Item 1A. Risk Factors 18
Item 1B. Unresolved Staff Comments 36
Item 2. Properties 36
Item 3. Legal Proceedings 36
Item 4. Mine Safety Disclosures 36
Part II
Item 6. Selected Financial Data 38
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 51
Item 8. Financial Statements and Supplementary Data 51
Item 9A. Controls and Procedures 51
Item 9B. Other Information 52
Part III
Item 10. Directors, Executive Officers and Corporate Governance 53
Item 11. Executive Compensation 59
Item 14. Principal Accountant Fees and Services 66
Part IV
Item 15. Exhibits and Financial Statement Schedules 68
Signatures 69
In
this Annual Report, unless otherwise indicated, the “Company”, “we”, “us” or “our” refer
to CEA Industries Inc. (formerly known as 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;
● the continuation of normal supply of products from our suppliers;
● our ability to attract and retain qualified personnel;
● future revenue being lower than expected;
● our intention not to pay dividends.
These
factors should not be construed as exhaustive and should be read with the other cautionary statements in this report.
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
The
Company is an industry leader in CEA (Controlled Environment Agriculture) facility design, technologies, and services. The CEA industry
is one of the fastest-growing sectors of the United States’ economy and is defined by type of facility. The CEA industry is composed
of any horticultural facility that is fully self-contained and has a controlled environment. Three facility types meet these criteria:
●
Indoor facilities – environmentally sealed facilities for growing crops and that require artificial lighting.
●
Vertical farms –cultivation facilities oriented vertically to minimize ground square footage.
●
Greenhouses – facilities that are made of translucent materials to use natural sunlight on the crops.
Crops
grown in CEA facilities include: leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true
leaf stage), ethnic vegetables, ornamentals and small fruits (such as strawberries, blackberries and raspberries), bell peppers,
cucumbers, tomatoes, cannabis and hemp. Historically, we have primarily served customers growing cannabis in indoor facilities
and we are currently pursuing our strategy to broaden our reach to serve other indoor farming including vertical farms.
We
provide full-service licensed architectural and mechanical, electrical, and plumbing (MEP) engineering services, carefully curated heating,
ventilation and air conditioning (“HVACD”) equipment, proprietary controls systems, air sanitation, lighting, and benching
and racking products. Our team (including both internal employees and outside partnerships) of project managers, licensed professional
architects and engineers, technology and horticulture specialists and systems integrations experts help our customers by precisely designing
for their unique applications. Through our partnership with a certified service contractor network, we provide maintenance services to
assist in a smooth build-out and ensure optimal facility performance.
We
leverage our industry-leading experience to bring value-added solutions to our customers that help improve their overall crop quality
and yield, optimize energy and water efficiency, and satisfy evolving state and local construction code, permitting and regulatory requirements.
Our revenue stream derives primarily from supplying our products, services and technologies to commercial indoor facilities ranging from
several thousand to more than 100,000 square feet.
CEA
facility operators face multiple headwinds from high energy costs, 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 are typically related
to their HVACD (50%) and lighting systems (40%). HVACD systems have historically been and continue to be our primary area of expertise
and energy efficiency is high on our list of considerations when engineering environmental control systems.
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. During 2021, we added architectural services to our offerings
in an attempt to engage with the customer at an even earlier stage. Going forward, we plan to leverage our existing customer relationships
by introducing them to our expanded design services along with our expanded product offerings. We believe these efforts will generate
incremental revenue and make us “stickier” to our customers.
We
have three core assets that we believe are important to our going-forward business strategy and that will contribute to our future growth.
First, we have a well-known brand name in the industry along with multi-year relationships with customers and others developed over our
fifteen years of service to the industry. This length of service and broad network of industry contacts will benefit not only our organic
growth initiatives, but also provide us with unique insight into other industry providers who may be appropriate for acquisition or
joint efforts. Second, we have specialized engineering know-how and experience gathered from designing environmental control
systems for over 200 commercial CEA cultivation facilities. Third, we have an expanding line of proprietary and curated environmental
control systems and other core technology components needed to build a CEA facility.
Our
website is www.ceaindustries.com, which contains a description of our Company and products. In addition, we also maintain
a branded technology product website at www.surna.com. The content of our websites is not incorporated herein
by reference.
