CEA Industries(CEAD) - 2021 Q4 - Annual Report

Part I Business CEA Industries Inc. provides design, technology, and services for controlled environment agriculture, serving cannabis and non-cannabis indoor farming sectors with a focus on expanding into vertical farming and broadening product offerings - The company is an industry leader in Controlled Environment Agriculture (CEA) facility design, technologies, and services, serving indoor facilities, vertical farms, and greenhouses[29] - Historically, the company has primarily served customers growing cannabis but is strategically expanding to serve other indoor farming sectors, including vertical farms for non-cannabis crops[32] - The company provides a full suite of services including licensed architectural and MEP engineering, curated HVACD equipment, proprietary controls (SentryIQ®), lighting, and benching products[33] - In November 2021, the company changed its corporate name from Surna Inc. to CEA Industries Inc. to better reflect its business and prepare for acquisitions and internal growth[94] Our Services and Equipment Solutions The company offers comprehensive indoor agriculture solutions, including architectural and MEP engineering services, proprietary environmental control products, and reselling of cultivation equipment - Service offerings encompass the full facility lifecycle, from architectural design and MEP engineering to equipment installation advice, startup support, and recurring preventative maintenance services[47][57] - Product offerings include a mix of proprietary, white-label, and resold equipment, with key proprietary products including the SentryIQ® controls and automation platform and Surna-branded environmental control systems[58][59][60] - The SentryIQ® sensors, controls, and automation (SCA) platform is a key high-margin product, providing a single-vendor solution for HVACD equipment and controls integration[60] Our Corporate Growth Strategy The company's growth strategy focuses on organic expansion into non-cannabis CEA markets, strategic M&A, and enhancing its public profile through Nasdaq uplisting and capital raises - Pursue aggressive organic growth by expanding into new markets like non-cannabis vertical farming and expanding product offerings to cover all primary technologies in a CEA facility[89][91][92] - Seek strategic mergers and acquisitions, using the company's engineering expertise and public platform to attract smaller component providers[95][97][98] - Improve public profile and stock liquidity through its uplisting to the Nasdaq Capital Market (February 2022) and a subsequent public offering that raised approximately $22 million net proceeds (February 2022)[100][101] US Government Regulation The company's business is significantly tied to the federally illegal cannabis industry, creating complex regulatory risks despite state legalizations and historical federal enforcement guidance - The company does not grow or sell cannabis, but nearly all of its products and services are provided to customers who cultivate marijuana[16] - Cannabis is a Schedule I controlled substance and illegal under federal law, even in states where it has been legalized for medical or recreational use, creating significant legal and financial risk[113][114] - Federal enforcement priorities have shifted over time, from the Obama-era Cole Memorandum to its rescission by the Trump administration, with the Joyce Amendment offering some protection but requiring annual re-enactment[115][117] Risk Factors The company faces substantial risks from limited revenues, internal control weaknesses, supply chain disruptions, federal cannabis illegality impacting customers, and stock volatility - The company has historically operated with limited revenues and a working capital deficit, and while a February 2022 offering provided ~$22 million, additional capital may be needed for future growth[123][136] - Material weaknesses in internal controls over financial reporting have been identified, including a lack of sufficient accounting personnel and inadequate segregation of duties, which could affect the accuracy of financial reporting[127][146][147] - Because cannabis remains illegal under federal law, strict enforcement against the company's customers would likely result in an inability to execute its business plan, posing a significant risk[132][197] - The company faces supply chain disruptions, including international shipping delays and inflationary cost pressures, which could harm its business, margins, and reputation[129][170] Properties The company leases its 11,491 square foot manufacturing and headquarters office in Louisville, Colorado, under a lease term from November 2021 to January 2027 - The company leases its headquarters and manufacturing space at 385 S. Pierce Avenue, Suite C, Louisville, Colorado 80027[255] - The lease term is from November 1, 2021, to January 31, 2027, for approximately 11,491 square feet of space[255] Legal Proceedings The company settled a former employee litigation in March 2021 for $107,000, issuing 6,667 common