UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM ____ TO _______

 

Commission File Number: 000-54286

 

SURNA INC.

(Exact name of registrant as specified in its charter)

 

Nevada   27-3911608

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1780 55 th Street, Suite C, Boulder, Colorado   80301
(Address of principal executive offices)   (Zip code)

 

(303) 993-5271

(Registrant’s telephone number, including area code)

 

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Class Registered

 

Common stock, par value $0.00001 per share

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X] .

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X] .

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days. Yes [X] No [  ] .

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ] .

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer, “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer [  ] Accelerated Filer [  ]
Non-accelerated Filer [  ] Smaller Reporting Company [X]
(Do not check if smaller reporting company) Emerging Growth Company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X] .

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $18.0 million based upon a closing price of $0.1175 reported for such date on the OTCMarkets. Common shares held by each executive officer and director and by each person who owns 5% or more of the outstanding common shares have been excluded in that such persons may be deemed to be affiliates.

 

As of March 30, 2018, the number of outstanding shares of common stock of the registrant was 214,976,478.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement relating to the 2018 Annual Meeting of Stockholders, to be filed within 120 days after the close of the registrant’s year end, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 
 

 

Surna Inc.

Annual Report on Form 10-K

For Fiscal Year Ended December 31, 2017

 

Table of Contents

 

      Page
Part I      
  Item 1. Business 4
  Item 1A. Risk Factors 11
  Item 1B. Unresolved Staff Comments 21
  Item 2. Properties 22
  Item 3. Legal Proceedings 22
  Item 4. Mine Safety Disclosures 22
       
Part II      
  Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 23
  Item 6. Selected Financial Data 24
  Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 24
  Item 7A. Quantitative and Qualitative Disclosures About Market Risk 32
  Item 8. Financial Statements and Supplementary Data 32
  Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 32
  Item 9A. Controls and Procedures 32
  Item 9B. Other Information 33
       
Part III      
  Item 10. Directors, Executive Officers and Corporate Governance 34
  Item 11. Executive Compensation 34
  Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 34
  Item 13. Certain Relationships and Related Transactions, and Director Independence 34
  Item 14. Principal Accountant Fees and Services 34
       
Part IV      
  Item 15. Exhibits and Financial Statement Schedules 35
     
  Signatures 37

 

2
 

 

In this Annual Report on Form 10-K, unless otherwise indicated, the “Company”, “we”, “us” or “our” refer to Surna Inc. and, where appropriate, its wholly owned subsidiaries.

 

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 inherent uncertainty of product development;
       
    regulatory, legislative and judicial developments, especially those related to changes in, and the enforcement of, cannabis laws;
       
     increasing competitive pressures in our industry;
       
     our relationships with our customers and suppliers;
       
     general economic conditions or conditions affecting demand for the products offered by us in the markets in which we operate, being less favorable than expected;
       
      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 to fund our growth strategy, including possible acquisitions;
       
     future revenue being lower than expected; and
       
      our intention not to pay dividends.

 

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this annual report on Form 10-K should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in “Risk Factors” in this Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, to reflect events or circumstances occurring after the date of this Annual Report on Form 10-K. The forward-looking statements and projections contained in this Annual Report on Form 10-K are excluded from the safe harbor protection provided by Section 27A of the Securities Act.

 

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PART I

 

Item 1. Business

 

Overview

 

We were incorporated in the State of Nevada on October 15, 2009. On July 25, 2014, we acquired 100% of the membership interests of Hydro Innovations, LLC, a Colorado limited liability company (“Hydro Innovations”) from Stephen and Brandy Keen (the “Keens”). Hydro Innovations was founded by the Keens in Austin, Texas in 2006 to provide agricultural and other growers with the means to maintain a properly controlled indoor cultivation environment with customized, purpose-built cooling equipment, rather than repurposing conventional equipment made for comfort cooling. In 2011, Hydro Innovations delivered its environmental control system to one of the first commercial, state-regulated cannabis cultivation facilities licensed to grow medical cannabis in Arizona.

 

As state laws regarding the use of cannabis have evolved, we have focused on designing, engineering and manufacturing application-specific environmental control and air sanitation systems for commercial, state- and provincial-regulated indoor cannabis cultivation facilities in the U.S. and Canada. Our engineering and technical team provides energy and water efficient solutions that allow growers to meet the unique demands of a cannabis 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.

 

Our objective is to leverage our experience in this space in order to bring value-added climate control solutions to our customers that help improve their overall crop quality and yield as well as optimize the resource efficiency of their controlled environment (i.e., indoor and greenhouses) cultivation facilities. We have been involved in consulting, equipment sales and/or full-scale design for over 700 grow facilities since 2006 making us a trusted resource for indoor environmental design and control management for the cannabis industry.

 

Our customers have included small cultivation operations to licensed commercial facilities ranging from several thousand to more than 100,000 square feet. We have sold our equipment and systems throughout the U.S. and Canada as well as internationally in South Africa, Switzerland and the United Kingdom. Our revenue stream is derived primarily from supplying mechanical engineering services and climate and environmental control equipment to commercial indoor cannabis grow facilities. We also sell equipment to smaller cultivators who can purchase either directly from us, or from our authorized wholesalers or retailers. Though our customers do, we neither produce nor sell cannabis.

 

We are headquartered in Boulder, Colorado.

 

Shares of our common stock are traded on the OTCMarkets under the ticker symbol “SRNA.”

 

Products and Services

 

System Design and Engineering Services

 

Our technical experience and know-how in designing indoor cannabis cultivation facilities allow us to deliver to our customers practical solutions to complicated problems in three primary areas: precision climate and environmental controls, energy and water efficiency, and building code and permitting. Our engineering design typically includes all mechanical components of a climate control system: cooling and heating, dehumidification, ventilation, air sanitation and odor control. We provide load calculations, equipment specifications, and engineered systems drawings for both the cultivation and comfort cooling portions of our customers’ facilities. We also have experience in, or knowledge of, state and local permitting and code compliance for cannabis facilities in states and provinces where cannabis has been legalized for either recreational or medical use, or is expected to be legalized.

 

Since 2006, we have been continuously improving our products and designs which we believe distinguishes us from our competition, including local heating, ventilation and air conditioning (“HVAC”) contractors, traditional HVAC design consultants, and others who may lack our cannabis-specific expertise. Traditional mechanical engineers, without our cannabis experience, are typically unfamiliar with the precise climate and air control requirements needed for cannabis cultivation. As important, they may be unable to effectively navigate the local code and permitting rules which did not contemplate cannabis cultivation facilities when enacted. With our engineering design resources and experience, we are able to provide a code-compliant mechanical plan set in any state or province by collaborating with local regulators and our customers to come up with creative solutions that not only meet the intent of the local codes but also address concerns about the growing energy and resource usage of these facilities.

 

4
 

 

Controlled environment cannabis cultivation facilities are energy intensive, with high density lighting and heavy HVAC requirements. We believe that cultivators who can reduce their energy consumption, and thereby energy costs, will be better situated to succeed in the increasingly competitive cannabis cultivation market, especially as more cultivators enter the market and the wholesale price per pound of cannabis continues to decline. Our engineering and technical sales team, which currently consists of eight people, is highly qualified and committed to delivering energy and resource efficient solutions to commercial cultivators. We recently augmented this team with the hire of a new Director of Engineering who is a licensed professional engineer and has over 10 years’ experience in mechanical engineering and environmental control systems design. In addition to our experience in meeting the demands of cultivation, our mechanical and climate control expertise includes cooling and heating, ventilation, dehumidification, air sanitation and exchange, and odor control, which we believe makes us one of the leading mechanical system solution providers for the indoor cannabis cultivation market.

 

We believe our experience in controlled cultivation environments, coupled with our ability to deliver practical solutions to unique and complex problems, allows us to deliver precise control of temperature and humidity at a reasonable cost, while optimizing energy, water, biosecurity and waste management. While data centers have high-intensity energy profiles similar to indoor cannabis cultivation, cannabis growers are moving more slowly toward energy efficient practices largely due to fears on how such changes could affect the quality of their product. Our goal is to design our application-specific chilled water cooling systems to achieve the targeted temperature, humidity, watering and lighting requirements of our customers and, while doing so, boost their return on investment (“ROI”) by reducing electricity costs. Electricity expense is an indoor cultivator’s highest recurring operating expense, typically representing an average of about 20% of overall operating costs. According to a report by the Northwest Power and Conservation Council, an indoor grow system for only four cannabis plants uses as much energy as 29 refrigerators. According to this same report, 51% of an average cannabis cultivation facility’s total electrical consumption is for HVAC and dehumidification functions, and lighting consumption represents about 38%.

 

Apart from real estate and building construction costs, an indoor cultivation facility’s climate control and lighting systems often represents the highest start-up cost for a cultivator, accounting for about 32% of overall start-up costs. Median start-up costs for indoor cannabis cultivation facility are about $75 per square foot. We estimate the average cost of climate control systems for a 4,000-square foot plant canopy (i.e., the area dedicated to plant growing) at between $80,000 to $140,000, and between $500,000 to $875,000 for a 25,000-square foot plant canopy, depending on system design and options. Understanding the significant investment that our customers must make for their climate control systems, our technical sales and engineering staff are involved early in the sales process advising our customers’ management, architectural firms and installation contractors with technical, systems optimization, and other know-how.

 

While the cost of a climate control system can vary widely, these systems are also the single most important component for a cultivator’s growing success. The cultivator’s decision on a climate control system has far-reaching operating and economic consequences for years to come. An improperly designed system can produce ineffective temperature, humidity and ventilation control that can not only reduce yield, but also weaken the cannabis plant, making it susceptible to mold and insect infestation which, in turn, can result in crop loss. For a 10,000-square foot plant canopy facility, and assuming a wholesale price of $1,500 per pound, a single complete cannabis crop loss could mean lost revenue of between $600,000 to $1,800,000, with the variance depending on the cultivator’s yield efficiency which we estimate ranges from one to three pounds per 25 square feet of plant canopy.

 

We believe that plant quality, influenced by humidity, temperature and ventilation control, coupled with proper integrated pest management, will increase in importance as the cannabis industry grows, states become even more vigilant in regulating product quality and safety, and consumer demands evolve. Our experience has shown that our precision environmental controls can reduce the reliance on the use of harmful pesticides and fungicides. We believe our experience in the tightly regulated Canadian market where pharmaceutical-like testing protocols exist for filtration, air quality and post-harvest plant quality also gives us an advantage over our competitors, especially as product quality testing regulations continue to be enacted by state and local agencies.

 

With our focus on indoor commercial facilities, since 2015 we have designed environmental control systems for nearly 170 state-licensed, commercial cannabis cultivators. We leverage this experience to offer our customers a cost-effective system. By this, we mean the best value for a customer’s money for the “right” solution. We believe the “right” solution for our cultivation customers must provide tight temperature/humidity control, reduced mold, mildew and insect contamination risk (“bio-security”), minimized regulatory compliance risk, and lower maintenance complexity, costs and downtime. Our bio-security program uses a combination of a sealed facility and unique approaches to air sterilization to maintain facility standards while destroying harmful airborne microbes without the production of byproducts.

 

Our engineering design typically includes all mechanical components of a climate control system: cooling and heating, dehumidification, ventilation, air sanitation and odor control. We provide load calculations, equipment specifications, and engineered systems drawings for both the cultivation and comfort cooling portions of our customers’ facilities. We also have experience in, or knowledge of, state and local permitting and code compliance for cannabis facilities in states and provinces where cannabis has been legalized for either recreational or medical use, or is expected to be legalized.

 

5
 

 

Environmental Control and Air Sanitation Equipment

 

We sell a wide array of environmental control and air sanitation equipment to our customers, including:

 

  Chillers (in all capacities);
     
  Energy recovery units;
     
  Fan coils and air handlers;
     
  Dehumidification equipment;
     
  Odor control and air sanitation equipment;
     
  Pumps; and
     
  Controllers (such as thermostats, nutrient temperature controllers and CO2 monitors).

 

Some of our equipment is manufactured by third parties, such as chillers over 25-ton capacity, fans, carbon filters, pumps, air separators, expansion tanks, and air sanitizers. In some cases, we have private label arrangements with our third-party manufacturing partners where we have jointly worked to develop customized design features specific to indoor cannabis cultivation applications. Our other equipment is manufactured or assembled in-house at our Boulder, Colorado facility.

 

We believe we are a leading company in North America supplying a complete product line for environmental control and air sanitation systems for the indoor cannabis cultivation market. Since 2006, we have made it our mission to continuously expand our product line and improve the functionality of our equipment. Because of our market experience, we have gained valuable feedback and design insights from our customers, and we continue to innovate and respond as cultivation facilities have increased in both size and complexity.

 

The foundation of our climate control system is our application-specific chilled water cooling system design, which provides the cannabis cultivator with a more reliable and efficient thermal cooling solution compared to traditional HVAC systems that are designed for space comfort cooling but repurposed for cannabis cultivation. Our hydronic cooling systems rely on liquid, instead of air, as a medium for heat exchange, which can reduce the costs associated with cooling indoor cultivation facilities compared to traditional air conditioning products. The nature of the chilled water system allows for compressors (i.e., chillers) to be shared between grow rooms without exchanging air between rooms, which can reduce electrical infrastructure requirements and related facility start-up costs and improve redundancy. Our system also delivers chilled water through a closed loop and does not require traditional air conditioning ducting for heat removal, which can distribute contaminants and increase the risk of crop loss. Our simplified chilled-water systems are designed to mitigate crop loss due to equipment failure or contamination. And our systems can easily scale, allowing for redundant system design for a nominal increase in cost relative to traditional ducted HVAC systems, and are designed to minimize maintenance complexity, costs, and downtime.

 

New Product Initiatives

 

We recently formalized our new product development initiatives by establishing a new internal product development team led by our Director of New Product Development, who most recently worked for a global product safety and performance testing and certification provider, and supported by our new Director of Engineering.

 

This product development team is tasked with identifying, testing and developing new and improved products to complement our current mechanical and environmental control product offerings. As the cannabis industry evolves and more states and provinces legalize recreational and medical cannabis use, we believe the indoor cannabis cultivator will face new challenges and complexities and will look more to system design and engineering providers such as us for new technologies to gain a competitive advantage and increase their ROI. For this reason, we are expanding our system design and engineering services to include energy and utility modeling.

 

As the cannabis market expands, it is our intention to capitalize on leading-edge trends in facility automation. Controls can vary in scope from simple environment measuring devices to full-scale system automation, which could lead to higher crop yields, greater sustainability, more reliability and better bio-security – all of which are intended to improve the cultivator’s ROI. These products could include advanced thermostats with remote data applications, and a wide range of “smart” sensor-based technologies, enabling our cultivator customers to further capitalize on the increased automation of their climate control systems.

 

6
 

 

We have a contract with Sterling Pharms, LLC (“Sterling”), a Colorado-regulated cannabis cultivation facility principally owned and operated by Stephen Keen. Under our contract, which is expected to commence in the second quarter of 2018, Sterling has agreed to monitor, test and evaluate our products installed at the Sterling facility and to collect data and provide feedback to us on the energy and operational efficiency and efficacy of the installed products. We intend to use this information to improve, enhance and develop new or additional product features, innovations and technologies. We believe our access to performance metrics using a controlled testing environment will set us apart from our competitors who have limited access to actual grow data. The data collected is also expected to further our mission of striving to provide the best cannabis-specific climate control and air sanitation systems to optimize temperature/humidity control, bio-security safeguards, crop yield, and evolving sensor and automation technologies.

 

We will also consider strategic and opportunistic acquisitions that are consistent with our mission to bring new and improved products to the indoor cannabis cultivation market and that complement our current mechanical, environmental control and air sanitation product offering. As a public company, we may have an advantage over private companies in making such acquisitions, as we may be able to pay for a portion of potential acquisitions using our stock, allowing us to preserve our limited cash resources.

 

While we are focused on the foregoing new product initiatives, there can be no assurance that we will be able to successfully identify, test or develop new and improved products or complete any acquisitions. Further, in the event we are able to develop or acquire new products, there can be no assurance that such new products will generate revenue or profitability at the levels we expect. Accordingly, our efforts will be primarily focused on working with current and new manufacturing partners to jointly develop new and improved products with cannabis-specific applications.

 

Cannabis Industry

 

The demand for our climate control and air sanitation systems, including system design and engineering, proprietary equipment, and third party manufactured equipment, is primarily influenced by the construction of new cannabis cultivation facilities in the U.S. and Canada. Due to continued uncertainty of the cannabis industry following the U.S. Justice Department’s announcement of its opposition to legalized cannabis in early 2017, and the January 4, 2018 rescission of the Cole Memo, we believe there may be an interim decrease in the development and financing of new cannabis cultivation facilities. However, this possible market effect is expected to be mitigated by California’s legalization of recreational cannabis use, which became effective on January 1, 2018, and the anticipated mid-2018 federal legalization of cannabis in Canada.

 

Recent and anticipated regulatory changes involving medicinal and/or recreational cannabis use in various jurisdictions, such as California and Canada, tend to be a leading indicator for the granting of licenses for new facility construction. As more new cultivation facilities become licensed, we in turn have an expanded set of potential customers that might buy our climate control systems.

 

For 2018, we intend to pursue customers seeking to build indoor cannabis cultivation facilities in all regulated markets, with special focus in California and Canada. In Canada medicinal use of cannabis is federally legal, and the Canadian federal government has indicated its intention to legalize recreational use by July 2018, although passage of recreational use federal legislation in Canada is not certain. We also believe that Michigan could offer opportunities in 2018 as the state attempts to move to a recreational use regulated market, with the second-largest medical cannabis patient base in the U.S.

 

Selected highlights of the U.S., California and Canada cannabis markets gathered from various industry sources and publications are set forth below:

 

U.S.

 

  Total U.S. legal cannabis market was estimated at $7.9 billion in sales in 2017, with approximately 63% medical use and 37% recreational use
     
  Colorado was the largest recreational use state with nearly $1 billion in recreational use sales in 2017
     
  By 2025, the total U.S. legal cannabis market is expected to grow to $24.1 billion, a compound annual growth rate (“CAGR”) of 16%, with approximately a 12% CAGR in medical use and a 21% CAGR in recreational use
     
  Nine states (Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, Vermont and Washington), as well as Washington, D.C., allow dual recreational and medical use; 21 states allow medical use only
     
  In 2017, cannabis sales in the U.S. generated estimated state tax revenues of $745 million, with $609 million from cannabis-specific taxes and the remainder from general sales taxes

 

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  By 2020, estimated state tax revenues are expected to grow to nearly $2.3 billion, with $1.8 billion from cannabis-specific taxes

 

California

 

  California is the largest state for medical cannabis sales with $2.7 billion in 2016, or 57% of all medical cannabis sales in U.S.
     
  By 2020, California is expected to see over $3 billion in annual recreational use, and total legal cannabis sales of $5.6 billion
     
  The California Department of Food and Agriculture (“CDFA”) will issue 17 types of cannabis cultivation licenses for medical and recreational use beginning in 2018, including three indoor cultivation licenses depending on plant canopy area ranging from 501 to 22,000 square feet (indoor cultivation facilities in excess of 22,000 square feet of plant canopy will not be issued by CDFA prior to January 1, 2023)

 

Canada

 

  In 2017, the medical use market was about $500 million in sales
     
  The medical use market is projected to grow to $943 million in 2018 and $1.23 billion by 2025
     
  Upon expected implementation of recreational use by mid-2018, the recreational use market is estimated to be $1.9 billion in 2018 alone, with annual recreational use expanding to $6.5 billion by 2021
     
  The total legal cannabis market is estimated to reach $7.5 billion in sales by 2025, a 2018-2025 CAGR of 17%

 

Sales and Marketing

 

Our marketing efforts are targeted at owner/operators, investors and companies who are actively seeking licenses to produce cannabis and needing the professional engineering services that are required for the completion of license applications and/or permitting. As such, the projects we quote may not advance to the contract stage due to either a failure of our potential customer to receive licensure or to obtain project financing. In other cases, the successful licensee may have either been unknown to us at the time of application or elected to use a competing technology – e.g., a rooftop duct system or traditional split air conditioning system – as opposed to our ductless hydronic system.

 

Due to our market presence and experience, we receive frequent inbound inquiries for our products and services. We are, however, proactive in our outreach to our target market using industry trade shows and conventions and speaking engagements to achieve industry visibility and presence cost-effectively. In the past, we have attended most major trade and industry conventions including Lift Expo (Vancouver), CannaCon (Seattle), Cannabis Cultivation (Oakland), Lift Expo (Toronto), NCIA Cannabis Business Summit (San Jose), Cannabis World Congress & Business Expo (Los Angeles), CCIA/NCIA California Cannabis Business Conference (Anaheim) and the Marijuana Business Conference & Expo (Las Vegas). Brandy Keen, a principal shareholder, co-founder and Vice President, is often engaged as a speaker on climate control and energy efficiency by organizations such as National Cannabis Industry Association, Cannabis World Congress and Business Exposition and CannaCon and is frequently cited in industry-related publications. Ms. Keen is also a member of Denver’s Department of Public Health and Environment Cannabis Sustainability Work Group, whose mission is to promote sustainability in the cannabis industry through education, the development and dissemination of best practices, and the facilitation of dialogue between the cannabis industry, the community, and technical experts.

 

We are a part of the Founder’s Circle of Resource Innovations Institute (“RII”), with Brandy Keen being a member of their technical advisory committee. RII promotes and quantifies energy and water conservation in the cannabis industry. As a result of our Founder’s Circle status, we have access to RII’s data as well as speaking position opportunities at their seminars.

 

These programs give us industry exposure and allow us to showcase our experience in environment management for cannabis cultivation. With many new participants in the cannabis cultivation industry, we will also be able to provide existing and prospective customers with access to the Sterling facility for demonstration tours in a working indoor grow environment, which we believe may assist it in the sale of our products in the future.

 

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The sales cycles for commercial projects can vary significantly. From pre-sales and technical advisory meetings to sales contract execution, to engineering services and equipment delivery, and all the way through installation and commissioning of the installed system, the full cycle can range from six months to two years. Since we do not install the climate control systems, our customers are required to use third-party installation contractors, which adds to the variability of the sales cycle.

 

The length of our sales cycle is driven by numerous factors including:

 

  the large number of first-time participants interested in the indoor cannabis cultivation business;
     
  the complexities and uncertainties involved in obtaining state and local licensure and permitting;
     
  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;
     
  the customer’s need to obtain cultivation facility financing;
     
  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);
     
  the large price tag and technical complexities of the climate control and air sanitation system;
     
  availability of power; and
     
  delays that are typical in completing any construction project.

 

While our typical commercial project sales contracts are generally non-cancellable, based on the foregoing factors, there are risks that we may not realize the full contract value in a timely manner or at all. Completion of a sales contract is dependent upon our customers’ ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. In order to address these risks, we have three key milestones built into our contracts.

 

First, we provide our customer with engineering services and plans. In many cases, the engineering phase is done as part of the license application or building permit process and takes approximately six to eight weeks to complete. Our strategy is to secure the sales contract and commence the engineering portion of the project early in the customer’s planning phase of the project. This is important for a number of reasons: (i) we can assist our customers with their engineering and design plans as part of their licensing application process as well as better assure the customer has the right sized equipment for their application, leading to a higher probability of a successful grow, (ii) we are better positioned to utilize our technology for the project at an earlier stage, and (iii) we are able to help reduce a customer’s time to market. Before we commence the engineering phase of the project, we will generally require an advanced payment ranging from 5-10% of the total contract value.

 

Second, upon completion of the engineering phase, it may take our customer an average of five months to complete the facility build-out, with possible delays due to financing or other aspects which are beyond our control. Customer delays in obtaining financing and completing facility build-out make the completion timing of our sales contract unpredictable. For this reason, we require an additional advance payment equal to 40-55% of the contract value before we begin manufacturing our proprietary equipment items.

 

And third, the final phase of our contract typically involves the delivery of third-party manufactured equipment items and other equipment to complete the project. We typically will not deliver until we receive a final advance payment for the remaining 40-50% of the contract value. After the project is completed and the climate control system has been fully installed by third-party installation contractors, we will deploy our technicians to the customer’s cultivation facility to “commission” the system. Commissioning involves testing that the equipment has been properly assembled and installed by the installation contractor and assuring the equipment is operating within the agreed specifications.

 

Given the timing of the deliverables of our sales contracts, we can experience large variances in quarterly revenue. 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.

 

We have implemented a two-tiered sales model. The first tier involves direct sales efforts in various regions across the U.S. and Canada. We currently have three employees assigned to direct sales and one employee assigned to inside sales. Our inside salesperson handles inbound inquiries and typically handles equipment sales from smaller cultivators and hobbyists as well as our wholesale business. The second tier involves utilization of our two senior technical advisors and their expertise to complement the direct sales efforts.

 

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Our direct salespeople are primarily focused on commercial project sales (typically in excess of 4,000 square feet of plant canopy, although some may be smaller) with each covering a specific geographical territory:

 

  1. the Northeast region (which includes eastern Canada);
  2. the Pacific Northwest region (which includes Washington, Oregon, Alaska and western Canada); and
  3. the West Coast region (which currently includes all of California).

 

As the California market continues to develop, we are considering a number of strategies to make sure we have proper coverage in both southern and northern California.

 

Since August 2017, we have focused our efforts on expanding and better qualifying our pipeline of opportunities, increasing our bookings of new sales contracts, and improving our project management processes to shorten the time period from sales execution to project completion. To further these efforts, we have made investments to improve and add personnel in critical positions within sales, sales management, project management, engineering, and production. We also have improved our performance management and metrics to give better visibility about our customer pipeline, the expected timing of new sales orders, the completion of our active commercial projects and more defined departmental accountability.

 

We are in the process of completing facility improvement and expansion program, increasing our approximate square footage from 12,700 to 18,600, and increasing our production floor space from 5,900 to 9,200 square feet. We are reconfiguring our production processes and work flows in an effort to increase our production capacity and improve efficiencies. These actions are expected to be completed in the second quarter of 2018, and they will be partially funded with a tenant improvement allowance being provided by our landlord as part of our new lease agreement.

 

We are also committed to continuing to improve our financial organization including, without limitation, expanding our accounting staff 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, these improvements have not always been possible and may not be economically feasible now or in the future.

 

We believe these investments are necessary to position us for our expected future growth. With the lengthy sales cycle, it may take six to 12 months or more before we can begin to realize a return on these investments. Nonetheless, 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. We continue to focus on increasing our sales contract backlog and quoting on larger (i.e., greater than $100,000) projects in an effort to increase revenue. We also will focus on leveraging our current market position and presence to build our pipeline in the California and Canadian markets, as well as other emerging U.S. markets. As sales opportunities are converted into contracts, we are preparing to meet our customers’ demand for timely delivery of a fully engineered, application-specific, climate control system.

 

Competition

 

Our climate control and air sanitation systems and our related engineering services compete with various national and local HVAC contractors and traditional HVAC equipment suppliers who traditionally resell, design, and implement climate control systems for commercial and industrial facilities and data centers, none of which have the specific knowledge that we have about the complexities and challenges of cannabis cultivation. We have positioned ourselves to differ from these competitors by providing engineering and climate control systems, based on our unique chilled-water cooling system design and equipment, tailored specifically for managing the distinct challenges involved in indoor cannabis cultivation. We believe our cannabis-specific applications and experience in this 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/humidity control, reduce bio-security risk, and minimize maintenance complexity, costs and downtime. However, as the legal cannabis market continues to grow, we expect increased competition in both the climate control systems and engineering services with some of these competitors attempting to emulate our cannabis specific-application model.

 

Intellectual Property

 

We rely on a combination of patent and trademark rights, trade secrets, laws that protect intellectual property, confidentiality procedures, and contractual restrictions with our employees and others to establish and protect our intellectual property rights. We have several pending patent applications, which include a combination of Patent Cooperation Treaty, utility and design patent applications that are directed to certain of our technologies. We have registered trademark registrations around our core Surna brand (“Surna”) 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 wordmark is also registered in the European Union and Canada. Subject to ongoing use and renewal, trademark protection is potentially perpetual.

 

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Operating Segments

 

We currently operate in one primary business segment, which encompasses designing, engineering, manufacturing, and distributing climate and environmental control systems for use in indoor cannabis grow facilities.

 

Employees

 

We currently have 35 full-time employees, however, we may utilize, and have in the past utilized, the services of a number of consultants, independent contractors, and other non-employee professionals. Additional employees will be hired in the future depending on need and our expansion.

 

Government Regulation

 

The use, possession, cultivation, and distribution of cannabis is prohibited by U.S. federal law. This includes medical and recreational cannabis. Although certain states have legalized medical and recreational cannabis, companies and individuals involved in the sector are still at risk of being prosecuted by federal authorities. Further, the landscape in the cannabis industry changes rapidly. This means that at any time the city, county, or state where cannabis is permitted can change the current laws and/or the federal government can supersede those laws and take prosecutorial action. Given the uncertain legal nature of the cannabis industry, it is imperative that investors understand that investments in the cannabis industry should be considered very high risk. A change in the current laws or enforcement policy can negatively affect the status and operation of our business, require additional fees, stricter operational guidelines and unanticipated shut-downs.

 

See the “ Risks Related to the Cannabis Industry ” set forth in Item 1A of this Annual Report which addresses various risks related to U.S. and foreign regulation and enforcement of cannabis laws and regulations and their potential impact on our business.

 

Available Information

 

Our website address is www.surna.com . Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are filed with the U.S. Securities and Exchange Commission (the “SEC”). Such reports and other information filed by us with the SEC are available free of charge through our website when such reports are available on the SEC’s website.

 

The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov .

 

The contents of the websites referred to above are not incorporated into this filing. Further, references to the URLs for these websites are intended to be inactive textual references only.

 

Item 1A. Risk Factors

 

Investing in our common stock involves a number of significant risks. Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully 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 occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment.

 

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Risks Relating to Our Business

 

We are solely dependent upon the funds we have raised so far to continue our operations, which may be insufficient to achieve significant revenue, and we may need to obtain additional financing, which may not be available to us and could dilute the ownership of current shareholders.

 

Historically, we have raised equity and debt capital to support our operations. We anticipate we will require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. We may need additional funds to complete further development of our business plan to achieve a sustainable sales level where ongoing operations can be funded out of revenue. During 2016 and 2017, we extinguished all of our debt owed to investors. In addition, we completed two private placement unit offerings, consisting of common stock and warrants, to accredited investors in 2017 for aggregate proceeds of $4,453,080. We will likely need to raise debt and equity financing in the future in order to continue our operations and achieve our growth targets. However, there can be no assurance that such financing will be available in sufficient amounts and on acceptable terms, when and if needed, or at all. 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. We believe our cash balances and cash flow from operations will be insufficient to fund our operations and growth for the next 12 months. If we are unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows from operations, then we will likely need to raise additional funding to continue our operations. Our failure to obtain sufficient financing on acceptable terms and conditions could have a material adverse effect on our growth prospects and our business, financial condition and results of operations.

 

To the extent that we raise additional equity capital, existing shareholders will experience a dilution in the voting power and ownership of their common stock, and earnings per share, if any, would be negatively impacted. Our inability to use our equity securities to finance our operations could materially limit our growth. Any borrowings made to finance operations 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 such 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.

 

Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern.

 

We have determined that our ability to continue as a going concern is dependent on raising additional capital to fund our operations and ultimately on generating future profits. Our independent registered public accounting firm has also included a “going concern” explanatory paragraph in its opinion on our financial statements, expressing substantial doubt that we can continue as an ongoing business for the next 12 months. Our financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we are unable to successfully raise the capital we need, we may need to and believe we can reduce the scope of our business to fully satisfy our future short-term liquidity requirements. If we cannot raise additional capital or reduce the scope of our business, we may be otherwise unable to achieve our goals or continue our operations. While we believe that we will be able to raise the capital we need to continue our operations, there can be no assurances that we will be successful in these efforts or will be able to resolve our liquidity issues or eliminate our operating losses.

 

Even if we obtain more customers, there is no assurance that we will make a profit.

 

Even if we obtain more customers, or increase the average order size, 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.

 

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 a significant strain 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 and shall report such in management’s report in this annual report on Form 10-K. In the event that our status with the 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.

 

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We have identified a material weakness 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.

 

We currently do 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.

 

Our inability to effectively manage our growth could harm our business and materially and adversely affect our operating results and financial condition.

 

Our strategy envisions growing our business. We plan to expand our product, sales, administrative and marketing operations. Any growth in or expansion of our business is likely to continue to place a strain on our management and administrative resources, infrastructure and systems. As with other growing businesses, 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 new 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:

 

  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.

 

Our inability or failure to manage our growth and expansion 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 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 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 do not accept our products, our sales and revenue will decline, resulting in a reduction in our operating income or possible increase in losses.

 

If we do not successfully develop additional products and services, or if such products and services are developed but 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 are currently investigating a number of new and improved product opportunities, and we intend to collaborate with manufacturing partners to optimize these products for the cannabis market. The processes of identifying and commercializing new products is 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 new products before knowing whether our investments will result in products the market will accept. We may be unable to differentiate our new products from those of our competitors, and our new products may not be accepted by the market. There can be no assurance that we will successfully identify additional new product opportunities, develop and bring new 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 noncompetitive. 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.

 

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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 and the planned growth and expansion of our business depend on us achieving greater and broader acceptance of our products and services and expanding our commercial customer base. 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 in The People’s Republic of China, for materials used to assemble our products. 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. Such disruptions in our business and/or delays in fulfilling orders could harm our reputation and could potentially cause us to lose our market.

 

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.

 

Our 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 products similar to ours, or make our products obsolete.

 

We are involved in a highly competitive industry where we compete with national and local HVAC contractors and traditional HVAC equipment suppliers who offer products and services similar to those that we sell. These competitors may have far greater resources than we do, giving our competitors an advantage in developing and marketing products and services similar to ours or products that make our products obsolete. While we believe we are better positioned to meet the exacting demands of a cannabis 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.

 

We will be required to attract and retain top quality talent to compete in the marketplace.

 

We believe our future growth and success will depend in part on our ability to attract and retain highly 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.

 

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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 to a significant extent on the continued service of these key employees. 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 of 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. 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 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.

 

The recently passed comprehensive U.S. tax reform bill could adversely affect our business and financial condition.

 

On December 22, 2017, President Trump signed into law new legislation that significantly revises the Internal Revenue Code of 1986, as amended (the “Code”). The newly enacted U.S. federal income tax law, among other things, contains significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of current year taxable income and elimination of net operating loss carrybacks, one-time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. Notwithstanding the reduction in the corporate income tax rate, the overall impact of the new federal tax law is uncertain and our business and financial condition could be adversely affected. In addition, it is uncertain if and to what extent various states will conform to the newly enacted federal tax law.

 

Our ability to use net operating losses to offset future taxable income may be subject to limitations.

 

As of December 31, 2017, we had federal and state net operating loss carryforwards of $10,848,000. Our ability to deduct these net operating loss carryforwards against future taxable income is contingent on our generation of future taxable income. Our federal and state net operating loss carryforwards will expire, if not utilized, in the years 2034 through 2037. These net operating loss carryforwards could expire unused and be unavailable to offset future income tax liabilities. Under the newly enacted federal income tax law, federal net operating losses incurred in 2018 and in future years may be carried forward indefinitely, but the deductibility of such federal net operating losses is limited. It is uncertain if and to what extent various states will conform to the newly enacted federal tax law. In addition, under Section 382 of 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 shifts in our stock ownership, some of which may be outside of our control. If an ownership change occurs and our ability to use our net operating loss carryforwards is materially limited, it would harm our future operating results by effectively increasing our future tax obligations.

 

Risks Related to the Cannabis Industry

 

U.S. federal laws, regulations and enforcement may adversely affect the implementation of state and local cannabis laws and regulations and, correspondingly, may adversely impact our customers. Such impact may negatively affect our revenue and profits, or we may be found to be in violation of the Controlled Substances Act or other U.S. federal, state or local laws.

 

Currently, 30 states and the District of Columbia permit some form of whole-plant cannabis use and cultivation either for medical or recreational use. Thirty-eight states allow or are considering legislation to allow the possession and use of non-psychoactive cannabidiol (“CBD”) oil for some medical conditions only. There are efforts in many other states to begin permitting cannabis use and/or cultivation in various contexts, and it has been reported that 11 states are actively considering bills to permit recreational use or to decriminalize the use of cannabis. Nevertheless, the U.S. federal government continues to prohibit cannabis in all its forms as well as its derivatives. Under the federal Controlled Substances Act (the “CSA”), the policy and regulations of the U.S. federal government and its agencies is that cannabis has no currently accepted medical use and a high potential for abuse, and a range of activities, including cultivation and use of cannabis, is prohibited. Until Congress amends the CSA or the executive branch de-schedules or reschedules cannabis under it, there is a risk that federal authorities may enforce current federal law. Enforcement of the CSA by federal authorities could impair our revenue and earnings, and it could even force us to cease operating entirely in the cannabis industry. The risk of strict federal enforcement of the CSA in light of congressional activity, judicial holdings and stated federal policy, including enforcement priorities, remains uncertain.

 

In an effort to provide guidance to federal law enforcement, the U.S. Department of Justice (the “DOJ”) issued Guidance Regarding Marijuana Enforcement to all United States Attorneys in a memorandum from Deputy Attorney General David Ogden on October 19, 2009, in a memorandum from Deputy Attorney General James Cole on June 29, 2011 and in a memorandum from Deputy Attorney General James Cole on August 29, 2013 (the “Cole Memo”). The Cole Memo also had provided guidance to federal prosecutors concerning cannabis enforcement in light of state laws legalizing medical and recreational cannabis possession in small amounts. Each memorandum provided that the DOJ was committed to enforcement of the CSA but the DOJ was also committed to using its limited investigative and prosecutorial resources to address the most significant threats in the most effective, consistent and rational way.

 

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The Cole Memo sets forth certain enforcement priorities that are important to the federal government:

 

  Distribution of marijuana to children;
     
  Revenue from the sale of marijuana going to criminals;
     
  Diversion of medical marijuana from states where it is legal under state law to states where it is not;
     
  Using state-authorized marijuana activity as a pretext for other illegal drug activity;
     
  Violence in the cultivation and distribution of marijuana;
     
  Drugged driving and other adverse public health consequences;
     
  Growing marijuana on public lands; and
     
  Possession or use of marijuana on federal property.

 

On January 4, 2018, the Cole Memo was rescinded by Attorney General Jeff Sessions (the “Sessions Memo”). The effect of rescinding the Cole Memo guidance is that U.S. Attorneys now have greater discretion to prosecute CSA violations with respect to individuals and companies that are otherwise complying with state law and the tenets previously set forth in the Cole Memo. The DOJ has not historically devoted resources to prosecuting individuals whose conduct is limited to possession of small amounts of cannabis for use on private property but relied on state and local law enforcement to address that form of cannabis activity. In the event the DOJ goes beyond the objectives of the Cole Memo guidance and begins strict enforcement of the CSA in states that have laws legalizing medical and recreational cannabis in small amounts, there may be a direct and adverse impact to our revenue and earnings, and it could even force us to cease operating entirely in the cannabis industry.

 

In 2014, the U.S. House of Representatives passed an amendment (the “Rohrabacher-Farr Amendment”) to the Commerce, Justice, Science, and Related Agencies Appropriations Bill, which funds the DOJ. The Rohrabacher-Farr Amendment prohibits the DOJ from using federally appropriated funds to prevent states with medical cannabis laws from implementing such laws by investigating and prosecuting individuals or businesses operating in accordance with applicable state laws. In August 2016, a Ninth Circuit federal appeals court ruled in United States v. McIntosh that the Rohrabacher-Farr Amendment bars the DOJ from spending funds on the prosecution of conduct that is allowed by state medical cannabis laws, provided that such conduct is in strict compliance with applicable state law. In March 2015, bipartisan legislation titled the Compassionate Access, Research Expansion, and Respect States Act (the “CARERS Act”) was introduced, proposing to allow states to regulate the medical use of cannabis by changing applicable federal law, including by reclassifying cannabis under the CSA to a Schedule II controlled substance and thereby changing the plant from a federally-criminalized substance to one that has recognized medical uses.

 

Although these developments have been met with a certain amount of optimism in the scientific community, the CARERS Act has not yet been adopted, and the Rohrabacher-Farr Amendment, as an amendment to an appropriations bill, must be renewed annually on a bipartisan basis in order to remain in effect. The Rohrabacher-Farr Amendment has been renamed the Rohrabacher-Blumenauer Amendment through the amendment language, but the intent remains the same. The currently enacted Commerce, Justice, Science, and Related Agencies Act, which includes the Rohrabacher-Blumenauer Amendment, is effective, by passage of continuing resolutions, through September 30, 2018. Following the Sessions Memo, however, the federal government could at any time change its enforcement priorities against the cannabis industry. Any change in enforcement priorities could render our operations unprofitable or even prohibit such operations. 

 

The former Obama administration effectively stated that it is 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. However, as discussed above, the Sessions Memo rescinded the Cole Memo enforcement guidance. Any further change in enforcement policy and a decision to enforce the federal laws more aggressively could cause significant financial damage to us and our shareholders and could adversely affect our ability to obtain equity or debt financing, or even prohibit our operating in the cannabis industry entirely.

 

We have not requested or obtained any opinion of counsel or ruling from any authority to determine if our operations are in compliance with or violate any state or federal laws or whether we are assisting others to violate a state or federal law. In the event that our operations are deemed to violate any laws or if we are deemed to be assisting others to violate a state or federal law, we could have liability that could cause us to modify or cease our operations.

 

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Our recent focus on and entrance into the cannabis industry in Canada presents significant opportunities, but it also presents significant risks that may ultimately affect the revenue and earnings of our business.

 

In addition to U.S. operations, we have recently begun selling products and services to cannabis growers in Canada, where medical cannabis currently is legal across the country both federally and provincially. Canadian Prime Minister Trudeau also is expected to introduce legislation to legalize, but strictly control, recreational use of cannabis. Passage of such legislation is expected in 2018 but remains uncertain. We believe Canada, with its federal legal regime, represents a significant business opportunity for us, but there can be no assurance that we will be able to make any additional sales of products or services in Canada. As a result, our revenue and earnings may be adversely affected.

 

Successful litigation by non-cannabis states affected by cannabis legalization could have significant adverse effects on our business.

 

Due to variations in state law among states sharing borders, certain states which have not approved any legal sale of cannabis may seek to overturn laws legalizing cannabis use in neighboring states. In December 2014, the attorney general of each of Nebraska and Oklahoma filed a complaint with the U.S. Supreme Court against the state of Colorado arguing that the Supremacy Clause (Article VI of the U.S. Constitution) prohibits Colorado from passing laws that conflict with federal anti-drug laws and that Colorado’s laws are increasing cannabis trafficking in neighboring states that maintain cannabis bans, thereby putting pressure on such neighboring states’ criminal justice systems. In March 2016, the U.S. Supreme Court, voting 6-2, declined to hear this case, but there is no assurance that it will do so in the future. Additionally, nothing prevents these or other states’ attorneys general from using the same or similar cause of action for a lawsuit in a lower federal or other court.

 

Previously, the U.S. Supreme Court has held that drug prohibition is a valid exercise of federal authority under the commerce clause; however, it has also held that an individual state itself is not required to adopt or enforce federal laws with which it disagrees. If the U.S. Supreme Court rules that a legal cannabis state’s legislation is unconstitutional, that could result in legal action against other states with laws legalizing medical and/or recreational cannabis use. Successful prosecution of such legal actions by non-cannabis states could have significant adverse effects on our business.

 

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.

 

Individual state laws do not always conform to the federal standard or to other states’ laws. A number of states have decriminalized cannabis to varying degrees; other states have created exemptions specifically for medical cannabis, and several have both decriminalization and medical laws. Nine states and the District of Columbia have legalized the recreational use of cannabis and various state legislatures are considering recreational use while ballot measures regarding recreational use are likely to be submitted to voters in 2018. Variations exist among states that have legalized, decriminalized, or created medical cannabis exemptions. 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.

 

As the possession and use of cannabis is illegal under the CSA, it is possible that our manufacture and sale of equipment that is used to cultivate cannabis may be deemed to be aiding and abetting illegal activities. It is also possible that our products could be considered “drug paraphernalia.”

 

Federal practices could change with respect to providers of equipment potentially usable by cultivators in the medical and recreational cannabis industry, which could adversely impact us. Cannabis growers use equipment that we offer for sale. While we are not aware of any threatened or current federal or state law enforcement actions against any supplier of equipment that might be used for cannabis growing, law enforcement authorities, in their attempt to regulate the illegal use of cannabis, may seek to bring an action or actions against us, including but not limited to a claim of aiding and abetting, or being an accessory to, another’s criminal activities or that our products are considered “drug paraphernalia.”

 

The federal aiding and abetting statute, U.S. Code Title 18 Section 2(a), provides that anyone who “commits an offense against the United States or aids, abets, counsels, commands, induces or procures its commission, is punishable as a principal.” Under U.S. Code Title 21 Section 863, the term “drug paraphernalia” means “any equipment, product or material of any kind which is primarily intended or designed for use in manufacturing, compounding, converting, concealing, producing, processing, preparing, injecting, ingesting, inhaling, or otherwise introducing into the human body a controlled substance.” Any drug paraphernalia involved in any violation of Section 863 shall be subject to seizure and forfeiture upon the conviction of a person for such violation. While Section 863(f) contains an exemption for any person authorized by local, state or federal law to manufacture, possess, or distribute such items, any such action may force us to cease operations and our investors could lose their entire investment.

 

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A risk exists that our activities could be deemed to be facilitating the selling or distribution of cannabis in violation of the CSA, or to constitute aiding or abetting, or being an accessory to, a violation of the CSA. There is also a risk that our products could be considered drug paraphernalia and could be subject to seizure. We believe, however, that such risks are relatively low. Federal authorities have not focused their resources on such tangential or secondary violations of the CSA, nor have they threatened to do so, with respect to the sale of equipment that might be used by cannabis cultivators, or with respect to any supplies marketed to participants in the medical and recreational cannabis industry. We are unaware of such a broad application of the CSA or the seizure of drug paraphernalia by federal authorities, and we believe that such an attempted application would be uncustomary.

 

If the federal government were to change its practices, or were to expend its resources investigating and prosecuting providers of equipment that could be usable by participants in the medical or recreational cannabis industry, such action could have a materially adverse effect on our operations, our customers, or the sales of our products. As a result of such an action, we may be forced to cease operations and our investors could lose their entire investment.

 

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, if not all, 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 set-backs 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.

