BNB Standard Corp: Form 10-K for the period ended Dec 31, 2021

Overview

The Company is an industry leader in CEA (Controlled Environment Agriculture) facility design, technologies, and services. The CEA industry is one of the fastest-growing sectors of the United States’ economy and is defined by type of facility. The CEA industry is composed of any horticultural facility that is fully self-contained and has a controlled environment. Three facility types meet these criteria:

• Indoor facilities – environmentally sealed facilities for growing crops and that require artificial lighting.
• Vertical farms –cultivation facilities oriented vertically to minimize ground square footage.
• Greenhouses – facilities that are made of translucent materials to use natural sunlight on the crops.

Crops grown in CEA facilities include: leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables, ornamentals and small fruits (such as strawberries, blackberries and raspberries), bell peppers, cucumbers, tomatoes, cannabis and hemp. Historically, we have primarily served customers growing cannabis in indoor facilities and we are currently pursuing our strategy to broaden our reach to serve other indoor farming including vertical farms.

We provide full-service licensed architectural and mechanical, electrical, and plumbing (MEP) engineering services, carefully curated heating, ventilation and air conditioning (“HVACD”) equipment, proprietary controls systems, air sanitation, lighting, and benching and racking products. Our team (including both internal employees and outside partnerships) of project managers, licensed professional architects and engineers, technology and horticulture specialists and systems integrations experts help our customers by precisely designing for their unique applications. Through our partnership with a certified service contractor network, we provide maintenance services to assist in a smooth build-out and ensure optimal facility performance.

We leverage our industry-leading experience to bring value-added solutions to our customers that help improve their overall crop quality and yield, optimize energy and water efficiency, and satisfy evolving state and local construction code, permitting and regulatory requirements. Our revenue stream derives primarily from supplying our products, services and technologies to commercial indoor facilities ranging from several thousand to more than 100,000 square feet.

CEA facility operators face multiple headwinds from high energy costs, water usage and waste materials, and, in the case of cannabis growing, increasingly rigorous quality standards and declining cannabis prices. To be competitive, among other things, our customers must develop innovative ways to meet the demands of their business and reduce energy costs, 90% of which are typically related to their HVACD (50%) and lighting systems (40%). HVACD systems have historically been and continue to be our primary area of expertise and energy efficiency is high on our list of considerations when engineering environmental control systems.

We often have the advantage of early engagement with our customers at the pre-build and construction phases and the corresponding opportunity to build longer-term relationships with our existing customers. During 2021, we added architectural services to our offerings in an attempt to engage with the customer at an even earlier stage. Going forward, we plan to leverage our existing customer relationships by introducing them to our expanded design services along with our expanded product offerings. We believe these efforts will generate incremental revenue and make us “stickier” to our customers.

We have three core assets that we believe are important to our going-forward business strategy and that will contribute to our future growth. First, we have a well-known brand name in the industry along with multi-year relationships with customers and others developed over our fifteen years of service to the industry. This length of service and broad network of industry contacts will benefit not only our organic growth initiatives, but also provide us with unique insight into other industry providers who may be appropriate for acquisition or joint efforts. Second, we have specialized engineering know-how and experience gathered from designing environmental control systems for over 200 commercial CEA cultivation facilities. Third, we have an expanding line of proprietary and curated environmental control systems and other core technology components needed to build a CEA facility.

Our website is www.ceaindustries.com (http://www.ceaindustries.com), which contains a description of our Company and products. In addition, we also maintain a branded technology product website at www.surna.com (http://www.surna.com). The content of our websites is not incorporated herein by reference.

Shares of our common stock and warrants to purchase shares of our common stock are traded on The Nasdaq Capital Market under the ticker symbols “CEAD” and “CEADW”.

Impact of the COVID-19 Pandemic on Our Business

The COVID-19 pandemic has prompted national, regional, and local governments, including those in the markets that the Company operates in, to implement preventative or protective measures to control its spread. As a result, there have been disruptions in business operations around the world, with an impact on our business.

