BNB Standard Corp 10-K, filed Mar 28, 2023
BNB Standard Corp (BNC)
About this 10-K
BNB Standard Corp filed this 10-K on March 28, 2023, covering the fiscal year ended December 31, 2022.
Headline figures
Fiscal year ended December 31, 2022, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $11.28M
- down 17.3% from $13.64M a year earlier
- Net loss
- $5.5M
- compared with a net loss of $1.34M a year earlier
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DOCUMENTS INCORPORATED BY REFERENCE
CEA Industries Inc. Annual Report on Form 10-K
For Fiscal Year Ended December 31, 2022
Table of Contents
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.
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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 business prospects and the prospects of our existing and prospective customers; | |
| ● | the impact on our business and that of our customers of the lasting effects of the COVID-19 government response.; | |
| ● | our overall financial condition, including the impact of higher interest rates and inflation, business disruption due to the COVID-19 pandemic, the Ukraine war, and the supply chains on which we depend; | |
| ● | the impact on our business from our restructuring and cost containment actions taken in the first quarter 2023;
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| ● | the inherent uncertainty of product development and product selection to meet client requirements; | |
| ● | regulatory, legislative and judicial developments, especially those related to changes in, and the enforcement of, cannabis laws; | |
| ● | increasing competitive pressures in the CEA (Controlled Environment Agriculture) industry and our supply position within the industry; | |
| ● | the ability to effectively operate our business, including servicing our existing customers and obtaining new business; | |
| ● | our relationships with our customers and suppliers; | |
| ● | the continuation of normal payment terms and conditions with our customers and suppliers, including our ability to obtain advance payments from our customers; | |
| ● | general economic conditions, our customers’ operations and access to capital, and market and business disruptions including severe weather conditions, natural disasters, health hazards, terrorist activities, financial crises, political crises or other major events, or the prospect of these events, adversely affecting demand for the products and services offered by us in the markets in which we operate; |
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| ● | the supply of products from our suppliers and our ability to complete contracts, some of which depend on other actors for a comprehensive project completion; | |
| ● | changes in our business strategy or development plans, including our expected level of capital expenses and working capital; | |
| ● | our ability to attract and retain qualified personnel; | |
| ● | our ability to raise equity and debt capital, as needed from time to time, to fund our operations and growth strategy, including possible acquisitions; | |
| ● | our ability to identify, complete and integrate potential strategic acquisitions; | |
| ● | future revenue being lower than expected; | |
| ● | our ability to convert our backlog into revenue in a timely manner, or at all; and | |
| ● | 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.
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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.
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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.
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| Service Solutions | ||||
| Facility Design and Budgeting | ||||
| ● | Licensed Architectural design, including space and operational planning | |||
| ● | Licensed Mechanical, Electrical, and Plumbing (MEP) engineering, including equipment layout and workflow | |||
| ● | Assessment of equipment options based on facility requirements | |||
| ● | Specification/recommendation of equipment for each facility | |||
| ● | Budget Formulation early in the design process to help the customer make appropriate design choices | |||
| 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).
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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.
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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.
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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; | |
| ● | criminal enterprises, gangs and cartels receiving revenue from the sale of cannabis; | |
| ● | the diversion of cannabis products from states where it is legal under state law to states where it is not legal under state law; | |
| ● | the use of state-authorized cannabis activity as a cover or pretext for the trafficking of other illegal drugs or other illegal activity; | |
| ● | violence and the use of firearms in the cultivation and distribution of cannabis products; | |
| ● | driving while impaired and the exacerbation of other adverse public health and safety consequences associated with cannabis product usage; | |
| ● | 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.
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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:
| ● | Historically, we have had limited revenues and operated our business with a working capital deficit. Additionally, our operating results have fluctuated over the years. |
| ● | We enter into contracts that are performed over a period of time; therefore, we have a contract backlog in differing amounts from quarter to quarter. Converting backlog to revenue depends on many factors, such as the customer obtaining financing, building permits and construction of their facility. We may not be able to convert all of our contracts representing backlog into revenue. We currently do not convert our backlog on a consistent basis quarter to quarter. | |
| ● | Although we are not cannabis plant touching, historically we have provided services and equipment to the cannabis industry segment. As a result, we may be subject to the changes within that sector and certain of the regulations and enforcement issues of the cannabis industry. | |
| ● | We have material weaknesses in our controls and procedures for financial reporting. |
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| ● | We may not be able to implement a successful growth program and, even if that is successful, we may not manage our growth effectively, which may affect our investors’ return on investment. | |
| ● | We will need to expand our customer base, developing customers operating in the CEA industry, expanding and developing our products and services for these potential customers and increasing our marketing and achieving timely contract execution. | |
| ● | Due to supply disruptions and competing demand for products, we continue to experience supply issues similar to other members of our industry. International trade disputes, tariffs, international shipping and domestic trucking issues all contribute to the challenges we face in obtaining the products we need for contract performance. We have experienced and are likely to continue to experience inflationary effects on the cost of products and labor, which is likely to adversely affect our margins. The failure to procure the products we need to satisfy our customer contracts would disrupt our business, harm our reputation, result in losses and potently cause us to lose our market. | |
| ● | We rely on third party manufacturers to supply the equipment we sell or lease. If the equipment does not perform to specifications or to our customers’ satisfaction, there may be an adverse impact on our business and our revenues. | |
| ● | The build side of the CEA industry is very competitive. To be able to compete successfully, we will need to offer a wide range of products, have adequate capital for expansion, supply and execution, and develop robust marketing. | |
| ● | We will need to attract and retain top quality employee talent. We are dependent on certain key sales, managerial and executive personnel for our current and future success. | |
| ● | Cannabis remains illegal under federal law, and therefore, strict enforcement of federal laws regarding cannabis, particularly against our customers, would likely result in our inability to execute our business plan. We are subject to a number of laws focused on businesses that are peripheral to the cannabis industry. Variations in state and local regulation and enforcement in states that have legalized cannabis may impose certain restrictions on cannabis-related activities that may adversely impact our business. Public opinion against cannabis may have an adverse impact on our business. | |
| ● | Effective February 10, 2022, trading commenced in the Company’s common stock and certain of the Company’s warrants on NASDAQ. There is no assurance that we will have an active trading market for our securities listed on NASDAQ. If there is a market, the prices of our publicly traded securities may be volatile, and the price may decrease substantially. We do not intend on paying dividends. |
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.
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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.
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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 | |
| ● | effectively incorporate the components of any business or product line that we may acquire in our effort to achieve growth. |
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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.
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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 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.
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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 engineering and design services and solutions are focused on CEA facilities that are able to grow a wide variety of crops beyond that of cannabis, such as leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables and small fruits (such as strawberries, blackberries and raspberries), bell peppers, cucumbers, and tomatoes. Some of these crops and their growing methodologies are subject to regulation by the United States Food and Drug Administration, environmental agencies, public utility agencies and other federal, state or foreign agencies. Changes to any regulations and laws that complicate the design and engineering of a subject CEA facility, such as wastewater treatment and electricity-related mandates, make it possible that potential related zoning and enforcement could decrease the demand for our services, and in turn negatively impact our revenues and business opportunities.
The CEA industry is highly competitive, and we have less capital and resources than many of our competitors, which may give them an advantage in developing and marketing services and products similar to ours or make our services and products obsolete.
There are many competitors in the CEA industry, including some companies that focus on the cannabis industry. These companies generally offer products and services similar or the same as those offered by us. There can be no guarantees that in the future other companies will not enter this arena by developing products that are in direct competition with us or even superior in quality or price. The barriers to entry into the CEA industry are not overly significant. Over time we anticipate growth in our competition. Some of our current and future competition may have longer operating histories, greater name recognition, larger client bases and significantly greater financial, technical, sales and marketing resources. One or more of these qualities may allow them to respond more quickly than us to market opportunities. They may be able to devote greater resources to the marketing, promotion and sale of their products and/or services. Competitors may also adopt more aggressive pricing policies and make more attractive offers to 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.
While we believe we are better positioned to meet the exacting demands of a controlled cultivation environment through precise temperature, humidity, light, and process controls and to satisfy the evolving code and regulatory requirements being imposed at the state and local levels, there can be no assurance that we will be able to successfully compete against these other contractors and suppliers.
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We will be required to have top quality talent to compete in the marketplace.
We believe our success will depend in part on our ability to have skilled managerial, product development, sales and marketing, and finance personnel. Our ability to attract and retain personnel with the requisite credentials, experience and skills will depend on several factors including, but not limited to, our ability to offer competitive wages, benefits and professional growth opportunities. There can be no assurance of success in attracting and retaining such personnel. Shortages in qualified personnel could limit our ability to increase sales of existing products and services and launch new product and service offerings.
We are dependent upon certain key sales, managerial and executive personnel for our future success. If we lose any of our key personnel, our ability to implement our business strategy could be significantly harmed.
We depend on the industry knowledge, technical and financial skill, and network of business contacts of certain key employees. Our future success will depend on the continued service of these key employees or our ability to engage others who are similarly situated in the industry. While we may have employment agreements with certain of these key employees, they are free to terminate their employment with us at any time, although they may be subject to certain restrictive covenants on their post-termination activities. We do not carry key-man life insurance on the lives of our key employees. The departure of any one of our key employees could have a material adverse effect on our ability to achieve our business objective and maintain the specialized services that we offer our customers.
System security risks, data protection breaches, cyber-attacks and systems integration issues could disrupt our internal operations or services provided to customers, and any such disruption could reduce our expected revenue, increase our expenses, damage our reputation and adversely affect our stock price.
Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack or otherwise exploit any security vulnerabilities of the products that we may sell in the future, especially our SentryIQ® sensors, controls and automation platform. The costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and our efforts to address these problems may not be successful and could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our engineering, sales, manufacturing, distribution or other critical functions.
Portions of our IT infrastructure may also experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource intensive. Such disruptions could adversely impact our ability to fulfill orders and interrupt other processes. Delayed sales, lower profits, or lost customers resulting from these disruptions could adversely affect our financial results, stock price and reputation.
We incur significant costs as a result of being a public company, which will make it more difficult for us to achieve profitability.
As a public company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as additional corporate governance requirements, including requirements under the Sarbanes-Oxley Act, and other rules implemented by the SEC. These costs will make it more difficult for us to achieve profitability.
Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.
U.S. generally accepted accounting principles (“GAAP”) and related pronouncements, implementation guidelines and interpretations with regard to a wide variety of matters that are relevant to our business, such as, but not limited to, revenue recognition, stock-based compensation, trade promotions, and income taxes are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes to these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported results.
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Our ability to use net operating losses to offset future taxable income may be subject to limitations.
As of December 31, 2022, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $25,949,000, of which $11,196,000 will expire, if not utilized, in the years 2034 through 2037. However, the balance of $14,753,000 NOLs generated subsequent to December 31, 2017, do not expire but may only be used against taxable income to 80%. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), and corresponding provisions of state law, if a corporation undergoes an “ownership change,” which is generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income or taxes may be limited. We have experienced ownership changes in the past and we may experience additional ownership changes in the future as a result of subsequent changes in our stock ownership, some of which may be outside of our control. Our September 2021 and February 2022 securities sales also will have to be taken into account for determination of any “ownership change” that we have undergone during a determination period. If an ownership change occurs and our ability to use our net operating loss carryforwards is materially limited, it would harm our post tax income by effectively increasing our future tax obligations.
We may not be able to successfully identify, consummate or integrate acquisitions or to successfully manage the impacts of such transactions on our operations.
Part of our business strategy includes evaluating and pursuing synergistic and other acquisitions. Material acquisitions and other strategic transactions involve a number of risks, including: (i) the potential disruption of our ongoing business; (ii) the distraction of management away from the ongoing oversight of our existing business activities; (iii) incurring additional indebtedness; (iv) the anticipated benefits and cost savings of those transactions not being realized fully, or at all, or taking longer to realize than anticipated; (v) an increase in the scope and complexity of our operations; (vi) the disruption of a significant reorganization of the company; and (vii) the loss or reduction of control over certain of our assets.
The pursuit of acquisitions may pose certain risks to us. We may not be able to identify acquisition candidates that fit our criteria for growth and profitability. Even if we are able to identify such candidates, we may not be able to acquire them on terms or financing satisfactory to us. We will incur expenses and dedicate attention and resources associated with the review of acquisition opportunities, whether or not we consummate such acquisitions.
Recent developments in financial institutions could adversely affect our current and projected business operations, financial condition and results of operations.
Recent events involving limited liquidity, defaults, non-performance and other adverse developments that affect financial institutions have led to market-wide liquidity concerns. For example, on March 10, 2023, Silicon Valley Bank was closed by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation, or FDIC, as receiver. On March 12, 2023, Signature Bank and Silvergate Capital Corp. were also placed into receivership. The company may experience delayed access or a loss of its uninsured deposits or other financial assets should its existing financial institution experience financial distress. While the U.S. Department of Treasury, FDIC and Federal Reserve Board have provided access to uninsured funds in connection with the SVB crisis, there is no guarantee that these institutions will provide access to uninsured funds in the future in the event of the closure of other banks or financial institutions, or that they would do so in a timely fashion. The Company currently has all of its funds in one bank and is currently evaluating its banking relationships with the intent of increasing the amount of deposits that are fully insured or invested in risk free instruments.
The results of events or concerns that involve non-performance by financial institutions could include a variety of material and adverse impacts on our current and projected business operations and our financial condition and results of operations. In addition, any further deterioration in the macroeconomic economy or financial services industry could lead to losses or defaults by companies with whom we do business, which in turn could have a material adverse effect on our current and/or projected business operations, results of operations and financial condition. In addition, a company could be adversely affected by any of the liquidity or other risks that are described above as factors that could result in material adverse impacts on us, including but not limited to delayed access or loss of access to uninsured deposits or loss of the ability to draw on existing credit facilities involving a troubled or failed financial institution.
Risks Related to the Cannabis Industry
Cannabis remains illegal under federal law, and therefore, strict enforcement of federal laws regarding cannabis, particularly against our customers, would likely result in our inability to execute our business plan.
All but three U.S. states have legalized, to some extent, cannabis for medical purposes. Thirty-seven states, the District of Columbia, Puerto Rico, the Virgin Islands, Guam, and the Northern Mariana Islands have legalized some form of whole-plant cannabis cultivation, sales and use for certain medical purposes (medical states). Nineteen of those states and the District of Columbia and Northern Mariana have also legalized cannabis for adults for non-medical purposes (sometimes referred to as adult use). Ten additional states have legalized low-tetrahydrocannabinol (“THC”)/high-CBD extracts for select medical conditions (CBD states).
Under U.S. federal law, however, those activities are illegal.
Cannabis, other than hemp (defined by the U.S. government as Cannabis sativa L. with a THC concentration of not more than 0.3% on a dry weight basis), is a Schedule I controlled substance under the U.S. Controlled Substances Act (21 U.S.C. § 801, et seq.) (the “CSA”). Even in states or territories that have legalized cannabis to some extent, the cultivation, possession, and sale of cannabis all violate the CSA and are punishable by imprisonment, substantial fines and forfeiture. Moreover, individuals and entities may violate federal law if they aid and abet another in violating the CSA, or conspire with another to violate the law, and violating the CSA is a predicate for certain other crimes, including money laundering laws and the Racketeer Influenced and Corrupt Organizations Act. The U.S. Supreme Court has ruled that the federal government has the authority to regulate and criminalize the sale, possession and use of cannabis, even for individual medical purposes, regardless of whether it is legal under state law. For over six years, however, the U.S. government has not enforced those laws against companies complying with state cannabis law and their vendors.
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The likelihood of any future adverse enforcement against companies complying with state cannabis laws remains uncertain. The U.S. Attorney’s Office will follow established principles that govern all federal prosecutions when deciding which cannabis activities to prosecute. As a result, federal prosecutors could and still can use their prosecutorial discretion to decide to prosecute even state-legal cannabis activities. However, generally, U.S. Attorneys have not targeted state law compliant entities. The policy of not prosecuting companies complying with state cannabis laws is likely to continue under the Biden Administration.
Additionally, since 2014, versions of the U.S. omnibus spending bill have included a provision prohibiting the DOJ, which includes the Drug Enforcement Administration, from using appropriated funds to prevent states from implementing their medical-use cannabis laws. In USA vs. McIntosh, the U.S. Court of Appeals for the Ninth Circuit held that the provision prohibits the DOJ from spending funds to prosecute individuals who engage in conduct permitted by state medical-use cannabis laws and who strictly comply with such laws. The court noted that, if the spending bill provision were not continued, prosecutors could enforce against conduct occurring during the statute of limitations even while the provision was previously in force. Other courts that have considered the issue have ruled similarly, although courts disagree about which party bears the burden of proof of showing compliance or noncompliance with state law.
We cannot predict the timing of any change in federal law or possible changes in federal enforcement. In the unlikely event that the federal government were to reverse its long-standing hands-off approach to the state legal cannabis markets and start more broadly enforcing federal law regarding cannabis, we would likely be unable to execute our business plan, and our business and financial results would be adversely affected.
Certain of our customers may be outside any protections extended to medical-use cannabis under the spending bill provision and more recent medical-use and research laws. This could subject them to greater and/or different federal legal and other risks as compared to businesses where cannabis is sold exclusively for medical use, which could in turn materially adversely affect our business. Furthermore, any change in the federal government’s enforcement posture with respect to state-licensed cannabis sales, including the enforcement postures of individual federal prosecutors in judicial districts where we operate, could result in our inability to execute our business plan, and we would likely suffer significant losses with respect to our customer base, which would adversely affect our operations, cash flow and financial condition.
We are and will be subject to applicable anti-money laundering laws and regulations.
We are subject to a variety of laws and regulations in the United States and Canada that involve money laundering, financial recordkeeping and proceeds of crime, including the U.S. Currency and Foreign 125 Transactions Reporting Act of 1970 (commonly known as the Bank Secrecy Act), as amended by Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada), as amended and the rules and regulations thereunder, and any related or similar rules, regulations or guidelines, issued, administered or enforced by governmental authorities in the United States, Canada and internationally. Further, under U.S. federal law, banks or other financial institutions that provide a cannabis business with a checking account, debit or credit card, small business loan, or any other service could be found guilty of money laundering if certain other elements are met.
Despite these laws, the FinCEN Memorandum states that in some circumstances, it is permissible for banks to provide services to cannabis-related businesses without risking FinCEN enforcement. It refers to and incorporates supplementary Cole Memo guidance issued to federal prosecutors relating to the prosecution of money laundering offenses predicated on cannabis-related violations of the CSA on the same day.
Notwithstanding former Attorney General Sessions’ revocation of the Cole Memo, the status of the FinCEN Memorandum has not been affected, nor has the Department of the Treasury given any indication that it intends to rescind the FinCEN Memorandum itself. Though it was originally intended for the Cole Memo and the FinCEN Memorandum to work in tandem, the FinCEN Memorandum appears to remain in effect as a standalone document which explicitly lists the eight enforcement priorities originally cited in the rescinded Cole Memo. Although the FinCEN Memorandum remains intact, indicating that the Department of the Treasury and FinCEN intend to continue abiding by its guidance, it is unclear whether the current administration will continue to follow the guidelines of the FinCEN Memorandum.
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We face risks related to civil asset forfeiture due to the regulatory environment of the cannabis industry in the United States.
Because the cannabis industry remains illegal under U.S. federal law, any property owned by participants in the cannabis industry, which are either used in the course of conducting such business, or are the proceeds of such business, could be subject to seizure by law enforcement and subsequent civil asset forfeiture. Even if the owner of the property were never charged with a crime, the property in question could still be seized and subject to an administrative proceeding by which, with minimal due process, it could be subject to forfeiture. As a result, the equipment that our customers acquire from us in the United States may be subject to such seizure and forfeiture. Additionally, a broad interpretation of the law could potentially result in the seizure and forfeiture of proceeds we generate from client payments who are subject to property seizure.
Public opinion and perception of the cannabis industry may have an adverse effect on our business reputation.
Government policy changes or public opinion may also result in a significant influence over the regulation of the cannabis industry in the United States, Canada, or elsewhere. Public opinion and support for medical and adult-use marijuana has traditionally been inconsistent and varies from jurisdiction to jurisdiction. While public opinion and support appears to be improving for legalizing medical and adult-use marijuana, it remains a controversial issue subject to differing opinions surrounding the level of legalization (for example, medical marijuana as opposed to legalization in general). A negative shift in the public’s perception of cannabis in the United States or any other applicable jurisdiction could affect future legislation or regulation. Among other things, such a shift could cause state jurisdictions to abandon initiatives or proposals to legalize medical and/or adult-use cannabis, thereby limiting the number of new state jurisdictions into which we could expand. Any inability to fully implement our expansion strategy may have a material adverse effect on our business, results of operations or prospects.
We may have difficulty accessing bankruptcy courts.
Because cannabis is illegal under federal law, federal bankruptcy protection is currently not available to parties who engage in the cannabis industry or cannabis-related businesses. Recent bankruptcy rulings have denied bankruptcies for dispensaries upon the justification that businesses cannot violate federal law and then claim the benefits of federal bankruptcy for the same activity and upon the justification that courts cannot ask a bankruptcy trustee to take possession of and distribute cannabis assets as such action would violate the CSA. Therefore, we may not be able to seek the protection of the bankruptcy courts, and this could materially affect our business or our ability to obtain credit.
Our business efforts in Canada present opportunities, but no assurance can be given that our revenues and earnings will be improved on the basis of our addressing the Canadian business.
In addition to U.S. operations, we seek to sell products and services to CEA and cannabis growers in Canada, where medical and recreational cannabis has been legal since 2018 across the country both federally and provincially (subject to certain restrictions relating to CBD). We believe Canada, with its federal legal regime, represents a business opportunity for us, but we have noticed softening demand from Canadian prospects due, in part, to limited capital being available for new facilities and an overbuilding of cultivation capacity following federal legalization. As a result, Canada now appears to be in a period of correction. There can be no assurance that we will be able to make any additional sales of products or services in Canada.
Variations in state and local regulation and enforcement in states that have legalized cannabis may impose certain restrictions on cannabis-related activities that may adversely impact our revenue and earnings.
Variations exist among states that have legalized, decriminalized, or created medical cannabis programs. For example, Alaska and Colorado have limits on the number of cannabis plants that can be grown by an individual in the home. In most states, the cultivation of cannabis for personal use continues to be prohibited except by those states that allow small-scale cultivation by the individual in possession of cannabis for medicinal purposes or that person’s caregiver. Active enforcement of state laws that prohibit personal cultivation of cannabis may indirectly and adversely affect our revenue and earnings.
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The cannabis industry could face strong opposition from other industries.
We believe that established businesses in other industries may have a strong economic interest in opposing the development of the cannabis industry. Cannabis may be seen by companies in other industries as an attractive alternative to their products, including recreational marijuana as an alternative to alcohol, and medical marijuana as an alternative to various commercial pharmaceuticals. Many industries that could view the emerging cannabis industry as an economic threat are well established, with vast economic and United States federal and state lobbying resources. It is possible that companies within these industries could use their resources to attempt to slow or reverse legislation legalizing cannabis. Any inroads these companies make in halting or impeding legislative initiatives that would be beneficial to the cannabis industry could have a detrimental impact on our clients and, in turn on our operations.
Changing legislation and evolving interpretations of law, could negatively impact our clients and, in turn, our operations.
Laws and regulations affecting the medical and adult-use marijuana industry are constantly changing, which could detrimentally affect our clients involved in that industry and, in turn, our operations. Local, state and federal cannabis laws and regulations are often broad in scope and subject to constant evolution and inconsistent interpretations, which could require our clients and ourselves to incur substantial costs associated with modification of operations to ensure compliance. In addition, violations of these laws, or allegations of such violations, could disrupt our clients’ business and result in a material adverse effect on our operations. In addition, it is possible that regulations may be enacted in the future that will limit the amount of cannabis growth or related products that our commercial clients are authorized to produce. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can it determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our operations.
The fact that we provide products and services to companies in the cannabis industry may impact our ability to raise adequate capital for future expansion, which could hinder our growth potential as well as our revenue and earnings.
A very large percentage of our customers are operating in an industry that is still illegal under U.S. federal law. With the lingering uncertainty of federal enforcement, many potential investors, especially institutional investors, either refuse to invest in the industry or are very reluctant to make such investments. Our inability to raise adequate capital for future expansion could substantially hinder our growth potential as well as our revenue and earnings.
Our success may be dependent on additional states legalizing recreational and/or medical cannabis use.
Continued development of the recreational and medical cannabis markets is dependent upon continued legislative authorization of cannabis at the state level for recreational and/or medical purposes. Any number of factors could slow or halt the progress. Furthermore, progress, while encouraging, is not assured, and the process normally encounters setbacks before achieving success. While there may be ample public support for legislative proposals, key support must be created in the relevant legislative committee, or a bill may never advance to a vote. Numerous factors impact the legislative process. Any one of these factors could slow or halt the progress and adoption of cannabis for recreational and/or medical purposes, which would limit the overall available market for our products and services, which could adversely impact our business, revenue and earnings.
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Our customers may have difficulty accessing the service of banks, which may make it difficult for them to purchase our products and services.
As a result of the federal illegality of marijuana, many banks do not provide banking services to the cultivation and distribution segments of the cannabis industry, the argument being that they would be accepting for deposit funds derived from the operation of a federally illegal business. On February 14, 2014, the U.S. Department of the Treasury Financial Crimes Enforcement Network (“FinCEN”) released guidance to banks “clarifying Bank Secrecy Act (“BSA”) expectations for financial institutions seeking to provide services to marijuana-related businesses.” In addition, there have been legislative attempts to allow banks to transact business with state-authorized cannabis businesses. While these are positive developments, there can be no assurance that legislation will be successful, or that, even with the FinCEN guidance, banks will decide to do business with cannabis companies, or that, in the absence of actual legislation, state and federal banking regulators will not strictly enforce current prohibitions on banks handling funds generated from an activity that is illegal under federal law. Moreover, the FinCEN guidance may be rescinded or amended at any time in order to reconcile the now conflicting guidance of the Sessions Memo. At present, few banks have taken advantage of the FinCEN guidance, resulting in many cannabis businesses still operating on an all-cash basis. This makes it difficult for cannabis businesses to manage their businesses and pay their employees and taxes; in addition, having so much cash on hand creates significant public safety issues. Many ancillary businesses that service cannabis businesses have to deal with the unpredictability of their clients or customers not having a bank account. The inability of our customers to open bank accounts and otherwise access the services of banks, including obtaining credit, may make it more difficult and costly for them to operate and more difficult for such customers to purchase our products and services, which could materially harm our business, revenue and earnings.
