10-K
1
form10-k.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2020
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR
THE TRANSITION PERIOD FROM ____ TO _______
Commission
File Number: 000-54286
SURNA
INC.
(Exact
name of registrant as specified in its charter)
(Address of principal executive offices) (Zip code)
(303)
993-5271
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Exchange Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
N/A N/A N/A
Securities
registered pursuant to Section 12(g) of the Act:
Title
of Each Class Registered
Common
stock, par value $0.00001 per share
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ]
No [X].
Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ]
No [X].
Indicate
by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during
the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the last 90 days. Yes [X] No [ ].
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant
to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit such files). Yes [X] No [ ].
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer, “accelerated filer,”
“non-accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule
12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [ ]
Non-accelerated Filer [X] Smaller Reporting Company [X]
Emerging Growth Company [ ]
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]
No [X].
The
aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of the last business
day of the registrant’s most recently completed second fiscal quarter was approximately $7,090,000 based upon a closing
price of $0.03 reported for such date on the OTCMarkets.
As
of March 23, 2021, the number of outstanding shares of common stock of the registrant was 236,526,638.
DOCUMENTS
INCORPORATED BY REFERENCE
None.
Surna
Inc.
Annual
Report on Form 10-K
For
Fiscal Year Ended December 31, 2020
Table
of Contents
Page
Part I
Item 1. Business 5
Item 1A. Risk Factors 19
Item 1B. Unresolved Staff Comments 32
Item 2. Properties 32
Item 3. Legal Proceedings 32
Item 4. Mine Safety Disclosures 32
Part II
Item 6. Selected Financial Data 33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 43
Item 8. Financial Statements and Supplementary Data 43
Item 9A. Controls and Procedures 43
Item 9B. Other Information 44
Part III
Item 10. Directors, Executive Officers and Corporate Governance 45
Item 11. Executive Compensation 49
Item 14. Principal Accountant Fees and Services 55
Part IV
Item 15. Exhibits and Financial Statement Schedules 57
Signatures 58
In
this Annual Report, unless otherwise indicated, the “Company”, “we”, “us” or “our”
refer to Surna Inc. and, where appropriate, its wholly-owned subsidiary.
Hemp
and marijuana are technically both part of the “Cannabis sativa L.” plant. “Hemp” is a term used to classify
varieties of cannabis that contain 0.3% or less tetrahydrocannabinol (“THC”) content (by dry weight), the principal
psychoactive constituent of cannabis. Hemp and its derivatives were federally legalized in the United States as part the Agricultural
Act of 2018. “Marijuana” is a term used to classify varieties of cannabis that contain more than 0.3% THC (by dry
weight). Marijuana is not federally legal in the United States. Many states, however, have taken action to make marijuana legal
for all purposes, made it available for medical uses, decriminalized it or a combination thereof. We currently provide nearly
all of our products and services to customers that cultivate marijuana. In this Annual Report, unless otherwise indicated, “cannabis”
refers to “marijuana.”
Although
our customers do, we neither grow, manufacture, distribute nor sell cannabis (marijuana) and hemp or any of their related products.
CAUTIONARY
STATEMENT
This
Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in Item 7, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking
statements are not historical facts, but are based on current management expectations that involve substantial risks, uncertainties,
and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially
from those expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or
our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,”
“should,” “expects,” “plans,” “anticipates,” “could,” “intends,”
“target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,”
“potential” or “continue” or the negative of these terms or other similar words. All statements, other
than statements of historical fact, are statements that could be deemed forward-looking statements including, but not limited
to, any projections of revenue, gross profit, earnings or loss, tax provisions, cash flows or other financial items; any statements
of the plans, strategies or objectives of management for future operations; any statements regarding current or future macroeconomic
or industry-specific trends or events and the impact of those trends and events on us or our financial performance; any statements
regarding pending investigations, legal claims or tax disputes; any statements of expectation or belief; and any statements of
assumptions underlying any of the foregoing.
These
forward-looking statements are subject to known and unknown risks, uncertainties, assumptions and other factors that could cause
our actual results of operations, financial condition, liquidity, performance, prospects, opportunities, achievements or industry
results, as well as those of the markets we serve or intend to serve, to differ materially from those expressed in, or suggested
by, these forward-looking statements. These forward-looking statements are based on assumptions regarding our present and future
business strategies and the environment in which we operate. Important factors that could cause those differences include, but
are not limited to:
● the inherent uncertainty of product development;
● our relationships with our customers and suppliers;
● our ability to attract and retain qualified personnel;
● future revenue being lower than expected;
● our intention not to pay dividends.