In response to the COVID-19 pandemic and the associated government and business response, the Company took and continues to take measures to adjust its operations as necessary. In early 2020 the Company responded to reduced orders by reducing expenses in an effort to preserve cash. Many expenses, including travel, marketing, headcount, work hours, and compensation were reduced, deferred, or eliminated while still allowing us to meet our customer obligations and develop new business. As 2020 progressed and our sales rebounded, and we were able to obtain additional funds through a forgivable bank loan, we restored our workforce and compensation. Many of these expense reductions were reversed by the end of 2021 when orders picked up and the overall business climate improved. Because the pandemic continues in different parts of the world and in different ways in the United States, the Company continues to actively monitor its operations.

We are experiencing unexpected and uncontrollable delays with our international supply of products and shipments from vendors due to a significant increase in shipments to U.S. ports, compounded by a reduction in cargo being shipped by air, a general shortage of containers, and a shortage of domestic truck driver availability. While these delays have moderately improved in recent months, we, along with many other importers of goods across all industries, continue to experience severe congestion and extensive wait times for carriers at ports across the United States. In addition, restrictions imposed by local, state and federal agencies due to the COVID-19 pandemic have led to reduced personnel of importers, government staff and others in our supply chain. We have been working diligently with our network of freight partners and suppliers to expedite delivery dates and provide solutions to reduce further impact and delays. However, we are unable to determine the full impact of these delays and how long they will continue as they are out of our control.

While the Company is continuing to navigate the financial, operational, and personnel challenges presented by the COVID-19 pandemic, the full extent of the impact of COVID-19 on our operational and financial performance will depend on future developments, including the duration and spread of the pandemic, the potential uncertainty related to (and proliferation of) new strains, and related actions taken by federal, state, local and international government officials, to prevent and manage the spread of COVID-19. All of these efforts are uncertain, out of our control, and cannot be predicted at this time.

The CEA Industry

According to leading market research firms Headset and New Frontier Data, the North American cannabis industry is expected to experience compound annual growth on the order of 14%-15% from 2022 through 2025. More U.S. states are legalizing either medical or recreational use of cannabis products, and sometimes both. Although the market is aware of how the cannabis sector is growing, it seems to be less aware of the non-cannabis CEA market, particularly the vertical farming segment which is growing nearly as fast as the cannabis market. Since the technical infrastructure and requirements for growing any plant in a controlled environment are similar, we believe we can bring our engineering expertise and suite of products to this adjacent high growth market.

Our Services and Equipment Solutions

Our goal is to develop relationships with our prospects and customers that will afford us the opportunity to provide comprehensive services and equipment for the complete lifecycle of indoor agriculture facilities. This lifecycle includes designing and engineering the facility, providing the many required infrastructure technologies, advising on and ensuring proper installation of the technologies, providing training and start-up support, and ultimately providing preventative and other ongoing services for ensuring proper maintenance and operations.

We provide a comprehensive range of services and products as follows:

• VAR of Lighting Products
• VAR of Benching and Racking Products

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Service Solutions: Facility Design Services

Our outsourced licensed architectural services provide facility design and layout to include space and workflow optimization, construction documents, and construction administration. Our extensive experience with CEA facilities brings extra value to our customers as we advise them on the design of their facility to maximize its productivity and return on investment.

We have professional engineers (PEs) on our staff to provide licensed, professional Mechanical, Electrical, and Plumbing (MEP) engineering services to all non-cannabis customers, and to cannabis customers that are in cannabis-legal states and provinces. Our engineers perform mechanical engineering, and we outsource electrical and plumbing engineering to several vendors with whom we have long-term, trusted relationships. We believe we are among the most experienced engineering firms serving the cannabis growing CEA industry and we have leading edge, sophisticated engineering capabilities. We provide these services to facilities from several thousand to over 100,000 square feet in size. Over time the size and sophistication of projects we have served has grown increasingly large, a trend we expect will continue as the industry builds ever larger facilities.