We are subject to certain federal regulations relating to cash reporting.
The BSA, enforced by FinCEN, requires us to report currency transactions in excess of $10,000, including identification of the customer by name and social security number, to the Internal Revenue Service. This regulation also requires us to report certain suspicious activity, including any transaction that exceeds $5,000 that we know, suspect or have reason to believe involves funds from illegal activity or is designed to evade federal regulations or reporting requirements and to verify sources of funds. Substantial penalties can be imposed against us if we fail to comply with this regulation. If we fail to comply with these laws and regulations, the imposition of a substantial penalty could have a material adverse effect on our business, financial condition and results of operations.
State and municipal governments in which our customers do business or seek to do business may have or may adopt laws that adversely affect our ability to do business with such customers.
While the federal government has the right to regulate and criminalize cannabis, state and municipal governments may adopt or amend additional laws and regulations that further criminalize or adversely affect cannabis businesses. States that currently have laws that decriminalize or legalize certain aspects of cannabis, such as medical marijuana, could in the future, reverse course and adopt new laws that further criminalize or adversely affect cannabis businesses. Additionally, municipal governments in certain states may have laws that adversely affect cannabis businesses, even though there are no such laws at the state level. For example, municipal governments may have zoning laws that restrict where cannabis operations can be located and the manner and size of which they can expand and operate. These municipal laws, like the federal laws, may adversely affect our customers’ ability to do business. Also, given the complexity and rapid change of the federal, state and local laws pertaining to cannabis, our customers may incur substantial legal costs associated with complying with these laws and in acquiring the necessary state and local licenses required by their business endeavors. All of the foregoing may impact our customers’ ability to purchase our products and services, which may adversely affect our business, revenue and earnings.
Most, if not all, of our customers are impacted by Section 280E of the Code, which limits certain expenses marijuana companies can deduct. This negative impact could affect the financial condition of our customers, which in turn may negatively affect the ability of our customers to purchase our products and services.
Section 280E of the Code forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the CSA. The Internal Revenue Service (the “IRS”) has subsequently applied Section 280E to state-legal cannabis businesses since marijuana is still a Schedule I substance. Section 280E states that no deductions should be allowed on any amount “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.” Section 280E affects all businesses that engage in the cultivation, sale or processing of marijuana. This includes cultivators, medical dispensaries, marijuana retail stores and infused product manufacturers, as well as marijuana-derived concentrates and oil manufacturers. Because Section 280E limits certain deductions, it can have a dramatic effect on the profitability of these businesses, which in turn may adversely affect their ability to purchase our products and services. Such result may adversely impact our revenue and earnings.
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There may be difficulty enforcing certain of our commercial agreements and contracts.
Courts will not enforce a contract deemed to involve a violation of law or public policy. Because cannabis remains illegal under U.S. federal law, parties to contracts involving the state legal cannabis industry have argued that the agreement was void as federally illegal or against public policy. Some courts have accepted this argument in certain cases, usually against the company trafficking in cannabis. While courts have enforced contracts related to activities by state-legal cannabis companies, and the trend is generally to enforce contracts with state-legal cannabis companies and their vendors, there remains doubt and uncertainty that we will be able to enforce our commercial agreements in court for this reason. We cannot be assured that we will have a remedy for breach of contract, which would have a material adverse effect on our business.
Due to our involvement in the cannabis industry, we may have a difficult time obtaining the various insurances that are desired to operate our business, which may expose us to additional risk and financial liability.
Insurance that is otherwise readily available, such as general liability and directors’ and officers’ insurance, is more difficult for us to find, and more expensive, because we are product and service providers to companies in the cannabis industry. There are no guarantees that we will be able to find such insurances in the future, or that the cost will be affordable to us. If we are forced to go without such insurances, it may prevent us from entering into certain business sectors, may inhibit our growth, and may expose us to additional risk and financial liabilities.
A drop in the retail price of cannabis products may negatively impact our business.
The fluctuations in economic and market conditions that impact the prices of commercially grown cannabis, such as increases in the supply of cannabis and decreases in demand for cannabis, could have a negative impact on our clients that are cannabis producers, and therefore could negatively impact our business.
Risks Related to Our Common Stock
Our securities prices may be volatile and may decrease substantially.
The public trading prices of our securities fluctuate, in some cases substantially, and we expect that they will continue to do so. The price of our securities in the market on any particular day depends on many factors including, but not limited to, the following:
| ● | price and volume fluctuations in the overall stock market from time to time; | |
| ● | investor demand for our shares and warrants; | |
| ● | significant volatility in the market price and trading volume of companies in the cannabis industry; | |
| ● | variations in our operating results and market conditions specific to our business; | |
| ● | the emergence of new competitors or new technologies; | |
| ● | operating and market price performance of other companies that investors deem comparable; | |
| ● | changes in our Board of Directors (the “Board”) or management; | |
| ● | sales or purchases of our securities by insiders, including sales of our common stock issued to employees, directors and consultants under our equity incentive plans which were registered under the Securities Act of 1933, as amended (the “Securities Act”) under our S-8 registration statement; | |
| ● | commencement of, or involvement in, litigation; | |
| ● | changes in governmental regulations, in particular with respect to the cannabis industry; | |
| ● | actual or anticipated changes in our earnings, and fluctuations in our quarterly operating results; | |
| ● | market sentiments about the cannabis industry; | |
| ● | general economic conditions and trends; and | |
| ● | departures of any of our key employees. |
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In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Due to the potential volatility of our securities prices, we may therefore be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business.
In addition, if the market for equity stocks of companies in our industry, or the stock market in general, experiences a loss of investor confidence, the market price of our securities could decline for reasons unrelated to our business, financial condition, or results of operations. If any of the foregoing occurs, it could cause the price of our securities to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to our Board of Directors and management.
Our Board of Directors is authorized to reclassify any unissued shares of our preferred stock into one or more classes, which could convey special rights and privileges to its owners.
Our articles of incorporation permit our Board of Directors to reclassify any authorized but unissued shares of preferred stock into one or more classes. Our Board of Directors will generally have broad discretion over the size and timing of any such classification, subject to a finding that the classification and issuance of preferred stock is in our best interests. In the event our Board of Directors opts to classify a portion of our unissued shares of preferred stock into a class of preferred stock, those preferred shares would have a preference over our common stock with respect to dividends and liquidation. The class voting rights of any preferred shares we may issue could make it more difficult for us to take some actions that may, in the future, be proposed by the Board of Directors and/or the holders of our common stock, such as a merger, exchange of securities, liquidation, or alteration of the rights of a class of our securities, if these actions were perceived by the holders of preferred shares as not in their best interests. These effects, among others, could have an adverse effect on your investment in our common stock.
Registration rights and Rule 144 sales contain risks for shareholders.
From time to time, we issue our securities on an unregistered basis, which may be eligible for resale under SEC Rule 144 promulgated under the Securities Act or may require us to register with the SEC the securities for resale. In the event there are securities outstanding that can be sold under Rule 144 or under a registration statement for resale, there may be market pressure on our stock to absorb the securities in respect of the then market value of the company.
We have a substantial number of options and warrants outstanding, which if exercised for shares of common stock, may put pressure on the market price of a share.
We have sold to public investors a substantial number of warrants to purchase common stock from time to time over the next several years. In addition, we have a substantial number of options and warrants outstanding held by investment bankers who provided us with underwriting and placement services that were issued warrants and employees that were issued options. To the extent that these are exercised for shares, there may be pressure on our stock price while the market absorbs them. The potential of exercise may also have the same effect. Investors should expect that the options and warrants will be exercised when the stock price is substantially above the exercise price.
We do not anticipate paying any cash dividends on our common stock in the foreseeable future.
We currently intend to retain our future earnings, if any, for the foreseeable future, to repay indebtedness and to fund the development and growth of our business. We do not intend to pay any dividends to holders of our common stock in the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, any legal or contractual limitations on our ability to pay dividends under our loan agreements or otherwise. As a result, if our Board does not declare and pay dividends, the capital appreciation in the price of our common stock, if any, will be your only source of gain on an investment in our common stock, and you may have to sell some or all of your common stock to generate cash flow from your investment.
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The market price of our securities may be adversely affected by the sale of shares by our management or large stockholders.
Sales of our shares of common stock by our officers or senior managers through 10b5-1 plans or otherwise or by large stockholders could adversely and unpredictably affect the price of our common stock. Additionally, the price of our shares of common stock could be affected even by the potential for sales by these persons. We cannot predict the effect that any future sales of our common stock, or the potential for those sales, will have on our share price. Furthermore, due to relatively low trading volume of our stock, should one or more large stockholders seek to sell a significant portion of their stock in a short period of time, the price of our stock may decline.
An active, liquid trading market for our common stock and warrants may not develop or be sustained, and as a result, investors may not be able to sell their common stock at or above their acquisition price, or at all.
Prior to February 10, 2022, our common stock was quoted on the OTC Markets Group, Inc., OTCQB. Trading on the OTCQB marketplace was infrequent and in limited volume. Although our common stock is now listed on Nasdaq, along with our public warrants, an active trading market for these securities may never develop or be sustained. If an active trading market does not develop, investors will have difficulty selling their shares of common stock and warrants at an attractive price, or at all. An inactive market may also impair our ability to raise capital and may impair our ability to expand our business by using our common stock and common stock related securities as consideration in an acquisition.
If we are unable to maintain our listing on The Nasdaq Markets for either the common stock or the warrants, or both, it could become more difficult to sell our securities in the public market.
Our common stock is listed on The Nasdaq Capital Market. To maintain our listing on this market, we must meet Nasdaq’s listing maintenance standards. If we are unable to continue to meet Nasdaq’s listing maintenance standards for any reason, our common stock could be delisted. If our common stock were delisted, we may seek to list our common stock on the NYSE American or on a regional stock exchange or, if one or more broker-dealer market makers comply with applicable requirements, the over-the-counter (OTC) market. Listing on such other market or exchange could reduce the liquidity of our common stock. If our common stock were to trade in the OTC market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the common stock.
A delisting from The Nasdaq Capital Market and failure to obtain listing on another market or exchange would subject our common stock to so-called penny stock rules that impose additional sales practice and market-making requirements on broker-dealers who sell or make a market in those securities. Consequently, removal from The Nasdaq Capital Market and failure to obtain listing on another market or exchange could affect the ability or willingness of broker-dealers to sell or make a market in our common stock and the ability of purchasers of our common stock to sell their securities in the secondary market.
Similarly, we have a series of common stock purchase warrants listed on The Nasdaq Global Market which could separately be delisted for not meeting maintenance standards. It these securities are delisted, we would try to list them on another market with or separately from the common stock. If we are not successful in listing the warrants on a different market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the warrants.
On March 22, 2023, the closing price of our common stock was $.88 per share and $.0541 per warrant.
You may be diluted by future issuances of preferred stock or additional common stock in connection with our incentive plans, acquisitions or otherwise; future sales of such shares in the public market, or the expectations that such sales may occur, could lower our stock price.
Our articles of incorporation authorizes us to issue shares of our common stock and options, rights, warrants and appreciation rights relating to our common stock for the consideration and on the terms and conditions established by our Board in its sole discretion. We could issue a significant number of shares of common stock in the future in connection with investments or acquisitions. Any of these issuances could dilute our existing stockholders, and such dilution could be significant. Moreover, such dilution could have a material adverse effect on the market price for the shares of our common stock.
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The future issuance of shares of preferred stock with voting rights may adversely affect the voting power of the holders of shares of our common stock, either by diluting the voting power of our common stock if the preferred stock votes together with the common stock as a single class, or by giving the holders of any such preferred stock the right or ability to block an action on which they have a separate class vote, even if the action were approved by the holders of our shares of our common stock.
The future issuance of shares of preferred stock with dividend or conversion rights, liquidation preferences or other economic terms favorable to the holders of preferred stock, when compared to the rights of the common stockholders, could adversely affect the market price for our common stock by making an investment in the common stock less attractive. For example, investors in the common stock may not wish to purchase common stock at a price above the conversion price of a series of convertible preferred stock because the holders of the preferred stock would effectively be entitled to purchase common stock at the lower conversion price, causing economic dilution to the holders of common stock.
Item 1B. Unresolved Staff Comments
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act, and therefore we are not required to provide information under this item.
Item 2. Properties
We own no real property. On July 28, 2021, we executed a lease, which became effective November 1, 2021, for our manufacturing and headquarters office space at 385 S. Pierce Avenue, Suite C, Louisville, Colorado 80027. The term of the lease commenced November 1, 2021, and continues through January 31, 2027. Our leased space is approximately 11,491 square feet. We believe that our lease is at market rates and that there is sufficient space available in the Louisville, Colorado area to obtain additional or other space if and when required.
Item 3. Legal Proceedings
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our customers. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Public Securities; Common Stock and Warrants
Our shares of common stock are quoted on Nasdaq under the symbol “CEAD”. In addition, we have a class of publicly traded warrants to purchase shares of common stock that are quoted on Nasdaq under the symbol “CEADW.”
As of March 28, 2023, we had approximately 32 shareholders of record and approximately 12,181 shareholders who hold their shares in street name.
We currently intend to retain our future earnings, if any, for the foreseeable future, to repay indebtedness and to fund the development and growth of our business. We do not intend to pay any dividends to holders of our common stock in the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, any legal or contractual limitations on our ability to pay dividends under our loan agreements or otherwise.
Equity Compensation Plans
2017 Equity Incentive Plan
On August 1, 2017, our Board of Directors adopted and approved the 2017 Equity Incentive Plan (the “2017 Equity Plan”) in order to attract, motivate, retain, and reward high-quality executives and other employees, officers, directors, consultants, and other persons who provide services to us by enabling such persons to acquire an equity interest in us. Under the 2017 Equity Plan, our Board of Directors may award stock options, stock appreciation rights (“SARs”), restricted stock awards (“RSAs”), restricted stock unit awards (“RSUs”), shares granted as a bonus or in lieu of another award, and other stock-based performance awards. The 2017 Equity Plan allocates 333,333 shares of our common stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. As of December 31, 2022, we have granted, under the 2017 Equity Plan, awards in the form of RSAs for services rendered by independent directors and consultants, non-qualified stock options, RSUs and stock bonus awards.
The information for our 2017 Equity Plan as of December 31, 2022 is summarized as follows:
| Number of shares to be issued upon exercise of outstanding options | Weighted-average exercise price of outstanding options | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in first column) | ||||||||||
| Equity compensation plans approved by shareholders | - | - | - | |||||||||
| Equity compensation plans not approved by shareholders (1) | 147,177 | $ | 11.88 | 22,464 | ||||||||
| Total | 147,177 | $ | 11.88 | 22,464 | ||||||||
(1) Of the 333,333 Plan Shares allocated for issuance under the 2017 Equity Plan, as of December 31, 2022, 163,692 shares have been issued, non-qualified stock options over 147,177 shares were issued and outstanding and securities in respect of the remaining 22,464 shares were available for future issuance.
2021 Equity Incentive Plan
On March 22, 2021, the Board approved the 2021 Equity Incentive Plan (the “2021 Equity Plan”), which was approved by the stockholders on July 22, 2021. The 2021 Equity Plan permits the Board to grant awards of up to 666,667 shares of common stock. The 2021 Plan provides for the grant of incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), non-qualified stock options, stock appreciation rights (“SARs”), restricted stock awards and restricted stock unit awards and other equity linked awards to our employees, consultants and directors. If an equity award (i) expires or otherwise terminates without having been exercised in full or (ii) is settled in cash (i.e., the holder of the award receives cash rather than stock), such expiration, termination or settlement will not reduce (or otherwise offset) the number of shares of common stock that may be issued pursuant to this Plan. As of December 31, 2022, we have granted under the 2021 Equity Plan, incentive stock options, non-qualified stock options, and a stock bonus award.
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| Number of shares to be issued upon exercise of outstanding options | Weighted-average exercise price of outstanding options | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in first column) | ||||||||||
| Equity compensation plans approved by shareholders | 102,017 | $ | 4.97 | 551,113 | ||||||||
| Equity compensation plans not approved by shareholders (1) | - | - | ||||||||||
| Total | 102,017 | $ | 4.97 | 551,113 | ||||||||
(1) Of the 666,667 Plan Shares allocated for issuance under the 2021 Equity Plan, as of December 31, 2022, 10,170 shares have been issued, non-qualified stock options over 61,201 shares were issued and outstanding, incentive stock options over 40,816 shares were issued and outstanding, restricted stock units over 3,367 shares were issued and outstanding, and securities in respect of the remaining 551,113 shares were available for future issuance.
Refer to Note 14 – Equity Incentive Plan of our consolidated financial statements, which are included as part of this Annual Report for the further details on our 2017 Equity Plan and 2021 Equity Plan.
Item 6. Selected Financial Data
We are a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act, and therefore we are not required to provide the information under this item.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information included elsewhere in this Annual Report, which include additional information about our accounting policies, practices, and the transactions underlying our financial results. In addition to historical information, this Annual Report contains forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under “Cautionary Statements” appearing elsewhere herein and the risks and uncertainties described or identified in “Item 1A – Risk Factors” in this Annual Report.
Please also refer to “Non-GAAP Financial Measures” discussed elsewhere in this Annual Report.
The following discussion should be read in conjunction with Item 1 – Business in this Annual Report, and our consolidated financial statements and accompanying notes to consolidated financial statements included in this Annual Report. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is segregated into four sections, including:
Executive Overview. This section provides a summary of our operating performance and cash flows, industry trends and our strategic initiatives.
Critical Accounting Policies and Estimates. This section describes the accounting areas where management makes critical estimates to report our financial condition and results of operations.
Results of Operations. This section provides an analysis of our consolidated results of operations for the two comparative periods presented in our consolidated financial statements.
Liquidity, Capital Resources and Financial Position. This section provides an analysis of cash flow, contractual obligations, and certain other matters affecting our financial position.
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Executive Overview
CEA Industries Inc. is a company focused on selling environmental control and other technologies and services to the Controlled Environment Agriculture (“CEA”) industry. Our principal service and product offerings include: (i) floor plans and architectural design of cultivation facilities, (ii) licensed mechanical, electrical, and plumbing (MEP) engineering of commercial scale environmental control systems specific to cultivation facilities, (iii) process cooling systems and other climate control systems, (iv) air handling equipment and systems, (v) LED lighting, (vi) benching and racking solutions for indoor cultivation, (vii) automation and control devices, systems and technologies used for environmental, lighting and climate control, and (viii) preventative maintenance services for CEA facilities. Our customers include commercial, state- and provincial-regulated CEA growers in the U.S. and Canada as well as in other international locations. Customers are those growers building new facilities and those expanding or retrofitting existing facilities, with both ranging in size from several thousand to more than 100,000 square feet.
Historically, our revenue stream is derived primarily from supplying our products, services and technologies to commercial indoor facilities that grow cannabis, but we have served facilities growing other crops and we intend to pursue such facilities as customers more in the future.
We have three core assets that we believe are important to our going-forward business strategy. First, we have multi-year relationships with customers and others in the CEA industry, notably in the cannabis segment. Second, we have specialized engineering know-how and experience gathered from designing environmental control systems for CEA cultivation facilities since 2016. Third, we have a line of proprietary and curated environmental control products.
Historically, nearly all of our customers have been in the cannabis cultivation business. We believe our customers engage us for their environmental and climate control systems because they value our reputation as experts in the industry. We leverage our reputation and know-how against the many local contractors and MEP engineers who collectively constitute our largest competitors.
Our revenue for the year ended December 31, 2022 was approximately $11,283,000 compared to approximately $13,639,000 for the year ended December 31, 2021, a decrease of $2,356,000, or 17%. Overall, we had a net loss of approximately $5,497,000 for the year ended December 31, 2022 as compared to a net loss of approximately $1,338,000 for the year ended December 31, 2021, an increase of $4,159,000, or 311%. Our 2022 adjusted net loss was $4,526,000 compared to a 2021 adjusted net loss of $889,000. Our adjusted net income (loss) is our GAAP net income (loss) after addback for our non-cash equity compensation expenses, debt-related items, goodwill impairment charges, and depreciation expense. Historically, one of the most significant financial challenges we face is the inconsistent and unpredictable revenue we generate quarter-over-quarter, and our revenue and cash flow remain difficult to predict.
Impact of the COVID-19 Pandemic on Our Business
The impact of the government and the business economic response to the COVID-19 pandemic has affected demand across the majority of our markets and disrupted workflow and completion schedules on projects. The COVID-19 pandemic is expected to have continued adverse effects on our sales, project implementation, supply chain infrastructure, operating margins, and working capital.
The resulting effects and uncertainties from the COVID-19 pandemic, including the depth and duration of the disruptions to customers and suppliers, its future effect on our business, on our results of operations, and on our financial condition, cannot be predicted. We expect that the economic disruptions will continue to have an effect on our business over the longer term. Despite this uncertainty, we continue to monitor costs and continue to take actions to reduce costs in order to mitigate the 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 year, the Company experienced significant delays in the receipt of equipment it had ordered to meet its customer orders due to disruption and delays in its supply chain arising from the long-term effects of the COVID-19 pandemic. Consequently, our revenue recognition of these customer sales has been delayed until future periods when the shipment of these orders can be completed.
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Impact of Ukrainian Conflict
Currently, 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 inflationary results of the conflict and government spending for 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.
Revenue. Our 2022 revenue was approximately $11,283,000. Our 2022 revenue represents a decrease of 17% compared to 2021. Included in our 2022 revenue were two projects with one of our MFO customers which accounted for 54% of our total revenue. We believe, among other things, that we need to build a diversified sales pipeline of MFOs, which we believe will increase our consistency and predictability of revenue.
Gross Margin. Our 2022 gross margin was 10.1%, a decrease from 21.5% in 2021. This decrease was primarily due to lower revenue, an increase in our fixed cost base, and an increase in our variable costs as a percent of revenue including lower margins on equipment sales as described in Results of Operations below.
Profitability. Our 2022 adjusted net loss was approximately $4,526,000 compared to a 2021 adjusted net loss of approximately $889,000. Our adjusted net income (loss) is a key management metric for us because it provides a proxy for the cash we generate from operations.
Capital Resources. The effects of the COVID-19 pandemic presented major challenges for the Company in both 2020 and 2021. We continue to experience business disruptions in a post-COVID environment, in the form of softening demand in the markets we serve, continued supply chain delays, inflation, and a broader macroeconomic slowdown. All of these challenges remain a source of further uncertainty to our business, and as discussed elsewhere in this Annual Report, we have taken steps during 2022 to focus on the Company’s core strategy and reduce our operating costs and general and administrative expenses to manage these challenges. More recently, in February 2023, we have taken steps to reduce our cost structure to better reflect the activity levels we are observing in the industry (as further described in Note 16 Subsequent Events). We believe these steps are necessary to protect our liquidity and our current cash balance, and we will continue to monitor this as we move through the year.
Nonetheless, there remain risks and uncertainties regarding our ability to grow revenue and generate sufficient revenues and cash flows. And there can be no assurances that we will be able to raise future capital on commercially reasonable terms, or at all.
Contract Bookings. Our bookings decreased in 2022, and our backlog at December 31, 2022, was $5,577,000, a decrease of $5,241,000, or 48%, from our December 31, 2021 backlog. During 2022, we had net bookings of $6,042,000, consisting of: (i) $8,962,000 of new sales contracts executed in 2022, (ii) $197,000 net positive changes orders, and (iii) $3,117,000 in project cancellations.
The following table sets forth: (i) our beginning backlog (the remaining contract value of outstanding sales contracts for which we have received an initial deposit as of the previous period), (ii) our net bookings for the period (new sales contracts executed during the period for which we received an initial deposit, net of any adjustments including cancellations and change orders during the period), (iii) our recognized revenue for the period, and (iv) our ending backlog for the period (the sum of the beginning backlog and net bookings, less recognized revenue). Based on the current economic climate and our cost cutting measures, there is no assurance that we will be able to continue to obtain the level of bookings that we have had in the past and or fulfill our current backlog, and we may experience contract cancellations, project scope reductions and project delays.
| For the quarter ended | ||||||||||||||||||||
| December 31, 2021 | March 31, 2022 | June 30, 2022 | September 30, 2022 | December 31, 2022 | ||||||||||||||||
| Backlog, beginning balance | $ | 9,881,000 | $ | 10,818,000 | $ | 11,179,000 | $ | 9,698,000 | $ | 6,832,000 | ||||||||||
| Net bookings, current period | $ | 3,993,000 | $ | 2,105,000 | $ | 1,534,000 | $ | 2,197,000 | $ | 206,000 | ||||||||||
| Recognized revenue, current period | $ | 3,056,000 | $ | 1,744,000 | $ | 3,015,000 | $ | 5,063,000 | $ | 1,461,000 | ||||||||||
| Backlog, ending balance | $ | 10,818,000 | $ | 11,179,000 | $ | 9,698,000 | $ | 6,832,000 | $ | 5,577,000 | ||||||||||
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The completion of a customer’s new build facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for these customers to complete a new build project, which corresponds to when we are able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price tag and technical complexities of the climate control and air sanitation systems; (vii) the availability of power; and (viii) delays that are typical in completing any construction project.
We have provided an estimate in our consolidated financial statements of when we expect to recognize revenue on our remaining performance obligations (i.e., our Q4 2022 backlog), using separate time bands, with respect to engineering only paid contracts and partial equipment paid contracts. However, there continues to be significant uncertainty regarding the timing of our recognition of revenue in our Q4 2022 backlog. Refer to the Revenue Recognition section of Note 2 in our consolidated financial statements, included as part of this Annual Report for additional information on our estimate of future revenue recognition on our remaining performance obligations.