Although
we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could
prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. In
light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this annual report on Form
10-K should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties
include those described or identified in “Risk Factors” in this Annual Report on Form 10-K. You should not place undue
reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. Except as required
by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result
of new information, future events or otherwise, to reflect events or circumstances occurring after the date of this Annual Report
on Form 10-K. The forward-looking statements and projections contained in this Annual Report on Form 10-K are excluded from the
safe harbor protection provided by Section 27A of the Securities Act.
Non-GAAP
Financial Measures
To
supplement our financial results on U.S. generally accepted accounting principles (“GAAP”) basis, we use non-GAAP
measures including net bookings, backlog, as well as adjusted net income (loss) which reflects adjustments for certain non-cash
expenses such as stock-based compensation, certain debt-related items and depreciation expense. We believe these non-GAAP measures
are helpful in understanding our past performance and are intended to aid in evaluating our potential future results. The presentation
of these non-GAAP measures should be considered in addition to our GAAP results and are not intended to be considered in isolation
or as a substitute for financial information prepared or presented in accordance with GAAP. We believe these non-GAAP financial
measures reflect an additional way to view aspects of our operations that, when viewed with our GAAP results, provide a more complete
understanding of factors and trends affecting our business. For purposes of this Annual Report, (i) “adjusted net income
(loss)” and “adjusted operating income (loss)” mean GAAP net income (loss) and operating income (loss), respectively,
after adjustment for non-cash equity compensation expense, debt-related items and depreciation expense, and (ii) “net bookings”
means new sales contracts executed during the quarter for which we received an initial deposit, net of any adjustments including
cancellations and change orders during the quarter.
Our
backlog, remaining performance obligations and net bookings may not be indicative of future operating results, and our customers
may attempt to renegotiate or terminate their contracts for a number of reasons, including delays in or inability to obtain project
financing or licensing or abandonment of the project entirely. Accordingly, there can be no assurance that contracts included
in the backlog or remaining performance obligations will actually generate revenues or when the actual revenues will be generated.
PART
I
Item
1. Business
Overview
We
design, engineer and sell environmental control and other technologies for the Controlled Environment Agriculture (CEA) industry.
The CEA industry is one of the fastest-growing sectors of the United States’ economy. From leafy greens (kale, Swiss chard,
mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables and small fruits (such as
strawberries, blackberries and raspberries) to bell peppers, cucumbers, tomatoes and cannabis and hemp, some producers grow crops
indoors in response to market dynamics or as part of their preferred farming practice. In service of the CEA, our principal technologies
include: (i) liquid-based process cooling systems and other climate control systems, (ii) air handling equipment and systems,
(iii) a full-service engineering package for designing and engineering commercial scale thermodynamic systems specific to cultivation
facilities, and (iv) automation and control devices, systems and technologies used for environmental, lighting and climate control.
Our customers include commercial, state- and provincial-regulated CEA growers in the U.S. and Canada as well as other international
locations. Customers are those growers building new facilities and those expanding or retrofitting existing facilities. Currently,
our revenue stream is derived primarily from supplying our products, services and technologies to commercial indoor facilities
ranging from several thousand to more than 100,000 square feet.
Headquartered
in Boulder, Colorado, we leverage our experience in this space to bring value-added climate control solutions to our customers
that help improve their overall crop quality and yield, optimize energy and water efficiency, and satisfy the evolving state and
local codes, permitting and regulatory requirements.
All
CEA facility operators are facing multiple headwinds of high energy costs, issues about water usage and waste materials, and,
in the case of cannabis growing, increasingly rigorous quality standards and declining cannabis prices. To be competitive, among
other things, our customers must develop innovative ways to meet the demands of their business and reduce energy costs, 90% of
which is typically related to their HVACD (50%) and lighting systems (40%). HVACD systems have historically been our focus. We
often have the advantage of early engagement with our customers at the pre-build and construction phases and the corresponding
opportunity to build longer-term relationships with our existing customers and their facilities. Going forward, our plan is to
leverage our existing customer relationships and attempt to sell them additional products and services, thereby becoming “stickier”
to our customers, in an effort to generate incremental revenue.
We
have three core assets that we believe are important to our going-forward business strategy. First, we have multi-year relationships
with customers and others in the CEA industry, notably in the cannabis segment. Second, we have specialized engineering know-how
and experience gathered from designing environmental control systems for CEA cultivation facilities since 2016. Third, we have
a line of proprietary environmental control products, which we are in the process of expanding.