Our licensed MEP engineering services provide stamped drawings that our customers need to obtain building permits and to build their facilities and specify equipment, and we can provide these services in any state or province. Our technical experience and know-how in engineering indoor cultivation facilities allow us to deliver to our customers practical solutions to complicated problems in four primary areas: (i) precision climate and environmental controls, (ii) energy and water efficiency, (iii) building code and permitting, and (iv) construction support services and start-up support of their environmental control equipment. 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 facilities in states and provinces where cannabis has been legalized for either recreational or medical use or is expected to be legalized, and we provide stamped, engineered drawings in all states and provinces where we operate. We provide a drawing package to our customers that allows them to obtain a building permit that is code compliant, identifies construction materials and alternates, and provides construction administration information for their general and sub-contractors to follow.

Service Solutions: Equipment Selection and Specification

Our goal as engineers is to identify the best technical solutions in the market and to offer a curated range of technologies to our customers to best meet the needs of their facilities. Our engineers assess each facility’s requirements and recommend the best equipment options for the customer without limitation or bias to a particular HVAC technology solution as we have access to all major HVAC system types and multiple vendors. Our product development and R&D groups search the market for the best technical solutions to offer our customers. We offer a wide range of the best products in the market.

Service Solutions: Equipment Installation Advisory

We do not offer construction services or perform equipment installation. Typically, a facility owner hires a general contractor (GC) to manage the project, and the GC hires sub-contractors in specific trades to conduct the installation of each sub-system, such as environmental control equipment. Our role in the construction process is to work with the GC and sub-contractors to provide the equipment that the customer has ordered at the required time and place. Then, during the construction process, our technical services employees are available to advise the construction contractors, and we conduct multiple site visits to ensure the quality of the installation.

Service Solutions: Start-up Services

After construction is completed, our technical services employees participate on-site to inspect the installation and to conduct startup of the systems that we have provided. When we are contracted for controls, we offer operator training for the facility personnel. After the facility is up and running, we provide support as needed to include site visits and to ensure that the facility is operating to its design specifications.

Service Solutions: Lifecycle Services

CEA facilities are technically sophisticated and require multiple sub-systems, including: environmental control, lighting, CO2 enrichment and control, water conditioning and reclamation, and fertigation/irrigation. We believe that facility operators will eventually want to focus on their core business of growing plants and not be distracted by the unrelated, but necessary and technical, work of maintaining these mission-critical sub-systems.

In the summer of 2021, we developed and began selling preventive maintenance (PM) services to meet this demand from our existing clients. Sold on a recurring subscription basis to existing cultivation facilities, the PM services are sold by us and are provided by third-party service companies located near the customer’s facility. We have partnered with a company that can provide this service across most of the geography where our customers and prospects are located. The PM services product is important for our business for three primary reasons. First, it provides recurring revenue. Second, it establishes a long-term relationship with the customer. Third, it offers the opportunity to be sold independently of our existing engineering offering and to any of the several thousand existing cultivation facilities.

Product Solutions.

We have historically been a provider of HVACD engineering and systems, and since 2019 we have broadened our product lines to now offer a wide range of products and infrastructure technologies. Because many different technologies are required to operate an indoor cultivation facility, our product strategy is to offer both proprietary (Surna Cultivation Technologies branded) and off the shelf products. Our proprietary products are made by us or vendors on a contract manufacturing basis to our specifications. We offer a curated selection of products and specify those that best meet the needs of our customers’ particular applications. Our product solutions can be divided into three categories.