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 backlog or remaining performance obligations will actually generate revenues or when the actual revenues will be generated. Net bookings and backlog are considered non-GAAP financial measures, and therefore, they should be considered in addition to, rather than as a substitute for, our GAAP measures for recognized revenue, deferred revenue and remaining performance obligations. Further, we can provide no assurance as to the profitability of our contracts reflected in remaining performance obligations, backlog and net bookings.
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain accounting policies are particularly important to the understanding of our financial position and results of operations and require the application of significant judgment by our management or can be materially affected by changes from period to period in economic factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In applying these policies, management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms of existing contracts, observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate. Actual results could materially differ from those estimates. For information regarding our critical accounting policies as well as recent accounting pronouncements, see Note 2 of our consolidated financial statements.
Our management has discussed the development and selection of critical accounting estimates with the Board of Directors and the Board of Directors has reviewed our disclosure relating to critical accounting estimates in this Annual Report. We believe the following are the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Allowance for accounts receivable. Accounts receivables are recorded at the invoiced amount or based on revenue earned for items not yet invoiced, and generally do not bear interest. An allowance for doubtful accounts is established, as necessary, based on past experience and other factors, which, in management’s judgment, deserve current recognition in estimating bad debts. Based on its review, we establish or adjust the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2022, and December 31, 2021, the allowance for doubtful accounts was $127,233 and $181,942, respectively. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
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Excess and obsolete inventory. Inventory is stated at the lower of cost or net realizable value. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolescence or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for that inventory is established; subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. As of December 31, 2022, and December 31, 2021, the allowance for excess and obsolete inventory was $70,907 and $91,379, respectively.
Goodwill impairment. Goodwill, defined as unidentified asset(s) acquired in conjunction with a business acquisition, is tested for impairment on an annual basis and between annual tests whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
The Company recorded goodwill in connection with its acquisition of Hydro Innovations, LLC in July 2014. Goodwill is reviewed for impairment annually or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. The Company performs a quantitative impairment test annually on December 31 by comparing the fair value of the reporting unit with its carrying amount, including goodwill. The Company’s fair value is calculated using a market valuation technique whereby an appropriate control premium is applied to the Company’s market capitalization as calculated by applying its publicly quoted share price to the number of its common shares issued and outstanding. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company determined that it has one reporting unit.
As of June 30, 2022, the Company experienced a triggering event due to a drop in its stock price and performed a quantitative analysis for potential impairment of its goodwill. As of June 30, 2022, the Company performed a quantitative analysis for potential impairment of its goodwill, by comparing the Company’s fair value to its carrying value as of June 30, 2022. Based on this analysis, the Company determined that its carrying value exceeded its fair value. As a result, the Company recorded a non-cash goodwill impairment charge of $631,064 at June 30, 2022. No income tax benefit related to this goodwill impairment charge was recorded at June 30, 2022.
Product warranty. We warrant the products that we manufacture for a warranty period equal to the lesser of 12 months from start-up or 18 months from shipment. Our warranty provides for the repair, rework, or replacement of products (at our option) that fail to perform within stated specification. Our third-party suppliers also warrant their products under similar terms, which are passed through to our customers. We assess the historical warranty claims on our manufactured products and, since 2016, warranty claims have been approximately 1% of annual revenue generated on these products. We continue to assess the need to record a warranty reserve at the time of sale based on historical claims and other factors. As of December 31, 2022, and December 31, 2021, we had an accrued warranty reserve amount of $180,457 and $186,605, respectively, which are included in accounts payable and accrued liabilities on our consolidated balance sheets.
Income taxes. We account for deferred tax liabilities and assets for the future consequences of events that have been recognized in our consolidated financial statements or tax returns. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of our assets and liabilities result in a deferred tax asset, we perform an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a net deferred tax asset is recorded when it is more likely than not that some portion or all of the net deferred tax asset will not be realized. Management’s judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against the net deferred tax assets. We recorded a full valuation allowance as of December 31, 2022, and December 31, 2021. Based on the available evidence, we believe it is more likely than not that we will be unable to utilize our net deferred tax assets in the foreseeable future. We intend to maintain valuation allowances until sufficient evidence exists to support the reversal of such valuation allowances. We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans. Should the actual amounts differ from our estimates, the carrying value of our deferred tax assets could be materially impacted.
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Share-based compensation. We recognize the cost resulting from all share-based compensation arrangements, including stock options, restricted stock awards and restricted stock units that we grant under our equity incentive plan in our consolidated financial statements based on their grant date fair value. The expense is recognized over the requisite service period or performance period of the award. The service inception date is typically the grant date, but the service inception date may be prior to the grant date. Awards with a graded vesting period based on service are expensed on a straight-line basis for the entire award. Awards with performance-based vesting conditions which require the achievement of a specific company financial performance goal at the end of the performance period and required service period are recognized over the performance period. Each reporting period, we reassess the probability of achieving the respective performance goal. If the goals are not expected to be met, no compensation cost is recognized, and any previously recognized amount recorded is reversed. If the award contains market-based vesting conditions, the compensation cost is based on the grant date fair value and expected achievement of market condition and is not subsequently reversed if it is later determined that the condition is not likely to be met or is expected to be lower than initially expected. The grant date fair value of stock options is based on the Black-Scholes Model. The Black-Scholes Model requires judgmental assumptions including volatility and expected term, both based on historical experience. The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected term of the option.
Allocation of transaction price; standalone selling price. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the transaction price to each performance obligation based on standalone selling price. When estimating the selling price, we use various observable inputs. The best observable input is our actual selling price for the same good or service. For engineering services, we estimate the standalone selling price by reference to certain physical characteristics of the project, such as facility size and mechanical systems involved, which are indicative of the scope and complexity of the mechanical engineering services to be provided. For equipment sales, the standalone selling price is determined by forecasting the expected costs of the equipment and then adding an appropriate margin, based on a range of acceptable margins established by management. Depending on the nature of the performance obligations, we may use a combination of different methods and observable inputs if certain performance obligations have highly variable or uncertain standalone selling prices. Once the selling prices are determined, we apply the relative values to the total contract consideration and estimates the amount of the transaction price to be recognized as each performance obligation is fulfilled.
Remaining performance obligations. The revenue standard requires certain quantitative and qualitative disclosures about our remaining performance obligations, which are defined as performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period, including (i) the aggregate amount of the transaction price allocated to the remaining performance obligations, and (ii) when we expect to recognize as revenue with respect to such amounts on either: (x) a quantitative basis using appropriate time bands for the duration of the remaining performance obligations, or (y) by using qualitative information. 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 on our remaining performance obligations. There are risks that we may not realize the full contract value on customer projects in a timely manner or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when we are able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the significant price and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays that are typical in completing any construction project. Further, based on the current economic climate, and the Company’s recent cost cutting measures, there is no assurance that the Company will be able to fulfill its backlog, and the Company may experience contract cancellations, project scope reductions and project delays.
There is significant uncertainty regarding the timing of our recognition on all remaining performance obligations as of December 31, 2022. Customer contracts for which we have only received an initial advance payment to cover the allocated value of our engineering services (“engineering only paid contracts”) carry enhanced risks that the equipment portion of these contracts will not be completed or will be delayed, which could occur if the customer is dissatisfied with the quality or timeliness of our engineering services or there is a delay or abandonment of the project due to the customer’s inability to obtain project financing or licensing. In contrast, after the customer has made an advance payment for a portion of the equipment to be delivered under the contract (“partial equipment paid contracts”), we are typically better able to estimate the timing of revenue recognition since the risks and delays associated with licensing, permitting and project funding are typically mitigated once the initial equipment payment is received.
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Commitments and contingencies. In the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of our business, that cover a wide range of matters, including, among others, customer disputes, government investigations and tax matters. An accrual for a loss contingency is recognized when it is probable that an asset has been impaired, or a liability has been incurred and the amount of loss can be reasonably estimated.
Results of Operations
Comparison of Years ended December 31, 2022 and 2021
Revenues and Cost of Goods Sold
Revenue for the year ended December 31, 2022 was $11,283,000 compared to $13,639,000 for the year ended December 31, 2021, a decrease of $2,356,000, or 17%. This revenue decrease was partly the result of our decreased net bookings in 2022 which dropped from $16,009,000 in 2021 to $6,042,000 in 2022, or 62%. Additionally, we experienced delays with our international supply of products and shipments from vendors which delayed contract fulfillment and revenue. Our revenue conversion is largely dependent on customer-centric factors—outside of our control—such as industry uncertainty, project financing concerns, the licensing and qualification of our prospective customers, and other reasons such as a challenging business climate including an overall post-COVID-19 economic downturn, which makes it difficult for us to predict when we will recognize revenue on our backlog.
Cost of revenue decreased by $575,000 from $10,713,000 for the year ended December 31, 2021 to $10,138,000 for the year ended December 31, 2022. The factors impacting this change are discussed below.
The gross profit for the year ended December 31, 2022 was $1,145,000 compared to $2,926,000 for the year ended December 31, 2021. Gross profit margin decreased by 11.4 percentage points from 21.5% for the year ended December 31, 2021 to 10.1% for the year ended December 31, 2022. This decrease was primarily due to an increase in our fixed cost base and higher variable costs as a percent of revenue.
Our revenue cost structure is comprised of both fixed and variable components. The fixed cost component represents engineering, manufacturing and project management salaries and benefits and manufacturing overhead that totaled $1,572,000, or 13.9% of total revenue, for the year ended December 31, 2022, as compared to $1,342,000, or 9.8% of total revenue, for the year ended December 31, 2021. The increase of $230,000 was primarily due to an increase in salaries and benefits (including stock-based compensation) of $249,000, offset by a decrease of $19,000 in fixed overhead. The variable cost component, which represents our cost of equipment, outside engineering costs, shipping and handling, travel and warranty costs, totaled $8,567,000, or 75.9% of total revenue, in the year ended December 31, 2022, as compared to $9,371,000, or 68.7% of total revenue, in the year ended December 31, 2021. In the year ended December 31, 2022, as compared to the prior year, our cost of equipment decreased by $1,077,000 primarily due to the decrease in revenue, offset by a minor increase in our equipment margin of 3.8 percentage points. Additionally in the year ended December 31, 2022 as compared to the year ended December 31, 2021: (i) our travel costs increased by $161,000 (ii) our warranty expense increased by $122,000, (iii) excess and obsolete inventory expense increased by $75,000, and (iv) other variable costs were $60,000 higher. These increases were offset by (i) a reduction of $103,000 in outside engineering costs and (ii) a decrease in shipping and handling of $42,000.
Operating Expenses
Operating expenses increased by 40% from $4,905,000 for the year ended December 31, 2021 to $6,869,000 for the year ended December 31, 2022, an increase of $1,964,000. The operating expense increase consisted of: (i) an increase in selling, general and administrative expenses (“SG&A expenses”) of $1,097,000, (ii) a goodwill impairment charge of $631,000, (iii) an increase in advertising and marketing expenses of $386,000 offset by, (iii) a decrease in product development expenses of $150,000.
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The increase in SG&A expenses for the year ended December 31, 2022 compared to the year ended December 31, 2021, was due primarily to: (i) an increase of $671,000 in salaries, benefits (including equity-based compensation) and other employee related costs, (ii) an increase of $251,000 for insurance, (iii) an increase in accounting and other professional fees of $177,000, (iv) an increase in board fees of $95,000, (v) an increase of $69,000 for travel expenses, (vi) an increase in bad debt of $67,000, (vii) an increase in investor relations expenses of $61,000, offset by, (viii) a decrease of $115,000 for commissions, (ix) a decrease of $94,000 for depreciation and loss on disposal of fixed assets, and (x) a decrease of $85,000 for business taxes, licenses and other office expenses .
The increase in advertising and marketing expenses was due primarily to: (i) an increase in salaries and benefits (including equity-based compensation) of $197,000, (ii) an increase of $111,000 for advertising and promotion, web development and other marketing expenses, (iii) an increase in expenses for industry trade shows and events of $59,000, (iv) an increase of $19,000 for outside marketing services.
The decrease in product development costs was primarily due to (i) a decrease in material costs of $130,000, (ii) a decrease in salaries and benefits (including equity-based compensation) of $88,000 offset by, (iii) an increase in consulting of $56,000 and, (iv) an increase in travel of $12,000.
Operating Loss
We had an operating loss of $5,724,000 for the year ended December 31, 2022, as compared to an operating loss of $1,979,000 for the year ended December 31, 2021, an increase of $3,745,000, or 189%. The operating loss included $631,000 for a goodwill impairment charge, $314,000 of non-cash, stock-based compensation expenses and $26,000 for depreciation and amortization in the year ended December 31, 2022, as compared to $324,000 for stock-based compensation and $58,000 of depreciation and amortization for the year ended December 31, 2021. Excluding these non-cash items, our adjusted operating loss increased by $3,156,000.
Other Income (Expense)
Our other income (net) decreased by $414,000 from $641,000 for the year ended December 31, 2021, to $227,000 for the year ended December 31, 2022. The other income for 2022 primarily consisted of (i) $185,000 from an insurance settlement, and (ii) $35,000 for interest on a money market account. The other income for 2021 primarily consisted of (i) $517,000 for loan forgiveness, (ii) $138,000 for ERC credits, (iii) $66,000 in rental income from the sub-lease of a portion of our previous facility, (iv) a $16,000 gain on lease termination, (v) a $13,000 gain from a contract cancellation from 2018, offset by (vi) expense for a legal settlement of $107,000.
Net Loss
Overall, we had a net loss of $5,497,000 for the year ended December 31, 2022, as compared to a net loss of $1,338,000 for the year ended December 31, 2021, an increase of $4,159,000. The net loss included $631,000 for a goodwill impairment charge, $314,000 of non-cash, stock-based compensation costs and depreciation and amortization expense of $26,000 in the year ended December 31, 2022, as compared to non-cash, stock-based compensation expense of $391,000 and depreciation and amortization of $58,000 in the year ended December 31, 2021. Excluding these non-cash items, our adjusted net loss increased by $3,637,000.
Liquidity, Capital Resources and Financial Position
Cash and Cash Equivalents
As of December 31, 2022, we had cash and cash equivalents of $18,637,000, compared to cash and cash equivalents of $2,160,000 as of December 31, 2021. The increase in cash and cash equivalents during the year ended December 31, 2022 was primarily the result of cash proceeds from the sale of common stock and warrants of $21,711,000, offset by the redemption of series B preferred stock and interest expense of $2,016,000, and cash used in operations of $3,190,000. Our cash is held in bank depository accounts in certain financial institutions. During the year ended December 31, 2022, we held deposits in financial institutions that exceeded the federally insured amount.
On February 15, 2022, we received the net proceeds from the offering of shares of common stock and warrants to purchase common stock in the amount of $21,711,000.
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As of December 31, 2022, we had accounts receivable (net of allowance for doubtful accounts) of $3,000, inventory (net of excess and obsolete allowance) of $348,000, and prepaid expenses and other of $1,490,000 (including $1,176,000 in advance payments on inventory purchases). While we typically require advance payment before we commence engineering services or ship equipment to our customers, we have made exceptions requiring us to record accounts receivable, which carry a risk of non-collectability, especially since most of our customers are funded on an as-needed basis to complete facility construction. We expect this exposure to accounts receivable risk to increase as we pursue larger projects.
As of December 31, 2022, we had no indebtedness, total accounts payable and accrued liabilities of $1,207,000, deferred revenue of $4,339,000, accrued equity compensation of $90,000, and the current portion of operating lease liability of $118,000. As of December 31, 2022, we had working capital of $14,724,000, compared to a working capital deficit of $415,000 as of December 31, 2021.
We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business. We have never declared or paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future.
Because of the post-pandemic macro-economic and CEA industry economy that has developed during 2021 and 2022, and is continuing into 2023, we cannot predict the continuing level of working capital that we will have in the future. Additionally, we cannot predict that our future financial position will not deteriorate due to cancelled or delayed contract fulfillment, reduced sales and our ability to perform our contracts. As mentioned elsewhere, we have taken steps to conserve our cash resources by reducing staff and taking other cost cutting measures.
Summary of Cash Flows
The following summarizes our cash flows for the years ended December 31, 2022 and 2021:
| For the Twelve Months Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Net cash used in operating activities | $ | (3,190,000 | ) | $ | (3,207,000 | ) | ||
| Net cash used in investing activities | (28,000 | ) | (57,000 | ) | ||||
| Net cash provided by financing activities | 19,695,000 | 3,139,000 | ||||||
| Net increase (decrease) in cash | $ | 16,477,000 | $ | (125,000 | ) | |||
Operating Activities
We incurred a net loss for the year ended December 31, 2022 of $5,497,000 compared to a net loss for the year ended December 31, 2021 of $1,338,000. We had an accumulated deficit of $34,279,000 as of December 31, 2022.
Cash used in operations for the year ended December 31, 2022 was $3,190,000 compared to cash used in operations of $3,207,000 for the year ended December 31, 2021, a decrease in cash usage of $17,000. The decrease was primarily attributable to: (i) an increase in net loss of $4,159,000, (ii) a decrease in cash used for working capital of $3,428,000 and, (iii) an increase in non-cash operating charges of $748,000. Significant non-cash items during 2022 included: (i) a goodwill impairment charge of $631,000, (ii) stock-related compensation of $314,000, and (iii) $103,000 for the amortization on an ROU asset. Significant non-cash items during 2021 included: (i) a gain on note payable forgiveness of $517,000, (ii) stock-related compensation of $391,000, (iii) amortization on an ROU asset of $205,000, (iv) $68,000 for loss on disposal of assets, and (iv) depreciation and amortization expense of $65,000.
Investing Activities
Cash used in investing activities for the year ended December 31, 2022 was $28,000, compared to cash used in investing activities of $57,000 for the year ended December 31, 2021. The change was related to lower purchases of property and equipment.
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Financing Activities
For the years ended December 31, 2022 and 2021, cash from financing activities was $19,695,000 and $3,139,000, respectively. Cash flows from financing activities during the year ended December 31, 2022, was the result of cash proceeds from the sale of common stock and warrants (net of issuance costs) of $21,711,000, offset by a cash payment of $2,016,000 for the redemption of series B preferred stock, including related interest. Cash flows from financing activities during the year ended December 31, 2021, was the result of cash proceeds from the sale of preferred stock and warrant (net of issuance costs) of $2,625,000 and proceeds from a note payable of $514,000. See Note 8 – Note Payable and Accrued Interest.
Common Stock Equity Offering
On February 10, 2022, the Company signed a firm commitment underwriting agreement for the public offering of shares of common stock and warrants, which closed on February 15, 2022. The Company received net proceeds of approximately $21,711,000 for the sale of 5,811,138 shares of common stock and 6,572,808 warrants, each warrant to purchase one share of common stock for five years, exercisable immediately, at an exercise price of $5.00. The Company also issued to the representative of the underwriters 290,557 warrants, each warrant to purchase one share of common stock at an exercise price of $5.16, during the period commencing August 9, 2022, and expiring on February 10, 2027.
The net proceeds from the offering will be used to advance the Company’s organic growth and new product initiatives, to pursue select acquisitions, and for general corporate and working capital purposes. In connection with this offering, we received approval to list our common stock on the Nasdaq Capital Market under the symbol “CEAD” and our warrants under the symbol “CEADW”. As a result, effective February 10, 2022, trading of both shares of the Company’s common stock and certain of the Company’s warrants commenced on the Nasdaq.
Capital Raising
Since inception, we have incurred significant operating losses and have funded our operations primarily through issuances of equity securities, debt, and operating revenue. As of December 31, 2022, we had an accumulated deficit of $34,279,000, working capital of $14,724,000, and stockholders’ equity of $14,895,000.
Inflation
Recently, our operations have started to be influenced by the inflation existent in the larger economy and in the industries related to building renovations, retrofitting and new build facilities in which we operate. We are likely to continue to face inflationary increases on the cost of products and our operations, which may adversely affect our margins and financial results and the pricing of our service and product supply contracts. Inflation is reflected in higher wages, increased pricing of equipment and other products that we have contracted to provide to our customers, and generally higher prices across all sectors of the economy. As we move forward, we plan to continuously monitor our various contract terms and may decide to add clauses that will permit us to adjust pricing if inflation and price increase pressures on us will impact our ability to perform our contracts and maintain our margins.
Contractual Payment Obligations
Refer to Note 3 – Leases of our consolidated financial statements, which are included as part of this Annual Report for further details on our obligations under a lease for our manufacturing and office space.
Commitments and Contingencies
Litigation
From time to time, in the normal course of our operations, we are subject to litigation matters and claims. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict, and our view of these matters may change in the future as the litigation and events related thereto unfold. An unfavorable outcome to any legal matter, if material, could have an adverse effect on our operations or our financial position, liquidity or results of operations.
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Other Commitments
In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of such agreements, services to be provided by us, or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers and employees that will require us to, among other things, indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers, or employees. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and certain of our officers and employees, and former officers, directors, and employees of acquired companies, in certain circumstances.
Off-Balance Sheet Arrangements
We are required to disclose any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors. As of December 31, 2022, we had no off-balance sheet arrangements. During 2022 and 2021, we did not engage in any off-balance sheet financing activities.
Recent Developments
Refer to Note 16 - Subsequent Events of our consolidated financial statements, included as part of this Annual Report, for the more significant events occurring since December 31, 2022.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act, therefore are not required to provide the information under this item.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements are included herein, beginning on page F-1. The information required by this item is incorporated herein by reference to the consolidated financial statements set forth in Item 15. “Exhibits and Financial Statement Schedules” of this Annual Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
See Item 14.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management conducted an evaluation, with the participation of our Chief Executive Officer and our Principal Financial and Accounting Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, our Chief Executive Officer and our Principal Financial and Accounting Officer concluded that as a result of the material weakness in our internal control over financial reporting described below, our disclosure controls and procedures were not effective as of December 31, 2022.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for the preparation of our financial statements and related information. Management uses its best judgment to ensure that the financial statements present fairly, in material respects, our financial position and results of operations in conformity with generally accepted accounting principles.
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in the Exchange Act. These internal controls are designed to provide reasonable assurance that the reported financial information is presented fairly, that disclosures are adequate and that the judgments inherent in the preparation of financial statements are reasonable. There are inherent limitations in the effectiveness of any system of internal controls including the possibility of human error and overriding of controls. Consequently, an effective internal control system can only provide reasonable, not absolute, assurance with respect to reporting financial information.
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Our internal control over financial reporting includes policies and procedures that: (i) pertain to maintaining records that, in reasonable detail, accurately and fairly reflect our transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of our financial statements in accordance with generally accepted accounting principles and that the receipts and expenditures of company assets are made in accordance with our management and directors authorization; and (iii) provide reasonable assurance regarding the prevention of or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on our financial statements.
Under the supervision of management, by our Chief Executive Officer and our Principal Financial and Accounting Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) published in 2013 and subsequent guidance prepared by COSO specifically for smaller public companies. Based on that evaluation, our management concluded that our internal control over financial reporting was not effective as of December 31, 2022, for the reasons discussed below.
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.
Management identified the following material weakness in its assessment of the effectiveness of internal control over financial reporting as of December 31, 2022:
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 our limited number of 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.
We intend to take appropriate and reasonable steps to make the necessary improvements to remediate these deficiencies. We are committed to taking steps to improve our financial organization including, without limitation, evaluating our accounting staff requirements and improving our systems and controls to reduce our reliance on the manual nature of our existing systems. However, due to our size and our financial resources, remediating the several identified weaknesses has not always been possible and may not be economically feasible now or in the future.
Our management, including our Chief Executive Officer and our Principal Financial and Accounting Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected.
The material weaknesses in internal control over financial reporting as of December 31, 2022, remained unchanged from December 31, 2021. Management believes that the material weaknesses set forth above did not have an effect on our financial reporting for the year ended December 31, 2022.
We will continue to monitor and evaluate the effectiveness of our internal control over financial reporting on an ongoing basis and are committed to taking further action and implementing additional enhancements or improvements, as necessary and as funds allow. We do not, however, expect that the material weaknesses in our disclosure controls will be remediated until such time as we have improved our internal control over financial reporting.
This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
There were no changes identified in connection with our internal control over financial reporting during the quarter ended December 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information about our Directors
The Company’s current directors are set forth below:
| Name | Age | Positions & Committees | ||
| Anthony K. McDonald | 64 | Chairman of the Board; Chief Executive Officer and President | ||
| James R. Shipley | 66 | Director; Compensation Committee Chair; Audit Committee Member | ||
| Nicholas J. Etten | 53 | Director; Nominating Committee Chair; Audit Committee Member | ||
| Troy L. Reisner | 55 | Director; Audit Committee Chair; Compensation Committee Member | ||
| Marion Mariathasan | 48 | Director; Nominating Committee Member |
Certain information with respect to the Company’s current directors is set forth below. The business address of each of the directors is 385 South Pierce Avenue, Suite C, Louisville, Colorado 80027.
| Name and Year First Elected Director | Background Information and Principal Occupation(s) During Past Five Years and Beyond | |
| Anthony K. McDonald (2018) | Mr. McDonald was appointed a director on September 12, 2018. On November 28, 2018, Mr. McDonald was appointed our Chief Executive Officer and President. On June 24, 2020, Mr. McDonald was appointed Chairman of the Board. Mr. McDonald has been involved in building businesses in the cleantech, energy efficiency and heating, ventilation and air conditioning (“HVACD”) industries over the past 10 years. From 2008 to 2018, Mr. McDonald led sales and business development as Vice-President—Sales for Coolerado Corp., a manufacturer and marketer of innovative, energy-efficient air conditioning systems for commercial, government, and military use. Along with Coolerado’s CEO, Mr. McDonald was instrumental in growing the business to become an INC. 600 high-growth company award winner and assisted in raising $15 million of private funding from a cleantech investment fund. In 2015, Coolerado was acquired by Seeley International, Australia’s largest air conditioning manufacturer and an innovative global leader in the design and production of energy-efficient cooling and heating products, where Mr. McDonald served as National Account Manager. He is also the founder and Managing Partner of Cleantechsell.com and the author of Cleantech Sell: The Essential Guide To Selling Resource Efficient Products In The B2B Market.
Prior to joining Coolerado, Mr. McDonald spent over ten years in the private equity industry where he was involved in numerous transactions in the technology, manufacturing, and power development industries. As a business development officer at several private equity acquisitions groups Mr. McDonald identified, financed, or acquired numerous transactions with total enterprise value in excess of $200 million.