We
are an integrated provider of MEP (mechanical, electrical, plumbing) engineering design, proprietary environmental control equipment,
and controls and automation offerings serving the CEA industry. Historically, nearly all of our customers have been in
the cannabis cultivation business. We believe our employees have more experience than most other MEP firms serving this industry.
Our customers engage us for their environmental and climate control systems because they want experts to design their facilities,
and they come to us because of our reputation. We leverage our reputation and know-how against the many local contractors and
MEP engineers who collectively constitute our largest competitors.
A
number of recent events have had an adverse impact on our operations and financial condition, including constraints on capital
availability for our customers and prospects who have commenced, or are contemplating, new and expanded CEA cultivation facilities
and the recent outbreak of COVID-19, a novel strain of coronavirus first identified in China, which has spread across the globe
including the U.S. Most recently, the response to this coronavirus by federal, state and local governments in the U.S. has resulted
in significant market and business disruptions across many industries and affecting businesses of all sizes. This pandemic has
also caused significant stock market volatility and further tightened capital access for most businesses.
Shares
of our common stock are traded on The OTC Markets under the ticker symbol “SRNA.”
Impact
of the COVID-19 Pandemic on Our Business
The
impact of the government and the business economic response to the COVID-19 pandemic has affected demand across the majority of
our markets and disrupted work on projects. The COVID-19 pandemic is expected to have continued adverse effects on our sales,
project implementation, operating margins, and working capital. As of the date of this filing, uncertainty continues to exist
concerning the magnitude and duration of the economic impact of the COVID-19 pandemic.
In
response to the COVID-19 pandemic, in late March of 2020 the Company downsized operations to preserve cash resources, implementing
workforce reductions, reductions of salaried employee compensation (including all executives and the CEO) and reduction of hours
worked, cutting costs and focusing its operations on customer-centric sales and project management activities.
Following
the receipt of loan funds in April 2020, the Company reinstated all staff who previously had been placed on furlough. Staff receiving
salaries of $100,000 per year or less were restored to their full salaries. All executives, including the CEO, had their compensation
reduced to the greater of $100,000 per year or 75% of their previous salary level. The Company re-engaged its staff so as to be
able to fulfill its current customer contracts and any new sales orders and to continue its marketing and selling efforts. Over
the course of the Summer 2020, the Company took further steps to adjust its work force by furloughing several employees, making
temporary hourly and salary reduction adjustments, and then, in late September 2020, in light of our then sales efforts, reinstating
continuing hourly employees to full-time status and restoring the salaries of continuing salaried employees.
Due
to the speed with which the COVID-19 pandemic developed and the resulting uncertainties, including the depth and duration of the
disruptions to customers and suppliers, its future effect on our business, on our results of operations, and on our financial
condition, we cannot predict the overall effect on our business over the longer term. Despite this uncertainty, we have undertaken
various plans to reduce costs so as to mitigate the impact of the COVID-19 pandemic to the best of our ability, although they
may not be sufficient in the long-run for us to avoid reduced sales, increased losses and reduced operating cash flows.
Refer
to Risk Factors, included in Part II, Item 1A of this Annual Report on Form 10-K below, for further discussion of the possible
impact of the COVID-19 pandemic on our business.
Our
Growth Strategy
We
believe there are several ways to grow a business: (i) increase the number of customers, (ii) increase the average revenue
per order, (iii) increase the frequency of orders, or (iv) expand the addressable market.
We
have a sales and marketing program that generates many prospective customer relationships. However, our limited range of higher
cost products, mostly chilled water systems, reduces the number of customer prospects who can afford to buy from us. In 2018 we
started an aggressive effort to broaden our product and service offerings to provide a wider range of HVACD technical solutions
(see chart below). In 2018 we began to offer stamped mechanical plan sets and our first 4-pipe chilled water systems. In 2019
we broadened our engineering services to include full MEP (mechanical, electrical, and plumbing) design services. We also began
to offer our SentryIQ® Controls System. And in 2020 we added new products to include: split system DX (direct expansion) with
integrated dehumidification, packaged DX systems with modulating hot gas reheat, heat recovery chiller/boiler for 4-pipe systems,
and our StrataAirTM TM racking airflow solution to address customer needs for multi-level cultivation facilities. These
various systems provide solutions to answer a broader range of technical and cost constraints, and we will continue to develop
and offer new solutions to our customers’ problems, so that a broader group of growers can take advantage of our engineering
expertise and capabilities. We believe these new products and services will increase our addressable market and increase sales,
further leveraging our investment in sales and marketing.