 

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 the cannabis industry, many banks do not provide banking services to the cultivation and distribution segments of the 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, pay their employees and taxes, and having so much cash on hand also 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.

 

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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 cannabis 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 cannabis 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 the cannabis plant. This includes cultivators, medical dispensaries, marijuana retail stores and infused product manufacturers, as well as concentrates and cannabis 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.

 

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 officer’s 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.

 

Risks Related to Our Common Stock

 

Our common stock price may be volatile and may decrease substantially.

 

The trading price of our common stock has fluctuated substantially, and we expect that it will continue to do so. The price of our common stock 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;
     
  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;

 

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  changes in our Board of Directors or management;
     
  sales or purchases of our common stock by insiders, including sales of our common stock issued to employees, directors and consultants under our equity incentive plan 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.

 

Presently, an exchange listing of our common stock is not likely since we are a U.S.-based company focused on the cannabis industry, which remains illegal under federal law. Moreover, we may not be able to attract institutional ownership of our stock or research analysts to cover our stock in the foreseeable future.

 

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 stock price, 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 stocks in our industry, or the stock market in general, experiences a loss of investor confidence, the market price of our common stock 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 common stock 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.

 

The application of the “penny stock” rules could adversely affect the market price of our common shares and increase an investor’s transaction costs to sell those shares.

 

The SEC has adopted Rule 3a51-1, which establishes the definition of a “penny stock,” for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, Rule 15g-9 requires:

 

  that a broker or dealer approve a person’s account for transactions in penny stocks, and
     
  the broker or dealer receives from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.

 

In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:

 

  obtain financial information and investment experience objectives of the person, and
     
  make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.

 

The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:

 

  sets forth the basis on which the broker or dealer made the suitability determination, and

 

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  that the broker or dealer received a signed, written agreement from the investor prior to the transaction.

 

Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.

 

Our directors and officers possess significant voting power, and through their ownership of our common and preferred stock, may have the ability to control us and our corporate actions.

 

Brandy Keen, one of our founders and a director, Vice President and Secretary, beneficially owns, directly and indirectly with her spouse, Stephen Keen, 35,189,669 shares of preferred stock and 20,284,669 shares of common stock. Chris Bechtel, our Chief Executive Officer and President and a director, beneficially owns 11,632,761 shares of our common stock. As of December 31, 2017, we had 206,248,522 shares of common stock issued and outstanding and 77,220,000 shares of preferred stock issued and outstanding. The holders of preferred stock have one vote per share of preferred stock equivalent to one vote of our common stock. Accordingly, these officers and directors have a significant influence in determining the outcome of any corporate transaction or other matters submitted to our shareholders for approval, including mergers, consolidations, and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions. Such officers and directors may also have the power to prevent or cause a change in control. In addition, without the consent of these shareholders, we could be prevented from entering into transactions that could be beneficial to us. The interests of these shareholders may give rise to a conflict of interest with us and our shareholders.

 

Our Board of Directors is authorized to reclassify any unissued shares of our stock into one or more classes of preferred stock, 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 stock into one or more classes of preferred stock. Our Board of Directors will generally have broad discretion over the size and timing of any such reclassification, subject to a finding that the reclassification and issuance of such preferred stock is in the best interests of us and our existing common stockholders. We are authorized to issue up to 350,000,000 shares of common stock and 150,000,000 shares of preferred stock. As of December 31, 2017, we had 206,248,522 shares of common stock issued and outstanding and 77,220,000 shares of preferred stock issued and outstanding. In the event our Board of Directors opts to reclassify 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 cost of any such reclassification would be borne by our existing common stockholders. 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.

 

Rule 144 contains risks for certain shareholders.

 

From time to time, we issue shares on an unregistered basis, which may be eligible for resale under SEC Rule 144 promulgated under the Securities Act. In the event there are shares outstanding that can be sold under Rule 144, there may be market pressure on our stock.

 

We do not intend to pay cash dividends on our common stock.

 

We currently are not profitable and do not expect to achieve profitability in the foreseeable future. We have never declared or paid dividends on our common stock. We intend to invest any available funds to continue to grow our revenue. Accordingly, we do not expect to pay cash dividends to our stockholders now or in the foreseeable future.

 

The market price of our shares of common stock 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 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.

 

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.

 

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Item 2. Properties

 

We own no real property. On June 27, 2017, we executed a lease, which became effective September 29, 2017, for our manufacturing and office space at 1780 55 th Street, Boulder, Colorado 80301. The term of the lease commenced September 29, 2017 and continues through August 31, 2022. As of January 2, 2018, our leased space is approximately 18,600 square feet. We believe that our lease is at market rates and that there is sufficient space available in the Boulder, 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

 

Price Range of Common Stock

 

Our shares of common stock are quoted on the OTCQB operated by OTCMarkets under the symbol “SRNA.” The following table sets forth the range of the high and low bid prices of our common stock as reported on the OTCQB for the period beginning January 1, 2016 through December 31, 2017. The information reflects inter-dealer prices, without retail mark-ups, markdowns, or commissions, and may not necessarily represent actual transactions.

 

    Price Range  
Quarter Ended   High     Low  
             
2017                
December 31, 2017   $ 0.24     $ 0.10  
September 30, 2017   $ 0.15     $ 0.10  
June 30, 2017   $ 0.20     $ 0.10  
March 31, 2017   $ 0.23     $ 0.15  
                 
2016                
December 31, 2016   $ 0.25     $ 0.12  
September 30, 2016   $ 0.11     $ 0.08  
June 30, 2016   $ 0.10     $ 0.07  
March 31, 2016   $ 0.09     $ 0.06  

 

The closing price of our common stock on March 29, 2018 was $0.175 per share, as reported by the OTCQB.

 

As of March 30, 2018, we had approximately 180 shareholders of record and we believe we have approximately 16,835 beneficial shareholders.

 

Dividend Policy

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

 

Equity Compensation Plans

 

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 (or the compensation committee of the Board of Directors, 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 50,000,000 shares of our common stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. As of December 31, 2017, 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.

 

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The information for our 2017 Equity Plan as of December 31, 2017 is summarized as follows:

 

    Number of securities to be issued upon exercise of outstanding options, warrants and rights     Weighted-average exercise price of outstanding options, warrants and rights     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)     11,135,000     $ 0.122       36,244,506  
Total     11,135,000     $ 0.122       36,244,506  

 

(1) The number of securities remaining available for future issuance include: (i) 13,800,000 shares to be issued upon vesting outstanding RSUs, (ii) 8,600,000 shares to be issued in connection with incentive stock bonuses pursuant to certain employment agreements, and (iii) remaining Plan Shares of 13,844,506 which are available for future award under the 2017 Equity plan.

 

Refer to Note 16 – Equity Incentive Plans of the Notes to Consolidated Financial Statements, which are included as part of this Annual Report for the further details on our 2017 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 financial statements and related notes and other financial information appearing elsewhere in this Annual Report. In addition to historical information, the following discussion and other parts of this Annual Report contain 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 “Risk Factors” and “Forward-Looking Statements and Projections” appearing elsewhere herein.

 

Non-GAAP Financial Measures

 

To supplement our financial results on U.S. generally accepted accounting principles (“GAAP”) basis, we use the non-GAAP measures including net bookings and backlog, as well as other significant non-cash expenses such as stock-based compensation and certain debt-related expenses. 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.

 

Overview

 

The sales cycles for our commercial indoor cannabis cultivation projects can vary significantly, ranging from six months to two years in some cases. The sales cycle is impacted by numerous factors including:

 

  the large number of first-time participants interested in the indoor cannabis cultivation business;
     
  the complexities and uncertainties involved in obtaining state and local licensure and permitting;
     
  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;
     
  the customer’s need to obtain cultivation facility financing;
     
  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);
     
  the large price-tag and technical complexities of the climate control and air sanitation system;
     
  availability of power; and
     
  delays that are typical in completing any construction project.

 

While our typical commercial project sales contracts are generally non-cancellable, based on the foregoing factors, there are risks that we may not realize the full contract value in a timely manner or at all. Completion of a sales contract is dependent upon our customers’ ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. To address these risks, we generally require a series of advance payments from our customers: (i) before we commence engineering services, (ii) before we begin manufacturing our proprietary equipment items, and (iii) before delivery of third-party manufactured equipment items and other equipment to complete the project.

 

Given the timing of the deliverables of our sales contracts, we can experience large variances in quarterly revenue. 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.

 

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Since August 2017, we have focused our efforts on expanding and better qualifying our pipeline of opportunities, increasing our bookings of new sales contracts, and improving our project management processes to shorten the time period from sales execution to project completion. To further these efforts, we have made investments to improve and add personnel in critical positions within sales, sales management, project management, engineering, and production. We also have improved our performance management and metrics to give better visibility about our customer pipeline, the expected timing of new sales orders, the completion of our active commercial projects and more defined departmental accountability.

 

We are in the process of completing facility improvement and expansion, increasing our square footage from 12,700 to 18,600, and increasing our production floor space from 5,900 to 9,200 square feet. We are reconfiguring our production processes and work flows in an effort to increase our production capacity and improve efficiencies. These actions are expected to be completed in the second quarter of 2018, and they will be partially funded with a tenant improvement allowance being provided by our landlord as part of our new lease agreement.

 

We believe these investments are necessary to position us for our expected future growth. With the lengthy sales cycle, it may take six to 12 months or more before we begin to realize a return on these investments. We continue to focus on increasing our sales contract backlog and quoting on larger (i.e., greater than $100,000) projects in an effort to increase revenue. We also will focus on leveraging our current market position to build up our sales pipeline in the California and Canadian markets, as well as other emerging cannabis-related U.S. markets. As sales opportunities are converted into contracts, we are preparing to meet our customers’ demand for timely delivery of a fully engineered, application-specific, climate control system.

 

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 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).

 

    For the quarter ended  
    March 31, 2017     June 30, 2017     September 30, 2017     December 31, 2017     2017 Total  
Backlog, beginning balance   $ 2,646,000     $ 3,790,000     $ 3,933,000     $ 4,311,000          
Net bookings, current period   $ 2,737,000     $ 1,885,000     $ 1,944,000     $ 2,454,000     $ 9,020,000  
Recognized revenue, current period   $ 1,593,000     $ 1,742,000     $ 1,566,000     $ 2,309,000     $ 7,210,000  
Backlog, ending balance   $ 3,790,000     $ 3,933,000     $ 4,311,000     $ 4,456,000          

 

During the fourth quarter of 2017, (i) our net bookings were $2,454,000, an increase of $510,000, or 26%, compared to the prior quarter, and (ii) our recognized revenue was $2,309,000, an increase of $743,000, or 47%, compared to the prior quarter.

 

As of December 31, 2017, our ending backlog was $4,456,000, an increase of $145,000, or 3%, compared to the prior quarter-end. About 41% of our December 31, 2017 ending backlog (down from 45% at September 30, 2017) is attributable to projects for which we have only received an initial deposit and, as a result, there are potential risks that the equipment portion of these projects will not be completed or will be delayed, which could occur if our 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.

 

Backlog 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. Accordingly, there can be no assurance that contracts included in backlog will actually generate revenues or when the actual revenues will be generated. Backlog and net bookings are considered non-GAAP financial measures, and therefore, they should be considered in addition to, rather than as a substitute for, recognized revenue and deferred revenue. Further, we can provide no assurance as to the profitability of our contracts reflected in backlog and net bookings.

 

Results of Operations

 

Comparison of Years ended December 31, 2017 and 2016

 

Revenues and Cost of Goods Sold

 

Revenue for the year ended December 31, 2017 was $7,210,000 compared to $7,580,000 for the year ended December 31, 2016, a decrease of $370,000, or 5%. Although our net bookings trended favorably and our backlog grew during 2017, revenue recognition continues to be impacted by our long and uncertain sales cycle and delays faced by our customers in the construction of new cultivation facilities. Further, while additional states have approved some form of cannabis use and cultivation, either for medical or recreational use, the legislation will not result in immediate new construction activity as states need time to issue implementing rules and regulations for the licensing and sales activity and local authorities need to issue building permits.

 

Cost of revenue increased by $24,000 from $5,276,000 for the year ended December 31, 2016 to $5,300,000 for the year ended December 31, 2017.

 

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The gross profit for the year ended December 31, 2017 was $1,910,000 compared to $2,304,000 for the year ended December 31, 2016. Gross profit margin decreased by four percentage points from 30% for the year ended December 31, 2016 to 26% for the year ended December 31, 2017. This decrease was due primarily to lower margin on our engineering services and an increase in shipping and handling costs in year ended December 31, 2017 compared to the year ended December 31, 2016.

 

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 $1,205,000, or 17% of total revenue, for the year ended December 31, 2017 as compared to $1,049,000, or 14% of total revenue, for the year ended December 31, 2016. The increase of $156,000 was primarily due to an increase in salaries and benefits of $56,000 and stock-based compensation of $75,000. The variable cost component, which represents our cost of equipment, outside engineering costs, shipping and handling, travel and warranty costs, totaled $4,095,000, or 57% of total revenue, in the year ended December 31, 2017 as compared to $4,227,000, or 56% of total revenue, in the year ended December 31, 2016. In the year ended December 31, 2017 as compared to the prior year: (i) our shipping and handling costs increased by $108,000, (ii) our charges for obsolete inventory allowances increased by $229,000 due to specifically-built inventory which our customer refused delivery, which were offset by (iii) a reduction in warranty costs of $682,000, which was primarily related to $533,000 in costs we incurred in 2016 to replace a customer’s system due to faulty installation by a third-party.

 

Operating Expenses

 

Operating expenses increased by 117% from $2,837,000 for the year ended December 31, 2016 to $6,152,000 for the year ended December 31, 2017, an increase of $3,315,000. The operating expense increase consisted of: (i) an increase in selling, general and administrative expenses (“SG&A expenses”) of $3,008,000, and (ii) an increase in advertising and marketing expenses of $336,000, offset by (iii) a decrease in product development expense of $29,000.

 

The increase in SG&A expenses for the year ended December 31, 2017 compared to the year ended December 31, 2016, was due primarily to: (i) an increase of $1,345,000 in stock-related compensation paid to employees and consultants, (ii) an increase of $614,000 in salaries and benefits, (iii) an increase of $204,000 in legal and consulting fees, (iv) an increase in sales travel of $134,000 and (v) an increase of $785,000 in cash and stock-related compensation paid to our independent directors.

 

The increase in marketing expenses were primarily for: (i) our investment in re-branding the Surna name and logo, including approximately $160,000 to revise and update our website and marketing materials, (ii) our increased presence at industry trade shows and events resulting in increased expenses of $49,000, and (iii) marketing salaries and benefits (including stock related-compensation) which increased by approximately $58,000. 

 

Operating Loss

 

We had an operating loss of $4,242,000 for the year ended December 31, 2017, as compared to an operating loss of $533,000 for the year ended December 31, 2016, an increase of $3,709,000. The operating loss included $2,140,000 of non-cash, stock-based compensation expenses in the year ended December 31, 2017 as compared to $4,000 for the year ended December 31, 2016. Excluding these non-cash items, our operating loss increased by $1,573,000.

 

Other Income (Expense)

 

Our other expenses (net) decreased by 75% from $2,740,000 for the year ended December 31, 2016 to $677,000 for the year ended December 31, 2017. This decrease is primarily related to the decrease in the amortization of debt discount and interest expense on convertible promissory notes. The convertible promissory notes converted in the fourth quarter of 2016 and the first quarter of 2017. We did incur a loss on extinguishment of debt of $643,000 and $338,000 for the years ended in December 31, 2017 and 2016, respectively, due to the conversion of certain notes.

 

Net Loss

 

Overall, we had a net loss of $4,919,000 for the year ended December 31, 2017 as compared to a net loss of $3,273,000 for the year ended December 31, 2016, an increase of $1,646,000. The net loss included $2,140,000 of non-cash, stock-based compensation expenses and $681,000 of debt-related costs in the year ended December 31, 2017 as compared to non-cash, stock-based compensation expense of $4,000 and debt-related costs of $2,780,000 in the year ended December 31, 2016. Excluding these non-cash items, our net loss increased by $1,609,000.

 

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Comparison of Years Ended December 31, 2016 and 2015

 

    2016     2015  
Revenue   $ 7,580,000     $ 7,865,000  
                 
Cost of revenue     5,276,000       6,924,000  
                 
Gross margin     2,304,000       941,000  
Gross margin %     30 %     12 %
                 
Operating expenses     2,837,000       4,055,000  
                 
Operating loss     (533,000 )     (3,114,000 )
                 
Other income (expense), net     (2,740,000 )     (2,182,000 )
                 
Net loss   $ (3,273,000 )   $ (5,296,000 )

 

Revenues and Cost of Goods Sold

 

Revenue for the year ended December 31, 2016 decreased by 4% to $7,580,000 for the year ended December 31, 2016 as compared to $7,865,000 for the year ended December 31, 2015. A significant portion of our revenues for 2015 were derived from growers in the State of Nevada (which legalized cannabis in 2014), which peaked in the third quarter of 2015. As our sales declined slightly from 2015 to 2016, our contractual sales commitments have been increasing. The sales amounts that we had under contract but which were not yet completed have increased year over year from $1,423,000 at December 31, 2015 to $2,646,000 at December 31, 2016.

 

Cost of revenue decreased by 24% to $5,276,000 for the year ended December 31, 2016 as compared to $6,924,000 for the year ended December 31, 2015. The gross margin for the year ended December 31, 2016 increased 18 percentage points to 30% as compared to 12% for the year ended December 31, 2015 due to: (i) negotiation of favorable pricing with key suppliers or sourcing new suppliers, (ii) a sales mix that consisted more of high margin products, and (iii) reduced spending on installation projects, as we no longer provide installation services. These decreases were offset by a one-time charge in the year ended December 31, 2016 of $530,000 for a warranty expense.

 

Operating Expenses

 

Operating expenses decreased by 30% to $2,837,000 for the year ended December 31, 2016 as compared to $4,055,000 for the year ended December 31, 2015. We decreased advertising and marketing expenses by 52% from $310,000 for the year ended December 31, 2015 to $150,000 for the year ended December 31, 2016 due to a heavier emphasis on advertising in the prior year and a focus on reigning in costs in 2016. We decreased product development costs by 51% from $708,000 in the year ended December 31, 2015 to $349,000 in the year ended December 31, 2016. Also in 2015, we had additional cost of $150,000 related to the development of a hybrid building. We decreased general and administrative expenses by 23% from $3,038,000 in the year ended December 31, 2015 to $2,338,000 in the year ended December 31, 2016 due to reductions in personnel cost of $200,000 as well as a focus on cost containment related to professional fees of $250,000. We also reduced selling expenses and travel by $150,000.

 

Other Income (Expense)

 

Other expenses increased by 26% to $2,740,000 for the year ended December 31, 2016 from $2,182,000 for the year ended December 31, 2015. The change is attributable to: (i) a decrease in amortization of debt discounts and interest expense, (ii) the conversion of certain convertible promissory notes converted in the first quarter and second quarter of 2016, (iii) the loss on the change in derivative liabilities, and (iv) the loss due to the extinguishment of debt in the fourth quarter of 2016.

 

Net Loss

 

As a result of our decrease in cost of revenue and operating expenses, we reduced our net loss to $3,273,000 for the year ended December 31, 2016 as compared to $5,296,000 for the year ended December 31, 2015.

 

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Financial Condition, Liquidity and Capital Resources

 

Cash and Cash Equivalents

 

As of December 31, 2017, we had cash and cash equivalents of $2,468,000, compared to cash and cash equivalents of $320,000 as of December 31, 2016. The $2,148,000 increase in cash and cash equivalents during the year ended December 31, 2017 was primarily the result of: (i) aggregate proceeds of $4,453,000 raised from the sale of investment units to accredited investors during the first and fourth quarter of 2017, with each unit consisting of one share of common stock and a warrant to purchase one share of common stock, and (ii) the proceeds of $500,000 raised from the issuance of certain promissory notes, which were converted into our common stock in the third quarter of 2017, offset by (iii) cash used for debt repayment of $332,000, (iv) cash used in our operating activities of $2,267,000, and (v) cash used in our investing activities of $205,000.

 

Our cash is held in bank depository accounts in certain financial institutions. We currently have deposits in financial institutions that exceed the federally insured amount.

 

As of December 31, 2017, we had accounts receivable (net of allowance for doubtful accounts) of $423,000, inventory (net of excess and obsolete allowance) of $523,000, and prepaid expenses of $293,000. As of December 31, 2017, we had no indebtedness (other than $7,000 owed under a related party note), total accounts payable and accrued expenses of $1,969,000, and deferred revenue of $1,012,000. As of December 31, 2017, we had a working capital surplus of $308,000, compared to a working capital deficit of $2,860,000 as of December 31, 2016.

 

Our accounts receivable from three customers made up 52%, 17% and 17%, respectively, of the total balance as of December 31, 2017.

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

 

Summary of Cash Flows

 

The following summarizes our cash flows for the years ended December 31, 2017 and 2016:

 

    For the Year Ended December 31,  
    2017     2016  
Net cash (used in) provided by operating activities   $ (2,267,000 )   $ 103,000  
Net cash (used in) provided by investing activities     (205,000 )     42,000  
Net cash provided by (used in) financing activities     4,621,000       (156,000 )
Net increase (decrease) in cash   $ 2,149,000     $ (11,000 )

 

Operating Activities

 

We have never reported net income. We incurred a net loss for the year ended December 31, 2017 of $4,919,000 and have an accumulated deficit of $19,255,000 as of December 31, 2017.

 

Cash used in operations for the year ended December 31, 2017 was $2,267,000 compared to cash provided by operations of $103,000 for the year ended December 31, 2016, a change of $2,370,000. The additional cash usage is primarily attributable to an increase in net loss of $1,646,000 and an increase in cash used for working capital of $1,348,000, which was offset by an increase in non-cash charges of $623,000. During the year ended December 31, 2017, significant non-cash items included: (i) stock-related compensation of $2,140,000, (ii) loss on extinguishment of debt of $643,000, (iii) an increase in excess and obsolete inventory of $276,000, and (iv) gain on the change in derivative liability of $67,000.

 

Investing Activities

 

Cash used in investing activities for the year ended December 31, 2017 was approximately $205,000 compared to cash provided by investing activities of $42,000 for the year ended December 31, 2016. During the year ended December 31, 2017, we received payments of approximately $157,000 on notes receivable offset by payments for fixed assets, intangibles assets and certain equipment to be held for lease to a related party of $362,000.

 

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Financing Activities

 

Cash provided by financing activities for the year ended December 31, 2017 was $4,621,000 compared to cash used in financing activities of $156,000 for the year ended December 31, 2016. During the year ended December 31, 2017, we completed two private placements consisting of the sale of shares of our common stock, with attached warrants, resulting in aggregate proceeds of $4,453,000. During the year ended December 31, 2017, we issued two unsecured promissory notes for aggregate proceeds of $500,000 in the first quarter of 2017, which were converted into common in the third quarter of 2017, and we made payments of $270,000 to extinguish the principal under our remaining convertible promissory notes.

 

Going Concern

 

Our consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Our independent registered public accounting firm included in its audit opinion on our financial statements for the year ended December 31, 2017 a statement that there is substantial doubt as to our ability to continue as a going concern. The financial statements have been prepared assuming that we will continue as a going concern. We have determined that our ability to continue as a going concern is dependent on raising additional capital to fund our operations and ultimately on generating future profitable operations. There can be no assurance that we will be able to raise sufficient additional capital or eventually have positive cash flow from operations to address all of our cash flow needs. If we are not able to find alternative sources of cash or generate positive cash flow from operations, our business and shareholders will be materially and adversely affected. The foregoing factors raise substantial doubt about our ability to continue as a going concern for a period of one year from the date our financial statements are issued. Our consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

Capital Raising

 

We believe our cash balances and cash flow from operations will be insufficient to fund our operations for the next 12 months. If we are unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then we will need to raise additional funding to continue as a going concern.

 

If results of operations for 2018 do not meet management’s expectations, or additional capital is not available, management believes it has the ability to reduce certain expenditures. The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for our products and services, the quality of product development efforts, management of working capital, and continuation of normal payment terms and conditions for purchase of our products and services.

 

Based on management’s estimate for our operational cash requirements, we will likely need to raise debt and/or equity financing during the second or third quarter of 2018 in order to continue our operations and achieve our growth targets. There can be no assurance that we will be able to raise debt or equity financing in sufficient amounts, when and if needed, on acceptable terms or at all.

 

If we are unable to generate sufficient cash flow from operations, make adjustments to our payment arrangements or raise sufficient additional capital through future debt and equity financings or strategic and collaborative ventures with potential partners, we will likely have to reduce the size and scope of our operations. Our officers and shareholders have not made any written or oral agreement to provide us additional financing. There can be no assurance that we will be able to continue to raise capital on terms and conditions that are deemed acceptable to us, or at all.

 

Inflation

 

In the opinion of management, inflation has not and will not have a material effect on our operations in the immediate future. Management will continue to monitor inflation and evaluate the possible future effects of inflation on our business and operations.

 

Contractual Payment Obligations

 

As of December 31, 2017, our contractual payment obligations consisted of a building lease. On June 27, 2017, we executed a lease, to be effective September 29, 2017, for our manufacturing and office space. The term of the lease commenced September 29, 2017 and continues through August 31, 2022. We occupied our same leased space for $12,967 per month until January 1, 2018. On January 2, 2018, the leased space was expanded and the monthly rental rate increased to $18,979 until August 31, 2018. Beginning September 1, 2018, the monthly rent will increase by 3% each year through the end of the lease.

 

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As of December 31, 2017, our contractual obligations under our building lease were as follows:

 

Contractual Obligations   Total     Less than 1 Year     1 - 3 Year     3 - 5 Years     More than 5 Years  
Operating lease obligations   $ 1,133,228     $ 230,025     $ 480,960     $ 422,243     $ -  

 

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.

 

Internal Revenue Service Penalties

 

We have been penalized by the Internal Revenue Service (“IRS”) for failure to file Foreign Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for the years 2011, 2012 and 2014 on a timely basis. The penalties and interest approximate $115,000. Our request that the penalties be abated for reasonable cause was denied by the IRS. We appealed the IRS’s denial based on statutory grounds under Revenue Procedure 92-70, which provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations. Persons complying with this revenue procedure are deemed to satisfy their Form 5471 filing obligations with respect to dormant foreign corporations and are not subject to penalties related to the failure to timely file a complete Form 5471 and to timely furnish information requested thereon. The IRS has notified us that it needs additional time to respond to our appeal, which response is not expected until April 2018. We believe we have complied with the summary filing procedures for filing Form 5471 under Revenue Procedure 92-70 and the likelihood of abatement is high. Accordingly, we have made no accrual for these IRS penalties for the year ended December 31, 2017. However, there can be no assurance of any abatement until the IRS acts upon the appeal.

 

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, 2017, we had no off-balance sheet arrangements. During 2017 and 2016, we did not engage in any off-balance sheet financing activities other than those included in the “Contractual Payment Obligations” discussed above and those reflected in Note 12 to our consolidated financial statements.

 

Recent Developments

 

Refer to Note 18 - Subsequent Events of the Notes to Consolidated Financial Statements, included as part of this Annual Report for the more significant events occurring since December 31, 2017.

 

Critical Accounting 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 their 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 to our consolidated financial statements.

 

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Our management has discussed the development and selection of critical accounting estimates with the Audit Committee of the Board of Directors and the Audit Committee 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, 2017 and 2016, the allowance for doubtful accounts was $105,267 and $91,000, 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.

 

Excess and obsolete inventory . Inventory is stated at the lower of cost or market. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower of cost or market 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, 2017 and 2016, the allowance for excess and obsolete inventory was $323,384 and $47,369, 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.  We recorded goodwill in connection with our acquisition of Hydro in July 2014. We perform a quantitative impairment test annually during the fourth quarter by comparing the fair value of the reporting unit with its carrying amount, including goodwill. 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. We completed this assessment as of December 31, 2017, and concluded that no impairment existed.

 

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, 2017 and 2016, we had an accrued warranty reserve amount of $105,122 and $85,000, 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, 2017 and 2016. Based on the available evidence, we believe it is more likely than not that we will not be able 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.

 

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. 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.

 

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 had been impaired or a liability had been incurred and the amount of loss can be reasonably estimated.

 

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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

 

On November 28, 2017, the Audit Committee dismissed RBSM LLC (“RBSM”) as our independent registered public accounting firm. RBSM’s audit reports on our consolidated financial statements as of and for the fiscal years ended December 31, 2015 and 2016 did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles, except that each such report included an explanatory paragraph raising substantial doubt about our ability to continue as a going concern and stated that our consolidated financial statements for the fiscal years ended December 31, 2015 and December 31, 2016, respectively, were prepared assuming that we would continue as a going concern.

 

During our two most recent fiscal years and the subsequent interim period from January 1, 2017 through November 28, 2017, (i) there were no “disagreements” (as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions) between us and RBSM on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of RBSM, would have caused RBSM to make reference to the subject matter of the disagreement in its report on our financial statements, and (ii) there were no “reportable events” (as that term is defined in Item 304(a)(1)(v) of Regulation S-K), except for the material weaknesses in internal controls as described in Item 9A of Form 10-K for the fiscal years ended December 31, 2015 and 2016, as follows:

 

“The Company did not maintain effective controls over certain aspects of the financial reporting process because we lacked 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. In addition, there was inadequate segregation of duties due to the limitation on the number of our accounting personnel.”

 

These material weaknesses have not been remediated as of the date of this Annual Report on Form 10-K.

 

On November 28, 2017, the Audit Committee approved the appointment of Anton Collins Mitchell LLP (“ACM”) as our new independent registered public accounting firm to perform independent audit services commencing for the fiscal year ending December 31, 2017.

 

During our two most recent fiscal years and the subsequent interim period from January 1, 2017 through November 28, 2017, neither us, nor anyone acting on behalf of us, consulted ACM regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our consolidated financial statements, and neither a written report nor oral advice was provided to us that ACM concluded was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a “disagreement” or a “reportable event.”

 

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, which positions are currently held by the same person, 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, 2017.

 

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.

 

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, 2017 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, 2017:

 

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.

 

32
 

 

We intend to take appropriate and reasonable steps to make the necessary improvements to remediate these deficiencies. We are committed to continuing to improve our financial organization including, without limitation, expanding our accounting staff 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, 2017 remained unchanged from December 31, 2016. Management believes that the material weaknesses set forth above did not have an effect on our financial reporting for the year ended December 31, 2017.

 

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, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

 

None.

 

33
 

 

PART III

 

We will file a definitive Proxy Statement for our 2018 Annual Meeting of Stockholders with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are incorporated by reference.

 

Item 10. Directors, Executive Officers and Corporate Governance

 

Information in response to this Item is incorporated in this Annual Report by reference to the information provided in our definitive Proxy Statement for our 2018 Annual Meeting of Stockholders (the “2018 Proxy Statement”) to be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

 

We have adopted a code of business conduct and ethics that applies to our directors, officers and employees. The code of business conduct and ethics is available on our website at www.surna.com . We will report any amendments to or waivers of a required provision of the code of business conduct and ethics on our website or in a Form 8-K.

 

Item 11. Executive Compensation

 

The information with respect to compensation of our executives and directors will be contained in the 2018 Proxy Statement to be filed with the SEC and is incorporated in this Annual Report by reference in response to this item.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information with respect to security ownership of certain beneficial owners and management will be contained in the 2018 Proxy Statement to be filed with the SEC and is incorporated in this Annual Report by reference in response to this item.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The information with respect to certain relationships and related transactions will be contained in the 2018 Proxy Statement to be filed with the SEC and is incorporated in this Annual Report by reference in response to this item.

 

Item 14. Principal Accountant Fees and Services

 

The information with respect to principal accountant fees and services will be contained in the 2018 Proxy Statement to be filed with the SEC and is incorporated in this Annual Report by reference in response to this item.

 

34
 

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

a. Documents Filed as Part of this Report

 

The following consolidated financial statements of Surna Inc. are filed as part of this Annual Report on Form 10-K:

 

Financial Statements Page(s)
   
Reports of Independent Registered Public Accounting Firms F-1
   
Consolidated Balance Sheets as of December 31, 2017 and 2016 F-3
   
Consolidated Statements of Operations for the Years Ended December 31, 2017 and 2016 F-4
   
Consolidated Statements of Changes in Shareholders’ Equity (Deficit) for the Years Ended December 31, 2017 and 2016 F-5
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016 F-6
   
Notes to Consolidated Financial Statements F-7

 

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.

 

35
 

 

Surna Inc.

Index to Consolidated Financial Statements

 

Financial Statements Page(s)
   
Reports of Independent Registered Public Accounting Firms F-1
   
Consolidated Balance Sheets as of December 31, 2017 and 2016 F-3
   
Consolidated Statements of Operations for the Years Ended December 31, 2017 and 2016 F-4
   
Consolidated Statements of Changes in Shareholders’ Equity (Deficit) for the Years Ended December 31, 2017 and 2016 F-5
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016 F-6
   
Notes to Consolidated Financial Statements F-7

 

 
 

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors and Stockholders

Surna Inc.

Boulder, Colorado

 

Opinion on the Consolidated Financial Statements

 

We have audited the accompanying consolidated balance sheet of Surna Inc. and subsidiary (the “Company”) as of December 31, 2017 and the related consolidated statement of operations, stockholders’ equity, and cash flows for the year then ended, and the related notes (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

The consolidated financial statements of Surna Inc. as of December 31, 2016, and for the year then ended were audited by other auditors whose report dated March 31, 2017, expressed an unqualified opinion on those statements.

 

Emphasis Paragraph for Going Concern Uncertainty

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 3 to the consolidated financial statements, the Company has suffered recurring losses from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the 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 Compan y in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the auditing standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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 audit included performing procedures to assess the risks of material misstatement of the consolidated 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 consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

/s/ Anton Collins Mitchell LLP  
   
We have served as the Company’s auditor since 2017.  

Denver, Colorado

 

April 2 , 2018

 

 

F- 1
 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of

Surna Inc.

Boulder, Colorado.

 

We have audited the consolidated balance sheets of Surna Inc. (the Company) and subsidiaries as of December 31, 2016, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2016. Surna, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of, Surna Inc. as of December 31, 2016, and the results of its operations and its cash flows for the year ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company has suffered losses from operations, which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

/s/ RBSM, LLP  
Larkspur, CA  

March 31, 2017

 

 

F- 2
 

 

Surna Inc.

Consolidated Balance Sheets

 

    December 31,  
    2017     2016  
ASSETS                
Current Assets                
Cash and cash equivalents   $ 2,468,199     $ 319,546  
Accounts receivable (net of allowance for doubtful accounts of $105,267 and $91,000, respectively)     422,589       47,166  
Notes receivable     -       157,218  
Other receivables     550       -  
Inventory, net     522,622       747,905  
Prepaid expenses     293,458       84,976  
Total Current Assets     3,707,418       1,356,811  
Noncurrent Assets                
Property and equipment, net     401,356       93,565  
Goodwill     631,064       631,064  
Intangible assets, net     37,985       36,381  
Deposits     51,000       -  
Total Noncurrent Assets     1,121,405       761,010  
                 
TOTAL ASSETS   $ 4,828,823     $ 2,117,821  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)                
                 
CURRENT LIABILITIES                
Accounts payable and accrued liabilities   $ 1,969,263     $ 1,337,853  
Deferred revenue     1,011,871       1,421,344  
Amounts due to shareholders     6,927       57,398  
Convertible promissory notes, net     -       761,440  
Convertible accrued interest     -       161,031  
Derivative liabilities     410,880       477,814  
Total Current Liabilities     3,398,941       4,216,880  
                 
NONCURRENT LIABILITIES                
Deferred rent     17,396       -  
Promissory note due shareholders     -       11,985  
Total Noncurrent Liabilities     17,396       11,985  
                 
TOTAL LIABILITIES     3,416,337       4,228,865  
                 
Commitments and Contingencies (Note 12)                
                 
SHAREHOLDERS’ EQUITY (DEFICIT)                
Preferred stock, $0.00001 par value; 150,000,000 shares authorized; 77,220,000 shares issued and outstanding     772       772  
Common stock, $0.00001 par value; 350,000,000 shares authorized; 206,248,522 and 160,744,916 shares issued and outstanding, respectively     2,062       1,607  
Additional paid in capital     20,664,563       12,222,789  
Accumulated deficit     (19,254,911 )     (14,336,212 )
Total Shareholders’ Equity (Deficit)     1,412,486       (2,111,044 )
                 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)   $ 4,828,823     $ 2,117,821  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 3
 

 

Surna Inc.

Consolidated Statements of Operations

 

    For the Years Ended December 31,  
    2017     2016  
Revenue, net   $ 7,210,241     $ 7,579,863  
                 
Cost of revenue     5,299,977       5,275,968  
                 
Gross profit     1,910,264       2,303,895  
                 
Operating expenses:                
Advertising and marketing expenses     625,773       289,992  
Product development costs     319,680       349,062  
Selling, general and administrative expenses     5,206,471       2,197,758  
Total operating expenses     6,151,924       2,836,812  
                 
Operating loss     (4,241,660 )     (532,917 )
                 
Other income (expense):                
Interest and other income, net     4,097       40,157  
Interest expense     (41,485 )     (373,688 )
Amortization of debt discount on convertible promissory notes     (63,157 )     (1,529,219 )
Loss on extinguishment of debt     (643,428 )     (338,241 )
Gain (loss) on change in fair value of derivative liabilities     66,934       (538,705 )
Total other income (expense)     (677,039 )     (2,739,696 )
                 
Loss from operations before provision for income taxes     (4,918,699 )     (3,272,613 )
                 
Income taxes     -       -  
                 
Net loss   $ (4,918,699 )   $ (3,272,613 )
                 
Loss per common share – basic and dilutive   $ (0.03 )   $ (0.02 )
                 
Weighted average number of common shares outstanding, basic and dilutive     182,857,538       140,604,764  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 4
 

 

Surna Inc.

Consolidated Statement of Changes in Shareholders’ Equity (Deficit)

 

    Preferred Stock     Common Stock     Additional           Shareholders’  
    Number of
Shares
    Amount     Number of
Shares
    Amount     Paid in
Capital
    Accumulated
Deficit
    Equity
(Deficit)
 
Balance January 1, 2016     77,220,000     $ 772       125,839,862     $ 1,259     $ 8,214,271     $ (11,063,599 )   $ (2,847,297 )
Common shares issued for conversion of debt and interest, net of unamortized debt discount     -       -       33,365,609       334       3,234,992       -       3,235,326  
Reclassification of derivative liability to equity for debt conversion     -       -       -       -       673,050       -       673,050  
Common shares issued for compensation     -       -       46,045       -       4,028       -       4,028  
Common shares issued for exercise of stock options     -       -       1,493,400       14       342       -       356  
Value attributed to modification of warrants     -       -       -       -       96,106       -       96,106  
Net loss     -       -       -       -       -       (3,272,613 )     (3,272,613 )
                                                         
Balance December 31, 2016     77,220,000       772       160,744,916       1,607       12,222,789       (14,336,212 )     (2,111,044 )
Common shares issued for conversion of debt and interest, net of unamortized debt discount     -       -       10,601,554       106       1,751,049       -       1,751,155  
Value attributed to modification of warrants     -       -       -       -       59,000       -       59,000  
Common shares issued with convertible notes payable     -       -       250,000       2       39,127       -       39,129  
Common shares issued for cash     -       -       31,515,250       315       4,452,765       -       4,453,080  
Fair value of warrants issued and options granted to directors for compensation     -       -       -       -       386,466       -       386,466  
Common shares issued as compensation for services     -       -       3,160,494       32       434,293       -       434,325  
Common shares issued in settlement of restricted stock units awarded as compensation for consulting services     -       -       200,000       2       20,497       -       20,499  
Fair value of vested restricted stock units awarded to employees and directors     -       -       -       -       744,556       -       744,556  
Fair value of vested stock options granted to employees     -       -       -       -       189,536       -       189,536  
Fair value of vested incentive stock bonuses awarded to employees     -       -       -       -       364,483       -       364,483  
Other common shares     -       -       (223,692 )     (2 )     2       -       -  
Net loss     -       -       -       -       -       (4,918,699 )     (4,918,699 )
Balance December 31, 2017     77,220,000     $ 772       206,248,522     $ 2,062     $ 20,664,563     $ (19,254,911 )   $ 1,412,486  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 5
 

 

Surna Inc.

Consolidated Statements of Cash Flows

 

    For the Years Ended December 31,  
    2017     2016  
Cash Flows From Operating Activities:                
Net loss   $ (4,918,699 )   $ (3,272,613 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:                
Depreciation and intangible asset amortization expense     44,865       53,084  
Amortization of debt discounts     37,637       1,529,219  
Amortization of original issue discount on notes payable     25,520       -  
(Gain) loss on change in derivative liabilities     (66,934 )     538,705  
Compensation paid in equity     2,139,865       4,386  
Provision for doubtful accounts     14,267       50,127  
Provision for excess and obsolete inventory     276,015       -  
Loss on extinguishment of debt     643,428       338,241  
Loss on disposal of other assets     26,682       4,280  
                 
Changes in operating assets and liabilities:                
Accounts and other receivable     (390,240 )     179,793  
Inventory     (50,732 )     513,897  
Prepaid expenses     (208,482 )     131,099  
Accounts payable and accrued liabilities     289,905       (775,309 )
Deferred revenue     (86,697 )     434,899  
Accrued interest     (9,772 )     373,688  
Deferred rent     17,396       -  
Lease deposit     (51,000 )     -  
Net cash (used in) provided by operating activities     (2,266,976 )     103,496  
                 
Cash Flows From Investing Activities                
Capitalization of intangible assets     (18,624 )     (25,292 )
Purchases of property and equipment     (183,783 )     (18,189 )
Proceeds from the sale of property equipment     -       35,100  
Cash disbursed for equipment held for lease     (159,806 )     -  
Cash disbursed for note receivable     -       (80,000 )
Payments received on note receivable     157,218       130,000  
Net cash (used in) provided by investing activities     (204,995 )     41,619  
                 
Cash Flows From Financing Activities                
Cash proceeds from sale of common stock and warrants     4,453,080       -  
Payments on convertible notes payable     (270,000 )     -  
Proceeds from issuance of notes payable     500,000       -  
Payments on loans     -       (34,115 )
Payments on loans from shareholders     (62,456 )     (122,011 )
Net cash provided by (used in)  financing activities     4,620,624       (156,126 )
                 
Net increase (decrease) in cash     2,148,653       (11,011 )
Cash, beginning of period     319,546       330,557  
Cash, end of period   $ 2,468,199     $ 319,546  
                 
Supplemental cash flow information:                
Interest paid   $ 44,150     $ -  
                 
Non-cash investing and financial activities:                
Conversions of promissory notes and accrued interest to common stock   $ 1,751,155     $ 3,235,326  
Derivative liability on convertible notes and warrants   $ -     $ 673,050  
Settlement liability reclassified from deferred revenue   $ 322,776     $ -  
Warrant modification included in loss on extinguishment of debt   $ 59,000     $ -  
Common shares issued with notes payable   $ 39,129     $ -  
Discount on notes payable   $ 37,500     $ -  
Unpaid purchases of equipment and other assets   $ 18,729     $ -  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 6
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Note 1 – Description of Business

 

Surna Inc. (the “Company”) was incorporated in Nevada on October 15, 2009. The Company develops innovative technologies and products that monitor, control and or address the energy and resource intensive nature of indoor cannabis cultivation. Currently, the Company’s revenue stream is derived primarily from supplying industrial technology and products to commercial indoor cannabis cultivation facilities. Headquartered in Boulder, Colorado, the Company’s engineering and technical team provides solutions that allow growers to meet the unique demands of a cannabis cultivation environment through precise temperature, humidity, light, and process controls, energy and water efficiency, and satisfaction of the evolving code and regulatory requirements being imposed at the state and local levels. The Company’s objective is to leverage its unique experience in this space in order to bring value-added climate control solutions to its customers that help improve their overall crop quality and yield as well as optimize the resource efficiency of their controlled environment (i.e,. indoor and greenhouses) cultivation facilities. The Company is not involved in the production or sale of cannabis.

 

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. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.

 

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. The Company has not generated sufficient revenue and has funded its operating losses through the sale of common stock and the issuance of debt. The Company is subject to risks, expenses and uncertainties similar to those encountered by similarly situated companies. See Note 3.

 

Basis of Consolidation and Reclassifications

 

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.

 

The Company has reclassified certain salaries related to marketing personnel from selling, general and administrative expense to advertising and marketing expenses in 2016 to conform to the Company’s presentation of such marketing personnel salaries in 2017. These reclassifications have been applied consistently to the periods presented and had no impact on net loss, total assets and liabilities, or equity.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make 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: valuation of derivative liabilities, valuation of intangible assets, valuation of equity-based compensation, valuation of deferred tax assets and liabilities, warranty accruals, inventory allowances, and legal contingencies.

 

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.

 

F- 7
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

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 its review, the Company establishes or adjusts the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2017 and 2016, the allowance for doubtful accounts was $105,267 and $91,000, respectively.

 

Inventory

 

Inventory is stated at the lower of cost or market. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower of cost or market 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, 2017 and 2016, the allowance for excess and obsolete inventory was $323,384 and $47,369, respectively.

 

Property and Equipment

 

Property and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings. For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which is generally five years. 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.

 

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 such impairment losses to date.

 

Goodwill and Intangible Assets

 

The Company recorded goodwill in connection with its acquisition of Hydro 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 during the fourth quarter by comparing the fair value of the reporting unit with its carrying amount, including goodwill. 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 completed this assessment as of December 31, 2017, and concluded that no impairment existed.

 

Separable identifiable intangibles consist of intellectual property such as patents and trademarks, and capitalized website costs. Except for trademarks which are not amortized, the Company’s separable identifiable intangible assets are subject to amortization on a straight-line basis over their estimated useful lives. Separable identifiable intangibles are also subject to evaluation for potential impairment if events or circumstances indicate the carrying value may not be recoverable.

 

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:

 

F- 8
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

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.

 

On a Recurring Basis

 

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.

 

As of December 31, 2017 and 2016, the Company had outstanding warrants to purchase common stock that were issued in connection with Series 3 convertible notes (“Series 3 Warrants”) that provided for a reduction in the exercise price of the warrants in the event the Company issued common stock in a registered offering at a price below the exercise price. See Note 11. In such event, the exercise price under the warrants would be reduced to the price of the common stock in the dilutive issuance.