Mr. McDonald was also a consultant to international banks with KMPG from 1994 to 1997 and served as a director for Keating Capital, Inc., a publicly traded business development company that made investments in pre-IPO companies. He previously served as a mentor for companies in the Clean Tech Open competition.
Mr. McDonald is a U.S. Army veteran and a graduate of the U.S. Military Academy at West Point, N.Y. where he earned a B.S. degree in Engineering and Economics. He also received an M.B.A. degree from the Harvard Business School.
Among the reasons for Mr. McDonald to be selected for service on the Board is his experience in sales, sales and operations management, mergers and acquisitions, the HVACD industry, his in-depth knowledge of climate control systems and technologies. |
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| James R. Shipley (2020) | Mr. Shipley was appointed a director on June 24, 2020. Mr. Shipley recently retired from AgTech Holdings where he was the Chief Strategy Officer of GroAdvisor and the Vice-President of Sales at VividGro since 2017. Since 2017, Mr. Shipley has assisted in design and build consulting along with supply chain management for cultivation operations in 12 states covering more than 500,000 square feet of warehouse indoor cultivation and continues to consult independently with operators in North America. From 2014 to 2017 Mr. Shipley, acting in several executive roles, helped build multiple business lines for MJIC Inc. (now CNSX: MSVN); these roles included being a member of the board of directors, Chairman and President. Mr. Shipley is currently president and a principal in RSX Enterprises Inc., a sales agency and marketing firm that sells and markets equipment for use in controlled environment agriculture on behalf of various manufacturers. Mr. Shipley has been active in the cannabis business, where he has founded various summits such as the Marijuana Investor Summit and been involved in many educational workshops and business expos. Previously, Mr. Shipley was an officer and chief revenue officer with Carrier Access Corporation (CACS), a public company trading on Nasdaq. Prior to Carrier Access, Mr. Shipley worked at Williams Companies in their telecommunications divisions.
Mr. Shipley was selected for service on the Board because of his experience in and commitment to the cannabis industry, his demonstrated and consistent record of success as an executive and entrepreneur, and his extensive network of contacts in the cannabis industry. | |
| Nicholas J. Etten (2020) | Mr. Etten was appointed a director on June 24, 2020. Mr. Etten joined Acreage Holdings in 2018 where he served as the Head of Government Affairs until 2021. Acreage is a vertically integrated, multi-state operator of cannabis licenses and assets in the U.S. In 2017 he founded the Veterans Cannabis Project where he continues to serve as Chairman. Veterans Cannabis Project (VCP) is an organization dedicated to advocating on behalf of cannabis access issues for U.S. military veterans. From 2015 to 2017, Mr. Etten set aside his career to provide care for his seriously ill son. Mr. Etten’s career has been focused on the growth equity market, and prior to Acreage, he held positions including Vice President of Global Business Development for FreightWatch International, and Director of Corporate Development for Triple Canopy. Mr. Etten was an investment professional at Trident Capital, where he focused on the cyber-security space, and an investment banker at Thomas Weisel Partners. Mr. Etten served on active duty as a U.S. Navy SEAL officer. He earned an MBA from the J.L. Kellogg Graduate School of Management at Northwestern University, and a BS in political science from the United States Naval Academy.
Mr. Etten was selected for service on the Board because of his experience in and commitment to the cannabis industry, his experience with multi-site cannabis operators, his demonstrated and consistent record of success as an executive, and his extensive network of contacts in the cannabis industry and investment banking world. |
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Troy L. Reisner (2022)
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Troy Reisner was appointed as a director on January 17, 2022. Mr. Reisner is currently the Chief Financial Officer at Keystone Tower Systems, Inc., headquartered in Denver, Colorado where he leads the finance and accounting functions, including raising capital and corporate governance matters, and serves as an executive team member. Prior to joining Keystone, Troy was a partner with the public accounting firm of Deloitte & Touche LLP until his retirement. Troy brings significant cumulative knowledge and expertise in accounting & auditing, including PCAOB auditing standards, M&A transactions, financial due diligence, financial reporting, including expertise in SEC rules, regulations & reporting, internal controls over financial reporting, and capital market and corporate governance experience and expertise.
He earned a B.S. degree in Accounting from Southern Illinois University at Edwardsville and practiced as a Certified Public Accountant for over 30 years and is licensed (inactive) as a CPA in the State of Missouri.
Mr. Reisner was selected for service on the Board because of his long experience in the accounting industry and his experience working with public companies. | |
Marion Mariathasan (2022)
|
Marion Mariathasan was appointed as a director on January 17, 2022. Mr. Mariathasan is the CEO and Co-Founder of Simplifya, the cannabis industry’s leading regulatory and operational compliance software platform. The company’s suite of products takes the guesswork out of confusing and continually changing state and local regulations. Featuring SOPs, badge tracking, document storage, tailored reporting and employee accountability features, the company’s Custom Audit software reduces the time clients spend on compliance by up to 45 percent.
Mr. Mariathasan is also a serial entrepreneur who has founded or advised numerous startups. He is currently an investor in 22 domestic and international companies that range from cannabis companies to dating apps - four of which he serves as a board member.
Mr. Mariathasan studied Architecture and Computer Science at the University of Kansas and Computer Information Systems with a minor in Business Management from Emporia State University. Marion is a regular guest speaker at events such as Denver Start-Up Week, Colorado University’s program on social entrepreneurship, various universities on the topic of entrepreneurship and the United Nations Global Accelerator Initiative.
Mr. Mariathasan was selected for service on the Board because of his experience in and commitment to the cannabis industry, his demonstrated and consistent record of success as an executive and entrepreneur, and his extensive network of contacts in the cannabis industry. |
Each of the directors on our Board of Directors was elected or appointed because he has demonstrated an ability to make meaningful contributions to our business and affairs and has skills, experience and background that are complementary to those of our other Board members.
Director Independence
The Nasdaq marketplace rules require that, subject to specified exceptions, each member of a listed company’s audit, compensation and nominations committees be independent, or, if a listed company has no nominations committee, that director nominees be selected or recommended for the board’s selection by independent directors constituting a majority of the board’s independent directors. The Nasdaq marketplace rules further require that audit committee members satisfy independence criteria set forth in Rule 10A-3 under the Exchange Act and that compensation committee members satisfy the independence criteria set forth in Rule 10C-1 under the Exchange Act.
Our Board has affirmatively determined that each of Messrs. Shipley, Etten, Mariathasan, and Reisner qualify as an independent director, as defined under the applicable corporate governance standards of Nasdaq.
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Audit Committee
Our Board has established an Audit Committee, which as of the date of this report consists of three independent directors, Mr. Reisner (Chairman), Mr. Shipley and Mr. Etten. The committee’s primary responsibilities include recommending the selection of our independent registered public accounting firm; evaluating the appointment, compensation and retention of our registered public accounting firm; receiving formal written statements from our independent registered public accounting firm regarding its independence, including a delineation of all relationships between it and the Company; reviewing with such independent registered public accounting firm the planning, scope and results of their audit of our financial statements; pre-approving the fees for services performed; reviewing with the independent registered public accounting firm the adequacy of internal control systems; reviewing our annual financial statements and periodic filings, and receiving our audit reports and financial statements. The Audit Committee also considers the effect on the Company of any changes in accounting principles or practices proposed by management or the independent registered public accounting firm, any changes in service providers, such as the accountants, that could impact the Company’s internal control over financial reporting, and any changes in schedules (such as fiscal or tax year-end changes) or structures or transactions that required special accounting activities, services or resources. The Audit Committee annually will conduct an enterprise fraud risk assessment, and generally will oversee the enterprise risk assessment and management process framework to insure monitoring for identification, assessment and mitigation of all significant enterprise risk. The Audit Committee will oversee compliance with the code of ethics of the Company and assess waivers of the code. At least annually, the Audit Committee will review and approve all related party transactions that are required to be disclosed publicly in the Company SEC reports.
The Committee may act in reliance on management, the Company’s independent auditors, internal auditors, and advisors and experts, as it deems necessary or appropriate. The Committee has the power, in its discretion, to conduct any investigation it deems necessary or appropriate to enable it to carry out its duties.
The Board has determined that each of our Audit Committee members are independent of management and free of any relationships that, in the opinion of the Board, would interfere with the exercise of independent judgment and are independent, as that term is defined under the enhanced independence standards for audit committee members in the Exchange Act and the rules promulgated thereunder.
The Board has determined that Mr. Reisner is an “audit committee financial expert,” as that term is defined in the rules promulgated by the SEC pursuant to the Sarbanes-Oxley Act of 2012. The Board has further determined that each of the members of the Audit Committee shall be financially literate and that at least one member of the committee has accounting or related financial management expertise, as such terms are interpreted by the Board in its business judgment.
Compensation Committee
Our Board has established a Compensation Committee, which as of the date of this report consists of two independent directors, Mr. Shipley (Chairman), and Mr. Reisner. The committee’s primary responsibilities include approving corporate goals and objectives relevant to executive officer compensation and evaluate executive officer performance in light of those goals and objectives, determining and approving executive officer compensation, including base salary and incentive awards, making recommendations to the Board regarding compensation plans, and administering our stock plan.
Our Compensation Committee determines and approves all elements of executive officer compensation. It also provides recommendations to the Board with respect to non-employee director compensation. The Compensation Committee may not delegate its authority to any other person, other than to a subcommittee.
The Company compensation policies for executive officers has two fundamental objectives: (i) to provide a competitive total compensation package that enables the Company to attract and retain highly qualified executives with the skills and experience required for the achievement of business goals; and (ii) to align certain compensation elements with the Company’s annual performance goals. With respect to each of the Company’s executive officers, the total compensation that may be awarded, including base salary, discretionary cash bonuses, annual stock incentive awards, stock options, restricted stock units and other equity awards, and other benefits and perquisites will be evaluated by the committee. Under certain circumstances, the committee may also award compensation payable upon termination of the executive officer under an employment agreement or severance agreement (if applicable). The Board recognizes that its overall goal is to award compensation that is reasonable when all elements of potential compensation are considered. The committee believes that cash compensation in the form of base salary and discretionary cash bonuses provides our executives with short-term rewards for success in operations, and that long-term compensation through the award of stock options, restricted stock units and other equity awards aligns the objectives of management with those of our stockholders with respect to long-term performance and success. The Board also has historically focused on the Company’s financial condition when making compensation decisions and approving performance objectives and compensation has been weighted more heavily toward equity-based compensation. The committee will continue to periodically reassess the appropriate weighting of cash and equity compensation in light of the Company’s expenditures in connection with commercial operations and its cash resources and working capital needs.
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Nominating Committee
Our Board has established a Nominating Committee, which as of the date of this report consists of two independent directors, Mr. Etten (Chairman), and Mr. Mariathasan. The committee’s primary responsibilities include identifying individuals qualified to serve on the Board as directors and on committees of the Board, establishing procedures for evaluating the suitability of potential director nominees consistent with the criteria approved by the Board, reviewing the suitability for continued service as a director when his or her term expires and at such other times as the committee deems necessary or appropriate, and determining whether or not the director should be re-nominated, and reviewing the membership of the Board and its committees and recommending making changes, if any.
In evaluating director nominees, the Nominating Committee will generally consider the following factors:
| ● | the appropriate size and composition of our Board of Directors; | |
| ● | whether or not the person is an “independent” director as defined in Rule 5605(a)(2) promulgated by the Nasdaq Stock Market; | |
| ● | the needs of the Company with respect to the particular talents and experience of its directors; | |
| ● | the knowledge, skills and experience of nominees in light of prevailing business conditions and the knowledge, skills and experience already possessed by other members of the Board of Directors; | |
| ● | familiarity with national and international business matters and the requirements of the industry in which we operate; | |
| ● | experience with accounting rules and practices; | |
| ● | the desire to balance the considerable benefit of continuity with the periodic injection of the fresh perspective provided by new members; and | |
| ● | all applicable laws, rules, regulations and listing standards, if applicable. |
There are no stated minimum criteria for director nominees, although the committee may consider such factors as it may deem are in the best interests of the Company and its stockholders. The Nominating Committee also believes it is appropriate for certain key members of our management to participate as members of the Board of Directors.
The Nominating Committee identifies nominees by first evaluating the current members of the Board willing to continue in service. Current members of the Board with skills and experience that are relevant to our business and who are willing to continue in service are considered for re-nomination, balancing the value of continuity of service by existing members of the Board with that of obtaining a new perspective. If any member of the Board does not wish to continue in service, or if the Nominating Committee decides not to re-nominate a member for re-election, the committee identifies the desired skills and experience of a prospective director nominee in light of the criteria above, or determines to reduce the size of the Board. Research may also be performed to identify qualified individuals. To date, we have not engaged third parties to identify or evaluate or assist in identifying potential nominees, nor do we anticipate doing so in the future.
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Stockholder Communications with Directors
Stockholders may communicate with the Board by sending a letter to the Corporate Secretary, CEA Industries Inc., 385 South Pierce Avenue, Suite C, Louisville, Colorado 80027. Each communication must set forth the name and address of the stockholder on whose behalf the communication is sent and should indicate in the address whether the communication is intended for the entire Board, the non-employee directors as a group or an individual director. Each communication will be screened by the Corporate Secretary or his designee to determine whether it is appropriate for presentation to the Board or any specified director(s). Examples of inappropriate communications include junk mail, spam, mass mailings, resumes, job inquiries, surveys, business solicitations and advertisements, as well as unduly hostile, threatening, illegal, unsuitable, frivolous, patently offensive or otherwise inappropriate material. Communications determined to be appropriate for presentation to the Board, or the director(s) to whom they are specifically addressed, will be submitted to the Board or such director(s) on a periodic basis. Any communications that concern accounting, internal control or auditing matters will be handled in accordance with procedures adopted by the Board of Directors.
Code of Ethics
Our Board has adopted a Code of Ethics, which is available for review on our website at www.ceaindustries.com and is also available in print, without charge, to any stockholder who requests a copy by writing to us at CEA Industries Inc., 385 South Pierce Avenue, Suite C, Louisville, Colorado 80027 Attention: Corporate Secretary. Each of our directors, employees and officers, including our Chief Executive Officer, and all of our other principal executive officers, are required to comply with the Code of Business Conduct and Ethics. There have not been any waivers of the Code of Ethics relating to any of our executive officers or directors in the past year.
Meetings and Committees of the Board
Our Board is responsible for overseeing the management of our business. We keep our directors informed of our business at meetings and through reports and analyses presented to the Board and the committees of the Board. Regular communications between our directors and management also occur outside of formal meetings of the Board and committees of the Board.
Meeting Attendance
Our Board generally holds meetings on a quarterly basis but may hold additional meetings as required. In 2022, the Board held four meetings. Most of our directors attended 100% of the Board meetings that were held during the periods when he was a director and each of our directors attended 100% of the meetings of each committee of the Board on which he served that were held during the periods that he served on such committee. The Board also took a number of actions by unanimous consent, pursuant to Nevada corporate law and our by-laws. We do not have a policy requiring that directors attend our annual meetings of stockholders.
Board Leadership Structure
The Board may, but is not required to, select a Chairman of the Board who presides over the meetings of the Board and meetings of the stockholders and performs such other duties as may be assigned to him by the Board. The positions of Chairman of the Board and Chief Executive Officer may be filled by one individual or two different individuals. Currently the positions of Chairman of the Board and Chief Executive Officer are held by Mr. McDonald.
Board’s Role in Risk Oversight
While risk management is primarily the responsibility of the Company’s management team, the Board is responsible for the overall supervision of the Company’s risk management activities. The Board as a whole has responsibility for risk oversight, and each Board committee has responsibility for reviewing certain risk areas and reporting to the full Board. The oversight responsibility of the Board and its committees is enabled by management reporting processes that are designed to provide visibility to the Board about the identification, assessment, and management of critical risks and management’s risk mitigation strategies in certain focus areas. These areas of focus include strategic, operational, financial and reporting, succession and compensation and other areas.
The Board oversees risks associated with their respective areas of responsibility. The Board oversees: (i) risks and exposures associated with our business strategy and other current matters that may present material risk to our financial performance, operations, prospects or reputation, (ii) risks and exposures associated with management succession planning and executive compensation programs and arrangements, including equity incentive plans, and (iii) risks and exposures associated with director succession planning, corporate governance, and overall board effectiveness.
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Management provides regular updates to the Board regarding the management of the risks they oversee at each regular meeting of the Board. We believe that the Board’s role in risk oversight must be evaluated on a case-by-case basis and that our existing Board’s role in risk oversight is appropriate. However, we continually re-examine the manners in which the Board administers its oversight function on an ongoing basis to ensure that they continue to meet the Company’s needs.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) requires our executive officers, directors and persons who beneficially own more than 10% of our common stock to file initial reports of ownership and reports of changes in ownership with the SEC. Such persons are required by SEC regulations to furnish us with copies of all Section 16(a) reports filed by such persons.
Based solely on our review of the copies of reports furnished to us, other than as noted below, we believe that during the fiscal year ended December 31, 2022, all executive officers, directors and greater than 10% beneficial owners of our common stock complied with the reporting requirements of Section 16(a) of the Exchange Act. In the year ended December 31, 2022, due to an administrative oversight, Mr. Shipley filed a late Form 4 report, on January 18, 2022, indicating the acquisition of 3,125 nonqualified stock options on January 3, 2022, and, Mr. Etten filed a late Form 4 report, on January 18, 2022, indicating the acquisition of 3,125 nonqualified stock options on January 3, 2022 Additionally, Mr. Mariathasan filed a late Form 3 report on January 21, 2022 and a late Form 4 report, on January 21, 2022, indicating the acquisition of 3,367 restricted stock units on January 17, 2022. Mr. Reisner filed a late Form 3 report on January 21, 2022, and a late Form 4 report, on January 21, 2022, indicating the acquisition of 3,367 restricted stock units on January 17, 2022. The delayed filings of the reports for both Mr. Mariathasan and Mr. Reisner were due to the time it took to obtain their EDGAR codes.
Executive Officers
Executive officers are appointed by our Board and serve at its discretion. Set forth below is information regarding our executive officers as of the date of this report.
| Name | Age | Positions | ||
| Anthony K. McDonald | 64 | Chief Executive Officer and President; Director | ||
| Ian K. Patel | 49 | Chief Financial Officer, Treasurer and Secretary* |
*Mr. Patel commenced employment in the stated positions on March 11, 2022, replacing Mr. Brian Knaley, who resigned on February 18, 2022.
Mr. McDonald’s biographical information is included with such information for the other members of our Board.
Mr. Patel served as an advisor to Maxwell Financial Labs, LLC, from October 2021 to March 2022. From July 2018 through September 2021, he served as Vice President of Finance and Investor Relations for FourPoint Energy LLC, where he was responsible for finance, treasury, corporate development and strategy. Prior to FourPoint, Mr. Patel served as Chief Financial Officer of S&A Resources, LLC, a private equity backed oil and gas company. Mr. Patel began his career as an investment banker with Citigroup and Goldman Sachs. During his investment banking career, Mr. Patel executed over $30 billion of M&A/advisory assignments and led capital market transactions of over $15 billion for clients. Mr. Patel holds an MBA from the Wharton School at the University of Pennsylvania, a JD from Harvard Law School, and a BS from the University of California at Riverside.
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Item 11. Executive Compensation
Director Compensation Program
On August 20, 2021, the Board of Directors adopted a new compensation plan for independent directors. The plan is effective retroactively for the current independent directors and for independent directors elected or appointed after the effective date of the plan.
The Company paid its independent directors an annual cash fee of $15,000, payable quarterly in advance on the first business day of each calendar quarter, retroactive commencing July 1, 2021, as consideration for their participation in: (i) any regular and special meetings of the Board and any committee participation and meetings thereof that are attended in person, (ii) any telephonic and other forms of electronic meetings of the Board or of any committee thereof in which the director is a member, (iii) any non-meeting consultations with the Company’s management, and (iv) any other services provided by them in their capacities as directors. In addition, on the first business day of January each year after the effective eate, each independent director will receive a grant of non-qualified stock options valued at $15,000. As part of the retroactive compensation, each independent director on the Board as of the effective date will receive an additional grant of non-qualified stock options valued at $7,500 for service in 2021.
On January 17, 2022 (the “Effective Date”), the Board of Directors adopted a compensation plan to replace the prior plan. The Plan is effective retroactively for the then current independent directors and for independent directors elected or appointed after the Effective Date of the plan.
The plan is divided into two phases: from the Effective Date of the Plan until February 9, 2022, the day prior to the uplisting of the Company to Nasdaq. (“Pre-uplist”) and from February 10, 2022, the uplist date forward (“Post-uplist”).
Pre-uplist phase: The Company paid its independent directors an annual cash fee of $15,000, payable quarterly in advance on the first business day of each quarter, as consideration for their participation in: (i) any regular or special meetings of the Board or any committee thereof attended in person, (ii) any telephonic meeting of the Board or any committee thereof in which the director is a member, (iii) any non-meeting consultations with the Company’s management, and (iv) any other services provided by them in their capacities as directors (other than services as the Chairman of the Board, the Chairman of the Company’s Audit Committee, and the Committee Chairman).
At the time of initial election or appointment, each independent director received an equity retention award in the form of restricted stock units (“RSUs”). The aggregate value of the RSUs at the time of grant was to be $25,000, with the number of shares underlying the RSUs to be determined based on the closing price of the Company’s common stock on the date immediately prior to the date of grant. Vesting of the RSUs was as follows: (i) 50% at the time of grant, and (ii) 50% on the first anniversary of the grant date.
In addition, on the first business day of January each year, each independent director will also receive an equity retention award in the form of RSUs. The aggregate value of the RSUs at the time of grant will be $25,000, with the number of shares underlying the RSUs to be determined based on the closing price of the Company’s common stock on the date immediately prior to the date of grant. These RSUs will be fully vested at date of grant.
The Company pays the Audit Committee Chairman an additional annual fee of $10,000, payable quarterly in advance, for services as the Audit Committee Chairman.
The Company pays the Chairmen of any other committees of the Board an additional annual fee of $5,000, payable quarterly in advance, for services as a Committee Chairman.
There is no additional compensation paid to members of any committee of the Board. Interested (i.e. Executive directors) serving on the Board do not receive compensation for their Board service.
Post-uplist phase: The Company will pay its independent directors an annual cash fee of $25,000, payable quarterly in advance on the first business day of each quarter. All other terms remain the same.
Each director is responsible for the payment of any and all income taxes arising with respect to the issuance of common stock and the vesting and settlement of RSUs.
The Company reimburses independent directors for out-of-pocket expenses incurred in attending Board and committee meetings and undertaking certain matters on the Company’s behalf.
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All independent directors, Messrs. Shipley, Etten, Reisner, and Mariathasan are subject to the plan.
Each independent director is responsible for the payment of any and all income taxes arising with respect to the issuance of any equity awarded under the plan, including the exercise of any non-qualified stock options.
Employee directors do not receive separate fees for their services as directors.
Indemnification; Insurance
Under the Nevada Revised Statutes and pursuant to our charter and bylaws, as currently in effect, the Company may indemnify the Company’s officers and directors for various expenses and damages resulting from their acting in these capacities. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our officers and directors pursuant to the foregoing provisions, we have been informed that, in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
The Company has entered into indemnification agreements with its directors and executive officers. The indemnification agreements are intended to provide the Company’s directors the maximum indemnification permitted under the Nevada Revised Statutes, unless otherwise limited by the Company’s charter and bylaws. Each indemnification agreement provides that the Company shall indemnify the director or executive officer who is a party to the agreement (an “Indemnitee”), including the advancement of legal expenses, if, by reason of his corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding. Each indemnification agreement further provides that the applicable provisions of the Company’s charter and bylaws regarding indemnification shall control in the event of any conflict with any provisions of such indemnification agreements.
The Company may secure insurance on behalf of any person who is or was or has agreed to become a director or officer of the Company for any liability arising out of his actions, regardless of whether the Nevada Revised Statues would permit indemnification. The Company currently has obtained liability insurance for its officers and directors.
Director Compensation Table
The following table sets forth the compensation earned by or awarded or paid in 2022 and 2021 to the individuals who served as our independent directors during such period.
| Name | Year | Fees Earned or Paid in Cash (1) | Stock Awards (2) | Option Awards (3), (4) | Total | |||||||||||||||
| James R. Shipley | 2022 | $ | 27,500 | $ | - | $ | 15,000 | $ | 42,500 | |||||||||||
| 2021 | $ | 7,500 | $ | - | $ | 7,500 | $ | 15,000 | ||||||||||||
| Nicholas J. Etten | 2022 | $ | 27,500 | $ | - | $ | 15,000 | $ | 42,500 | |||||||||||
| 2021 | $ | 7,500 | $ | - | $ | 7,500 | $ | 15,000 | ||||||||||||
| Troy Reisner | 2022 | $ | 32,500 | $ | 25,000 | $ | - | $ | 57,500 | |||||||||||
| Marion Mariathasan | 2022 | $ | 22,500 | $ | 25,000 | $ | - | $ | 47,500 | |||||||||||
(1) Excludes reimbursement of out-of-pocket expenses.
(2) Reflects grants to two new independent directors of 3,367 each of restricted stock units on January 17,2022, in connection with their appointment. 1,684 shares were immediately vested and 1,683 vested on January 17, 2023.
(3) Reflects the dollar amount of the grant date fair value of awards, measured in accordance with FASB Accounting Standards Codification (“ASC”) Topic 718 (“Topic 718”) without adjustment for estimated forfeitures. For a discussion of the assumptions used to calculate the value of equity awards, refer to Note 14 to our consolidated financial statements for the fiscal year ended December 31, 2022 included in this Annual Report.
(4) Reflects grants to each independent director on August 20, 2021 of non-qualified stock options to purchase 769 shares of the Company’s common stock and a grant to each independent director on January 3, 2022 of non-qualified stock options to purchase 3,125 shares of the Company’s common stock.