The
success of our product development initiative can be seen in the following table, which documents the number of commercial-scale
projects (over $100,000 sales) that have included one or more of our new products:
Year Percent using New Products
Growing
live plants indoors in a controlled environment is a technically demanding business, and a failed crop can cost a grower significant
foregone revenue. We believe our licensed professional engineers are some of the industry’s leading experts in the design
of such facilities, and we seek to extend that leadership into more advanced technology products.
In
2019 we introduced our SentryIQ® control system. If our climate control design and products are the proverbial car, then SentryIQ®
is the proverbial steering wheel—one is needed to direct the car where to go. Before SentryIQ® we had to send our customers
elsewhere for controls to regulate their cultivation environments, but we now have the ability to capture that revenue. To date,
we have signed thirteen contracts for controls systems with an aggregate value of approximately $1,700,000.
Our
next step down this technology and innovation road will be the eventual development of the equivalent of a self-driving car. Growers
will tell the control system what they want to achieve, and the system will sense the environment and direct the climate control
system to achieve the grower’s goals. These systems will be able to integrate data analytics—and eventually deploy
artificial intelligence—to optimize multiple variables to maximize the grower’s profits. While we are in the early
stages of development of these technology-driven systems, we believe it is important for us to become a player in this market
because it expands our addressable market for both sensors and software while offering the possibility of higher margins and recurring
revenue over time.
Strategic
relationships might include referral marketing agreements, selling through manufacturer’s representative organizations,
co-development of unique integrated solutions with best-in-class partners, and acquisitions. To extend the automotive analogy,
engaging in these types of relationships is like adding more dealers to sell our products, at little cost to us.
If
some of these strategic alliances are successful in driving top-line revenue for us and our partners, over time these relationships
could develop into more exclusive arrangements or evolve into possible acquisitions or a source of strategic capital for us. There
can be no assurance that we will be able to successfully execute any of these strategic initiatives. Efforts will be primarily
focused on working with new strategic partners to co-market each other’s products and services and possibly jointly develop
new and improved products and services, as opposed to exclusively seeking acquisitions.
4. Expand our addressable market
Our
sales and marketing efforts have historically been oriented towards the cannabis-cultivation segment of the CEA industry. The
non-cannabis CEA industry is growing as well, and we believe our products and services can address that market either as currently
engineered or with minimal modification.
Surna’s
core and historic expertise and products center on providing mechanical engineering for environmental controls for indoor growing
facilities. We believe that our demonstrated expertise and experience positions us to expand our product and service offerings
vertically, to include integrating many of the technologies and services required to build and operate a CEA cultivation facility,
such as space programming and facility layout in addition to the MEP engineering we do today. In addition, we believe we can expand
our product offerings to include the selection, integration, and provision of lighting, benching, irrigation and fertigation equipment
and add-on maintenance and other recurring revenue services to operating facilities.
********
Our
Key Initiatives
Our
strategic business plan has four primary objectives:
4. Seek uplisting to a national securities exchange at a propitious moment.
Our
goal for the immediate future is to grow organically, strategically and profitably within the CEA industry. We will
also consider acquisitions of complementary businesses both within and potentially outside of the CEA industry. We
believe the worldwide CEA market will grow substantially for the foreseeable future, and that this will lead to more new build,
retrofit and expansion projects to drive our continued growth. Here are some of the initiatives we pursued in 2020, and where
more work is needed to progress each of them.
Focus
on Multi-facility Operators. We actively pursue business from multi-facility operators (MFOs), which we define as businesses
that own and operate two or more CEA cultivation facilities in either the U.S. or Canada. These MFOs are typically larger and
have greater financial and organizational wherewithal to buy more and larger systems and are less prone to project delays and
cancellations, compared to the smaller (and riskier) independent cultivators that had been our primary customers in the past.
In 2020 we booked three projects totaling $3.5 million. We recorded $2.9 million in revenue from these projects, or 35% of our
total 2020 revenue. Going forward, we will conduct our operations to seek a sales pipeline with MFO customers that we believe
will result in more consistent and predictable revenue and cash flow. Because MFOs are typically more sophisticated and may, in
many cases, have in-house engineering teams, such MFOs may not need the engineering expertise and experience we offer. This contrasts
with the independent smaller grower market that places significant value in our overall expertise and experience, including our
specific CEA related growing knowledge.
The
table below shows our 2020 full year results for commercial-scale projects, which we define as contracts with a value over $100,000,
by project and customer type.