 

The Company determined that these outstanding warrants subject to the exercise price reduction qualified as a derivative financial instrument. See Note 11 for a discussion of the impact the derivative financial instruments had on the Company’s consolidated financial statements and results of operations.

 

Financial liabilities carried at fair value, measured on a recurring basis were as follows:

 

    As of December 31, 2017     As of December 31, 2016  
    Level 1     Level 2     Level 3     Fair Value     Gain     Level 1     Level 2     Level 3     Fair Value     (Loss) (1)  
Financial liabilities:                                                                                
Derivative liabilities - conversion feature   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ (200,083 )
Derivative liabilities - warrants     -       -       410,880       410,880       66,934       -       -       477,814       477,814       (338,622 )
Total financial liabilities   $ -     $ -     $ 410,880     $ 410,880     $ 66,934     $ -     $ -     $ 477,814     $ 477,814     $ (538,705 )

 

    (1) The loss on change in derivative liabilities of $538,705 presented in the statement of operations for the year ended December 31, 2016 also includes gains on derivatives associated with convertible promissory note balances outstanding at various dates during the year ended December 31, 2016, which were converted to common stock prior to December 31, 2016.

 

The change in the balance of the warrant derivative liabilities during the years ended December 31, 2017 and 2016 was calculated using the Black-Scholes Option Pricing Model (the “Black-Scholes Model”), which is classified as gain (loss) on change in warrant derivative liabilities in the consolidated statements of operations. The Black-Scholes Model does take into consideration the Company’s stock price, historical volatility, and the risk-free interest rate, which do have observable Level 1 or Level 2 inputs.

 

During the year ended December 31, 2016, the Company converted all of the Series 3 and 4 convertible promissory notes issued in 2015 into common stock, which gave rise to the fair value liabilities for the embedded conversion features. See Note 11. At conversion, the balance of the derivative liability of $673,050 was credited to additional paid in capital in the consolidated balance sheet.

 

On a Non-Recurring Basis

 

Intangible assets that are amortized are evaluated for recoverability whenever adverse effects or changes in circumstances indicate that the carrying value may not be recoverable. The recoverability test consists of comparing the undiscounted projected cash flows with the carrying amount. Should the carrying amount exceed undiscounted projected cash flows, an impairment loss would be recognized to the extent the carrying amount exceeds fair value. For the Company’s indefinite-lived goodwill, the impairment test consists of comparing the fair value, determined using the market value method, with its carrying amount. An impairment loss would be recognized for the carrying amount in excess of its fair value. As of December 31, 2017, the Company concluded that no indicators of impairment relating to intangible assets or goodwill existed and an interim test was not performed.

 

F- 9
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Due to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximate fair value.

 

Derivative Financial Instruments

 

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, the Company uses the Black-Scholes Model to value the derivative instruments. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

 

The Company determined that the Series 3 Warrants qualified as derivative financial instruments. Accordingly, the Series 3 Warrants are derivative liabilities and are marked to market at the end of each reporting period. Any change in fair value during the period is recorded in as gain (loss) on change in derivative liabilities in the Company’s consolidated statements of operations.

 

Revenue Recognition

 

The Company recognizes revenue from the sale of its manufactured products as well as from products manufactured by third-party suppliers, which are typically drop-shipped to the Company’s customer. The principal markets for the Company’s products are the U.S. and Canada. Revenue is recognized when products are shipped and title passes to the customer, provided that persuasive evidence of an arrangement exists, the price is fixed or determinable, and collection of the resulting receivable is reasonably assured. Sales of the Company’s products are not subject to regulatory requirements that vary from state to state. The Company generally does not provide its customers with a contractual right of return. In certain cases, the Company provides engineering services in connection with the sale of its products and recognizes revenue from such engineering services as the performance of such services occur. Management believes that all relevant criteria and conditions are considered when recognizing revenue.

 

The Company provides climate control equipment and engineering design services for the controlled environment agriculture industry with contract terms typically less than one year. Advance payments received from customers are included in deferred revenue, a component of current liabilities, until such time that all criteria are met, as noted above, and revenue is recognized.

 

Sales arrangements sometimes involve delivering multiple elements, including engineering services and multiple items of equipment. In these instances, revenue is assigned to each element based on vendor-specific objective evidence, third-party evidence or a management estimate of the relative selling price. Revenue is recognized individually for delivered elements only if they have value to the customer on a stand-alone basis and the performance of the undelivered items is probable and substantially in the Company’s control, or the undelivered elements are inconsequential or perfunctory and there are no unsatisfied contingencies related to payment. The majority of these deliverables are tangible products, such as equipment, with a relatively smaller portion attributable to engineering services. The Company does not provide any separate maintenance. Generally, contract duration is less than one-year and cancellation, termination or refund provisions apply only in the event of contract breach.

 

The Company typically charges its customers for shipping and handling, which is included in revenue. Shipping and handling costs are reported within cost of revenue in the consolidated statements of operations.

 

F- 10
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

The following table sets forth the Company’s revenue by source:

 

    2017     2016  
Equipment   $ 6,255,150     $ 6,787,348  
Engineering services     588,849       537,020  
Shipping and handling     238,908       207,650  
Other revenue     127,334       47,845  
Total revenue   $ 7,210,241     $ 7,579,863  

 

The Company accounts for sales taxes and other related taxes on a net basis, excluding such taxes from revenue.

 

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.

 

The Company assesses the historical warranty claims on its manufactured products and, since 2016, warranty claims have been approximately 1% of annual revenue generated on these products. The Company continues 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, 2017 and 2016, the Company had an accrued warranty reserve amount of $105,122 and $85,000, respectively, which are included in accounts payable and accrued liabilities on the Company’s consolidated balance sheets.

 

Concentrations

 

Two customers accounted for 12% and 11% of the Company’s revenue for the year ended December 31, 2017. Two customers accounted for 14% and 10% of the Company’s revenue for the year ended December 31, 2016.

 

The Company’s accounts receivable from three customers made up 52%, 17% and 17%, respectively, of the total balance as of December 31, 2017. The Company’s accounts receivable from two customers made up 39% and 29% of the total balance as of December 31, 2016.

 

Two suppliers accounted for 35% and 10% of the Company’s purchases of inventory for the year ended December 31, 2017 and 41% and 10% of the Company’s purchases of inventory for the year ended December 31, 2016.

 

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, 2017 and 2016, the Company incurred $319,680 and $349,062, respectively, on product development.

 

Accounting for Share-Based Compensation

 

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. The expense is recognized over the requisite service period or performance period of the award. 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, the Company reassesses 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.

 

F- 11
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

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.

 

Share-based compensation expense is reduced 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 awards granted to non-employees are recorded at their fair value on the measurement date and are subject to periodic adjustment as the underlying share-based awards vest.

 

Share-based payments to employees, directors and non-employees totaled $2,139,865 and $4,386 for the years ended December 31, 2017 and 2016, respectively.

 

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. The following is a summary of share-based compensation costs included in the Company’s consolidated statements of operations for the years ended December 31, 2017 and 2016:

 

    2017     2016  
Share-based compensation expense included in:                
Cost of revenue   $ 75,255     $ -  
Advertising and marketing expenses     16,377       -  
Product development costs     5,956       -  
Selling, general and administrative expenses     2,042,277       4,386  
Total share-based compensation expense included in consolidated statement of operations   $ 2,139,865     $ 4,386  

 

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.

 

F- 12
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Basic and Diluted Net Loss per Common Share

 

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents. In periods when losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be 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, 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 cannabis 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. See Note 3.

 

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 one operating segment that is dedicated to the manufacture and sale of its products.

 

Recently Adopted Accounting Pronouncements

 

On January 1, 2017, the Financial Accounting Standards Board (“FASB”) adopted Accounting Standards Update (“ASU”) 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . As required by the standard, excess tax benefits and deficiencies recognized on share-based compensation expense are recorded in the consolidated statement of comprehensive income as a component of income tax expense. Previously, these amounts were recorded as a component of additional paid-in capital on the consolidated balance sheet. The Company elected to apply the change in presentation to the consolidated statement of cash flows prospectively to classify excess tax benefits as an operating activity rather than a financing activity. Upon adoption, the Company determined that it did not have previously unrecognized excess tax benefits to be recognized on a modified retrospective transition method as an adjustment to retained earnings. The Company will continue to classify cash paid related to shares withheld to satisfy tax-withholding requirements as a financing activity, as required by the standard. The Company made a policy election to account for forfeitures as they occur, rather than estimating the expected forfeitures over the course of the vesting period. ASU 2016-09 also requires that excess tax benefits and deficiencies be prospectively excluded from assumed future proceeds in the calculation of diluted weighted average shares when calculating diluted earnings per share utilizing the treasury stock method. The Company applied this change prospectively, and it did not have a material impact on the Company’s consolidated financial statements.

 

During the first quarter of 2017, the Company early adopted ASU 2017-04, Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350) , which simplifies the goodwill impairment test by eliminating step 2, which is the step requiring companies to perform a hypothetical purchase price allocation to measure goodwill. Instead, under the new standard, impairment will be measured using the difference between the fair value of a reporting unit with its carrying amount. Any impairment charge will be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, taking into consideration income tax effects from any deductible goodwill on the carrying amount of the reporting unit. This standard was applied prospectively. The adoption did not have a material effect on the Company’s consolidated financial statements or related disclosures.

 

F- 13
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330) - Simplifying the Measurement of Inventory, which simplifies the subsequent measurement of inventories by replacing the lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out (LIFO) and the retail inventory method. The guidance in the ASU is effective for fiscal years beginning after December 15, 2016 and early adoption is permitted. The Company adopted the ASU in the first quarter of fiscal 2017. The adoption of the ASU in the first quarter of fiscal 2017 did not impact the Company’s financial position or results of operations.

 

Recently Issued Accounting Pronouncements

 

In July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-11, (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception . The new standard applies to issuers of financial instruments with down-round features. A down-round provision is a term in an equity-linked financial instrument (i.e. a freestanding warrant contract or an equity conversion feature embedded within a host debt or equity contract) that triggers a downward adjustment to the instrument’s strike price (or conversion price) if equity shares are issued at a lower price (or equity-linked financial instruments are issued at a lower strike price) than the instrument’s then-current strike price. The purpose of the feature is typically to protect the instrument’s counterparty from future issuances of equity shares at a more favorable price. The ASU amends (1) the classification of such instruments as liabilities or equity by revising the certain guidance relative to evaluating if they must be accounted for as derivative instruments and (2) the guidance on recognition and measurement of freestanding equity-classified instruments. This ASU is effective January 1, 2019, with early adoption permitted. The Company is currently evaluating the impact of this new accounting guidance on its consolidated results of operations and financial condition.

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718) – Scope of Modification Accounting , to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new standard, modification is required only if the fair value, the vesting conditions, or the classification of an award as equity or liability changes as a result of the change in terms or conditions. The amendments are effective for all entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and will be applied prospectively. Early adoption is permitted. The Company does not believe the adoption of this new accounting guidance will have a material impact on its consolidated results of operations, cash flows and financial position.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . The amendments within ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Entities may early adopt the amendments within this ASU but not prior to the fiscal years beginning after December 15, 2018, including the interim periods within those fiscal years. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) which requires companies leasing assets to recognize on their balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on contracts longer than one year. The lessee is permitted to make an accounting policy election to not recognize lease assets and lease liabilities for short-term leases. How leases are recorded on the balance sheet represents a significant change from previous GAAP guidance in Topic 840. ASU 2016-02 maintains a distinction between finance leases and operating leases similar to the distinction under previous lease guidance for capital leases and operating leases. ASU 2016-02 is effective for fiscal periods beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.

 

In May 2014, the FASB issued ASU 2014-09 (Topic 606), Revenue from Contracts with Customers . The new revenue recognition standard supersedes all existing revenue recognition guidance. Under ASU 2014-09, an entity must recognize revenue relating to contracts with customers that depicts the transfer of promised goods or services to customers in an amount reflecting the consideration to which the entity expects to be entitled in exchange for such goods or services. In order to meet this requirement, the entity must apply the following steps: (i) identify the contracts with the customers; (ii) identify performance obligations in the contracts; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations per the contracts; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Additionally, disclosures required for revenue recognition will include qualitative and quantitative information about contracts with customers, significant judgments and changes in judgments, and assets recognized from costs to obtain or fulfill a contract. This guidance is effective for the Company beginning in the first quarter of 2018.

 

F- 14
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

The new guidance allows for two transition methods in application: (i) retrospective to each prior reporting period presented, or (ii) prospective with the cumulative effect of adoption recognized on January 1, 2018, also known as the modified retrospective approach. The Company intends to adopt the standard using the modified retrospective approach, which will result in an adjustment to accumulated deficit for the cumulative effect of applying this guidance to contracts in process as of the adoption date. Under this approach, prior financial statements presented will not be restated. This guidance requires additional disclosures of the amount by which each financial statement line item affected in the current reporting period during 2018 as compared to the guidance that was in effect before the change, and an explanation of the reasons for the significant changes.

 

The Company is finalizing implementation activities in accordance with the planned effective date. These activities are focused on the review of significant customer contracts and the design and implementation of relevant internal controls. The Company believes that the new standard will not materially change the timing of revenue recognition. The Company also believes that this new guidance will not have a material impact on its consolidated results of operations, cash flows and financial position.

 

Note 3 – Going Concern

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

 

The Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $4,919,000 for the year ended December 31, 2017, and had an accumulated deficit of approximately $19,255,000 as of December 31, 2017. Since inception, the Company has financed its activities principally through debt and equity financing. Management expects to incur additional losses and cash outflows in the foreseeable future in connection with development of its operating activities.

 

The Company is subject to a number of risks similar to those of other similar stage companies, including dependence on key individuals, successful development, marketing and branding of products; uncertainty of product development and generation of revenues; dependence on outside sources of financing; risks associated with research, development; dependence on third-party suppliers and collaborators; protection of intellectual property; and competition with larger, better-capitalized companies. Ultimately, the attainment of profitable operations is dependent on future events, including obtaining adequate financing to fulfill its development activities and generating a level of revenues adequate to support the Company’s cost structure. To support the Company’s financial performance, management undertook several initiatives during 2017, including:

 

  In the first quarter of 2017, the Company converted promissory notes with an original principal amount of $510,000, together with accrued interest of $134,553, in exchange for 5,001,554 shares of the Company’s common stock;
     
  In the second quarter of 2017, the Company amended certain promissory notes, each in the original principal amount of $268,750, to provide for the conversion of such notes into 2,800,000 shares, or 5,600,000 shares in the aggregate;
     
  In the first quarter of 2017, the Company also issued 16,781,250 investment units to accredited investors for gross proceeds of $2,685,000, with each unit consisting one share of common stock and a warrant to purchase one share of common stock (the “Q1 2017 Unit Offering”); and
     
  In the fourth quarter of 2017, the Company issued 14,734,000 investment units to accredited investors for gross proceeds of $1,768,000, with each unit consisting one share of common stock and a warrant to purchase one share of common stock (the “Q4 2017 Unit Offering”).

 

The warrants issued under the Q1 2017 Unit Offering and the Q4 2017 Unit Offering have an exercise price of $0.26 and $0.20 per share, respectively, and are callable at the Company’s option under conditions. Depending on the market price of the Company’s common stock, these warrants may provide an additional source of capital if they are exercised by the holder. As of January 29, 2018, the call conditions with respect to the warrants issued under the Q4 2017 Unit Offering were satisfied, however, the Company has not yet elected to call such warrants.

 

F- 15
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

The Company also adopted the 2017 Equity Incentive Plan (the “2017 Equity Plan”) which allows the Company to grant equity-based awards to attract, motivate, retain, and reward employees, directors and consultants, while permitting the Company preserve its cash resources.

 

There can be no assurance that the Company will be able to raise debt or equity financing in sufficient amounts, when and if needed, on acceptable terms or at all. If results of operations for 2018 do not meet management’s expectations, or additional capital is not available, management believes it has the ability to reduce certain expenditures. The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for the Company’s products and services, the quality of product development efforts, management of working capital, and continuation of normal payment terms and conditions for purchase of the Company’s products. The Company believes its cash balances and cash flow from operations will be insufficient to fund its operations for the next 12 months. If the Company is unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then the Company will need to raise additional funding to continue as a going concern.

 

The foregoing factors raise substantial doubt about the Company’s ability to continue as a going concern for a period of one year from the date the financial statements are issued. These consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

Note 4 – Inventory

 

Inventory consisted of the following:

 

    As of December 31,  
    2017     2016  
Finished goods   $ 569,047     $ 591,564  
Work in progress     14,348       16,518  
Raw materials     262,611       187,192  
Allowance for excess & obsolete inventory     (323,384 )     (47,369 )
Inventory, net   $ 522,622     $ 747,905  

 

Overhead expenses of $28,554 and $26,764 were included in the inventory balance as of December 31, 2017 and 2016, respectively.

 

Note 5 – Property and Equipment

 

Property and equipment consisted of the following:

 

    As of December 31,  
    2017     2016  
Furniture and equipment   $ 326,894     $ 171,709  
Equipment held for lease to related party     159,806       -  
Molds     -       31,063  
Vehicles     15,000       15,000  
Leasehold Improvements     33,257       38,101  
      534,957       255,873  
Accumulated depreciation     (133,601 )     (162,308 )
Property and equipment, net   $ 401,356     $ 93,565  

 

F- 16
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Depreciation expense amounted to $39,978 for the year ended December 31, 2017, of which $8,302 was allocated to cost of revenue. Depreciation expense amounted to $47,773 for the year ended December 31, 2016, of which $8,349 was allocated to cost of revenue and inventory.

 

As of December 31, 2017, the Company has recorded $159,806 for the cost of the equipment located at the Sterling facility as leased equipment under fixed assets. See Note 8.

 

Note 6 – Intangible Assets

 

Intangible assets consisted of the following:

 

    As of December 31,  
    2017     2016  
Patents   $ 29,952     $ 24,192  
Website development costs     22,713       22,713  
Trademarks     1,830       1,099  
      54,495       48,004  
Accumulated amortization     (16,510 )     (11,623 )
Intangible assets, net   $ 37,985     $ 36,381  

 

Patents when issued are amortized over 14 years, and web site development costs are amortized over five years. Trademarks are not amortized since they have an indefinite life. Amortization expense for intangibles amounted to $4,887 and $5,311 for the years ended December 31, 2017 and 2016, respectively.

 

Note 7 – Accounts Payable and Accrued Liabilities

 

Accounts payable and accrued liabilities consisted of the following:

 

    As of December 31,  
    2017     2016  
Accounts payable   $ 1,159,975     $ 1,020,224  
Sales commissions payable     21,931       40,736  
Sales tax payable     8,750       23,631  
Accrued payroll liabilities     58,557       43,573  
Product warranty accrual     105,122       85,000  
Commercial dispute settlement     332,418       -  
Other accrued expenses     282,510       124,689  
Total   $ 1,969,263     $ 1,337,853  

 

As of December 31, 2017, the Company reclassified $322,776 from previously recorded deferred revenue and recorded a loss of $9,642 in connection with the settlement of a commercial dispute. See Note 18.

 

Note 8 – Related Party Agreements and Transactions

 

Amounts Due to Shareholders

 

In July of 2014, the Company issued a $250,000 unsecured promissory note (“Hydro Note”) to Stephen and Brandy Keen as part of the purchase price of Hydro. Stephen Keen is a principal shareholder of the Company and was a former executive officer and director, and is now a consultant to the Company (see below). Brandy Keen, the wife of Stephen Keen, is also a principal shareholder of the Company and has been, and currently serves as, an executive officer and director of the Company. On April 15, 2016, the Keens and the Company entered into an amendment to the original Hydro Note under which the Company made a payment of $100,000 in April 2016, which resulted in the reduction of the outstanding balance from $194,514 to $94,514. Additionally, pursuant to the amendment, the Company was not obligated to make further payments until July 2016, at which time, the Company would resume monthly payments equal to $5,000 per month until the Hydro Note was paid in full. As part of the amendment, the parties also agreed that the Hydro Note no longer had to be paid in full by July 18, 2016 and that no default had occurred. The interest rate is 6% per annum. As of December 31, 2017, the Hydro Note had a balance of $6,927, which is reflected on the balance sheet as a current liability. As of December 31, 2016, the Hydro Note had a balance of $69,383, of which $57,398 and $11,985 were reflected on the Company’s consolidated balance sheet as a current and long-term liability, respectively. Subsequent to December 31, 2017, the balance of the Hydro Note was paid in full.

 

F- 17
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

As of December 31, 2015, there was a deferred compensation balance of $25,600 due to Stephen and Brandy Keen, which was paid in full during 2016.

 

Stephen Keen Consulting Agreement

 

On May 10, 2017, the Board approved a three-year consulting agreement between the Company and Stephen Keen, a principal shareholder of the Company and a former executive officer and director. Under the consulting agreement, Stephen Keen will provide certain consulting services to the Company including research and development, new product design and innovations, existing product enhancements and improvements, and other technology advancements with respect to the Company’s business and products in exchange for an annual consulting fee of $30,000. The consulting agreement also includes certain activity restrictions which prohibit Stephen Keen from competing with the Company. In connection with the execution of this consulting agreement, Stephen Keen’s employment with the Company ceased as of April 28, 2017 and he resigned as a director of the Company on May 10, 2017. Pursuant to the terms of this consulting agreement, the Company recorded consulting fees of $20,000 payable to Stephen Keen during 2017.

 

Sterling Pharms Equipment Agreement

 

On May 10, 2017, the Board approved a three-year equipment, demonstration and product testing agreement between the Company and Sterling Pharms, LLC (“Sterling”), an entity controlled by Stephen Keen, which operates a Colorado-regulated cannabis cultivation facility currently under construction. Under this agreement, the Company agreed to provide to Sterling certain lighting, environmental control, and air sanitation equipment for use at the Sterling facility in exchange for a quarterly fee of $16,500. Also, under this agreement, Sterling agreed to allow the Company and its existing and prospective customers to have access to the Sterling facility for demonstration tours in a working environment, which the Company believes will assist it in the sale of its products. Sterling also agreed to monitor, test and evaluate the Company’s products installed at the Sterling facility and to collect data and provide feedback to the Company on the energy and operational efficiency and efficacy of the installed products, which the Company intends to use to improve, enhance and develop new or additional product features, innovations and technologies. In consideration for access to the Sterling facility to conduct demonstration tours and for the product testing and data to be provided by Sterling, the Company will pay Sterling a quarterly fee of $12,000.

 

As of December 31, 2017, Sterling Pharms had accepted substantially all the equipment under this agreement, but is in the process of completing the installation of the equipment. Pursuant to the terms of this agreement, the respective payments will begin upon the delivery and installation of the equipment. As of December 31, 2017, the Company has recorded $159,806 for the cost of the equipment located at the Sterling facility as equipment held for lease to related party in fixed assets. Upon commencement of the respective payments under this agreement, the Company intends to record the $16,500 quarterly fee for use of the equipment as other income and to depreciate the cost of the leased equipment over the term of this agreement. The Company’s quarterly fee payable to Sterling will be charged equally between marketing and product development expense.

 

During the fourth quarter of 2017, the Company and Sterling agreed to revise the equipment schedule to the original agreement to include additional equipment purchased by the Company at a cost of $23,580.

 

Subsequent to December 31, 2017, at the request of Sterling, the Company purchased additional equipment at a cost of $7,687 to be included in the equipment schedule to the original agreement. On March 22, 2018, the Company and Sterling entered into an amendment of the original agreement to include the additional leased equipment as discussed above and to increase the quarterly fee payable to the Company to $18,330. The amendment of the original agreement also provided that, upon expiration of the initial three-year term, either: (i) the leased equipment would be returned to the Company and the agreement would terminate, (ii) Sterling could purchase the leased equipment at the agreed upon residual value of $81,827, or (iii) Sterling and the Company could agree to an extension of the original agreement at mutually agreed to quarterly payments to and from the parties. See Note 18.

 

F- 18
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Separately, Sterling purchased equipment from the Company unrelated to this agreement for $78,310, which represented the Company’s cost.

 

Note 9 – Promissory Notes

 

On February 9, 2017, the Company entered into a securities purchase agreement with two accredited investors pursuant to which the Company issued promissory notes in the aggregate original principal amount of $537,500. In addition, each investor received 125,000 shares, an aggregate of 250,000 shares, of the Company’s common stock. The notes were unsecured, had an interest rate of 6%, per annum and were originally due and payable, with all accrued interest, on November 9, 2017. The total proceeds were approximately $500,000 with an original issue discount of approximately $37,500. The Company allocated the cash proceeds amount between the debt and shares issued on a relative fair value basis. Based on relative fair value, the Company allocated approximately $461,000 and $39,000 to the promissory notes and the shares of common stock, respectively. The original issue discount of $37,500 and fair value of the shares issued of $39,000 were amortized and expensed over the life of the loans.

 

On August 8, 2017, the Company executed an amendment (the “Amendment”) with the holders of the promissory notes, each in the original principal amount of $268,750. The Amendment provided for each of the holder’s notes to convert its principal into 2,800,000 shares, or 5,600,000 shares in the aggregate, of the Company’s common stock, at a price per share of approximately $0.096. The Company’s closing share price on August 7, 2017 was $0.135. In connection with this Amendment, the holders also agreed to surrender to the Company the portion of the promissory notes representing the accrued interest as the consideration for this Amendment, which approximated $15,900 in total. The transactions contemplated by the Amendment closed on August 22, 2017.

 

The Company has accounted for the Amendment as debt extinguishment whereby the difference between the reacquisition price of the debt and the net carrying amount of the extinguished debt was recognized as a loss during the third quarter of 2017. The following details the calculation of the loss on extinguishment of the notes payable:

 

Carrying amount of debt      
Principal converted   $ 537,500  
Accrued interest converted     15,904  
Unamortized debt discount     (25,832 )
Total carrying amount of debt     527,572  
Reacquisition price of debt        
Fair value of shares of common stock issued     756,000  
Loss on extinguishment of debt   $ (228,428 )

 

 

During the year ended December 31, 2017, the amortization expense related to the debt discount was $49,997.

 

F- 19
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Note 10 – Convertible Notes

 

The following table summarizes the convertible promissory notes for the years ended December 31, 2017 and 2016:

 

    Series 2     Series 3     Series 4     Total  
Balance January 1, 2016   $ 2,536,250     $ 711,000     $ 103,273     $ 3,350,523  
Additions     -       -       -       -  
Conversions     (1,756,250 )     (711,000 )     (103,273 )     (2,570,523 )
Balance December 31, 2016   $ 780,000     $ -     $ -       780,000  
Discounts and deferred finance charges                             (18,560 )
Convertible notes payable, net                             761,440  
Less current portion - December 31, 2016                             761,440  
Long-term portion - December 31, 2016                           $ -  
                                 
Balance January 1, 2017   $ 780,000     $ -     $ -     $ 780,000  
Conversions     (510,000 )     -       -       (510,000 )
Repayments     (270,000 )     -       -       (270,000 )
Balance December 31, 2017   $ -     $ -     $ -     $ -  

 

Series 2 Convertible Notes

 

In October 2014, the Company offered up to 60 investment units at a price per unit of $50,000. Each unit consisted of (i) 250,000 shares of the Company’s common stock, (ii) a $50,000 10% convertible promissory note (“Series 2 Convertible Note”), and (iii) warrants for the purchase of 50,000 shares of the Company’s common stock (Series 2 Warrants”). The Series 2 Convertible Notes: (i) were unsecured, (ii) accrued interest at the rate of 10% per annum, and (iii) if not converted, were due and payable two years from the date of issuance. The Series 2 Convertible Notes were convertible after 360 days from the issuance date, at the investor’s option, into a number of shares of the Company’s common stock that was determined by dividing the amount to be converted by the $0.60 conversion price. Additionally, the entire principal amount under the Series 2 Convertible Notes would be automatically converted into common stock at a conversion price equal to the greater of $0.50 per share or 75% of the public offering price per share, without any action by the investor, on the earlier of: (x) the date on which the Company closed on a financing transaction involving the sale of the Company’s common stock at a price of no less than $2.00 per share with gross proceeds to the Company of no less than $5,000,000, or (y) the date which is three days after the common stock traded at a volume-weighted-average-price (“VWAP”) of at least $2.00 per share for a period of 10 consecutive trading days. The Company raised $2,536,250 from the sale of these investment units.

 

The gross proceeds from the sale of the Series 2 Convertible Notes were recorded net of a discount related to the conversion feature of the embedded conversion option and the fair value of the Series 2 Warrants, each of which were calculated pursuant to the Black-Scholes Model. The fair value of conversion feature and the Series 2 Warrants were recorded as a reduction to the Series 2 Convertible Notes payable and were charged to operations as interest expense in accordance with the effective interest method within the term of the Series 2 Convertible Notes. Transaction costs were apportioned to Series 2 Convertible Notes payable, common stock, Series 2 Warrants and derivative liabilities. The portion of transaction costs attributed to the conversion feature, warrants and common stock were immediately expensed, because the derivative liabilities are accounted for at fair value through the statement of operations.

 

During the year ended December 31, 2016 and the first quarter of 2017, the Company entered into note conversion and warrant amendment agreements (each, an “Agreement” and together, the “Agreements”) to: (i) amend the Series 2 Convertible Notes to reduce the conversion price and simultaneously cause the conversion of the outstanding amount under such Series 2 Convertible Notes into shares of the Company’s common stock, and (ii) reduce the exercise price of the Series 2 Warrants. Each Agreement has been privately negotiated so the terms vary.

 

Pursuant to the Agreements, the Series 2 Convertible Notes were amended to reflect a reduced conversion price per share between $0.09 and $0.22. Additionally, pursuant to the Agreements, the Series 2 Warrants were amended to reflect a reduced exercise price per share between $0.30 and $0.35, except for one Series 2 Warrant to reflect a reduced exercise price of $0.15 per share. The term of one Series 2 Warrant was also extended.

 

F- 20
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Pursuant to the Agreements, during the year ended December 31, 2016, the Company converted Series 2 Convertible Notes with an aggregate outstanding principal amount of $1,756,250, together with accrued interest of $399,063, in exchange for the issuance of 15,253,089 shares of the Company’s common stock. The exercise price of the Series 2 Warrants related to these converted notes was also reduced.

 

Pursuant to the Agreements, in the first quarter of 2017, the Company converted Series 2 Convertible Notes with an aggregate outstanding principal amount of $510,000, together with accrued interest of $134,553, in exchange for the issuance of 5,001,554 shares of the Company’s common stock. The exercise price of the Series 2 Warrants related to these converted notes was also reduced.

 

In the first quarter of 2017, the Company also made payments of $314,150 to settle Series 2 Convertible Notes in the principal amount of $270,000, together with accrued interest of $44,150. As of December 31, 2017, the Company had no Series 2 Convertible Notes outstanding.

 

The Company has accounted for the Agreements as debt extinguishment whereby the difference between the reacquisition price of the debt and the net carrying amount of the extinguished debt was recognized as a loss during for the years ended December 31, 2017 and 2016. The following details the calculation of the loss on extinguishment of the Series 2 Convertible Notes:

 

    For the Year ended December 31,  
    2017     2016  
Carrying amount of debt                
Principal converted   $ 510,000     $ 1,756,250  
Accrued interest converted     134,553       399,063  
Unamortized debt discount     (5,398 )     (51,208 )
Total carrying amount of debt     639,155       2,104,105  
Reacquisition price of debt                
Fair value of shares of common stock issued     995,155       2,346,240  
Warrant modification value     59,000       96,106  
Total reacquisition price of debt     1,054,155       2,442,346  
Loss on extinguishment of debt   $ (415,000 )   $ (338,241 )

 

During the year ended December 31, 2017, the amortization expense related to the debt discount was $13,160.

 

As of December 31, 2017, Series 2 Warrants to purchase 2,536,250 shares of common stock are outstanding. The exercise price varies from a low of $0.15 to a high of $3.00 per share, with a weighted average exercise price of $0.45 per share.

 

Series 3 Convertible Notes

 

During the third quarter of 2015, the Company entered into Securities Purchase Agreements with three accredited investors (each a “Purchaser” and together the “Purchasers”), pursuant to which the Company sold and the Purchasers purchased convertible notes (“Series 3 Convertible Notes”) with a one-year term in the aggregate original principal amount of $711,000, with an aggregate original issue discount of $61,000, together with warrants to purchase up to an aggregate of 2,625,000 shares of the Company’s common stock (“Series 3 Warrants”), for aggregate cash proceeds of $656,250. The Series 3 Convertible Notes accrued interest a rate of 10% per annum, expect for Series 3 Convertible Notes in the principal amount of $106,000 which had an interest rate of 11% per annum.

 

The conversion price of the Series 3 Convertible Notes was equal to 80% of the lowest trading price of the Company’s common stock as reported on the OTCQB for the 15 trading days prior to conversion. The Company determined that the Series 3 Convertible Notes had an embedded conversion option that qualified for derivative accounting and bifurcation under ASC 815-40 and, as a result, the Company recognized the fair value of the embedded conversion feature as a derivative liability upon issuance of the Series 3 Convertible Notes.

 

The Series 3 Warrants have a five-year term and an exercise price of $0.25 per share, subject to adjustment. The Series 3 Warrants may be exercised on a cashless basis. The Series 3 Warrants also provide for a reduction in the exercise price in the event the Company issued common stock in a registered offering at a price below the exercise price. In such case, the exercise price under the warrants would be reduced to the price of the common stock in the registered offering. The Company determined that this exercise price reduction qualified as a derivative financial instrument.

 

F- 21
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

The gross proceeds from the sale of the Series 3 Convertible Notes were recorded net of a discount related to the conversion feature of the embedded conversion option and the fair value of the Series 3 Warrants, each of which were calculated pursuant to the Black-Scholes Model. The fair value of conversion feature and the Series 3 Warrants were recorded as a reduction to the Series 3 Convertible Notes payable and were charged to operations as interest expense in accordance with the effective interest method within the term of the Series 3 Convertible Notes. Transaction costs were apportioned to Series 3 Convertible Notes payable, Series 3 Warrants and derivative liabilities. The portion of transaction costs attributed to the conversion feature, warrants and common stock were immediately expensed, because the derivative liabilities are accounted for at fair value through the statement of operations.

 

Upon issuance of the Series 3 Convertible Notes, the Company determined a fair value of $1,023,881 for the derivative liabilities, with the fair value of the warrants determined to be $246,020 and the fair value of the conversion feature determined to be $777,861. The aggregate debt discount was amortized over the term of the Series 3 Convertible Notes.

 

During the year ended December 31, 2016, the Company issued 15,598,870 shares of its common stock in connection with the conversion the Series 3 Convertible Notes in the principal amount of $711,000 and accrued interest of $72,128.

 

As of December 31, 2017, Series 3 Warrants to purchase 2,625,000 shares of common stock are outstanding.

 

Series 4 Convertible Note

 

On December 18, 2015, the Company and the noteholder agreed to amend a certain secured promissory note issued in July 2015 which, at the time of the amendment, had an outstanding principal balance of $100,273 together with accrued interest of $3,046. Pursuant to the amendment, the maturity date was extended to from December 22, 2015 to April 30, 2016 and a conversion was added allowing for conversion into shares of the Company’s common stock, at any time following the amendment, at a conversion price equal to 70% of the lowest trading price of the Company’s common stock as reported on the OTCQB for the 20 trading days prior to conversion (“Series 4 Convertible Note”).

 

The Series 4 Convertible Note had an embedded conversion option that qualified for derivative accounting and bifurcation under GAAP. The Company recognized the fair value of the embedded conversion feature as a derivative liability at the time of amendment. Since the present value of the cash flows under the new debt instrument was at least ten percent different from the present value of the remaining cash flows under the terms of the original debt instrument, the Company accounted for the amendment as a debt extinguishment.

 

During the year ended December 31, 2016, the Company issued 2,289,958 shares of its common stock in connection with the conversion the Series 4 Convertible Notes in the principal amount of $103,319 and accrued interest of $2,637.

 

Note 11 – Derivative Liabilities

 

The Company determined that the Series 3 Warrants qualified as derivative financial instruments. Accordingly, the Series 3 Warrants are derivative liabilities and are marked to market at the end of each reporting period. Any change in fair value during the period is recorded in as gain (loss) on change in derivative liabilities in the Company’s consolidated statements of operations.

 

The following table sets forth movement in the derivative liability related to the Series 3 Warrants:

 

Balance December 31, 2015   $ 139,192  
Loss on change in derivative liability, net     338,622  
Balance December 31, 2016     477,814  
(Gain) on change in derivative liability, net     (66,934 )
Balance December 31, 2017   $ 410,880  

 

F- 22
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

During the year ended December 31, 2016, the Company also had a loss on change in derivative liabilities of $200,083 associated with certain convertible promissory note balances outstanding at various dates during the year ended December 31, 2016, which were converted to common stock prior to December 31, 2016.

 

Note 12 – Commitments and Contingencies

 

Litigation

 

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.

 

Internal Revenue Service Penalties

 

The Company has been penalized by the Internal Revenue Service (“IRS”) for failure to file its Foreign Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for the years 2011, 2012 and 2014 on a timely basis. The penalties and interest approximate $115,000. The Company’s request that the penalties be abated for reasonable cause was denied by the IRS. The Company has appealed the IRS’s denial based on statutory grounds under Revenue Procedure 92-70, which provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations. Persons complying with this revenue procedure are deemed to satisfy their Form 5471 filing obligations with respect to dormant foreign corporations and are not subject to penalties related to the failure to timely file a complete Form 5471 and to timely furnish information requested thereon. The IRS has notified the Company that it needs additional time to respond to the Company’s appeal, which response is not expected until April 2018. The Company believes it has complied with the summary filing procedures for filing Form 5471 under Revenue Procedure 92-70 and the likelihood of abatement is high. However, there can be no assurance of any abatement until the IRS acts upon the appeal. See Note 17.

 

Building Lease

 

The Company had a lease agreement for its manufacturing and office space consisting of approximately 18,000 square feet during 2016, which expired April 1, 2017. As the parties negotiated a new lease agreement in connection with the sale of the property to a new landlord, the parties extended the then current lease until September 29, 2017. On June 27, 2017, the Company executed a new lease, which commenced September 29, 2017 and continues through August 31, 2022. The Company occupied its same leased space for $12,967 per month until January 1, 2018. On January 2, 2018, the leased space was expanded and the monthly rental rate increased to $18,979 until August 31, 2018. Beginning September 1, 2018, the monthly rent will increase by 3% each year through the end of the lease. Pursuant to the new lease, the Company made a security deposit of $51,000 on July 31, 2017 and is entitled to a $100,000 tenant allowance for leasehold improvements. The Company has recorded leasehold improvements in progress of $7,285 as of December 31, 2017, none of which had been reimbursed by the landlord under the tenant improvement allowance as of December 31, 2017. During the first quarter of 2016, the Company also rented additional space under a short-term lease. Rent expense under these leases amounted to $218,926 and $210,957 for the years ended December 31, 2017 and 2016, respectively.

 

The following is a schedule by years of the minimum future lease payments on the new building lease as of December 31, 2017.

 

Year Ended December 31,      
2018   $ 230,025  
2019     236,926  
2020     244,034  
2021     251,355  
2022     170,888  
Total future minimum lease payments   $ 1,133,228  

 

F- 23
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Total rent under the new building lease is charged to expense over the term of the lease on a straight-line basis, resulting in the same monthly rent expense throughout the lease. The difference between the rent expense amount and the actual rent paid is recorded to deferred rent on the Company’s consolidated balance sheets.

 

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 13 – Preferred and Common Stock

 

Preferred Stock

 

As of December 31, 2017 and 2016, there were 77,220,000 shares of Series A preferred stock, par value $0.00001 per share, issued and outstanding. The holders of Series A preferred stock have one vote per share of Series A preferred stock equivalent to one vote of the Company’s common stock. The Series A preferred stock ranks senior to the Company’s common stock. The holders of shares of Series A Preferred Stock are not entitled to receive dividends and have no conversion or preemptive rights. Upon liquidation, dissolution or winding up of the Company’s business, after payment to the holders of any senior securities, the holders of Series A preferred stock are entitled to receive a preferential cash payment per share of Series A preferred stock equal to the stated value of the preferred stock, prior to any payment to the holders of common stock.

 

Common Stock

 

During the year ended December 31, 2017, the Company issued restricted shares of its common stock as follows:

 

  5,001,554 shares of common stock were issued upon conversion of Series 2 Convertible Notes with a principal amount of $510,000, together with accrued interest (see Note 10);
     
  40,000 shares of common stock were issued to an employee as compensation;
     
  250,000 shares were issued to two investors in connection with the Company’s issuance of certain promissory notes;
     
  16,781,250 shares of common stock were issued to accredited investors in the Q1 2017 Unit Offering (see Note 14);
     
  5,600,000 shares of common stock were issued to two investors upon conversion of certain promissory notes (see Note 9);
     
  700,000 shares of common stock were issued to an independent director as an equity retention payment; and
   
  14,734,000 shares of common stock were issued to accredited investors in the Q4 2017 Unit Offering (see Note 14).

 

During the year ended December 31, 2017, the Company also issued shares of its common stock under the 2017 Equity Plan as follows:

 

  216,009 shares of common stock were issued to independent directors in lieu of cash director fees;
     
  600,000 shares of common stock were issued to a director as compensation for services prior to becoming a director;

 

F- 24
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

  1,200,000 shares were issued to an employee in connection with the execution of an employment agreement with the Company;
     
  200,000 shares of common stock were issued to a consultant in settlement of vested restricted stock units; and
     
  404,485 shares were issued to a consultant as compensation for services rendered in lieu of cash fees.

 

During the year ended December 31, 2016, the Company issued restricted shares of its common stock as follows:

 

  46,045 shares of common stock were issued to employees as compensation;
     
  1,493,400 shares of common stock were issued upon the exercise of stock options;
     
  15,253,089 shares of common stock were issued upon conversion of Series 2 Convertible Notes with a principal amount of $1,756,250 (see Note 10); and
     
  17,888,828 shares of common stock were issued upon conversion of the Series 3 and 4 Convertible Notes (see Note 10).

 

Note 14 – Unit Offerings

 

In March 2017, the Company entered into a securities purchase agreement with certain accredited investors. The Company issued an aggregate of 16,781,250 investment units, for aggregate gross proceeds of $2,685,000, or $0.16 per unit. Each unit consisted of one share of the Company’s common stock and one warrant for the purchase of one share of the Company’s common stock (“Q1 2017 Warrants”); however, one investor declined receipt of the warrant to purchase 468,750 shares of the Company’s common stock.

 

Pursuant to the Q1 2017 Warrants, the holder thereof may at any time on or after six months after the issuance date and on or prior to the close of business on the date that is the third anniversary of the issuance date, purchase up to the number of shares of the Company’s common stock as set forth in the respective warrant. The exercise price per share of the common stock under the Q1 2017 Warrants is $0.26, subject to customary adjustments as provided in the warrant. Each Q1 2017 Warrant is callable at the Company’s option commencing six months from the issuance date, provided the closing price of the Company’s common stock is $0.42 or greater for five consecutive trading days. Commencing at any time after the date on which such call condition is satisfied, the Company has the right, upon 30 days’ notice to the holder, to redeem the warrant shares at a price of $0.01 per warrant share. The holder may exercise the warrant at any time (in whole or in part) prior to the redemption date at the exercise price.

 

On December 12, 2017, the Company completed a private placement offering of investment units, at a price of $0.12 per unit, with certain accredited investors. Each unit consisted of one share of the Company’s common stock and one warrant for the purchase of one share of the Company’s common stock (“Q4 2017 Warrants”). The Company issued a total of 14,734,000 units for aggregate proceeds of $1,768,080.

 

The Q4 2017 Warrants have an exercise price of $0.20 per share, subject to customary adjustments as provided in the warrant, and have a term of three years. The Q4 2017 Warrants are callable at the Company’s option, provided the closing price of the Company’s common stock is $0.36 or greater for five consecutive trading days. Commencing at any time after the date on which the call condition is satisfied, the Company has the right, upon notice to the holders, to redeem the shares of common stock underlying each warrant at a price of $0.01 per share, but such redemption may not occur earlier than sixty-one (61) days following the date of the receipt of notice by the holder. The holder may exercise the warrant at any time (in whole or in part) prior to the redemption date at the exercise price. The call condition with respect to the Q4 2017 Warrants was satisfied on January 29, 2018, however, the Company has not elected to call such warrants.

 

As of December 31, 2017, Q1 2017 Warrants to purchase 16,312,500 shares of common stock and Q4 2017 Warrants to purchase 14,734,000 shares of common stock are outstanding.

 

F- 25
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

Note 15 – Equity Issued as Compensation for Services

 

Warrants Issued to Former Director

 

Pursuant to certain letter agreements dated May 26, 2017 and June 16, 2017, and in connection with the resignation of a former director, the Company agreed to issue the former director three individual warrants to purchase: (i) 900,000 shares (“Warrant 1”), (ii) 460,525 shares (“Warrant 2”), and (iii) 460,525 shares (“Warrant 3”) (collectively, the “Warrants”) of the Company’s common stock for a period of five years. Warrant 1 was granted on June 20, 2017, is fully vested, and can be exercised beginning December 21, 2017 at an exercise price of $0.114 per share with the option for a cashless exercise. Warrants 2 and 3 were granted on June 20, 2017, are fully vested, and can be exercised beginning December 21, 2017 at an exercise price of $0.0005 per share with the option for a cashless exercise. The Company recorded $189,592 of compensation expense for the fair value of the Warrants on the grant date. The fair value of the Warrants at the date of grant was determined using the Black-Scholes Model. The assumptions used in the Black-Scholes Model were the term of the Warrants of 5 years, volatility rate of 119.96%, quarterly dividends 0%, and a risk-free interest rate of 1.77%.

 

Warrants Issued to Investment Bank

 

Pursuant to a certain agreement dated June 19, 2017, for services rendered in connection with the conversion of the Original Notes, the Company issued to an investment bank or its designees a warrant (“Banker Warrant”) to purchase, at an exercise price $0.35 per share, 500,000 shares of the Company’s common stock for a period of three years. The Banker Warrants were fully vested on the date of issuance and may be exercised beginning December 20, 2017. The Company recorded $30,687 of expense for the fair value of the Banker Warrant on the date of issuance. The fair value of the Banker Warrants at date of issuance was determined using the Black-Scholes Model. The assumptions used in the Black-Scholes Model were term of the Banker Warrant of 3 years, volatility rate of 120.02%, rate of quarterly dividends 0% and a risk-free interest rate of 1.52%.