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The aggregate number of non-qualified stock options and restricted stock units held as of December 31, 2022, by each independent director are as follows:
| Name | Shares Underlying Non-Qualified Stock Options (1) | Shares Underlying Restricted Stock Units (2) | Total | |||||||||
| James R. Shipley | 10,561 | – | 10,561 | |||||||||
| Nicholas J. Etten | 10,561 | – | 10,561 | |||||||||
| Troy Reisner | - | 3,367 | 3,367 | |||||||||
| Marion Mariathasan | - | 3,367 | 3,367 | |||||||||
(1) Includes grant to each independent director on June 24, 2020 of non-qualified stock options to purchase 6,667 shares of the Company’s common stock, a grant to each independent director on August 20, 2021 of non-qualified stock options to purchase 769 shares of the Company’s common stock, and a grant on January 3, 2022 of non-qualified stock options to purchase 3,125 shares of the Company’s common stock.
(2) Includes grants to two new independent directors of 3,367 restricted stock units on January 17, 2022.
Subsequent to the financial statement date, the following cash fees were paid to directors based on the January 17, 2022 compensation plan.
| Name | Cash Fees Paid | |||
| James R. Shipley | $ | 7,500 | ||
| Nicholas J. Etten | $ | 7,500 | ||
| Troy L. Reisner | $ | 8,750 | ||
| Marion Mariathasan | $ | 6,250 | ||
| Total | $ | 30,000 | ||
Subsequent to the financial statement date, the following restricted stock units were issued to directors based on the January 17, 2022 compensation plan.
| Name | Shares Underlying Restricted Stock Units | |||
| James R. Shipley | 29,758 | |||
| Nicholas J. Etten | 29,758 | |||
| Troy L. Reisner | 29,758 | |||
| Marion Mariathasan | 29,758 | |||
| 119,032 | ||||
These restricted stock units vested upon grant.
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Executive Compensation
Summary Executive Compensation Table
The following table summarizes compensation earned by or awarded or paid to our named executive officers for the years ended December 31, 2022 and 2021.
| Name and Principal Position | Year | Salary | Bonus | Stock Awards (1) | Option Awards (1) | Non-equity Incentive Plan Compensation | Non-qualified Deferred Compensation Earnings | All Other Compensation | Total | |||||||||||||||||||||||||||
| Anthony K. McDonald - Chief | 2022 | $ | 338,173 | $ | 22,917 | $ | - | $ | 22,917 | $ | - | $ | - | $ | 19,313 | $ | 403,320 | |||||||||||||||||||
| Executive Officer and President (2) | 2021 | $ | 216,731 | $ | 50,000 | $ | 50,000 | $ | 342,939 | $ | - | $ | - | $ | 49,383 | $ | 709,053 | |||||||||||||||||||
| Ian K. Patel- Chief Financial Officer, Secretary, and Treasurer (3) | 2022 | $ | 212,596 | $ | - | $ | - | $ | 33,000 | $ | - | $ | - | $ | 7,615 | $ | 253,212 | |||||||||||||||||||
| Richard B. Knaley - Chief Financial | 2022 | $ | 54,719 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 1,499 | $ | 56,218 | |||||||||||||||||||
| Officer and Treasurer (3) | 2021 | $ | 120,192 | $ | - | $ | - | $ | 122,000 | $ | - | $ | - | $ | 4,275 | $ | 246,467 | |||||||||||||||||||
(1) Reflects the dollar amount of the grant date fair value of awards granted in 2021 or 2022, measured in accordance with FASB Accounting Standards Codification (“ASC”) Topic 718 (“Topic 718”) without adjustment for estimated forfeitures. For a discussion of the assumptions used to calculate the value of equity awards, refer to Note 14 to our consolidated financial statements for the fiscal year ended December 31, 2022, included in this Annual Report.
(2) Mr. McDonald was appointed Chief Executive Officer and President in November 2018. Amounts presented include all compensation for Mr. McDonald for the full 2022 and 2021 years. The 2022 bonus was paid in recognition of services rendered and contributions to the Company’s performance, in respect of the 2021 Annual Incentive Plan. 2021 bonus includes cash bonus paid in recognition of services rendered and contributions to the Company’s performance in 2021, pursuant to the November 24, 2021 employment agreement. 2022 option awards include non-qualified stock options to purchase 9,230 shares of common stock which vested upon grant. These options were awarded in recognition of services rendered and contributions to the Company’s performance in 2021, pursuant to the 2021 Annual Incentive Plan. 2021 stock awards include 6,803 shares of common stock issued in relation to a new employment agreement effective November 24, 2021. 2021 option awards include non-qualified stock options to purchase 1,791 shares of common stock awarded in February 2021, pursuant to the 2021 Incentive Compensation Plan, incentive stock options to purchase 40,816 shares of common stock, and non-qualified stock options to purchase 4,453 shares of common stock both awarded in the November 24, 2021 employment agreement. Some of these options are subject to certain vesting (see Outstanding Equity Awards table, below). Other compensation in 2022 and 2021 includes (i) employer-paid portion of health plan benefits ($7,113 and $8,282, respectively), (ii) employer matching contributions under our 401(k) plan ($12,200 and $10,685, respectively), and (iii) other fringe benefits and taxes ($0 and $30,416, respectively).
(3) Mr. Patel was appointed Chief Financial Officer, Secretary and Treasurer in March 2022. Amounts presented include all compensation for Mr. Patel for 2022. Option awards include non-qualified stock options to purchase 15,000 shares of common stock awarded subject to his employment agreement. Some of these options are subject to certain vesting (see Outstanding Equity Awards table, below). Other compensation includes the employer matching contributions under our 401(k) plan.
(4) Mr. Knaley was appointed Chief Financial Officer and Treasurer in June 2021. Amounts presented include all compensation for Mr. Knaley for the full year 2022 and 2021. Option awards include non-qualified stock options to purchase 13,333 shares of common stock awarded subject to his employment agreement. Some of these options are subject to certain vesting (see Outstanding Equity Awards table, below). Other compensation for both 2022 and 2021 includes the employer-paid portion of health plan benefits. Mr. Knaley resigned his position effective February 18, 2022, and the options to purchase the shares under the common stock award were terminated on March 20, 2022.
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Outstanding Equity Awards
The following table sets forth certain information regarding outstanding equity awards held by our named executive officers as of December 31, 2022.
| Option Awards | Stock Awards | |||||||||||||||||||||||||||||||||
| Name | Number of Securities Underlying Unexercised Options Exercisable | Number of Securities Underlying Unexercised Options Unexercisable | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options | Option Exercise Price | Option Expiration Date | Number of Shares or Units of Stock That Have Not Vested | Market Value of Shares or Units of Stock That Have Not Vested | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested (1) | |||||||||||||||||||||||||
| Anthony K. McDonald (1) (2) (3) (4) | 33,333 | – | – | $ | 13.35 | 11/28/2028 | – | – | – | – | ||||||||||||||||||||||||
| 6,667 | – | – | $ | 10.50 | 1/2/2030 | – | – | – | – | |||||||||||||||||||||||||
| 1,791 | – | – | $ | 19.50 | 2/16/2031 | – | – | – | – | |||||||||||||||||||||||||
| 30,179 | 15,090 | – | $ | 7.35 | 11/24/2031 | – | – | – | – | |||||||||||||||||||||||||
| 9,230 | – | – | $ | 2.51 | 4/1/2032 | |||||||||||||||||||||||||||||
| Ian K. Patel (5) | 2,000 | 13,000 | – | $ | 2.20 | 3/11/2032 | ||||||||||||||||||||||||||||
(1) On November 28, 2018, we granted to Mr. McDonald non-qualified stock options to purchase 33,333 shares of common stock under our 2017 Equity Incentive Plan, of which: (i) 6,667 options vested and became exercisable on the grant date, (ii) 13,333 options vested and became exercisable on December 31, 2019, and (iii) 13,333 options vested and became exercisable on December 31, 2020. On January 2, 2020, we granted to Mr. McDonald non-qualified stock options to purchase 6,667 shares of common stock under our 2017 Equity Incentive Plan in recognition of his performance during 2019, which options vested and became exercisable on the grant date. On February 16, 2021, we granted to Mr. McDonald non-qualified stock options to purchase 1,791 shares of common stock under our 2017 Equity Incentive Plan in recognition of his performance during 2020, which options vested and became exercisable on the grant date.
(2) On November 24, 2021, we granted to Mr. McDonald non-qualified stock options to purchase 4,452 shares of common stock under our 2021 Equity Incentive Plan, of which: (i) 1,484 options vested and became exercisable on the grant date, (ii) 1,484 options will vest and became exercisable on November 24, 2022, and (iii) 1,484 options will vest and became exercisable on November 24, 2023. Also on November 24, 2021, we granted to Mr. McDonald incentive stock options to purchase 40,815 shares of common stock under our 2021 Equity Incentive Plan of which: (i) 13,605 options vested and became exercisable on the grant date, (ii) 13,605 options will vest and became exercisable on November 24, 2022, and (iii) 13,605 options will vest and became exercisable on November 24, 2023. These grants were in accordance with a new Executive Employment Agreement effective November 24, 2021.
(3) On November 24, 2021, we granted Mr. McDonald 6,803 restricted shares of common stock under our 2021 Equity Incentive Plan, in accordance with a new Executive Employment Agreement effective November 24, 2021.
(4) On April 1, 2022, we granted Mr. McDonald non-qualified stock options to purchase 9,230 shares of common stock under out 2021 Equity Incentive Plan, in respect to our 2021 Annual Incentive Plan. The options vested and became exercisable upon grant.
(5) On March 11, 2022, we granted to Mr. Patel non-qualified stock options to purchase 15,000 shares of common stock under our 2021 Equity Incentive Plan, of which: 2,000 options vested and became exercisable on the grant date. The balance of the non-qualified options vest and become exercisable as follows: (i) 3,000 on March 11, 2023, (ii) 5,000 on March 11, 2024, and (iii) 5,000 on March 11, 2025. These options were in accordance with his Employment Agreement effective March 11, 2022.
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Compensation Arrangements with Named Executive Officers
Anthony K. McDonald
On November 24, 2021, the Company entered into an employment agreement with Mr. McDonald, the Company’s Chief Executive Officer and President. The initial term of the employment agreement commenced on November 24, 2021, for a one-year term that is automatically extended for an additional three years upon completion by the Company of a “qualified offering.” After the initial term (as may be extended), the employment agreement automatically renews for one-year periods unless notice of non-renewal is given 90 days prior to the end of the then expiring term. A qualified offering is (A) the closing of a sale of the securities of the Company, whether in a private placement or pursuant to an effective registration statement under the Securities Act of 1933, or (B) the occurrence of an up-listing event (i.e., having the Company’s stock quoted on an alternative trading platform from the Over-the-Counter (OTC) exchange to a major stock exchange).
Mr. McDonald will be paid an annualized base salary of $275,000 per year, which increased to $350,000 per year upon the completion of the Qualified Offering on February 15, 2022. The base salary will be reviewed at least annually prior to the end of each calendar year to ascertain whether, in the judgment of the board of directors, it should be increased for the next calendar year. Mr. McDonald is eligible to receive an annual incentive bonus under the Company’s annual incentive compensation plan and policy for each full completed calendar year of employment during the term as determined by the board of directors in its sole discretion. Mr. McDonald will be eligible for an annual target bonus of fifty percent of the base salary. Payment of the annual bonus may be made in the form of cash, stock, or a combination thereof, as determined in the sole discretion of the board of directors. Mr. McDonald will also receive an immediate cash amount of $50,000, payable promptly after the signing of the employment agreement.
Mr. McDonald, at the signing of the employment agreement was issued 6,803 shares of common stock, which has an aggregate fair market value of $50,000, and was paid a gross up on that amount for federal state and local income tax. Mr. McDonald was awarded a stock option to purchase 45,269 shares of common stock under the 2021 Stock Award Plan, that was approved by shareholders, with an exercise price of $7.35 per share, the price of a share of common stock on the day immediately prior to the signing of the employment agreement. The vesting of the options is at the rate of one-third on each of the date of the signing of the employment agreement and the first and second anniversary of the signing of the employment agreement. The option, once vested, is exercisable for ten years from the date the employment contract was signed. Vesting will be accelerated upon a change of control of the Company and certain termination events.
Mr. McDonald is entitled to participate in the Company employee benefit plans, including any group health and welfare insurance and profit sharing and 401(k) plans that are sponsored generally by the Company for its employees, as may be offered from time to time. Notwithstanding the foregoing, the Company may modify or terminate any employee benefit plan at any time. Mr. McDonald will be entitled to vacation, personal days, sick days and expense reimbursement. If Mr. McDonald’s employment is terminated for cause, due to death, due to disability or voluntary resignation, he will be paid his base salary to the date of termination, any unpaid annual bonus, COBRA benefits and any unpaid expense reimbursement. If he is terminated without cause or he resigns for good reason, then he will be paid one year’s base salary, and the annual bonus for that year. The employment agreement has typical activity restrictions for non-solicitation of customers and employees of the Company and covenants for confidentiality, non-competition, inventions and protection of Company intellectual property.
Separately from his prior employment agreement dated November 28, 2018, on January 2, 2020, the Board awarded Mr. McDonald a special one-time grant of non-qualified stock options to purchase 6,667 shares of the Company’s common stock and a $20,000 cash bonus, in recognition of his services as the Company’s Chief Executive Officer during 2019. These non-qualified stock options were immediately vested on the date of grant, had a term of 10 years, and had an exercise price of $10.50 per share, the closing price of the Company’s common stock on The OTC Markets on the day immediately preceding the grant date. Further, on February 16, 2021, Mr. McDonald was awarded non-qualified stock options to purchase 1,791 shares of common stock under our 2017 Equity Incentive Plan. This grant was based on his performance during 2020. The options vested and became exercisable on the grant date. The associated equity compensation expense was accrued during 2020.
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Ian K. Patel
Mr. Patel is employed on an at will basis, provided that either the Company or Mr. Patel may terminate his employment agreement, at any time, with or without cause, by providing the other party with 30-days’ prior written notice. In the event Mr. Patel’s employment is terminated by the Company without cause, Mr. Patel will be entitled to receive his base salary for an additional 30 days. Mr. Patel will receive an annualized base salary of $275,000, and he also is eligible to receive an annual incentive bonus as described in the Company’s Annual Incentive Compensation Plan and Policy. Mr. Patel is entitled to participate in those various employee benefits that the Company generally offers to its employees from time to time. The employment agreement also provides for typical activity restrictions such as non-competition and assignment of invention provisions.
As part of his compensation pursuant to his employment agreement, on March 11, 2022, the Board granted Mr. Patel non-qualified stock options to purchase up to 15,000 shares of the Company’s common stock, which vest as follows: (i) 2,000 options vested and became exercisable on the grant date, (ii) 3,000 options vest and become exercisable on March 11, 2023, if Mr. Patel continues to be employed by the Company on that date, (iii) 5,000 options vest and become exercisable on March 11, 2024, if Mr. Patel continues to be employed by the Company on that date, and (iv) 5,000 options vest and become exercisable on March 11, 2025, if Mr. Patel continues to be employed by the Company on that date. The exercise price of these options is $2.20 and was based on the closing price of the Company’s common stock on March 10, 2022. In the event of a change of control involving the Company, any unvested stock options will become vested on the date of the change of control, provided Mr. Patel is employed on the date of the change of control.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
PRINCIPAL STOCKHOLDERS
The following table sets forth the shares of our common stock beneficially owned by (i) each of our directors, (ii) each of our named executive officers, (iii) all of our directors and executive officers as a group, and (iv) all persons known by us to beneficially own more than 5% of our outstanding common stock as of the date of the filing of this report.
The Company has determined the beneficial ownership shown on this table in accordance with the rules of the SEC. Under these rules, shares are considered beneficially owned if held by the person indicated, or if such person, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares the power to vote, to direct the voting of and/or to dispose of or to direct the disposition of such shares. A person is also deemed to be a beneficial owner of shares if that person has the right to acquire such shares within 60 days through the exercise of any warrant, option or right or through conversion of a security. Except as otherwise indicated in the accompanying footnotes, the information in the table below is based on information as of March 28, 2023. Unless otherwise indicated in the footnotes to the following table, each person named in the table has sole voting and investment power with respect to shares of common and preferred stock and the address for such person is c/o CEA Industries Inc. 385 South Pierce Avenue, Suite C, Louisville, CO 80027.
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| Common Stock | ||||||||
| Name of Beneficial Owner | Number of Shares Owned Beneficially (1) | Percentage of Class (2) | ||||||
| Directors | ||||||||
| Anthony K. McDonald (3) | 89,320 | 1.1 | % | |||||
| James R. Shipley (4) | 40,319 | *% | ||||||
| Nicholas J. Etten (5) | 40,319 | *% | ||||||
| Troy L. Reisner (6) | 33,125 | *% | ||||||
| Marion Mariathasan (7) | 33,125 | *% | ||||||
| Executive Officers who are not Directors | ||||||||
| Ian K. Patel (8) | 5,000 | *% | ||||||
| Executive Officers and Directors as a Group | 241,208 | 3.0 | % | |||||
| 5% or More Stockholders | ||||||||
*Represents less than 0.1%.
(1) Beneficial ownership has been determined in accordance with Rule 13d-3 under the Exchange Act.
(2) Based on a total of 8,076,372 shares of the Company’s common stock issued and outstanding as of March 29, 2022.
(3) Includes 81,201 shares of common stock issuable upon the exercise of options exercisable within 60 days and does not include 15,089 shares of common stock that become exercisable in the future.
(4) Includes 10,561 shares of common stock issuable upon the exercise of options exercisable within 60 days and 29,758 shares of common stock issued as restricted stock units.
(5) Includes 10,561 shares of common stock issuable upon the exercise of options exercisable within 60 days and 29,758 shares of common stock issued as restricted stock units.
(6) Includes 33,125 shares of common stock issued as restricted stock units.
(7) Includes 33,125 shares of common stock issued as restricted stock units.
(8) Includes 5,000 shares of common stock issuable upon the exercise of options exercisable within 60 days and does not include 10,000 shares of common stock that become exercisable in the future.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Transactions with Related Parties
On January 7, 2021, the Company entered into a consulting agreement with RSX Enterprises, Inc. (RSX), a company controlled by Mr. James R. Shipley, a director of the Company. RSX provided consulting services to the Company focused on product offerings, engineering requirements, key customer marketing outreach, and related matters, as mutually determined by the Company and RSX. The Company paid a monthly consulting fee of $6,500 for up to 50 hours per month for the various consulting activities undertaken and provided for reimbursement of expenses. The total amount paid on this agreement was $19,500. The term of the agreement was set for three months. Any intellectual property developed by RSX will belong to the Company, and the contract provides for typical indemnification obligations and confidentiality provisions.
| 55 |
The company entered into a manufacturer representative agreement with RSX Enterprises in March 2021 to become a non-exclusive representative for the Company to assist in marketing and soliciting orders. James R. Shipley, a current director of the Company, has a significant ownership interest in RSX.
Under the manufacturer representative agreement, RSX will act as a non-exclusive representative for the Company within the United States, Canada and Mexico and may receive a commission for qualified customer leads. The agreement has an initial term through December 31, 2021, with automatic one-year renewal terms unless prior notice is given 90 days prior to each annual expiration. During the year ended December 31, 2022, the Company paid $9,884 in commissions under this agreement. During the year ended December 31, 2021, the Company paid $42,639 in commissions under this agreement.
On October 13, 2022, the Company entered into an agreement with Lone Star Bioscience, Inc. (Lone Star) to provide engineering design services. Nicholas Etten, one of our independent directors, is the Chief Executive Officer of Lone Star. The agreement totaled $2,500 with $1,250 received as a deposit in 2022. Another agreement for engineering services was signed on December 20, 2022, in the amount of $10,900. The cash deposit for this agreement was received in January of 2023.
During 2022, except as discussed above, there have been no transactions in which the Company was or is a participant, and there are no currently proposed transactions in which the Company is to be a participant, in which the amount involved exceeds the lesser of $120,000 or 1% of the Company’s average assets at year-end for the last two completed fiscal years, and in which any director, executive officer or beneficial holder of more than 5% of any class of our voting securities or member of such person’s immediate family had or will have a direct or indirect material interest.
Company Policy Regarding Related Party Transactions
The Company has procedures in place for the review, approval and monitoring of transactions involving the Company and certain persons related to the Company. The Company has a code of business conduct and ethics that generally prohibits any employee, officer or director from engaging in any transaction where there is a conflict between such individual’s personal interest and the interests of the Company. Waivers to the code of business conduct and ethics can generally only be obtained from the Audit Committee of the Board and are publicly disclosed as required by applicable law and regulations.
In addition, the Audit Committee of the Board will review all related party transactions for potential conflict of interest situations on an ongoing basis (if such transactions are not reviewed and overseen by another independent body of the Board). In accordance with that policy, the Audit Committee’s practice is to review and oversee any transactions that are reportable as related party transactions under the Financial Accounting Standards Board (“FASB”) and SEC rules and regulations. Management advises the Board on a regular basis of any such transaction that is proposed to be entered into or continued and seeks approval.
Item 14. Principal Accountant Fees and Services
Sadler, Gibb & Associates, L.L.C. (“SGA”) has acted as the Company’s independent registered public accounting firm for the fiscal years ended December 31, 2022 and 2021. SGA has advised us that neither the firm nor any present member or associate of it has any material financial interest, direct or indirect, in the Company or its affiliates. ACM LLP (“ACM”) acted as the Company’s independent registered public accounting firm for the fiscal year ended December 31, 2019.
| 56 |
The following table summarizes the fees for SGA for the year ended December 31, 2022 and fees for SGA and ACM for the year ended December 31, 2021.
| 2022 | 2021 | |||||||
| Audit Fees | $ | 107,060 | $ | 97,500 | ||||
| Audit-Related Fees | 90,000 | 32,800 | ||||||
| Tax Fees | 12,574 | (1) | 7,850 | (2) | ||||
| Total | $ | 209,634 | $ | 138,150 | ||||
(1) Tax fees in 2022 relate to tax returns for the 2021 year.
(2) Tax fees in 2021 relate to tax returns for the 2020 year.
Audit Fees. Audit fees consist of fees billed by our independent registered public accounting firms for professional services rendered in connection with the audit of our annual consolidated financial statements, and the review of our consolidated financial statements included in our quarterly reports.
Audit-Related Fees. Audit-related services consist of fees billed by our independent registered public accounting firms for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements and are not reported under “Audit Fees.” These services include the review of our registration statements on Forms S-8 and Forms S-1.
Tax Fees. Tax fees consist of fees billed by our independent registered public accounting firms for professional services rendered for tax compliance, tax planning and tax advice. These services include assistance regarding federal, state, and local tax compliance.
All Other Fees. All other fees would include fees for products and services other than the services reported above.
Pre-Approval Policy
Our Audit Committee of the Board pre-approves all services to be provided by our independent registered public accounting firm.
| 57 |
PART IV
Item 15. Exhibits and Financial Statement Schedules
a. Documents Filed as Part of this Report
The following consolidated financial statements of CEA Industries Inc. are filed as part of this Annual Report on Form 10-K:
b. Exhibits
See “Exhibit Index” on the page following the consolidated financial statements and related footnotes and the signature page to this Annual Report on Form 10-K.
c. Financial Statement Schedules
No financial statement schedules are filed herewith because (i) such schedules are not required, or (ii) the information has been presented in the aforementioned financial statements.
Item 16. Form 10-K Summary
The Company has elected not to provide the summary of information under this item.
| 58 |
CEA Industries Inc.
Index to Consolidated Financial Statements
| 59 |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of CEA Industries Inc.:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of CEA Industries Inc. (“the Company”) as of December 31, 2022 and 2021, the related consolidated statements of operations, changes in shareholders’ equity (deficit), and cash flows for each of the years in the two-year period December 31, 2022 and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) related to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgements. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Revenue Recognition – Contracts with Multiple Performance Obligations
Critical Audit Matter Description
As described in Note 2 to the financial statements, the Company’s contracts with customers often include the promise to transfer multiple goods and services to a customer. Distinct promises within a contract are referred to as performance obligations and are accounted for as separate units of account. Management assesses whether each promised good or service is distinct for the purpose of identifying the performance obligations in the contract. This assessment involves subjective determinations and requires management to make judgments about the individual promised goods or services and whether such goods or services are separable from the other aspects of the contractual relationship. The Company’s performance obligations include various distinct goods and services such as equipment and various engineering services. When multiple performance obligations are identified within a contract, management exercises judgement in allocating the transaction price amongst the various performance obligations. In addition, when discounts are provided for a particular contract, the discount is allocated to each performance obligation proportionally based upon the stand-alone selling price of each performance obligation.
| F-1 |
We determined that performing procedures related to the identification of performance obligations in revenue contracts and allocation of the transaction price to the respective performance obligations is a critical audit matter as there was significant judgment by management in identifying performance obligations in revenue contracts and allocating the consideration, which in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures to evaluate whether performance obligations in revenue contracts were appropriately identified by management and consideration was appropriately allocated.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the following:
| ● | Obtaining an understanding and testing management’s process for identifying, evaluating, and accounting for contracts with multiple performance obligations. | |
| ● | Examining revenue arrangements on a test basis, including assessing the key terms and conditions of the arrangements and testing the identification, evaluation, and accounting of the performance obligation for conformity with relevant authoritative guidance. | |
| ● | Evaluating the reasonableness of the approaches used to determine estimated stand-alone selling price and allocation of the transaction price. |
| /s/ |
|
| We have served as the Company’s auditor since 2020. | |
| March 28, 2023 |
| F-2 |
CEA Industries Inc.
