Filing summary
Entity and period: The supplied filing is a Form 10-Q for the quarter ended June 30, 2017, filed August 14, 2017. It identifies the registrant as Surna Inc., not CEA Industries Inc.; verify that this is the intended filing. Financial statements are unaudited.
Business context and reporting period
Surna designs and supplies equipment and integrated solutions for controlled-environment agriculture, with a focus on commercial indoor cannabis cultivation facilities. It does not cultivate or distribute cannabis. Results cover the three and six months ended June 30, 2017, compared with the same 2016 periods.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $1.742 million | $1.891 million | $3.335 million | $4.390 million |
| Gross profit | $413,000 | $313,000 | $841,000 | $1.401 million |
| Gross margin | 24% | 17% | 25% | 32% |
| Operating expenses | $1.610 million | $612,000 | $2.628 million | $1.336 million |
| Operating loss (income) | $(1.197) million | $(299,000) | $(1.786) million | $66,000 |
| Net loss | $(1.073) million | $(704,000) | $(2.074) million | $(1.450) million |
- Q2 revenue fell 8% year over year; six-month revenue fell 24%. Q2 gross margin improved, while the six-month margin declined.
- Operating cash flow was a use of $1.980 million for the first six months of 2017, compared with $60,000 provided in 2016. Investing activities provided $132,000 and financing activities provided $2.882 million. Cash increased by $1.034 million to $1.353 million.
- At June 30, 2017, current assets were $2.258 million and current liabilities $3.036 million, a $778,000 working-capital deficit. Total liabilities were $3.036 million; shareholders’ equity was a deficit of $14,905. Accumulated deficit was $16.410 million.
- The balance sheet included $500,835 of notes payable, net, and no convertible notes outstanding. The company’s February 2017 notes had $537,500 original principal and were due November 2017. Subsequent to quarter-end, holders agreed to exchange the principal for 5.6 million shares, with closing expected around August 15, 2017; the filing does not establish that the exchange had closed when filed.
- Common shares outstanding were 183,294,028 at June 30 and August 7, 2017. The first-half private placement raised $2.685 million and issued 16.781 million shares with warrants.
Material changes and management commentary
- Management attributed lower revenue partly to contracts being signed earlier in customer projects, delaying equipment revenue until customers secure permits, prepare sites, and complete construction. It also cited uncertainty around cannabis regulation and customer projects.
- Q2 backlog was approximately $3.933 million, up about $143,000 from Q1. About 30% lacked a further deposit for proprietary equipment, creating potential cancellation or delay risk. A $1.3 million project was in engineering; a substantial portion of backlog was expected to convert to revenue in Q4 2017 or the first half of 2018. Backlog is not reported revenue.
- Q2 operating expenses rose 163%, with higher director compensation and equity awards, sales staffing, professional fees, marketing, travel, and a one-time investment-banking payment among the cited drivers. The 2016 comparison also included a $455,000 warranty charge and a $208,000 inventory allowance, which affected cost comparisons.
- Management described efforts to grow bookings and accelerate project delivery, including added sales resources, a CRM system, faster quotation tools, and strengthened project tracking. It offered no firm revenue or earnings forecast.
Outlook, risks, contingencies, and unusual items
- Going concern and funding: The company reported recurring losses and stated that June 30 cash and operating cash flow would not fund the next 12 months. It might need financing as early as Q4 2017 and said additional financing may be required even with cost reductions. Management warned that failure to obtain cash could require reducing operations. The 2016 audit opinion had expressed substantial doubt about the company’s ability to continue as a going concern.
- Execution and market risks: Revenue depends on customer licensing, financing, construction, and installation timelines, as well as regulatory developments and competition. Management noted that customer delays and project timing make revenue recognition difficult to predict.
- Contingency: IRS penalties of approximately $120,000 related to late Forms 5471 were under an abatement request; management believed abatement was warranted, but no assurance was provided. The filing reports no material pending legal proceedings.
- Other commitments and related parties: A five-year facility lease was signed, with rent starting at $12,967 per month and rising to $18,979 per month in January 2018, followed by annual 3% increases from September 2018. Related-party agreements included a $30,000 annual consulting fee and a quarterly equipment, demonstration, and testing arrangement with an entity controlled by a principal shareholder; equipment delivery began after permits were obtained in July.
- Controls and accounting: Management concluded disclosure controls were ineffective at June 30 due to material weaknesses, including insufficient accounting expertise, inadequate supervisory review, and limited segregation of duties. The company was evaluating the impact of new accounting standards, including revenue recognition guidance planned for adoption in 2018.
- Equity incentives: Subsequent to quarter-end, the company adopted a 2017 Equity Incentive Plan reserving 50 million shares. Disclosed awards and director compensation create potential dilution; some employee options are tied to revenue thresholds of $10 million in 2017, $18 million in 2018, and $25 million in 2019. These are vesting conditions, not management guidance.
Important facts for investors to verify
- Confirm the issuer: the filing names Surna Inc., while the request names CEA Industries Inc.
- Verify completion and terms of the post-quarter-end note-for-stock exchange, and the resulting share count and dilution.
- Assess cash runway, near-term financing requirements, and the status of the going-concern risk.
- Track backlog conversion, deposits, customer project delays, and the timing of the $1.3 million project and other expected revenue.
- Review the $120,000 IRS penalty abatement request, the new lease obligations, related-party arrangements, and progress remediating control weaknesses.