shares, and currently faces no other material legal proceedings - The Company settled a litigation with a former employee on March 30, 2021, by issuing 6,667 shares of common stock, with the total cost of the settlement being $107,000[256] - The company is not currently a party to any other material legal proceedings[257] Mine Safety Disclosures This section is not applicable to the company's operations - Not applicable[258] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock and warrants trade on Nasdaq, with no foreseeable dividend payments, and it operates two equity incentive plans for stock-based awards - The company's common stock and warrants are quoted on Nasdaq under the symbols "CEAD" and "CEADW"[260] - The company does not anticipate paying cash dividends on its common stock in the foreseeable future, intending to retain earnings for business development and growth[261] Equity Compensation Plan Information as of December 31, 2021 | Plan | Shares to be Issued Upon Exercise | Weighted-Average Exercise Price | Shares Available for Future Issuance | | :--- | :--- | :--- | :--- | | 2017 Equity Plan | 162,238 | $11.70 | 7,403 | | 2021 Equity Plan | 46,807 | $7.43 | 613,057 | Management's Discussion and Analysis of Financial Condition and Results of Operations In FY2021, revenue grew 60% to $13.6 million, net loss decreased to $1.3 million, and gross margin improved, with a significant $22 million equity raise in early 2022 enhancing liquidity Financial Performance Comparison (FY 2021 vs. FY 2020) | Metric | FY 2021 | FY 2020 | Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Revenue | $13,639,000 | $8,514,000 | +$5,125,000 | +60% | | Gross Profit | $2,926,000 | $1,553,000 | +$1,373,000 | +88% | | Gross Margin | 21.5% | 18.2% | +3.3 pts | N/A | | Operating Loss | ($1,979,000) | ($2,363,000) | +$384,000 | -16% | | Net Loss | ($1,338,000) | ($1,759,000) | +$421,000 | -24% | - Backlog at December 31, 2021, was $10,818,000, a 28% increase from the $8,448,000 backlog at the end of 2020[304][308] - In February 2022, the company received net proceeds of approximately $22 million from a public offering of common stock and warrants, providing significant liquidity to fund its growth strategy[292][341][354] - The company's cash and cash equivalents decreased from $2.3 million at year-end 2020 to $2.2 million at year-end 2021, prior to the February 2022 capital raise[340] Controls and Procedures Management concluded disclosure controls were ineffective as of December 31, 2021, due to material weaknesses in accounting personnel, segregation of duties, and spreadsheet controls, with remediation efforts potentially constrained by financial resources - Management concluded that disclosure controls and procedures were not effective as of December 31, 2021[368] - A material weakness was identified due to: (i) lack of sufficient personnel with accounting expertise and adequate supervisory review, (ii) inadequate segregation of duties, and (iii) insufficient controls over financial reporting spreadsheets[374] - These material weaknesses remained unchanged from December 31, 2020, and while the company is committed to improving its financial organization, remediation may be limited by its size and financial resources[375][377] Part III Directors, Executive Officers and Corporate Governance The company's five-member board, with four independent directors, has established key committees, adopted a Code of Ethics, and appointed Ian K. Patel as the new CFO in March 2022 - The Board of Directors consists of Anthony K. McDonald (Chairman, CEO, President), James R. Shipley, Nicholas J. Etten, Troy L. Reisner, and Marion Mariathasan[384] - The Board has determined that Messrs. Shipley, Etten, Mariathasan, and Reisner are independent directors[400] - The Board has established an Audit Committee, a Compensation Committee, and a Nominating Committee, with specified independent director memberships and responsibilities[401][406][409] - Ian K. Patel was appointed Chief Financial Officer, Treasurer and Secretary on March 11, 2022, replacing Brian Knaley[428][429] Executive Compensation CEO Anthony K. McDonald's 2021 compensation totaled $722,339, independent director compensation was revised post-Nasdaq uplisting, and employment agreements are in place for key executives 2021 Named Executive Officer Compensation | Name and Principal Position | Year | Salary | Bonus | Stock Awards | Option Awards | Total | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Anthony K. McDonald (CEO) | 2021 | $216,731 | $50,000 | $73,498 | $360,378 | $722,339 | | Richard B. Knaley (Former CFO) | 2021 | $120,192 | $0 | $0 | $122,000 | $246,467 | - CEO Anthony K. McDonald's employment agreement provides for an annualized base salary of $275,000, which increased to $350,000 upon the February 2022 qualified offering, plus eligibility for an annual target bonus of 50% of base salary[471][473] - Independent directors' compensation was revised in January 2022, with the annual cash fee increasing to $25,000 post-Nasdaq uplisting, supplemented by RSU