Product Solutions: White-label environmental control products

Environmental Control Systems. We offer a broad range of HVACD technologies, to include chilled water systems, custom air handling units, split systems, and packaged roof-top units. We sell our proprietary products under the brand names Surna®, IsoStream®, EnviroPro™, EcoChill™, StrataAir™ and SentryIQ®. We have a national accounts relationship with Trane, and we resell their chillers under a joint label agreement. We also have a national accounts relationship with Anden, and we resell their dehumidifiers under a joint label agreement. During 2019, we launched upgraded, white-labeled equipment lines of fan coils and air handlers. In 2020 we introduced our first DX-based packaged systems. We offer various configurations of our Surna-branded fan coil units, which provide greater efficiency, design flexibility and control for growers using modular chilled water systems. This expanded product line allows us to serve customers across a wide range of application and budget requirements. We have chosen to offer white-label products for two reasons. First, we can design the products to our own specifications, using our accumulated knowledge to develop products that meet the particular and demanding challenges of indoor agriculture. Second, we can maintain better product margins by offering products that are proprietary to us and are not otherwise available to potential competitors.

Product Solutions: Proprietary Facility Control System

Sensing and Control Systems. In 2018 we began to develop, and in 2019 began to offer, a branded, proprietary controls and monitoring system (consisting of sensors, controllers, software, monitoring and a user interface). Branded as SentryIQ®, it is a sensors, controls and automation (“SCA”) platform—a turnkey, single-vendor HVACD equipment and controls integration solution to new build projects as well as existing facilities in the startup and operation phases. We have continued the rollout of SentryIQ® and to date we have entered into nineteen contracts to implement our SentryIQ® SCA platform. This product line is important for tactical and strategic reasons, and we hope to offer this as a standalone offering in the future. SentryIQ® is our highest-margin product.

Cultivation facilities must have SCA to operate their HVACD equipment. In simple form, SCA is the computerized thermostat in the room. The SCA also functions as the “brains” in bringing multiple variables together for CEA grow operations. The operator selects the desired temperature set point, the wall thermostat (Sensor) detects the actual temperature, and when the space temperature deviates from the desired set point the controller (Control) commands the environmental control components to supply heated, cooled, or dehumidified air to bring the room temperature back to the set point. In the case of indoor cultivation facilities, there are more environmental conditions to monitor and control (such as temperature, relative humidity, CO2, lighting, vapor pressure deficit status, and more) than in a typical residential home.

Indoor CEA growers also need to vary and tightly control environmental conditions depending on the stage of plant growth (i.e., clone, vegetative and flowering stages), the time of day, and the plant genetics. In a cultivation facility, the desired conditions change many times during the plant’s growth cycle and even within a day, and this is most easily accomplished with a custom design, computerized environmental control system (automation), similar to the most sophisticated building automation systems (BAS) found in commercial and process cooling applications. This control system may also command lighting and CO2 enrichment.

Our SentryIQ® SCA package includes precision sensors to measure temperature, humidity, light, and CO2 levels more accurately than typical HVACD sensors and within tighter tolerance levels. Our controllers are purpose-built computers programmed by us to ensure our industrial environmental control equipment follows the engineered sequences of operation to obtain desired set points. Our sensors connect to our branded controllers through wires installed in the facility, and similarly they are wired to our HVACD equipment (e.g., chillers, fan coils and dehumidifiers) to direct these pieces of equipment. The controllers also provide a custom user interface on a screen so they can be easily programmed and controlled to achieve the customer’s environmental objectives and give the cultivator the ability to access this data and react to alerts remotely.

We entered this aspect of our business to satisfy customer needs that we did not previously address and that historically were provided by third-party controls contractors. Our entry into the SCA market helps both our customers and our business. Our customers benefit because they are saved the extra work of finding and engaging an experienced CEA controls contractor. This allows them to get their facility up and running more quickly by taking one decision off the table and thereby establishing a single point of responsibility for controls implementation. We are also in a position to provide SCA because we know our proprietary equipment better than anyone, thereby ensuring smooth integration with our equipment with minimal work scope shortcomings, what we refer to as “scope gap.”

