Item 1A. Risk Factors 11
Item 1B. Unresolved Staff Comments 27
Item 2. Properties 27
Item 3. Legal Proceedings 27
Item 4. Mine Safety Disclosures 27
Part II
Item 6. Selected Financial Data 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 39
Item 8. Financial Statements and Supplementary Data 39
Item 9A. Controls and Procedures 39
Item 9B. Other Information 40
Part III
Item 10. Directors, Executive Officers and Corporate Governance 41
Item 11. Executive Compensation 48
Item 14. Principal Accountant Fees and Services 56
Part IV
Item 15. Exhibits and Financial Statement Schedules 58
Signatures 60
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:
● 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.
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
CEA
Industries, through our subsidiary, Surna Cultivation Technologies LLC, is a company focused on selling environmental control and other
technologies and services to the Controlled Environment Agriculture (“CEA”) industry. The CEA industry aims to optimize
the use of horticultural resources such as water, energy, space, capital, and labor, to create an agriculture business that is more efficient
and more productive than those that use traditional farming methods. Typically, the CEA industry is focused on indoor agriculture and
vertical farming.
Headquartered
in Colorado, we leverage our experience in the CEA industry to bring our customers a variety of value-added technology solutions 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. We do this by offering our customers a variety of principal service and product offerings that
include: (i) architectural design and licensed engineering of commercial scale thermodynamic systems specific to cultivation facilities,
(ii) liquid-based process cooling systems and other climate control systems, (iii) air handling equipment and systems, (iv) air sanitation
products, (v) LED lighting, (vi) benching and racking solutions for indoor cultivation, (vii) proprietary and third party controls systems
and technologies used for environmental, lighting and climate control, and (viii) preventative maintenance services, through our partnership
with a certified service contractor network, for CEA facilities.
Our
revenue stream is currently derived primarily from supplying our products, services and technologies to licensed commercial indoor facilities
operating in the cannabis industry. Our customers include state and provincial-regulated CEA growers located in the U.S., Canada, and
other international locations. We recently have developed customers in the non-cannabis CEA market to expand our market reach. Customers
use our services for building new CEA facilities and expanding or retrofitting existing CEA facilities.
CEA
growers currently face a challenging business environment that includes high energy costs, water usage and conservation issues, continuously
evolving waste removal regulations, inflationary pressures, and labor shortages. In addition to these issues, our cannabis growing customers
face increasingly rigorous quality standards and declining cannabis prices in a growing industry whose standards are constantly evolving.
We
support our clients by providing integrated mechanical, electrical, and plumbing (“MEP”) engineering design, proprietary
and curated environmental control equipment, and automation offerings that serve the CEA industry. Over our 16 years in business, we
have served hundreds of commercial indoor CEA facilities.
We
believe our customers partner with us because we have the reputation and experience to help them make cost-conscious and effective decisions
on the design and engineering of their indoor cultivation facilities. CEA facilities are resource intensive, and a growing list of states
have implemented building code changes that limit energy consumption in cultivation facilities. Energy and resource efficiency is a high
priority to us as engineers, and the senior engineers on our team hold the Leadership in Energy and Environmental Design (“LEED”)
credential. We believe this sustainability-focused technical experience is crucial in the value we provide to our customers.
We
have three core assets that we believe will support us as we pursue our business strategy. First, we enjoy strong relationships with
relevant stakeholders in the CEA industry. Largely focused in the cannabis segment, our partnerships include relationships with new and
existing growers, capital providers, consultants, independent contractors, and numerous others. These partnerships include agreements
reached in 2022 with Merida Capital and Hydrobuilder Holdings LLC. In June we announced a marketing arrangement with Merida Capital,
a cannabis-focused private equity firm, whereby Merida will use CEA Industries Inc. as its sole provider of certain products and services
for its indoor cultivation facilities. This relationship resulted in a new contract in October 2022 with one of Merida’s Connecticut
based clients. In November of 2022 we announced a strategic alliance with Hydrobuilder Holdings that we believe will result in more project
opportunities.
Second,
our experience in this industry over time has built up specialized engineering know-how and experience. We have been serving indoor cultivators
since 2006 and designing CEA cultivation facilities since 2016. Since then, we have tested and solidified best practices from designing
environmental control systems for CEA cultivation facilities.