Shares
of our common stock and warrants to purchase shares of our common stock are traded on The Nasdaq Capital Market under the ticker
symbols “CEAD” and “CEADW”.
Impact
of the COVID-19 Pandemic on Our Business
The
COVID-19 pandemic has prompted national, regional, and local governments, including those in the markets that the Company operates in,
to implement preventative or protective measures to control its spread. As a result, there have been disruptions in business operations
around the world, with an impact on our business.
In
response to the COVID-19 pandemic and the associated government and business response, the Company took and continues to take
measures to adjust its operations as necessary. In early 2020 the Company responded to reduced orders by reducing expenses in
an effort to preserve cash. Many expenses, including travel, marketing, headcount, work hours, and compensation were reduced, deferred,
or eliminated while still allowing us to meet our customer obligations and develop new business. As 2020 progressed and our sales rebounded,
and we were able to obtain additional funds through a forgivable bank loan, we restored our workforce and compensation. Many of these
expense reductions were reversed by the end of 2021 when orders picked up and the overall business climate improved. Because
the pandemic continues in different parts of the world and in different ways in the United States, the Company continues to actively
monitor its operations.
We
are experiencing unexpected and uncontrollable delays with our international supply of products and shipments from vendors due to a significant
increase in shipments to U.S. ports, compounded by a reduction in cargo being shipped by air, a general shortage of containers,
and a shortage of domestic truck driver availability. While these delays have moderately improved in recent months, we, along
with many other importers of goods across all industries, continue to experience severe congestion and extensive wait times for carriers
at ports across the United States. In addition, restrictions imposed by local, state and federal agencies due to the COVID-19 pandemic
have led to reduced personnel of importers, government staff and others in our supply chain. We have been working diligently with
our network of freight partners and suppliers to expedite delivery dates and provide solutions to reduce further impact and delays. However,
we are unable to determine the full impact of these delays and how long they will continue as they are out of our control.
While
the Company is continuing to navigate the financial, operational, and personnel challenges presented by the COVID-19 pandemic, the full
extent of the impact of COVID-19 on our operational and financial performance will depend on future developments, including the duration
and spread of the pandemic, the potential uncertainty related to (and proliferation of) new strains, and related actions
taken by federal, state, local and international government officials, to prevent and manage the spread of COVID-19.
All of these efforts are uncertain, out of our control, and cannot be predicted at this time.
The
CEA Industry
According to leading market
research firms Headset and New Frontier Data, the North American cannabis industry is expected to experience compound annual growth on
the order of 14%-15% from 2022 through 2025. More U.S. states are legalizing either medical or recreational use of cannabis products,
and sometimes both. Although the market is aware of how the cannabis sector is growing, it seems to be less aware of the non-cannabis
CEA market, particularly the vertical farming segment which is growing nearly as fast as the cannabis market. Since the technical infrastructure
and requirements for growing any plant in a controlled environment are similar, we believe we can bring our engineering expertise and
suite of products to this adjacent high growth market.
Our
Services and Equipment Solutions
Our
goal is to develop relationships with our prospects and customers that will afford us the opportunity to provide comprehensive services
and equipment for the complete lifecycle of indoor agriculture facilities. This lifecycle includes designing and engineering the facility,
providing the many required infrastructure technologies, advising on and ensuring proper installation of the technologies, providing
training and start-up support, and ultimately providing preventative and other ongoing services for ensuring proper maintenance and operations.
We
provide a comprehensive range of services and products as follows:
Service Solutions
Facility Design and Budgeting
● Licensed Architectural design, including space and operational planning
● Assessment of equipment options based on facility requirements
● Specification/recommendation of equipment for each facility
Equipment Selection and Specification
● Identifying, assessing, and selecting equipment to meet customer requirements
Equipment Installation Advisory
● Advising contractors to ensure proper cultivation equipment installation
Start-up Services
● Initial equipment start-up support
● Controls system checkout and tuning
● Operator training
Lifecycle Services
● Preventative Maintenance Services (Subscription)
Product Solutions
● Proprietary, white-label environmental control products
● Proprietary Facility Control System (SentryIQ®)
● Value-Added Reseller (“VAR”) of Cultivation and Environmental Control Products
● VAR of Lighting Products
● VAR of Benching and Racking Products
Service
Solutions: Facility Design Services
Our
outsourced licensed architectural services provide facility design and layout to include space and workflow optimization, construction
documents, and construction administration. Our extensive experience with CEA facilities brings extra value to our customers as we advise
them on the design of their facility to maximize its productivity and return on investment.
