Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 26
Item 1C. Cybersecurity 26
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 38
Item 8. Financial Statements and Supplementary Data 38
Item 9A. Controls and Procedures 38
Item 9B. Other Information 39
Part III
Item 10. Directors, Executive Officers and Corporate Governance 40
Item 11. Executive Compensation 47
Item 14. Principal Accountant Fees and Services 55
Part IV
Item 15. Exhibits and Financial Statement Schedules 56
Signatures 58
In
this Annual Report, unless otherwise indicated, the “Company”, “we”, “us” or “our” refer
to CEA Industries 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 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 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 aim to provide customers with 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 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.
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.
The part of the CEA industry focused on food related crops is also facing disruption from evolving market demand, competition, and reorganization,
including the lack of growth capital and several noteworthy bankruptcies.
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. During our 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.
Shares
of our common stock and warrants currently are traded on the Nasdaq Capital Markets under the ticker symbols “CEAD” and “CEADW”,
respectively.
We
received a continued listing deficiency letter and must satisfy the deficiency prior to April 9, 2024. If we do not satisfy the deficiency
our securities will be removed from trading on Nasdaq by action of the exchange. We believe our securities will then trade on the OTC.
We do not anticipate applying for listing on the higher tiers of the OTC. We will continue to be a reporting company with the Securities
and Exchange Commission, and we anticipate that brokers will continue to be able to make share transactions in our securities, although
they will be subject to trading requirements that will substantially restrict the ability of our stockholders to make share sales and
others to make share purchases.
Impact
of the COVID-19 Pandemic on Our Business
The
impact of the government and the business economic response to the COVID-19 pandemic affected demand across the majority of our markets
and disrupted workflow and completion schedules on projects. We believe we continue to have adverse effects on our sales, project implementation,
supply chain infrastructure, operating margins, costs, and working capital, as a result of the pandemic. Due to this uncertainty, we
continue to monitor costs and continue to take actions to reduce costs in order to mitigate the long-term impact of the COVID-19 pandemic
to the best of our ability. However, these actions may not be sufficient in the long run to avoid reduced sales, increased losses, and
reduced operating cash flows in our business. During the years ended December 31, 2023 and December 31, 2022, and continuing since then,
the Company experienced delays in the receipt of equipment it had ordered to meet its customer orders due to disruption and delays in
its supply chain. Consequently, our revenue recognition of some customer sales has been delayed until future periods when the shipment
of orders can be completed.
Impact
of Ukrainian and Israeli Conflicts
We
believe that the conflicts involving Ukraine and Israel do not have any direct impact on our operations, financial condition, or financial
reporting. We believe the conflicts 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 countries involved in the conflicts, supply chain
challenges, and the international and US domestic inflation resulting from the conflict and government spending in relation to the conflicts.
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 the conflicts. 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 conflicts 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 conflicts.
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.
Our
Customers and Prospects
We
aim to 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). We currently do not have projects with the largest, publicly traded firms (typically
referred to as “MSOs,” or Multi-State Operators).
Sales
and Marketing
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. 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.
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.
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 10 active full-time employees. We review our staffing needs in light of our contract obligations and attempt to size and
skill match our employees as required. 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.
The
Company has experienced a decline in activity, as indicated in its 2023 sales and its current backlog. This decline is due to many factors,
including (i) recent challenges in the cannabis market, (ii) continued supply chain-related delays and cancellations that have affected
many of its vendors and partners, and (iii) a broader slowdown in the macroeconomic environment. As a result, the Company evaluated its
current operations, personnel needs and liquidity to make sure our personnel levels match the activity we expect to service over the
next several months. On January 5, 2024, we implemented a downsizing of our operations, including a 23% reduction in our workforce, and
significant non-personnel cost reductions in order to preserve our cash resources and better reflect our activity levels.
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 the enforcement of cannabis laws 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.