Consolidated Balance Sheets
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| ASSETS | ||||||||
| Current Assets | ||||||||
| Cash and cash equivalents | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Inventory, net | ||||||||
| Prepaid expenses and other | ||||||||
| Total Current Assets | ||||||||
| Noncurrent Assets | ||||||||
| Property and equipment, net | ||||||||
| Goodwill | ||||||||
| Intangible assets, net | ||||||||
| Deposits | ||||||||
| Operating lease right-of-use asset | ||||||||
| Total Noncurrent Assets | ||||||||
| TOTAL ASSETS | $ | $ | ||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT) | ||||||||
| LIABILITIES | ||||||||
| Current Liabilities | ||||||||
| Accounts payable and accrued liabilities | $ | $ | ||||||
| Deferred revenue | ||||||||
| Accrued equity compensation | ||||||||
| Other liabilities | ||||||||
| Current portion of operating lease liability | ||||||||
| Total Current Liabilities | ||||||||
| Noncurrent Liabilities | ||||||||
| Operating lease liability, net of current portion | ||||||||
| Total Noncurrent Liabilities | ||||||||
| TOTAL LIABILITIES | ||||||||
| Commitments and Contingencies (Note 11) | ||||||||
| TEMPORARY EQUITY | ||||||||
| Series B Redeemable Convertible Preferred Stock, $ par value; and issued and outstanding, respectively | ||||||||
| Total Temporary Equity | ||||||||
| SHAREHOLDERS’ EQUITY (DEFICIT) | ||||||||
| Preferred stock, $ par value; and shares authorized, respectively; shares issued and outstanding | ||||||||
| Common stock, $ par value; and shares authorized, respectively; and shares issued and outstanding, respectively | ||||||||
| Additional paid in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total Shareholders’ Equity (Deficit) | ( | ) | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT) | $ | $ | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-3 |
CEA Industries Inc.
Consolidated Statements of Operations
| 2022 | 2021 | |||||||
For the Twelve Months Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Revenue, net | $ | $ | ||||||
| Cost of revenue | ||||||||
| Gross profit | ||||||||
| Operating expenses: | ||||||||
| Advertising and marketing expenses | ||||||||
| Product development costs | ||||||||
| Selling, general and administrative expenses | ||||||||
| Goodwill impairment charges | ||||||||
| Total operating expenses | ||||||||
| Operating loss | ( | ) | ( | ) | ||||
| Other income (expense): | ||||||||
| Other income (expense), net | ||||||||
| Interest income (expense),net | ( | ) | ||||||
| Gain on lease termination | ||||||||
| Total other income (expense) | ||||||||
| Loss before provision for income taxes | ( | ) | ( | ) | ||||
| Income taxes | ||||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| Convertible preferred series B stock redemption value adjustment | $ | $ | ( | ) | ||||
| Convertible preferred series B stock dividends | ( | ) | ( | ) | ||||
| Dividend on redemption of series A preferred stock | ( | ) | ||||||
| Deemed dividend on convertible preferred series B stock on down round | ( | ) | ||||||
| Net loss available to common shareholders | $ | ( | ) | $ | ( | ) | ||
| Loss per common share – basic and diluted | $ | ( | ) | $ | ( | ) | ||
| Weighted average number of common shares outstanding, basic and diluted | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-4 |
CEA Industries Inc.
Consolidated Statements of Changes in Shareholders’ Equity (Deficit)
| Number of Shares | Amount | Number of Shares | Amount | Paid in Capital | Accumulated Deficit | Shareholders’ Deficit | ||||||||||||||||||||||
| Series A Preferred Stock | Common Stock | Additional | ||||||||||||||||||||||||||
| Number of Shares | Amount | Number of Shares | Amount | Paid in Capital | Accumulated Deficit | Shareholders’ Deficit | ||||||||||||||||||||||
| Balance December 31, 2020 | $ | $ | $ | $ | ( | ) | $ | ( | ) | |||||||||||||||||||
| Common shares issued in settlement of legal dispute | - | |||||||||||||||||||||||||||
| Fair value of vested stock options granted to employees | - | - | ||||||||||||||||||||||||||
| Fair value of vested stock options granted to directors | - | - | ||||||||||||||||||||||||||
| Issuance of series B preferred stock and warrants, net | - | - | ||||||||||||||||||||||||||
| Conversion of series A preferred stock to common | ( | ) | ( | ) | ||||||||||||||||||||||||
| Issuance of common stock in settlement of accrued interest | - | |||||||||||||||||||||||||||
| Issuance of restricted common stock to employee | - | |||||||||||||||||||||||||||
| Accrued interest on series B preferred stock | - | - | ( | ) | ( | ) | ||||||||||||||||||||||
| Adjustment to redemption value of series B preferred stock | - | - | ( | ) | ( | ) | ||||||||||||||||||||||
| Net loss | - | - | ( | ) | ( | ) | ||||||||||||||||||||||
| Balance December 31, 2021 | $ | $ | $ | $ | ( | ) | $ | ( | ) | |||||||||||||||||||
| Fair value of vested stock options granted to employees | - |
- | ||||||||||||||||||||||||||
| Fair value of vested stock options granted to directors | - |
- | ||||||||||||||||||||||||||
| Common shares issued in settlement of restricted stock units issued to directors | - |
|||||||||||||||||||||||||||
| Stock based compensation | - |
- | ||||||||||||||||||||||||||
| Common shares and warrants issued for cash | - |
|||||||||||||||||||||||||||
| Dividends on series B preferred stock | - |
- | ( | ) | ( | ) | ||||||||||||||||||||||
| Issuance of common shares to round up partial shares following reverse split | - |
|||||||||||||||||||||||||||
| Common shares and warrants issued on conversion of series B preferred stock | - |
|||||||||||||||||||||||||||
| Cashless exercise of prefunded warrants | - |
( | ) | |||||||||||||||||||||||||
| Net loss | - |
- | ( | ) | ( | ) | ||||||||||||||||||||||
| Balance December 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-5 |
CEA Industries Inc.
Consolidated Statements of Cash Flows
| 2022 | 2021 | |||||||
For the Twelve Months Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Cash Flows From Operating Activities: | ||||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||
| Depreciation and intangible asset amortization expense | ||||||||
| Gain on forgiveness of note payable | ( | ) | ||||||
| Share-based compensation | ||||||||
| Common stock issued for other expense | ||||||||
| Provision for doubtful accounts | ( | ) | ||||||
| Provision for excess and obsolete inventory | ( | ) | ( | ) | ||||
| Gain on lease termination | ( | ) | ||||||
| Loss on disposal of assets | ||||||||
| Amortization of operating lease ROU asset | ||||||||
| Goodwill impairment charges | ||||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | ) | ||||||
| Inventory | ( | ) | ||||||
| Prepaid expenses and other | ( | ) | ( | ) | ||||
| Accounts payable and accrued liabilities | ( | ) | ( | ) | ||||
| Deferred revenue | ( | ) | ||||||
| Accrued interest | ||||||||
| Deposits | ( | ) | ||||||
| Operating lease liability, net | ( | ) | ( | ) | ||||
| Accrued equity compensation | ( | ) | ||||||
| Net cash used in operating activities | ( | ) | ( | ) | ||||
| Cash Flows From Investing Activities | ||||||||
| Purchases of property and equipment | ( | ) | ( | ) | ||||
| Proceeds from the sale of property and equipment | ||||||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash Flows From Financing Activities | ||||||||
| Payment of dividends on series B preferred stock | ( | ) | ||||||
| Redemption of series B preferred stock | ( | ) | ||||||
| Net cash proceeds on sale of common stock and warrants, net of expenses | ||||||||
| Cash proceeds from sale of preferred stock and warrants, net of issuance costs | ||||||||
| Proceeds from issuance of note payable | ||||||||
| Net cash provided by financing activities | ||||||||
| Net change in cash and cash equivalents | ( | ) | ||||||
| Cash and cash equivalents, beginning of period | ||||||||
| Cash and cash equivalents, end of period | $ | $ | ||||||
| Supplemental cash flow information: | ||||||||
| Interest paid | $ | $ | ||||||
| Income taxes paid | $ | $ | ||||||
| Non-cash investing and financing activities: | ||||||||
| Adjustment of carrying value of series B preferred stock to redemption value | $ | $ | ||||||
| Conversion of series B preferred stock | $ | $ | ||||||
| Accrued series B interest payable settled in shares of common stock | $ | $ | ||||||
| Series A preferred stock converted into shares of common stock | $ | $ | ||||||
| Deemed dividend on series B preferred stock arising on down round | $ | $ | ||||||
| Dividend on redemption of series A preferred stock settled in shares of common stock | $ | $ | ||||||
| Right of Use asset arising on new office lease | $ | $ | ||||||
| Cashless exercise of prefunded warrants | $ | $ | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-6 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Note 1 – Organization and Description of Business
CEA Industries Inc., formerly Surna Inc. (the “Company”), was incorporated in Nevada on October 15, 2009. We design, engineer and sell environmental control and other technologies for the Controlled Environment Agriculture (“CEA”) industry. The CEA industry is one of the fastest-growing sectors of the United States’ economy. From leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables, ornamentals, and small fruits (such as strawberries, blackberries and raspberries) to bell peppers, cucumbers, tomatoes and cannabis and hemp, more and more producers consider or act to grow crops indoors in response to market dynamics or as part of their preferred farming practice. In service of the CEA industry, we provide: (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) preventive maintenance services, through our partnership with a certified service contractor network, for CEA facilities. Our customers include commercial, state- and provincial-regulated CEA growers in the U.S. and Canada. Customers are those growers building new facilities and those expanding or retrofitting existing facilities. Currently, our revenue stream is derived primarily from supplying our products, services, and technologies to commercial indoor facilities ranging from several thousand to more than 100,000 square feet. Headquartered in Louisville, Colorado, we leverage our experience in this space to bring value-added climate control solutions to our customers that help improve their overall crop quality and yield, optimize energy and water efficiency, and satisfy the evolving state and local codes, permitting and regulatory requirements. Although most of our customers do, we neither produce nor sell cannabis or its related products.
Impact of the COVID-19 Pandemic on Our Business
The impact of the government and the business economic response to the COVID-19 pandemic has affected demand across the majority of our markets and disrupted workflow and completion schedules on projects. The COVID-19 pandemic is expected to have continued adverse effects on our sales, project implementation, supply chain infrastructure, operating margins, and working capital.
The resulting effects and uncertainties from the COVID-19 pandemic, including the depth and duration of the disruptions to customers and suppliers, its future effect on our business, on our results of operations, and on our financial condition, cannot be predicted. We expect that the economic disruptions will continue to have an effect on our business over the longer term. Despite this uncertainty, we continue to monitor costs and continue to take actions to reduce costs in order to mitigate the 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 year ended December 31, 2022, the Company experienced significant delays in the receipt of equipment it had ordered to meet its customer orders due to disruption and delays in its supply chain arising from the long-term effects of the COVID-19 pandemic. Consequently, our revenue recognition of these customer sales has been delayed until future periods when the shipment of these orders can be completed.
Refer to Risk Factors, included in Part I, Item 1A of this Annual Report on Form 10-K above, for further discussion of the possible impact of the COVID-19 pandemic on our business.
Impact of Ukrainian Conflict
Currently, 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 has 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 inflationary results of the conflict and government spending for and funding of our country’s response. As our operations are related only to the North American controlled environment 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.
| F-7 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Note 2 – Basis of Presentation; Summary of Significant Accounting Policies
Financial Statement Presentation
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect reported amounts and related disclosures.
Liquidity
The
accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business within one year after the date the consolidated financial statements
are available to be issued. The Company continues to experience recurring losses since its inception. As a result, in order to continue
as a going concern, the Company has been reliant on the ability to obtain additional sources of financing to fund growth. As indicated
in Note 12 – Preferred and Common Stock below, on February 15, 2022, the Company received approximately $
Reverse Stock Split
As a result of this reverse stock split, the number of the Company’s shares of common stock issued and outstanding as of December 31, 2021, was reduced from to .
All Common Stock, warrants, options and per share amounts set forth herein are presented to give retroactive effect to the Reverse Split for all periods presented.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its controlled and wholly owned subsidiary, Hydro Innovations, LLC (“Hydro”). Intercompany transactions, profit, and balances are eliminated in consolidation.
Use of Estimates
Management makes estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and that affect the reported amounts of revenue and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Key estimates include: allocation of transaction prices to performance obligations under contracts with customers, standalone selling prices, timing of expected revenue recognition on remaining performance obligations under contracts with customers, valuation of intangible assets as it applies to impairment analysis, valuation of equity-based compensation, valuation of deferred tax assets and liabilities, warranty accruals, inventory allowances, and legal contingencies.
| F-8 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Cash and Cash Equivalents
All
highly liquid investments with original maturities of three months or less at the date of purchase are considered to be cash equivalents.
The Company may, from time to time, have deposits in financial institutions that exceed the federally insured amount of $
Accounts Receivable and Allowance for Doubtful Accounts
Accounts
receivables are recorded at the invoiced amount or based on revenue earned for items not yet invoiced, and generally do not bear interest.
An allowance for doubtful accounts is established, as necessary, based on past experience and other factors, which, in management’s
judgment, deserve current recognition in estimating bad debts. Based on the Company’s review, it establishes or adjusts the allowance
for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2022, and December 31, 2021, the allowance
for doubtful accounts was $
Inventory
Inventory
is stated at the lower of cost or net realizable value. The inventory is valued based on a first-in, first-out (“FIFO”) basis.
Lower of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other
factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolescence
or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for that inventory is established
and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
As of December 31, 2022, and December 31, 2021, the allowance for excess and obsolete inventory was $
Property and Equipment
Property and equipment are stated at cost. For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives as disclosed in the table below. Leasehold improvements are amortized on a straight-line basis over the lesser of their useful lives or the life of the lease. Upon sale or retirement of assets, the cost and related accumulated depreciation and amortization are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance and repairs are charged to operations as incurred.
Schedule of Property and Equipment
| Asset Type | Estimated Useful Life | |||
| Furniture and fixtures | ||||
| Computers | ||||
| Equipment | ||||
| Vehicles | ||||
Long-lived Assets
Long-lived tangible assets, including property and equipment, are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. When such an event occurs, management determines whether there has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset’s carrying value. If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash flows or appraised value, depending on the nature of the asset. The Company has not identified any indicators of impairment during the years ended December 31, 2022 and 2021.
Goodwill and Intangible Assets
The Company recorded goodwill in connection with its acquisition of Hydro Innovations, LLC in July 2014. Goodwill is reviewed for impairment annually or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. The Company performs a quantitative impairment test annually on December 31 by comparing the fair value of the reporting unit with its carrying amount, including goodwill. The Company’s fair value is calculated using a market valuation technique whereby an appropriate control premium is applied to the Company’s market capitalization as calculated by applying its publicly quoted share price to the number of its common shares issued and outstanding. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company determined that it has one reporting unit.
| F-9 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
As
of June 30, 2022, the Company experienced a triggering event due to a drop in its stock price and performed a quantitative analysis for
potential impairment of its goodwill. As of June 30, 2022, the Company performed a quantitative analysis for potential impairment of
its goodwill, by comparing the Company’s fair value to its carrying value as of June 30, 2022. Based on this analysis, the Company
determined that its carrying value exceeded its fair value. As a result, the Company recorded a non-cash goodwill impairment charge of
$
Fair Value Measurement
The Company records its financial assets and liabilities at fair value. The accounting standard for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting standard establishes a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 - inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 - inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value.
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.
Due to their short-term nature, the carrying values of accounts receivable, accounts payable, and accrued expenses, approximate fair value.
Leases
The Company accounts for leases in accordance with ASC 842. The Company determines whether a contract is a lease at contract inception or for a modified contract at the modification date. At inception or modification, the Company recognizes right-of-use (“ROU”) assets and related lease liabilities on the balance sheet for all leases greater than one year in duration. Lease liabilities and their corresponding ROU assets are initially measured at the present value of the unpaid lease payments as of the lease commencement date. If the lease contains a renewal and/or termination option, the exercise of the option is included in the term of the lease if the Company is reasonably certain that a renewal or termination option will be exercised. As the Company’s leases do not provide an implicit rate, the Company uses an estimated incremental borrowing rate (“IBR”) based on the information available at the commencement date of the respective lease to determine the present value of future payments. The IBR is determined by estimating what it would cost the Company to borrow a collateralized amount equal to the total lease payments over the lease term based on the contractual terms of the lease and the location of the leased asset.
Operating lease payments are recognized as an expense on a straight-line basis over the lease term in equal amounts of rent expense attributed to each period during the term of the lease, regardless of when actual payments are made. This generally results in rent expense in excess of cash payments during the early years of a lease and rent expense less than cash payments in later years. The difference between rent expense recognized and actual rental payments is typically represented as the spread between the ROU asset and lease liability.
| F-10 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
The Company’s facilities operating leases have lease and non-lease fixed cost components, which we account for as one single lease component in calculating the present value of minimum lease payments. Variable lease and non-lease cost components are expensed as incurred.
The Company does not recognize ROU assets and lease liabilities for short-term leases that have an initial lease term of 12 months or less. The Company recognizes the lease payments associated with short-term leases as an expense on a straight-line basis over the lease term.
Revenue Recognition
On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606), Revenue from Contracts with Customers and all the related amendments (“ASC 606” or the “revenue standard”) to all contracts and elected the modified retrospective method.
The following table sets forth the Company’s revenue by source:
Schedule of Revenue by Source
| 2022 | 2021 | |||||||
For the Twelve Months Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Equipment and systems sales | $ | $ | ||||||
| Engineering and other services | ||||||||
| Shipping and handling | ||||||||
| Total revenue | $ | $ | ||||||
Revenue Recognition Accounting Policy Summary
The Company accounts for revenue in accordance with ASC 606. Under the revenue standard, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Most of the Company’s contracts contain multiple performance obligations that include engineering and technical services as well as the delivery of a diverse range of climate control system equipment and components, which can span multiple phases of a customer’s project life cycle from facility design and construction to equipment delivery and system installation and start-up. The Company does not provide construction services or system installation services. Some of the Company’s contracts with customers contain a single performance obligation, typically engineering only services contracts.
| F-11 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, the Company allocates the transaction price to each performance obligation based on standalone selling price. When estimating the selling price, the Company uses various observable inputs. The best observable input is the Company’s actual selling price for the same good or service, however, this input is generally not available for the Company’s contracts containing multiple performance obligations. For engineering services, the Company estimates the standalone selling price by reference to certain physical characteristics of the project, such as facility size and mechanical systems involved, which are indicative of the scope and complexity of the mechanical engineering services to be provided. For equipment sales, the standalone selling price is determined by forecasting the expected costs of the equipment and components and then adding an appropriate margin, based on a range of acceptable margins established by management. Depending on the nature of the performance obligations, the Company may use a combination of different methods and observable inputs if certain performance obligations have highly variable or uncertain standalone selling prices. Once the selling prices are determined, the Company applies the relative values to the total contract consideration and estimates the amount of the transaction price to be recognized as each promise is fulfilled.
Generally, satisfaction occurs when control of the promised goods is transferred to the customer or as services are rendered or completed in exchange for consideration in an amount for which the Company expects to be entitled. The Company recognizes revenue for the sale of goods when control transfers to the customer, which primarily occurs at the time of shipment. The Company’s historical rates of return are insignificant as a percentage of sales and, as a result, the Company does not record a reserve for returns at the time the Company recognizes revenue. The Company has elected to exclude from the measurement of the transaction price all taxes (e.g., sales, use, value added, and certain excise taxes) that are assessed by a governmental authority in connection with a specific revenue-producing transaction and collected by the Company from the customer. Accordingly, the Company recognizes revenue net of sales taxes. The revenue and cost for freight and shipping is recorded when control over the sale of goods passes to the Company’s customers.
The Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Revenue is recognized from this type of performance obligation as services are rendered based on the percentage completion towards certain specified milestones.
The Company offers assurance-type warranties for its products and products manufactured by others to meet specifications defined by the contracts with customers and does not have any material separate performance obligations related to these warranties. The Company maintains a warranty reserve based on historical warranty costs.
Disaggregation of Revenue
In accordance with ASC 606-10-50-5 through 6, the Company considered the appropriate level of disaggregated revenue information that depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. Additionally, per the implementation guidance in ASC 606-10-55-90 through 91, the Company also considered (a) disclosures presented outside of the financial statements such as earnings releases and investor presentations, (b) information regularly reviewed by the Chief Operating Decision Maker for evaluating the financial performance of operating segments and (c) other information that is similar to the types of information identified in (a) and (b) and that is used by the Company or users of the Company’s financial statements to evaluate financial performance or make resource allocation decisions. Finally, we considered the examples of categories found in the guidance that might be appropriate, including: (a) type of good or service (major product lines), (b) geographical region (country or region), (c) market or type of customer (government or non-government customers), (d) type of contract (fixed-price or time-and-materials), (e) contract duration (short- or long-term), (f) timing of transfer of goods or services (point-in-time or over time) and (g) sales channels (direct to customers or through intermediaries).
Based on the aforementioned guidance and considerations, the Company determined that disaggregation of revenue by sales, services and shipping and handling was required.
Other Judgments and Assumptions
The Company typically receives customer payments in advance of its performance of services or transfers of goods. Applying the practical expedient in ASC 606-10-32-18, which the Company has elected, the Company does not adjust the promised amount of consideration for the effects of a significant financing component since the Company expects, at contract inception, that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. Accordingly, the remaining performance obligations related to customer contracts does not consider the effects of the time value of money.
Applying the practical expedient in ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred since the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs include certain sales commissions and incentives, which are included in selling, general and administrative expenses, and are payable only when associated revenue has been collected and earned by the Company.
Contract Assets and Contract Liabilities
Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers based on the terms established in its contracts.
Contract assets include unbilled amounts where revenue recognized exceeds the amount billed to the customer and the right of payment is conditional, subject to completing a milestone, such as a phase of a project. The Company typically does not have material amounts of contract assets since revenue is recognized as control of goods are transferred or as services are performed. As of December 31, 2022, and 2021, the Company had no contract assets.
| F-12 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Contract
liabilities consist of advance payments in excess of revenue recognized. The Company’s contract liabilities are recorded as a current
liability in deferred revenue in the consolidated balance sheets since the timing of when the Company expects to recognize revenue is
generally less than one year. As of December 31, 2022, and December 31, 2021, deferred revenue, which was classified as a current liability,
was $
For
the year ended December 31, 2022, the Company recognized revenue of $
Remaining Performance Obligations
Remaining performance obligations, or backlog, represents the aggregate amount of the transaction price allocated to the remaining obligations that the Company has not performed under its customer contracts. The Company has elected not to use the optional exemption in ASC 606-10-50-14, which exempts an entity from such disclosures if a performance obligation is part of a contract with an original expected duration of one year or less. Accordingly, the information disclosed about remaining performance obligations includes all customer contracts, including those with an expected duration of one year or less.
Industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of the Company’s control, make it difficult for the Company to predict when it will recognize revenue on its remaining performance obligations. There are risks that the Company may not realize the full contract value on customer projects in a timely manner or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when the Company is able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price tag and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays that are typical in completing any construction project. Further, based on the current economic climate, the uncertainty regarding the COVID-19 virus, and the Company’s recent cost cutting measures, there is no assurance that the Company will be able to fulfill its backlog, and the Company may experience contract cancellations, project scope reductions and project delays.
As
of December 31, 2022, the Company’s remaining performance obligations, or backlog, was $
The remaining performance obligations expected to be recognized through 2024 are as follows:
Schedule of Remaining Performance Obligations Expected to be Recognized
| 2023 | 2024 | Total | ||||||||||
| Remaining performance obligations related to engineering only paid contracts | $ | $ | $ | |||||||||
| Remaining performance obligations related to partial equipment paid contracts | ||||||||||||
| Total remaining performance obligations | $ | $ | $ | |||||||||
| F-13 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Product Warranty
The Company warrants the products that it manufactures for a warranty period equal to the lesser of 12 months from start-up or 18 months from shipment. The Company’s warranty provides for the repair, rework, or replacement of products (at the Company’s option) that fail to perform within stated specification. The Company’s third-party suppliers also warrant their products under similar terms, which are passed through to the Company’s customers.
Cost of Revenue
Cost of revenue includes product costs (material, direct labor and overhead costs), shipping and handling expense, outside engineering costs, engineering, project management and service salaries and benefits, client visits and warranty.
Concentrations
Three
customers accounted for
The
Company’s accounts receivable from two customers made up
Four
suppliers accounted for
Product Development
The
Company expenses product development costs as incurred. Internal product development costs are expensed as incurred, and third-party
product developments costs are expensed when the contracted work has been performed or as milestone results have been achieved. For the
years ended December 31, 2022 and December 31, 2021, the Company incurred $
The Company recognizes the cost resulting from all share-based compensation arrangements, including stock options, restricted stock awards and restricted stock units that the Company grants under its equity incentive plan in its consolidated financial statements based on their grant date fair value. For awards subject to service conditions, compensation expense is recognized over the vesting period on a straight-line basis. Awards subject to performance conditions are attributed separately for each vesting tranche of the award and are recognized ratably from the service inception date to the vesting date for each tranche, based on the probability of vesting. The probability of awards with future performance conditions is evaluated each reporting period and compensation expense is adjusted based on the probability assessment.
Awards are considered granted, and the service inception date begins, when mutual understanding of the key terms and conditions of the award between the Company and the recipient has been established. For awards that provide discretion to adjust the amount of the award, the service inception date for such awards could precede the grant date as a mutual understanding of the key terms and conditions of the award between the Company and the recipient has not yet been established. For awards in which the service inception date precedes the grant date, compensation cost is accrued beginning on the service inception date.
| F-14 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
On March 16, 2022, the Company’s Board of Directors (the “Board”) approved annual incentive compensation awards to certain employees payable in non-qualified stock options, based on the Company’s performance and each employee’s contributions to such performance for the 2021 year. The non-qualified stock options were granted, were not subject to an additional service requirement and were immediately vested at the date of the grant. The final amount of the annual incentive compensation award, and number of non-qualified stock options granted, were determined, and communicated to the employees. The estimated compensation expense of $ related to the 2021 incentive awards was accrued as of December 31, 2021. Since such incentive awards were settled in non-qualified stock options, the accrued compensation expense was classified as a current liability until the number of non-qualified stock options was fixed pursuant to a grant by the Board. At that time, the incentive awards of $ were classified to equity as stock options issued and recorded to paid-in capital on April 1, 2022.
For the year ended December 31, 2022, $was recorded in respect of the 2022 annual incentive compensation awards. The final amount of the awards was approved by the Compensation Committee and Board of Directors on March 22, 2023. The number of non-qualified stock options to be granted will be determined on March 31, 2023, and communicated to the employees. The estimated expense was accrued as accrued equity compensation in current liabilities at December 31, 2022.