We
have professional engineers (PEs) on our staff to provide licensed, professional Mechanical, Electrical, and Plumbing (MEP) engineering
services to all non-cannabis customers, and to cannabis customers that are in cannabis-legal states and provinces. Our engineers
perform mechanical engineering, and we outsource electrical and plumbing engineering to several vendors with whom we have long-term,
trusted relationships. We believe we are among the most experienced engineering firms serving the cannabis growing CEA industry and we
have leading edge, sophisticated engineering capabilities. We provide these services to facilities from several thousand to over 100,000
square feet in size. Over time the size and sophistication of projects we have served has grown increasingly large, a trend we
expect will continue as the industry builds ever larger facilities.
Our
licensed MEP engineering services provide stamped drawings that our customers need to obtain building permits and to build their facilities
and specify equipment, and we can provide these services in any state or province. Our technical experience and know-how in engineering
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) construction
support services and start-up support of their environmental control equipment. 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. We provide a drawing package to
our customers that allows them to obtain a building permit that is code compliant, identifies construction materials and alternates,
and provides construction administration information for their general and sub-contractors to follow.
Service
Solutions: Equipment Selection and Specification
Our
goal as engineers is to identify the best technical solutions in the market and to offer a curated range of technologies to our customers
to best meet the needs of their facilities. Our engineers assess each facility’s requirements and recommend the best equipment
options for the customer without limitation or bias to a particular HVAC technology solution as we have access to all major HVAC system
types and multiple vendors. Our product development and R&D groups search the market for the best technical solutions to offer our
customers. We offer a wide range of the best products in the market.
Service
Solutions: Equipment Installation Advisory
We
do not offer construction services or perform equipment installation. Typically, a facility owner hires a general contractor (GC) to
manage the project, and the GC hires sub-contractors in specific trades to conduct the installation of each sub-system, such as environmental
control equipment. Our role in the construction process is to work with the GC and sub-contractors to provide the equipment that the
customer has ordered at the required time and place. Then, during the construction process, our technical services employees are available
to advise the construction contractors, and we conduct multiple site visits to ensure the quality of the installation.
Service
Solutions: Start-up Services
After
construction is completed, our technical services employees participate on-site to inspect the installation and to conduct startup
of the systems that we have provided. When we are contracted for controls, we offer operator training for the facility personnel. After
the facility is up and running, we provide support as needed to include site visits and to ensure that the facility is operating to its
design specifications.
Service
Solutions: Lifecycle Services
CEA
facilities are technically sophisticated and require multiple sub-systems, including: environmental control, lighting, CO2
enrichment and control, water conditioning and reclamation, and fertigation/irrigation. We believe that facility operators will eventually
want to focus on their core business of growing plants and not be distracted by the unrelated, but necessary and technical, work of maintaining
these mission-critical sub-systems.
In
the summer of 2021, we developed and began selling preventive maintenance (PM) services to meet this demand from our existing clients.
Sold on a recurring subscription basis to existing cultivation facilities, the PM services are sold by us and are provided by third-party
service companies located near the customer’s facility. We have partnered with a company that can provide this service across most
of the geography where our customers and prospects are located. The PM services product is important for our business for three primary
reasons. First, it provides recurring revenue. Second, it establishes a long-term relationship with the customer. Third, it offers
the opportunity to be sold independently of our existing engineering offering and to any of the several thousand existing cultivation
facilities.
Product
Solutions.
We
have historically been a provider of HVACD engineering and systems, and since 2019 we have broadened our product lines to now
offer a wide range of products and infrastructure technologies. Because many different technologies are required to operate an indoor
cultivation facility, our product strategy is to offer both proprietary (Surna Cultivation Technologies branded) and off the shelf products.
Our proprietary products are made by us or vendors on a contract manufacturing basis to our specifications. We offer a curated selection
of products and specify those that best meet the needs of our customers’ particular applications. Our product solutions
can be divided into three categories.
