CEA Industries Inc. — Form 10-Q Summary
Issuer identification: The supplied filing is for Surna Inc., not CEA Industries Inc. The filing reports the quarter ended September 30, 2017, and was signed November 14, 2017. Financial statements are unaudited.
Business context and reporting period
Surna develops, designs, and distributes controlled-environment agriculture systems, with a focus on commercial indoor cannabis cultivation facilities. Its products and services include lighting, environmental control, air sanitation, cultivation-facility systems, and engineering. Surna does not cultivate or distribute cannabis.
Financial performance and liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue, 2017 | $1.566 million | $4.901 million |
| Revenue, 2016 | $1.171 million | $5.561 million |
| Gross profit, 2017 | $391,209 | $1.233 million |
| Gross margin, 2017 / 2016 | 25% / 36% | 25% / 33% |
| Operating loss, 2017 | $1.234 million | $3.021 million |
| Net loss, 2017 / 2016 | $1.478 million / $669,000 | $3.553 million / $2.118 million |
| Operating cash flow, 2017 / 2016 | Not presented for the quarter | $(1.961) million / $35,000 |
Third-quarter revenue rose 34% year over year, while nine-month revenue fell 12%. For the nine-month period, operating expenses increased 114% to $4.253 million, including higher selling, general and administrative and marketing costs. Equity-based compensation was $626,154 for the quarter and $925,859 for the nine months; the company attributed much of the expense growth to compensation, staffing, professional fees, and marketing investments.
At September 30, cash was $1.301 million, versus $320,000 at December 31, 2016. Current assets were $2.312 million and current liabilities $2.980 million, a working-capital deficit of approximately $667,000. Total liabilities were $2.980 million; the balance sheet showed no convertible promissory notes or long-term liabilities, but included a $265,760 warrant derivative liability. Nine-month financing cash flow was $2.867 million, including $2.685 million from a private placement and $500,000 from promissory notes. The company reported no income-tax provision and no income taxes paid.
Material changes and unusual items
- Gross margin declined year over year in both periods, which management attributed to a less favorable mix of lower-margin third-party equipment and higher manufacturing overhead. Nine-month costs also included a $208,801 inventory obsolescence provision related to specifically built inventory a customer would not accept.
- In March, Surna raised $2.685 million through a common-stock-and-warrant private placement. During the first quarter, it converted $510,000 of convertible-note principal and accrued interest into shares and paid $314,150 to settle other convertible notes.
- In August, two promissory notes totaling $537,500 principal were converted into 5.6 million common shares. The conversion resulted in a $228,428 extinguishment loss; the nine-month statements report a total $643,428 loss on extinguishment of debt.
- Common shares outstanding were 189,865,919 at September 30 and 191,265,919 as of November 10. Approximately 19.1 million potential shares from options, warrants, and restricted stock units were excluded from diluted loss per share as anti-dilutive.
Outlook, risks, and contingencies
- Funding and going concern: Surna reported recurring losses, an accumulated deficit of $17.889 million, and stated that cash and operating cash flow would not fund operations and growth for the next 12 months. Management expected it would likely need additional debt or equity financing in the first half of 2018; availability and terms were uncertain. The 2016 audit opinion had raised substantial doubt about the company’s ability to continue as a going concern.
- Sales outlook: Unearned contract value for contracts with initial deposits was $4.311 million at quarter-end; about 45% had not received a further deposit for proprietary equipment and could face delay or cancellation. Management believed at least 50% of this backlog could be recognized in fourth-quarter 2017, but revenue timing depended on customers obtaining licenses, financing, permits, and completing facilities. This was management’s expectation, not formal financial guidance.
- Market and execution risks: Management cited uncertainty about U.S. cannabis policy as a possible reason for delayed projects, as well as competition, customer financing and construction delays, and project mix. It was building a direct-sales model and improving project management and sales systems.
- Lease: A manufacturing and office lease runs through August 2022, with disclosed minimum future payments totaling $1.172 million. Monthly rent increases from $12,967 to $18,979 in January 2018, followed by annual increases.
- Contingencies and controls: The IRS assessed approximately $115,000 in penalties for late foreign information returns; Surna was appealing and believed abatement likely, but no outcome was assured. The company disclosed that disclosure controls were ineffective because of material weaknesses, insufficient accounting expertise and supervisory review, and inadequate segregation of duties.
- Other items: Surna disclosed ordinary-course litigation risk but no material legal proceeding. It also described a disputed former-CEO option exercise request that the Board had not approved. No material off-balance-sheet arrangements were reported.
Most important facts for investors to verify
- Confirm the issuer and ticker relevant to the request: this filing names Surna Inc., not CEA Industries Inc.
- Assess whether the $4.311 million backlog converted to revenue and whether projects lacking further deposits were delayed or canceled.
- Verify subsequent financing, cash burn, and the company’s ability to fund operations beyond the next 12 months.
- Review the causes and sustainability of the decline in gross margin and the increase in operating expenses.
- Track dilution from outstanding shares, warrants, options, restricted stock units, and equity-based compensation.
- Monitor the IRS penalty appeal, the former-CEO option matter, and remediation of internal-control weaknesses.