Currently,
there is much legislation being considered to reform cannabis products and use. The proposed laws cover a wide spectrum from complete
federal legalization to specific industry nuances. In September 2023, the MORE Act was introduced that would provide full federal legalization
through descheduling with a particular focus on equity provisions, including expungement for certain cannabis offenses and a community
reinvestment program. The MORE Act has not passed through committee. There are two proposed federal bills that would remove cannabis
from the Controlled Substances Act (CSA) entirely and task the Food and Drug Administration (FDA) with regulation of cannabis products.
One of these bills, The States Reform Act, adopts a dual federal-state regulatory model, like the regulation of alcohol. Another bill,
the Strengthening the Tenth Amendment Through Entrusting States (STATES) 2.0 Act, would permit states to to maintain the prohibition
of cannabis, but interstate commerce in state-law-compliant cannabis would be legalized, so non-legal states would not be able to prohibit
shipments to and from legal states from crossing through their borders. Finally, only one piece of legislation took the rescheduling
approach to cannabis legalization in 2023. The Marijuana 1-to-3 Act of 2023, opens new tab would simply direct the Attorney General to
transfer cannabis from Schedule I to Schedule III of the CSA without clarifying or addressing any other provisions of federal law. However,
that was not the only piece of rescheduling-related legislation introduced last year.
Lawmakers
continued to offer various solutions for providing financial relief for cannabis businesses and legal protections for ancillary businesses
in 2023. The most well-known of these bills is the Secure and Fair Enforcement Regulation (SAFER) Banking Act, which would provide safe
harbor for financial institutions and other ancillary businesses that work with cannabis industry clients, thus increasing the industry’s
access to traditional financial services like loans and deposit accounts. Similar to SAFER but with a narrower scope, the Clarifying
Law Around Insurance of Marijuana (CLAIM) Act would provide a specific safe harbor for insurance companies that serve the cannabis industry.
As for financial support, the Small Business Tax Equity Act of 2023, would exempt cannabis sales conducted in compliance with state law
from the prohibition of 26 U.S.C. § 280E, thereby allowing businesses to deduct normal business expenses from their taxes.
During
2023, there have been a myriad of additional bills introduced that govern the expungement and/or sealing of criminal records for non-violent
cannabis offenses, legalizing hem and CBD products and adding FDA regulation for these products, facilitating research on cannabis, access
for veterans to medical cannabis, and restoring eligibility for federal employment and the right of medical cannabis patient to purchase
and possess firearms.
Notwithstanding
the actions of the Biden administration, it should be expected that the Department of Justice will continue at this time 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 March 8, 2024. 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:
● We rely on a limited number of customers and suppliers.
Risk
Factors
Risks
Relating to Our Business
Our
revenues have been limited, and we will need to obtain financing for any substantive growth, and possibly our continued 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, 2023, we had working capital of approximately $12,110,000 and our cash balance was approximately
$12,508,000. Notwithstanding that 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
impact of the government and the business economic response to the COVID-19 pandemic affected demand across the majority of our markets
and disrupted workflow and completion schedules on projects. We believe we continue to see adverse effects on our sales, project implementation,
supply chain infrastructure, operating margins, costs, and working capital.
Due
to this uncertainty, we continue to monitor costs and continue to take actions to reduce costs in order to mitigate the long-term impact
of the COVID-19 pandemic to the best of our ability. However, these actions may not be sufficient in the long run to avoid reduced sales,
increased losses, and reduced operating cash flows in our business. During the years ended December 31, 2023, and December 31, 2022,
and continuing into the current fiscal quarter, the Company experienced delays in the receipt of equipment it had ordered to meet its
customer orders due to disruption and delays in its supply chain.
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 operational reorganization could harm our business and materially and adversely affect our operating
results and financial condition.
If
there is any growth in or reorganization of our business and operations, it is likely to place a strain on our management and
administrative resources, infrastructure and systems. We expect that in those instances 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. More recently, we have been experiencing a decline in revenues, which has also affected our operating results. 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 overwhelming 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 might increase over time, decreases in demand from
the legal cannabis industry will have a material adverse effect on our revenues and the success of our business operations.