From a tactical perspective, and with limited incremental selling costs, our current sales team can now offer our SCA package to nearly every prospect since every cultivation facility requires SCA technology. We believe this technology value-added solution gives us an opportunity to achieve incremental project revenue at higher margins than we earn from our other equipment. Strategically, through our SCA package, we are also able to deepen our long-term customer relationship by tethering us to the customer through a controls interface (dashboard) to their facility. Future development will allow our customers to use artificial intelligence (AI) by aggregating environment and growing data to optimize energy use, operating efficiency, and product quality and yield. While there are several other total controls systems providers, we believe that our industry know-how, experience and reputation with climate control environments gives us a compelling and competitive SCA offering.

Product Solutions: VAR of Cultivation and Environmental Control Products

Some of the technologies required in CEA facilities are non-proprietary and widely available, thus making it difficult to earn strong margins on resale of products like pumps, valves, piping, etc. are commodities within the HVAC industry. However, we add value by selecting, providing and integrating these products into our customers’ projects.

We offer CEA-specific products as a reseller from trusted suppliers. For example, we have partnered with a third party to offer energy efficient, cost competitive LED lighting products at attractive margins. As another example, we offer benching and racking products via a partnership with a well-respected and widely used third party manufacturer.

Our Customers and Prospects

We provide our services and products to customers who are building, upgrading, or expanding an indoor cultivation facility for any crop. Our customers can be defined on a range of criteria.

New construction or the retrofit of an existing facility. Nearly all of our business has historically been for new construction facilities, but we have done retrofit projects and we believe that over time more of such business will become available.

Existing commercial retrofit projects represent a business opportunity in the CEA industry. The estimated 5,000+ existing cannabis producing CEA facilities in North America are easier to identify than new build projects. We believe, based on evidence and our market knowledge, that some of these exiting facilities are operating sub-optimally and have environmental control problems that our services and products can help remediate. We also believe that the energy consumption of these facilities can be reduced, and we have commenced developing services and products to help them realize savings. We believe that retrofit projects do not typically carry the financial uncertainties associated with new build projects such as licensing, permitting and funding.

Crop, either cannabis or non-cannabis. Nearly all of our projects have been for cannabis cultivation facilities as that has been the focus of our sales and marketing efforts. However, we have recently performed services for several non-cannabis facilities. As non-cannabis markets are growing at a pace previously seen in the cannabis markets, we are actively pursuing this market.

Size of facility. We serve facilities ranging in size from 2,000 square feet to over 100,000 square feet. Most facilities are between 20,000 and 70,000 square feet.

Customer type. Most of our customers are new entrants to the industry and have no other cultivation facilities. Some customers have one or more facilities which we classify as MFOs (multi-facility operators), and these are our favored prospects that we pursue aggressively or who turn to us after we have served them on a previous facility. We currently do not have projects with the largest, publicly traded firms (typically referred to as “MSOs,” or Multi-State Operators).

MFOs are customers who already own cultivation facilities and they are our preferred customers because they are likely already successful and cash-flowing, and they understand the challenges of building a new cultivation facility. They are thus a less risky prospect with a much higher likelihood of successfully completing a project.

New entrants are often times investors from outside the CEA industry who are attracted by the growth opportunities available as the CEA industry grows. We are particularly effective at winning business from these prospects because of our fifteen-year track record and well-known brand name within the industry. However, the risks of a failed project with these prospects are higher because of the challenges that must be overcome to successfully build and operate a CEA operation—which include (but are not limited to) ability to obtain funding, licensure, and an appropriate facility.

Sales and Marketing

We have both marketing and sales organizations and employees. Our Marketing team consists of a Vice-President of Marketing Communications and three staff members. Our Sales team is comprised of a Vice-President of Sales and four sales representatives located across the country. Our sales and marketing efforts focus on winning business from new entrants and smaller MFOs.