Third,
we have a line of proprietary environmental control products that support the specific growing environments that our customers want.
We believe these products offer significant benefits to our customers.
Shares
of our common stock and warrants are traded on the Nasdaq Capital Markets under the ticker symbols “CEAD” and “CEADW”,
respectively.
Impact
of the COVID-19 Pandemic on Our Business
As
a result of the government measures to control the COVID-19 pandemic, there continue to be disruptions in business operations around
the world, with a persistent impact on our business.
We
still are experiencing delays with our international supply of products and shipments from vendors. While these delays have improved
in recent months, we, along with many other importers of goods across all industries, continue to experience supply chain disruption.
Also, shipping times are still longer than they were prior to the COVID-19 pandemic. We continue to work 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.
Impact
of Ukrainian Conflict
We
believe that the conflict between Ukraine and Russia does not have any direct impact on our operations, financial condition, or financial
reporting. We believe the conflict will have only a general impact on our operations in the same manner as it is having a general impact
on all businesses that have their operations limited to North America resulting from international sanction and embargo regulations,
possible shortages of goods and goods incorporating parts that may be supplied from the Ukraine or Russia, supply chain challenges, and
the international and US domestic inflation resulting from the conflict and government spending for the Ukraine and funding of our country’s
response. As our operations are related only to the North American controlled agricultural industry, largely within the cannabis space,
we do not believe we will be targeted for cyber-attacks related to this conflict. We have no operations in the countries directly involved
in the conflict or are specifically impacted by any of the sanctions and embargoes, as we principally operate in the United States and
Canada. We do not believe that the conflict will have any impact on our internal control over financial reporting. Other than general
securities market trends, we do not have reason to believe that investors will evaluate the company as having special risks or exposures
related to the Ukrainian conflict.
The
CEA Industry
According to a leading market
research firm, New Frontier Data, the North American cannabis industry is expected to experience compound annual growth on the order of
12% from 2022 through 2030. In addition to the cannabis CEA market the non-cannabis CEA market is also expected to experience material
growth over the next years. Since the technical infrastructure and requirements for growing any plant in a controlled environment are
similar, we believe we can bring our operational expertise and suite of products to this adjacent 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 service solutions that include facility design and budgeting, equipment selection and specification,
equipment installation advisory, and preventative maintenance services. In addition, we provide our customers with product offerings
that include both proprietary products and value-added reseller (“VAR”) products.
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
● VAR of Water Remediation Products and HVAC equipment
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 vary based on the size of the facility, type of crop being cultivated, and extent of construction or retrofitting of the
facility.
Most
of our customers are new entrants to the CEA 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.
Sales
and Marketing
We
have both marketing and sales employees who focus on winning business from new entrants and smaller MFOs. Through our marketing activities,
we focus on generating new leads and positioning ourselves 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.
Our
sales strategy involves reaching out to potential customers on leads developed by our marketing efforts and developing those relationships.
Our sales cycle can range from several months to 18 months from first contact with a prospect to signing a contract. 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.
Sales,
Contract, and Fulfillment 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.
Anticipated
Average Project Revenues.
Architectural
and engineering services fees per project can range from $10,000 to over $100,000, depending on the size of the project. Revenue from
equipment sales on an individual projects has been as much as $3,000,000 but most typically, the per project range is from $500,000 to
$1,500,000.
Our
Competition
Our
environmental control systems and our related engineering and design services compete with various national and local Mechanical, Electrical
& Plumbing (MEP) engineering firms. We also compete with national and local HVACD contractors and traditional HVACD equipment suppliers
who resell, design, and implement climate control systems for commercial and industrial facilities, but most of whom do not have the
specific knowledge that we have about the complexities and challenges of CEA facilities. We have positioned ourselves to differ from
these competitors by providing a broad range of engineering and design services and environmental control systems, across most major
HVACD solutions, including chilled water systems, custom air handling units, split systems, and packaged roof-top units. Each is tailored
specifically for managing the distinct challenges involved in CEA facilities. We believe our industry-specific applications and experience
in the CEA market allow us to deliver the right solution to our cultivation customers. Unlike many of our competitors, our solutions
are designed specifically for cultivators to provide tight temperature and humidity control, reduce bio-security risks, reduce energy
requirements, and minimize maintenance complexity, costs and downtime. However, we are seeing more competitors enter the CEA market,
focused on emulating the same types of crop-specific climate control systems and engineering services that we offer. We believe this
increased competition may adversely impact our ability to obtain new facility projects from both MFOs and independent smaller growers
and could require us to accept lower gross margins on our projects.
