CEA Industries Inc. quarterly report, Q3 FY2012

Business context and reporting period

This is Surna Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2012; the filing was signed November 20, 2012. The request metadata names CEA Industries Inc., but the filing itself identifies Surna Inc. as the registrant. Surna describes itself as a start-up developing online and mobile games, primarily for the PRC market.

Financial performance and condition

• Gross profit and gross margin are not separately presented in the filing.
• For the first nine months, operating expenses were $638,474, including salaries of $449,455, product development costs of $39,620 and general and administrative expenses of $149,399. No income tax provision was recorded.
• Cash was $1,912 at September 30, 2012, versus $2,745 at December 31, 2011. Nine-month net cash used in operating activities was $573,750; financing provided $572,036, entirely reported as advances from related parties.
• Current assets were $162,627 and current liabilities were $2,319,641, a working capital deficit of $2,157,014. Total assets were $182,628; stockholders’ deficit was $2,137,013.
• Amounts due to related parties were $2,245,439, up from $1,664,117 at year-end. The advances, including salary due, are unsecured, non-interest-bearing and due on demand.
• Accounts receivable was $158,140, compared with $1,273 at December 31, 2011. The company reported no allowance for doubtful accounts.

Material changes versus comparable periods

Revenue increased from minimal prior-year levels, while quarterly and nine-month losses narrowed substantially. Nine-month 2011 operating expenses included $769,231 in compensation expense, which was not recorded in 2012. The company’s nine-month 2012 revenue came entirely from one customer. The filing attributes $11,607 of nine-month income to discontinued operations, compared with a $15,287 loss in the prior-year period.

Outlook, risks and unusual items

• Going concern: Management reports minimal recurring revenue, a substantial working capital deficit and cumulative losses of $2,283,093 through September 30, 2012. The filing says these conditions raise substantial doubt about the company’s ability to continue as a going concern. Operations depend on obtaining additional financing; failure to do so could require suspension or cessation of operations.
• Business plans: Surna intends to develop browser-based and mobile games and expects to earn through licensing and revenue or profit sharing. It provides no quantified financial guidance or launch timetable in this filing.
• Concentration and operating risks: One customer represented 100% of nine-month revenue. The filing also cites competition, limited resources for development and marketing, PRC regulatory and economic risks, currency exposure, and dependence on successful game launches and monetization.
• Licensing structure: PRC game-publishing restrictions involve contractual arrangements and a variable interest entity; the filing describes licensing and technical-services agreements supporting the economic benefit of a game license.
• Discontinued operations: Surna sold Surna Networks Inc. and Surna Networks Limited on March 27, 2012 for $1 and assumed $9,286 of liabilities.
• Controls and filing timing: Management concluded disclosure controls were ineffective due to a material weakness involving inadequate segregation of duties and the absence of a formal accounting procedures manual. The filing was late because Hurricane Sandy disrupted the independent accountant’s work and related filing preparation.
• Other: Management reported no pending litigation and no material changes in internal control during the quarter. The company’s former auditors had issued a going-concern opinion, as noted in MD&A.

Important facts for investors to verify

• Whether Surna can obtain financing to meet obligations, given minimal cash, demand-related-party advances and the stated going-concern uncertainty.
• Whether the $158,140 receivable from the sole revenue customer is collected and whether customer concentration persists.
• The terms, repayment expectations and any changes in related-party balances and advances.
• Progress and commercial results for game development, licensing, publishing and monetization plans, including the PRC contractual and VIE arrangements.
• Whether management remediates the disclosed control weaknesses and whether future filings are timely.
• The issuer identity: the filing is for Surna Inc., not the company named in the request metadata.