 

Common Shares Issued to Employee

 

During the first quarter of 2017, the Company issued to an employee 40,000 shares of common stock which were valued at $8,840 on the date of issuance. These shares were fully vested on the date of issuance and immediately expensed.

 

Common Shares Issued to Director

 

Pursuant to an agreement dated March 7, 2017, the Company issued to its Chairman of the Board (the “Chairman”) 700,000 shares of common stock as an equity retention award. These shares were valued, using the closing price for the Company’s common stock, as of the date of ratification for total value of $121,450, which was immediately expensed as compensation.

 

Note 16 – Equity Incentive Plans

 

2014 Stock Ownership Plan

 

As of December 31, 2016, the Company had non-qualified stock options to purchase 6,177,600 shares of the Company’s common stock, with an exercise price of $0.00024, outstanding under the 2014 Stock Ownership Plan of Safari Resource Group, Inc. (the “2014 Stock Plan”). Upon the adoption of the Company’s 2017 Equity Incentive Plan (the “2017 Equity Plan”), there will be no further awards under the 2014 Stock Plan.

 

In March 2017, in a private transaction, certain principal shareholders of the Company, assigned to the Previous CEO, non-qualified stock options to purchase 3,088,800 shares of the Company’s common stock outstanding under the 2014 Stock Plan. The principal shareholders informed the Company that they agreed to assign these options as an incentive (i) for the Previous CEO to complete the negotiations with the Company’s convertible noteholders to convert their notes into shares of the Company’s common stock, and (ii) for the Previous CEO to complete a private placement of the Company’s common stock. The Previous CEO thereupon delivered a purported notice of exercise of the options to the Company just prior to the expiration of the options. The Company erroneously reported in its Form 10-K for the year ended December 31, 2016 that the common stock underlying these options had been issued during the three months ended March 31, 2017. Prior to the Company’s acceptance of the notice of exercise and issuances of these shares in response thereto, in May 2017, the Previous CEO and the principal shareholders entered into a rescission agreement to nullify the March 2017 assignment transaction. Pursuant to their terms, these options have expired.

 

F- 26
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

In March 2017, a former CEO of the Company, holding non-qualified options to 3,088,800 shares of the Company’s common stock outstanding under the 2014 Stock Plan, requested to exercise options with respect to 3,000,000 shares at an exercise price of $0.00024 per share. The Board did not approve the request for the issuance of the common stock underlying these exercised options and, as a result, the Company has treated these options as expired.

 

As of December 31, 2017, there are no options outstanding under the 2014 Stock Plan.

 

The following table summarizes certain details regarding the options under the 2014 Stock Plan are set forth in the table below:

 

    Number of Options     Weighted-
Average
Exercise
Price
    Weighted-
Average
Remaining
Contractual
Term (in years)
    Aggregate
Intrinsic
Value of
Outstanding
Options
 
Outstanding, December 31, 2016     6,177,600     $ 0.00024       0.2     $ 1,155,211  
Granted     -       -       -          
Exercised     -       -       -          
Forfeited     -       -       -          
Expired     (6,177,600 )   $ 0.00024       -          
Outstanding, December 31, 2017     -                          
Vested and exercisable, December 31, 2017     -                          

 

2017 Equity Incentive Plan

 

On August 1, 2017, the Board adopted and approved 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 the Company by enabling such persons to acquire an equity interest in the Company. Under the 2017 Equity Plan, 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 50,000,000 shares of the Company’s common stock (“Plan Shares”) for issuance of equity awards under the 2017 Equity Plan. As of December 31, 2017, the Company has 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 total unrecognized compensation expense for unvested non-qualified stock options, RSUs and stock bonus awards at December 31, 2017 was $1,311,109, which will be recognized over approximately 2.25 years. This unrecognized compensation expense does not include the potential future compensation expense related to non-qualified stock options and RSUs which are subject to vesting based on certain revenue thresholds for 2018 and 2019 being satisfied (the “Performance-based Awards”). As of December 31, 2017 and the grant date, the Company has determined that the likelihood of performance levels being obtained is remote. The unrecognized compensation expense with respect to these Performance-based Awards at December 31, 2017 was $1,102,780.

 

Restricted Stock Awards

 

On August 8, 2017, the Company’s current Chief Executive Officer (the “CEO”) was awarded 600,000 shares of restricted stock under the 2017 Equity Plan in consideration of services rendered to the Company prior to his appointment as a director. These restricted shares were fully vested at the time of the award and the value attributable to these shares, which were issued in August 2017, was $84,000 as calculated using the fair value of the Company’s common stock on August 7, 2017.

 

On August 8, 2017, the Company awarded 111,113 restricted shares under the 2017 Equity Plan to independent directors in lieu of the payment of cash fees earned during the second quarter of 2017. The quarterly director fees are paid 50% in cash and 50% in shares of the Company’s common stock, with the number of shares determined based on the closing price of the common stock on the date of issuance. These restricted shares were fully vested at the time of the award. The value attributable to these shares, which were issued in August 2017, was $15,000 as calculated using the fair value of the Company’s common stock on August 7, 2017.

 

F- 27
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

On August 8, 2017, the Company awarded 260,778 restricted shares under the 2017 Equity Plan to a consultant who provided corporate and financial services to the Company. These restricted shares were awarded in lieu of cash fees earned for the April, May, June and July 2017 and were fully vested at the time of the award. The value attributable to these shares, which were issued in August 2017, was $35,205 as calculated using the fair value of the Company’s common stock on August 7, 2017.

 

On September 6, 2017, the Company awarded 1,200,000 restricted shares under the 2017 Equity Plan to an employee as compensation. These restricted shares were fully vested at the time of the award. The value attributable to these shares, which were issued in October 2017, was $134,280 as calculated using the fair value of the Company’s common stock on September 6, 2017.

 

On November 7, 2017, the Company awarded 104,896 restricted shares under the 2017 Equity Plan to independent directors in lieu of the payment of cash fees earned during the third quarter of 2017. These restricted shares were fully vested at the time of the award. The value attributable to these shares, which were issued in November 2017, was $15,000 as calculated using the fair value of the Company’s common stock on November 6, 2017. As of December 31, 2017, the independent directors are owed cash fees of $15,000 which were paid in the form of fully vested restricted shares in February 2018. See Note 18.

 

On November 7, 2017, the Company awarded 143,707 restricted shares under the 2017 Equity Plan to a consultant who provided corporate and financial services to the Company. These restricted shares were awarded in lieu of cash fees earned in August September and October 2017 and were fully vested at the time of the award. The value attributable to these shares, which were issued in November 2017, was $20,550 as calculated using the fair value of the Company’s common stock on November 6, 2017, which is equivalent to the value of the services provided. As of December 31, 2017, the consultant is owed cash fees of $12,750 which were paid in the form of fully vested restricted shares in February 2018. See Note 18.

 

Non-Qualified Stock Options

 

On August 8, 2017, the Board granted to certain independent directors non-qualified stock options, under the 2017 Equity Plan, to purchase a total of 1,800,000 shares of the Company’s common stock at an exercise price of $0.135 per share for a period of ten years. These options vest 50% on date of grant and the remaining 50% on March 1, 2018, provided they are still serving as a director on such date. On August 17, 2017, one of these independent directors was appointed the CEO and, in consideration of the grant of the restricted stock units and the eligibility for the special bonus, the CEO agreed to terminate and cancel the non-qualified stock options to purchase 900,000 shares of the Company’s common stock previously granted to him.

 

During 2017, the Board granted to certain employees non-qualified stock options, under the 2017 Equity Plan, to purchase a total of 12,530,000 shares of the Company’s common stock at an exercise price equal to the closing market price of the Company’s common stock on the day before the grant. The terms of the options are summarized as follows:

 

  (a) Non-qualified stock options to purchase 1,805,000 shares at an exercise price of $0.135 per share granted to certain employees on August 8, 2017, which vest based on the employee’s continued service over 2.4 years, as follows: (i) 661,672 options will vest if the employee remains employed at various dates during 2017, (ii) 571,665 options will vest if the employee remains employed at various dates during 2018, and (iii) 571,663 options will vest if the employee remains employed at various dates during 2019, and have a term of 10 years. As of December 31, 2017, non-qualified stock options to purchase 60,000 shares expired unexercised, and non-qualified options to purchase 285,000 shares were forfeited due to employee terminations.
     
  (b) Non-qualified stock options to purchase 1,300,000 shares at an exercise price of $0.121 per share granted to a former employee on August 17, 2017, which were fully vested on the grant date and have a term of three years.
     
  (c) Non-qualified stock options to purchase 1,200,000 shares at an exercise price of $0.135 per share granted to certain employees on August 8, 2017, which vest based on the employee’s continued service and subject to the following performance thresholds: (i) 400,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively, for the year end December 31, 2017, (ii) 400,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and (iii) 400,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As of December 31, 2017, non-qualified stock options to purchase 400,000 shares were forfeited due to the failure to achieve the 2017 performance thresholds.
     
  (d) Non-qualified stock options to purchase 4,050,000 shares at an exercise price of $0.121 per share granted to certain employees on August 17, 2017, which vest based on the employee’s continued service and subject to the following performance thresholds: (i) 800,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively, for the year end December 31, 2017, (ii) 1,300,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and (iii) 1,950,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As of December 31, 2017, non-qualified stock options to purchase 800,000 shares were forfeited due to the failure to achieve the 2017 performance thresholds.

 

F- 28
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

  (e) Non-qualified stock options to purchase 4,000,000 shares at an exercise price of $0.112 per share granted to an employee on September 6, 2017, which vest based on the employee’s continued service and subject to the following performance thresholds: (i) 750,000 options will vest if the Company achieves $8,000,000 and $10,000,000 of revenue and new bookings, respectively, for the year end December 31, 2017, (ii) 1,250,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and (iii) 2,000,000 options will vest if the Company achieves 2019 revenue of $25,000,000, and have a term of 10 years. As of December 31, 2017, non-qualified stock options to purchase 750,000 shares were forfeited due to the failure to achieve the 2017 performance thresholds.
     
  (f) Non-qualified stock options to purchase 175,000 shares at an exercise price of $0.105 per share granted to certain employees on October 10, 2017, which vest based on the employee’s continued service over 2.25 years, as follows: (i) 58,336 options will vest if the employee remains employed during 2017, (ii) 58,332 options will vest if the employee remains employed during 2018, and (iii) 58,332 options will vest if the employee remains employed during 2019, and have a term of 10 years.

 

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 115.82% - 118.20%; expected term in years 1.5 - 7.5 and risk-free interest rate 1.32% - 2.18%.

 

A summary of the non-qualified stock options granted to employees under the 2017 Equity Plan as of December 31, 2017, and changes during the year then ended, are presented in the table below:

 

    Number of
Options
    Weighted
Average
Exercise Price
    Weighted
Average
Remaining
Contractual
Term
    Aggregate Intrinsic
Value
 
                         
Outstanding, December 31, 2016     -                          
Granted     12,530,000     $ 0.121                  
Exercised     -       -                  
Forfeited     (2,235,000 )     0.122                  
Expired     (60,000 )     0.135                  
Outstanding, December 31, 2017     10,235,000       0.121       8.7     $ 1,218,375  
Exercisable , December 31, 2017     1,885,008       0.124       4.5     $ 217,876  
Outstanding vested and expected to vest, December 31, 2017     2,935,000       0.127       6.4     $ 331,625  
                                 
Performance options based on 2018 and 2019 revenue thresholds - uncertain vesting as of December 31, 2017     7,300,000       0.119       9.7     $ 886,750  

 

F- 29
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

A summary of non-vested non-qualified stock options granted to employees under the 2017 Equity Plan as of December 31, 2017, and any changes during the year then ended, are presented in the table below:

 

  Number of
Options
    Weighted Average
Grant-Date
Fair Value
    Aggregate
Intrinsic Value
 
                 
Nonvested, December 31, 2016     -                  
Granted     12,530,000     $ 0.103          
Vested     (1,885,008 )   $ 0.082          
Forfeited     (2,235,000 )   $ 0.109          
Expired     (60,000 )   $ 0.122          
Nonvested, December 31, 2017     8,349,992     $ 0.107     $ 1,000,499  

 

During the year ended December 31, 2017, the Company has recorded $189,536 as compensation expense related to vested options issued to employees, net of forfeitures. As of December 31, 2017, total unrecognized share-based compensation related to unvested options was $863,610, of which $96,530 was related to time-based vesting and $767,080 was related to performance-based vesting.

 

As of December 31, 2017, the Company had granted non-qualified options to purchase 9,250,000 shares which were performance-based. At December 31, 2017, non-qualified options to purchase 1,950,000 shares were forfeited due to the failure to satisfy the 2017 performance thresholds. Of the remaining non-qualified options to purchase 7,300,000 shares which are performance-based, the Company has determined that the likelihood of the performance thresholds being satisfied is remote as of the date of grant and December 31, 2017; therefore, no expense was recognized.

 

A summary of the non-qualified stock options granted to the directors under the 2017 Equity Plan as of December 31, 2017, and changes during the year then ended, are presented in the table below:

 

    Number of Options     Weighted Average Exercise Price     Weighted Average Remaining Contractual Term     Aggregate Intrinsic Value ($000)  
                         
Outstanding, December 31, 2016     -     $ -       -       -  
Granted     1,800,000       0.135                  
Exercised     -       -                  
Forfeited/Cancelled     (900,000 )     0.135                  
Expired     -       -                  
Outstanding, December 31, 2017     900,000     $ 0.135       9.6     $ 94,500  
Exercisable , December 31, 2017     450,000     $ 0.135       9.6     $ 47,250  
Outstanding vested and expected to vest, December 31, 2017     900,000     $ 0.135       9.6     $ 94,500  

 

F- 30
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

A summary of non-vested non-qualified stock options granted to directors under the 2017 Equity Plan as of December 31, 2017, and any changes during the year then ended, are presented in the table below:

 

  Number of Options     Weighted Average Grant-Date
Fair Value
    Aggregate
Intrinsic Value
 
                 
Nonvested, December 31, 2016     -                  
Granted     1,800,000     $ 0.123          
Vested     (450,000 )   $ 0.123          
Forfeited     (900,000 )   $ 0.123          
Expired     -                  
Nonvested, December 31, 2017     450,000     $ 0.123     $ 52,470  

 

During the year ended December 31, 2017, the Company has recorded $166,187 as compensation expense related to vested options issued to directors. As of December 31, 2017, total unrecognized share-based compensation related to unvested options was $6,306.

 

Restricted Stock Units

 

On August 8, 2017, the Company awarded 700,000 RSUs to the Chairman based on the retention agreement between the Company and the Chairman entered into in March 2017 prior to his appointment. These RSUs will vest on March 1, 2018, provided he remains a director on such date, and will be settled by the issuance of one share of common stock for each vested restricted stock unit.

 

On June 12, 2017, the Company entered into a consulting agreement for a sales and business development services. The consulting term ended on September 1, 2017. The consultant was compensated with an award of 200,000 RSUs, which vested on the following dates: 66,667 units on July 7, 2017, 66,667 units on August 4, 2017 and 66,666 units on September 1, 2017. Each vested RSU will be settled by the issuance of one share of common stock. The Company will account for these RSUs using the graded vesting method with the total value of the RSUs calculated on the date the shares of common stock are issued to the consultant. For accounting purposes, the RSUs will be revalued at each reporting date with the final value being the date the shares of common stock are issued to the consultant. The Company recorded an expense of $20,499 for the year ended December 31, 2017. The Company issued 200,000 shares of common stock to settle the vested RSUs on October 3, 2017.

 

During 2017, the Company also issued 13,100,000 RSUs to employees as follows:

 

  (a) On August 17, 2017, the Company granted 700,000 RSUs to certain employees which vest at various times during the first quarter of 2018, provided the employee remains employed as of the vesting date.
     
  (b) On August 17, 2017, the Company granted to the Company’s former Chief Executive Officer (the “Previous CEO”) 9,000,000 RSUs, which vest in 12 equal installments (750,000 RSUs per installment) commencing on the first business day of January 2018 and continuing on the first business day of each of the next 11 calendar months, provided that the Previous CEO is employed by the Company on such vesting date or, if the initial term under the employment agreement has expired, the Previous CEO has not materially breached any non-competition, non-solicitation and other post-termination of his employment obligations.
     
  (c) On September 6, 2017, the Company granted 3,000,000 RSUs to the CEO, which vest based on the CEO’s continued service and subject to the following performance thresholds: (i) 1,500,000 RSUs will vest if the Company achieves 2018 revenue of $18,000,000, and (ii) 1,500,000 RSUs will vest if the Company achieves 2019 revenue of $25,000,000.
     
  (d) During the fourth quarter of 2017, the Company granted 400,000 RSUs to certain employees which vest at various times during the second quarter of 2018, provided the employee remains employed as of the vesting date.

 

F- 31
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

All of the foregoing RSUs will be settled by the issuance of one share of common stock for each vested RSU. Subsequent to December 31, 2017, the Company issued a total of 2,250,000 shares of common stock to the Previous CEO in settlement of RSUs that vested on the first business day of January, February and March 2018 and were settled in shares of common stock. See Note 18.

 

A summary of the RSUs awarded to employees, directors and consultants under the 2017 Equity Plan as December 31, 2017 and changes during the period then ended, are presented in the table below:

 

  Number of Units     Weighted Average Grant-Date Fair Value     Aggregate Intrinsic Value  
                 
Outstanding, December 31, 2016     -                  
Granted     14,000,000     $ 0.122          
Vested and settled with share issuance     (200,000 )   $ 0.103          
Forfeited     -                  
Outstanding, December 31, 2017     13,800,000     $ 0.122     $ 3,312,000  
Expected to vest as of December 31, 2017     10,800,000     $ 0.125     $ 2,592,000  
                         
2018/2019 Performance Units - uncertain vesting     3,000,000     $ 0.112     $ 720,000  

 

During the year ended December 31, 2017, the Company has recorded $765,055 as compensation expense related to vested RSUs issued to employees, directors and consultants. As of December 31, 2017, total unrecognized share-based compensation related to unvested RSUs was $938,056, of which $602,356 was related to time-based vesting and $335,700 was related to performance-based vesting. The total intrinsic value of RSUs vested and settled with share issuance was $20,499 for the year ended December 31, 2017.

 

As of December 31, 2017, the Company had granted 3,000,000 RSUs to the CEO which were performance-based. The Company has determined that the likelihood of the performance thresholds being satisfied is remote as of the date of grant and December 31, 2017; therefore, no expense was recognized.

 

Incentive Stock Bonus Awards

 

Beginning December 31, 2017 and for each six-month period thereafter through December 31, 2019, the CEO is eligible to receive a special bonus of 1,000,000 shares of the Company’s common stock, provided the Board has determined, in its sole discretion, that the CEO’s performance has been average or better for such special bonus period. This special bonus was granted as part of the CEO’s employment agreement and is payable only if the CEO continues in the employment of the Company. On February 13, 2018, the Board approved the issuance of the special stock bonus of 1,000,000 shares of common stock to the CEO for the period ended December 31, 2017. See Note 18.

 

Beginning December 31, 2017 and for each six-month period thereafter through December 31, 2019, an employee is eligible to receive a special bonus of 560,000 shares of the Company’s common stock, provided the Board has determined, in its sole discretion, that the employee’s performance has been average or better for such special bonus period. This special bonus was granted as part of the employee’s employment agreement and is payable only if the employee continues in the employment of the Company. On February 13, 2018, the Board approved the issuance of the special stock bonus of 560,000 shares of common stock to the employee for the period ended December 31, 2017. See Note 18.

 

In addition, three other employees are eligible to receive special bonuses aggregating 400,000 shares of the Company’s common stock on the first and second anniversaries of their employment, provided the Board has determined, in its sole discretion, that the employee’s performance has been average or better for such special bonus period. This special bonus was granted as part of the employee’s employment agreement and is payable only if the employee continues in the employment of the Company.

 

These incentive stock bonus awards are treated as vesting over each award’s service period based on the fair value of the award at the time of grant. Even though the awards are subject to Board approval, the awards are vested over each service period because it is more likely than not that the Board will approve the award based on the “average or better” employee performance standard. Since the awards are denominated in shares of common stock, the fair value of the vested award is charged to additional paid-in capital.

 

F- 32
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

A summary of the incentive stock bonus awards granted to employees under the 2017 Equity Plan as December 31, 2017 and changes during the period then ended, are presented in the table below:

 

  Number of Shares     Weighted Average Grant-Date
Fair Value
    Aggregate Intrinsic Value  
                 
Unvested, December 31, 2016     -     $ -          
Awarded     8,600,000     $ 0.113          
Vested     (1,560,000 )   $ 0.113          
Forfeited     -                  
Unvested, December 31, 2017     7,040,000     $ 0.113     $ 1,689,600  
Expected to vest as of December 31, 2017     7,040,000     $ 0.113     $ 1,689,600  

 

During the year ended December 31, 2017, the Company has recorded $364,483 as compensation expense related to vested stock bonus awards issued to employees. As of December 31, 2017, total unrecognized share-based compensation related to unvested stock bonus awards was $605,917. Subsequent to December 31, 2017, the Company issued 1,560,000 shares in payment of the vested stock bonus awards having a total intrinsic value of $374,400.

 

Note 17 – Income Taxes

 

On December 22, 2017, the Tax Cuts and Jobs Act was enacted into law. This U.S. tax reform contains several key provisions including the reduction of the U.S. federal corporate income tax rate to 21% effective January 1, 2018 as well as a variety of other changes including the limitation of the tax deductibility of interest expense, acceleration of expensing of certain business assets, and reductions in the amount of executive pay that could qualify as a tax deduction. As a result of the change in the corporate tax rate, the Company remeasured its deferred tax assets as of December 31, 2017 based on the rate at which they are expected to reverse in the future, and recorded a reduction in net deferred tax assets of $1,177,000 in the fourth quarter of 2017, which is fully offset by the corresponding reduction in the valuation allowance of the same amount. This remeasurement and interpretation of the new law is provisional subject to clarifications of the provisions of the new legislation and final calculations. Any future changes to the Company’s provisional estimated impact of the U.S. tax reform will be reflected as a change in estimate in the period in which the change in estimate is made in accordance with Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the Tax Cuts and Jobs Act . SAB 118 allows for a measurement period of up to one year after the enactment date of the U.S. tax reform to finalize the recording of the related tax impacts.

 

For financial reporting purposes, the provision for income taxes consisted of the following components:

 

      2017       2016  
Current taxes:                
U.S. Federal   $ -     $ -  
U.S. State     -       -  
International     -       -  
Current taxes     -       -  
Deferred taxes:                
U.S. Federal     -       -  
U.S. State     -       -  
International     -       -  
Deferred taxes     -       -  
Provision for income taxes, net   $ -     $ -  

 

F- 33
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

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:

 

    2017     2016  
Expected income tax (benefit) expense at the federal statutory rate   $ (1,535,000 )   $ (1,021,000 )
State taxes, net of federal benefits     (109,000 )     (92,000 )
Permanent differences     225,000       50,000  
Other, net     (8,000 )     122,000  
Change due to U.S. tax reform     1,177,000       -  
Change in valuation allowance     250,000       941,000  
Reported income tax (benefit) expense   $ -     $ -  

 

The components of the net deferred tax assets as of December 31, 2017 and 2016 are as follows:

 

    2017     2016  
Deferred tax assets:                
Net operating losses   $ 2,706,000     $ 2,735,000  
Equity compensation     274,000       -  
Other deferred tax assets     263,000       297,000  
Total deferred tax assets     3,243,000       3,032,000  
                 
Deferred tax liabilities:                
Other deferred tax liabilities     -       (39,000 )
Total deferred tax liabilities     -       (39,000 )
                 
Net deferred tax assets before valuation allowance     3,243,000       2,993,000  
Less valuation allowance     (3,243,000 )     (2,993,000 )
Net deferred tax assets   $ -     $ -  

 

The Company went through a determination of its 2016 deferred tax assets and has modified certain components of the 2016 deferred tax assets which are offset by a full valuation allowance. There was no material effect on the Company’s net deferred tax assets, liabilities or income tax expense as a result of these modifications.

 

As of December 31, 2017, the Company has U.S. federal and state NOLs of approximately $10,848,000, which will expire, if not utilized, in the years 2034 through 2037. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, use of the Company’s NOLs carryforwards may be limited in the event of cumulative changes in ownership of more than 50% within a three-year period.

 

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, 2017 and 2016. 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.

 

F- 34
 

 

Surna Inc.

Notes to Consolidated Financial Statements

   

The Company is under examination, or may be subject to examination, by the IRS for the calendar year 2009 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. The Company has filed its U.S. federal corporate income tax returns from 2009 through 2016, although the returns for the years 2009 through 2015 were not timely filed. Accordingly, the Company may be subject to penalties, including those described below, for non-compliance; however, the Company believes that it had no taxable income in the U.S. or in any foreign jurisdiction for the years 2009 through 2016. The Company has filed Colorado state tax returns for years 2014 through 2016. The Company intends to amend its U.S. and Colorado income tax returns for the years 2014 through 2016.

 

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 12 months of the reporting date. There were no penalties or interest liabilities accrued as of December 31, 2017 or 2016, nor were any penalties or interest costs included in expense for the years ended December 31, 2017 and 2016.

 

The Company has been penalized by the IRS for failure to file its Foreign Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for the years 2011, 2012 and 2014 on a timely basis. The penalties and interest approximate $115,000. The Company’s request that the penalties be abated for reasonable cause was denied by the IRS. The Company has appealed the IRS’s denial based on statutory grounds under Revenue Procedure 92-70, which provides a summary filing procedure for filing Form 5471 with respect to dormant foreign corporations. Persons complying with this revenue procedure are deemed to satisfy their Form 5471 filing obligations with respect to dormant foreign corporations and are not subject to penalties related to the failure to timely file a complete Form 5471 and to timely furnish information requested thereon. The IRS has notified the Company that it needs additional time to respond to the Company’s appeal, which response is not expected until April 2018. The Company believes it has complied with the summary filing procedures for filing Form 5471 under Revenue Procedure 92-70 and the likelihood of abatement is high. However, there can be no assurance of any abatement until the IRS acts upon the appeal.

 

Note 18 – Subsequent Events

 

In accordance with ASC 855, Subsequent Events, the Company has evaluated all subsequent events through April 2, 2018, the date the financial statements were available to be issued. The following events occurred after December 31, 2017.

 

Since December 31, 2017, the Company issued shares of its restricted common stock as follows:

 

  100,000 shares upon the exercise of Series 2 Warrants by an investor and payment of the exercise price of $15,000;
     
  1,039,079 shares upon the exercise of Warrant 1 and Warrant 2 by a former director on a cashless exercise basis (see Note 15);
     
  1,168,540 shares upon exercise of certain Series 3 Warrants by investors on a cashless exercise basis (see Note 10); and
     
  800,000 shares in connection with the settlement of a commercial dispute, together with certain other cash and equipment consideration provided by the Company, all of which were adequately accrued for in the Company’s consolidated financial statements as of December 31, 2017 (see Note 7).

 

Since December 31, 2017, the Company also issued shares of its common stock under the 2017 Equity Plan as follows:

 

  2,250,000 shares to the Previous CEO in settlement of restricted stock units that vested on the first business day of January, February and March 2018 and were settled in shares of common stock (see Note 16);
     
  25,000 shares upon exercise of certain non-qualified stock options by a former employee upon payment of the exercise price of $3,375;

 

F- 35
 

 

Surna Inc.

Notes to Consolidated Financial Statements

 

  53,004 shares of common stock to independent directors in lieu of cash director fees of $15,000 related to the fourth quarter of 2017;
     
  158,658 shares to a consultant as compensation for services rendered in lieu of cash fees of $44,900 for the period November 1, 2017 to February 13, 2018;
     
  700,000 shares to a director in settlement of certain RSUs that vested in 2018;
     
  700,000 shares to certain employees in settlement of certain RSUs that vested in 2018;
     
  173,675 shares to a consultant as compensation for services rendered in connection with recruiting; and
     
  1,560,000 shares pursuant to special incentive stock bonuses earned by the CEO and another employee for the period ended December 31, 2017.

 

On February 13, 2018, the Company granted to a new employee: (i) 200,000 restricted stock units which vest in the third quarter of 2018, and (ii) non-qualified stock options to purchase 1,000,000 shares at an exercise price of $0.283 per share, which vest based on the employee’s continued service and subject to the following performance thresholds: (x) 400,000 options will vest if the Company achieves 2018 revenue of $18,000,000, and (y) 600,000 options will vest if the Company achieves 2019 revenue of $25,000,000.

 

Subsequent to December 31, 2017, at the request of Sterling, the Company purchased additional equipment at a cost of $7,687 to be included in the equipment schedule to the original agreement. On March 22, 2018, the Company and Sterling entered into an amendment of the original agreement to include the additional leased equipment as discussed above and to increase the quarterly fee payable to the Company to $18,330. The amendment of the original agreement also provided that, upon expiration of the initial three-year term, either: (i) the leased equipment would be returned to the Company and the agreement would terminate, (ii) Sterling could purchase the leased equipment at the agreed upon residual value of $81,827, or (iii) Sterling and the Company could agree to an extension of the original agreement at mutually agreed to quarterly payments to and from the parties. See Note 8.

 

F- 36
 

 

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.

 

  SURNA INC.
  (the “Registrant”)
     
Dated: April 2, 2018 By: /s/ Chris Bechtel
    Chris Bechtel
    Chief Executive Officer and President
    (Principal Executive Officer)
     
Dated: April 2, 2018 By: /s/ Chris Bechtel
    Chris Bechtel
    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: April 2, 2018 By: /s/ Brandy M. Keen
    Brandy M. Keen, Director
     
Dated: April 2, 2018 By: /s/ Chris Bechtel
    Chris Bechtel, Director
     
Dated: April 2, 2018 By: /s/ Timothy J. Keating
    Timothy J. Keating, Chairman of the Board
     
Dated: April 2, 2018 By: /s/ J. Taylor Simonton
    J. Taylor Simonton, Director

 

37
 

 

EXHIBITS

 

Exhibit    
Number   Description of Exhibit
     
3.1(a)   Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registration Statement on Form S-1 as filed on January 28, 2010).
     
3.1(b)*   Amendment to Articles of Incorporation.
     
3.1(c)   Certificate of Designations of Preferences, Rights, and Limitations of Preferred Stock (incorporated herein by reference to Exhibit 3.2 to the Current Report on Form 8-K as filed on May 12, 2014).
     
3.2*   Bylaws, as amended.
     
4.1   Specimen Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the Registration Statement on Form S-1 filed on January 28, 2010).
     
4.2*   Form of Common Stock Warrant issued with Convertible Notes.
     
4.3   Form of Note Conversion and Warrant Amendment Agreement (incorporated herein by reference to Exhibit 10.15 to the Annual Report on Form 10-K filed March 31, 2017).
     
4.4*   Form of Common Stock Warrant issued in Q1 2017 Unit Offering.
     
4.5*   Form of Common Stock Warrant issued in Q4 2017 Unit Offering.
     
10.1*+   Executive Employment Agreement between the Company and Chris Bechtel effective September 6, 2017.
     
10.2*+   Executive Employment Agreement between the Company and Brandy Keen effective October 10, 2017.
     
10.3+   Board of Directors Agreement between Surna Inc. and Timothy J. Keating dated March 7, 2017 (incorporated herein by reference to Exhibit 10.18 to the Annual Report on Form 10-K filed March 31, 2017).
     
10.4+   Surna Inc. 2017 Equity Incentive Plan (incorporated herein by reference to Exhibit 99.1 to the Registration Statement on Form S-8 filed on August 3, 2017).
     
10.5   Purchase Agreement between Surna Inc. and Sante Veritas Therapeutics Inc. dated February 21, 2017 (incorporated herein by reference to Exhibit 10.16 to the Annual Report on Form 10-K filed March 31, 2017).
     
14.1   Code of Business Code and Ethics adopted February 13, 2018 (incorporated herein by reference to Exhibit 14 to the Current Report on Form 8-K filed February 14, 2018).
     
21.1*   Subsidiaries
     
23.1*   Consent of Anton Collins Mitchell LLP, Independent Registered Public Accounting Firm, relating to Registration Statement on Form S-8.
     
23.2*   Consent of RBSM, LLP, Independent Registered Public Accounting Firm, relating to Registration Statement on Form S-8.
     
31.1 *   Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2 *   Certification of Principal Financial and Accounting Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1**   Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2**   Certification of Principal Financial and Accounting, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
99.1*   Press Release dated April 2, 2018, announcing financial condition and financial results
     
101.INS*   XBRL Instance Document
     
101.SCH*   XBRL Taxonomy Schema
     
101.CAL*   XBRL Taxonomy Calculation Linkbase
     
101.DEF*   XBRL Taxonomy Definition Linkbase
     
101.LAB*   XBRL Taxonomy Label Linkbase
     
101.PRE*   XBRL Taxonomy Presentation Linkbase
     
+ Indicates a management contract or compensatory plan.
* Filed herewith.
** Furnished herewith.

 

38
 

 

 

 

 

 

 

SURNA INC.

ADDITIONAL ARTICLES

 

Section 1. Capital Stock

 

The aggregate number of shares that the Corporation will have authority to issue is Five Hundred Million (500,000,000) of which Three Hundred Fifty Million (350,000,000) shares will be common stock, with a par value of $0.00001 per share, and One Hundred Fifty Million (150,000,000) shares will be preferred stock, with a par value of $0.00001 per share.

 

The Preferred Stock may be divided into and issued in series. The Board of Directors of the Corporation is authorized to divide the authorized shares of Preferred Stock into one or more series, each of which shall be so designated as to distinguish the shares thereof from the shares of all other series and classes. The Board of Directors of the Corporation is authorized, within any limitations prescribed by law and this Article, to fix and determine the designations, rights, qualifications, preferences, limitations and terms of the shares of any series of Preferred Stock including but not limited to the following:

 

(a) The rate of dividend, the time of payment of dividends, whether dividends are cumulative, and the date from which any dividends shall accrue;

 

(b) Whether shares may be redeemed, and, if so, the redemption price and the terms and conditions of redemption;

 

(c) The amount payable upon shares in the event of voluntary or involuntary liquidation;

 

(d) Sinking fund or other provisions, if any, for the redemption or purchase of shares;

 

(e) The terms and conditions on which shares may be converted, if the shares of any series are issued with the privilege of conversion;

 

(f) Voting powers, if any, provided that if any of the Preferred Stock or series thereof shall have voting rights, such Preferred Stock or series shall vote only on a share for share basis with the Common Stock on any matter, including but not limited to the election of directors, for which such Preferred Stock or series has such rights; and,

 

(g) Subject to the foregoing, such other terms, qualifications, privileges, limitations, options, restrictions, and special or relative rights and preferences, if any, of shares or such series as the Board of Directors of the Corporation may, at the time so acting, lawfully fix and determine under the laws of the State of Nevada.

 

The Corporation shall not declare, pay or set apart for payment any dividend or other distribution (unless payable solely in shares of Common Stock or other class of stock junior to the Preferred Stock as to dividends or upon liquidation) in respect of Common Stock, or other class of stock junior the Preferred Stock, nor shall it redeem, purchase or otherwise acquire for consideration shares of any of the foregoing, unless dividends, if any, payable to holders of Preferred Stock for the current period (and in the case of cumulative dividends, if any, payable to holder of Preferred Stock for the current period and in the case of cumulative dividends, if any, for all past periods) have been paid, are being paid or have been set aside for payments, in accordance with the terms of the Preferred Stock, as fixed by the Board of Directors.

 

In the event of the liquidation of the Corporation, holders of Preferred Stock shall be entitled to received, before any payment or distribution on the Common Stock or any other class of stock junior to the Preferred Stock upon liquidation, a distribution per share in the amount of the liquidation preference, if any, fixed or determined in accordance with the terms of such Preferred Stock plus, if so provided in such terms, an amount per share equal to accumulated and unpaid dividends in respect of such Preferred Stock (whether or not earned or declared) to the date of such distribution. Neither the sale, lease or exchange of all or substantially all of the property and assets of the Corporation, nor any consolidation or merger of the Corporation, shall be deemed to be a liquidation for the purposes of this Article.

 

 

 

 

Section 2. Acquisition of Controlling Interest.

 

The Corporation elects not to be governed by NRS 78.378 to 78.3793, inclusive.

 

Section 3. Combinations with Interest Stockholders.

 

The Corporation elects not to be governed by NRS 78.411 to 78.444, inclusive.

 

Section 4. Liability.

 

To the fullest extent permitted by NRS 78, a director or officer of the Corporation will not be personally liable to the Corporation or its stockholders for damages for breach of fiduciary duty as a director or officer, provided that this article will not eliminate or limit the liability of a director or officer for:

 

(a) acts or omissions which involve intentional misconduct, fraud or a knowing violation of law; or

 

(b) the payment of distributions in violation of NRS 78.300, as amended,

 

Any amendment or repeal of this Section 4 will not adversely affect any right or protection of a director of the Corporation existing immediately prior to such amendment or repeal.

 

Section 5. Indemnification

 

(a) Right to Indemnification. The Corporation will indemnify to the fullest extent permitted by law any person (the “Indemnitee”) made or threatened to be made a party to any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative (whether or not by or in the right of the Corporation) by reason of the fact that he or she is or was a director of the Corporation or is or was serving as a director, officer, employee or agent of another entity at the request of the Corporation or any predecessor of the Corporation against judgments, fines, penalties, excise taxes, amounts paid in settlement and costs, charges and expenses (including attorneys’ fees and disbursements) that he or she incurs in connection with such action or proceeding.

 

(b) Inurement. The right to indemnification will inure whether or not the claim asserted is based on matters that predate the adoption of this Section 5, will continue as to an Indemnitee who has ceased to hold the position by virtue of which he or she was entitled to indemnification, and will inure to the benefit of his or her heirs and personal representatives,

 

(c) Non-exclusivity of Rights. The right to indemnification and to the advancement of expenses conferred by this Section 5 are not exclusive of any other rights that an Indemnitee may have or acquire under any statue, bylaw, agreement, vote of stockholders or disinterested directors, the Certificate of Incorporation or otherwise.

 

(d) Other Sources. The Corporation’s obligation, if any, to indemnify or to advance expenses to any Indemnitee who was or is serving at the request as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, enterprise or other entity will be reduced by any amount such Indemnitee may collect as indemnification or advancement or expenses from such other entity.

 

(e) Advancement of Expenses. The Corporation will, from time to time, reimburse or advance to any Indemnitee the funds necessary for payment of expenses, including attorneys’ fees and disbursements, incurred in connection with defending any proceeding from which he or she is indemnified by the Corporation, in advance of the final disposition of such proceeding; provided that the Corporation has received the undertaking of such director or officer to repay any such amount so advanced if it is ultimately determined by a final and unappealable judicial decision that the director or officer is not entitled to be indemnified for such expenses.

 

 

 

 

 

BYLAWS, AS AMENDED,

OF

SURNA INC.

 

I. SHAREHOLDER’S MEETING

 

.01 Annual Meetings.

 

The annual meeting of the shareholders of this Corporation, for the purpose of election of Directors and for such other business as may come before it, shall be held at the registered office of the Corporation, or such other places, either within or without the State of Nevada, as may be designated by the notice of the meeting, on the first week in March of each and every year, at 1:00 p.m., commencing in 2011 but in case such day shall be a legal holiday, the meeting shall be held at the same hour and place on the next succeeding day not a holiday.

 

.02 Special Meeting.

 

Special meetings of the shareholders of this Corporation may be called at any time by the holders of ten percent (10%) of the voting shares of the Corporation, or by the President, or by the Board of Directors or a majority thereof. No business shall be transacted at any special meeting of shareholders except as is specified in the notice calling for said meeting. The Board of Directors may designate any place, either within or without the State of Nevada, as the place of any special meeting called by the president or the Board of Directors, and special meetings called at the request of shareholders shall be held at such place in the State of Nevada, as may be determined by the Board of Directors and placed in the notice of such meeting.

 

.03 Notice of Meeting.

 

Written notice of annual or special meetings of shareholders stating the place, day, and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called shall be given by the secretary or persons authorized to call the meeting to each shareholder of record entitled to vote at the meeting. Such notice shall be given not less than ten (10) nor more than fifty (50) days prior to the date of the meeting, and such notice shall be deemed to be delivered when deposited in the United States mail addressed to the shareholder at his/her address as it appears on the stock transfer books of the Corporation.

 

.04 Waiver of Notice.

 

Notice of the time, place, and purpose of any meeting may be waived in writing and will be waived by any shareholder by his/her attendance thereat in person or by proxy. Any shareholder so waiving shall be bound by the proceedings of any such meeting in all respects as if due notice thereof had been given.

 

 
 

 

.05 Quorum and Adjourned Meetings.

 

A majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. A majority of the shares represented at a meeting, even if less than a quorum, may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. The shareholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum.

 

.06 Proxies.

 

At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or by his/her duly authorized attorney in fact. Such proxy shall be filed with the secretary of the Corporation before or at the time of the meeting. No proxy shall be valid after eleven (11) months from the date of its execution, unless otherwise provided in the proxy.

 

.07 Voting of Shares.

 

Except as otherwise provided in the Articles of Incorporation or in these Bylaws, every shareholder of record shall have the right at every shareholder’s meeting to one (1) vote for every share standing in his/her name on the books of the Corporation, and the affirmative vote of a majority of the shares represented at a meeting and entitled to vote thereat shall be necessary for the adoption of a motion or for the determination of all questions and business which shall come before the meeting.

 

II. DIRECTORS

 

.01 General Powers.

 

The business and affairs of the Corporation shall be managed by its Board of Directors.

 

.02 Number, Tenure and Qualifications.

 

The number of Directors of the Corporation shall be not less than one nor more than thirteen, as determined from time to time by action of the Shareholders or by a resolution of the entire Board of Directors (excluding any un-filled vacancies), or if the number is not fixed, the number shall be one. Each Director shall hold office until the next annual meeting of shareholders and until his/her successor shall have been elected and qualified. Directors need not be residents of the State of Nevada or shareholders of the Corporation.

 

.03 Election.

 

The Directors shall be elected by the shareholders at their annual meeting each year; and if, for any cause the Directors shall not have been elected at an annual meeting, they may be elected at a special meeting of shareholders called for that purpose in the manner provided by these Bylaws.

 

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.04 Vacancies.

 

In case of any vacancy in the Board of Directors, the remaining Directors, whether constituting a quorum or not, may elect a successor to hold office for the unexpired portion of the terms of the Directors whose place shall be vacant, and until his/her successor shall have been duly elected and qualified. Further, the remaining Directors may fill any empty seats on the Board of Directors even if the empty seats have never been occupied.

 

.05 Resignation.

 

Any Director may resign at any time by delivering written notice to the secretary of the Corporation.

 

.06 Meetings.

 

At any annual, special or regular meeting of the Board of Directors, any business may be transacted, and the Board may exercise all of its powers. Any such annual, special or regular meeting of the Board of Directors of the Corporation may be held outside of the State of Nevada, and any member or members of the Board of Directors of the Corporation may participate in any such meeting by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other at the same time; the participation by such means shall constitute presence in person at such meeting.

 

A. Annual Meeting of Directors.

 

Annual meetings of the Board of Directors shall be held immediately after the annual shareholders’ meeting or at such time and place as may be determined by the Directors. No notice of the annual meeting of the Board of Directors shall be necessary.

 

B. Special Meetings.

 

Special meetings of the Directors shall be called at any time and place upon the call of the president or any Director. Notice of the time and place of each special meeting shall be given by the secretary, or the persons calling the meeting, by mail, radio, telegram, or by personal communication by telephone or otherwise at least one (1) day in advance of the time of the meeting. The purpose of the meeting need not be given in the notice. Notice of any special meeting may be waived in writing or by telegram (either before or after such meeting) and will be waived by any Director in attendance at such meeting.

 

C. Regular Meetings of Directors.

 

Regular meetings of the Board of Directors shall be held at such place and on such day and hour as shall from time to time be fixed by resolution of the Board of Directors. No notice of regular meetings of the Board of Directors shall be necessary.

 

.07 Quorum and Voting.

 

A majority of the Directors presently in office shall constitute a quorum for all purposes, but a lesser number may adjourn any meeting, and the meeting may be held as adjourned without further notice. At each meeting of the Board at which a quorum is present, the act of a majority of the Directors present at the meeting shall be the act of the Board of Directors. The Directors present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough Directors to leave less than a quorum.

 

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.08 Compensation.

 

By resolution of the Board of Directors, the Directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as Director. No such payment shall preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor.

 

.09 Presumption of Assent.

 

A Director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his/her dissent shall be entered in the minutes of the meeting or unless he/she shall file his/her written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a Director who voted in favor of such action.

 

.10 Executive and Other Committees.

 

The Board of Directors, by resolution adopted by a majority of the full Board of Directors, may designate from among its members an executive committee and one of more other committees, each of which, to the extent provided in such resolution, shall have and may exercise all the authority of the Board of Directors, but no such committee shall have the authority of the Board of Directors, in reference to amending the Articles of Incorporation, adoption a plan of merger or consolidation, recommending to the shareholders the sale, lease, exchange, or other disposition of all of substantially all the property and assets of the dissolution of the Corporation or a revocation thereof, designation of any such committee and the delegation thereto of authority shall not operate to relieve any member of the Board of Directors of any responsibility imposed by law.

 

.11 Chairman of Board of Directors.

 

The Board of Directors may, in its discretion, elect a chairman of the Board of Directors from its members; and, if a chairman has been elected, he/she shall, when present, preside at all meetings of the Board of Directors and the shareholders and shall have such other powers as the Board may prescribe.

 

.12 Removal.

 

Directors may be removed from office with or without cause by a vote of shareholders holding a majority of the shares entitled to vote at an election of Directors.

 

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III. ACTIONS BY WRITTEN CONSENT

 

Any corporate action required by the Articles of Incorporation, Bylaws, or the laws under which this Corporation is formed, to be voted upon or approved at a duly called meeting of the Directors may be accomplished without a meeting if a written memorandum setting forth the action so taken, shall be signed by all the Directors. Any corporate action required by the Articles of Incorporation, Bylaws, or the laws under which this Corporation is formed, to be voted upon or approved at a duly called meeting of the Shareholders, may be accomplished without a meeting if a written memorandum setting forth the action so taken, shall be signed by holders of a majority of the total outstanding shares of common stock.

 

IV. OFFICERS

 

.01 Officers Designated.