As
the cannabis segment of the CEA industry continues to mature and develop and legalization becomes more prevalent, we expect to see more
competition from agricultural product and service providers who seek to expand into this niche of the CEA market. Companies already operating
in the non-cannabis CEA industry may have longer operating histories, greater name recognition, larger client bases and significantly
greater financial, technical, sales and marketing resources. These competitors may adopt more aggressive pricing policies and make more
attractive offers to existing and potential clients, employees, strategic partners, distribution channels and advertisers. Increased
competition is likely to result in price reductions, reduced gross margins and a potential loss of market share.
Intellectual
Property
We
rely on a combination of patent and trademark rights, licenses, trade secrets, and laws that protect intellectual property, confidential
procedures, and contractual restrictions with our employees and others to establish and protect our intellectual property rights. While
we have several issued patents, we do not believe that these issued patents currently provide us with a meaningful competitive advantage.
We have registered trademarks around our core Surna brand in the United States and select foreign jurisdictions, as well as the Surna
logo and the combined Surna logo and name in the United States. Our Surna trademark is also registered in the European Union and Canada.
We also recently secured trademark registration for our proprietary SCA platform, SentryIQ, in the United States and Canada. Subject
to ongoing use and renewal, trademark protection is potentially perpetual. We actively protect our inventions, new technologies, and
product developments by maintaining trade secrets and, in limited circumstances, filing for patent protection.
Employees
We
currently have 19 active full-time employees. However, we may engage, and have in the past utilized, the services of consultants, independent
contractors, and other non-employee professionals. Additional employees may be hired in the future depending on need, available resources,
and our achieved growth.
US
Government Regulation
While
we do not generate any revenue from the direct sale of cannabis products, we have historically, and continue to, offer our services and
engineering solutions to indoor cultivators that are engaged in various aspects of the cannabis industry. Cannabis is a Schedule I controlled
substance and is illegal under federal law. Even in those states in which specific uses of marijuana have been legalized, such as medical
marijuana or for adult recreational purpose, its use remains a violation of federal laws.
A
Schedule I controlled substance is defined as a substance that has no currently accepted medical use in the United States, a lack of
safety for use under medical supervision and a high potential for abuse. The Department of Justice defines Schedule I controlled substances
as “the most dangerous drugs of all the drug schedules with potentially severe psychological or physical dependence.” If
the federal government decides to enforce the Controlled Substances Act with respect to cannabis, persons that are charged with distributing,
possessing with intent to distribute, or growing cannabis could be subject to fines and terms of imprisonment, the maximum being life
imprisonment and a $50 million fine. Any change in the federal government’s enforcement of current federal laws could cause significant
financial damage to us. While we do not intend to harvest, manufacture, distribute or sell cannabis or cannabis products, we may be irreparably
harmed by a change in enforcement by the federal or state governments.
In
the past, the Obama administration took the position that it was not an efficient use of resources to direct federal law enforcement
agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana. The Trump
administration revised this policy but made no major changes in enforcement through Attorney General Jeffrey Sessions rescinding the
Cole Memorandum. Although President Biden stood for decriminalization and descheduling during his campaign, his administration has not
formulated an explicit policy on cannabis. The Biden administration has implemented pardons for past federal cannabis possession convictions
and encouraged governors to do the same. Also, in May 2021 the Drug Enforcement Administration approved licensed facilities to grow cannabis
for the purpose of medical research, and on December 2, 2022, President Biden signed the Medical Marijuana and Cannabidiol Research Expansion
Act. This act is “the first standalone marijuana-related bill approved by both chambers of the United States Congress” and
allows medical marijuana research. The act requires the Drug Enforcement Administration to register researchers and suppliers of cannabis
for medical research in a timely manner, who will then be able to legally manufacture, distribute, dispense and possess the substance.