To
achieve profitability in the future, we must first be able to generate a more consistent and predictable revenue stream. To do
so, we must: (i) maximize our new build facility projects, and (ii) supplement those projects with an increased number of retrofit
and expansion projects—which typically have shorter completion cycles and fewer external contingencies that we do not control.
Historically, whenever a new build project has been delayed or cancelled, which can occur often, our revenue and cash flow has
taken a corresponding dramatic hit.
Offer
a Broader Range of Products and Services Across the Cultivation Facility Lifecycle. During 2019, we fulfilled the
first step of this goal with the introduction of our SentryIQ® controls package. We also began offering full mechanical, electrical,
and plumbing engineering services, developed and sold a four-pipe, chilled water environmental control system with Surna branded
fan coil units and custom air handlers, developed a proprietary destratification fan, and performed facility retrofit services.
Our new custom air handlers alone generated $2.3 million in revenue in 2019, and another $516,000 in 2020. In 2020 we continued
this effort by introducing several new DX-based packaged products (EnviroProTM) and our StrataAirTM air distribution
product.
Following
up on our product launch successes in 2019 and 2020, we plan to address facility lifecycle revenue opportunities by leveraging
our strong brand name and positioning ourselves as the “trusted advisor” in environmental controls management. In
addition, we will begin to offer recurring-revenue services for facility monitoring and preventive maintenance services. Our expanded
product offering is illustrated by the following 4-phase matrix of product/service depth and facility lifecycle participation.
We
attempt to become “stickier” to our customers by providing climate control products and services across the entire
4-phase facility lifecycle. Each phase of the facility lifecycle has many activities that present potential opportunities for
us. We do not intend to offer products and services in all activities in each phase, but rather we will focus on technology and
innovation that provide value-add to our customers as they attempt to seek out “best-in-class” partners to automate
and control the indoor grow facilities of the future. We believe, if successful, this could possibly translate into greater demand
for our proprietary, customized equipment, technology and software solutions.
Enter
Strategic Alliances to Expand our Marketing and Sales Reach. We have identified several business verticals that we believe
are logical and natural complements to our climate control business, such as: lighting, fertigation (automated process of delivering
nutrients and water to plants), benches (customized systems to optimize use of the growing space), cultivation management technology
(software), consumables (growing, packaging, facility and lab supplies), and operational improvement analytics (modeling, data
aggregation and artificial intelligence). We will also consider strategic alliances, such as distribution, reseller, co-marketing
or product development agreements, with select companies which are consistent with our strategic direction. Our strategic alliances
will likely involve development of more comprehensive, end-to-end, integrated solutions for our customers, as well as specialized
products and services that help cultivators compete in the market, whether through automation, software or operating efficiencies.
If
some of these strategic alliances are successful in driving top-line revenue for us and our partners, over time these relationships
could develop into more exclusive arrangements or evolve into possible acquisitions or a source of strategic capital for us. There
can be no assurance that we will be able to successfully execute any of these strategic initiatives. Efforts will be primarily
focused on working with new strategic partners to co-market each other’s products and services and possibly jointly develop
new and improved products and services for the CEA industry.
Cash
and Dilution. We started 2020 with just over $922,000 in cash but with a new discipline on cost control and increased
bookings in the second half of the year we were able to increase our cash to $2,285,000 at the end of 2020. In 2019 and 2020 we
used operating cash flows and loan proceeds to support our operations and did not engage in any dilutive financing. In 2020, we
exercised strict financial discipline to weather a dramatic drop in new projects in the first half of the year, largely due to
the Covid-19 pandemic response. We recovered in the second half. In the first two quarters of the year we had a major project
cancellation and fewer new project bookings. Our adjusted net loss in 2020 was $1,239,000 compared to an adjusted net income in
2019 of $92,000. Our adjusted net income (loss) is our GAAP net income (loss) after addback for our non-cash equity compensation
expenses, debt-related items and depreciation expense.
Our
working capital remains negative, which is a constant impediment to the overall viability of our business as planned, so we must
land more MFO and other contracts and we may have to raise capital again to fund our working capital needs and future growth.
Investor
Relations. We previously had limited investor relations activities of any kind prior to 2019. In 2019 we began to attend
investor conferences and we engaged an Investor Relations firm. Due to the financial impact of the pandemic we terminated these
activities at the end of Q1 2020. Our goal remains to create an actively traded, widely held, and fully valued stock over time
and in concert with our achievement of consistent financial goals. We intend to resume Investor Relations activities as our finances
allow.