 

The Officers of the Corporation shall be a president, one or more vice presidents (the number thereof to be determined by the Board of Directors), a secretary and a treasurer, each of whom shall be elected by the Board of Directors. Such other Officers and assistant officers as may be deemed necessary may be elected or appointed by the Board of Directors. Any Officer may be held by the same person, except that in the event that the Corporation shall have more than one director, the offices of president and secretary shall be held by different persons.

 

.02 Election, Qualification and Term of Office.

 

Each of the Officers shall be elected by the Board of Directors. None of said Officers except the president need be a Director, but a vice president who is not a Director cannot succeed to or fill the office of president. The Officers shall be elected by the Board of Directors. Except as hereinafter provide, each of said Officers shall hold office from the date of his/her election until the next annual meeting of the Board of Directors and until his/her successor shall have been duly elected and qualified.

 

.03 Powers and Duties.

 

The powers and duties of the respective corporate Officers shall be as follows:

 

A. President.

 

The president shall be the chief executive Officer of the Corporation and, subject to the direction and control of the Board of Directors, shall have general charge and supervision over its property, business, and affairs. He/she shall, unless a Chairman of the Board of Directors has been elected and is present, preside at meetings of the shareholders and the Board of Directors.

 

B. Vice President.

 

In the absence of the president or his/her inability to act, the senior vice president shall act in his place and stead and shall have all the powers and authority of the president, except as limited by resolution of the Board of Directors.

 

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C. Secretary.

 

The secretary shall:

 

1. Keep the minutes of the shareholder’s and of the Board of Directors meetings in one or more books provided for that purpose;

 

2. See that all notices are duly given in accordance with the provisions of these Bylaws or as required by law;

 

3. Be custodian of the corporate records and of the seal of the Corporation and affix the seal of the Corporation to all documents as may be required;

 

4. Keep a register of the post office address of each shareholder which shall be furnished to the secretary by such shareholder;

 

5. Sign with the president, or a vice president, certificates for shares of the Corporation, the issuance of which shall have been authorized by resolution of the Board of Directors;

 

6. Have general charge of the stock transfer books of the corporation; and,

 

7. In general perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him/her by the president or by the Board of Directors.

 

D. Treasurer.

 

Subject to the direction and control of the Board of Directors, the treasurer shall have the custody, control and disposition of the funds and securities of the Corporation and shall account for the same; and, at the expiration of his/her term of office, he/she shall turn over to his/her successor all property of the Corporation in his/her possession.

 

E. Assistant Secretaries and Assistant Treasurers.

 

The assistant secretaries, when authorized by the Board of Directors, may sign with the president or a vice president certificates for shares of the Corporation the issuance of which shall have been authorized by a resolution of the Board of Directors. The assistant treasurers shall, respectively, if required by the Board of Directors, give bonds for the faithful discharge of their duties in such sums and with such sureties as the Board of Directors shall determine. The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or the treasurer, respectively, or by the president or the Board of Directors.

 

.04 Removal.

 

The Board of Directors shall have the right to remove any Officer whenever in its judgment the best interest of the Corporation will be served thereby.

 

.05 Vacancies.

 

The Board of Directors shall fill any office which becomes vacant with a successor who shall hold office for the unexpired term and until his/her successor shall have been duly elected and qualified.

 

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.06 Salaries.

 

The salaries of all Officers of the Corporation shall be fixed by the Board of Directors.

 

V. SHARE CERTIFICATES

 

.01 Form and Execution of Certificates.

 

Certificates for shares of the Corporation shall be in such form as is consistent with the provisions of the Corporation laws of the State of Nevada. They shall be signed by the president and by the secretary, and the seal of the Corporation shall be affixed thereto. Certificates may be issued for fractional shares.

 

.02 Transfers.

 

Shares may be transferred by delivery of the certificates therefor, accompanied either by an assignment in writing on the back of the certificates or by a written power of attorney to assign and transfer the same signed by the record holder of the certificate. Except as otherwise specifically provided in these Bylaws, no shares shall be transferred on the books of the Corporation until the outstanding certificate therefor has been surrendered to the Corporation.

 

.03 Loss or Destruction of Certificates.

 

In case of loss or destruction of any certificate of shares, another may be issued in its place upon proof of such loss or destruction and upon the giving of a satisfactory bond of indemnity to the Corporation. A new certificate may be issued without requiring any bond, when in the judgment of the Board of Directors it is proper to do so.

 

VI. BOOKS AND RECORDS

 

.01 Books of Accounts, Minutes and Share Register.

 

The Corporation shall keep complete books and records of accounts and minutes of the proceedings of the Board of Directors and shareholders and shall keep at its registered office, principal place of business, or at the office of its transfer agent or registrar a share register giving the names of the shareholders in alphabetical order and showing their respective addresses and the number of shares held by each.

 

.02 Copies of Resolutions.

 

Any person dealing with the Corporation may rely upon a copy of any of the records of the proceedings, resolutions, or votes of the Board of Directors or shareholders, when certified by the president or secretary.

 

VII. CORPORATE SEAL

 

The Corporation is not required to have a corporate seal.

 

VIII. LOANS

 

No loans shall be made by the Corporation to its Officers or Directors

 

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IX. INDEMNIFICATION OF DIRECTORS AND OFFICERS

 

.01 Indemnification.

 

The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that such person is or was a Director, Trustee, Officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, Trustee, Officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgment, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe such person’s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action proceeding, had reasonable cause to believe that such person’s conduct was unlawful.

 

.02 Derivative Action.

 

The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in the Corporation’s favor by reason of the fact that such person is or was a Director, Trustee, Officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, Trustee, Officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorney’s fees) and amount paid in settlement actually and reasonably incurred by such person in connection with the defense or settlement of such action or suit if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to amounts paid in settlement, the settlement of the suit or action was in the best interests of the Corporation; provided, however, that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for gross negligence or willful misconduct in the performance of such person’s duty to the Corporation unless and only to the extent that, the court in which such action or suit was brought shall determine upon application that, despite circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses as such court shall deem proper. The termination of any action or suit by judgment or settlement shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the Corporation.

 

.03 Successful Defense.

 

To the extent that a Director, Trustee, Officer, employee or Agent of the Corporation has been successful on the merits or otherwise, in whole or in part in defense of any action, suit or proceeding referred to in Paragraphs .01 and .02 above, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection therewith.

 

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.04 Authorization.

 

Any indemnification under Paragraphs .01 and .02 above (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the Director, Trustee, Officer, employee or agent is proper in the circumstances because such person has met the applicable standard of conduct set forth in Paragraphs .01 and .02 above. Such determination shall be made (a) by the Board of Directors of the Corporation by a majority vote of a quorum consisting of Directors who were not parties to such action, suit or proceeding, or (b) is such a quorum is not obtainable, by a majority vote of the Directors who were not parties to such action, suit or proceeding, or (c) by independent legal counsel (selected by one or more of the Directors, whether or not a quorum and whether or not disinterested) in a written opinion, or (d) by the Shareholders. Anyone making such a determination under this Paragraph .04 may determine that a person has met the standards therein set forth as to some claims, issues or matters but not as to others, and may reasonably prorate amounts to be paid as indemnification.

 

.05 Advances.

 

Expenses incurred in defending civil or criminal action, suit or proceeding shall be paid by the Corporation, at any time or from time to time in advance of the final disposition of such action, suit or proceeding as authorized in the manner provided in Paragraph .04 above upon receipt of an undertaking by or on behalf of the Director, Trustee, Officer, employee or agent to repay such amount unless it shall ultimately be by the Corporation is authorized in this Section.

 

.06 Nonexclusivity.

 

The indemnification provided in this Section shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any law, bylaw, agreement, vote of shareholders or disinterested Directors or otherwise, both as to action in such person’s official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a Director, Trustee, Officer, employee or agent and shall inure to the benefit of the heirs, executors, and administrators of such a person.

 

.07 Insurance.

 

The Corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a Director, Trustee, Officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, Trustee, Officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability assessed against such person in any such capacity or arising out of such person’s status as such, whether or not the corporation would have the power to indemnify such person against such liability.

 

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.08 “Corporation” Defined.

 

For purposes of this Section, references to the “Corporation” shall include, in addition to the Corporation, an constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had the power and authority to indemnify its Directors, Trustees , Officers, employees or agents, so that any person who is or was a Director, Trustee, Officer, employee or agent of such constituent corporation or of any entity a majority of the voting stock of which is owned by such constituent corporation or is or was serving at the request of such constituent corporation as a Director, Trustee, Officer, employee or agent of the corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Section with respect to the resulting or surviving Corporation as such person would have with respect to such constituent corporation if its separate existence had continued.

 

X. AMENDMENT OF BYLAWS

 

.01 By the Shareholders.

 

These Bylaws may be amended, altered, or repealed at any regular or special meeting of the shareholders if notice of the proposed alteration or amendment is contained in the notice of the meeting.

 

.02 By the Board of Directors.

 

These Bylaws may be amended, altered, or repealed by the affirmative vote of a majority of the entire Board of Directors at any regular or special meeting of the Board.

 

XI. FISCAL YEAR

 

The fiscal year of the Corporation shall be set by resolution of the Board of Directors.

 

XII. RULES OF ORDER

 

The rules contained in the most recent edition of Robert’s Rules or Order, Newly Revised, shall govern all meetings of shareholders and Directors where those rules are not inconsistent with the Articles of Incorporation, Bylaws, or special rules or order of the Corporation.

 

XIII. REIMBURSEMENT OF DISALLOWED EXPENSES

 

If any salary, payment, reimbursement, employee fringe benefit, expense allowance payment, or other expense incurred by the Corporation for the benefit of an employee is disallowed in whole or in part as a deductible expense of the Corporation for Federal Income Tax purposes, the employee shall reimburse the Corporation, upon notice and demand, to the full extent of the disallowance. This legally enforceable obligation is in accordance with the provisions of Revenue Ruling 69115, 19691 C.B. 50, and is for the purpose of entitling such employee to a business expense deduction for the taxable year in which the repayment is made to the Corporation. In this manner, the Corporation shall be protected from having to bear the entire burden of disallowed expense items.

 

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FORM OF WARRANT

 

NEITHER THIS SECURITY NOR THE SECURITIES FOR WHICH THIS SECURITY IS EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THIS SECURITY AND THE SECURITIES ISSUABLE UPON EXERCISE OF THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR OTHER LOAN SECURED BY SUCH SECURITIES.

 

COMMON STOCK PURCHASE WARRANT

 

SURNA, INC.    
     
Warrant Shares:                            Initial Exercise Date:               , 2014

 

THIS COMMON STOCK PURCHASE WARRANT (the “Warrant”) certifies that, for value received,         or its assigns (the “Holder”) is entitled, upon the terms and subject to the limitations on exercise and the conditions hereinafter set forth, at any time on or after six months after the date hereof (the “Initial Exercise Date”) and on or prior to the close of business on         , 2018 (the “Termination Date”) but not thereafter, to subscribe for and purchase from SURNA, INC., a Colorado corporation (the “Company”), up to          shares (as subject to adjustment hereunder, the “Warrant Shares”) of Common Stock. The purchase price of one share of Common Stock under this Warrant shall be equal to the Exercise Price, as defined in Section 2(b).

 

Section 1

 

Definitions

 

Capitalized terms used and not otherwise defined herein shall have the meanings set forth in that certain Securities Purchase Agreement (the “Purchase Agreement”), dated [         ], 2014, among the Company and the purchasers signatory thereto.

 

Exercise; Call and Redemption

 

Section 2

 

a) Exercise of Warrant by Holder. Exercise of the purchase rights represented by this Warrant may be made, in whole or in part, at any time or times on or after the Initial Exercise Date and on or before the Termination Date by delivery to the Company (or such other office or agency of the Company as it may designate by notice in writing to the registered Holder at the address of the Holder appearing on the books of the Company) of a duly executed facsimile copy of the Notice of Exercise in the form annexed hereto and the Company shall have received payment of the aggregate Exercise Price of the shares thereby purchased by wire transfer or cashier’s check drawn on a United States bank. No ink-original

 

 
 

 

Notice of Exercise shall be required, nor shall any medallion guarantee (or other type of guarantee or notarization) of any Notice of Exercise form be required. Notwithstanding anything herein to the contrary, the Holder shall not be required to physically surrender this Warrant to the Company until the Holder has purchased all of the Warrant Shares available hereunder and the Warrant has been exercised in full, in which case, the Holder shall surrender this Warrant to the Company for cancellation within three (3) Trading Days of the date the final Notice of Exercise is delivered to the Company. Partial exercises of this Warrant resulting in purchases of a portion of the total number of Warrant Shares available hereunder shall have the effect of lowering the outstanding number of Warrant Shares purchasable hereunder in an amount equal to the applicable number of Warrant Shares purchased. The Holder and the Company shall maintain records showing the number of Warrant Shares purchased and the date of such purchases. The Company shall deliver any objection to any Notice of Exercise within one (1) Business Day of receipt of such notice. The Holder and any assignee, by acceptance of this Warrant, acknowledge and agree that, by reason of the provisions of this paragraph, following the purchase of a portion of the Warrant Shares hereunder, the number of Warrant Shares available for purchase hereunder at any given time may be less than the amount stated on the face hereof.

 

b) Mandatory Call (Redemption) Provisions. Notwithstanding anything to the contrary contained in this Warrant, this Warrant is callable (redeemable) at the Company’s option commencing six (6) months from the Initial Exercise Date, provided the Common Stock trades at a VWAP of $3.60 or greater for ten (10) consecutive Trading Days on the Trading Market (the “Call Condition”). Commencing at any time after the date on which the Call Condition is satisfied, the Company shall have the right, upon 20 days’ notice to the Holder given not later than fifteen (15) Trading Days after the date on which the Call Condition is satisfied (the “Redemption Notice”), to redeem the number of Warrant Shares specified in the applicable Call Condition at a price of $.01 per Warrant Share (the “Redemption Price”), on the date set forth in the Redemption Notice, but in no event earlier than 20 days following the date of the receipt by the Holder of the Redemption Notice (the “Redemption Date”). The Holder may exercise this Warrant at any time (in whole or in part) prior to the Redemption Date at the Exercise Price. Any portion of this Warrant that is subject to the applicable Call Condition which is not exercised by the Redemption Date shall no longer be exercisable and shall be returned to the Company (and, if not so returned, shall automatically be deemed canceled), and the Company, upon its receipt of the unexercised portion of this Warrant, shall issue therefore in full and complete satisfaction of its obligations under such called but unexercised portion of this Warrant to the Holder an amount equal to the number of shares of Common Stock called but remaining unexercised multiplied by the Redemption Price. The Redemption Price shall be mailed to such Holder at its address of record, and the Warrant shall be canceled.

 

c) Exercise Price. The exercise price per share of the Common Stock under this Warrant shall be $3.00, subject to adjustment hereunder (the “Exercise Price”).

 

d) Mechanics of Exercise.

 

i. Delivery of Warrant Shares Upon Exercise. Warrant Shares purchased hereunder shall be transmitted by the Company or its transfer agent to the Holder the Holder in the Notice of Exercise within a commercially reasonable time, pursuant to SEC regulations, with the goal of accomplishing such action three (3) business days after delivery to the Company of the Notice of Exercise (such date, the “Warrant Share Delivery Date”). The Warrant Shares shall be deemed to have been issued, and Holder or any other person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the Warrant has been exercised, with payment to the Company of the Exercise Price and all taxes required to be paid by the Holder, if any, pursuant to Section 2(d)(vi) prior to the issuance of such shares, having been paid.

 

 
 

 

ii. Delivery of New Warrants Upon Exercise. If this Warrant shall have been exercised in part, the Company shall, at the request of a Holder and upon surrender of this Warrant certificate, at the time of delivery of the Warrant Shares, deliver to the Holder a new Warrant evidencing the rights of the Holder to purchase the unpurchased Warrant Shares called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant.

 

iii. No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which the Holder would otherwise be entitled to purchase upon such exercise, the Company shall, at its election, either pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Exercise Price or round up to the next whole share.

 

iv. Charges, Taxes and Expenses. Issuance of Warrant Shares shall be made without charge to the Holder for any issue or transfer tax or other incidental expense in respect of the issuance of Warrant Shares, all of which taxes and expenses shall be paid by the Company, and such Warrant Shares shall be issued in the name of the Holder or in such name or names as may be directed by the Holder; provided, however, that in the event that Warrant Shares are to be issued in a name other than the name of the Holder, this Warrant when surrendered for exercise shall be accompanied by the Assignment Form attached hereto duly executed by the Holder and the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. The Company shall pay all Transfer Agent fees required for same-day processing of any Notice of Exercise and all fees to the Depository Trust Company (or another established clearing corporation performing similar functions) required for same-day electronic delivery of the Warrant Shares.

 

v. Closing of Books. The Company will not close its stockholder books or records in any manner which prevents the timely exercise of this Warrant, pursuant to the terms hereof.

 

Section 3

 

Certain Adjustments

 

a) Stock Dividends and Splits. If the Company, at any time while this Warrant is outstanding: (i) pays a stock dividend or otherwise makes a distribution or distributions on shares of its Common Stock or any other equity or equity equivalent securities payable in shares of Common Stock (which, for avoidance of doubt, shall not include any shares of Common Stock issued by the Company upon exercise of this Warrant), (ii) subdivides outstanding shares of Common Stock into a larger number of shares, (iii) combines (including by way of reverse stock split) outstanding shares of Common Stock into a smaller number of shares or (iv) issues by reclassification of shares of the Common Stock any shares of capital stock of the Company, then in each case the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding immediately before such event and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event, and the number of shares issuable upon exercise of this Warrant shall be proportionately adjusted such that the aggregate Exercise Price of this Warrant shall remain unchanged. Any adjustment made pursuant to this Section 3(a) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re classification.

 

 
 

 

b) Pro Rata Distributions. During such time as this Warrant is outstanding, if the Company shall declare or make any dividend or other distribution of its assets (or rights to acquire its assets) to holders of shares of Common Stock, by way of return of capital or otherwise (including, without limitation, any distribution of cash, stock or other securities, property or options by way of a dividend, spin off, reclassification, corporate rearrangement, scheme of arrangement or other similar transaction) (a “Distribution”), at any time after the issuance of this Warrant, then, in each such case, the Holder shall be entitled to participate in such Distribution to the same extent that the Holder would have participated therein if the Holder had held the number of shares of Common Stock acquirable upon complete exercise of this Warrant immediately before the date of which a record is taken for such Distribution, or, if no such record is taken, the date as of which the record holders of shares of Common Stock are to be determined for the participation in such Distribution.

 

c) Fundamental Transaction. If, at any time while this Warrant is outstanding, (i) the Company, directly or indirectly, in one or more related transactions effects any merger or consolidation of the Company with or into another Person, (ii) the Company, directly or indirectly, effects any sale, lease, license, assignment, transfer, conveyance or other disposition of all or substantially all of its assets in one or a series of related transactions, (iii) any, direct or indirect, purchase offer, tender offer or exchange offer (whether by the Company or another Person) is completed pursuant to which holders of Common Stock are permitted to sell, tender or exchange their shares for other securities, cash or property and has been accepted by the holders of 50% or more of the outstanding Common Stock, (iv) the Company, directly or indirectly, in one or more related transactions effects any reclassification, reorganization or recapitalization of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is effectively converted into or exchanged for other securities, cash or property, or (v) the Company, directly or indirectly, in one or more related transactions consummates a stock or share purchase agreement or other business combination (including, without limitation, a reorganization, recapitalization, spin-off or scheme of arrangement) with another Person or group of Persons whereby such other Person or group acquires more than 50% of the outstanding shares of Common Stock (not including any shares of Common Stock held by the other Person or other Persons making or party to, or associated or affiliated with the other Persons making or party to, such stock or share purchase agreement or other business combination) (each a “Fundamental Transaction”), then, upon any subsequent exercise of this Warrant, the Holder shall have the right to receive, for each Warrant Share that would have been issuable upon such exercise immediately prior to the occurrence of such Fundamental Transaction, at the option of the Holder, the number of shares of Common Stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such Fundamental Transaction (without regard to any limitation in Section 2(e) on the exercise of this Warrant). For purposes of any such exercise, the determination of the Exercise Price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the Exercise Price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the Holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of this Warrant following such Fundamental Transaction.

 

 
 

 

d) Calculations. All calculations under this Section 3 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. For purposes of this Section 3, the number of shares of Common Stock deemed to be issued and outstanding as of a given date shall be the sum of the number of shares of Common Stock (excluding treasury shares, if any) issued and outstanding.

 

e) Notice to Holder.

 

i. Adjustment to Exercise Price. Whenever the Exercise Price is adjusted pursuant to any provision of this Section 3, the Company shall promptly mail to the Holder a notice setting forth the Exercise Price after such adjustment and any resulting adjustment to the number of Warrant Shares and setting forth a brief statement of the facts requiring such adjustment.

 

ii. Notice to Allow Exercise by Holder. If (A) the Company shall declare a dividend (or any other distribution in whatever form) on the Common Stock, (B) the Company shall declare a special nonrecurring cash dividend on or a redemption of the Common Stock, (C) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights, (D) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property, or (E) the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, then, in each case, the Company shall cause to be mailed to the Holder at its last address as it shall appear upon the Warrant Register of the Company, at least 20 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. To the extent that any notice provided hereunder constitutes, or contains, material, non-public information regarding the Company or any of the Subsidiaries, the Company shall simultaneously file such notice with the Commission pursuant to a Current Report on Form 8-K, provided that the requirement in this sentence shall only apply if any of the Company’s securities are listed or quoted for public trading. The Holder shall remain entitled to exercise this Warrant during the period commencing on the date of such notice to the effective date of the event triggering such notice except as may otherwise be expressly set forth herein.

 

 
 

 

Section 4

 

Transfer of Warrant

 

a) Transferability. Subject to compliance with any applicable securities laws and the conditions set forth in Section 4(d) hereof and to the provisions of Section 4.1 of the Purchase Agreement, this Warrant and all rights hereunder (including, without limitation, any registration rights) are transferable, in whole or in part, upon surrender of this Warrant at the principal office of the Company or its designated agent, together with a written assignment of this Warrant substantially in the form attached hereto duly executed by the Holder or its agent or attorney and funds sufficient to pay any transfer taxes payable upon the making of such transfer. Upon such surrender and, if required, such payment, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees, as applicable, and in the denomination or denominations specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, and this Warrant shall promptly be cancelled. Notwithstanding anything herein to the contrary, the Holder shall not be required to physically surrender this Warrant to the Company unless the Holder has assigned this Warrant in full, in which case, the Holder shall surrender this Warrant to the Company within three (3) Trading Days of the date the Holder delivers an assignment form to the Company assigning this Warrant full. The Warrant, if properly assigned in accordance herewith, may be exercised by a new holder for the purchase of Warrant Shares without having a new Warrant issued.

 

b) New Warrants. This Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by the Holder or its agent or attorney. Subject to compliance with Section 4(a), as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. All Warrants issued on transfers or exchanges shall be dated the Initial Exercise Date and shall be identical with this Warrant except as to the number of Warrant Shares issuable pursuant thereto.

 

c) Warrant Register. The Company shall register this Warrant, upon records to be maintained by the Company for that purpose (the “Warrant Register”), in the name of the record Holder hereof from time to time. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof for the purpose of any exercise hereof or any distribution to the Holder, and for all other purposes, absent actual notice to the contrary.

 

d) Transfer Restrictions. If, at the time of the surrender of this Warrant in connection with any transfer of this Warrant, the transfer of this Warrant shall not be either (i) registered pursuant to an effective registration statement under the Securities Act and under applicable state securities or blue sky laws or (ii) eligible for resale pursuant to Rule 144, the Company may require, as a condition of allowing such transfer, that the Holder or transferee of this Warrant, as the case may be, comply with the provisions of Section 5.7 of the Purchase Agreement.

 

e) Representation by the Holder. The Holder, by the acceptance hereof, represents and warrants that it is acquiring this Warrant and, upon any exercise hereof, will acquire the Warrant Shares issuable upon such exercise, for its own account and not with a view to or for distributing or reselling such Warrant Shares or any part thereof in violation of the Securities Act or any applicable state securities law, except pursuant to sales registered or exempted under the Securities Act.

 

 
 

 

Section 5

 

Miscellaneous

 

a) No Rights as Stockholder Until Exercise. This Warrant does not entitle the Holder to any voting rights, dividends or other rights as a stockholder of the Company prior to the exercise hereof as set forth in Section 2(d)(i), except as expressly set forth in Section 3.

 

b) Loss, Theft, Destruction or Mutilation of Warrant. The Company covenants that upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant or any stock certificate relating to the Warrant Shares, and in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it (which, in the case of the Warrant, shall not include the posting of any bond), and upon surrender and cancellation of such Warrant or stock certificate, if mutilated, the Company will make and deliver a new Warrant or stock certificate of like tenor and dated as of such cancellation, in lieu of such Warrant or stock certificate.

 

c) Saturdays, Sundays, Holidays, etc. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall not be a Business Day, then, such action may be taken or such right may be exercised on the next succeeding Business Day.

 

d) Authorized Shares. The Company covenants that, during the period the Warrant is outstanding, it will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the Warrant Shares upon the exercise of any purchase rights under this Warrant. The Company further covenants that its issuance of this Warrant shall constitute full authority to its officers who are charged with the duty of issuing the necessary Warrant Shares upon the exercise of the purchase rights under this Warrant. The Company will take all such reasonable action as may be necessary to assure that such Warrant Shares may be issued as provided herein without violation of any applicable law or regulation, or of any requirements of the Trading Market upon which the Common Stock may be listed. The Company covenants that all Warrant Shares which may be issued upon the exercise of the purchase rights represented by this Warrant will, upon exercise of the purchase rights represented by this Warrant and payment for such Warrant Shares in accordance herewith, be duly authorized, validly issued, fully paid and nonassessable and free from all taxes, liens and charges created by the Company in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue).

 

e) Jurisdiction. All questions concerning the construction, validity, enforcement and interpretation of this Warrant shall be determined in accordance with the provisions of the Purchase Agreement.

 

f) Restrictions. The Holder acknowledges that the Warrant Shares acquired upon the exercise of this Warrant, if not registered, will have restrictions upon resale imposed by state and federal securities laws.

 

g) Nonwaiver and Expenses. No course of dealing or any delay or failure to exercise any right hereunder on the part of Holder shall operate as a waiver of such right or otherwise prejudice the Holder’s rights, powers or remedies, notwithstanding the fact that all rights hereunder terminate on the Termination Date. If the Company willfully and knowingly fails to comply with any provision of this Warrant, which results in any material damages to the Holder, the Company shall pay to the Holder such amounts as shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys’ fees, including those of appellate proceedings, incurred by the Holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder.

 

h) Notices. Any notice, request or other document required or permitted to be given or delivered to the Holder by the Company shall be delivered in accordance with the notice provisions of the Purchase Agreement.

 

 
 

 

i) Limitation of Liability. No provision hereof, in the absence of any affirmative action by the Holder to exercise this Warrant to purchase Warrant Shares, and no enumeration herein of the rights or privileges of the Holder, shall give rise to any liability of the Holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company.

 

j) Remedies. The Holder, in addition to being entitled to exercise all rights granted by law , including recovery of damages, will be entitled to specific performance of its rights under this Warrant. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Warrant and hereby agrees to waive and not to assert the defense in any action for specific performance that a remedy at law would be adequate.

 

k) Successors and Assigns. Subject to applicable securities laws, this Warrant and the rights and obligations evidenced hereby shall inure to the benefit of and be binding upon the successors and permitted assigns of the Company and the successors and permitted assigns of Holder . The provisions of this Warrant are intended to be for the benefit of any Holder from time to time of this Warrant and shall be enforceable by the Holder or holder of Warrant Shares.

 

I) Amendment. This Warrant may be modified or amended or the provisions hereof waived with the written consent of the Company and the Holder.

 

m) Severability. Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Warrant.

 

n) Headings. The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant.

 

IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its officer thereunto duly authorized as of the date first above indicated.

 

SURNA, INC.
     
  By:           
  Name:  
  Title:  

 

 
 

 

 

NOTICE OF EXERCISE

 

TO: SURNA, INC.

 

(1) The undersigned hereby elects to purchase       Warrant Shares of the Company pursuant to the terms of the attached Warrant (only if exercised in full), and tenders herewith payment of the exercise price in full, together with all applicable transfer taxes, if any.

 

(2) Payment shall take the form of (check applicable box):

[  ] in lawful money of the United States.

 

(3) Please issue said Warrant Shares in the name of the undersigned or in such other name as is specified below:

 

 

The Warrant Shares shall be delivered to the following DWAC Account Number:

 

 

 

 

 

 

 

(4) Accredited Investor. The undersigned is an “accredited investor” as defined in Regulation D promulgated under the Securities Act of 1933, as amended.

 

[SIGNATURE OF HOLDER]  
   
Name of Investing Entity:  
   
Signature of Authorized Signatory of Investing Entity:  
   
   
Name of Authorized Signatory:  
   
   
Title of Authorized Signatory:  
   
   
Date:  
   
   

 

 
 

 

EXHIBIT B

 

ASSIGNMENT FORM

 

(To assign the foregoing Warrant, execute this form and supply required information. Do not use this form to purchase shares.)

 

FOR VALUE RECEIVED, the foregoing Warrant and all rights evidenced thereby are hereby assigned to

 

Name:  
  (Please Print)  
     
Address:  
  (Please Print)  
     
Dated: ________________________________,     ________  
   

 

Holder’s Signature:  
     
Holder’s Address:  
     
     

 

 
 

 

FORM OF WARRANT

 

NEITHER THIS SECURITY NOR THE SECURITIES FOR WHICH THIS SECURITY IS EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THIS SECURITY AND THE SECURITIES ISSUABLE UPON EXERCISE OF THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR OTHER LOAN SECURED BY SUCH SECURITIES.

 

COMMON STOCK PURCHASE WARRANT

 

SURNA INC.    
     
Warrant Shares:                      Initial Exercise Date:                   , 2017

 

THIS COMMON STOCK PURCHASE WARRANT (the “Warrant”) certifies that, for value received,             or its assigns (the “Holder”) is entitled, upon the terms and subject to the limitations on exercise and the conditions hereinafter set forth, at any time on or after six months after the date hereof (the “Initial Exercise Date”) and on or prior to the close of business on          , 2020 (the “Termination Date”) but not thereafter, to subscribe for and purchase from SURNA, INC., a Nevada corporation (the “Company”), up to          shares (as subject to adjustment hereunder, the “Warrant Shares”) of Common Stock. The purchase price of one share of Common Stock under this Warrant shall be equal to the Exercise Price, as defined in Section 2(b).

 

Section 1 – Definitions

 

Capitalized terms used and not otherwise defined herein shall have the meanings set forth in that certain Securities Purchase Agreement (the “Purchase Agreement”), dated [            ], 2017, among the Company and the purchasers signatory thereto.

 

Section 2 – Exercise; Call and Redemption

 

a)        Exercise of Warrant by Holder. Exercise of the purchase rights represented by this Warrant may be made, in whole or in part, at any time or times on or after the Initial Exercise Date and on or before the Termination Date by delivery to the Company (or such other office or agency of the Company as it may designate by notice in writing to the registered Holder at the address of the Holder appearing on the books of the Company) of a duly executed facsimile copy of the Notice of Exercise in the form annexed hereto and the Company shall have received payment of the aggregate Exercise Price of the shares thereby purchased by wire transfer or cashier’s check drawn on a United States bank. No ink-original Notice of Exercise shall be required, nor shall any medallion guarantee (or other type of guarantee or notarization) of any Notice of Exercise form be required. Notwithstanding anything herein to the contrary, the Holder shall not be required to physically surrender this Warrant to the Company until the Holder has purchased all of the Warrant Shares available hereunder and the Warrant has been exercised in full, in which case, the Holder shall surrender this Warrant to the Company for cancellation within three (3) Trading Days of the date the final Notice of Exercise is delivered to the Company. Partial exercises of this Warrant resulting in purchases of a portion of the total number of Warrant Shares available hereunder shall have the effect of lowering the outstanding number of Warrant Shares purchasable hereunder in an amount equal to the applicable number of Warrant Shares purchased. The Holder and the Company shall maintain records showing the number of Warrant Shares purchased and the date of such purchases. The Company shall deliver any objection to any Notice of Exercise within one (1) Business Day of receipt of such notice. The Holder and any assignee, by acceptance of this Warrant, acknowledge and agree that, by reason of the provisions of this paragraph, following the purchase of a portion of the Warrant Shares hereunder, the number of Warrant Shares available for purchase hereunder at any given time may be less than the amount stated on the face hereof.

 

 
 

 

b)        Mandatory Call (Redemption) Provisions . Notwithstanding anything to the contrary contained in this Warrant, this Warrant is callable (redeemable) at the Company’s option commencing six (6) months from the Initial Exercise Date, provided the closing price of the Common Stock is $0.42 (adjusted to reflect forward or reverse stock splits, recapitalizations, reorganizations or the like) or greater for five (5) consecutive Trading Days on the Trading Market (the “Call Condition”). Commencing at any time after the date on which the Call Condition is satisfied, the Company shall have the right, upon 30 days’ notice to the Holder (the “Redemption Notice”), to redeem the number of Warrant Shares specified in the applicable Call Condition at a price of $0.01 per Warrant Share (the “Redemption Price”), on the date set forth in the Redemption Notice, but in no event earlier than 30 days following the date of the receipt by the Holder of the Redemption Notice (the “Redemption Date”). The Holder may exercise this Warrant at any time (in whole or in part) prior to the Redemption Date at the Exercise Price. Any portion of this Warrant that is subject to the applicable Call Condition which is not exercised by the Redemption Date shall no longer be exercisable and shall be returned to the Company (and, if not so returned, shall automatically be deemed canceled), and the Company, upon its receipt of the unexercised portion of this Warrant, shall issue therefore in full and complete satisfaction of its obligations under such called but unexercised portion of this Warrant to the Holder an amount equal to the number of shares of Common Stock called but remaining unexercised multiplied by the Redemption Price. The Redemption Price shall be mailed to such Holder at its address of record, and the Warrant shall be canceled.

 

c)        Exercise Price . The exercise price per share of the Common Stock under this Warrant shall be $0.26, subject to adjustment hereunder (the “Exercise Price”).

 

d)        Mechanics of Exercise.

 

i.      Delivery of Warrant Shares Upon Exercise. Warrant Shares purchased hereunder shall be transmitted by the Company or its transfer agent to the Holder the Holder in the Notice of Exercise within a commercially reasonable time, pursuant to SEC regulations, with the goal of accomplishing such action three (3) Trading Days after delivery to the Company of the Notice of Exercise (such date, the “Warrant Share Delivery Date”). The Warrant Shares shall be deemed to have been issued, and Holder or any other person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the Warrant has been exercised, with payment to the Company of the Exercise Price and all taxes required to be paid by the Holder, if any, pursuant to Section 2(d)(vi) prior to the issuance of such shares, having been paid.

 

ii.      Delivery of New Warrants Upon Exercise . If this Warrant shall have been exercised in part, the Company shall, at the request of a Holder and upon surrender of this Warrant certificate, at the time of delivery of the Warrant Shares, deliver to the Holder a new Warrant evidencing the rights of the Holder to purchase the unpurchased Warrant Shares called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant.

 

iii.     No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which the Holder would otherwise be entitled to purchase upon such exercise, the Company shall, at its election, either pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Exercise Price or round up to the next whole share.

 

iv.     Charges, Taxes and Expenses. Issuance of Warrant Shares shall be made without charge to the Holder for any issue or transfer tax or other incidental expense in respect of the issuance of Warrant Shares, all of which taxes and expenses shall be paid by the Company, and such Warrant Shares shall be issued in the name of the Holder or in such name or names as may be directed by the Holder; provided, however, that in the event that Warrant Shares are to be issued in a name other than the name of the Holder, this Warrant when surrendered for exercise shall be accompanied by the Assignment Form attached hereto duly executed by the Holder and the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. The Company shall pay all Transfer Agent fees required for same-day processing of any Notice of Exercise and all fees to the Depository Trust Company (or another established clearing corporation performing similar functions) required for same-day electronic delivery of the Warrant Shares as applicable.

 

2
 

 

v.      Closing of Books. The Company will not close its stockholder books or records in any manner which prevents the timely exercise of this Warrant, pursuant to the terms hereof.

 

Section 3 – Certain Adjustments

 

a)       Stock Dividends and Splits. If the Company, at any time while this Warrant is outstanding: (i) pays a stock dividend or otherwise makes a distribution or distributions on shares of its Common Stock or any other equity or equity equivalent securities payable in shares of Common Stock (which, for avoidance of doubt, shall not include any shares of Common Stock issued by the Company upon exercise of this Warrant), (ii) subdivides outstanding shares of Common Stock into a larger number of shares, (iii) combines (including by way of reverse stock split) outstanding shares of Common Stock into a smaller number of shares or (iv) issues by reclassification of shares of the Common Stock any shares of capital stock of the Company, then in each case the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding immediately before such event and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event, and the number of shares issuable upon exercise of this Warrant shall be proportionately adjusted such that the aggregate Exercise Price of this Warrant shall remain unchanged. Any adjustment made pursuant to this Section 3(a) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re classification.

 

b)       Fundamental Transaction . If, at any time while this Warrant is outstanding, (i) the Company, directly or indirectly, in one or more related transactions effects any merger or consolidation of the Company with or into another Person, (ii) the Company, directly or indirectly, effects any sale, lease, license, assignment, transfer, conveyance or other disposition of all or substantially all of its assets in one or a series of related transactions, (iii) any, direct or indirect, purchase offer, tender offer or exchange offer (whether by the Company or another Person) is completed pursuant to which holders of Common Stock are permitted to sell, tender or exchange their shares for other securities, cash or property and has been accepted by the holders of 50% or more of the outstanding Common Stock, (iv) the Company, directly or indirectly, in one or more related transactions effects any reclassification, reorganization or recapitalization of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is effectively converted into or exchanged for other securities, cash or property, or (v) the Company, directly or indirectly, in one or more related transactions consummates a stock or share purchase agreement or other business combination (including, without limitation, a reorganization, recapitalization, spin-off or scheme of arrangement) with another Person or group of Persons whereby such other Person or group acquires more than 50% of the outstanding shares of Common Stock (not including any shares of Common Stock held by the other Person or other Persons making or party to, or associated or affiliated with the other Persons making or party to, such stock or share purchase agreement or other business combination) (each a “Fundamental Transaction”), then, upon any subsequent exercise of this Warrant, the Holder shall have the right to receive, for each Warrant Share that would have been issuable upon such exercise immediately prior to the occurrence of such Fundamental Transaction, at the option of the Holder, the number of shares of Common Stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such Fundamental Transaction (without regard to any limitation in Section 2(e) on the exercise of this Warrant). For purposes of any such exercise, the determination of the Exercise Price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the Exercise Price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the Holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of this Warrant following such Fundamental Transaction.

 

3
 

 

c)        Calculations. All calculations under this Section 3 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. For purposes of this Section 3, the number of shares of Common Stock deemed to be issued and outstanding as of a given date shall be the sum of the number of shares of Common Stock (excluding treasury shares, if any) issued and outstanding.

 

d)        Notice to Holder.

 

i.       Adjustment to Exercise Price. Whenever the Exercise Price is adjusted pursuant to any provision of this Section 3, the Company shall promptly mail to the Holder a notice setting forth the Exercise Price after such adjustment and any resulting adjustment to the number of Warrant Shares and setting forth a brief statement of the facts requiring such adjustment.

 

ii.      Notice to Allow Exercise by Holder . If (A) the Company shall declare a dividend (or any other distribution in whatever form) on the Common Stock, (B) the Company shall declare a special nonrecurring cash dividend on or a redemption of the Common Stock, (C) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights, (D) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property, or (E) the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, then, in each case, the Company shall cause to be mailed to the Holder at its last address as it shall appear upon the Warrant Register of the Company, at least 20 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. To the extent that any notice provided hereunder constitutes, or contains, material, non-public information regarding the Company or any of the Subsidiaries, the Company shall simultaneously file such notice with the Commission pursuant to a Current Report on Form 8-K, provided that the requirement in this sentence shall only apply if any of the Company’s securities are listed or quoted for public trading. The Holder shall remain entitled to exercise this Warrant during the period commencing on the date of such notice to the effective date of the event triggering such notice except as may otherwise be expressly set forth herein.

 

Section 4 – Transfer of Warrant

 

a)       Transferability . Subject to compliance with any applicable securities laws and the conditions set forth in Section 4(d) hereof and to the provisions of Section 4.1 of the Purchase Agreement, this Warrant and all rights hereunder are transferable, in whole or in part, upon surrender of this Warrant at the principal office of the Company or its designated agent, together with a written assignment of this Warrant substantially in the form attached hereto duly executed by the Holder or its agent or attorney and funds sufficient to pay any transfer taxes payable upon the making of such transfer. Upon such surrender and, if required, such payment, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees, as applicable, and in the denomination or denominations specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, and this Warrant shall promptly be cancelled. Notwithstanding anything herein to the contrary, the Holder shall not be required to physically surrender this Warrant to the Company unless the Holder has assigned this Warrant in full, in which case, the Holder shall surrender this Warrant to the Company within three (3) Trading Days of the date the Holder delivers an assignment form to the Company assigning this Warrant full. The Warrant, if properly assigned in accordance herewith, may be exercised by a new holder for the purchase of Warrant Shares without having a new Warrant issued.

 

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b)       New Warrants. This Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by the Holder or its agent or attorney. Subject to compliance with Section 4(a), as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. All Warrants issued on transfers or exchanges shall be dated the Initial Exercise Date and shall be identical with this Warrant except as to the number of Warrant Shares issuable pursuant thereto.

 

c)       Warrant Register . The Company shall register this Warrant, upon records to be maintained by the Company for that purpose (the “Warrant Register”), in the name of the record Holder hereof from time to time. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof for the purpose of any exercise hereof or any distribution to the Holder, and for all other purposes, absent actual notice to the contrary.

 

d)       Transfer Restrictions. If, at the time of the surrender of this Warrant in connection with any transfer of this Warrant, the transfer of this Warrant shall not be either (i) registered pursuant to an effective registration statement under the Securities Act and under applicable state securities or blue sky laws or (ii) eligible for resale pursuant to Rule 144, the Company may require, as a condition of allowing such transfer, that the Holder or transferee of this Warrant, as the case may be, comply with the provisions of Section 5.7 of the Purchase Agreement.

 

e)        Representation by the Holder. The Holder, by the acceptance hereof, represents and warrants that it is acquiring this Warrant and, upon any exercise hereof, will acquire the Warrant Shares issuable upon such exercise, for its own account and not with a view to or for distributing or reselling such Warrant Shares or any part thereof in violation of the Securities Act or any applicable state securities law, except pursuant to sales registered or exempted under the Securities Act.

 

Section 5 – Miscellaneous

 

a)        No Rights as Stockholder Until Exercise . This Warrant does not entitle the Holder to any voting rights, dividends or other rights as a stockholder of the Company prior to the exercise hereof as set forth in Section 2(d)(i).

 

b)       Loss, Theft, Destruction or Mutilation of Warrant . The Company covenants that upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant or any stock certificate relating to the Warrant Shares, and in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it (which, in the case of the Warrant, shall not include the posting of any bond), and upon surrender and cancellation of such Warrant or stock certificate, if mutilated, the Company will make and deliver a new Warrant or stock certificate of like tenor and dated as of such cancellation, in lieu of such Warrant or stock certificate.

 

c)        Saturdays, Sundays, Holidays, etc . If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall not be a Business Day, then, such action may be taken or such right may be exercised on the next succeeding Business Day.

 

d)        Authorized Shares. The Company covenants that, during the period the Warrant is outstanding, it will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the Warrant Shares upon the exercise of any purchase rights under this Warrant. The Company further covenants that its issuance of this Warrant shall constitute full authority to its officers who are charged with the duty of issuing the necessary Warrant Shares upon the exercise of the purchase rights under this Warrant. The Company will take all such reasonable action as may be necessary to assure that such Warrant Shares may be issued as provided herein without violation of any applicable law or regulation, or of any requirements of the Trading Market upon which the Common Stock may be traded. The Company covenants that all Warrant Shares which may be issued upon the exercise of the purchase rights represented by this Warrant will, upon exercise of the purchase rights represented by this Warrant and payment for such Warrant Shares in accordance herewith, be duly authorized, validly issued, fully paid and non-assessable and free from all taxes, liens and charges created by the Company in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue).

 

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e)       Jurisdiction . All questions concerning the construction, validity, enforcement and interpretation of this Warrant shall be determined in accordance with the provisions of the Purchase Agreement.

 

f)        Restrictions. The Holder acknowledges that the Warrant Shares acquired upon the exercise of this Warrant, if not registered, will have restrictions upon resale imposed by state and federal securities laws.

 

g)        Non-waiver and Expenses. No course of dealing or any delay or failure to exercise any right hereunder on the part of Holder shall operate as a waiver of such right or otherwise prejudice the Holder’s rights, powers or remedies, notwithstanding the fact that all rights hereunder terminate on the Termination Date. If the Company willfully and knowingly fails to comply with any provision of this Warrant, which results in any material damages to the Holder, the Company shall pay to the Holder such amounts as shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys’ fees, including those of appellate proceedings, incurred by the Holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder.

 

h)        Notices. Any notice, request or other document required or permitted to be given or delivered to the Holder by the Company shall be delivered in accordance with the notice provisions of the Purchase Agreement.

 

i)         Limitation of Liability. No provision hereof, in the absence of any affirmative action by the Holder to exercise this Warrant to purchase Warrant Shares, and no enumeration herein of the rights or privileges of the Holder, shall give rise to any liability of the Holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company.

 

j)        Remedies. The Holder, in addition to being entitled to exercise all rights granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Warrant. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Warrant and hereby agrees to waive and not to assert the defense in any action for specific performance that a remedy at law would be adequate.

 

k)        Successors and Assigns. Subject to applicable securities laws, this Warrant and the rights and obligations evidenced hereby shall inure to the benefit of and be binding upon the successors and permitted assigns of the Company and the successors and permitted assigns of Holder. The provisions of this Warrant are intended to be for the benefit of any Holder from time to time of this Warrant and shall be enforceable by the Holder or holder of Warrant Shares.

 

l)        Amendment. This Warrant may be modified or amended or the provisions hereof waived with the written consent of the Company and the Holder.

 

m)       Severability . Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Warrant.

 

n)        Headings . The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant.

 

IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its officer thereunto duly authorized as of the date first above indicated.

 

SURNA INC.  
     
