CEA Industries Inc. (identified in the filing as Surna Inc.) — Q1 2017 Form 10-Q
Entity note: The request metadata names CEA Industries Inc., but the filing identifies the registrant as Surna Inc. Investors should verify the issuer and filing before relying on this summary.
Business context and reporting period
The unaudited report covers the three months ended March 31, 2017, with comparisons to the same 2016 period. Surna designs, manufactures and sells equipment and engineering services for controlled-environment agriculture, with a focus on commercial indoor cannabis cultivation facilities. The company stated that it does not cultivate or distribute cannabis.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 or prior balance-sheet date |
|---|---|---|
| Revenue | $1.593 million | $2.499 million |
| Gross profit and margin | $428,336; 27% | $1.089 million; 44% |
| Operating expenses | $1.018 million | $724,000 |
| Operating loss | $589,618 | Operating income of $364,979 |
| Net loss | $1.001 million | $746,214 |
| Operating cash flow | $(1.338) million | $774,000 provided |
| Investing cash flow | $72,742 provided | $69,643 provided |
| Financing cash flow | $2.915 million provided | $33,757 used |
| Cash | $1.969 million at March 31, 2017 | $319,546 at December 31, 2016 |
| Working capital | Approximately $43,000 | Deficit of approximately $2.860 million at December 31, 2016 |
| Total liabilities | $2.969 million | $4.229 million at December 31, 2016 |
Q1 2017 loss per common share was $0.01. The filing reports no income tax provision. At March 31, current liabilities included $475,559 of notes payable, $422,814 of warrant derivative liability, and $924,861 of deferred revenue. The company reported no convertible notes outstanding at quarter-end; a separate February borrowing had $537,500 principal due in November 2017.
Material changes versus the prior period
- Revenue fell 36%, which management attributed mainly to a sales-contract strategy that secures contracts earlier in the customer project cycle and to increased cannabis-industry uncertainty after the U.S. presidential election.
- Gross margin declined 17 percentage points to 27%. Management cited project mix, lower revenue against fixed costs, and variable equipment and vendor costs.
- Operating expenses rose 41%, including higher personnel, investor-relations and public-relations costs. Noncash compensation expense was approximately $136,000, versus approximately $3,000 a year earlier.
- Net loss increased by approximately $255,000. Lower interest and debt-discount expense was offset in part by a $415,000 debt-extinguishment loss and weaker operating performance.
- Cash increased primarily due to a $2.685 million private placement and $500,000 of proceeds from promissory notes. Operating activities used $1.338 million, including cash outflows associated with lower accounts payable and deferred revenue.
- The company issued 16.8 million common shares in the private placement and 5.0 million shares upon conversion of debt and accrued interest. Common shares outstanding rose to 183.3 million from 160.7 million at year-end.
Outlook, risks and unusual items
- Funding and going concern: The company reported recurring losses, an accumulated deficit of $15.337 million, and uncertainty about whether cash and operating cash flow would fund the next 12 months. Management said additional capital would be needed in the second half of 2017, absent expense reductions, and that the March 31 cash balance was insufficient for the next 12 months. No financing commitment from officers or shareholders was in place.
- Backlog and revenue timing: Unearned contract value was approximately $3.790 million at March 31; about 78% related to projects without a further deposit for proprietary equipment. A substantial portion was not expected to be recognized until the second half of 2017. Customer licensing, financing, facility construction and deposit timing could delay or prevent conversion to revenue. A roughly $1.3 million contract signed in April was at an early stage.
- Debt and contingencies: February notes totaling $537,500 mature in November 2017, bear 6% interest, and provide for an 18% rate upon specified defaults. The filing discusses ordinary-course litigation and a former CEO’s disputed request to exercise an option for 3 million shares; the board had not approved issuance and was reviewing the matter.
- Related-party arrangements: In May 2017, the company approved a three-year consulting agreement with principal shareholder and former director Stephen Keen for $30,000 annually, and a three-year equipment, demonstration and testing agreement with Sterling Pharms, an entity controlled by Mr. Keen. The company agreed to receive quarterly equipment fees of $16,500 and pay Sterling $12,000 quarterly for demonstrations and product testing.
- Controls: Management concluded disclosure controls were ineffective at March 31, 2017, citing insufficient accounting expertise, inadequate supervisory review and limited segregation of duties. The filing reported no material change in internal control during the quarter.
- No specific financial guidance: Management discussed sales initiatives and possible cost reductions but provided no quantified revenue or earnings forecast. It cited regulatory shifts, competition, customer financing and project execution as uncertainties.
Important facts to verify
- Confirm that this Surna Inc. filing is the intended filing for CEA Industries Inc.
- Assess the company’s ability to obtain the additional financing management says is required and to repay the November 2017 notes.
- Track conversion of the reported backlog into deposits, completed projects, recognized revenue and cash collections.
- Review the effects of the private placement, warrants and other share issuances on dilution and potential future financing.
- Review the terms, approval and performance of the related-party agreements, and the status of the former CEO option matter.
- Monitor remediation of the disclosed material weaknesses and effectiveness of financial reporting controls.