Product
Solutions: White-label environmental control products
Environmental
Control Systems. We offer a broad range of HVACD technologies, to include chilled water systems, custom air handling units, split systems,
and packaged roof-top units. We sell our proprietary products under the brand names Surna®, IsoStream®, EnviroProTM, EcoChillTM,
StrataAirTM and SentryIQ®. We have a national accounts relationship with Trane, and we resell their chillers under a
joint label agreement. We also have a national accounts relationship with Anden, and we resell their dehumidifiers under a joint
label agreement. During 2019, we launched upgraded, white-labeled equipment lines of fan coils and air handlers. In 2020 we introduced
our first DX-based packaged systems. We offer various configurations of our Surna-branded fan coil units, which provide greater efficiency,
design flexibility and control for growers using modular chilled water systems. This expanded product line allows us to serve customers
across a wide range of application and budget requirements. We have chosen to offer white-label products for two reasons. First, we can
design the products to our own specifications, using our accumulated knowledge to develop products that meet the particular and demanding
challenges of indoor agriculture. Second, we can maintain better product margins by offering products that are proprietary to us and
are not otherwise available to potential competitors.
Product
Solutions: Proprietary Facility Control System
Sensing
and Control Systems. In 2018 we began to develop, and in 2019 began to offer, a branded, proprietary controls and monitoring system (consisting
of sensors, controllers, software, monitoring and a user interface). Branded as SentryIQ®, it is a 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 have continued the rollout of SentryIQ® and to date we have entered
into nineteen contracts 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. SentryIQ® is our highest-margin product.
Cultivation
facilities must have SCA to operate their HVACD equipment. In simple form, SCA is the computerized thermostat in the room. The SCA also
functions as the “brains” in bringing multiple variables together for CEA grow operations. The operator selects the desired
temperature set point, the wall thermostat (Sensor) detects the actual temperature, and when the space temperature deviates from the
desired set point the controller (Control) commands the environmental control components to supply heated, cooled, or dehumidified air
to bring the room temperature back to the set point. In the case of 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 custom design, computerized environmental
control system (automation), similar to the most sophisticated building automation systems (BAS) found in commercial and process cooling
applications. This control system may also command lighting and CO2 enrichment.
Our
SentryIQ® SCA package includes precision sensors to measure temperature, humidity, light, 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
custom 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
entered this aspect of our business to satisfy customer needs that we did not previously address and that historically were provided
by third-party controls contractors. Our entry into the SCA market helps both our customers and our business. Our customers
benefit because they are saved the extra work of finding and engaging an experienced CEA controls contractor. This 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 minimal work scope shortcomings, what we refer to as “scope gap.”
From
a tactical perspective, and with limited incremental selling costs, our current sales team can now offer our SCA package to nearly every
prospect since every cultivation facility requires SCA technology. We believe this technology value-added solution gives us an opportunity
to achieve incremental project revenue at higher margins than we earn from our other equipment. 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 customers 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.
Product
Solutions: VAR of Cultivation and Environmental Control Products
Some of the technologies required
in CEA facilities are non-proprietary and widely available, thus making it difficult to earn strong margins on resale of products like
pumps, valves, piping, etc. are commodities within the HVAC industry. However, we add value by selecting, providing and integrating these
products into our customers’ projects.
We offer CEA-specific products
as a reseller from trusted suppliers. For example, we have partnered with a third party to offer energy efficient, cost
competitive LED lighting products at attractive margins. As another example, we offer benching and racking products via a partnership
with a well-respected and widely used third party manufacturer.
Our
Customers and Prospects
We
provide our services and products to customers who are building, upgrading, or expanding an indoor cultivation facility for any crop.
Our customers can be defined on a range of criteria.
New
construction or the retrofit of an existing facility. Nearly all of our business has historically been for new construction facilities,
but we have done retrofit projects and we believe that over time more of such business will become available.
Existing
commercial retrofit projects represent a business opportunity in the CEA industry. The estimated 5,000+ 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 services and 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 believe that retrofit projects do not typically carry the financial uncertainties
associated with new build projects such as licensing, permitting and funding.
Crop,
either cannabis or non-cannabis. Nearly all of our projects have been for cannabis cultivation facilities as that has been the focus
of our sales and marketing efforts. However, we have recently performed services for several non-cannabis facilities. As non-cannabis
markets are growing at a pace previously seen in the cannabis markets, we are actively pursuing this market.
Size
of facility. We serve facilities ranging in size from 2,000 square feet to over 100,000 square feet. Most facilities are between
20,000 and 70,000 square feet.