By:  
  Trent Doucet  
  President and Chief Executive Officer  

 

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NOTICE OF EXERCISE

 

TO: SURNA INC.

 

(1) The undersigned hereby elects to purchase          Warrant Shares of the Company pursuant to the terms of the attached Warrant (only if exercised in full), and tenders herewith payment of the exercise price in full, together with all applicable transfer taxes, if any.

 

(2) Payment shall take the form of (check applicable box):

 

[  ] in lawful money of the United States.

 

(3) Please issue said Warrant Shares in the name of the undersigned or in such other name as is specified below:

 

(please print name)

 

The Warrant Shares shall be delivered to the following Address:

 

 

 

 

 

 

(4) Accredited Investor. The undersigned is an “accredited investor” as defined in Regulation D promulgated under the Securities Act of 1933, as amended.

 

Holder’s Signature: ____________________________________________________
 
Name of Investing Entity: _______________________________________________
 
Signature of Authorized Signatory of Investing Entity: _________________________
 
Name of Authorized Signatory of Investing Entity: ____________________________
 
Title of Authorized Signatory of Investing Entity: _____________________________
 
Dated: _____/_____/20_____

 

 
 

 

EXHIBIT B

 

ASSIGNMENT FORM

 

TO: SURNA INC.

 

(To assign the foregoing Warrant, execute this form and supply required information. Do not use this form to purchase shares.)

 

FOR VALUE RECEIVED, the foregoing Warrant and all rights evidenced thereby are hereby assigned to:

 

Name:  
(Please Print)  
     
Address:  
(Please Print)  
     
Dated: _____/_____/20_____  

 

Holder’s Signature:  
     
Holder’s Address:  
     
     

 

 
 

 

EXHIBIT C

 

INVESTOR SUITABILITY REQUIREMENTS

 

 
 

 

EXHIBIT D

 

RISK FACTORS

 

 
 

 

NEITHER THIS SECURITY NOR THE SECURITIES FOR WHICH THIS SECURITY IS EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THIS SECURITY AND THE SECURITIES ISSUABLE UPON EXERCISE OF THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR OTHER LOAN SECURED BY SUCH SECURITIES.

 

Warrant No. __________   Number of Shares: ______
Date of Issuance:   December __, 2017   (subject to adjustment)

 

SURNA INC.

 

Common Stock Warrant

 

Surna Inc., a Nevada corporation (the “Company”), for value received, hereby certifies that ____________________, or its registered assigns (the “Registered Holder”), is entitled, subject to the terms set forth below, to purchase from the Company at any time after the Date of Issuance and on or before December ___, 2020 (the “Expiration Date”), _______ shares (as adjusted from time to time pursuant to the provisions of this Warrant) of common stock, par value $0.00001 per share, of the Company (the “Common Stock”), at an exercise price of $0.20 per share. The shares issuable upon exercise of this Warrant and the exercise price per share, as adjusted from time to time pursuant to the provisions of this Warrant, are sometimes hereinafter referred to as the “Warrant Shares” and the “Exercise Price,” respectively.

 

This Warrant is issued pursuant to that certain Securities Purchase Agreement dated as of December 12, 2017 by and among the Company and the purchasers signatory thereto (the “Purchase Agreement”). Capitalized terms used and not otherwise defined herein shall have the meanings set forth in the Purchase Agreement.

 

1. Exercise

 

a. Exercise By Registered Holder . At any time on or after the Date of Issuance and on or before the Expiration Date, this Warrant may be exercised by the Registered Holder, in whole or in part, by surrendering this Warrant, with the purchase/exercise form attached hereto as Exhibit A (the “Notice of Exercise”) duly executed by the Registered Holder or by the Registered Holder’s duly authorized attorney, at the principal office of the Company, or at such other office or agency as the Company may designate, accompanied by payment in full of the aggregate Exercise Price payable in respect of the number of Warrant Shares purchased upon such exercise. No ink-original Notice of Exercise shall be required, nor shall any medallion guarantee (or other type of guarantee or notarization) of any Notice of Exercise form be required. Notwithstanding anything herein to the contrary, the Registered Holder shall not be required to physically surrender this Warrant to the Company until the Registered Holder has purchased all of the Warrant Shares available hereunder and the Warrant has been exercised in full, in which case, the Registered Holder shall surrender this Warrant to the Company for cancellation within three (3) Trading Days of the date the final Notice of Exercise is delivered to the Company. Partial exercises of this Warrant resulting in purchases of a portion of the total number of Warrant Shares available hereunder shall have the effect of lowering the outstanding number of Warrant Shares purchasable hereunder in an amount equal to the applicable number of Warrant Shares purchased. The Registered Holder and the Company shall maintain records showing the number of Warrant Shares purchased and the date of such purchases, provided, however, if there are any discrepancies, the records of the Company shall prevail. The Company shall deliver any objection to any Notice of Exercise within one (1) Business Day of receipt of such notice. The Registered Holder and any assignee, by acceptance of this Warrant, acknowledge and agree that, by reason of the provisions of this Section 1(a), following the purchase of a portion of the Warrant Shares hereunder, the number of Warrant Shares available for purchase hereunder at any given time may be less than the amount stated on the face hereof. The Exercise Price may be paid by certified check or wire transfer.

 

 

 

 

b. Call (Redemption) Provisions . Notwithstanding anything to the contrary contained in this Warrant, this Warrant is callable (redeemable) at the Company’s option at any time, provided the closing price of the Common Stock is $0.36 (adjusted to reflect forward or reverse stock splits, recapitalizations, reorganizations or the like) or greater for five (5) consecutive Trading Days on the Trading Market (the “Call Condition”). Commencing at any time after the date on which the Call Condition is satisfied, the Company shall have the right, upon notice to the Registered Holder (the “Redemption Notice”), to redeem the number of Warrant Shares specified in the applicable Call Condition at a price of $0.01 per Warrant Share (the “Redemption Price”), on the date set forth in the Redemption Notice, but in no event earlier than sixty-one (61) days following the date of the receipt by the Registered Holder of the Redemption Notice (the “Redemption Date”). The Registered Holder may exercise this Warrant at any time (in whole or in part) prior to the Redemption Date at the Exercise Price. Any portion of this Warrant that is subject to the applicable Call Condition which is not exercised by the Redemption Date shall no longer be exercisable and shall be returned to the Company (and, if not so returned, shall automatically be deemed canceled), and the Company, upon its receipt of the unexercised portion of this Warrant, shall issue therefore in full and complete satisfaction of its obligations under such called but unexercised portion of this Warrant to the Registered Holder an amount equal to the number of shares of Common Stock called but remaining unexercised multiplied by the Redemption Price. The Redemption Price shall be mailed to such Registered Holder at its address of record, and the Warrant shall be canceled.

 

c. Mechanics of Exercise.

 

i. Delivery of Warrant Shares upon Exercise. Warrant Shares purchased hereunder shall be transmitted by the Company or its transfer agent to the Registered Holder in the Notice of Exercise within a commercially reasonable time, pursuant to SEC regulations, with the goal of accomplishing such action within three (3) Trading Days after delivery to the Company of the Notice of Exercise (such date, the “Warrant Share Delivery Date”). The Warrant Shares shall be deemed to have been issued, and the Registered Holder or any other person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the Warrant has been exercised, with payment to the Company of the Exercise Price and all taxes required to be paid by the Registered Holder, if any, having been paid and collected.

 

ii. Delivery of New Warrants Upon Exercise . If this Warrant shall have been exercised in part, the Company shall, at the request of the Registered Holder and upon surrender of this Warrant certificate, at the time of delivery of the Warrant Shares, deliver to the Registered Holder a new Warrant evidencing the rights of the Registered Holder to purchase the unpurchased Warrant Shares called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant.

 

iii. No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which the Registered Holder would otherwise be entitled to purchase upon such exercise, the Company shall, at its election, either pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Exercise Price or round up to the next whole share.

 

iv. Charges, Taxes and Expenses. Issuance of Warrant Shares shall be made without charge to the Registered Holder for any issue or transfer tax or other incidental expense in respect of the issuance of Warrant Shares, all of which taxes and expenses shall be paid by the Company, and such Warrant Shares shall be issued in the name of the Registered Holder or in such name or names as may be directed by the Registered Holder; provided, however, that in the event that Warrant Shares are to be issued in a name other than the name of the Registered Holder, this Warrant when surrendered for exercise shall be accompanied by the Assignment Form attached hereto duly executed by the Registered Holder and the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. The Company shall pay all transfer agent fees required for same-day processing of any Notice of Exercise and all fees to the Depository Trust Company (or another established clearing corporation performing similar functions) required for same-day electronic delivery of the Warrant Shares as applicable.

 

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v. Closing of Books. The Company will not close its stockholder books or records in any manner which prevents the timely exercise of this Warrant, pursuant to the terms hereof.

 

2. Adjustments .

 

a. Stock Dividends and Splits. If the Company, at any time while this Warrant is outstanding: (i) pays a stock dividend or otherwise makes a distribution or distributions on shares of its Common Stock or any other equity or equity equivalent securities payable in shares of Common Stock (which, for avoidance of doubt, shall not include any shares of Common Stock issued by the Company upon exercise of this Warrant), (ii) subdivides outstanding shares of Common Stock into a larger number of shares, (iii) combines (including by way of reverse stock split) outstanding shares of Common Stock into a smaller number of shares or (iv) issues by reclassification of shares of the Common Stock any shares of capital stock of the Company, then in each case the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding immediately before such event and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event, and the number of shares issuable upon exercise of this Warrant shall be proportionately adjusted such that the aggregate Exercise Price of this Warrant shall remain unchanged. Any adjustment made pursuant to this Section 2(a) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re classification.

 

b. Fundamental Transaction . If, at any time while this Warrant is outstanding, (i) the Company, directly or indirectly, in one or more related transactions effects any merger or consolidation of the Company with or into another Person, (ii) the Company, directly or indirectly, effects any sale, lease, license, assignment, transfer, conveyance or other disposition of all or substantially all of its assets in one or a series of related transactions for which shareholder approval is required, (iii) any, direct or indirect, purchase offer, tender offer or exchange offer (whether by the Company or another Person) is completed pursuant to which holders of Common Stock are permitted to sell, tender or exchange their shares for other securities, cash or property and has been accepted by the holders of 50% or more of the outstanding Common Stock, (iv) the Company, directly or indirectly, in one or more related transactions effects any reclassification, reorganization or recapitalization of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is effectively converted into or exchanged for other securities, cash or property, or (v) the Company, directly or indirectly, in one or more related transactions consummates a stock or share purchase agreement or other business combination (including, without limitation, a reorganization, recapitalization, spin-off or scheme of arrangement) with another Person or group of Persons whereby such other Person or group acquires more than 50% of the outstanding shares of Common Stock (not including any shares of Common Stock held by the other Person or other Persons making or party to, or associated or affiliated with the other Persons making or party to, such stock or share purchase agreement or other business combination) (each a “Fundamental Transaction”), then, upon any subsequent exercise of this Warrant, the Registered Holder shall have the right to receive, for each Warrant Share that would have been issuable upon such exercise immediately prior to the occurrence of such Fundamental Transaction, at the option of the Registered Holder, the number of shares of Common Stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such Fundamental Transaction. For purposes of any such exercise, the determination of the Exercise Price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the Exercise Price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the Registered Holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of this Warrant following such Fundamental Transaction.

 

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c. Calculations. All calculations under this Section 2 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. For purposes of this Section 2, the number of shares of Common Stock deemed to be issued and outstanding as of a given date shall be the sum of the number of shares of Common Stock (excluding treasury shares, if any) issued and outstanding.

 

d. Notice to Registered Holder.

 

i. Adjustment to Exercise Price. Whenever the Exercise Price is adjusted pursuant to any provision of this Section 2, the Company shall promptly mail to the Registered Holder a notice setting forth the Exercise Price after such adjustment and any resulting adjustment to the number of Warrant Shares and setting forth a brief statement of the facts requiring such adjustment.

 

ii. Notice to Allow Exercise by Registered Holder . If (A) the Company shall declare a dividend (or any other distribution in whatever form) on the Common Stock, (B) the Company shall declare a special nonrecurring cash dividend on or a redemption of the Common Stock, (C) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights, (D) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property, or (E) the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, then, in each case, the Company shall cause to be mailed to the Registered Holder at its last address as it shall appear upon the Warrant Register of the Company, at least 20 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. To the extent that any notice provided hereunder constitutes, or contains, material, non-public information regarding the Company, the Company shall simultaneously file such notice with the Commission pursuant to a Current Report on Form 8-K, provided that the requirement in this sentence shall only apply if any of the Company’s securities are listed or quoted for public trading. The Registered Holder shall remain entitled to exercise this Warrant during the period commencing on the date of such notice to the effective date of the event triggering such notice except as may otherwise be expressly set forth herein

 

3. Transfers.

 

a. Unregistered Security. Each Registered Holder acknowledges that this Warrant and the Warrant Shares have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), and agrees not to sell, pledge, distribute, offer for sale, transfer, or otherwise dispose of this Warrant or any Warrant Shares issued upon its exercise in the absence of (i) an effective registration statement under the Securities Act as to this Warrant or such Warrant Shares and registration or qualification of this Warrant or such Warrant Shares under any applicable U.S. federal or state securities law then in effect or (ii) at the cost of the Registered Holder of this Warrant, an opinion of counsel, satisfactory to the Company, that such registration and qualification are not required. The Registered Holder acknowledges that the Warrant Shares acquired upon the exercise of this Warrant, if not registered, will have restrictions upon resale imposed by state and federal securities laws. It is estimated that there will be at least a six month minimum holding period before any resales may be made of the Warrant Shares in the public market, however depending on the circumstances from time to time. Each certificate or other instrument for Warrant Shares issued upon the exercise of this Warrant shall bear a legend substantially to the foregoing effect.

 

b. Transferability . Subject to the provisions of Section 3(a) hereof, this Warrant and all rights hereunder are transferable, in whole or in part, upon surrender of this Warrant with a properly executed assignment (in the form of Exhibit B hereto) at the principal office of the Company.

 

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c. Warrant Register . The Company will maintain a register containing the names and addresses of the Registered Holders of this Warrant. Until any transfer of this Warrant is made in the warrant register, the Company may treat the Registered Holder of this Warrant as the absolute owner hereof for all purposes; provided , however , that if this Warrant is properly assigned in blank, the Company may (but shall not be required to) treat the bearer hereof as the absolute owner hereof for all purposes, notwithstanding any notice to the contrary. Any Registered Holder may change such Registered Holder’s address as shown on the warrant register by written notice to the Company requesting such change.

 

d. Legend of Warrant Shares . The Registered Holder agrees that the Warrant Shares upon issuance may be notated with the following legend or legend of similar import: “THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH TRANSFER MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL IN A FORM SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933, AS AMENDED.” The Registered Holder agrees that in conformity with the Securities Purchase Agreement any other relevant legends may be affixed to the certificates or notations representing the Warrant Shares as applicable thereto.

 

4. No Impairment. The Company will not, by amendment of its charter or through reorganization, consolidation, merger, dissolution, sale of assets, or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Registered Holder against impairment.

 

5. Termination . This Warrant (and the right to purchase securities upon exercise hereof) shall terminate on the Expiration Date.

 

6. Reservation of Stock . The Company will reserve and use reasonable commercial efforts to keep available, solely for the issuance and delivery upon the exercise of this Warrant, the Warrant Shares and other stock, securities, and property, as from time to time shall be issuable upon the exercise of this Warrant

 

7. Exchange of Warrants . Upon the surrender by the Registered Holder of this Warrant, properly endorsed, to the Company at the principal office of the Company, the Company will, subject to the provisions of Section 3 hereof, issue and deliver to or upon the order of such Registered Holder, at the Company’s expense, a new Warrant or Warrants of like tenor, in the name of such Registered Holder or as such Registered Holder (upon payment by such Registered Holder of any applicable transfer taxes) may direct, calling in the aggregate on the face or faces thereof for the number of Warrant Shares called for on the face or faces of the Warrant or Warrants so surrendered.

 

8. Replacement of Warrants . Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction, or mutilation of this Warrant and (in the case of loss, theft, or destruction) upon delivery of an indemnity agreement (with surety if reasonably required) in an amount reasonably satisfactory to the Company, or (in the case of mutilation) upon surrender and cancellation of this Warrant, the Company will issue, in lieu thereof, a new Warrant of like tenor.

 

9. Miscellaneous .

 

a. No Rights as Stockholder. Until the exercise of this Warrant, the Registered Holder of this Warrant shall not have or exercise any rights by virtue hereof as a stockholder of the Company.

 

b. Amendment or Waiver . Any term of this Warrant may be amended or waived upon written consent of the Company and the Registered Holder.

 

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c. Headings . The headings in this Warrant are used for convenience only and are not to be considered in construing or interpreting any provision of this Warrant.

 

d. Governing Law . This Warrant shall be governed, construed, and interpreted in accordance with the laws of the state of Colorado, without giving effect to principles of conflicts of law.

 

e. Successors and Assigns . Unless otherwise provided in this Warrant, the terms and conditions of this Warrant shall inure to the benefit of and be binding upon the permitted successors and assigns of the parties. Nothing in this Warrant, express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Warrant, except as expressly provided in this Warrant.

 

f. Severability . If one or more provisions of this Warrant are held to be unenforceable under applicable law, such provision shall be excluded from this Warrant, the balance of this Warrant shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms.

 

g. Delays or Omissions . No delay or omission to exercise any right, power, or remedy accruing to any party under this Warrant, upon any breach or default of any other party under this Warrant, shall impair any such right, power, or remedy of such non-breaching or non-defaulting party nor shall it be construed to be a waiver of any such breach or default, or an acquiescence therein, or of or in any similar breach or default thereafter occurring; nor shall any waiver of any single breach or default be deemed a waiver of any other breach or default theretofore or thereafter occurring. Any waiver, permit, consent, or approval of any kind or character on the part of any party of any breach or default under this Warrant, or any waiver on the part of any party of any provisions or conditions of this Warrant, must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Warrant or by law or otherwise afforded to any party, shall be cumulative and not alternative. If the Company willfully and knowingly fails to comply with any provision of this Warrant, which results in any material damages to the Registered Holder, the Company shall pay to the Registered Holder such amounts as shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys’ fees, including those of appellate proceedings, incurred by the Registered Holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder.

 

h. Notices . All notices, requests, consents, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given on the date of service if served personally on the party to whom notice is to be given, on the date of transmittal of services via telecopy or email to the party to whom notice is to be given (with a confirming copy delivered within 24 hours thereafter), or on the third day after mailing if mailed to the party to whom notice is to be given, by first class mail, registered or certified, postage prepaid, or on the next day after mailing if overnight mail via a nationally recognized courier providing a receipt for delivery and properly addressed at the respective addresses of the parties as set forth herein. Any party may change its address for purposes of this paragraph by giving notice of the new address to each of the other parties in the manner set forth above.

 

i. Representation by Registered Holder. The Registered Holder, by the acceptance hereof, represents and warrants that it is acquiring this Warrant and, upon any exercise hereof, will acquire the Warrant Shares issuable upon such exercise, for its own account and not with a view to or for distributing or reselling such Warrant Shares or any part thereof in violation of the Securities Act or any applicable state securities law, except pursuant to sales registered or exempted under the Securities Act.

 

j. Saturdays, Sundays, Holidays, etc . If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall not be a Business Day, then, such action may be taken or such right may be exercised on the next succeeding Business Day.

 

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k. Authorized Shares . The Company covenants that, during the period this Warrant is outstanding, it will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the Warrant Shares upon the exercise of any purchase rights under this Warrant. The Company further covenants that its issuance of this Warrant shall constitute full authority to its officers who are charged with the duty of issuing the necessary Warrant Shares upon the exercise of the purchase rights under this Warrant. The Company will take all such reasonable action as may be necessary to assure that such Warrant Shares may be issued as provided herein without violation of any applicable law or regulation, or of any requirements of the Trading Market upon which the Common Stock may be traded. The Company covenants that all Warrant Shares which may be issued upon the exercise of the purchase rights represented by this Warrant will, upon exercise of the purchase rights represented by this Warrant and payment for such Warrant Shares in accordance herewith, be duly authorized, validly issued, fully paid and non-assessable and free from all taxes, liens and charges created by the Company in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue).

 

l. Limitation of Liability. No provision hereof, in the absence of any affirmative action by the Registered Holder to exercise this Warrant to purchase Warrant Shares, and no enumeration herein of the rights or privileges of the Registered Holder, shall give rise to any liability of the Registered Holder for the Exercise Price of any Warrant Shares or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company.

 

m. Remedies. The Registered Holder, in addition to being entitled to exercise all rights granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Warrant. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Warrant and hereby agrees to waive and not to assert the defense in any action for specific performance that a remedy at law would be adequate.

 

[Remainder of Page Intentionally Left Blank]

 

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IN WITNESS WHEREOF, the Company has caused this Common Stock Warrant to be signed on its behalf, in its corporate name, by its duly authorized officer, all as of the day and year first above written.

 

  SURNA INC.
   
  By:    
      Chris Bechtel, Chief Executive Officer
       
  Address:   1780 55 th Street
      Boulder, Colorado 80301

 

SIGNATURE PAGE TO COMMON STOCK WARRANT

 

 

 

 

EXHIBIT A

 

NOTICE OF EXERCISE

 

To: Surna Inc. Dated: _______________

 

The undersigned, pursuant to the provisions set forth in the attached Warrant No. _______, hereby irrevocably elects to purchase _____ shares of the Common Stock covered by such Warrant and herewith makes payment of $ _________, representing the full purchase price for such shares at the price per share provided for in such Warrant, together with all applicable transfer taxes, if any.

 

Payment has been made in lawful money of the United States by:

 

  [  ] Certified check (enclosed herewith)
     
  [  ] Wire transfer

 

The shares of Common Stock to be issued will contain the restrictive legend under the Securities Act. Please indicate your preference for the issuance of shares of Common Stock ( must check one box only ):

 

  [  ] The shares of Common Stock should be issued in book entry form to be held at the Company’s transfer agent. The undersigned understands that, upon issuance of the shares, the undersigned will receive a transaction report reflecting such book entry issuance directly from the transfer agent.
     
  [  ] The shares of Common Stock should be issued in a physical certificate and delivered to the address shown below:

 

_______________________________

 

_______________________________

 

The undersigned hereby certifies that it is an “accredited investor” as defined in Regulation D promulgated under the Securities Act.

 

  Signature:________________________________________
   
  Name (print):_ _____________________________________
   
  Title (if applicable): _________________________________
   
  Entity Name (if applicable): ___________________________

 

 

 

 

Exhibit b

 

ASSIGNMENT FORM

 

FOR VALUE RECEIVED, _________________________________________ hereby sells, assigns, and transfers all of the rights of the undersigned under the attached Warrant with respect to the number of shares of Warrant Shares covered thereby set forth below, to:

 

Name of Assignee

 

Address/Email

 

No. of Shares

         
         
         

 

Dated:     Signature:  
         
    Witness:  

 

 

 

 

 

 

EXECUTIVE EMPLOYMENT AGREEMENT

 

This Executive Employment Agreement (this “ Agreement ”) is made and entered into effective this 6 th day of September, 2017 by and between Surna Inc. , a Nevada corporation whose address is 1780 55th Street, Suite A, Boulder, Colorado 80301 (the “ Company ”) and Chris Bechtel , an adult resident of the State of Texas (the “ Executive ”). The Executive and the Company may be referred to herein individually as a “ Party ” or collectively as the “ Parties .”

 

AGREED ACKNOWLEDGMENTS

 

A. The Company is engaged in the development, design and distribution of cultivation technologies for controlled environment agriculture for state-regulated cannabis cultivation facilities and traditional indoor agricultural facilities, including lighting, environmental control and air sanitation designed to meet the specific environmental conditions required for indoor cultivation and to reduce energy and water consumption (the “ Business ”).

 

B. In connection with the Business, the Company manufactures or is developing, sells and delivers the following products and services: (i) liquid-based process cooling and climate control systems, (ii) reflectors and lighting systems, including water-cooled reflectors, (iii) a full-service engineering package for designing and engineering commercial scale thermodynamic systems specific to indoor cultivation facility conditions, (iv) automation and control devices, systems and technologies used for environmental, lighting and climate control in indoor cultivation facilities, (v) a comprehensive, hybrid cultivation facility design and building utilizing sunlight and a high-power LED lighting system, and (vi) and other products, services, and technologies now or hereafter developed related to the foregoing (collectively, the “ Products ”)

 

C. The Business of the Company is highly competitive and requires the creation of intimate and prolonged relationships with the Company’s customers because of the custom products developed for individual customers, and the significance of adapting to the marketing plans continually being created by these customers.

 

D. The Company has invested and will continue to invest considerable sums of time, money, and other resources in developing the confidence and loyalty of its customers and potential customers and to recruit, train, support and compensate its employees and potential employees. In addition, the Company expends significant amounts of time and money to attract, identify, locate, and establish contacts and business relationships with prospective customers. The loss of these existing and prospective relationships with customers, and with existing and potential employees, will cause substantial and irreparable harm to the Company, which cannot be accurately or adequately compensated by money alone.

 

E. The Company desires to retain the services of the Executive as a member of the Company’s management team. The Executive desires to continue such employment and commits to devote all of the Executive’s business time and attention to services benefiting the Company. Both the Executive and the Company wish to enter into this Agreement to set forth the terms and conditions of the Executive’s employment with the Company.

 

F. The Executive acknowledges that, in connection with the execution of this Agreement, the Executive is receiving new and valuable consideration from the Company including, without limitation, an incentive bonus program and the grant of certain restricted stock units and non-qualified stock options under the Company’s 2017 Equity Incentive Plan, as adopted by the Company’s Board of Directors (the “ Board ”) on August 1, 2017, as may be modified and amended by the Company from time to time (the “ EIP ”).

 

G. The Executive acknowledges that, in the course of the Executive’s employment with the Company, the Executive will frequently come into contact with the Company’s customers and suppliers to such an extent that the Executive may be able to control or direct, in whole or in part, the business and relationships between the Company and its customers and suppliers. Accordingly, the Company reposes its trust in the Executive not to disrupt or otherwise misappropriate the customer and supplier relationships developed and/or supported by the Company.

 

 

 

 

H. The Executive will also, during the course of the Executive’s employment with the Company, have frequent and close contact with the Company’s other executive managers, salespeople, and key staff employees. As a result of the Executive’s position, the Executive will acquire and have access to confidential information concerning the Company’s employees, prospective employees, customers, suppliers, and prospective customers and suppliers that is not easily or generally available to the Company’s competitors.

 

I. The Executive acknowledges that, by virtue of the Executive’s position with the Company, the Executive will have access to certain secret and confidential business data and information belonging to the Company including, but not limited to: marketing plans, financial strategies, market surveys and assessments, customer and Company technical information, financial statements, budget data, personnel records, customer profiles and purchase requirements, product design, engineering and technical specifications, pricing plans and strategies, sales contracts and proposals, private and confidential discussions with executive managers, legal advice and strategies, performance evaluations, price schedules from suppliers, litigation and planned litigation, capital needs, lists of customers and potential customers, hiring and training goals, internal operation and production reports and schedules, compensation packages, customer account projections, licenses, promotional plans and information, corporate policies for internal operations, bids and proposals by suppliers and to customers, identities and personal profiles of key persons at customers and potential customers, expense data by customer, and other confidential and sensitive business information developed and maintained by the Company.

 

J. The Company has a valuable and proprietary interest in the confidential information described in paragraph I above and has expended considerable time and money to safeguard and protect such information from direct or indirect divulgence of same by its employees, including the Executive. In addition, as part of the Company’s relationship with each of its customers, the Company assures customers that the unique, confidential, and secret information shared by customers with the Company will be protected from disclosure to and unauthorized use by others. Any divulgence of such information will constitute an irreparable injury to the Company and the Company’s customers.

 

K. The Executive acknowledges that (i) the Executive’s position with the Company is one of great trust and confidence requiring that the Executive exercise a high degree of loyalty, honesty, and integrity, (ii) the Executive has and will receive substantial and adequate monetary consideration and benefits pursuant to this Agreement, (iii) the Executive has read and understood the terms of this Agreement and signed the same as a free and voluntary act, and (iv) the Executive understands that there is no need to continue employment with the Company, but the Executive has freely chosen to enter into this Agreement because of a desire to take advantage of the specific and unique opportunities offered by continued employment with the Company and the additional benefits provided for herein.

 

AGREEMENTS

 

In consideration of the Agreed Acknowledgments and the mutual covenants and agreements set forth in this Agreement, the Parties agree as follows:

 

1. Acknowledgments . The acknowledgments set forth above are accurate and are hereby incorporated by reference in this Agreement.

 

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2. Employment . The Company hereby employs the Executive and the Executive hereby accepts employment with the Company on the terms and conditions set forth in this Agreement.

 

3. Duties . During the Term (as defined below), the Executive shall be employed by the Company as the Chief Executive Officer and President and, as such, the Executive shall have such responsibilities and authority as are customary for such position of a company of similar size and nature as the Company as may be assigned from time to time by the Board. The Executive will also hold such other executive officer positions as the Board may appoint from time to time. The Executive shall faithfully perform for the Company the duties of such position and shall report directly to the Board. At all times during the Term, the Executive shall adhere to all of the Company’s policies, rules and regulations governing the conduct of its employees, including without limitation, any compliance manual, code of ethics, employee handbook or other policies adopted by the Company from time to time. The Company and the Executive acknowledge that the Parties have entered into that certain Indemnification Agreement dated May 31, 2017 (“ D&O Indemnity Agreement ”). Effective as of the Effective Date, the Executive hereby resigns from the Audit Committee of the Board.

 

4. Extent of Services . Except for illnesses and vacation periods, the Executive shall devote the Executive’s full business time and attention and the Executive’s best efforts to the performance of the Executive’s duties and responsibilities under this Agreement. Notwithstanding the foregoing, the Executive may participate in charitable, academic, community religious or other non-profit activities, and in trade or professional organizations, and engage and participate in the specific activities listed in Exhibit A hereto (the “ Permitted Activities ”) or such other activities as specifically agreed to in writing by the Company in advance from time to time in the Company’s sole discretion, provided that all of the Executive’s activities outside of the Executive’s duties to the Company, individually or in the aggregate, shall comply with the Company’s conflict of interest policies and corporate governance guidelines as in effect from time to time, do not otherwise interfere with the Executive’s duties and responsibilities to the Company, and do not compete with or adversely affect the Business of the Company. Subject to the provisions of Section 11 herein, the Executive may make any passive investment in any publicly traded entity, or own five percent (5%) or less of the issued and outstanding voting securities of any entity, provided, in any event, that the Executive is not obligated or required to, and shall not in fact, devote any consulting or managerial effort or services in connection therewith, except for the Permitted Activities.

 

5. Place of Performance . The Executive will perform the Executive’s duties for the Company from the Company’s corporate offices in Boulder, Colorado (the “ Corporate Office ”), except that: (i) the Employee may continue to reside in Houston, Texas, but will commute to, perform the duties hereunder at, the Corporate Office at least fifty percent (50%) of the working days with the Employee being allowed to work from the Employee’s residence in Houston, Texas for the other fifty percent (50%) of the working days, and (ii) the Employee will travel to perform services as required for the proper performance of the Employee’s duties under this Agreement.

 

6. Term; At-Will Employment; Termination . This Agreement and the Executive’s employment hereunder shall commence on August 17, 2017 (the “ Effective Date ”) and, subject to earlier termination as provided in this Section 6, shall continue in full force and effect thereafter until December 31, 2019 (the “ Initial Term ”) and, by mutual written agreement of the Parties, may be extended for a term of one (1) additional year (an “ Extended Term ”) at the end of the Initial Term, and an additional one (1) year Extended Term at the end of each Extended Term (the last day of the Initial Term and each such Extended Term is referred to herein as a “ Term Date ”). Notwithstanding any other provision of this Agreement to the contrary, either Party may terminate this Agreement, at any time, with or without Cause (as defined herein), by providing the other Party with 30-days’ prior written notice. During the Term (as defined below) and for so long as the Executive is employed by Company, the Executive shall be an at-will employee of Company. The employment of the Executive by the Company shall terminate immediately upon death of the Executive. Any termination of the Executive’s employment by the Company or by the Executive (other than termination pursuant to death) shall be communicated by written notice of termination to the other Party hereto in accordance with this Agreement. For purposes of this Agreement, “ Term ” shall mean the actual duration of the Executive’s employment hereunder, taking into account any extensions or any termination of employment pursuant to this Section 6, and “ Date of Termination ” shall mean the date the Executive’s employment is terminated in accordance with this Section 6.

 

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7. Compensation .

 

a. Salary . The Company shall pay the Executive an annualized base salary (the “ Base Salary ”) of $180,000 per year, which shall be payable in equal installments in accordance with the Company’s standard payroll practice from time to time, less customary or legally required withholdings and deductions, for periods actually worked by the Executive.

 

b. Restricted Stock Units . Upon execution of this Agreement or as soon as practicable thereafter, subject to the approval of the Board (or an authorized committee thereof), as compensation for entering into this Agreement, the Company shall grant 3,000,000 Restricted Stock Units (as defined in the EIP) to the Executive, which shall subject to the terms of the EIP and a separate Restricted Stock Unit Agreement to be executed by the Company and the Executive, substantially in the form attached hereto as Exhibit B . The Restricted Stock Units shall be valued at Fair Market Value (as defined in the EIP) on the date such Restricted Stock Units vest and, upon vesting, the Executive will receive one share of the Company’s common stock (“ Common Stock ”) for each vested Restricted Stock Unit (with no cash purchase price to be paid by the Executive for such share of Common Stock). As a condition to the Company’s obligations with respect to the Restricted Stock Units (including, without limitation, any obligation to deliver any shares of Common Stock upon vesting of the Restricted Stock Units), the Executive shall make arrangements satisfactory to the Company to pay to the Company any federal, state, local, or foreign taxes of any kind required to be withheld with respect to the delivery of shares of Common Stock corresponding to such Restricted Stock Units. The Restricted Stock Units shall vest as follows:

 


Number of Restricted Stock Units
  Vesting Schedule

 

1,500,000 shares

 

 

 

Vest on March 31, 2019, if the Company’s 2018 revenue is at least $18 million (provided the Executive is employed by, or providing services to, the Company at December 31, 2018)

     

 

1,500,000 shares

 

 

Vest on March 31, 2020, if the Company’s 2019 revenue is at least $25 million (provided the Executive is employed by, or providing services to, the Company at December 31, 2019)

 

Any Restricted Stock Units that do not vest on the date specified above due to failure to meet the applicable performance threshold will be forfeited on such date.

 

For purposes of determining the vesting of the Restricted Stock Units, which are subject to a revenue threshold for 2018 and 2019, the achievement of such revenue threshold will be based on the Company’s annual revenue as reported in the Company’s financial statements for such year, as audited by the Company’s accounting firm, excluding any revenue attributable to any business acquired by the Company after the Effective Date.

 

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c. Incentive Bonus Program . The Executive shall be eligible to receive an annual incentive bonus (each an “ Annual Incentive Bonus ”) for each completed year of employment during the Term in accordance with a bonus policy adopted by the Board (or an authorized committee thereof), as may be amended or modified from time to time. The bonus policy will provide that the Executive shall be entitled to earn an Annual Incentive Bonus for such completed year of employment based on performance criteria determined in the sole discretion of the Board. The Annual Incentive Bonus for a completed year of employment shall be paid within forty-five (45) days following the end of the completed year. Other than as set forth in Section 9, the Executive must be employed by, or be providing services to, the Company or an affiliate of the Company on the date an Annual Incentive Bonus is to be paid to be eligible to receive the Annual Incentive Bonus for such completed year of employment. Payment of the Annual Incentive Bonus may be made in the form of cash, stock bonus (issued pursuant to the EIP), or a combination thereof, as determined in the sole discretion of the Board (or an authorized committee thereof). As a condition to the Company’s obligations with respect to any stock bonus (including, without limitation, any obligation to deliver any shares of Common Stock with respect to any stock bonus), the Executive shall make arrangements satisfactory to the Company to pay to the Company any federal, state, local, or foreign taxes of any kind required to be withheld with respect to the delivery of shares of Common Stock with respect to such stock bonus.

 

In lieu of the Annual Incentive Bonus for each completed year of employment during the Initial Term, which the Executive acknowledges that the Executive will not be eligible to receive, the Company has adopted a special incentive bonus program under which the Executive will be eligible to receive an incentive bonus on each December 31 and June 30 during the Initial Term (the “ Special Incentive Bonus ”). For each of the five (5) Special Incentive Bonuses payable during the Initial Term, the Executive shall be eligible to receive a bonus of 1,000,000 shares of the Company’s Common Stock, provided the Board has determined, in its sole discretion, that the Executive’s performance has been average or better for such Special Incentive Bonus period. The Special Incentive Bonus for each period shall be paid within forty-five (45) days following December 31 or June 30, as applicable. Other than as set forth in Section 9, the Executive must be employed by, or providing services to, the Company or an affiliate of the Company on the date the Special Incentive Bonus is to be paid to be eligible to receive the Special Incentive Bonus for such period. As a condition to the Company’s obligations with respect to each Special Incentive Bonus (including, without limitation, any obligation to deliver any shares of Common Stock with respect to any Special Incentive Bonus), the Executive shall make arrangements satisfactory to the Company to pay to the Company any federal, state, local, or foreign taxes of any kind required to be withheld with respect to the delivery of shares of Common Stock with respect to such Special Incentive Bonus.

 

d. Non-qualified Stock Options . In consideration of the grant of the foregoing Restricted Stock Units and the eligibility for the Special Incentive Bonus, the Company and the Executive hereby agree that the non-qualified stock options to purchase 900,000 shares of the Company’s common stock, which were granted to the Executive as an equity retention award in connection with the Executive’s appointment to the Board on August 8, 2017, are hereby terminated and cancelled effective as of the date of this Agreement.

 

e. Clawback . Notwithstanding any other provisions in this Agreement to the contrary, any incentive-based compensation, or any other compensation, paid to the Executive pursuant to this Agreement or any other agreement or arrangement with the Company which is subject to recovery under any law, governmental regulation, or stock exchange listing requirement, will be subject to such deductions and clawback as may be required to be made pursuant to such law, government regulation or stock exchange listing requirement.

 

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f. Change of Control . In the event that there is a “ Change in Control ” (as defined below) prior to the date on which the Restricted Stock Units become fully vested, then 100% of the Restricted Stock Units not already vested shall become vested on the date of the Change of Control (other than those Restricted Stock Units that have been previously forfeited due to failure to meet the performance threshold), provided the Executive is employed by, or providing services to, the Company on the date immediately preceding the date of the Change of Control. In the event of a Change of Control prior to December 31, 2019, then the remaining Special Incentive Bonuses related to any Special Incentive Bonus period ending after the date of the Change of Control shall become due and payable on the date of the Change of Control, provided the Executive is employed by, or providing services to, the Company on the date immediately preceding the date of the Change of Control. A “ Change of Control ” means a reorganization, merger, statutory share exchange, or consolidation or similar transaction involving the Company, or a sale or other disposition of all or substantially all of the assets of the Company, unless, following such transaction, all or substantially all of the individuals and entities who were the beneficial owners of the Company’s equity and voting securities immediately prior to such transaction beneficially own, directly or indirectly, more than fifty percent (50%) of the value of the then outstanding equity securities and the combined voting power of the then outstanding voting securities

 

8. Fringe Benefits . The Company shall provide the following benefits to the Executive during the Term:

 

a. Executive Benefit Plans . The Executive will be eligible to participate in any employee benefit plans including, without limitation, group insurance, profit sharing and 401(k) plans, 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.

 

b. Vacation . The Executive shall accrue in accordance with the Company’s vacation policy as in effect from time to time twenty (20) days per year of paid vacation time, provided that, any earned but unused vacation in a year may not be carried forward to future years.

 

c. Personal Days, Sick Leave and Holidays . The Executive shall be entitled to receive paid personal days, sick days and holidays under the guidelines established by the Company from time to time for the Company’s executive and management employees, provided that, any earned but unused personal and sick days in a year may not be carried forward to future years.

 

d. Business Expense Reimbursement . Subject to the Company’s policies and procedures for the reimbursement of business expenses incurred by its executive and management employees, the Company shall reimburse the Executive for reasonable expenses incurred by the Executive in connection with the performance of the Executive’s duties pursuant to this Agreement, including, but not limited to, travel expenses, professional conventions or similar professional functions and other reasonable business expenses. The Executive agrees to provide the Company with receipts and/or documentation sufficient to permit the Company to take its full business expense deduction. The Company shall have no obligation to reimburse the Executive for expenses claimed if the Executive does not provide sufficient receipts and/or documentation. The Executive shall submit requests for reimbursement of business expenses at least once every month. The Executive shall not be entitled to a corporate credit card, and any frequent flyer miles earned for travel contemplated under this Agreement shall be owned by the Executive. The Parties acknowledge and agree that, during the Term: (i) the Executive will be reimbursed for air travel and airport parking to commute to and from Houston and Denver, (ii) all lodging, meal and food costs incurred by the Executive while commuting or working from the Corporate Office shall be reimbursed, (iii) while working from the Corporate Office, the Executive will be reimbursed for rental car and fuel costs, (iv) all costs and expenses reimbursable under this sentence shall be subject the Company’s reimbursement policies and procedures, and (v) the Executive shall use the Executive’s best efforts to minimize the costs and expenses subject to reimbursement under this sentence, and the Company shall only be required to reimburse reasonable costs and expenses.

 

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e. Miscellaneous Benefits . The Executive is also entitled to receive any other fringe benefits that Company may from time to time make available generally to its management employees.

 

9. Effects of Termination .

 

a. Accrued Benefits . If the employment of the Executive should terminate at the election of the Company with or without Cause, at the election of the Executive, due to the Executive’s death, or upon expiration of the Term, then the Company will pay or provide to the Executive or, in the event of the Executive’s death, to the estate of the Executive:

 

i. any earned and accrued but unpaid Base Salary through the Date of Termination payable in accordance with the Company’s normal payroll practices;

 

ii. reimbursement for any unreimbursed business expenses incurred through the Date of Termination in accordance with Section 8(d); and

 

iii. all other applicable payments or benefits to which the Executive shall be entitled under, and paid or provided in accordance with, the terms of any applicable arrangement, plan or program under Section 8(a)-(d) (collectively, Sections 9(a)(i)-(iii), payable in accordance with this Section 9(a), shall be hereafter referred to as the “ Accrued Benefits ”).

 

b. Death Benefit . If the employment of the Executive should terminate during the Term due to the Executive’s death, then the Company will pay or provide to the estate of the Executive (in addition to the Accrued Benefits payable under Section 9(a)), subject to Section 9(e) :

 

i. any accrued but unpaid Annual Incentive Bonus for any completed year of employment prior to the year of the Executive’s death, payable when the applicable Annual Incentive Bonus for such completed year of employment would have otherwise been paid; and

 

ii. any accrued but unpaid Special Incentive Bonus for any completed period of employment prior to the Executive’s death, payable when the applicable Special Incentive Bonus for such completed period of employment would have otherwise been paid; and

 

iii. the unvested Restricted Stock Units that are scheduled to vest under Section 7(b) on the March 31 st immediately following the calendar year in which the Executive dies shall continue to vest in accordance with the vesting schedule set forth in Section 7(b) notwithstanding the Executive’s death, provided that , the Company achieves the applicable full year revenue threshold for such vesting for the calendar year in which the Executive dies.

 

All other unvested Restricted Stock Units at the time of the Executive’s death under Section 7(b) shall be forfeited.

 

c. Termination by the Company without Cause . If the employment of the Executive should terminate at the election of the Company without Cause, the Company will pay or provide to the Executive (in addition to the Accrued Benefits payable under Section 9(a)), subject to Sections 9(e) and 10 :

 

i. continued payment of the Executive’s Base Salary for a period equal to the lesser of thirty (30) days from the Date of Termination or the then applicable Term Date, whichever occurs first, payable in accordance with the Company’s normal payroll practices (but off employee payroll) (the “ Severance Payments ”); provided that, the first payment of the Severance Payments shall be made on the fifteenth (15 th ) day after the Date of Termination, and will include payment of any amount of the Severance Payments that were otherwise due prior thereto;

 

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ii. any accrued but unpaid Annual Incentive Bonus for any completed year of employment prior to the year of the Executive’s termination, payable when the applicable Annual Incentive Bonus for such completed year of employment would have otherwise been paid; and

 

iii. any accrued but unpaid Special Incentive Bonus for any completed period of employment prior to the Executive’s termination, payable when the applicable Special Incentive Bonus for such completed period of employment would have otherwise been paid; and

 

iv. the unvested Restricted Stock Units that are scheduled to vest under Section 7(b) on the March 31 st immediately following the calendar year in which the Executive’s termination occurred shall continue to vest in accordance with the vesting schedule set forth in Section 7(b) notwithstanding the Executive’s termination of employment with the Company, provided that , the Company achieves the applicable full year revenue threshold for such vesting for the calendar year in which the Executive’s termination occurred.

 

All other unvested Restricted Stock Units at the time of the Executive’s termination of employment with the Company under Section 7(b) shall be forfeited.

 

For purposes of this Agreement, the term “ Cause ” means that the Executive: (i) has been convicted of, or entered a plea of guilty or “ nolo contendere ” to, a felony or a crime involving moral turpitude causing material harm to the standing and reputation of the Company, (ii) violated any of the Executive’s obligations under this Agreement, any award agreement under the EIP, any proprietary rights, non-competition, non-disclosure or other restrictive covenant agreements in effect between the Executive and the Company, including such agreements in this Agreement, which are demonstrably willful or deliberate on the Executive’s part, (iii) has willfully or deliberately failed to perform the Executive’s material duties assigned by, or to follow the lawful orders and direction of, the Board (other than by reason of illness or temporary disability), (iv) has engaged in illegal conduct, gross misconduct, fraud or material dishonesty in connection with the Business of the Company, (v) has engaged in willful misappropriation or embezzlement of any of the Company’s funds or property, or (vi) has engaged in conduct that violated the Company’s then existing written internal policies or procedures and which is detrimental to the Business or reputation of the Company. Any of the aforesaid clauses (ii), (iii) and (vi) may be cured by the Executive, if curable, if cured within fifteen (15) days after receipt by the Executive of written notice of the same. In the event such acts or omissions are capable of being cured, the effective date of termination, in the event of the Executive’s failure to cure, must be at least fifteen (15) days after such notice of termination to afford the Executive the ability to cure the same. The Company may place the Executive on paid leave for up to sixty (60) consecutive days while it is determining whether there is a basis to terminate Executive’s employment for Cause.