It also creates a mechanism for FDA approval of drugs derived from the cannabis plant and “protects doctors who may now discuss
the harms and benefits of using cannabis and cannabis derivatives.” It also requires the Department of Health and Human Services
to investigate the medical utility of cannabis and barriers that exist to conducting research, and requires the U.S. Attorney General
to conduct an annual review to ensure that cannabis is being adequately produced for research purposes. In January 2023, the FDA stated
that given the growing cannabidiol (CBD) products market, it had convened a high-level internal working group to explore potential regulatory
pathways for CBD products and is prepared to find a new regulatory pathway for CBD to balance individuals’ desire for access to
CBD products with the regulatory oversight needed to manage risks. Notwithstanding the actions of the Biden administration, it should
be expected that the Department of Justice will continue to enforce the Controlled Substances Act with respect to cannabis under established
principles in setting their law enforcement priorities to prevent:
● the distribution of cannabis products, such as marijuana, to minors;
● the growing of cannabis on public lands; and
● cannabis possession or use on federal property.
Since
the use of marijuana is illegal under federal law, most federally chartered banks will not accept deposit funds from businesses involved
with marijuana. Consequently, businesses involved in the marijuana industry generally bank with state-chartered banks and credit unions
to provide banking to the industry.
In
2014, Congress passed a spending bill containing a provision (the Rohrabacher-Farr amendment and sometimes referred to as the Rohrabacher-Blumenauer
Amendment) blocking federal funds and resources allocated under the federal appropriations bills from being used to “prevent such
States from implementing their own State medical marijuana laws.” The Rohrabacher-Blumenauer Amendment, however, did not codify
any federal protections for medical marijuana patients and producers operating within state law. The Justice Department maintains that
it can still prosecute violations of the federal cannabis laws and continue cases already in the courts. The Rohrabacher-Blumenauer Amendment
must be re-enacted every year, and it is continued through September 30, 2023. However, state laws do not supersede the prohibitions
set forth in the federal drug laws.
In
order to participate in either the medical or the adult use aspects of the cannabis industry, all businesses and employees must obtain
licenses from the state and, for businesses, local jurisdictions as well. As an example, Colorado issues four types of business licenses
including cultivation, manufacturing, dispensing, and testing. In addition, all owners and employees must obtain an occupational license
to be permitted to own or work in a facility. All applicants for licenses undergo a background investigation, including a criminal record
check for all owners and employees.
Colorado
has also enacted stringent regulations governing the facilities and operations of cannabis businesses that are involved with the plant
and its products. All facilities are required to be licensed by the state and local authorities and are subject to comprehensive security
and surveillance requirements. In addition, each facility is subject to extensive regulations that govern its businesses practices, which
includes mandatory seed-to-sale tracking and reporting, health and sanitary standards, packaging and labeling requirements, and product
testing for potency and contaminants.
Laws
and regulations affecting the medical marijuana industry are constantly changing, which could detrimentally affect our proposed operations.
Local, state and federal medical marijuana laws and regulations are broad in scope and subject to evolving interpretations, which could
require us to incur substantial costs associated with compliance or alter our business plan. In addition, violations of these laws, or
allegations of such violations, could disrupt our business and result in a material adverse effect on our operations. It is also possible
that regulations may be enacted in the future that will be directly applicable to our business. We cannot predict the nature of any future
laws, regulations, interpretations or applications, nor can we determine what effect additional governmental regulations or administrative
policies and procedures, when and if promulgated, could have on our business.
Item
1A. Risk Factors
Investing
in our securities involves significant risks. Certain factors may have a material adverse effect on our business, financial condition,
and results of operations. You should carefully consider the risks and uncertainties described below, in addition to other information
contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties
described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe
are not material, may also become important factors that adversely affect our business. If any of the following risks actually occur,
our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event,
the trading price of our securities could decline, and you could lose part or all of your investment.
Summary
Of Risk Factors
Our
business is subject to a number of risks and uncertainties, including those risks discussed at length in the section below titled “Risk
Factors.” These risks include, among others, the following:
Risk
Factors
Risks
Relating to Our Business
Our
revenues have been limited, and we will need to obtain financing for future growth, and possibly our operations, which may not be available
to us.
Historically,
we have raised equity and debt capital to support our operations. We raised approximately $22 million from a public offering completed
in February 2022. As of December 31, 2022, we had working capital of approximately $14,724,000 and our cash balance was $18,637,000.