Customer
type. Most of our customers are new entrants to the industry and have no other cultivation facilities. Some customers have
one or more facilities which we classify as MFOs (multi-facility operators), and these are our favored prospects that we pursue aggressively
or who turn to us after we have served them on a previous facility. We currently do not have projects with the largest, publicly traded
firms (typically referred to as “MSOs,” or Multi-State Operators).
MFOs
are customers who already own cultivation facilities and they are our preferred customers because they are likely already successful
and cash-flowing, and they understand the challenges of building a new cultivation facility. They are thus a less risky prospect with
a much higher likelihood of successfully completing a project.
New entrants
are often times investors from outside the CEA industry who are attracted by the growth opportunities available as the CEA industry
grows. We are particularly effective at winning business from these prospects because of our fifteen-year track record and
well-known brand name within the industry. However, the risks of a failed project with these prospects are higher because of
the challenges that must be overcome to successfully build and operate a CEA operation—which include (but are not limited
to) ability to obtain funding, licensure, and an appropriate facility.
Sales
and Marketing
We
have both marketing and sales organizations and employees. Our Marketing team consists of a Vice-President of Marketing
Communications and three staff members. Our Sales team is comprised of a Vice-President of Sales and four sales representatives
located across the country. Our sales and marketing efforts focus on winning business from new entrants and smaller MFOs.
Marketing
Strategy
Our
marketing activities are focused on generating new leads and positioning us as a leader in the CEA facilities indoor cultivation
market. We lead with our value proposition of offering a wide range of proprietary and curated products and services, giving more options
to our customers to satisfy their individual applications and goals, versus our competition, which only offers single solutions
for each of their products.
Brand
Image. We emphasize our 15-year presence serving the industry and our status as an industry pioneer that was founded by cultivators
to provide service to cultivators. We have also positioned ourselves as an engineering company that is, we believe, the most experienced
such firm serving the cannabis segment of the CEA industry. We are well-known in the industry because of the many projects we have performed
and because of our longevity serving the same. We reinforce our message and positioning with regular blog posts on our website, interviews
with our technical cannabis professionals in certain industry magazines and podcasts, talks and presentations at trade
shows, and technical white papers. Some of our engineers sit on industry technical standards groups. Some of our projects are
referred to us by previous customers, and we reap the benefits of a virtuous cycle of past projects leading to new projects.
Internet.
Our marketing activities include a fresh, easy to navigate website that provides education through our SEO-optimized landing pages,
case studies, white papers, blogs and articles, advertising in various trade publications and digital outlets, social media and email
campaigns.
Paid
Referrals. We provide referral agreements to parties in the industry who are in a position to refer business to us.
Trade
Shows. We make regular appearances at trade shows. We are also frequent speakers or panel members at trade show educational events.
Our co-founder, Brandy Keen, is a well-known industry pioneer and authority who writes regular blog posts and is a sought-after speaker
at industry events.
Investor
Relations/Public Relations. We actively manage our public image to both the industry and to investors. For the industry we
regularly publish press releases with positive company news including new product releases and major project wins. We retain an
Investor Relations firm to provide regular coverage of Company developments to our investors and other stakeholders.
Sales
Strategy
Our
sales strategy is to call on leads developed by our marketing efforts, leads referred by existing customers, networking at industry events
and trade shows, and to develop relationships with potential prospects. Our sales cycle is long, ranging from several months to 18 months
from first contact with a prospect to signing a contract. In the organic growth strategy update we announced in May of 2021, we
specifically added architectural services to our offering. Typically, architectural services are the first that will be needed when a
facility is to be built. By selling our architectural services to a prospect we gain an early foothold in the relationship with the prospect.
By offering most of the services and products that the prospect will need for their facility, we attempt to keep competitors out of the
relationship.
Sales,
Contract, and Fulfillment Cycle
The
sales cycles for our new build commercial projects can vary significantly depending on the size and complexity of the project. 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 startup of the installed system, the full cycle can range from three months to two years. Since we do not install
any of the products we sell, our customers are required to use third-party installation contractors, which adds to the variability of
the sales cycle.
When
a customer agrees to enter into a contract with us it can be for any or all of the following:
● Architectural design services;
● MEP engineering services;
● Equipment provision; and
● Preventative maintenance.