 

d. Expiration of Term . In the event that the Initial Term expires on December 31, 2019 without being extended by the Parties, the Company will pay or provide to the Executive (in addition to the Accrued Benefits payable under Section 9(a)), subject to Section 9(e) :

 

i. any accrued but unpaid Special Incentive Bonus for the six-month period ended December 31, 2019, payable when the applicable Special Incentive Bonus for such completed period of employment would have otherwise been paid; and

 

ii. the unvested Restricted Stock Units that are scheduled to vest under Section 7(b) on March 31, 2020 shall continue to vest in accordance with the vesting schedule set forth in Section 7(b) notwithstanding the Executive’s termination of employment with the Company, provided that , the Company achieves the full year revenue threshold for such vesting for the 2019 calendar year.

 

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e. Release . Any payments or benefits by the Company required under Sections 9(b), 9(c), and 9(d) shall be conditioned on and shall not be payable unless the Company receives from the Executive (or, in the event of the Executive’s death, the estate of the Executive) within thirty (30) days of the Date of Termination a fully effective and non-revocable written release in form and substance reasonably acceptable to the Company of any and all past, present or future claims that the Executive (or, in the event of the Executive’s death, the estate of the Executive) may have against the Company or any of its affiliates and any of their respective officers, directors and other related parties (all claims released in this Section 9(e) being referred to as the “ Released Claims ”), provided, however, that the Released Claims shall not include any claim by the Executive for indemnification from the Company relating to any act or omission prior to the Date of Termination, in each instance to the extent the Executive would have the right to be indemnified therefor under (and not otherwise prohibited or restricted by) (i) the laws of the State of Nevada, (ii) any Federal law applicable to the Company or the Executive, (iii) the Company’s articles of incorporation or bylaws, as amended, and (iv) the D&O Indemnity Agreement. The Company agrees to provide a form of release within seven (7) days of the Date of Termination.

 

f. Termination of Authority . Immediately upon the Executive terminating or being terminated from the Executive’s employment with the Company for any reason, notwithstanding anything else appearing in this Agreement or otherwise, the Executive will stop serving the functions of the Executive’s terminated or expired position(s), including but not limited to any director or officer positions at the Company or any of its affiliates, and shall be without any of the authority or responsibility for such position(s).

 

10. Section 409A .

 

a. Although the Company does not guarantee the tax treatment of any payments under this Agreement, the intent of the Parties is that the payments and benefits under this Agreement be exempt from, or comply with, Section 409A of the Internal Revenue Code of 1986, as amended (the “ Code ”), and all Treasury Regulations and guidance promulgated thereunder (“ Code Section 409A ”) and to the maximum extent permitted this Agreement shall be limited, construed and interpreted in accordance with such intent. In no event whatsoever shall the Company or its affiliates or their respective officers, directors, employees or agents be liable for any additional tax, interest or penalties that may be imposed on the Executive by Code Section 409A or damages for failing to comply with Code Section 409A.

 

b. Notwithstanding any other provision of this Agreement to the contrary, to the extent that any reimbursement of expenses constitutes “deferred compensation” under Code Section 409A, such reimbursement shall be provided no later than December 31 st of the year following the year in which the expense was incurred (or, where applicable, no later than such earlier time required by this Agreement). The amount of expenses reimbursed in one year shall not affect the amount eligible for reimbursement in any subsequent year. The amount of any in-kind benefits provided in one year shall not affect the amount of in-kind benefits provided in any other year.

 

c. For purposes of Code Section 409A (including, without limitation, for purposes of Treasury Regulation Section 1.409A-2(b)(2)(iii)), the right to receive payments in the form of installment payments shall be treated as a right to receive a series of separate payments and, accordingly, each installment payment shall at all times be considered a separate and distinct payment. Whenever a payment under this Agreement may be paid within a specified period, the actual date of payment within the specified period shall be within the sole discretion of the Company.

 

d. Notwithstanding any other provision of this Agreement to the contrary, if at the time of the Executive’s separation from service (as defined in Code Section 409A), the Executive is a “Specified Executive”, then the Company will defer the payment or commencement of any nonqualified deferred compensation subject to Code Section 409A payable upon separation from service (without any reduction in such payments or benefits ultimately paid or provided to the Executive) until the date that is six (6) months following separation from service or, if earlier, the earliest other date as is permitted under Code Section 409A (and any amounts that otherwise would have been paid during this deferral period will be paid in a lump sum on the day after the expiration of the six (6)- month period or such shorter period, if applicable). The Executive will be a “Specified Executive” for purposes of this Agreement if, on the date of the Executive’s separation from service, the Executive is an individual who is, under the method of determination adopted by the Company designated as, or within the category of executives deemed to be, a “Specified Executive” within the meaning and in accordance with Treasury Regulation Section 1.409A-1(i). The Company shall determine in its sole discretion all matters relating to who is designated as a “Specified Executive” and the application of and effects of the change in such determination.

 

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e. Notwithstanding anything in this Agreement or elsewhere to the contrary, a termination of employment shall not be deemed to have occurred for purposes of any provision of this Agreement providing for the payment of any amounts or benefits that constitute “non-qualified deferred compensation” within the meaning of Code Section 409A upon or following a termination of the Executive’s employment unless such termination is also a “separation from service” within the meaning of Code Section 409A and, for purposes of any such provision of this Agreement, references to a “termination,” “termination of employment” or like terms shall mean “separation from service” and the date of such separation from service shall be the date of termination for purposes of any such payment or benefits.

 

11. Activity Restrictions; Executive Covenants .

 

a. Purpose . As previously acknowledged, the Company has invested heavily in its information systems, personnel, product development, customers, and customer development. As a member of the Company’s executive management group, the Executive is entrusted with the fruits of these investments and the decisions to be made regarding similar future investments. In order to participate in the benefits of a highly compensated position of trust with the Company, the Company requires a written commitment from key employees that its trust will not be misplaced and its investments lost or damaged. Accordingly, the Executive makes the following promises regarding the Executive’s activities.

 

b. Best Efforts . The Executive will at all times perform all of the Executive’s assigned duties faithfully and exert the Executive’s best efforts to fully perform those duties pursuant to the express and implicit terms of this Agreement to the reasonable satisfaction of the Company. During employment, the Executive will not engage in or become interested in any calling, activity, or other business which is or may be contrary to or in competition with the interests and welfare of the Company.

 

c. Inventions; Intellectual Property .

 

i. Inventions . Every invention and improvement conceived, invented or developed by the Executive relating to or useable in the Business then being carried on or actively contemplated by the Company now existing or hereafter developed shall become the exclusive property of the Company. With respect to all inventive ideas originated or developed by the Executive which relate to the Business during the Term hereof, or as to which the Executive has acquired information as a result of the Executive’s employment with the Company, and all patents obtained on such inventive ideas, (a) the Executive agrees to disclose and assign, without charge, all such inventive ideas and any patents obtained thereon to the Company, but without expense to the Executive, (b) the Executive agrees that all such inventive ideas and any patents thereof shall be the exclusive property of the Company, and (c) the Executive will, at any and all times, furnish such information and assistance and execute such applications and other documents as may be advisable in the opinion of the Company to obtain both domestic and foreign patents, title to which is to be vested in the Company, and the Executive shall give the Company the full and exclusive power to prosecute all such applications and all proceedings in connection therewith.

 

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ii. Intellectual Property . The Executive shall promptly disclose to the Company or any successor or assign, and grant to the Company or its successors and assigns without any separate remuneration or compensation other than that received by the Executive in the course of the Executive’s employment, the Executive’s entire right, title and interest in and to any and all inventions, developments, discoveries, models, or business plans or opportunities, or any other intellectual property of any type or nature whatsoever related to the Business or the Products (“ Intellectual Property ”), developed by the Executive during the period of the Executive’s employment by the Company or its affiliates and whether developed by the Executive during or after business hours, or alone or in connection with others, that is in any way related to the Business of the Company, its successors or assigns. This provision shall not apply to books or articles authored by the Executive during non-work hours, consistent with the Executive’s obligations under this Agreement, so long as such books or articles (a) are not funded in whole or in part by the Company, and (b) do not contain any confidential information or Intellectual Property of the Company. The Executive agrees, at the Company’s expense, to take all steps necessary or proper to vest title to all such Intellectual Property in the Company, and cooperate fully and assist the Company in any litigation or other proceedings involving any such Intellectual Property.

 

d. Non-solicitation of Business . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Executive will not, directly or indirectly, solicit, interfere with, or divert away from the Company any customer of the Company who did any business with the Company during the Term hereof.

 

e. Non-enticement of Personnel . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Executive shall not, directly or indirectly, as an individual or on behalf of any other person or entity, hire, solicit, recruit, or attempt to entice away from the Company or any customer of the Company any person employed by or providing services to the Company or any customer of the Company. The Executive shall not approach any such employees for such a prohibited purpose and shall not knowingly cooperate in any other person or entity’s efforts to do so. The Company’s customers are third-party beneficiaries of this covenant and shall have standing to enforce the terms of this Section 11(e) by seeking whatever equitable and legal remedies may be available to the Company hereunder.

 

f. Confidentiality . The Executive shall not at any time during the Term hereof or at any time thereafter communicate, divulge, disclose, take, or use for himself any information, knowledge, data, or materials that were disclosed or obtained by the Executive during the Term (including, without limitation, any information and knowledge that was conceived, created, or developed by the Executive during the course of the Executive’s employment with the Company) which is related to the Business and the Products and is not already generally known in the Company’s trade by competitors. This restriction on confidential information disclosure and use shall apply to knowledge or information which relates to the Business or the business of the Company’s customers and is in the nature of a business secret of the Company or the Company’s customers. Included within the scope of this restriction shall be the specific items identified in Section 11(h) hereof and any other information and matters designated by the Company (verbally or in writing) to be confidential during the Term hereof. The Company’s customers are third-party beneficiaries of the aforestated covenants in this Section 11(f) and shall have standing to enforce its terms and seek whatever equitable or legal remedy that is necessary to repay or avoid harm to them, including, but not limited to, any remedy available to the Company under this Agreement. The obligations of the Executive with respect to the disclosure and use of confidential information under this Section 11(f) shall cease to the extent such information becomes generally known in the Company’s trade by competitors through a means other than a breach of this Agreement by the Executive. In the event the Executive is required by any legal proceedings to disclose confidential information, the Executive shall provide the Company with prompt notice thereof so that the Company may seek an appropriate protective order and/or waive compliance by the Executive with the provisions hereof.

 

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g. Non-competition . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Executive shall not, alone, or as an agent, employee, servant, officer, partner or stockholder of any other corporation or business, directly or indirectly, engage in employment or business activity which relates to the sale, manufacturing, or marketing of products which are competitive with, substantially similar to, or serve the same function as the Products manufactured, marketed or sold by the Company either now or at any time during the Term. This post-termination restriction is limited to activities in or directed at the geographic area located in North America where the Company has sold or manufactured the Products at any time during the Term hereof. The Executive specifically agrees, without limitation, that the Executive will not accept a similar position or perform the same or similar responsibilities or services as performed for the Company for any business entity that is engaged in a business that is the same, or substantially similar to, the Business (i.e., a competitor).

 

h. Return of Company Materials . Upon request at any time during the Term hereof and without request at the time of the termination or expiration of this Agreement, without regard for who initiated the termination, the Executive agrees to promptly return (without retaining any copies, summaries, files or notes derived from source materials) all information and records regarding the Business and the Products, whether or not created by the Executive during the Term hereof including, but not be limited to: all financial, sales and purchase data for the Business and the Company’s customers, all financial statements and projections, all marketing surveys and analyses, all strategic planning material, all data on the Company’s competitors, all customer information, all records regarding prospective customers of the Company, all documents regarding pending or threatened litigation involving the Company, all legal opinions, all personnel evaluations for the Company’s employees and outside vendors and contractors, all computer hardware and software, all price lists and formulas, all pricing quotations or proposals, all lists or compilations of customers and prospects, all promotional materials, all internal operating reports, all budgets and projections, all information related to the Company’s product development and intellectual property, all product designs, specifications, drawing, engineering, bills of material and other information related to the Products, all corporate and equipment manuals and policies, all contracts with customers and suppliers, all supplier prices and quotations, all business correspondence, all catalogs and product samples, all sensitive customer information, all sales reports and invoices, and all tangible and intangible property owned by the Company.

 

i. Non-Disparagement . During the Term and thereafter, the Executive shall not knowingly, directly or indirectly, make negative comments or otherwise disparage the Company, any of its affiliates, or any of their respective officers, directors, employees, shareholders, agents or businesses in any manner likely to be harmful to them or their business reputations or personal reputations. The Company shall direct its officers, directors and senior management team to not disparage or encourage or induce others to disparage the Executive. The foregoing shall not be violated by truthful statements in response to legal process, required governmental testimony or filings, or administrative or arbitral proceedings (including depositions in connection with such proceedings), provided that the Executive has given the Company prompt written notice of any such legal process and cooperated with the Company’s efforts to seek a protective order.

 

j. Executive’s Representations . The Executive represents and acknowledges that none of the activity restrictions set forth in this Section 11 will prevent the Executive from obtaining employment, cause undue hardship, cause a relocation, or adversely impact numerous other business and employment opportunities that are not affected by the existence of these restrictions. The Executive further acknowledges that the Executive believes the foregoing restrictions to be reasonable and necessary to protect the Company’s legitimate business interests. Any violation of the restrictions in this Section 11 can cause harm to the Company of an irreparable nature for which money damages alone will not suffice. The Executive agrees that the Executive will fully and promptly disclose to any person or entity with which the Executive becomes associated subsequent to the termination or expiration of this Agreement all of the restrictions on the Executive’s post-termination activities. The Company shall also have the right to disclose this Agreement to any business entity hiring or utilizing the services of the Executive subsequent to the termination or expiration of this Agreement.

 

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k. Common Law and Trade Secrets . The Executive and the Company agree that nothing in this Agreement shall be construed to limit or negate the common law of torts or trade secrets where it provides the Company with broader protection than that provided herein.

 

l. Tolling . In the event of any violation of the provisions of this Section 11, the Executive acknowledges and agrees that the post-termination restrictions contained in this Section 11 shall be extended by a period of time equal to the period of such violation, it being the intention of the Parties hereto that the running of the applicable post-termination restriction period shall be tolled during any period of such violation.

 

m. Rights and Remedies upon Breach . The Executive acknowledges and agrees that any breach by the Executive of any of the provisions of Section 11 (the “ Restrictive Covenants ”) would result in irreparable injury and damage for which money damages would not provide an adequate remedy. Therefore, if the Executive breaches, or threatens to commit a breach of, any of the provisions of the Restrictive Covenants, the Company and its affiliates shall have the following rights and remedies, each of which rights and remedies shall be independent of the other and severally enforceable, and all of which rights and remedies shall be in addition to, and not in lieu of, any other rights and remedies available to the Company and its affiliates, under law or in equity (including, without limitation, the recovery of damages):

 

i. the right and remedy to have the Restrictive Covenants specifically enforced (without posting bond and without the need to prove damages) by any court of competent jurisdiction, including, without limitation, the right to an entry against the Executive of restraining orders and injunctions (preliminary, mandatory, temporary and permanent) against violations, threatened or actual, and whether or not then continuing, of such covenants; and

 

ii. the right and remedy to require the Executive to account for and pay over to the Company or any of its affiliates all compensation, profits, monies, accruals, increments or other benefits (collectively, “ Benefits ”) derived or received by the Executive as the result of any transactions constituting a breach of the Restrictive Covenants, and the Executive shall account for and pay over such Benefits to the Company and, if applicable, its affected affiliates.

 

12. Successors and Assigns . This Agreement shall be binding upon and inure to the benefit of the Company’s successors and assigns and the Executive’s personal or legal representatives, executors, administrators, heirs, distributees, devisees and legatees. This Agreement shall not be assignable by the Executive, it being understood and agreed that this is a contract for the Executive’s personal services. This Agreement shall not be assignable by the Company, except that the Company may assign it to an affiliate of the Company and shall assign it in connection with a transaction involving the succession by a third party to all or substantially all of the Company’s business and/or assets (whether direct or indirect and whether by purchase, merger, consolidation, liquidation or otherwise). When assigned to a successor, the assignee shall assume this Agreement and expressly agree to perform this Agreement in the same manner and to the same extent as the Company would be required to perform it in the absence of such an assignment and the Company shall be released of all obligations hereunder. For all purposes under this Agreement, the term “Company” shall include any successor to the Company’s business and/or assets that executes and delivers the assumption agreement described in the immediately preceding sentence or that becomes bound by this Agreement by operation of law. This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns as provided in this Section 12 and is not for the benefit of, nor may any provision hereof be enforced by, any other person, except as otherwise set forth in this Agreement.

 

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13. Alternative Dispute Resolution .

 

a. Coverage . Except as otherwise expressly provided in this Agreement or by law, this Section 13 is the sole and exclusive method by which the Executive and the Company are required to resolve any and all disputes arising out of or related to the Executive’s employment with the Company or the termination of that employment, each of which is referred to as “ Employment-Related Dispute, ” including, but not limited to, disputes arising out of or related to any of the following subjects: (i) compensation or other terms or conditions of the Executive’s employment, (ii) application or enforcement of any Company program or policy to the Executive, (iii) any disciplinary action or other adverse employment decision of the Company or any statement related to the Executive’s employment, performance or termination, (iv) any policy of the Company or any agreement between the Executive and the Company, (v) disputes over the arbitrability of any controversy or claim which arguably is or may be subject to this Section 13, (vi) claims arising out of or related to any current or future federal, state or local civil rights laws, fair employment laws, wage and hour laws, fair labor or employment standards laws, laws against discrimination, equal pay laws, wage and salary payment laws, plant or facility closing or layoff laws, laws in regard to employment benefits or protections, family and medical leave laws, and whistleblower laws, including by way of example, but not limited to, the federal Civil Rights Acts of 1866, 1871, 1964 and 1991, the Pregnancy Discrimination Act of 1978, the Age Discrimination in Employment Act of 1967, the Equal Pay Act of 1963, the Fair Labor Standards Act of 1938, the Americans with Disabilities Act of 1990, the Family and Medical Leave Act of 1993, and the Executive Retirement Income Security Act of 1978, as they have been or may be amended from time to time, or (vii) any other dispute arising out of or related to the Executive’s employment or the Executive’s termination.

 

b. Negotiation; Mediation . Any Employment-Related Dispute asserted by one Party against the other Party shall be delivered in writing to the other Party. During the fifteen (15)-day period following receipt of the assertion by the other Party, the Parties shall attempt in good faith to negotiate a resolution of the Employment-Related Disputes so asserted. If the Employment-Related Disputes so asserted cannot be settled through negotiation and remains unresolved after the fifteen (15)-day negotiation period, the Executive or the Company may submit the dispute to mediation and the Parties shall attempt in good faith to resolve the dispute by mediation, under the mediation procedure of the American Arbitration Association (“ AAA ”). Unless the Parties agree otherwise in writing, the mediation shall be conducted by a single mediator, and the mediator shall be selected from an appropriate AAA panel pursuant to the AAA rules, respectively. The mediation shall be conducted in Denver, Colorado. Unless the Parties agree otherwise, the cost of the mediator’s professional fees and expenses and any reasonable administrative fee will be shared and paid equally by the Parties, and each Party shall bear its own attorneys’ fees and costs of the mediation.

 

c. Binding Arbitration . If the Employment-Related Disputes so asserted cannot be settled through mediation and remains unresolved thirty (30) days after the appointment of a mediator, the Executive or the Company may submit the dispute to arbitration and the dispute shall be settled in arbitration. Notice of a demand to arbitrate a dispute by either Party shall be given in writing to the other at their last known address. Arbitration shall be commenced by the filing by a party of an arbitration demand with the AAA in its office in Denver, Colorado. The arbitration and resolution of the dispute shall be resolved by a single arbitrator appointed by the AAA pursuant to AAA rules. The arbitration shall in all respects be governed and conducted by applicable AAA rules, and any award and/or decision shall be conclusive and binding on the parties. The arbitration shall be conducted in Denver, Colorado regardless of the particular plant or facility of the Parties. The arbitrator shall supply a written opinion supporting any award, and judgment may be entered on the award in any court of competent jurisdiction. Each Party shall pay its own fees and expenses for the arbitration except for any costs and charges imposed by the AAA which may be assessed against the losing Party by the arbitrator. Any fees of the arbitrator for the arbitrator’s services shall in all events be shared and paid equally by the Parties.

 

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d. Equitable Relief . In the event that preliminary or permanent injunctive relief is necessary or desirable in order to prevent a Party from acting contrary to this Agreement or to prevent irreparable harm prior to a confirmation of an arbitration award, including without limitation as provided under Section 14(h) hereof, then either Party is authorized and entitled to commence a lawsuit solely to obtain equitable relief against the other pending the completion of the arbitration in a court having jurisdiction over the Parties. All rights and remedies of the parties shall be cumulative and in addition to any other rights and remedies obtainable from arbitration.

 

e. Severability . In the event that any court or arbitrator finds or holds any restriction contained in this Agreement, including the Restrictive Covenants, to be unreasonable, invalid, or unenforceable, then it is the express intent of the Parties that the court or arbitrator so holding shall modify or amend the offending restriction or restrictions in any reasonable fashion so as to render it or them enforceable to the fullest extent possible under prevailing law. In the event that any restriction is deemed void and unenforceable and not suitable or capable of being so modified, then such restriction shall be severed. Each term and provision of this Agreement is and shall be construed as severable in whole or in part, and, if any provision or the application thereof to particular circumstances should be invalid, illegal, or unenforceable, then the remaining terms and provisions shall not be affected and shall remain fully enforceable. An adjudication or finding of invalidity or unenforceability for one jurisdiction of any particular provision shall not invalidate or void such provision in any other jurisdiction. It is the express intent of the Parties that all restrictions imposed by this Agreement be construed and applied to avoid legal nullities and with a view towards enforcement whenever possible

 

14. Miscellaneous .

 

a. Time of the Essence . Time is of the essence with respect to this Agreement. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall not be a business day (i.e, a Saturday, Sunday or federal holiday), then such action may be taken or such right may be exercised on the next succeeding business day.

 

b. Entire Agreement . This Agreement constitutes the entire understanding or agreement between the Company and the Executive relating to the subject matter hereof and there is no understanding or agreement, oral or written, which is not set forth herein. This Agreement supersedes and replaces any prior employment agreement or understanding, oral or written, between the Company and the Executive. This Agreement may only be amended by a writing signed by the Company and the Executive.

 

c. Waiver . No provision of this Agreement may be waived, modified, supplemented or amended except in a written instrument signed by the Parties. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any subsequent default or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of any Party to exercise any right hereunder in any manner impair the exercise of any such right.

 

d. Construction . In the event of a conflict or ambiguity created between the Company’s current personnel manual for all employees and this Agreement, it is agreed that this Agreement shall control. No policies, procedures, or statements of any nature by the Company shall modify this Agreement or be construed to create express or implied obligations to the Executive. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. The Parties agree that each of them and/or their respective counsel have reviewed and had an opportunity to revise this Agreement and, therefore, the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting Party shall not be employed in the interpretation of this Agreement or any amendments thereto. The word “including” shall be construed to include the words “without limitation.” In this Agreement, unless the context otherwise requires, references to the singular shall include the plural and vice versa. The word “Company” shall be construed to include the Company and its subsidiaries and affiliates, whether now existing or hereafter established.

 

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e. Notices . All notices and other communications hereunder shall be in writing, and shall be deemed to have been duly given if delivered personally or if sent by overnight courier or by certified mail, return receipt requested, postage prepaid, to the relevant address set forth below, or to such other address as the recipient of such notice or communication shall have specified in writing to the other Party hereto, in accordance with this Section 14(e).

 

  i. If to the Company:   Surna Inc.
      1780 55 th Street, Suite A
      Boulder, Colorado 80301
      Attention: CEO

 

ii. If to the Executive, at the Executive’s last residence shown on the records of the Company.

 

f. Public Announcements . The Company intends to publicly announce and disclose this Agreement and the subject matter hereof in accordance with applicable laws. Until such time as the Company has publicly announced and/or disclosed this Agreement and the subject matter hereof, the Executive shall not publicly announce or disclose to any third party the existence of this Agreement or the subject matter hereof.

 

g. Governing Law . All questions concerning the construction, validity, enforcement and interpretation of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Colorado, without regard to the principles of conflicts of law thereof.

 

h. Equitable Relief . The Executive acknowledges and agrees that, notwithstanding anything herein to the contrary, including without limitation Section 13(d) hereof, upon any breach by the Executive of the Executive’s obligations under Section 11, the Company will have no adequate remedy at law, and accordingly shall be immediately entitled to specific performance and other appropriate injunctive and equitable relief in a court of competent jurisdiction.

 

i. Cooperation in Future Matters . The Executive hereby agrees that for a period of eighteen (18) months following the Executive’s termination of employment, the Executive shall cooperate fully with the Company’s reasonable requests relating to matters that pertain to the Executive’s employment by the Company, including, without limitation, providing information or limited consultation as to such matters, participating in legal proceedings, investigations or audits on behalf of the Company, or otherwise making himself reasonably available to the Company for other related purposes. Any such cooperation shall be performed at scheduled times taking into consideration the Executive’s other commitments. The Executive shall not be required to perform such cooperation to the extent it conflicts with any requirements of exclusivity of services for another employer or otherwise, nor in any manner that in the good faith belief of the Executive would conflict with the Executive’s rights under or ability to enforce this Agreement.

 

j. Withholding . Any payments provided for in this Agreement shall be paid net of any applicable income tax withholding required under federal, state or local law.

 

k. Survival . Notwithstanding anything in this Agreement or elsewhere to the contrary, the provisions of Sections 9, 10, 11, 12, 13 and 14 shall survive the termination of the Executive’s employment or this Agreement.

 

l. Execution and Counterparts . This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. Counterparts may be delivered via facsimile, electronic mail (including pdf or any electronic signature complying with the U.S. ESIGN Act of 2000, e.g., www.docusign.com) or other transmission method and any counterpart so delivered shall be deemed to have been duly and validly delivered and be valid and effective for all purposes.

 

[Remainder of this page intentionally left blank. Signature page follows.]

 

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IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year written below.

 

EXECUTIVE   COMPANY
     
  Surna Inc.  
     
/s/ Chris Bechtel   By: /s/ Timothy J. Keating
Chris Bechtel, Individually     Timothy J. Keating, Chairman of the Board  

 

[Signature Page to Executive Employment Agreement]

 

     

 

 

EXHIBIT A

 

Permitted Activities

 

Bechtel Consulting, LLC – during the Term, the Executive will not engage in or provide any consulting services either individually or through Bechtel Consulting, LLC without the prior approval of the Board.

 

Ravencrest Resources, Inc. (CSE: RVT) – during the Term, the Executive may act as an independent director of Ravencrest Resources, provided that the Board may require the Executive to resign from such director position if such position creates a conflict of interest with the Company or requires more than ten (10) hours per month.

 

     

 

 

EXHIBIT B

 

Form of Restricted Stock Unit Agreement

 

     

 

 

 

 

EMPLOYMENT AGREEMENT

 

This Employment Agreement (this “ Agreement ”) is made and entered into effective this 10 th day of October, 2017 by and between Surna Inc. , a Nevada corporation whose address is 1780 55th Street, Suite A, Boulder, Colorado 80301 (the “ Company ”) and Brandy M. Keen , an adult resident of the State of Colorado (the “ Employee ”). The Employee and the Company may be referred to herein individually as a “ Party ” or collectively as the “ Parties .”

 

AGREED ACKNOWLEDGMENTS

 

A. The Company is engaged in the development, design and distribution of cultivation technologies for controlled environment agriculture for state-regulated cannabis cultivation facilities and traditional indoor agricultural facilities, including lighting, environmental control and air sanitation designed to meet the specific environmental conditions required for indoor cultivation and to reduce energy and water consumption (the “ Business ”).

 

B. In connection with the Business, the Company manufactures or is developing, sells and delivers the following products and services: (i) liquid-based process cooling and climate control systems, (ii) reflectors and lighting systems, including water-cooled reflectors, (iii) a full-service engineering package for designing and engineering commercial scale thermodynamic systems specific to indoor cultivation facility conditions, (iv) automation and control devices, systems and technologies used for environmental, lighting and climate control in indoor cultivation facilities, (v) a comprehensive, hybrid cultivation facility design and building utilizing sunlight and a high-power LED lighting system, and (vi) and other products, services, and technologies now or hereafter developed related to the foregoing (collectively, the “ Products ”)

 

C. The Business of the Company is highly competitive and requires the creation of intimate and prolonged relationships with the Company’s customers because of the custom products developed for individual customers, and the significance of adapting to the marketing plans continually being created by these customers.

 

D. The Company has invested and will continue to invest considerable sums of time, money, and other resources in developing the confidence and loyalty of its customers and potential customers and to recruit, train, support and compensate its employees and potential employees. In addition, the Company expends significant amounts of time and money to attract, identify, locate, and establish contacts and business relationships with prospective customers. The loss of these existing and prospective relationships with customers, and with existing and potential employees, will cause substantial and irreparable harm to the Company, which cannot be accurately or adequately compensated by money alone.

 

E. The Company desires to retain the services of the Employee as a member of the Company’s management team. The Employee desires to continue such employment and commits to devote all of the Employee’s business time and attention to services benefiting the Company. Both the Employee and the Company wish to enter into this Agreement to set forth the terms and conditions of the Employee’s employment with the Company.

 

F. The Employee acknowledges that, in connection with the execution of this Agreement, the Employee is receiving new and valuable consideration from the Company including, without limitation, an increased salary and a revised sales incentive plan.

 

G. The Employee acknowledges that, in the course of the Employee’s employment with the Company, the Employee will frequently come into contact with the Company’s customers and suppliers to such an extent that the Employee may be able to control or direct, in whole or in part, the business and relationships between the Company and its customers and suppliers. Accordingly, the Company reposes its trust in the Employee not to disrupt or otherwise misappropriate the customer and supplier relationships developed and/or supported by the Company.

 

 

 

 

H. The Employee will also, during the course of the Employee’s employment with the Company, have frequent and close contact with the Company’s other executive managers, salespeople, and key staff employees. As a result of the Employee’s position, the Employee will acquire and have access to confidential information concerning the Company’s employees, prospective employees, customers, suppliers, and prospective customers and suppliers that is not easily or generally available to the Company’s competitors.

 

I. The Employee acknowledges that, by virtue of the Employee’s position with the Company, the Employee will have access to certain secret and confidential business data and information belonging to the Company including, but not limited to: marketing plans, financial strategies, market surveys and assessments, customer and Company technical information, financial statements, budget data, personnel records, customer profiles and purchase requirements, product design, engineering and technical specifications, pricing plans and strategies, sales contracts and proposals, private and confidential discussions with executive managers, legal advice and strategies, performance evaluations, price schedules from suppliers, litigation and planned litigation, capital needs, lists of customers and potential customers, hiring and training goals, internal operation and production reports and schedules, compensation packages, customer account projections, licenses, promotional plans and information, corporate policies for internal operations, bids and proposals by suppliers and to customers, identities and personal profiles of key persons at customers and potential customers, expense data by customer, and other confidential and sensitive business information developed and maintained by the Company.

 

J. The Company has a valuable and proprietary interest in the confidential information described in paragraph I above and has expended considerable time and money to safeguard and protect such information from direct or indirect divulgence of same by its employees, including the Employee. In addition, as part of the Company’s relationship with each of its customers, the Company assures customers that the unique, confidential, and secret information shared by customers with the Company will be protected from disclosure to and unauthorized use by others. Any divulgence of such information will constitute an irreparable injury to the Company and the Company’s customers.

 

K. The Employee acknowledges that (i) the Employee’s position with the Company is one of great trust and confidence requiring that the Employee exercise a high degree of loyalty, honesty, and integrity, (ii) the Employee has and will receive substantial and adequate monetary consideration and benefits pursuant to this Agreement, (iii) the Employee has read and understood the terms of this Agreement and signed the same as a free and voluntary act, and (iv) the Employee understands that there is no need to continue employment with the Company, but the Employee has freely chosen to enter into this Agreement because of a desire to take advantage of the specific and unique opportunities offered by continued employment with the Company and the additional benefits provided for herein.

 

AGREEMENTS

 

In consideration of the Agreed Acknowledgments and the mutual covenants and agreements set forth in this Agreement, the Parties agree as follows:

 

1. Acknowledgments . The acknowledgments set forth above are accurate and are hereby incorporated by reference in this Agreement.

 

2. Employment . The Company hereby employs the Employee and the Employee hereby accepts employment with the Company on the terms and conditions set forth in this Agreement.

 

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3. Duties . During the Term (as defined below), the Employee shall be employed by the Company as the Vice President, Secretary and Senior Technical Advisor and, as such, the Employee shall have such responsibilities and authority as are customary for such position of a company of similar size and nature as the Company as may be assigned from time to time, including, without limitation, serving as the technical advisor to the Company’s sales representatives, providing technical support to assess and develop scope of work, solutions and technical requirements for customer and prospective customer projects, assisting the Company in securing Product sales, serving as technical advisor to the Company’s engineering and product development teams, and providing input and direction for the product development and overall engineering focus for the Company. The Employee shall faithfully perform for the Company the duties of such position and shall report directly to the Vice President – Sales and Project Management. The Employee will also hold such other executive officer positions as the Company’s Board of Directors (the “ Board ”) may appoint from time to time. The Company and the Employee acknowledge that the Parties have entered into that certain Indemnification Agreement dated May 10, 2017 (“ D&O Indemnity Agreement ”). At all times during the Term, the Employee shall adhere to all of the Company’s policies, rules and regulations governing the conduct of its employees, including without limitation, any compliance manual, code of ethics, employee handbook or other policies adopted by the Company from time to time.

 

4. Extent of Services . Except for illnesses and vacation periods, the Employee shall devote the Employee’s full business time and attention and the Employee’s best efforts to the performance of the Employee’s duties and responsibilities under this Agreement. Notwithstanding the foregoing, the Employee may participate in charitable, academic, community religious or other non-profit activities, and in trade or professional organizations, and engage and participate in the specific activities listed in Exhibit A hereto (the “ Permitted Activities ”) or such other activities as specifically agreed to in writing by the Company in advance from time to time in the Company’s sole discretion, provided that all of the Employee’s activities outside of the Employee’s duties to the Company, individually or in the aggregate, shall comply with the Company’s conflict of interest policies and corporate governance guidelines as in effect from time to time, do not otherwise interfere with the Employee’s duties and responsibilities to the Company, and do not compete with or adversely affect the Business of the Company. Subject to the provisions of Section 11 herein, the Employee may make any passive investment in any publicly traded entity, or own five percent (5%) or less of the issued and outstanding voting securities of any entity, provided, in any event, that the Employee is not obligated or required to, and shall not in fact, devote any consulting or managerial effort or services in connection therewith, except for the Permitted Activities.

 

5. Place of Performance . The Employee will perform the Employee’s duties for the Company from the Company’s corporate offices in Boulder, Colorado, except that the Employee will travel to perform services as required for the proper performance of the Employee’s duties under this Agreement.

 

6. Term; At-Will Employment; Termination . This Agreement and the Employee’s employment hereunder shall commence on October 1, 2017 (the “ Effective Date ”) and, subject to earlier termination as provided in this Section 6, shall continue in full force and effect thereafter until December 31, 2019 (the “ Initial Term ”) and, by mutual written agreement of the Parties, may be extended for a term of one (1) additional year (an “ Extended Term ”) at the end of the Initial Term, and an additional one (1) year Extended Term at the end of each Extended Term (the last day of the Initial Term and each such Extended Term is referred to herein as a “ Term Date ”). Notwithstanding any other provision of this Agreement to the contrary, either Party may terminate this Agreement, at any time, with or without Cause (as defined herein), by providing the other Party with 30-days’ prior written notice. During the Term (as defined below) and for so long as the Employee is employed by Company, the Employee shall be an at-will employee of Company. The employment of the Employee by the Company shall terminate immediately upon death of the Employee. Any termination of the Employee’s employment by the Company or by the Employee (other than termination pursuant to death) shall be communicated by written notice of termination to the other Party hereto in accordance with this Agreement. For purposes of this Agreement, “ Term ” shall mean the actual duration of the Employee’s employment hereunder, taking into account any extensions or any termination of employment pursuant to this Section 6, and “ Date of Termination ” shall mean the date the Employee’s employment is terminated in accordance with this Section 6.

 

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7. Compensation .

 

a. Salary . The Company shall pay the Employee an annualized base salary (the “ Base Salary ”) of $150,000 per year, which shall be payable in equal installments in accordance with the Company’s standard payroll practice from time to time, less customary or legally required withholdings and deductions, for periods actually worked by the Employee.

 

b. Sales Incentive Program . The Employee shall be eligible to participate in the Company’s sales incentive program for sales personnel, as in effect and as amended from time to time by the Company (the “ Sales Program ”). In connection with the Sales Program, the Employee will be entitled to a sales incentive equal to one-quarter of one percent (0.25%) of the net revenue collected and earned from Products sales originated by the Employee and any other salesperson employed by the Company, payable quarterly in arrears (the “ Sales Incentive ”). The Company and the Employee acknowledge and agree that the Sales Incentive will terminate effective December 31, 2019, notwithstanding any extension of the Term hereunder as set forth in Section 6 hereof.

 

c. Equity Incentive Plan . Subject to the approval of the independent members of the Board, the Employee may be eligible to participate in the Company’s 2017 Equity Incentive Plan, as adopted by the Board on August 1, 2017, as may be modified and amended by the Company from time to time (the “ EIP ”).

 

d. Clawback . Notwithstanding any other provisions in this Agreement to the contrary, any incentive-based compensation, or any other compensation, paid to the Employee pursuant to this Agreement or any other agreement or arrangement with the Company which is subject to recovery under any law, governmental regulation, or stock exchange listing requirement, will be subject to such deductions and clawback as may be required to be made pursuant to such law, government regulation or stock exchange listing requirement.

 

8. Fringe Benefits . The Company shall provide the following benefits to the Employee during the Term:

 

a. Employee Benefit Plans . The Employee will be eligible to participate in any employee benefit plans including, without limitation, group insurance, profit sharing and 401(k) plans, 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.

 

b. Vacation . The Employee shall accrue in accordance with the Company’s vacation policy as in effect from time to time twenty (20) days per year of paid vacation time, provided that, any earned but unused vacation in a year may not be carried forward to future years.

 

c. Personal Days, Sick Leave and Holidays . The Employee shall be entitled to receive paid personal days, sick days and holidays under the guidelines established by the Company from time to time for the Company’s executive and management employees, provided that, any earned but unused personal and sick days in a year may not be carried forward to future years.

 

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d. Business Expense Reimbursement . Subject to the Company’s policies and procedures for the reimbursement of business expenses incurred by its executive and management employees, the Company shall reimburse the Employee for reasonable expenses incurred by the Employee in connection with the performance of the Employee’s duties pursuant to this Agreement, including, but not limited to, travel expenses, professional conventions or similar professional functions and other reasonable business expenses. The Employee agrees to provide the Company with receipts and/or documentation sufficient to permit the Company to take its full business expense deduction. The Company shall have no obligation to reimburse the Employee for expenses claimed if the Employee does not provide sufficient receipts and/or documentation. The Employee shall submit requests for reimbursement of business expenses at least once every month. The Employee shall be entitled to a corporate credit card, and any frequent flyer miles earned for travel contemplated under this Agreement shall be owned by the Employee.

 

e. Miscellaneous Benefits . The Employee is also entitled to receive any other fringe benefits that Company may from time to time make available generally to its management employees.

 

9. Effects of Termination .

 

a. Accrued Benefits . If the employment of the Employee should terminate at the election of the Company with or without Cause, at the election of the Employee, due to the Employee’s death, or upon expiration of the Term, then the Company will pay or provide to the Employee or, in the event of the Employee’s death, to the estate of the Employee:

 

i. any earned and accrued but unpaid Base Salary through the Date of Termination payable in accordance with the Company’s normal payroll practices;

 

ii. reimbursement for any unreimbursed business expenses incurred through the Date of Termination in accordance with Section 8(d); and

 

iii. all other applicable payments or benefits to which the Employee shall be entitled under, and paid or provided in accordance with, the terms of any applicable arrangement, plan or program under Section 8(a)-(c) (collectively, Sections 9(a)(i)-(iii), payable in accordance with this Section 9(a), shall be hereafter referred to as the “ Accrued Benefits ”).

 

b. Death Benefit . If the employment of the Employee should terminate during the Term due to the Employee’s death, then the Company will pay or provide to the estate of the Employee (in addition to the Accrued Benefits payable under Section 9(a)), subject to Section 9(e) , any accrued but unpaid Sales Incentive for the calendar quarter immediately prior to the Employee’s death, payable when the applicable Sales Incentive for such calendar quarter would have otherwise been paid.

 

c. Termination by the Company without Cause . If the employment of the Employee should terminate at the election of the Company without Cause, the Company will pay or provide to the Employee (in addition to the Accrued Benefits payable under Section 9(a)), subject to Sections 9(e) and 10 :

 

i. continued payment of the Employee’s Base Salary for a period equal to the lesser of thirty (30) days from the Date of Termination or the then applicable Term Date, whichever occurs first, payable in accordance with the Company’s normal payroll practices (but off employee payroll) (the “ Severance Payments ”); provided that, the first payment of the Severance Payments shall be made on the fifteenth (15 th ) day after the Date of Termination, and will include payment of any amount of the Severance Payments that were otherwise due prior thereto; and

 

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ii. any accrued but unpaid Sales Incentive for the calendar quarter immediately prior to the Employee’s termination, payable when the applicable Sales Incentive for such calendar quarter would have otherwise been paid.

 

For purposes of this Agreement, the term “ Cause ” means that the Employee: (i) has been convicted of, or entered a plea of guilty or “ nolo contendere ” to, a felony or a crime involving moral turpitude causing material harm to the standing and reputation of the Company, (ii) violated any of the Employee’s obligations under this Agreement, any award agreement under the EIP, any proprietary rights, non-competition, non-disclosure or other restrictive covenant agreements in effect between the Employee and the Company, including such agreements in this Agreement, which are demonstrably willful or deliberate on the Employee’s part, (iii) has willfully or deliberately failed to perform the Employee’s material duties assigned by, or to follow the lawful orders and direction of, the CEO or the Board (other than by reason of illness or temporary disability), (iv) has engaged in illegal conduct, gross misconduct, fraud or material dishonesty in connection with the Business of the Company, (v) has engaged in willful misappropriation or embezzlement of any of the Company’s funds or property, or (vi) has engaged in conduct that violated the Company’s then existing written internal policies or procedures and which is detrimental to the Business or reputation of the Company. Any of the aforesaid clauses (ii), (iii) and (vi) may be cured by the Employee, if curable, if cured within fifteen (15) days after receipt by the Employee of written notice of the same. In the event such acts or omissions are capable of being cured, the effective date of termination, in the event of the Employee’s failure to cure, must be at least fifteen (15) days after such notice of termination to afford the Employee the ability to cure the same. The Company may place the Employee on paid leave for up to sixty (60) consecutive days while it is determining whether there is a basis to terminate Employee’s employment for Cause.

 

d. Expiration of Term . In the event that the Initial Term expires on December 31, 2019 without being extended by the Parties, the Company will pay or provide to the Employee (in addition to the Accrued Benefits payable under Section 9(a)), subject to Section 9(e) , any accrued but unpaid Sales Incentive for the calendar quarter ended December 31, 2019, payable when the applicable Sales Incentive for such calendar quarter would have otherwise been paid.

 

e. Release . Any payments or benefits by the Company required under Sections 9(b), 9(c), and 9(d) shall be conditioned on and shall not be payable unless the Company receives from the Employee (or, in the event of the Employee’s death, the estate of the Employee) within thirty (30) days of the Date of Termination a fully effective and non-revocable written release in form and substance reasonably acceptable to the Company of any and all past, present or future claims that the Employee (or, in the event of the Employee’s death, the estate of the Employee) may have against the Company or any of its affiliates and any of their respective officers, directors and other related parties (all claims released in this Section 9(e) being referred to as the “ Released Claims ”), provided, however, that the Released Claims shall not include any claim by the Employee for indemnification from the Company relating to any act or omission prior to the Date of Termination, in each instance to the extent the Employee would have the right to be indemnified therefor under (and not otherwise prohibited or restricted by) (i) the laws of the State of Nevada, (ii) any Federal law applicable to the Company or the Employee, (iii) the Company’s articles of incorporation or bylaws, as amended, and (iv) the D&O Indemnity Agreement. The Company agrees to provide a form of release within seven (7) days of the Date of Termination.

 

f. Termination of Authority . Immediately upon the Employee terminating or being terminated from the Employee’s employment with the Company for any reason, notwithstanding anything else appearing in this Agreement or otherwise, the Employee will stop serving the functions of the Employee’s terminated or expired position(s), including but not limited to any director or officer positions at the Company or any of its affiliates, and shall be without any of the authority or responsibility for such position(s).

 

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10. Section 409A .

 

a. Although the Company does not guarantee the tax treatment of any payments under this Agreement, the intent of the Parties is that the payments and benefits under this Agreement be exempt from, or comply with, Section 409A of the Internal Revenue Code of 1986, as amended (the “ Code ”), and all Treasury Regulations and guidance promulgated thereunder (“ Code Section 409A ”) and to the maximum extent permitted this Agreement shall be limited, construed and interpreted in accordance with such intent. In no event whatsoever shall the Company or its affiliates or their respective officers, directors, employees or agents be liable for any additional tax, interest or penalties that may be imposed on the Employee by Code Section 409A or damages for failing to comply with Code Section 409A.

 

b. Notwithstanding any other provision of this Agreement to the contrary, to the extent that any reimbursement of expenses constitutes “deferred compensation” under Code Section 409A, such reimbursement shall be provided no later than December 31 st of the year following the year in which the expense was incurred (or, where applicable, no later than such earlier time required by this Agreement). The amount of expenses reimbursed in one year shall not affect the amount eligible for reimbursement in any subsequent year. The amount of any in-kind benefits provided in one year shall not affect the amount of in-kind benefits provided in any other year.

 

c. For purposes of Code Section 409A (including, without limitation, for purposes of Treasury Regulation Section 1.409A-2(b)(2)(iii)), the right to receive payments in the form of installment payments shall be treated as a right to receive a series of separate payments and, accordingly, each installment payment shall at all times be considered a separate and distinct payment. Whenever a payment under this Agreement may be paid within a specified period, the actual date of payment within the specified period shall be within the sole discretion of the Company.

