$SRNA Form 10-Q

Overview

Surna develops, designs, and distributes cultivation technologies for controlled environment agriculture (“CEA”). The Company’s customers include state-regulated cannabis cultivation facilities as well as traditional indoor agricultural facilities, including organic herb and vegetable producers. Surna’s technologies include a comprehensive line of optimized lighting, environmental control, air sanitation, and cultivation facilities. These technologies are designed to meet the specific environmental conditions required for CEA and dramatically reduce energy and water consumption.

In addition, Surna offers mechanical design services specific to hydronic cooling, including mechanical equipment and piping design.

Recent Developments

Between April 1 and May 13, 2016, the Company issued a total of 6,843,972 shares of common stock to certain holders of the Company’s Series 3 Notes, reflecting the conversion of a balance of $384,260 in principal and interest.

On April 15, 2016, the Company agreed to an amendment to a promissory note originally issued as partial payment for the acquisition of Hydro Innovations, LLC and held by Stephen Keen, the Company’s Chief Executive Officer and President, and Brandy Keen, the Company’s Vice President of Sales and Secretary (collectively, the “Keens”). The note had an unpaid balance (reflecting all of the remaining principal together with all unpaid interest) of $194,514, which was due not later than July 18, 2016. It was amended such that the Company agreed to make an immediate payment of $100,000 and to then pay the remaining balance of $94,514 in $5,000 installments monthly beginning on July 15, 2016. The Keens also serve as directors on the Company’s board of directors and are married.

Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based upon our interim unaudited condensed 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 positions 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. For information regarding the Company’s critical accounting policies as well as recent accounting pronouncements, see Note 1 to the consolidated financial statements.

Results of Operations



Three Months Ended March 31, 2016 Compared to the Three Months Ended March 31,
2015



                                                               For the Three Months Ended
                                                                        March 31,
                                                                  2016              2015
Revenue                                                      $    2,498,604     $    819,063

Cost of revenue                                                   1,409,944          730,764

Gross margin                                                      1,088,660           88,299
Gross margin %                                                           44 %             11 %

Operating expenses                                                  723,681          967,845

Operating income (loss)                                             364,979         (879,546 )

Other income (expense), net                                      (1,111,193 )       (538,897 )

Loss from continuing operations                                    (746,214 )     (1,418,443 )

Loss from discontinued operations                                         -                -

Net loss                                                     $     (746,214 )   $ (1,418,443 )

Loss per common share from continuing operations - basic     $        (0.01 )   $      (0.01 )

Loss per common share from discontinued operations - basic   $         0.00     $       0.00

Loss per common share - basic                                $        (0.01 )   $      (0.01 )

Cost of revenue for the three months ended March 31, 2016 was $1,409,944 as compared to $730,764 (93% increase) for the three months ended March 31, 2015. Increases are due primarily to increases in sales. Gross margin increased to 44% from 11% a year ago due to several factors including: price increases that took effect late in the third quarter of 2015, negotiation of favorable pricing with key suppliers in the fourth quarter of 2015, a sales mix that consisted of high margin products and reduced spend on installation projects as Surna exits that business.

Operating expenses for the three months ended March 31, 2016 were $723,681 as compared to $967,845 (25% decrease) for the three months ended March 31, 2015. The decrease in advertising and marketing expenses from $31,142 to $13,503 (57% decrease) was due to a heavier emphasis on advertising in the prior year and a focus on reigning in costs in the current year. The 41% decrease in research and development costs from $180,989 to $106,279 was due to the product life cycle of the reflector, which has moved from development stage in the first quarter of 2015 to production stage in the first quarter of 2016. General and administrative expenses decreased 20% from $755,714 to $603,899 due to reductions in personnel as well as a focus on cost containment.

We incurred net other expenses of $1,111,193 for the three months ended March 31, 2016 compared to $538,897 (106% increase) for the three months ended March 31, 2015. The increase was due in part to additional debt Surna tookon during the first and third quarters of 2015. Stock price increases during the quarter drove a loss on change in derivatives of $421,717 as compared to a gain of $48,163 in the first quarter of 2015. Surna experienced high growth in the second half of 2015 and experienced cash shortages as the Company increased inventory purchases to meet the new rates of demand. In order to meet the immediate cash requirements at that time, Surna incurred debt. Surna management is focused on improving margins by reducing costs and optimizing pricing so that reliance on outside debt is limited in the future.

For the three months ended March 31, 2016 and 2015, we had no federal taxable income due to utilization of net operating loss carryforwards for the current quarter and operating losses in the first quarter of 2015.

Overall, we realized a net operating profit of $364,979 for the three months ended March 31, 2016 as compared to a net operating loss of $879,546 for the three months ended March 31, 2015. We realized a net loss of $746,214 for the three months ended March 31, 2016 as compared to a loss of $1,418,443 (47% decrease) for the three months ended March 31, 2015.

Liquidity and Capital Resources



The following summarizes our cash flows:



                                                             For the Three Months Ended
                                                                      March 31,
                                                               2016               2015
Cash provided by (used in) operating activities            $    774,380       $ (1,011,984 )
Cash flows provided by (used in) investing activities            69,643           (162,600 )
Cash flows provided by (used in) financing activities           (33,757 )          849,865
Net change in cash                                         $    810,266       $   (324,719 )

Cash Requirements

Our ability to fund our growth and meet our obligations on a timely basis is dependent on our ability to match our available financial resources to our growth strategy, which includes acquisitions for cash or a combination of cash and debt. The decisions we make with regard to acquisitions drive the level of capital required and the level of our financial obligations.

If we are unable to generate cash flow from operations or successfully raise sufficient additional capital through future debt and equity financings or strategic and collaborative ventures with potential partners, we would likely have to reduce the size and scope of our acquisitions.

We have suffered recurring losses from operations. The continuation of our company is dependent upon our company attaining and maintaining profitable operations and raising additional capital as needed. In this regard, we have raised additional capital through equity offerings and loan transactions, and, in the short term, will seek to raise additional capital in such manners to fund 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.

Operating Activities

Cash provided by operations for the three months ended March 31, 2016 was $774,380 compared to cash used in operations of $1,011,984 for the three months ended March 31, 2015. The fluctuation was due to the $672,229 reduction in the recorded net loss and the $678,495 increase in recorded non-cash expenses for the current period compared to the same period in the prior year coupled with the $435,640 net favorable fluctuation in operating asset and liability balances as of current period end compared to a year prior.

Investing Activities

Cash provided by investing activities for the three months ended March 31, 2016 was $69,643 compared to cash used by investing activities of $162,600 for the three months ended March 31, 2015. This fluctuation reflects the $160,000 of cash invested in Agrisoft in 2015 and the $50,000 cash receipt against the note receivable from Agrisoft in 2016.

Financing Activities

Cash used in financing activities for the three months ended March 31, 2016 was $33,757 compared to cash provided by financing activities of $849,865 for the three months ended March 31, 2015. No debt was issued in the current period compared to the $911,250 of convertible promissory note issuances in the comparable prior year period.

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

We have obligations under notes payable and a non-cancelable operating lease. As of March 31, 2016, these contractual obligations totaled $3,539,610.

Off-Balance Sheet Arrangements

There are no 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 is material to investors.