Notwithstanding the recent capital raise, we expect to need additional funds in the longer term, from time to time, to complete aspects
of the overall development of our business plan, such as in connection with the acquisition of strategic assets. The precise amount and
timing of our funding needs cannot be determined accurately at this time, and will depend on a number of factors, including market demand
for our products and services, the success of our product development efforts, the timing of receipts for customer payments, the management
of working capital, and the continuation of normal payment terms and conditions for our purchase of goods and services. The continuation
of normal payment terms and conditions with our customers and suppliers, including our ability to obtain advance payments from our customers,
significantly impacts our ability to fund our ongoing operations.
Any
future equity offering will result in dilution to our shareholders; obtaining borrowed capital may not be possible for us.
To
the extent that we raise equity and equity linked securities in any future offerings, our existing shareholders will experience a dilution
in the voting power and ownership of their common stock, and our earnings per share, if any, would be impacted. Any borrowings made to
finance operations, which are difficult to obtain from most traditional banks due to the federal laws prohibiting cannabis, could make
us more vulnerable to a downturn in our operating results, a downturn in economic conditions, or increases in interest rates on borrowings
that are subject to interest rate fluctuations. The amount and timing of additional financing needs will vary principally depending on
the timing of new product launches, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources
are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain a credit facility.
The
results of the COVID-19 pandemic may continue to adversely impact, the Company’s operations and financial
results.
The
COVID-19 pandemic resulted in economic disruption that continues. The extent to which our business and financial results are impacted
will depend on numerous evolving factors which are uncertain and cannot be predicted. In addition, the change in macroeconomic conditions
are impacting the financial and capital markets, foreign currency exchange rates, commodity and energy prices, and interest rates. The
effect of inflation in the post pandemic economy is also becoming a significant factor in our business operations and considerations.
We
still are experiencing delays with our international supply of products and shipments from vendors. While these delays have improved
in recent months, we, along with many other importers of goods across all industries, continue to experience supply chain disruption.
Also, shipping times are still longer than they were prior to the COVID-19 pandemic. These factors have impacted our operations and our
contract fulfilment schedules. Our customers also are experiencing post-pandemic disruption that has resulted in delaying grow facility
projects, reductions in project size and cancellations of projects.
Although
our current accounting estimates contemplate current and expected future conditions, as applicable, it is reasonably possible that actual
business conditions could differ from our expectations, which could materially affect our results of operations and financial position.
Such changes could result in future impairments of goodwill, intangible assets, long-lived assets, incremental credit losses on accounts
receivable, or excess and obsolete inventory. Any of these events could amplify the other risks and uncertainties described in this Annual
Report and could have an adverse effect on our business and financial results.
There
is no assurance that we will be able to convert our backlog into revenue or make a profit.
We
may be unable to convert the full contract value of our backlog in a timely manner, or at all. We inconsistently convert our backlog
into revenue on a quarter-to-quarter basis. The performance of our obligations under a sales contract, and the timing of our revenue
recognition, is dependent upon our customers’ ability to secure funding and real estate, obtain a license and then build their
cultivation facility so they can use our services and take possession of the equipment we provide. Our sales contracts currently are
not time specific as to when our customers are required to take delivery of our services and equipment. More recently, we determined
that some of our new construction facility projects are becoming larger and more complex and, as a result, delays were more likely due
to licensing and permitting, lack of, or delay in, funding, staged facility construction, and/or the shifting priorities of certain customers
with multiple facility projects in progress at one time. Even if we obtain more customers, or increase the average size of our projects,
there is no guarantee that we will be able to generate a profit. Because we are a small company with limited capital, limited products
and services, and limited marketing activities, we may not be able to generate sufficient revenue to operate profitably. If we cannot
operate profitably, we may have to suspend or cease operations.
We
may extend credit to our customers in the future and, if we are unable to collect these accounts receivable, our future profitability
could be adversely impacted.
Historically,
we had little exposure to the collection risk on accounts receivable since we typically received payments from our customers in advance
of our performance of services or delivery of equipment. However, in certain situations, especially as we expand our products and services
offering for a customer’s entire facility lifecycle, we may extend credit to our customers, in which case we are at risk for the
collection of account receivables. Accordingly, we will be at greater risk for the collection of account receivables. Any customer credit
arrangements are negotiated and may not protect us if a customer develops operational difficulty or incurs operating losses which could
lead to a bankruptcy. In these cases, we may lose most of the outstanding balance due. In addition, we are typically not able to insure
our accounts receivables. The risk is that we derive our revenue and profits from selling products and services to the emerging cannabis
industry. The failure of our customers to pay the full amounts due to us could negatively affect future profitability.