To
enter into a contract, we require a 5-10% deposit and a signed contract. We then require progress payments as architectural and/or engineering
work is completed, and before equipment is shipped. We generally do not ship equipment to a customer unless that equipment has been fully
paid. The sales and fulfillment cycle can be summarized as follows, with elapsed time from start:
Start:
Early meetings to understand goals and resources;
1-2
months: Proposal development and presentation;
3
months: Contract acceptance (requires 5-10% deposit);
3
months: Architectural and MEP engineering work begin;
4-5
months: Architectural and MEP engineering work completed, and equipment selections finalized (services paid for before release of construction
drawings);
5
months: equipment ordered (40% deposit on equipment received prior to ordering);
6-18
months: construction project commences, equipment delivered as required (fully paid for before shipping); and
12-18
months: all equipment shipped and installed, project completed, operator training and system startup conducted.
Gross
Margins and Revenue.
Architectural
and Engineering services fees can range from $10,000 to over $100,000, depending on the size of the project. Revenue from equipment sales
on individual projects has been over $3,000,000 but most typically ranges from $500,000 to $1,500,000. Our target gross margin from equipment
sales ranges from 25% to 60%, with services margins ranging from 10% to 20%.
Our
Corporate Growth Strategy
We continue to
build upon the significant momentum we experienced in 2019, prior to the business disruptions caused by the COVID 19 pandemic. As we
navigated through these challenges in the first half of 2020, we have seen an encouraging return to the pre-COVID-19 momentum, as evidenced
by our revenue growth from Q3 2020 to Q4 2021. We believe this validates our market opportunity and our business model, and we remain
committed to growing revenue and margin.
To
that end, our corporate strategy for growing the Company and increasing shareholder value are based on the following pillars:
Pursue
Aggressive Organic Growth.
We
serve a market for the construction and expansion of CEA facilities and businesses that is projected to grow at a 20%+ compound annual
growth rate for the foreseeable future. Our primary vertical market of cannabis cultivation facilities has been joined by the similarly
rapidly growing urban vertical farming market to create two market opportunity segments that we are positioned to serve.
In
May of 2021 we announced a new strategy for our organic growth, which included the following elements.:
Identify
and Pursue New markets
Non-cannabis
CEA (vertical/urban farming). We have expanded our business development plan to pursue non-cannabis CEA facilities, at least doubling
our total addressable market. We have served several non-cannabis CEA facilities in the past and present and we have expanded our marketing
efforts to aggressively pursue this vertical market.
Expand
Product & Services Offering
We
decided to expand our product offerings from a focus on primarily environmental control offerings to one that offers
all of the primary technologies and services required in a CEA facility: architectural design, lighting, benching, HVACD, sensing
& control systems, CO2 enrichment and control, water filtration & condensate reclamation, irrigation & fertigation
systems, wastewater treatment, air sanitation, preventative maintenance and odor mitigation. In the last four months alone, we have
seen a broadening of our booked contract pipeline to include offerings of architectural design, lighting, benching, HVACD, sensing &
control systems, CO2 control, water reclamation, air sanitation and preventative maintenance.
Enhance
Brand Through New Corporate and Trade Name
In
May of 2021 we adopted the trade name “Surna Cultivation Technologies” because we believe that the new name
will more clearly identify our business to prospects and make us easier to find on various social media and search engines. In November
of 2021, we changed our corporate name from Surna Inc. to CEA Industries Inc. In January of 2022, Surna Cultivation Technologies
LLC was formed and is a wholly owned subsidiary of CEA Industries Inc. Our recent name change, and internal restructuring were affected
to prepare us to acquire potential targets and to nurture internal growth initiatives.
Seek Strategic Relationships,
Mergers, and Acquisitions to Add to our Existing Business.
We
also intend to grow our business through mergers, acquisitions, and strategic partnerships that serve our goal of being a leading
and rapidly-growing supplier to the CEA industry. Our strategy is to use our insight to select the right partners to align with and the
right acquisition targets to pursue.
Our
experience and engineering advantages. Our core expertise, developed over many years, is engineering the environmental controls of CEA
facilities, which is a sophisticated engineering challenge due to the high humidity (latent heat) and heat load (sensible heat) within
these facilities. Not only are the loads high, but the environmental conditions within these facilities must be held closely within limits
that these facilities’ managers request. Engineering to meet these limits requires us to consider all of the primary components
within the facility: lighting, irrigation, HVACD, fertigation, sensors, controls, CO2 dosing, monitoring and alarms, facility
physical limits such as power availability, and energy consumption. This expertise uniquely informs our view on the requirements of CEA
facilities.