The grant date fair value of stock options is based on the Black-Scholes Model. The Black-Scholes Model requires judgmental assumptions including volatility and expected term, both based on historical experience. The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected term of the option.
The grant date fair value of restricted stock and restricted stock units is based on the closing price of the underlying stock on the date of the grant.
The Company has elected to reduce share-based compensation expense for forfeitures as the forfeitures occur since the Company does not have historical data or other factors to appropriately estimate the expected employee terminations and to evaluate whether particular groups of employees have significantly different forfeiture expectations.
Share-based compensation costs (including expenses from the accrued compensation liabilities related to the annual incentive awards subsequently settled in non-qualified stock options) totaled $ and $ for the years ended December 31, 2022 and 2021, respectively. Such share-based compensation costs are classified in the Company’s consolidated financial statements in the same manner as if such compensation was paid in cash.
Schedule of Share-based Compensation Costs
| 2022 | 2021 | |||||||
For the Twelve Months Ended December 31, | ||||||||
| 2022 | 2021 | |||||||
| Share-based compensation expense included in: | ||||||||
| Cost of revenue | $ | $ | ||||||
| Advertising and marketing expenses | ||||||||
| Product development costs | ||||||||
| Selling, general and administrative expenses | ||||||||
| Total share-based compensation expense included in consolidated statement of operations | $ | $ | ||||||
| F-15 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company recognizes deferred tax assets to the extent that the Company believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
The Company records uncertain tax positions on the basis of a two-step process in which: (i) the Company determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position, and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement with the related tax authority.
Basic income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding during the period without consideration of common stock equivalents. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding and potentially dilutive common stock equivalents, including stock options, warrants and restricted stock units and other equity-based awards, except in periods when losses are reported where the effect of the common stock equivalents would be antidilutive. Potential common stock equivalents consist of common stock issuable upon exercise of stock options and warrants and the vesting of restricted stock units using the treasury method. As of December 31, 2022, and December 31, 2021, and potential common share equivalents from Series B Preferred Stock, restricted stock units, warrants, and options, respectively, were excluded from the diluted EPS calculations as their effect is anti-dilutive.
Commitments and Contingencies
In the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, customer disputes, government investigations and tax matters. An accrual for a loss contingency is recognized when it is probable that an asset had been impaired, or a liability had been incurred and the amount of loss can be reasonably estimated.
Other Risks and Uncertainties
To achieve profitable operations, the Company must successfully develop, manufacture and market its products. There can be no assurance that any such products can be developed or manufactured at an acceptable cost and with appropriate performance characteristics, or that such products will be successfully marketed. These factors could have a material adverse effect upon the Company’s financial results, financial position, and future cash flows.
The Company is subject to risks common to similarly-situated companies including, but not limited to, general economic conditions, its customers’ operations and access to capital, and market and business disruptions including severe weather conditions, natural disasters, health hazards, terrorist activities, financial crises, political crises or other major events, or the prospect of these events, new technological innovations, dependence on key personnel, protection of proprietary technology, compliance with government regulations, uncertainty of market acceptance of products, product liability, and the need to obtain additional financing. As a supplier of services and equipment to cannabis cultivators, the Company is also subject to risks related to the cannabis industry. Although certain states have legalized medical and/or recreational cannabis, U.S. federal laws continue to prohibit marijuana in all its forms as well as its derivatives. Any changes in the enforcement of U.S. federal laws may adversely affect the implementation of state and local cannabis laws and regulations that permit medical or recreational cannabis and, correspondingly, may adversely impact the Company’s customers. The Company’s success is also dependent upon its ability to raise additional capital and to successfully develop and market its products.
| F-16 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Segment Information
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly
by the Company’s senior management team in deciding how to allocate resources and in assessing performance. The Company has
Recently Issued Accounting Pronouncements
In December 2022, the FASB issued ASU No. 2022-06, which defers the sunset date of Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”) from December 31, 2022 to December 31, 2024. ASU No. 2022-06 was effective upon issuance. Topic 848 provides temporary optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting, providing optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The Company does not expect this ASU to have a material impact on its consolidated results of operations, cash flows and financial position.
In September 2022, the FASB issued Update 2022-04, “Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations”. The update was issued in response to requests from financial statement users for increased transparency surrounding the use of supplier finance programs. The amendments in Update 2022-04 require that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. The amendments in this update do not affect the recognition, measurement, or financial statement presentation of obligations covered by supplier finance programs. The amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The Company does not expect this ASU to have a material impact on its consolidated results of operations, cash flows and financial position.
In October 2021, the FASB issued ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers”, which requires companies to apply ASC 606, “Revenue from Contracts with Customers” to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination. This creates an exception to the general recognition and measurement principle in ASC 805, which uses fair value. The guidance is effective for fiscal years beginning after December 15, 2022 and interim periods within those fiscal years. Early adoption is permitted, and the guidance should be applied prospectively. The impact of the standard on Company’s consolidated financial statements is dependent on the size and frequency of any future acquisitions the Company may complete.
In May 2021, the FASB issued ASU 2021-04, Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. This guidance clarifies and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options due to a lack of explicit guidance in the FASB Codification. The guidance is effective for interim and annual periods beginning after December 15, 2021. Early adoption is permitted. The guidance is to be applied prospectively to modifications or exchanges occurring on or after the effective date. The adoption of this guidance has not had a material impact on the Company’s consolidated financial statements.
In March 2020, the FAS issued ASU No. 2020-04 “Reference Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”). ASU 2020-04 provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments are effective for the Company as of March 12, 2020 through December 31, 2022. The adoption of this guidance has not had a material impact on the Company’s consolidated financial statements.
| F-17 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.
Note 3 – Leases
The Boulder Facility Lease
On
June 27, 2017, the Company entered into a lease for its manufacturing and office space (the “Boulder Facility Lease”), which
commenced September 29, 2017 and continued through August 31, 2022. The Company occupied a
Under
the Boulder Facility Lease, the landlord agreed to pay the Company or the Company’s contractors for tenant improvements made by
the Company not to exceed $
Upon
adoption of ASC 842 on January 1, 2019, the Company recognized its Boulder Facility Lease on the balance sheet as an operating lease
right-of-use asset in the amount of $
During
2020, the Company entered into an agreement with its landlord to apply its rent deposit of $
On
April 30, 2021, the Company entered into an agreement to sublease approximately
| F-18 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
On
July 27, 2021, the Company entered into a Boulder Facility Lease Termination Agreement with its landlord for the
The New Facility Lease
On
July 28, 2021, the Company entered into an agreement to lease
Upon
commencement of the New Facility Lease, the Company recognized on the balance sheet an operating lease right-of-use asset and lease liability
in the amount of $
The Company’s operating and finance right-of-use assets and lease liabilities are as follows:
Schedule of Lease Cost
As of December 31, 2022 | As of December 31, 2021 | |||||||
| Operating lease right-of-use asset | $ | $ | ||||||
| Operating lease liability, current | $ | $ | ||||||
| Operating lease liability, long-term | $ | $ | ||||||
| Remaining lease term | ||||||||
| Discount rate | % | % | ||||||
Cash paid during the year for amounts included in the measurement of lease liabilities is as follows:
For the Twelve Months Ended December 31, 2022 | For the Twelve Months Ended December 31, 2021 | |||||||
| Operating cash outflow from operating lease | $ | $ | ||||||
| F-19 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Future annual minimum under non-cancellable operating leases as of December 31, 2022 were as follows:
Schedule of Future Annual Minimum Lease Payments
| Years ended December 31, | ||||
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| Total minimum lease payments | ||||
| Less imputed interest | ( | ) | ||
| Present value of minimum lease payments | $ | |||
Note 4 – Inventory
Inventory consisted of the following:
Schedule of Inventory
| 2022 | 2021 | |||||||
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| Finished goods | $ | $ | ||||||
| Work in progress | ||||||||
| Raw materials | ||||||||
| Allowance for excess & obsolete inventory | ( | ) | ( | ) | ||||
| Inventory, net | $ | $ | ||||||
Overhead
expenses of $
Note 5 – Property and Equipment
Property and equipment consisted of the following:
Schedule of Property and Equipment
| 2022 | 2021 | |||||||
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| Furniture and equipment | $ | $ | ||||||
| Vehicles | ||||||||
| Property and equipment, gross | ||||||||
| Accumulated depreciation | ( | ) | ( | ) | ||||
| Property and equipment, net | $ | $ | ||||||
Depreciation
expense amounted to $
| F-20 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Note 6 – Intangible Assets
Intangible assets consisted of the following:
Schedule of Intangible Assets
| As of December 31, | ||||||||
| 2022 | 2021 | |||||||
| Patents | $ | $ | ||||||
| Website development costs | ||||||||
| Trademarks | ||||||||
| Accumulated amortization | ( | ) | ( | ) | ||||
| Intangible assets, net | $ | $ | ||||||
Patents
when issued are amortized over
Note 7 – Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consisted of the following:
Schedule of Accounts Payable and Accrued Liabilities
| 2022 | 2021 | |||||||
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| Accounts payable | $ | $ | ||||||
| Sales commissions payable | ||||||||
| Accrued payroll liabilities | ||||||||
| Product warranty accrual | ||||||||
| Other accrued expenses | ||||||||
| Total | $ | $ | ||||||
Note 8 – Note Payable and Accrued Interest
On
February 10, 2021, the Company entered into a note payable with its current bank in the principal amount of $
The
loan amount incurred interest at
During
the year ended December 31, 2021, interest of $
| F-21 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
On
November 30, 2021, the Company received notice from the bank that its loan received on February 10, 2021, in the principal amount of
$
Note 9 – Temporary Equity
On
September 28, 2021, the Company sold to an institutional investor (the “Investor”), shares of Series B Convertible
Preferred Stock (“Series B Preferred Stock”), stated value $ per share, convertible into shares of common stock, for
an aggregate purchase price of $
The
Series B Preferred Stock had an annual dividend of
The
Series B Preferred Stock was mandatorily convertible on the third anniversary of its issuance. All conversions of the Series B Preferred
Stock were subject to a blocker provision of
On
February 16, 2022, the Company redeemed
shares of its Series B Preferred Stock for payment of $
On
February 16, 2022, the remaining shares of the Company’s Series B Preferred Stock were converted into shares of common
stock and warrants; of the warrants vested immediately, had an indefinite term and an exercise price of $
The Company has no shares of Series B Preferred Stock outstanding as of December 31, 2022.
| F-22 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Note 10 – Related Party Agreements and Transactions
Agreements and Transaction with a Company Director
On
January 7, 2021, the Company entered into a consulting agreement with RSX Enterprises, Inc. (RSX), a company controlled by Mr. James
R. Shipley, a director of the Company. RSX provided consulting services to the Company focused on product offerings, engineering requirements,
key customer marketing outreach, and related matters, as mutually determined by the Company and RSX. The Company paid a monthly consulting
fee of $
The company entered into a manufacturer representative agreement with RSX Enterprises in March 2021 to become a non-exclusive representative for the Company to assist in marketing and soliciting orders. James R. Shipley, a current director of the Company, has a significant ownership interest in RSX.
Under
the manufacturer representative agreement, RSX will act as a non-exclusive representative for the Company within the United States, Canada
and Mexico and may receive a commission for qualified customer leads. The agreement has an initial term through December 31, 2021, with
automatic one-year renewal terms unless prior notice is given 90 days prior to each annual expiration. During the year ended December
31, 2022, the Company paid $
On
October 13, 2022, the Company entered into an agreement with Lone Star Bioscience, Inc. (Lone Star) to provide engineering design services.
Nicholas Etten, one of our independent directors, is the Chief Executive Officer of Lone Star. The agreement totaled $
Note 11 – Commitments and Contingencies
Litigation
The
Company settled a litigation with a former employee effective March 30, 2021. While the Company disputed the merits of the claims, the
Company agreed to issue an aggregate of shares of common stock of the Company, as part of the settlement. These shares were issued
on April 8, 2021, as “restricted securities,” subject to a lock-up agreement of six months, without registration rights,
and pursuant to a private placement exemption. The settlement agreement also included mutual releases and no admission of liability.
The cost to the Company of this settlement, $
From time to time, in the normal course of its operations, the Company is subject to litigation matters and claims. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict, and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a liability for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.
Leases
The Company has a lease agreement for its manufacturing and office space. Refer to Note 3 Leases above.
| F-23 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Other Commitments
In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers and employees that will require the Company to, among other things, indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers, or employees. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and certain of its officers and employees, and former officers, directors, and employees of acquired companies, in certain circumstances.
Note 12 – Preferred and Common Stock
Preferred Stock
As of December 31, 2022, and December 31, 2021, the Company had and shares of Preferred Stock authorized, respectively, at a $.
Effective January 17, 2022, the Board of Directors approved a reduction in the number of authorized shares of preferred stock from to shares of preferred stock.
shares of preferred stock were issued or outstanding as of December 31, 2022 and shares of Series B Preferred Stock was issued and outstanding at December 31, 2021.
Series A Preferred Stock
As of December 31, 2022, and December 31, 2021, the Company has shares of Series A Preferred Stock issued and outstanding, respectively.
Effective November 4, 2021, the Company redeemed all shares of Series A Preferred Stock issued and outstanding for the issuance of shares of common stock.
The $
excess in the fair value of the shares of common stock ($
Series B Preferred Stock
As of December 31, 2022, and December 31, 2021, the Company has and shares of Series B Preferred Stock issued and outstanding, respectively.
As
further described in Note 9 – Temporary Equity above, on September 28, 2021, the Company entered into a Securities Purchase
Agreement (“Purchase Agreement”) with an institutional investor (the “Investor”), pursuant to which the Investor
purchased from the Company shares of Series B Preferred Stock with a stated value of $ per share, or $
On
February 16, 2022, the Company redeemed
shares of its Series B Preferred Stock for payment of $
On
February 16, 2022, the remaining shares of the Company’s Series B Preferred Stock were converted into
Consequently, as of December 31, 2022, shares of Series B Preferred Stock were issued and outstanding.
Common Stock
Authorized Common Stock
As of December 31, 2022, and December 31, 2021, the Company was authorized to issue and shares of common stock, respectively, with a par value of $ per share.
Effective November 3, 2021, the Company increased the number of authorized shares of common stock from to .
Effective January 17, 2022, the Company’s Board of Directors approved a reduction in the number of authorized shares of common stock from to shares of common stock.
| F-24 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Reverse Split
As a result of this reverse stock split, the number of the Company’s shares of common stock issued and outstanding as of December 31, 2021, was reduced from to .
All Common Stock, warrants, options and per share amounts set forth herein are presented to give retroactive effect to the Reverse Split for all periods presented.
Issued Common Stock
As of December 31, 2022, and December 31, 2021, the Company has and shares of common stock issued and outstanding, respectively.
During the year ended December 31, 2022, the Company issued shares of its common stock as follows:
| ● | On January 17, 2022, the Company issued shares of common stock in settlement of restricted stock units issued to newly appointed directors. | |
| ● | ||
| ● | On
February 15, 2022, the Company issued shares of common stock and warrants,
each warrant to purchase one share of common stock for five years, exercisable immediately, at an exercise price of $, for net
proceeds of approximately $ | |
| ● | On
February 16, 2022, the Company issued shares of common stock and warrants; of the warrants vested immediately,
had an indefinite term and an exercise price of $ | |
| ● | On
June 21, 2022, the Company issued shares on common stock on the cashless exercise |
Consequently, effective December 31, 2022, shares of common stock were issued and outstanding.
During the year ended December 31, 2021, the Company issued shares of its common stock as follows:
| ● | On April 8, 2021, the Company issued shares of common stock, valued at $ as part of a legal settlements as further described in Note 11 – Commitments and Contingencies – Litigation above. | |
| ● | On
November 4, 2021, the Company issued shares of common stock, valued at $ | |
| ● | On
November 24, 2021, the Company issued shares of its common stock, valued at $ | |
| ● | On
December 30, 2021, the Company issued shares of its common stock, valued at $ |
Consequently, effective December 31, 2021, shares of common stock were issued and outstanding.
As further discussed in Note 16. Subsequent Events below:
Effective January 3, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to directors that vested immediately.
Effective January 17, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to newly appointed directors in 2022 that vested one year after issuance.
Consequently, as of the date of the issuance of these financial statements shares of our common stock are issued and outstanding.
| F-25 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Note 13 – Outstanding Warrants
The following table summarizes information with respect to outstanding warrants to purchase common stock during the years ended December 31, 2022 and 2021:
Schedule of Outstanding Warrants to Purchase Common Stock
| Weighted | ||||||||||||||||||||
| Weighted | Average | |||||||||||||||||||
| Warrants | Average Exercise | Remaining Life | Aggregate Intrinsic | |||||||||||||||||
| Outstanding | Exercisable | Price | In Months | Value | ||||||||||||||||
| Outstanding at December 31, 2020 | $ | |||||||||||||||||||
| Granted | $ | |||||||||||||||||||
| Exercised | $ | |||||||||||||||||||
| Expired | ( | ) | ( | ) | $ | - | ||||||||||||||
| Outstanding at December 31, 2021 | $ | $ | ||||||||||||||||||
| Granted | $ | * | $ | |||||||||||||||||
| Exercised | ( | ) | ( | ) | $ | * | ($ | ) | ||||||||||||
| Expired | - | |||||||||||||||||||
| Outstanding at December 31, 2022 | $ | |||||||||||||||||||
| * |
The following table summarizes information about warrants outstanding at December 31, 2022.
Schedule of Warrants Outstanding
| Warrants | Weighted Average | |||||||||||||
| Exercise price | Outstanding | Exercisable | Months Outstanding | |||||||||||
| F-26 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Q1 2022 Investor Warrants
On
February 15, 2022, the Company issued investment units for aggregate gross proceeds
of $
Q1 2022 Overallotment Warrants
Further
on February 15, 2022, in connection with the Company’s issuance of investment units for aggregate gross proceeds
of $
Q1 2022 Underwriter Warrants
Further
on February 15, 2022, in connection with the Company’s issuance of investment units for aggregate gross proceeds
of $
Q1 2022 Series B Preferred Shares Pre-Funded Conversion Warrants
On February 16, 2022, in connection with the conversion of shares of Series B Preferred Stock into shares of the Company’s common stock, the Series B Preferred Shareholder was issued pre-funded conversion warrants. Each warrant entitled the holder to purchase one share of common stock at an exercise price of $, vested immediately and had an indefinite life.
On June 21, 2022, the holder of all pre-funded conversion warrants exercised all of their warrants on a cashless basis and received shares of the Company’s common stock as a result of the exercise.
No pre-funded conversion warrants remained outstanding at December 31, 2022.
Q1 2022 Series B Preferred Shares Conversion Warrants
Further on February 16, 2022, in connection with the conversion of shares of Series B Preferred Stock into shares of the Company’s common stock, the Series B Preferred Shareholder was also issued with Series B Preferred shares conversion warrants. Each warrant entitled the holder to purchase one share of common stock at an exercise price of $, vested immediately and had a term of years.
Q3 2021 Warrants Issued to Series B Preferred Stockholder
On
September 28, 2021, the Company entered into a Securities Purchase Agreement with an institutional investor, pursuant to which the investor
purchased from the Company shares of convertible Series B Preferred Stock
with a stated value of $per share, or $
Q3 2021 Warrants Issued to Series B Preferred Placement Agent
In
connection with the sale of the shares of convertible Series B Preferred Stock described above, the Company issued
| F-27 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Revised Compensation Plan
On August 20, 2021, the Board of Directors revised the previously adopted equity-based compensation plan and adopted a new compensation plan for independent directors (the “Plan”). The Plan is effective retroactively for the current independent directors and for independent directors elected or appointed after the Effective Date of the Plan.
The
Company will pay its independent directors an annual cash fee of $
On January 17, 2022, the Board of Directors revised the previously adopted compensation plan. This plan supersedes the plan adopted on August 20, 2021. The Plan is effective retroactively for the current independent directors and for independent directors elected or appointed after the Effective Date.
The plan is divided into two phases: from the Effective Date of the Plan until February 9, 2022, the day prior to the uplisting of the Company to Nasdaq. (“Pre-uplist”) and from February 10, 2022, the uplist date forward (“Post-uplist”).
Pre-uplist
phase: The Company paid its independent directors an annual cash fee of $
At the time of initial election or appointment, each independent director received an equity retention award in the form of restricted stock units (“RSUs”). The aggregate value of the RSUs at the time of grant was to be $, with the number of shares underlying the RSUs to be determined based on the closing price of the Company’s common stock on the date immediately prior to the date of grant. .
In addition, on the first business day of January each year, each independent director will also receive an equity retention award in the form of RSUs. The aggregate value of the RSUs at the time of grant will be $, with the number of shares underlying the RSUs to be determined based on the closing price of the Company’s common stock on the date immediately prior to the date of grant. These RSUs will be fully vested at date of grant.
The
Company pays the Audit Committee Chairman an additional annual fee of $
The
Company pays the Chairmen of any other committees of the Board an additional annual fee of $
There is no additional compensation paid to members of any committee of the Board. Interested (i.e. Executive directors) serving on the Board do not receive compensation for their Board service.
Post-uplist
phase: The Company will pay its independent directors an annual cash fee of $
Each director is responsible for the payment of any and all income taxes arising with respect to the issuance of common stock and the vesting and settlement of RSUs.
| F-28 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
The Company reimburses independent directors for out-of-pocket expenses incurred in attending Board and committee meetings and undertaking certain matters on the Company’s behalf.
All independent directors, Messrs. Shipley, Etten, Reisner, and Mariathasan are subject to the Plan.
Each independent director is responsible for the payment of any and all income taxes arising with respect to the issuance of any equity awarded under the plan, including the exercise of any non-qualified stock options.
Employee directors do not receive separate fees for their services as directors.
2017 Equity Incentive Plan
Under the Company’s 2017 Equity Incentive Plan, as may be modified and amended by the Company from time to time (the “2017 Equity Plan”), the Board of Directors (the “Board”) (or the compensation committee of the Board, if one is established) may award stock options, stock appreciation rights (“SARs”), restricted stock awards (“RSAs”), restricted stock unit awards (“RSUs”), shares granted as a bonus or in lieu of another award, and other stock-based performance awards. The 2017 Equity Plan allocates shares of the Company’s common stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. If any shares subject to an award are forfeited, expire, or otherwise terminate without issuance of such shares, the shares will, to the extent of such forfeiture, expiration, or termination, again be available for awards under the 2017 Equity Plan.
As of December 31, 2022, of the shares authorized under the 2017 Equity Plan, relate to restricted shares issued, relate to outstanding non-qualified stock options and shares remain available for future equity awards.
2021 Equity Incentive Plan
On March 22, 2021, the Board approved the 2021 Equity Incentive Plan (the “2021 Equity Plan”), which was approved by the stockholders on July 22, 2021. The 2021 Equity Plan permits the Board to grant awards of up to shares of common stock. The 2021 Plan provides for the grant of incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), non-qualified stock options, stock appreciation rights (“SARs”), restricted stock awards and restricted stock unit awards and other equity linked awards to our employees, consultants and directors. If an equity award (i) expires or otherwise terminates without having been exercised in full or (ii) is settled in cash (i.e., the holder of the award receives cash rather than stock), such expiration, termination or settlement will not reduce (or otherwise offset) the number of shares of common stock that may be issued pursuant to this Plan.
Equity Incentive Plan Issuances During 2022
| - | Issued shares of its common stock to two new independent directors under the 2021 Equity Incentive Plan, pursuant to the Director Compensation plan adopted in January 2022. | |
| - | Granted awards for non-qualified stock options to newly hired employees and stock options were cancelled under the 2021 Equity Incentive Plan. | |
| - | Granted awards for non-qualified stock options to directors under the 2021 Equity Incentive Plan, pursuant to the Director Compensation plan adopted in August of 2021. | |
| - | Issued non-qualified stock options were issued to 21 employees in respect of the Company’s 2021 Equity Incentive Plan. The options vested immediately, have a term of years and an exercise price of $. The expense in respect of this issuance had been fully accrued in 2021. |
As of December 31, 2022, of the shares authorized under the 2021 Equity Plan, relate to restricted shares issued, relate to outstanding non-qualified stock options, relate to outstanding incentive stock options, relate to outstanding restricted stock units and shares remain available for future equity awards.
There was $ in unrecognized compensation expense for unvested non-qualified stock options, incentive stock options and restricted stock units at December 31, 2022 which will be recognized over approximately years.
| F-29 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
As further discussed in Note 16 Subsequent Events below, effective January 3, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to directors that vested immediately. Further on January 17, 2023, the Company issued a further shares of common stock in settlement of restricted stock units issued to newly appointed directors in 2022 that vested one year after issuance.
Restricted Stock Awards
No shares of restricted stock were issued during the year ended December 31, 2022.
During
the year ended December 31, 2021, the Company awarded shares of restricted stock under the 2021 Equity Incentive Plan with a value
of $
Stock Options
The Company uses the Black-Scholes Model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. Changes in the subjective input assumptions can materially affect the fair value estimate. The expected stock price volatility assumptions are based on the historical volatility of the Company’s common stock over periods that are similar to the expected terms of grants and other relevant factors. The Company derives the expected term based on an average of the contract term and the vesting period taking into consideration the vesting schedules and future employee behavior with regard to option exercise. The risk-free interest rate is based on U.S. Treasury yields for a maturity approximating the expected term calculated at the date of grant. The Company has never paid any cash dividends on its common stock and the Company has no intention to pay a dividend at this time; therefore, the Company assumes that no dividends will be paid over the expected terms of option awards.