Because
we currently do not maintain effective internal controls over financial reporting, we may be unable to accurately report our financial
results or prevent fraud, and investor confidence and the market price of our common stock may, therefore, be adversely impacted.
Our
reporting obligations as a public company place significant requirements on our management, operational and financial resources, and
systems, and will continue to do so for the foreseeable future. Annually, we are required to prepare a management report on our management’s
assessment of the effectiveness of our internal control over financial reporting. Management has concluded that our internal control
over financial reporting is currently not effective. In the event that our status with the U.S. Securities and Exchange Commission (“SEC”)
changes to that of an accelerated filer from a smaller reporting company, our independent registered public accounting firm will be required
to attest to and report on our management’s assessment of the effectiveness of our internal control over financial reporting. Under
such circumstances, even if our management concludes that our internal control over financial reporting is effective, our independent
registered public accounting firm may still decline to attest to our management’s assessment, or may issue a report that is qualified,
if it is not satisfied with our controls, or the level at which our controls are documented, designed, operated or reviewed, or if it
interprets the relevant requirements differently from us.
We
have identified material weaknesses in our internal control over financial reporting and, if we do not remediate the material weakness
or are unable to implement and maintain effective internal control over financial reporting in the future, the accuracy and timeliness
of our financial reporting may be adversely affected.
The Company did not maintain effective controls over certain aspects of the financial reporting process because: (i) we lack a sufficient
complement of personnel with a level of accounting expertise and an adequate supervisory review structure that is commensurate with our
financial reporting requirements, (ii) there is inadequate segregation of duties due to the limitation on the number of our accounting
personnel, and (iii) we have insufficient controls and processes in place to adequately verify the accuracy and completeness of spreadsheets
that we use for a variety of purposes including revenue, taxes, stock-based compensation and other areas, and place significant reliance
on, for our financial reporting. A material weakness is a deficiency or a combination of deficiencies in internal control over financial
reporting such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements
will not be prevented or detected on a timely basis. If we are unable to achieve effective internal control over financial reporting,
or if our independent registered public accounting firm determines we continue to have a material weakness in our internal control over
financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the market price of
our shares could decline, and our reputation may be damaged.
The
inability to effectively manage our growth or our operational reorganization could harm our business and materially and adversely affect
our operating results and financial condition.
Any
growth in or reorganization of our business and operations is likely to place a strain on our management and administrative resources,
infrastructure and systems. We expect that we will need to further refine and expand our business development capabilities, our systems
and processes and our access to financing sources. We also will need to hire, train, supervise, and manage employees. These processes
are time consuming and expensive, will increase management responsibilities and will divert management attention. We cannot assure that
we will be able to:
● execute on our business plan and strategy;
● expand our products effectively or efficiently or in a timely manner;
● allocate our human resources optimally;
● meet our capital needs;
● identify and hire qualified employees or retain valued employees; or
Our
inability or failure to manage our company effectively could harm our business and materially and adversely affect our operating results
and financial condition.
Our
operating results may fluctuate significantly based on customer acceptance of our services and products, industry uncertainty, project
financing concerns, and the licensing and qualification of our prospective customers. As a result, period-to-period comparisons of our
results of operations are unlikely to provide a good indication of our future performance.
Management
expects that, under typical operating conditions, we will experience substantial variations in our revenues and operating results from
quarter to quarter. Our revenue recognition is dependent upon shipment of the equipment portions of our sales contracts, which, in many
cases, may be delayed while our customers complete permitting, prepare their facilities for equipment installation or obtain project
financing. Industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which
are out of our control, make it difficult for us to predict when we will recognize revenue. If customers are unable to obtain licensing,
permitting or financing, our sales and revenue will decline, resulting in a reduction in our operating income or possible increase in
losses. Also, because of the coronavirus responses and our own cost savings actions, we cannot predict the course of our revenues and
operating results with accuracy at this time.
To
date, the majority of our revenues have been generated from clients that operate in the legal cannabis industry in the United States
and Canada.
