,243,000
|
)
|
Net deferred
tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
As
of December 31, 2018, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $15,626,000,
which will expire, if not utilized, in the years 2034 through 2037, however, NOLs generated subsequent to December 31, 2017 do
not expire but may only be used against taxable income to 80%. Pursuant to Section 382 of the Internal Revenue Code of 1986, as
amended, use of the Company’s NOLs carryforwards may be limited in the event of cumulative changes in ownership of more
than 50% within a three-year period.
The
Company must assess the likelihood that its net deferred tax assets will be recovered from future taxable income, and to the extent
the Company believes that recovery is not likely, the Company establishes a valuation allowance. Management’s judgment is
required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any valuation
allowance recorded against the net deferred tax assets. The Company recorded a full valuation allowance as of December 31, 2018
and 2017. Based on the available evidence, the Company believes it is more likely than not that it will not be able to utilize
its net deferred tax assets in the foreseeable future. The Company intends to maintain valuation allowances until sufficient evidence
exists to support the reversal of such valuation allowances. The Company makes estimates and judgments about its future taxable
income that are based on assumptions that are consistent with the Company’s plans. Should the actual amounts differ from
the Company’s estimates, the carrying value of the Company’s deferred tax assets could be materially impacted.
The
Company is subject to examination by the IRS for the calendar year 2009 and thereafter. These examinations may lead to ordinary
course adjustments or proposed adjustments to the Company’s taxes or the Company’s net operating losses with respect
to years under examination as well as subsequent periods. The Company has filed its U.S. federal corporate income tax returns
from 2009 through 2017, although the returns for the years 2009 through 2015 were not timely filed. Accordingly, the Company may
be subject to penalties, including those described below, for non-compliance; however, the Company believes that it had no taxable
income in the U.S. or in any foreign jurisdiction for the years 2009 through 2017. The Company has filed Colorado state income
tax returns for years 2014 through 2017, and Alaska, California and Connecticut state income tax returns for the year 2017.
Surna
Inc.
Notes
to Consolidated Financial Statements
The
Company recognizes in its consolidated financial statements the impact of a tax position, if that position is more likely than
not of being sustained on audit, based on the technical merits of the position. The Company’s policy is to recognize interest
and penalties accrued on any unrecognized tax benefits as a component of operating expense. The Company does not believe there
are any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly
increase or decrease within twelve months of the reporting date. There were no penalties or interest liabilities accrued as of
December 31, 2018 or 2017, nor were any penalties or interest costs included in expense for the years ended December 31, 2018
and 2017.
Note
18 – Subsequent Events
In
accordance with ASC 855,
Subsequent Events
, the Company has evaluated all subsequent events through March 19, 2019, the
date the financial statements were available to be issued. The following events occurred after December 31, 2018.
Since
December 31, 2018, the Company issued shares of its common stock under the 2017 Equity Plan as follows:
|
●
|
197,370
shares of common stock to independent directors in lieu of cash director fees of $15,000 related to the fourth quarter of
2018;
|
|
|
|
|
●
|
789,474
shares of common stock to independent directors for 2019 director fees of $60,000 payable in equity;
|
|
|
|
|
●
|
1,000,000
shares to an employee in settlement of certain RSUs that vested in 2018;
|
|
|
|
|
●
|
560,000
shares pursuant to a special incentive stock bonus approved the Board for the period ended December 31, 2018.
|
In
January 2019, the Company granted to a consultant the following non-qualified stock options with an exercise price of $0.0795
per share: (i) 1,000,000 options which vested on the date of grant, and (ii) 1,000,000 options which vest on June 30, 2019, subject
to the consultant’s continued service through the vesting date.