grants[434][441] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of March 29, 2022, executive officers and directors collectively owned less than 1% of common stock, while Lind Global Partners II, LLC and Maier J. Tarlow's group each held over 5% - As of March 29, 2022, all executive officers and directors as a group beneficially owned 91,488 shares, representing less than 1% of the class[484] 5% or More Stockholders (as of March 29, 2022) | Name of Beneficial Owner | Number of Shares Owned Beneficially | Percentage of Class | | :--- | :--- | :--- | | Lind Global Partners II, LLC | 400,000 | 5.1% | | Maier J. Tarlow | 424,113 | 5.4% | Certain Relationships and Related Transactions, and Director Independence The company engaged in consulting and manufacturer representative agreements with RSX Enterprises, Inc., controlled by a director, paying $19,500 for consulting and $42,639 in commissions in 2021, with related party transaction policies in place - In 2021, the Company entered into a consulting agreement and a manufacturer representative agreement with RSX Enterprises, Inc., a company controlled by director James R. Shipley[493][494] - Total payments to RSX Enterprises, Inc. in 2021 were $19,500 for consulting and $42,639 for sales commissions[493][495] Principal Accountant Fees and Services Sadler, Gibb & Associates, L.L.C. served as the independent auditor for FY2021 and FY2020, with total fees of $105,350 and $137,000 respectively, and all services pre-approved by the Audit Committee Accountant Fees (2021 vs 2020) | Fee Type | 2021 | 2020 | | :--- | :--- | :--- | | Audit Fees | $97,500 | $116,000 | | Audit-Related Fees | $0 | $32,800 | | Tax Fees | $7,850 | $21,000 | | Total | $105,350 | $137,000 | Part IV Exhibits and Financial Statement Schedules This section includes CEA Industries Inc.'s consolidated financial statements and exhibits, with no separate financial statement schedules filed as information is integrated - The consolidated financial statements of CEA Industries Inc. are filed as part of the report[508] - No financial statement schedules are filed because they are not required or the necessary information is already presented in the financial statements[510] Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm The independent auditor issued a fair opinion on the financial statements but identified revenue recognition for multi-obligation contracts as a critical audit matter due to significant management judgment - The auditor's opinion states that the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020[516] - A Critical Audit Matter was identified concerning Revenue Recognition, specifically the management judgment required to identify distinct performance obligations in contracts and allocate the transaction price among them[522][523] Consolidated Financial Statements As of December 31, 2021, total assets were $5.3 million, total liabilities $4.9 million, and shareholders' deficit $3.6 million, with 2021 revenue of $13.6 million and a net loss of $1.3 million Consolidated Balance Sheet Highlights (as of Dec 31) | Account | 2021 | 2020 | | :--- | :--- | :--- | | Total Current Assets | $3,991,098 | $3,683,293 | | Total Assets | $5,281,962 | $4,813,266 | | Total Current Liabilities | $4,406,269 | $5,903,689 | | Total Liabilities | $4,892,495 | $6,146,964 | | Total Shareholders' Deficit | ($3,570,533) | ($1,333,698) | Consolidated Statement of Operations Highlights (Year Ended Dec 31) | Account | 2021 | 2020 | | :--- | :--- | :--- | | Revenue, net | $13,638,558 | $8,514,272 | | Gross Profit | $2,925,995 | $1,552,967 | | Operating Loss | ($1,978,515) | ($2,362,624) | | Net Loss | ($1,337,923) | ($1,758,716) | Consolidated Statement of Cash Flows Highlights (Year Ended Dec 31) | Activity | 2021 | 2020 | | :--- | :--- | :--- | | Net cash (used in)/provided by operating activities | ($3,207,000) | $818,000 | | Net cash used in investing activities | ($57,000) | ($9,000) | | Net cash provided by financing activities | $3,139,000 | $554,000 | Notes to Consolidated Financial Statements The notes detail accounting policies, including a January 2022 1-for-150 reverse stock split, 2021 revenue primarily from equipment sales, and significant early 2022 events like a Nasdaq uplisting and a $22 million equity raise - A 1-for-150 reverse stock split was approved and became effective in January 2022, with all share and per-share amounts in the report presented retroactively to reflect this split[552][553] - In September 2021, the company sold 3,300 shares of Series B Redeemable Convertible Preferred Stock and warrants to an institutional investor for an aggregate price of $3 million[661] - As of December 31, 2021, the company had U.S. federal and state net operating losses (NOLs) of approximately $21.1 million, the future use of which may be limited by ownership changes[734] - Subsequent to year-end, the company uplisted to Nasdaq (Feb 2022), raised approximately $22 million in a public offering (Feb 2022), and redeemed or converted all outstanding Series B Preferred Stock (Feb 2022)[753][754][755][756]