We
provide the majority of our facility engineering design and equipment integration and solutions to facilities in the legal cannabis industry.
While we are hopeful that the proportion of non-cannabis revenues will increase over time, a decrease in demand in the legal cannabis
industry could have a material adverse effect on our revenues and the success of our business.
The
cannabis industry has been an emerging industry over the last several years, and cannabis has only been legalized in some states and
remains illegal in other states and under U.S. federal law, making it difficult to accurately forecast the demand for our engineering
and product solutions in this specific industry. Losing clients from the cannabis industry may have a material adverse effect on our
revenues and the success of our business.
The
cannabis industry is still in its early stages of development in the United States. While the majority of U.S. states now have legal
cannabis, it remains illegal under U.S. federal law, making it difficult to accurately predict and forecast the demand for our engineering
and product solutions. If the U.S. Department of Justice (“DOJ”) did take action against the cannabis industry, we believe
those of our clients operating in the legal cannabis industry would be lost to us.
In
our operations, we rely heavily upon the various U.S. federal governmental memos issued in the past, including the memorandum issued
by the DOJ on October 19, 2009, known as the “Ogden Memorandum”, the memorandum issued by the DOJ on August 29, 2013, known
as the “Cole Memorandum” and other guidance, in the attempt to keep our operations acceptable to those state and federal
entities that regulate, enforce, or choose to defer enforcement of certain current regulations regarding cannabis. By doing this, we
seek to avoid the many possible consequences of providing grow equipment to the cannabis industry as our customers continue to comply
with their state and local jurisdictional laws, rules and regulations and the interpretations of relevant authorities.
The
legal cannabis industry is not yet well or fully developed, and many aspects of this industry’s development and evolution cannot
be accurately predicted. Therefore, the loss of any of our current clients or our inability to capture new client contracts will have
a material adverse effect on our business. While we have attempted to identify our business risks in the legal cannabis industry, you
should carefully consider that there are other risks that cannot be foreseen or are not described in this report, which could materially
and adversely affect our business and financial performance.
There
is heightened scrutiny by Canadian regulatory authorities related to the cannabis industry.
We
seek grower customers in the CEA Canadian market, some of which are cannabis growers. Therefore, our existing and future operations may
become the subject of heightened scrutiny by those regulators and other authorities in Canada that oversee the cannabis industry. As
a result, we may become subject to direct and indirect interaction with public officials in one or both the United States and Canada.
No assurance can be provided that any heightened scrutiny will not in turn lead to the imposition of restrictions on our ability to operate
in Canada, in addition to those described herein.
If
we do not successfully have additional products and services, or if those products and services are not successfully commercialized,
we could lose revenue opportunities.
Our
future success depends, in part, on our ability to expand our product and service offerings. We intend to collaborate with manufacturing
partners to optimize products for the CEA (including cannabis) market. The processes of identifying and commercializing products are complex
and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends our business could
be harmed. We have already and may have to continue to commit significant resources to commercializing products before knowing whether
our investments will result in products the market will accept. We may be unable to differentiate our products from those of our competitors,
and our products may not be accepted by the market. There can be no assurance that we will successfully identify additional product opportunities,
develop and bring products to market in a timely manner, or achieve market acceptance of our products or that products and technologies
developed by others will not render our products or technologies obsolete or non-competitive. Furthermore, we may not execute successfully
on commercializing those products because of errors in product planning or timing, technical hurdles that we fail to overcome in a timely
fashion, or a lack of appropriate resources. This could result in competitors providing those solutions before we do and a reduction
in revenue and earnings.
Our
future success depends on our ability to grow and expand our customer base. Our failure to achieve such growth or expansion could materially
harm our business.
Our
success depends on us achieving greater and broader acceptance of our products and services. This will require us to expand our commercial
customer base and win larger contracts. Recently in later 2022 and early 2023, we have not been as successful in these endeavours as
in the recent past. There can be no assurance our overall sales efforts will be successful to result in profitability. There can be no
assurance that customers will purchase our services or products or that we will continue to expand our customer base. If we are unable
to effectively market or expand our product and service offerings, we will be unable to grow and expand our business or implement our
business strategy. This could materially impair our ability to increase sales and revenue, and materially and adversely affect our margins,
which could harm our business and cause our stock price to decline.
Our