The Company determines the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant dates. As such, the Company may use different assumptions for options granted throughout the year. The valuation assumptions used to determine the fair value of each option award on the date of grant were: expected stock price volatility % - %; expected term of - years and risk-free interest rate % - %.
| F-30 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Employee and Consultant Options
Schedule of Stock Option Activity
| Number of Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||||||
| Outstanding, December 31, 2020 | $ | $ | ||||||||||||||
| Granted | $ | $ | - | |||||||||||||
| Exercised | $ | - | $ | - | ||||||||||||
| Forfeited | ( | ) | $ | $ | - | |||||||||||
| Expired | $ | - | $ | - | ||||||||||||
| Outstanding, December 31, 2021 | $ | $ | ||||||||||||||
| Granted | $ | $ | - | |||||||||||||
| Exercised | $ | - | $ | - | ||||||||||||
| Forfeited | ( | ) | $ | $ | - | |||||||||||
| Expired | $ | - | $ | - | ||||||||||||
| Outstanding, December 31, 2022 | $ | $ | ||||||||||||||
| Exercisable, December 31, 2022 | $ | $ | ||||||||||||||
Summary of Non-vested Non-qualified Stock Option Activity
| Number of Options | Weighted Average Grant-Date Fair Value | Aggregate Intrinsic Value | Grant-Date Fair Value | |||||||||||||
| Nonvested, December 31, 2020 | $ | $ | $ | |||||||||||||
| Granted | $ | $ | - | $ | ||||||||||||
| Vested | ( | ) | $ | $ | - | $ | ( | ) | ||||||||
| Forfeited | $ | $ | - | $ | ||||||||||||
| Expired | $ | $ | - | $ | ||||||||||||
| Nonvested, December 31, 2021 | $ | $ | $ | |||||||||||||
| Granted | $ | $ | - | $ | ||||||||||||
| Vested | ( | ) | $ | $ | - | $ | ||||||||||
| Forfeited | ( | ) | $ | $ | - | $ | ||||||||||
| Expired | $ | $ | - | $ | ||||||||||||
| Nonvested, December 31, 2022 | $ | $ | $ | |||||||||||||
For
the years ended December 31, 2022 and 2021, the Company recorded $ and $ as compensation expense related to vested options
issued to employees and consultants, net of forfeitures, respectively. The expense for 2022 was comprised of $
| F-31 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Director Options
Schedule of Stock Option Activity
| Number of Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value ($000) | |||||||||||||
| Outstanding, December 31, 2020 | $ | $ | ||||||||||||||
| Granted | $ | $ | - | |||||||||||||
| Exercised | - | $ | - | |||||||||||||
| Forfeited/Cancelled | - | $ | - | |||||||||||||
| Expired | - | $ | - | |||||||||||||
| Outstanding, December 31, 2021 | $ | $ | ||||||||||||||
| Granted | $ | $ | - | |||||||||||||
| Exercised | - | $ | - | |||||||||||||
| Forfeited/Cancelled | - | $ | - | |||||||||||||
| Expired | - | $ | - | |||||||||||||
| Outstanding, December 31, 2022 | $ | $ | ||||||||||||||
| Exercisable, December 31, 2022 | $ | $ | ||||||||||||||
Summary of Non-vested Non-qualified Stock Option Activity
| Number of Options | Weighted Average Grant-Date Fair Value | Aggregate Intrinsic Value | Grant-Date Fair Value | |||||||||||||
| Nonvested, December 31, 2020 | $ | $ | $ | |||||||||||||
| Granted | $ | $ | ||||||||||||||
| Vested | ( | ) | $ | $ | $ | ( | ) | |||||||||
| Forfeited | - | $ | - | |||||||||||||
| Expired | - | - | $ | - | ||||||||||||
| Nonvested, December 31, 2021 | $ | |||||||||||||||
| Granted | $ | $ | - | $ | ||||||||||||
| Vested | ( | ) | $ | $ | - | $ | ||||||||||
| Forfeited | - | $ | - | |||||||||||||
| Expired | - | $ | - | |||||||||||||
| Nonvested, December 31, 2022 | $ | $ | ||||||||||||||
During the years ended December 31, 2022 and 2021, the Company incurred $ and $, respectively, as compensation expense related to and vested options, respectively, issued to directors. As of December 31, 2022, there was no unrecognized share-based compensation related to unvested options.
Effective January 3, 2022, the Company issued non-qualified stock options under the 2021 Equity Plan to its then current directors. The options vested upon grant. The options have a term of years and an exercise price equal to the closing price of the Company’s common stock on The OTC Markets on the day immediately preceding the grant date.
Effective August 20, 2021, the Company issued non-qualified stock options under the 2021 Equity Plan to its directors. The options vested upon grant. The options have a term of years and an exercise price equal to the closing price of the Company’s common stock on The OTC Markets on the day immediately preceding the grant date of $.
| F-32 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
Restricted Stock Units
Schedule of Restricted Stock Units Activity
| Number of Units | Weighted Average Grant-Date Fair Value | Aggregate Intrinsic Value | ||||||||||
| Outstanding, December 31, 2020 | $ | $ | ||||||||||
| Granted | $ | - | ||||||||||
| Vested and settled with share issuance | ( | ) | $ | $ | - | |||||||
| Forfeited/canceled | ( | ) | $ | $ | - | |||||||
| Outstanding, December 31, 2021 | $ | $ | ||||||||||
| Granted | $ | $ | - | |||||||||
| Vested and settled with share issuance | ( | ) | $ | $ | - | |||||||
| Forfeited/canceled | $ | $ | - | |||||||||
| Outstanding, December 31, 2022 | $ | $ | ||||||||||
For the years ended December 31, 2022 and 2021, the Company recorded $ and $ as compensation expense related to vested RSUs issued to employees, directors and consultants. As of December 31, 2022, there was $ in unrecognized share-based compensation related to unvested RSUs.
As further discussed in Note 16 Subsequent Events below, effective January 3, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to directors that vested immediately. Further on January 17, 2023, the Company issued a further shares of common stock in settlement of restricted stock units issued to newly appointed directors in 2022 that vested one year after issuance.
Note 15 – Income Taxes
For financial reporting purposes, there were no provisions for U.S. federal, state or international income taxes for the years ended December 31, 2022 or 2021 due to the Company’s net operating losses (“NOLs”) in such periods and full valuation allowance recorded against the net deferred tax assets.
The differences between income taxes expected at the U.S. federal statutory income tax rate and the reported provision for income taxes are summarized as follows:
Schedule of U.S Federal Statutory Income Tax Rate and Reported Provision for Income Taxes
| 2022 | 2021 | |||||||
| Income taxes computed at the federal statutory rate | $ | ( | ) | $ | ( | ) | ||
| States taxes, net of federal benefits | ( | ) | ( | ) | ||||
| Permanent differences | ( | ) | ||||||
| True-up adjustments | ||||||||
| Adjustment to net operating loss | ( | ) | ( | ) | ||||
| Change in valuation allowance | ||||||||
| Reported income tax (benefit) expense | $ | $ | ||||||
| F-33 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
The components of the net deferred tax assets as of December 31, 2022 and 2021 are as follows:
Schedule of Deferred Tax Assets
| 2022 | 2021 | |||||||
| Deferred tax assets: | ||||||||
| Net operating losses | $ | $ | ||||||
| Equity compensation | ||||||||
| Other deferred tax assets | ||||||||
| Total deferred tax assets | ||||||||
| Deferred tax liabilities: | ||||||||
| Other deferred tax liabilities | ( | ) | ( | ) | ||||
| Total deferred tax liabilities | ( | ) | ( | ) | ||||
| Net deferred tax assets before valuation allowance | ||||||||
| Less valuation allowance | ( | ) | ( | ) | ||||
| Net deferred tax assets | $ | $ | ||||||
As
of December 31, 2022, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $
As
further discussed in Note 12 Preferred and Common Stock in our consolidated financial statements below, effective February 15,
2022, the Company received net proceeds of approximately $
These securities sales and our September 2021 securities sales as described in Note 9 Temporary Equity above will also have to be taken into account for determination of any “ownership change” that we have undergone during a determination period. If an ownership change occurs and our ability to use our net operating loss carryforwards is materially limited, it would harm our future post tax results by effectively increasing our future tax obligations.
The Company must assess the likelihood that its net deferred tax assets will be recovered from future taxable income, and to the extent the Company believes that recovery is not likely, the Company establishes a valuation allowance. Management’s judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against the net deferred tax assets. The Company recorded a full valuation allowance as of December 31, 2022 and 2021. Based on the available evidence, the Company believes it is more likely than not that it will not be able to utilize its net deferred tax assets in the foreseeable future. The Company intends to maintain valuation allowances until sufficient evidence exists to support the reversal of such valuation allowances. The Company makes estimates and judgments about its future taxable income that are based on assumptions that are consistent with the Company’s plans. Should the actual amounts differ from the Company’s estimates, the carrying value of the Company’s deferred tax assets could be materially impacted.
The Company is subject to examination by the IRS for the calendar year 2018 and thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to the Company’s taxes or the Company’s net operating losses with respect to years under examination as well as subsequent periods.
| F-34 |
CEA Industries Inc.
Notes to Consolidated Financial Statements
December 31, 2022
(in US Dollars except share numbers)
The Company recognizes in its consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of operating expense. The Company does not believe there are any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve months of the reporting date. There were no penalties or interest liabilities accrued as of December 31, 2022 or 2021, nor were any penalties or interest costs included in expense for the years ended December 31, 2022 and 2021.
Note 16 – Subsequent Events
In accordance with ASC 855, Subsequent Events, the Company has evaluated all subsequent events through the date the financial statements were available to be issued. The following events occurred after December 31, 2022.
Effective January 3, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to directors that vested immediately.
Effective January 17, 2023, the Company issued shares of common stock in settlement of restricted stock units issued to newly appointed directors in 2022 that vested one year after issuance.
Consequently, as of the date of the issuance of these financial statements shares of our common stock are issued and outstanding.
Workforce Reduction
The Company has experienced a decline in activity, as indicated in its 2022 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 of this decline in activity, 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 February 21, 2023, we implemented a downsizing of our operations, including a 32% reduction in our workforce, and significant non-personnel cost reductions in order to preserve our cash resources and better reflect our activity levels.
We believe these efforts are necessary and will help focus our existing operations on delivering value for customers of both our equipment sales and project management activities. In the meantime, we continue aggressive efforts to increase liquidity and reduce costs and will take additional actions as market conditions warrant.
| F-35 |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| CEA INDUSTRIES INC. | ||
| (the “Registrant”) | ||
| Dated: March 28, 2023 | By: | /s/ Anthony K. McDonald |
| Anthony K. McDonald | ||
| Chief Executive Officer and President | ||
| (Principal Executive Officer) | ||
| Dated: March 28, 2023 | By: | /s/ Ian K. Patel |
| Ian K. Patel | ||
| Principal Financial and Accounting Officer | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Dated: March 28, 2023 | By: | /s/ Anthony K. McDonald |
| Anthony K. McDonald, Chairman of the Board | ||
| Dated: March 28, 2023 | By: | /s/ James R. Shipley |
| James R. Shipley, Director | ||
| Dated: March 28, 2023 | By: | /s/ Nicholas J. Etten |
| Nicholas J. Etten, Director | ||
| Dated: March 28, 2023 | By: | /s/ Troy Reisner |
| Troy Reisner, Director | ||
| Dated: March 28, 2023 | By: | /s/ Marion Mariathasan |
| Marion Mariathasan, Director |
| 60 |
EXHIBITS
| 61 |
| + | Indicates a management contract or compensatory plan. |
| * | Filed herewith. |
| ** | Furnished herewith. |
| 62 |
Exhibit 4.8
Description of Securities
Description of Capital Stock
General
The following is a summary of information concerning capital stock of CEA Industries Inc. (“Company”) as of March 29, 2022. The summaries and descriptions below do not purport to be complete statements of the relevant provisions of the Company’s Articles of Incorporation (“Charter”) and Amended and Restated By-laws (the “By-laws”) and are entirely qualified by these documents.
Common Stock (“Common Stock”)
Our articles of incorporation, as amended on January 27, 2022, currently authorizes us to issue up to 200,000,000 shares of common stock.
Subject to prior dividend rights of the holders of any shares of issued and outstanding preferred stock of the Company, holders of shares of common stock are entitled to receive dividends when, as and if declared by the Board out of funds legally available for that purpose.
Each share of common stock is entitled to one vote on all matters submitted to a vote of stockholders. Holders of shares of common stock do not have cumulative voting rights. The holders of a majority of the shares of common stock present and entitled to vote in the election of directors can elect all directors standing for election.
In the event of any liquidation, dissolution or winding up of the Company, after the satisfaction in full of the liquidation preferences of holders of any shares of issued and outstanding preferred stock, holders of shares of common stock are entitled to ratable distribution of the remaining assets available for distribution to stockholders. The shares of common stock are not subject to redemption by operation of a sinking fund or otherwise. Holders of shares of common stock are not currently entitled to pre-emptive rights.
The issued and outstanding shares of common stock are fully paid and non-assessable. Any additional shares of common stock that the Company may issue in the future will also be fully paid and non-assessable.
Preferred Stock
Our articles of incorporation, as amended, authorizes us to issue up to 25,000,000 shares of undesignated preferred stock, par value $0.00001. We may issue preferred stock from time to time in one or more series, without shareholder approval, when authorized by our Board. No shares of preferred stock are outstanding.
The specific terms of any series of preferred stock will be governed by our articles of incorporation and by the certificate of designations relating to that series. The Board has the right, without prior approval of the holders of common stock, subject to any rights of currently issued preferred stock, to specify any and all terms of a series of preferred stock, including the rank, dividend and distribution rights, voting rights, liquidation rights and redemption, conversion and preemption rights. The issuance of preferred stock could have the effect of restricting dividends on our common stock, diluting the voting power of our common stock, impairing the liquidation rights of our common stock, or delaying or preventing a change in control of us, all without further action by our stockholders.
September 2021 Warrants
As part of the purchase of the Series B Preferred Stock in September 2021, which is now fully converted and redeemed, the Company issued a warrant to purchase up to 192,982 shares of common stock, until September 28, 2024 at an initial exercise price of $9.45, subject to adjustment for stock splits, stock dividends and other typical adjustments and changes in capitalization, including mergers and acquisitions and distribution of rights. This warrant provides for cashless exercise if the underlying shares of common stock are not registered for resale by the holder. This warrant is subject to the registration rights agreement described below. This warrant provides for various penalties payable by the Company if it does not timely deliver the common stock issuable on exercise, and issuances upon exercise are subject to a 4.99% blocker provision.
The Company also issued to ThinkEquity LLC and its designees placement agent warrants to purchase up to an aggregate of 34,737 shares of common stock as part of the compensation due to ThinkEquity LLC in acting as the placement agent for the transaction in which we issued the Series B Preferred Stock, now fully converted and redeemed. Half of the warrants were issued on September 28, 2021, and the second half were issued on November 3, 2021. The exercise price per share of the placement agent warrants is $10.40, subject to adjustment for stock splits, stock dividends and other typical adjustments and changes in capitalization, including mergers and acquisitions and distribution of rights. The warrants are exercisable for three years, September 28, 2024 and November 3, 2024, based on the issuance date. The placement agent warrants have registration rights described below and may be included on the registration statement provided to the holder of the Series B Preferred Stock for registration of the common stock underlying the preferred shares and the investor warrant.
Registration Rights
The Company entered into a registration rights agreement with the then holder of the Series B Preferred Stock. Under the agreement, the Company is obliged to register the common stock underlying and issuable upon conversion of the Series B Preferred Stock, now converted, and exercise of the warrant issued to the holder of the then Series B Preferred Stock. The Company is obligated to file a registration statement for resale of the common stock no later than 180 days after the date of a qualified offering, and have it effective 225 days after the Qualified Offering if there is no SEC review of the resale registration statement, and if there is an SEC review, then 255 days after the date of the qualified offering. The Company is to keep the registration effective until all the shares registered have been sold or may be sold under Rule 144, without regard to volume and holding period restrictions. Securities of other holders may not be included on any registration statement for the securities of the holder of the Series B Preferred Stock, except those of holders of the warrants issued to ThinkEquity LLC and its designees, and there are the typical cut back provisions for any limitation of the number of shares of common stock that may be included thereon due to SEC policy. The registration rights agreement also has demand and piggyback registration rights. The registration rights agreement provides for substantive cash penalties due to the Investor if any of the obligations to register shares are not fulfilled on a timely basis. The registration rights agreement provides for typical securities indemnification to the holders in respect of the registration statement.
The warrants issued to ThinkEquity LLC also have registration rights. The holders of these warrants have one demand registration right, upon the request of 51% of the warrants outstanding, and unlimited piggyback registration rights for 7 years after the issuance date. If there is a demand for registration, the Company is obligated to file a registration statement within sixty days and use its reasonable best efforts to have the registration statement declared effective promptly thereafter.
Public Warrants – February 2022
On February 10, 2022, we issued in a public offering an aggregate of 5,811,138 warrants to investors. The warrants are traded on Nasdaq under the symbol CEADW. The warrants are exercisable for shares of our common stock, and all of such shares currently are registered for issuance upon the exercise of the warrants. Currently, the aggregate number of shares of common stock that may be acquired upon exercise of the warrants is 5,811,138 shares of common stock.
Form. The warrants will be issued in electronic book-entry form to the investors.
Exercisability. The warrants are exercisable at any time after their original issuance, and at any time up to the date that is five years after their original issuance. The warrants will be exercisable, at the option of each holder, in whole or in part by delivering to us a duly executed exercise notice and, at any time a registration statement registering the issuance of the shares of common stock underlying the warrants under the Securities Act is effective and available for the issuance of such shares, by payment in full in immediately available funds for the number of shares of common stock purchased upon such exercise. If a registration statement registering the issuance of the shares of common stock underlying the warrants under the Securities Act is not effective or available, the holder may, in its sole discretion, elect to exercise the warrant through a cashless exercise, in which case the holder would receive upon such exercise the net number of shares of common stock determined according to the formula set forth in the warrant. No fractional shares of common stock will be issued in connection with the exercise of a warrant. In lieu of fractional shares, we will pay the holder an amount in cash equal to the fractional amount multiplied by the exercise price or round up to the next whole share.
Exercise Limitation. A holder will not have the right to exercise any portion of the warrant if the holder (together with its affiliates) would beneficially own in excess of 4.99% of the number of shares of our common stock outstanding immediately after giving effect to the exercise, as such percentage ownership is determined in accordance with the terms of the warrants. However, any holder may increase or decrease such percentage to any other percentage not in excess of 9.99% upon at least 61 days’ prior notice from the holder to us.
Exercise Price. The exercise price per whole share of common stock purchasable upon exercise of the warrants is $5.00 per share of common stock. The exercise price is also subject to appropriate adjustment in the event of certain stock dividends and distributions, stock splits, stock combinations, reclassifications or similar events affecting our common stock and also upon any distributions of assets, including cash, stock or other property to our stockholders.
Transferability. Subject to applicable laws, the warrants may be offered for sale, sold, transferred or assigned without our consent.
Fundamental Transactions. In the event of a fundamental transaction, as described in the warrants and generally including any reorganization, recapitalization or reclassification of our common stock, the sale, transfer or other disposition of all or substantially all of our properties or assets, our consolidation or merger with or into another person, the acquisition of more than 50% of our outstanding common stock, or any person or group becoming the beneficial owner of 50% of the voting power represented by our outstanding common stock, the holders of the warrants will be entitled to receive upon exercise of the warrants the kind and amount of securities, cash or other property that the holders would have received had they exercised the warrants immediately prior to such fundamental transaction.
Rights as a Stockholder. Except as otherwise provided in the warrants or by virtue of such holder’s ownership of shares of our common stock, the holder of a warrant does not have the rights or privileges of a holder of our common stock, including any voting rights, until the holder exercises the warrant.
Pre-Funded Warrants
The following summary of certain terms and provisions of the pre-funded warrant that we issued as part of the conversion of the Series B Preferred Stock, which took place February 10, 2022. We issued a pre-funded warrant to purchase up to 170,382 shares of common stock.
Duration and Exercise Price. The pre-funded warrant was issued for $4.99 and has an initial exercise price per share equal to $0.01. The pre-funded warrants are immediately exercisable and may be exercised at any time until the pre-funded warrants are exercised in full, or they expire. The exercise price and number of shares of common stock issuable upon exercise is subject to appropriate adjustment in the event of stock dividends, stock splits, reorganizations or similar events affecting our common stock and the exercise price.
Exercisability. The pre-funded warrant is, at the option of the holder, in whole or in part, by delivering to us a duly executed exercise notice accompanied by payment in full for the number of shares of our common stock purchased upon such exercise (except in the case of a cashless exercise as discussed below). There is no expiration date for the pre-funded warrants. A holder (together with its affiliates) may not exercise any portion of the pre-funded warrant to the extent that the holder would own more than 4.99% (or at the election of the holder prior to the issuance of any pre-funded warrants, 9.99%) of the outstanding shares of common stock immediately after exercise. Any holder may increase such percentage to any percentage not in excess of 9.99% upon at least 61 days’ prior notice to us. No fractional shares of common stock will be issued in connection with the exercise of a pre-funded warrant. In lieu of fractional shares of common stock, we will pay the holder an amount in cash equal to the fractional amount multiplied by the exercise price of such pre-funded warrant or round up to the next whole share.
Cashless Exercise. In lieu of making the cash payment otherwise contemplated to be made to us upon such exercise in payment of the aggregate exercise price, the holder may elect instead to receive upon such exercise (either in whole or in part) the net number of shares of common stock determined according to a formula set forth in the pre-funded warrants.
Fundamental Transaction. In the event of a fundamental transaction, as described in the pre-funded warrants and generally including any reorganization, recapitalization or reclassification of our common stock, the sale, transfer or other disposition of all or substantially all of our properties or assets, our consolidation or merger with or into another person, the acquisition of more than 50% of our outstanding shares of common stock, or any person or group becoming the beneficial owner of 50% of the voting power represented by our outstanding shares of common stock, the holders of the pre-funded warrants will be entitled to receive upon exercise of the pre-funded warrants the kind and amount of securities, cash or other property that the holders would have received had they exercised the pre-funded warrants immediately prior to such fundamental transaction.
Transferability. Subject to applicable laws, a pre-funded warrant may be transferred at the option of the holder upon surrender of the pre-funded warrant to us together with the appropriate instruments of transfer.
Exchange Listing. The pre-funded warrant is not listed on any securities exchange or nationally recognized trading system.
Rights as a Stockholder. Except as otherwise provided in the pre-funded warrants or by virtue of such holder’s ownership of shares of our common stock, the holders of the pre-funded warrants do not have the rights or privileges of holders of our common stock, including any voting rights, until they exercise their pre-funded warrants.
On June 21, 2022, the holder of all 170,382 pre-funded conversion warrants exercised all of their warrants on a cashless basis and received 169,530 shares of the Company’s common stock as a result of the exercise.
No pre-funded conversion warrants remained outstanding as of December 31, 2022.
Representative’s Warrants
Upon closing of our offering of shares and warrants in February 2022, we issued to the Representative of the underwriters, and its designees, as compensation, several warrants to purchase up to 290,557 shares of common stock, which was equal to 5% of the aggregate number of shares of common stock sold in the offering. The Representative’s Warrants are exercisable at a per share exercise price of $5.1625. The Representative’s Warrants are five-year warrants, exercisable at any time and from time to time, in whole or in part, commencing 180 days from the effective date of the registration statement of the aforementioned offering. The exercise price and number of shares issuable upon exercise of the warrants may be adjusted in certain circumstances including in the event of a stock dividend or our recapitalization, reorganization, merger or consolidation. However, the warrant exercise price or underlying shares will not be adjusted for issuances of shares of common stock at a price below the warrant exercise price.
The Representative Warrants have a one-time demand registration right that may be exercised within five years from the effective date of the registration statement for the aforementioned offering and unlimited piggyback registration rights provided they will not be exercised after seven years from the effective date of the registration statement for the aforementioned offering. We will bear all fees and expenses attendant to registering the securities issuable on exercise of the warrants other than underwriting commissions incurred and payable by the holders.
Exhibit 21.1
SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT
The following are the significant subsidiaries of CEA Industries Inc. as of December 31, 2022 and the states or jurisdictions in which they are organized. Except as otherwise specified, in each case CEA Industries Inc. owns, directly or indirectly, 100% of the voting securities of each subsidiary.
| Name | State or jurisdiction of Entity | |
| Hydro Innovations, LLC | Colorado |
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CEA Industries Inc.
Louisville, CO
We hereby consent to the incorporation by reference in each of the Registration Statement of CEA Industries Inc. on Form S-8 (No. 333-219674) pertaining to the 2017 Equity Incentive Plan and Form S-8 (No.333-263955) pertaining to the 2021 Equity Incentive Plan of our report dated March 28, 2023, relating to the consolidated financial statements of CEA Industries Inc., which appears in this Annual Report on Form 10-K for the year ended December 31, 2022.
| /s/ Sadler, Gibb & Associates, LLC| | |
| Draper, UT | |
| March 28, 2023 |
Exhibit 31.1
CERTIFICATION PURSUANT TO RULE 13a-14(a) and 15d-14(a)
UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
I, Anthony K. McDonald, the Chief Executive Officer of CEA Industries Inc. certify that:
1. I have reviewed this annual report on Form 10-K of CEA Industries Inc. for the fiscal year ended December 31, 2022;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and registrant’s board of directors (or persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 28th day of March 2023.
| By: | /s/ Anthony K. McDonald | |
Anthony K. McDonald Chief Executive Officer |
Exhibit 31.2
CERTIFICATION PURSUANT TO RULE 13a-14(a) and 15d-14(a)
UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
I, Ian K. Patel, the Principal Financial and Accounting Officer of CEA Industries Inc. certify that:
1. I have reviewed this annual report on Form 10-K of CEA Industries Inc. for the fiscal year ended December 31, 2022;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the registrant’s board of directors (or persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 28th day of March 2023.
| By: | /s/ Ian K. Patel | |
Ian K. Patel Principal Financial and Accounting Officer |
Exhibit 32.1
CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K for the year ended December 31, 2022 (the “Report”) of CEA Industries Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Anthony K. McDonald, the Chief Executive Officer of the Registrant, hereby certify, to the best of my knowledge, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| /s/ Anthony K. McDonald | ||
| Name: | Anthony K. McDonald, Chief Executive Officer | |
| Date: | March 28, 2023 |
This certification accompanies this Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.
Exhibit 32.2
CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K for the year ended December 31, 2022 (the “Report”) of CEA Industries Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Ian K. Patel, the Principal Financial and Accounting Officer of the Registrant, hereby certify, to the best of my knowledge, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| /s/ Ian K. Patel | ||
| Name: | Ian K. Patel, Principal Financial and Accounting Officer | |
| Date: | March 28, 2023 |
This certification accompanies this Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.