Products
and Services
We
now offer a broader range of products and services to the CEA market than the mechanical engineering and modular chilled water
systems we historically offered. This includes products and services targeting smaller indoor grow facilities and commercial-scale
facilities as well as sealed greenhouse, or hybrid, facilities.
Services:
Engineering and Design. We offer licensed professional mechanical, electrical and plumbing design and engineering services
to all customers, and those customers in the cannabis growing industry that are in cannabis-legal states and provinces. We believe
we have leading edge, sophisticated engineering capabilities, which we attempt to leverage with independent small growers as well
as MFOs that are building larger and more sophisticated commercial projects.
Going
forward, we plan to: (i) emphasize our strong mechanical engineering team that includes an in-house staff of degreed engineers
including an experienced licensed professional engineer (PE), (ii) offer pre-construction energy modeling to help our customers
and enhance our sales closing rate, (iii) develop an engineering, design and audit services program for the expanding retrofit
market, which remediates existing grow facilities that suffer from sub-optimal performance, and (iv) potentially offer other facility
management programs.
Our
technical experience and know-how in designing indoor cultivation facilities allow us to deliver to our customers practical solutions
to complicated problems in four primary areas: (i) precision climate and environmental controls, (ii) energy and water efficiency,
(iii) building code and permitting, and (iv) project management of construction of our products in the facility. Our engineering
design typically includes all mechanical components of a climate control system: cooling and heating, dehumidification, ventilation,
air sanitation and odor control. We provide load calculations, equipment specifications, and engineered systems drawings for both
the cultivation and comfort cooling portions of our customers’ facilities. We also have experience in, or knowledge of,
state and local permitting and code compliance for facilities in states and provinces where cannabis has been legalized for either
recreational or medical use or is expected to be legalized, and we provide stamped, engineered drawings in all states and provinces
where we operate.
Our
competitive advantages are our experience and reputation. Since 2006 we have continuously improved our CEA facility design capabilities
which we believe distinguishes us from our competition. Our primary competitors include local heating, ventilation and air conditioning
(“HVAC”) contractors, traditional MEP engineering firms, and other CEA-focused design firms. CEA facilities present
a very difficult mechanical engineering challenge, and traditional mechanical engineers, without our experience, are typically
unfamiliar with the precise climate and air control requirements needed for such facilities. As important, they may be unable
to effectively navigate the local code and permitting rules which did not contemplate the special requirements of CEA facilities
when enacted. With our engineering design resources and experience, we are able to provide a code-compliant MEP plan set by collaborating
with local regulators and our customers to engineer creative solutions that not only meet the intent of the local codes but also
address concerns about the growing energy and resource usage of these facilities.
Energy
use is, and will increasingly become, a primary concern for regulators and indoor cultivators. Two states, Massachusetts and Illinois,
have already placed regulatory caps on energy density in indoor cultivation facilities and we expect this trend to continue. Energy
costs are frequently the second largest operating expense for a cultivation facility, after labor, with HVACD and lighting comprising
approximately 50% and 40%, respectively, of a facility’s energy use.
As
a result, licensed producers are adopting practices to maximize energy efficiency and thereby reduce operating costs, which will
become even more important as the industry matures and wholesale prices continue to decline. These practices include more efficient
uses of water, more efficient lighting (typically LED lighting), and renewable energy alternatives. Sealed greenhouses, or hybrid
facilities—which are insulated for energy efficiency and combine natural light with the use of artificial lights—also
provide a more economical way to grow agricultural products compared to warehouse type indoor production. But regardless of whether
an indoor or a hybrid facility is the grow venue, precise environmental controls are required to deliver consistent product quality
and yield. We are evaluating possible strategic relationships with providers that are seeking an environmental controls partner
for these specific facility applications.
We
believe the right solution for our cultivation customers must include: (i) precise temperature/humidity control; (ii) reduced
fungus, pollen, pesticide and insect contamination risk (“bio-security”); (iii) controlled regulatory compliance risk;
(iv) lower maintenance complexity, costs and downtime; and (v) energy and resource efficiency.
Our
bio-security program uses a combination of a sealed facility and customized approaches to air sterilization to maintain facility
standards, while destroying harmful airborne microbes without the production of byproducts. Additionally, our ductless modular
chilled water systems—using fan coil units within each grow room—isolate the air and potential contaminants within
each room, while taking advantage of the energy efficiencies and redundancies offered by such systems. Our experience has shown
that our precision environmental controls can reduce the reliance on the use of harmful pesticides and fungicides. We also believe
our experience in the tightly regulated Canadian market where pharmaceutical-like standards (including Good Manufacturing Practice
standards) exist for filtration, air quality and post-harvest plant quality gives us an advantage over our competitors, especially
as product quality testing regulations continue to be enacted and made more stringent by state, provincial and local agencies.