 

d. Notwithstanding any other provision of this Agreement to the contrary, if at the time of the Employee’s separation from service (as defined in Code Section 409A), the Employee is a “Specified Employee”, then the Company will defer the payment or commencement of any nonqualified deferred compensation subject to Code Section 409A payable upon separation from service (without any reduction in such payments or benefits ultimately paid or provided to the Employee) until the date that is six (6) months following separation from service or, if earlier, the earliest other date as is permitted under Code Section 409A (and any amounts that otherwise would have been paid during this deferral period will be paid in a lump sum on the day after the expiration of the six (6)- month period or such shorter period, if applicable). The Employee will be a “Specified Employee” for purposes of this Agreement if, on the date of the Employee’s separation from service, the Employee is an individual who is, under the method of determination adopted by the Company designated as, or within the category of executives deemed to be, a “Specified Employee” within the meaning and in accordance with Treasury Regulation Section 1.409A-1(i). The Company shall determine in its sole discretion all matters relating to who is designated as a “Specified Employee” and the application of and effects of the change in such determination.

 

e. Notwithstanding anything in this Agreement or elsewhere to the contrary, a termination of employment shall not be deemed to have occurred for purposes of any provision of this Agreement providing for the payment of any amounts or benefits that constitute “non-qualified deferred compensation” within the meaning of Code Section 409A upon or following a termination of the Employee’s employment unless such termination is also a “separation from service” within the meaning of Code Section 409A and, for purposes of any such provision of this Agreement, references to a “termination,” “termination of employment” or like terms shall mean “separation from service” and the date of such separation from service shall be the date of termination for purposes of any such payment or benefits.

 

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11. Activity Restrictions; Employee Covenants .

 

a. Purpose . As previously acknowledged, the Company has invested heavily in its information systems, personnel, product development, customers, and customer development. As a member of the Company’s executive management group, the Employee is entrusted with the fruits of these investments and the decisions to be made regarding similar future investments. In order to participate in the benefits of a highly compensated position of trust with the Company, the Company requires a written commitment from key employees that its trust will not be misplaced and its investments lost or damaged. Accordingly, the Employee makes the following promises regarding the Employee’s activities.

 

b. Best Efforts . The Employee will at all times perform all of the Employee’s assigned duties faithfully and exert the Employee’s best efforts to fully perform those duties pursuant to the express and implicit terms of this Agreement to the reasonable satisfaction of the Company. During employment, the Employee will not engage in or become interested in any calling, activity, or other business which is or may be contrary to or in competition with the interests and welfare of the Company.

 

c. Inventions; Intellectual Property .

 

i. Inventions . Every invention and improvement conceived, invented or developed by the Employee relating to or useable in the Business then being carried on or actively contemplated by the Company now existing or hereafter developed shall become the exclusive property of the Company. With respect to all inventive ideas originated or developed by the Employee which relate to the Business during the Term hereof, or as to which the Employee has acquired information as a result of the Employee’s employment with the Company, and all patents obtained on such inventive ideas, (a) the Employee agrees to disclose and assign, without charge, all such inventive ideas and any patents obtained thereon to the Company, but without expense to the Employee, (b) the Employee agrees that all such inventive ideas and any patents thereof shall be the exclusive property of the Company, and (c) the Employee will, at any and all times, furnish such information and assistance and execute such applications and other documents as may be advisable in the opinion of the Company to obtain both domestic and foreign patents, title to which is to be vested in the Company, and the Employee shall give the Company the full and exclusive power to prosecute all such applications and all proceedings in connection therewith.

 

ii. Intellectual Property . The Employee shall promptly disclose to the Company or any successor or assign, and grant to the Company or its successors and assigns without any separate remuneration or compensation other than that received by the Employee in the course of the Employee’s employment, the Employee’s entire right, title and interest in and to any and all inventions, developments, discoveries, models, or business plans or opportunities, or any other intellectual property of any type or nature whatsoever related to the Business or the Products (“ Intellectual Property ”), developed by the Employee during the period of the Employee’s employment by the Company or its affiliates and whether developed by the Employee during or after business hours, or alone or in connection with others, that is in any way related to the Business of the Company, its successors or assigns. This provision shall not apply to books or articles authored by the Employee during non-work hours, consistent with the Employee’s obligations under this Agreement, so long as such books or articles (a) are not funded in whole or in part by the Company, and (b) do not contain any confidential information or Intellectual Property of the Company. The Employee agrees, at the Company’s expense, to take all steps necessary or proper to vest title to all such Intellectual Property in the Company, and cooperate fully and assist the Company in any litigation or other proceedings involving any such Intellectual Property.

 

d. Non-solicitation of Business . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Employee will not, directly or indirectly, solicit, interfere with, or divert away from the Company any customer of the Company who did any business with the Company during the Term hereof.

 

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e. Non-enticement of Personnel . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Employee shall not, directly or indirectly, as an individual or on behalf of any other person or entity, hire, solicit, recruit, or attempt to entice away from the Company or any customer of the Company any person employed by or providing services to the Company or any customer of the Company. The Employee shall not approach any such employees for such a prohibited purpose and shall not knowingly cooperate in any other person or entity’s efforts to do so. The Company’s customers are third-party beneficiaries of this covenant and shall have standing to enforce the terms of this Section 11(e) by seeking whatever equitable and legal remedies may be available to the Company hereunder.

 

f. Confidentiality . The Employee shall not at any time during the Term hereof or at any time thereafter communicate, divulge, disclose, take, or use for himself any information, knowledge, data, or materials that were disclosed or obtained by the Employee during the Term (including, without limitation, any information and knowledge that was conceived, created, or developed by the Employee during the course of the Employee’s employment with the Company) which is related to the Business and the Products and is not already generally known in the Company’s trade by competitors. This restriction on confidential information disclosure and use shall apply to knowledge or information which relates to the Business or the business of the Company’s customers and is in the nature of a business secret of the Company or the Company’s customers. Included within the scope of this restriction shall be the specific items identified in Section 11(h) hereof and any other information and matters designated by the Company (verbally or in writing) to be confidential during the Term hereof. The Company’s customers are third-party beneficiaries of the aforestated covenants in this Section 11(f) and shall have standing to enforce its terms and seek whatever equitable or legal remedy that is necessary to repay or avoid harm to them, including, but not limited to, any remedy available to the Company under this Agreement. The obligations of the Employee with respect to the disclosure and use of confidential information under this Section 11(f) shall cease to the extent such information becomes generally known in the Company’s trade by competitors through a means other than a breach of this Agreement by the Employee. In the event the Employee is required by any legal proceedings to disclose confidential information, the Employee shall provide the Company with prompt notice thereof so that the Company may seek an appropriate protective order and/or waive compliance by the Employee with the provisions hereof.

 

g. Non-competition . During the Term hereof and for a period of one (1) year after the termination or expiration of this Agreement, regardless of who initiated the termination, the Employee shall not, alone, or as an agent, employee, servant, officer, partner or stockholder of any other corporation or business, directly or indirectly, engage in employment or business activity which relates to the sale, manufacturing, or marketing of products which are competitive with, substantially similar to, or serve the same function as the Products manufactured, marketed or sold by the Company either now or at any time during the Term. This post-termination restriction is limited to activities in or directed at the geographic area located in North America where the Company has sold or manufactured the Products at any time during the Term hereof. The Employee specifically agrees, without limitation, that the Employee will not accept a similar position or perform the same or similar responsibilities or services as performed for the Company for any business entity that is engaged in a business that is the same, or substantially similar to, the Business (i.e., a competitor). Notwithstanding the foregoing, the provisions of this Section 11(g) shall not apply if the Employee is terminated by the Company without Cause.

 

9

 

 

h. Return of Company Materials . Upon request at any time during the Term hereof and without request at the time of the termination or expiration of this Agreement, without regard for who initiated the termination, the Employee agrees to promptly return (without retaining any copies, summaries, files or notes derived from source materials) all information and records regarding the Business and the Products, whether or not created by the Employee during the Term hereof including, but not be limited to: all financial, sales and purchase data for the Business and the Company’s customers, all financial statements and projections, all marketing surveys and analyses, all strategic planning material, all data on the Company’s competitors, all customer information, all records regarding prospective customers of the Company, all documents regarding pending or threatened litigation involving the Company, all legal opinions, all personnel evaluations for the Company’s employees and outside vendors and contractors, all computer hardware and software, all price lists and formulas, all pricing quotations or proposals, all lists or compilations of customers and prospects, all promotional materials, all internal operating reports, all budgets and projections, all information related to the Company’s product development and intellectual property, all product designs, specifications, drawing, engineering, bills of material and other information related to the Products, all corporate and equipment manuals and policies, all contracts with customers and suppliers, all supplier prices and quotations, all business correspondence, all catalogs and product samples, all sensitive customer information, all sales reports and invoices, and all tangible and intangible property owned by the Company.

 

i. Non-Disparagement . During the Term and thereafter, the Employee shall not knowingly, directly or indirectly, make negative comments or otherwise disparage the Company, any of its affiliates, or any of their respective officers, directors, employees, shareholders, agents or businesses in any manner likely to be harmful to them or their business reputations or personal reputations. The Company shall direct its officers, directors and senior management team to not disparage or encourage or induce others to disparage the Employee. The foregoing shall not be violated by truthful statements in response to legal process, required governmental testimony or filings, or administrative or arbitral proceedings (including depositions in connection with such proceedings), provided that the Employee has given the Company prompt written notice of any such legal process and cooperated with the Company’s efforts to seek a protective order.

 

j. Employee’s Representations . The Employee represents and acknowledges that none of the activity restrictions set forth in this Section 11 will prevent the Employee from obtaining employment, cause undue hardship, cause a relocation, or adversely impact numerous other business and employment opportunities that are not affected by the existence of these restrictions. The Employee further acknowledges that the Employee believes the foregoing restrictions to be reasonable and necessary to protect the Company’s legitimate business interests. Any violation of the restrictions in this Section 11 can cause harm to the Company of an irreparable nature for which money damages alone will not suffice. The Employee agrees that the Employee will fully and promptly disclose to any person or entity with which the Employee becomes associated subsequent to the termination or expiration of this Agreement all of the restrictions on the Employee’s post-termination activities. The Company shall also have the right to disclose this Agreement to any business entity hiring or utilizing the services of the Employee subsequent to the termination or expiration of this Agreement.

 

k. Common Law and Trade Secrets . The Employee and the Company agree that nothing in this Agreement shall be construed to limit or negate the common law of torts or trade secrets where it provides the Company with broader protection than that provided herein.

 

l. Tolling . In the event of any violation of the provisions of this Section 11, the Employee acknowledges and agrees that the post-termination restrictions contained in this Section 11 shall be extended by a period of time equal to the period of such violation, it being the intention of the Parties hereto that the running of the applicable post-termination restriction period shall be tolled during any period of such violation.

 

10

 

 

m. Rights and Remedies upon Breach . The Employee acknowledges and agrees that any breach by the Employee of any of the provisions of Section 11 (the “ Restrictive Covenants ”) would result in irreparable injury and damage for which money damages would not provide an adequate remedy. Therefore, if the Employee breaches, or threatens to commit a breach of, any of the provisions of the Restrictive Covenants, the Company and its affiliates shall have the following rights and remedies, each of which rights and remedies shall be independent of the other and severally enforceable, and all of which rights and remedies shall be in addition to, and not in lieu of, any other rights and remedies available to the Company and its affiliates, under law or in equity (including, without limitation, the recovery of damages):

 

i. the right and remedy to have the Restrictive Covenants specifically enforced (without posting bond and without the need to prove damages) by any court of competent jurisdiction, including, without limitation, the right to an entry against the Employee of restraining orders and injunctions (preliminary, mandatory, temporary and permanent) against violations, threatened or actual, and whether or not then continuing, of such covenants; and

 

ii. the right and remedy to require the Employee to account for and pay over to the Company or any of its affiliates all compensation, profits, monies, accruals, increments or other benefits (collectively, “ Benefits ”) derived or received by the Employee as the result of any transactions constituting a breach of the Restrictive Covenants, and the Employee shall account for and pay over such Benefits to the Company and, if applicable, its affected affiliates.

 

12. Successors and Assigns . This Agreement shall be binding upon and inure to the benefit of the Company’s successors and assigns and the Employee’s personal or legal representatives, executors, administrators, heirs, distributees, devisees and legatees. This Agreement shall not be assignable by the Employee, it being understood and agreed that this is a contract for the Employee’s personal services. This Agreement shall not be assignable by the Company, except that the Company may assign it to an affiliate of the Company and shall assign it in connection with a transaction involving the succession by a third party to all or substantially all of the Company’s business and/or assets (whether direct or indirect and whether by purchase, merger, consolidation, liquidation or otherwise). When assigned to a successor, the assignee shall assume this Agreement and expressly agree to perform this Agreement in the same manner and to the same extent as the Company would be required to perform it in the absence of such an assignment and the Company shall be released of all obligations hereunder. For all purposes under this Agreement, the term “Company” shall include any successor to the Company’s business and/or assets that executes and delivers the assumption agreement described in the immediately preceding sentence or that becomes bound by this Agreement by operation of law. This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns as provided in this Section 12 and is not for the benefit of, nor may any provision hereof be enforced by, any other person, except as otherwise set forth in this Agreement.

 

13. Alternative Dispute Resolution .

 

a. Coverage . Except as otherwise expressly provided in this Agreement or by law, this Section 13 is the sole and exclusive method by which the Employee and the Company are required to resolve any and all disputes arising out of or related to the Employee’s employment with the Company or the termination of that employment, each of which is referred to as “ Employment-Related Dispute, ” including, but not limited to, disputes arising out of or related to any of the following subjects: (i) compensation or other terms or conditions of the Employee’s employment, (ii) application or enforcement of any Company program or policy to the Employee, (iii) any disciplinary action or other adverse employment decision of the Company or any statement related to the Employee’s employment, performance or termination, (iv) any policy of the Company or any agreement between the Employee and the Company, (v) disputes over the arbitrability of any controversy or claim which arguably is or may be subject to this Section 13, (vi) claims arising out of or related to any current or future federal, state or local civil rights laws, fair employment laws, wage and hour laws, fair labor or employment standards laws, laws against discrimination, equal pay laws, wage and salary payment laws, plant or facility closing or layoff laws, laws in regard to employment benefits or protections, family and medical leave laws, and whistleblower laws, including by way of example, but not limited to, the federal Civil Rights Acts of 1866, 1871, 1964 and 1991, the Pregnancy Discrimination Act of 1978, the Age Discrimination in Employment Act of 1967, the Equal Pay Act of 1963, the Fair Labor Standards Act of 1938, the Americans with Disabilities Act of 1990, the Family and Medical Leave Act of 1993, and the Employee Retirement Income Security Act of 1978, as they have been or may be amended from time to time, or (vii) any other dispute arising out of or related to the Employee’s employment or the Employee’s termination.

 

11

 

 

b. Negotiation; Mediation . Any Employment-Related Dispute asserted by one Party against the other Party shall be delivered in writing to the other Party. During the fifteen (15)-day period following receipt of the assertion by the other Party, the Parties shall attempt in good faith to negotiate a resolution of the Employment-Related Disputes so asserted. If the Employment-Related Disputes so asserted cannot be settled through negotiation and remains unresolved after the fifteen (15)-day negotiation period, the Employee or the Company may submit the dispute to mediation and the Parties shall attempt in good faith to resolve the dispute by mediation, under the mediation procedure of the American Arbitration Association (“ AAA ”). Unless the Parties agree otherwise in writing, the mediation shall be conducted by a single mediator, and the mediator shall be selected from an appropriate AAA panel pursuant to the AAA rules, respectively. The mediation shall be conducted in Denver, Colorado. Unless the Parties agree otherwise, the cost of the mediator’s professional fees and expenses and any reasonable administrative fee will be shared and paid equally by the Parties, and each Party shall bear its own attorneys’ fees and costs of the mediation.

 

c. Binding Arbitration . If the Employment-Related Disputes so asserted cannot be settled through mediation and remains unresolved thirty (30) days after the appointment of a mediator, the Employee or the Company may submit the dispute to arbitration and the dispute shall be settled in arbitration. Notice of a demand to arbitrate a dispute by either Party shall be given in writing to the other at their last known address. Arbitration shall be commenced by the filing by a party of an arbitration demand with the AAA in its office in Denver, Colorado. The arbitration and resolution of the dispute shall be resolved by a single arbitrator appointed by the AAA pursuant to AAA rules. The arbitration shall in all respects be governed and conducted by applicable AAA rules, and any award and/or decision shall be conclusive and binding on the parties. The arbitration shall be conducted in Denver, Colorado regardless of the particular plant or facility of the Parties. The arbitrator shall supply a written opinion supporting any award, and judgment may be entered on the award in any court of competent jurisdiction. Each Party shall pay its own fees and expenses for the arbitration except for any costs and charges imposed by the AAA which may be assessed against the losing Party by the arbitrator. Any fees of the arbitrator for the arbitrator’s services shall in all events be shared and paid equally by the Parties.

 

d. Equitable Relief . In the event that preliminary or permanent injunctive relief is necessary or desirable in order to prevent a Party from acting contrary to this Agreement or to prevent irreparable harm prior to a confirmation of an arbitration award, including without limitation as provided under Section 14(h) hereof, then either Party is authorized and entitled to commence a lawsuit solely to obtain equitable relief against the other pending the completion of the arbitration in a court having jurisdiction over the Parties. All rights and remedies of the parties shall be cumulative and in addition to any other rights and remedies obtainable from arbitration.

 

e. Severability . In the event that any court or arbitrator finds or holds any restriction contained in this Agreement, including the Restrictive Covenants, to be unreasonable, invalid, or unenforceable, then it is the express intent of the Parties that the court or arbitrator so holding shall modify or amend the offending restriction or restrictions in any reasonable fashion so as to render it or them enforceable to the fullest extent possible under prevailing law. In the event that any restriction is deemed void and unenforceable and not suitable or capable of being so modified, then such restriction shall be severed. Each term and provision of this Agreement is and shall be construed as severable in whole or in part, and, if any provision or the application thereof to particular circumstances should be invalid, illegal, or unenforceable, then the remaining terms and provisions shall not be affected and shall remain fully enforceable. An adjudication or finding of invalidity or unenforceability for one jurisdiction of any particular provision shall not invalidate or void such provision in any other jurisdiction. It is the express intent of the Parties that all restrictions imposed by this Agreement be construed and applied to avoid legal nullities and with a view towards enforcement whenever possible

 

12

 

 

14. Miscellaneous .

 

a. Time of the Essence . Time is of the essence with respect to this Agreement. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall not be a business day (i.e, a Saturday, Sunday or federal holiday), then such action may be taken or such right may be exercised on the next succeeding business day.

 

b. Entire Agreement . This Agreement constitutes the entire understanding or agreement between the Company and the Employee relating to the subject matter hereof and there is no understanding or agreement, oral or written, which is not set forth herein. This Agreement supersedes and replaces any prior employment agreement or understanding, oral or written, between the Company and the Employee including, without limitation, that certain employment agreement between the Company and the Employee dated July 25, 2014. This Agreement may only be amended by a writing signed by the Company and the Employee.

 

c. Waiver . No provision of this Agreement may be waived, modified, supplemented or amended except in a written instrument signed by the Parties. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any subsequent default or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of any Party to exercise any right hereunder in any manner impair the exercise of any such right.

 

d. Construction . In the event of a conflict or ambiguity created between the Company’s current personnel manual for all employees and this Agreement, it is agreed that this Agreement shall control. No policies, procedures, or statements of any nature by the Company shall modify this Agreement or be construed to create express or implied obligations to the Employee. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. The Parties agree that each of them and/or their respective counsel have reviewed and had an opportunity to revise this Agreement and, therefore, the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting Party shall not be employed in the interpretation of this Agreement or any amendments thereto. The word “including” shall be construed to include the words “without limitation.” In this Agreement, unless the context otherwise requires, references to the singular shall include the plural and vice versa. The word “Company” shall be construed to include the Company and its subsidiaries and affiliates, whether now existing or hereafter established.

 

e. Notices . All notices and other communications hereunder shall be in writing, and shall be deemed to have been duly given if delivered personally or if sent by overnight courier or by certified mail, return receipt requested, postage prepaid, to the relevant address set forth below, or to such other address as the recipient of such notice or communication shall have specified in writing to the other Party hereto, in accordance with this Section 14(e).

 

  i.   If to the Company:  Surna Inc.
       1780 55 th Street, Suite A
       Boulder, Colorado 80301
      Attention: CEO
       
  ii. If to the Employee, at the Employee’s last residence shown on the records of the Company.

 

13

 

 

f. Public Announcements . The Company intends to publicly announce and disclose this Agreement and the subject matter hereof in accordance with applicable laws. Until such time as the Company has publicly announced and/or disclosed this Agreement and the subject matter hereof, the Employee shall not publicly announce or disclose to any third party the existence of this Agreement or the subject matter hereof.

 

g. Governing Law . All questions concerning the construction, validity, enforcement and interpretation of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Colorado, without regard to the principles of conflicts of law thereof.

 

h. Equitable Relief . The Employee acknowledges and agrees that, notwithstanding anything herein to the contrary, including without limitation Section 13(d) hereof, upon any breach by the Employee of the Employee’s obligations under Section 11, the Company will have no adequate remedy at law, and accordingly shall be immediately entitled to specific performance and other appropriate injunctive and equitable relief in a court of competent jurisdiction.

 

i. Cooperation in Future Matters . The Employee hereby agrees that for a period of eighteen (18) months following the Employee’s termination of employment, the Employee shall cooperate fully with the Company’s reasonable requests relating to matters that pertain to the Employee’s employment by the Company, including, without limitation, providing information or limited consultation as to such matters, participating in legal proceedings, investigations or audits on behalf of the Company, or otherwise making himself reasonably available to the Company for other related purposes. Any such cooperation shall be performed at scheduled times taking into consideration the Employee’s other commitments. The Employee shall not be required to perform such cooperation to the extent it conflicts with any requirements of exclusivity of services for another employer or otherwise, nor in any manner that in the good faith belief of the Employee would conflict with the Employee’s rights under or ability to enforce this Agreement.

 

j. Withholding . Any payments provided for in this Agreement shall be paid net of any applicable income tax withholding required under federal, state or local law.

 

k. Survival . Notwithstanding anything in this Agreement or elsewhere to the contrary, the provisions of Sections 9, 10, 11, 12, 13 and 14 shall survive the termination of the Employee’s employment or this Agreement.

 

l. Execution and Counterparts . This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. Counterparts may be delivered via facsimile, electronic mail (including pdf or any electronic signature complying with the U.S. ESIGN Act of 2000, e.g., www.docusign.com) or other transmission method and any counterpart so delivered shall be deemed to have been duly and validly delivered and be valid and effective for all purposes.

 

[Remainder of this page intentionally left blank. Signature page follows.]

 

14

 

 

IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year written below.

 

EMPLOYEE   COMPANY
     
    Surna Inc.
     
/s/ Brandy M. Keen   By: /s/ Chris Bechtel           
Brandy M. Keen, Individually     Chris Bechtel, Chief Executive Officer

 

[Signature Page to Employee Employment Agreement]

 

 

 

 

EXHIBIT A

 

Permitted Activities

 

None

 

 

 

 

 

Exhibit 21.1

 

SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT

 

The following are the significant subsidiaries of Surna Inc. as of December 31, 2017 and the states or jurisdictions in which they are organized. Except as otherwise specified, in each case Surna 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

 

We consent to the incorporation by reference in the Registration Statement on Form S-8 (Registration No. 333-219674) pertaining to the Surna Inc. 2017 Equity Incentive Plan of our report dated April 2, 2018, with respect to the consolidated financial statements of Surna Inc., (which report expresses an unqualified opinion on the consolidated financial statements and an explanatory paragraph referring to the Company’s ability to continue as a going concern), included in its Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission.

 

/s/ Anton Collins Mitchell LLP

Denver, Colorado

April 2 , 2018

 

     
     

 

 

Exhibit 23.2

 

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

We consent to the incorporation by reference in the Registration Statement on Form S-8 (Registration No. 333-219674) pertaining to the Surna Inc. 2017 Equity Incentive Plan of our report dated March 31, 2017, with respect to the consolidated financial statements of Surna Inc., (which report expresses an unqualified opinion on the consolidated financial statements and an explanatory paragraph referring to the Company’s ability to continue as a going concern), included in its Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission.

  

/s/ RBSM  LLP

Larkspur, CA

April 2 , 2018

 

     
     

 

Exhibit 31.1

 

CERTIFICATION PURSUANT TO RULE 13a-14(a) and 15d-14(a)

UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

 

I, Chris Bechtel, the Chief Executive Officer of Surna Inc. certify that:

 

1. I have reviewed this annual report on Form 10-K of Surna Inc. for the fiscal year ended December 31, 2017;

 

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 audit committee of 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 2 nd day of April 2018.

 

By: /s/ Chris Bechtel  
  Chris Bechtel  
  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, Chris Bechtel, the Principal Financial and Accounting Officer of Surna Inc. certify that:

 

1. I have reviewed this annual report on Form 10-K of Surna Inc. for the fiscal year ended December 31, 2017;

 

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 audit committee of 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 2 nd day of April 2018.

 

By: /s/ Chris Bechtel  
  Chris Bechtel  
  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, 2017 (the “Report”) of Surna Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Chris Bechtel, 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/ Chris Bechtel
  Name: Chris Bechtel, Chief Executive Officer
  Date: April 2, 2018

 

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, 2017 (the “Report”) of Surna Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Chris Bechtel, 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/ Chris Bechtel
  Name:

Chris Bechtel, Principal Financial and
Accounting Officer

  Date: April 2, 2018

 

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 99.1

 

FOR IMMEDIATE RELEASE

 

Surna Reports Q4 2017 Results

 

April 2, 2018 – Boulder, Colorado – Surna Inc., a manufacturer of application-specific climate and environmental control and air sanitation systems for state-regulated indoor cannabis cultivation facilities (OTCQB: SRNA), announced today operating and financial results for the three and twelve months ended December 31, 2017. We will not be hosting a conference call following the release of our financial results.

 

Highlights

 

  Our revenue for the three months ended December 31, 2017 was $2,309,000, an increase of $743,000, or 47%, compared to the three months ended September 30, 2017, and an increase of $290,000, or 14%, compared to the three months ended December 31, 2016.
     
  Our fourth quarter 2017 revenue represents our largest quarterly revenue since our first quarter of 2016 revenue of $2,499,000.
     
  Revenue for the year ended December 31, 2017 was $7,210,000, a decrease of $370,000, or 5%, compared to the year ended December 31, 2016. However, our total net bookings for 2017 were $9,020,000.
     
  During the three months ended December 31, 2017, we had net bookings of $2,454,000, an increase of $510,000, or 26%, compared to the three months ended September 30, 2017.
     
  Our ending backlog as of December 31, 2017 was $4,456,000, an increase of $145,000, or 3%, compared to our September 30, 2017 backlog, and our largest quarter-end backlog in 2017.
     
  We realized a net loss of $1,366,000 for the three months ended December 31, 2017, which includes $869,000 of non-cash equity-related compensation expenses, and $145,000 of non-cash debt-related expenses.

 

Chris Bechtel, the Company’s CEO stated: “Overall, we are pleased with the progress Surna has made in the fourth quarter. We continue to upgrade our engineering, technical and other personnel, expand our sales coverage and marketing outreach, focus on new product development, and improve our project management and production processes. We believe these investments and increased staffing are necessary for us to continue to leverage our current market presence, build our pipeline in the California and Canadian markets, and position us for our expected future growth.”

 

Results of Operations

 

Revenue for the year ended December 31, 2017 was $7,210,000 compared to $7,580,000 for the year ended December 31, 2016, a decrease of $370,000, or 5%. Although our net bookings trended favorably and our backlog grew during 2017, revenue recognition continues to be impacted by our long and uncertain sales cycle and delays faced by our customers in the construction of new cultivation facilities. Further, while additional states have approved some form of cannabis use and cultivation, either for medical or recreational use, the legislation will not result in immediate new construction activity as states need time to issue implementing rules and regulations for the licensing and sales activity and local authorities need to issue building permits. These factors make it difficult for us to predict when we will recognize revenue.

 

Cost of revenue increased by $24,000 from $5,276,000 for the year ended December 31, 2016 to $5,300,000 for the year ended December 31, 2017. Our gross profit for the year ended December 31, 2017 was $1,910,000 compared to $2,304,000 for the year ended December 31, 2016. Gross profit margin decreased by four percentage points from 30% for the year ended December 31, 2016 to 26% for the year ended December 31, 2017. This decrease was due primarily to lower margin on our engineering services and an increase in shipping and handling costs in year ended December 31, 2017 compared to the year ended December 31, 2016.

 

 
 

 

Operating expenses increased by 117% from $2,837,000 for the year ended December 31, 2016 to $6,152,000 for the year ended December 31, 2017, an increase of $3,315,000. The operating expense increase consisted of: (i) an increase in selling, general and administrative expenses (“SG&A expenses”) of $3,008,000, and (ii) an increase in advertising and marketing expenses of $336,000, offset by (iii) a decrease in product development expense of $29,000.

 

The increase in SG&A expenses for the year ended December 31, 2017 compared to the year ended December 31, 2016, was due primarily to: (i) an increase of $1,345,000 in stock-related compensation paid to employees and consultants, (ii) an increase of $614,000 in salaries and benefits, (iii) an increase of $204,000 in legal and consulting fees, (iv) an increase in sales travel of $134,000, and (v) an increase of $785,000 in cash and stock-related compensation paid to our independent directors.

 

The increase in marketing expenses were primarily for: (i) our investment in re-branding the Surna name and logo, including approximately $160,000 to revise and update our website and marketing materials, (ii) our increased presence at industry trade shows and events resulting in increased expenses of $49,000, and (iii) marketing salaries and benefits (including stock related-compensation) which increased by approximately $58,000.

 

We had an operating loss of $4,242,000 for the year ended December 31, 2017, as compared to an operating loss of $533,000 for the year ended December 31, 2016, an increase of $3,709,000. The operating loss included $2,140,000 of non-cash, stock-based compensation expenses in the year ended December 31, 2017 as compared to $4,000 for the year ended December 31, 2016. Excluding these non-cash items, our operating loss increased by $1,573,000.

 

Overall, we had a net loss of $4,919,000 for the year ended December 31, 2017 as compared to a net loss of $3,273,000 for the year ended December 31, 2016, an increase of $1,646,000. The net loss included $2,140,000 of non-cash, stock-based compensation expenses and $681,000 of debt-related costs in the year ended December 31, 2017 as compared to non-cash, stock-based compensation expense of $4,000 and debt-related costs of $2,780,000 in the year ended December 31, 2016. Excluding these non-cash items, our net loss increased by $1,609,000.

 

Regulatory Changes are Leading Indicator for New Facility Construction

 

The demand for our climate control and air sanitation systems, including system design and engineering, proprietary equipment, and third party manufactured equipment, is primarily influenced by the construction of new cannabis cultivation facilities in the U.S. and Canada. Due to continued uncertainty of the cannabis industry following the U.S. Justice Department’s announcement of its opposition to legalized cannabis in early 2017, and the January 4, 2018 rescission of the Cole Memo, we believe there may be an interim decrease in the development and financing of new cannabis cultivation facilities. However, this possible market effect is expected to be mitigated by California’s legalization of recreational cannabis use, which became effective on January 1, 2018, and the anticipated mid-2018 federal legalization of cannabis in Canada.

 

Recent and anticipated regulatory changes involving medicinal and/or recreational cannabis use in various jurisdictions, such as California and Canada, tend to be a leading indicator for the granting of licenses for new facility construction. As more new cultivation facilities become licensed, we in turn have an expanded set of potential customers that might buy our climate control systems.

 

For 2018, we intend to pursue customers seeking to build indoor cannabis cultivation facilities in all regulated markets, with special focus in California and Canada. In Canada medicinal use of cannabis is federally legal, and the Canadian federal government has indicated its intention to legalize recreational use by July 2018, although passage of recreational use federal legislation in Canada is not certain. We also believe that Michigan could offer opportunities in 2018 as the state attempts to move to a recreational use regulated market, with the second-largest medical cannabis patient base in the U.S.

 

 
 

 

Sales Contract Backlog

 

Since August 2017, we have focused our efforts on expanding and better qualifying our pipeline of opportunities, increasing our bookings of new sales contracts, and improving our project management processes to shorten the time period from sales execution to project completion. To further these efforts, we have made investments to improve and add personnel in critical positions within sales, sales management, project management, engineering, and production. We also have improved our performance management and metrics to give better visibility about our customer pipeline, the expected timing of new sales orders, the completion of our active commercial projects and more defined departmental accountability.

 

We are in the process of completing facility improvement and expansion, increasing our square footage from 12,700 to 18,600, and increasing our production floor space from 5,900 to 9,200 square feet. We are reconfiguring our production processes and work flows in an effort to increase our production capacity and improve efficiencies. These actions are expected to be completed in the second quarter of 2018, and they will be partially funded with a tenant improvement allowance being provided by our landlord as part of our new lease agreement.

 

We believe these investments are necessary to position us for our expected future growth. With the lengthy sales cycle, it may take six to 12 months or more before we begin to realize a return on these investments. We continue to focus on increasing our sales contract backlog and quoting on larger (i.e., greater than $100,000) projects in an effort to increase revenue. We also will focus on leveraging our current market position to build up our sales pipeline in the California and Canadian markets, as well as other emerging cannabis-related U.S. markets. As sales opportunities are converted into contracts, we are preparing to meet our customers’ demand for timely delivery of a fully engineered, application-specific, climate control system.

 

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 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).

 

    For the quarter ended        
    March 31,
2017
    June 30,
2017
    September 30,
2017
    December 31,
2017
    2017 Total  
Backlog, beginning balance   $ 2,646,000     $ 3,790,000     $ 3,933,000     $ 4,311,000          
Net bookings, current period   $ 2,737,000     $ 1,885,000     $ 1,944,000     $ 2,454,000     $ 9,020,000  
Recognized revenue, current period   $ 1,593,000     $ 1,742,000     $ 1,566,000     $ 2,309,000     $ 7,210,000  
Backlog, ending balance   $ 3,790,000     $ 3,933,000     $ 4,311,000     $ 4,456,000          

 

During the fourth quarter of 2017, (i) our net bookings were $2,454,000, an increase of $510,000, or 26%, compared to the prior quarter, and (ii) our recognized revenue was $2,309,000, an increase of $743,000, or 47%, compared to the prior quarter.

 

As of December 31, 2017, our ending backlog was $4,456,000, an increase of $145,000, or 3%, compared to the prior quarter-end. About 41% of our December 31, 2017 ending backlog (down from 45% at September 30, 2017) is attributable to projects for which we have only received an initial deposit and, as a result, there are potential risks that the equipment portion of these projects will not be completed or will be delayed, which could occur if our 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.

 

Backlog 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. Accordingly, there can be no assurance that contracts included in backlog will actually generate revenues or when the actual revenues will be generated. Backlog and net bookings are considered non-GAAP financial measures, and therefore, they should be considered in addition to, rather than as a substitute for, recognized revenue and deferred revenue. Further, we can provide no assurance as to the profitability of our contracts reflected in backlog and net bookings. See “Non-GAAP Financial Measures” below.

 

 
 

 

Balance Sheet and Capital Requirements

 

As of December 31, 2017, we had cash and cash equivalents of $2,468,000, compared to cash and cash equivalents of $320,000 as of December 31, 2016. The $2,148,000 increase in cash and cash equivalents during the year ended December 31, 2017 was primarily the result of: (i) aggregate proceeds of $4,453,000 raised from the sale of investment units to accredited investors during the first and fourth quarter of 2017, with each unit consisting of one share of common stock and a warrant to purchase one share of common stock, and (ii) the proceeds of $500,000 raised from the issuance of certain promissory notes, which were converted into our common stock in the third quarter of 2017, offset by (iii) cash used for debt repayment of $332,000, (iv) cash used in our operating activities of $2,267,000, and (v) cash used in our investing activities of $205,000.

 

Since our inception, we have raised capital through private sales of common stock and debt securities. Our future success is dependent upon our ability to achieve profitable operations and generate cash from operating activities, including our receipt of deposits from customers under our sales contracts.

 

Management has determined that we will likely need to raise debt and/or equity financing during the second or third quarter of 2018 in order to continue our operations and achieve our growth targets. However, there can be no assurance that we will be able to raise such financing in sufficient amounts or on acceptable terms, or at all. If we are unable to raise such financing, we intend to explore various operating cost reductions. The precise amount and timing of the funding needs will depend on a number of factors, including the market demand for our products and services, the timing of our receipt of deposits from our customers under our sales contracts, our management of working capital, and the continuation of normal payment terms and conditions for purchase of goods and services.

 

About Surna Inc.

 

Surna Inc. ( www .surna.com ) designs, engineers and manufactures application-specific environmental control and air sanitation systems for commercial, state- and provincial-regulated indoor cannabis cultivation facilities in the U.S. and Canada. Our engineering and technical team provides energy and water efficient solutions that allow growers to meet the unique demands of a cannabis 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.

 

Headquartered in Boulder, Colorado, we leverage our experience in this space in order to bring value-added climate control solutions to our customers that help improve their overall crop quality and yield as well as optimize the resource efficiency of their controlled environment (i.e., indoor and greenhouses) cultivation facilities. We have been involved in consulting, equipment sales and/or full-scale design for over 700 grow facilities since 2006 making us a trusted resource for indoor environmental design and control management for the cannabis industry.

 

Our customers have included small cultivation operations to licensed commercial facilities ranging from several thousand to more than 100,000 square feet. We have sold our equipment and systems throughout the U.S. and Canada as well as internationally in South Africa, Switzerland and the United Kingdom. Our revenue stream is derived primarily from supplying mechanical engineering services and climate and environmental control equipment to commercial indoor cannabis grow facilities. We also sell equipment to smaller cultivators who can purchase either directly from us, or from our authorized wholesalers or retailers. Though our customers do, we neither produce nor sell cannabis.

 

Forward Looking Statements

 

This press release may contain statements of a forward-looking nature relating to future events. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect our current beliefs, and a number of important factors could cause actual results to differ materially from those expressed in this press release, including the factors set forth in “Risk Factors” set forth in our Form 10-K and Form 10-Q filed with the Securities and Exchange Commission (“SEC”), and subsequent filings with the SEC. Please refer to our SEC filings for a more detailed discussion of the risks and uncertainties associated with our business, including but not limited to the risks and uncertainties associated with our business prospects and the prospects of our existing and prospective customers; the inherent uncertainty of product development; regulatory, legislative and judicial developments, especially those related to changes in, and the enforcement of, cannabis laws; increasing competitive pressures in our industry; and relationships with our customers and suppliers. 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. The reference to Surna’s website has been provided as a convenience, and the information contained on such website is not incorporated by reference into this press release.

 

 
 

 

Non-GAAP Financial Measures

 

To supplement our financial results on U.S. generally accepted accounting principles (“GAAP”) basis, we use the non-GAAP measures including net bookings and backlog, as well as other significant non-cash expenses such as stock-based compensation and certain debt-related expenses. 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.

 

Statement about Cannabis Markets

 

The use, possession, cultivation, and distribution of cannabis is prohibited by U.S. federal law. This includes medical and recreational cannabis. Although certain states have legalized medical and recreational cannabis, companies and individuals involved in the sector are still at risk of being prosecuted by federal authorities. Further, the landscape in the cannabis industry changes rapidly. This means that at any time the city, county, or state where cannabis is permitted can change the current laws and/or the federal government can supersede those laws and take prosecutorial action. Given the uncertain legal nature of the cannabis industry, it is imperative that investors understand that investments in the cannabis industry should be considered very high risk. A change in the current laws or enforcement policy can negatively affect the status and operation of our business, require additional fees, stricter operational guidelines and unanticipated shut-downs.

 

  Surna Marketing
   
  Jamie English
  Director of Marketing
  jamie.english@surna.com
  (303) 993-5271

 

 
 

 

Surna Inc.

Consolidated Balance Sheets

 

    December 31,  
    2017     2016  
ASSETS                
Current Assets                
Cash and cash equivalents   $ 2,468,199     $ 319,546  
Accounts receivable (net of allowance for doubtful accounts of $105,267 and $91,000, respectively)     422,589       47,166  
Notes receivable     -       157,218  
Other receivables     550       -  
Inventory, net     522,622       747,905  
Prepaid expenses     293,458       84,976  
Total Current Assets     3,707,418       1,356,811  
Noncurrent Assets                
Property and equipment, net     401,356       93,565  
Goodwill     631,064       631,064  
Intangible assets, net     37,985       36,381  
Deposits     51,000       -  
Total Noncurrent Assets     1,121,405       761,010  
                 
TOTAL ASSETS   $ 4,828,823     $ 2,117,821  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)                
                 
CURRENT LIABILITIES                
Accounts payable and accrued liabilities   $ 1,969,263     $ 1,337,853  
Deferred revenue     1,011,871       1,421,344  
Amounts due to shareholders     6,927       57,398  
Convertible promissory notes, net     -       761,440  
Convertible accrued interest     -       161,031  
Derivative liabilities     410,880       477,814  
Total Current Liabilities     3,398,941       4,216,880  
                 
NONCURRENT LIABILITIES                
Deferred rent     17,396       -  
Promissory note due shareholders     -       11,985  
Total Noncurrent Liabilities     17,396       11,985  
                 
TOTAL LIABILITIES     3,416,337       4,228,865  
                 
Commitments and Contingencies (Note 12)                
                 
SHAREHOLDERS’ EQUITY (DEFICIT)                
Preferred stock, $0.00001 par value; 150,000,000 shares authorized; 77,220,000 shares issued and outstanding     772       772  
Common stock, $0.00001 par value; 350,000,000 shares authorized; 206,248,522 and 160,744,916 shares issued and outstanding, respectively     2,062       1,607  
Additional paid in capital     20,664,563       12,222,789  
Accumulated deficit     (19,254,911 )     (14,336,212 )
Total Shareholders’ Equity (Deficit)     1,412,486       (2,111,044 )
                 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)   $ 4,828,823     $ 2,117,821  

 

 
 

 

Surna Inc.

Consolidated Statements of Operations

 

    For the Years Ended December 31,  
    2017     2016  
Revenue, net   $ 7,210,241     $ 7,579,863  
                 
Cost of revenue     5,299,977       5,275,968  
                 
Gross profit     1,910,264       2,303,895  
                 
Operating expenses:                
Advertising and marketing expenses     625,773       289,992  
Product development costs     319,680       349,062  
Selling, general and administrative expenses     5,206,471       2,197,758  
Total operating expenses     6,151,924       2,836,812  
                 
Operating loss     (4,241,660 )     (532,917 )
                 
Other income (expense):                
Interest and other income, net     4,097       40,157  
Interest expense     (41,485 )     (373,688 )
Amortization of debt discount on convertible promissory notes     (63,157 )     (1,529,219 )
Loss on extinguishment of debt     (643,428 )     (338,241 )
Gain (loss) on change in fair value of derivative liabilities     66,934       (538,705 )
Total other income (expense)     (677,039 )     (2,739,696 )
                 
Loss from operations before provision for income taxes     (4,918,699 )     (3,272,613 )
                 
Income taxes     -       -  
                 
Net loss   $ (4,918,699 )   $ (3,272,613 )
                 
Loss per common share – basic and dilutive   $ (0.03 )   $ (0.02 )
                 
Weighted average number of common shares outstanding, basic and dilutive     182,857,538       140,604,764  

 

 
 

 

Surna Inc.

Consolidated Statements of Cash Flows

 

    For the Years Ended December 31,  
    2017     2016  
Cash Flows From Operating Activities:                
Net loss   $ (4,918,699 )   $ (3,272,613 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:                
Depreciation and intangible asset amortization expense     44,865       53,084  
Amortization of debt discounts     37,637       1,529,219  
Amortization of original issue discount on notes payable     25,520       -  
(Gain) loss on change in derivative liabilities     (66,934 )     538,705  
Compensation paid in equity     2,139,865       4,386  
Provision for doubtful accounts     14,267       50,127  
Provision for excess and obsolete inventory     276,015       -  
Loss on extinguishment of debt     643,428       338,241  
Loss on disposal of other assets     26,682       4,280  
                 
Changes in operating assets and liabilities:                
Accounts and other receivable     (390,240 )     179,793  
Inventory     (50,732 )     513,897  
Prepaid expenses     (208,482 )     131,099  
Accounts payable and accrued liabilities     289,905       (775,309 )
Deferred revenue     (86,697 )     434,899  
Accrued interest     (9,772 )     373,688  
Deferred rent     17,396       -  
Lease deposit     (51,000 )     -  
Net cash (used in) provided by operating activities     (2,266,976 )     103,496  
                 
Cash Flows From Investing Activities                
Capitalization of intangible assets     (18,624 )     (25,292 )
Purchases of property and equipment     (183,783 )     (18,189 )
Proceeds from the sale of property equipment     -       35,100  
Cash disbursed for equipment held for lease     (159,806 )     -  
Cash disbursed for note receivable     -       (80,000 )
Payments received on note receivable     157,218       130,000  
Net cash (used in) provided by investing activities     (204,995 )     41,619  
                 
Cash Flows From Financing Activities                
Cash proceeds from sale of common stock and warrants     4,453,080       -  
Payments on convertible notes payable     (270,000 )     -  
Proceeds from issuance of notes payable     500,000       -  
Payments on loans     -       (34,115 )
Payments on loans from shareholders     (62,456 )     (122,011 )
Net cash provided by (used in) financing activities     4,620,624       (156,126 )
                 
Net increase (decrease) in cash     2,148,653       (11,011 )
Cash, beginning of period     319,546       330,557  
Cash, end of period   $ 2,468,199     $ 319,546  
                 
Supplemental cash flow information:                
Interest paid   $ 44,150     $ -  
                 
Non-cash investing and financial activities:                
Conversions of promissory notes and accrued interest to common stock   $ 1,751,155     $ 3,235,326  
Derivative liability on convertible notes and warrants   $ -     $ 673,050  
Settlement liability reclassified from deferred revenue   $ 322,776     $ -  
Warrant modification included in loss on extinguishment of debt   $ 59,000     $ -  
Common shares issued with notes payable   $ 39,129     $ -  
Discount on notes payable   $ 37,500     $ -  
Unpaid purchases of equipment and other assets   $ 18,729     $ -