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 developing 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 in 2023, we have not been as successful in these endeavours as in
the 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
suppliers could fail to fulfill our orders for parts used to assemble our products, which would disrupt our business, increase our costs,
harm our reputation, and potentially cause us to lose our market.
We
depend on third party suppliers around the world, including those in The People’s Republic of China, for materials used to assemble
our products. Any of these suppliers could fail to produce products to our specifications or in a workmanlike manner and may not deliver
the material or products on a timely basis. Our suppliers may also have to obtain inventories of the necessary parts and tools for production.
Any change in our suppliers’ approach to resolving production issues could disrupt our ability to fulfill orders and could also
disrupt our business due to delays in finding new suppliers, providing specifications and testing initial production.
Our
suppliers could experience uncontrollable delays in delivering our products.
We
have experienced some 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, less cargo being shipped by air, unavailability of truckers and a general shortage
of containers. We expect this to continue for some time. These disruptions are also causing price increases, which may become an inflationary
force in the marketplace.
Equipment
failures or poor performance may negatively impact our business.
We
rely on third party manufacturers for equipment which we sell or lease. From time to time, such equipment may not perform to specifications
or to our customers’ satisfaction. Such equipment deficiencies may lead to down time impacting our revenue. Further, frequent downtime
at customers’ sites due to equipment failures may result in such customers generating less revenue and increasing credit default
risk. In addition, these failures may also result in additional time spent by our personnel, decreasing profit margins on certain ancillary
services.
We
have a concentration of customers and suppliers, which could affect our financial results.
Three
customers accounted for 37%, 21% and 12% of the Company’s revenue for the year ended December 31, 2023. Three customers accounted
for 27%, 26% and 11% of the Company’s revenue for the year ended December 31, 2022. The Company’s accounts receivable from
three customers made up 59%, 29%, and 12%, respectively, of the total balance as of December 31, 2023. The Company’s accounts receivable
from two customers made up 57%, and 43%, respectively, of the total balance as of December 31, 2022. Three suppliers accounted for 34%,
17%, and 16% of the Company’s purchases of inventory for the year ended December 31, 2023, and four suppliers accounted for 30%,
17%, 16%, and 11% of the Company’s purchases of inventory for the year ended December 31, 2022. Our results of operations will
be significantly affected if we lose our primary customer, or if we are not able to replace the customer at the conclusion of our services
to that customer. Our operations will also be impacted negatively if we are not able to find suppliers to replace those that we currently
use. Overall, our operations and, therefore, financial results are dependent on a limited number of customers and suppliers.
International
trade disputes could result in tariffs and other protectionist measures that could adversely affect the Company’s business.
Tariffs
could increase the cost of our products and the components and raw materials that go into making them. These increased costs could adversely
impact the gross margin that we earn on sales of our products. Tariffs could also make our products more expensive for customers, which
could make our products less competitive and reduce customer demand. Countries may also adopt other protectionist measures that could
limit our ability to offer our products and services.
Our
inability to effectively protect our intellectual property would adversely affect our ability to compete effectively, our revenue, our
financial condition, and our results of operations.
We
may be unable to obtain intellectual property rights to effectively protect our branding, products, and other intangible assets. Our
ability to compete effectively may be affected by the nature and breadth of our intellectual property rights. While we intend to defend
against any threats to our intellectual property rights, there can be no assurance that any such actions will adequately protect our
interests. If we are unable to secure intellectual property rights to effectively protect our branding, products, and other intangible
assets, our revenue and earnings, financial condition, or results of operations could be adversely affected.
We
also rely on non-disclosure and non-competition agreements to protect portions of our intellectual property portfolio. There can be no
assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that third parties will not
otherwise gain access to our trade secrets or proprietary knowledge, or that third parties will not independently develop competitive
products with similar intellectual property.
We
may become subject to additional regulation of CEA facilities.
Our