The
following perspectives explain and help conceptualize the complexity of the environmental controls systems that need to be deployed
by indoor cultivators:
New
technologies and applications, coupled with emerging cultivation innovations, are providing opportunities for increased efficiency,
which we are positioned to deliver to our customers. Our engineering and product development teams, which currently consist of
seven people, are fully qualified and committed to delivering energy and resource efficient solutions to commercial cultivators.
Leveraging their technical competence, and our customers’ increasing focus on energy efficiency, quality and yield, in the
future we intend to offer retrofit/design, energy audit, energy efficiency improvement, performance audit, and preventive maintenance
services.
Products:
Environmental Control Systems. We offer, in addition to modular chilled water systems, other HVACD solutions, such
as custom air handling units, split systems, packaged roof-top units, and self-contained and complex water chilled systems. During
2019, we launched upgraded equipment lines of fan coils and air handlers. In 2020 we introduced our first DX-based packaged systems.
This expanded product line will allow us in the future to offer less expensive products that can help us serve customers who have
tighter budget constraints.
We
are now offering various configurations of our new Surna-branded fan coil units, which provide greater efficiency, design flexibility
and control for growers using modular chilled water systems. We are capable of offering a utility rebate consulting service to
help our new build customers obtain utility rebates. While this service is not expected to generate significant revenue, it should
help us sell our environmental controls systems because our customers will be able to use these rebates to offset some of their
capital costs.
There
can be no assurance that we will be able to successfully execute any of these product initiatives, or identify, test and develop
improved products or services, or that such products or services will generate revenue or profitability at the levels we expect.
We also intend to work with select “best-in-class” vendors and partners that may be interested in jointly developing
and marketing new and improved products and services.
Technology:
Sensors, Controls and Automation Business. One of our key initiatives for 2019 was the development of a branded, proprietary
controls and monitoring offering (consisting of sensors, controllers, software, monitoring and a user interface). We accomplished
this and launched in April 2019 our SentryIQ® sensors, controls and automation (“SCA”) platform—a turnkey,
single-vendor HVACD equipment and controls integration solution to new build projects as well as existing facilities in the startup
and operation phases. We continued the rollout of SentryIQ® and to date we have entered into thirteen contracts with twelve
different companies to implement our SentryIQ® SCA platform. This product line is important for tactical and strategic reasons,
and we hope to offer this as a standalone offering in the future.
Cultivation
facilities must have SCA to operate their HVACD equipment. In simple form, SCA is the thermostat in the room, with the occupant
selecting the desired temperature set point, the wall thermostat (Sensor) detecting the actual temperature, and when the space
temperature deviates from the desired set point the thermostat (Control) commands the furnace or air-conditioner to supply heated
or cooled air to bring the room temperature back to the set point. In the case of the indoor cultivation facilities, there are
more environmental conditions to monitor and control (such as temperature, relative humidity, CO2, lighting, vapor
pressure deficit status, and more) than in a typical residential home.
Indoor
CEA growers also need to vary and tightly control environmental conditions depending on the stage of plant growth (i.e., clone,
vegetative and flowering stages), the time of day, and the plant genetics. In a cultivation facility the desired conditions change
many times during the plant’s growth cycle and even within a day, and this is most easily accomplished with a programmable
environmental control system (automation), not unlike a simple programmable thermostat in a home.
Our
SentryIQ® SCA package includes precision sensors to measure temperature, humidity, and CO2 levels—more accurately
than typical HVACD sensors and within tighter tolerance levels. Our controllers are purpose-built computers programmed by us to
ensure our industrial environmental control equipment follows the engineered sequences of operation to obtain desired set-points.
Our sensors connect to our branded controllers through wires installed in the facility, and similarly they are wired to our HVACD
equipment (e.g., chillers, fan coils and dehumidifiers) to direct these pieces of equipment. The controllers also provide a user
interface on a screen so they can be easily programmed and controlled to achieve the customer’s environmental objectives,
and give the cultivator the ability to access this data and react to alerts remotely.
We
have entered this business to satisfy our customer’s needs that we did not previously address and that historically was
provided by third-party controls contractors. Our entry into the SCA market helps both our customers’ and our businesses.