Technical advantages as a strategic
partner and acquirer. We believe that the expertise gained in engineering many of the primary technical components within a CEA facility
provides us with a uniquely well-informed view of the efficacy of the many primary components on offer in the marketplace. We further
believe that this knowledge will help us make wise choices when deciding on products to pursue for strategic relationships, and
providers to potentially merge with or acquire.
Corporate
advantages as a strategic partner and acquirer. For smaller component providers we believe that our publicly traded platform and our
existing sales and marketing reach will make us an attractive partner. Our public status provides sources of capital, and our sales and
marketing resources can help us bring other products to market.
Continue
to Improve Our Public Profile and the Market for Our Securities
We
recognize that the costs of being a public company are substantial. However, we believe that a public currency offers a wider audience
to support our story and partnership opportunities to build that story. With that goal in mind, we continue to build our public brand
through public capital markets, and as part of that effort, we completed two capital markets transactions that we believe will benefit
our current and future shareholders.
First,
effective February 10, 2022, trading of both shares of the Company’s common stock and certain of the Company’s warrants (which
previously traded on the over-the-counter (“OTCQB”) market) commenced on the Nasdaq Capital Market (the “Uplist”). We believe
an Uplist to the Nasdaq will contribute to our stock’s liquidity and offer a more visible and attractive equity currency to current
and future investors.
Second,
effective February 15, 2022, the Company received net proceeds of approximately $22 million from the sale of 5,811,138 shares of its
common stock together with 5,811,138 warrants (the “Offering”). We believe the Offering will provide immediate liquidity
to help fund the Company’s growth strategy through both organic development and opportunistic acquisitions. We also believe the
expansion of our investor base created by the Offering will enhance our overall audience and strengthen the market for our securities.
Our
Competitive Advantages
Customer
Operations. First and foremost, we seek to help our customers build the most effective and efficient facility possible. We believe
that we are uniquely positioned to engineer all of the complex components of a CEA facility into a holistic whole because of our dedicated
engineering staff and our experience with over 800 cultivators including over 200 commercial facilities. Our 15 years in the business
has provided us a wide network of technology vendors from which we curate a selection of the best products. In addition, we are the leading
experts in applying the most challenging component of the technical infrastructure, the environmental controls, and we have the knowledge
required to engineer the interactions among the required components. A PE license is required for all MEP engineering
work, and this engineering competence is one of our greatest strengths.
Sustainability.
Indoor cultivation facilities, like data centers, are resource intensive. Several U.S. states have implemented building code changes
that place limits on the energy consumption allowed within cultivation facilities, and we anticipate that more states will do the same.
Among our objectives is to provide our customers with the most energy-efficient alternatives for their infrastructure. Energy and resource
efficiency is a high priority to us as engineers, and our most senior engineering staff hold the LEED (Leadership in Energy and Environmental
Design) credential. Our CEO previously helped build a cleantech company, has been involved in the cleantech industry for over five years,
and published a book on selling energy efficient technologies. We believe that we are in a position to lead the industry in sustainability
initiatives which our customers will highly value.
Customer
Acquisition. By offering Facility Selection & Design services we seek to build relationships with prospects at the earliest opportunity
in the lifecycle of the cultivation business. By expanding our offerings to include nearly every piece of the technical infrastructure
required in a facility we hope to engage at the earliest possible moment with the customer and earn the opportunity to provide all the
products and services required for a facility. Our post-start-up, lifecycle services help us maintain a relationship with
the customer as long as the facility is in operation. Our observation is that our customers want to focus on growing plants and
entrust us to maintain the technical infrastructure of complex systems; we believe that they will accept our offer to do so,
as some already have.
Revenue
and Revenue Recurrence. We believe that our revenue can be expanded by offering most of the primary technical infrastructure components
for a cultivation facility. For example, if we are able to provide all of the primary infrastructure components to a cultivation facility,
our revenue on a project could be up to 200% higher than if we provided the environmental controls systems alone. In the past we did
not have products or services to offer our customers after a facility was constructed. We have recently begun to offer preventative maintenance
services, and we believe that by expanding this service offering we will be able to gain long-term recurring revenue on a subscription