Our customers benefit because they are saved the extra work of finding and engaging a controls contractor, which allows them to
get their facility up and running more quickly by taking one decision off the table and thereby establishing a single point of
responsibility for controls implementation. We are also in a position to provide SCA because we know our proprietary equipment
better than anyone, thereby ensuring smooth integration with our equipment with no work scope shortcomings, what we refer to as
“scope gap.”
From
a tactical perspective, with limited incremental selling costs, our current sales team can now offer our SCA package to nearly
every prospect since every cultivation facility should have SCA technology. We believe this technology value-added solution gives
us an opportunity to achieve incremental project revenue. Strategically, through our SCA package, we are also able to deepen our
long-term customer relationship by tethering us to the customer through a controls interface (dashboard) to their facility. Future
development will allow our customer to use artificial intelligence (AI) by aggregating environment and growing data to optimize
energy use, operating efficiency, and product quality and yield. While there are several other total controls systems providers,
we believe that our industry know-how, experience and reputation with climate control environments gives us a compelling and competitive
SCA offering.
Sales
and Marketing
Multi-Facility
Operator (“MFO”) Focus
Our
sales and marketing efforts will continue to focus on MFOs. However, we face multiple sources of competition in our attempt to
penetrate the MFO market.
We
believe we can compete in the MFO market for the following reasons:
Our
ability to develop relationships with, and obtain new business from, other MFOs will be critical to generating consistent revenues
quarter-over-quarter. During the first half of 2020, we experienced project delays and cancellations due to the Covid pandemic.
Fortunately, our bookings rebounded in the second half, and we finished the 2020 year with $8.4 million of backlogged projects.
Notwithstanding our efforts, there is no assurance that we will be successful in growing and maintaining our business with these
MFOs, especially in light of the uncertainty surrounding the potential impact of the coronavirus on our business and the business
of our customers and customer prospects.
New
Commercial-Scale Projects
The
demand for our environmental control systems is driven primarily by the construction of new CEA facilities in the U.S. and Canada.
As the CEA industry expands, the cannabis cultivation segment is, in turn, driven by changed legislation approving either medical
or recreational use. Recent regulatory changes involving medical and/or recreational cannabis use in various jurisdictions, such
as California, Michigan, Oklahoma, Utah, Missouri, Illinois and Canada, tend to be a leading indicator for the granting of licenses
for new facility construction. As more new cultivation facilities become licensed, we in turn have an expanded set of potential
customers that might buy our environmental control systems. However, since both medical and recreational cannabis use remains
prohibited under U.S. federal law, uncertainty continues and tends to unfavorably impact the development and financing of new
cultivation facilities in the U.S.
The
following table sets forth our commercial-scale project bookings, which we define as contracts executed with a value over $100,000,
for which we received an initial deposit for the years 2016 through 2020. Based on the current economic climate and our downsizing
measures, there is no assurance that we will be able to continue to obtain the level of bookings that we had in the past.
Number of New Commercial-Scale Project Bookings
Our
marketing efforts will be targeted at MFOs, smaller independent growers, design-build firms, architects working in the CEA industry,
investors and consulting firms operating in that space. We believe these represent the largest markets, based on the state and
local regulatory framework, for our products and services. We believe our marketing efforts will be curtailed for the foreseeable
future due to our efforts to preserve our cash resources as we deal with the uncertainty surrounding the coronavirus.
Retrofit
Market
Existing
commercial retrofit projects also represent a business opportunity in the CEA industry. The estimated 3,000+ existing cannabis
producing CEA facilities in North America are easier to identify than new build projects. We believe, based on evidence and our
market knowledge, that some of these exiting facilities are operating sub-optimally and have environmental control problems that
our products can help remediate. We also believe that the energy consumption of these facilities can be reduced, and we have commenced
developing services and products to help them realize savings. We have a full product and service offering in mind, but we expect
that the roll-out will take up to two years. To expedite this roll-out, we are evaluating possible strategic partners that could
add products and services that are an immediate value-add to our customers. These CEA facilities retrofit projects do not typically
carry the uncertainties associated with new build projects such as licensing, permitting and funding. In the future, we also will
potentially launch an internally developed facility assessment and analysis tool to assist existing facilities in solving their
environmental controls challenges.
New
Build Facility Sales Cycle and Risks
The
sales cycles for our new build commercial projects can vary significantly. From pre-sales and technical advisory meetings to sales
contract execution, to engineering and design services and equipment delivery, and all the way through installation and commissioning
of the installed system, the full cycle can range from six months to two years. Since we do not install the climate control systems,