Marketing Strategy

Our marketing activities are focused on generating new leads and positioning us as a leader in the CEA facilities indoor cultivation market. We lead with our value proposition of offering a wide range of proprietary and curated products and services, giving more options to our customers to satisfy their individual applications and goals, versus our competition, which only offers single solutions for each of their products.

Brand Image. We emphasize our 15-year presence serving the industry and our status as an industry pioneer that was founded by cultivators to provide service to cultivators. We have also positioned ourselves as an engineering company that is, we believe, the most experienced such firm serving the cannabis segment of the CEA industry. We are well-known in the industry because of the many projects we have performed and because of our longevity serving the same. We reinforce our message and positioning with regular blog posts on our website, interviews with our technical cannabis professionals in certain industry magazines and podcasts, talks and presentations at trade shows, and technical white papers. Some of our engineers sit on industry technical standards groups. Some of our projects are referred to us by previous customers, and we reap the benefits of a virtuous cycle of past projects leading to new projects.

Internet. Our marketing activities include a fresh, easy to navigate website that provides education through our SEO-optimized landing pages, case studies, white papers, blogs and articles, advertising in various trade publications and digital outlets, social media and email campaigns.

Paid Referrals. We provide referral agreements to parties in the industry who are in a position to refer business to us.

Trade Shows. We make regular appearances at trade shows. We are also frequent speakers or panel members at trade show educational events. Our co-founder, Brandy Keen, is a well-known industry pioneer and authority who writes regular blog posts and is a sought-after speaker at industry events.

Investor Relations/Public Relations. We actively manage our public image to both the industry and to investors. For the industry we regularly publish press releases with positive company news including new product releases and major project wins. We retain an Investor Relations firm to provide regular coverage of Company developments to our investors and other stakeholders.

Sales Strategy

Our sales strategy is to call on leads developed by our marketing efforts, leads referred by existing customers, networking at industry events and trade shows, and to develop relationships with potential prospects. Our sales cycle is long, ranging from several months to 18 months from first contact with a prospect to signing a contract. In the organic growth strategy update we announced in May of 2021, we specifically added architectural services to our offering. Typically, architectural services are the first that will be needed when a facility is to be built. By selling our architectural services to a prospect we gain an early foothold in the relationship with the prospect. By offering most of the services and products that the prospect will need for their facility, we attempt to keep competitors out of the relationship.

Sales, Contract, and Fulfillment Cycle

The sales cycles for our new build commercial projects can vary significantly depending on the size and complexity of the project. From pre-sales and technical advisory meetings to sales contract execution, to engineering and design services and equipment delivery, and all the way through installation and startup of the installed system, the full cycle can range from three months to two years. Since we do not install any of the products we sell, our customers are required to use third-party installation contractors, which adds to the variability of the sales cycle.

When a customer agrees to enter into a contract with us it can be for any or all of the following:

• Architectural design services;
• MEP engineering services;
• Equipment provision; and
• Preventative maintenance.

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To enter into a contract, we require a 5-10% deposit and a signed contract. We then require progress payments as architectural and/or engineering work is completed, and before equipment is shipped. We generally do not ship equipment to a customer unless that equipment has been fully paid. The sales and fulfillment cycle can be summarized as follows, with elapsed time from start:

Start: Early meetings to understand goals and resources;

1-2 months: Proposal development and presentation;

3 months: Contract acceptance (requires 5-10% deposit);

3 months: Architectural and MEP engineering work begin;

4-5 months: Architectural and MEP engineering work completed, and equipment selections finalized (services paid for before release of construction drawings);

5 months: equipment ordered (40% deposit on equipment received prior to ordering);

6-18 months: construction project commences, equipment delivered as required (fully paid for before shipping); and

12-18 months: all equipment shipped and installed, project completed, operator training and system startup conducted.

Gross Margins and Revenue.

Architectural and Engineering services fees can range from $10,000 to over $100,000, depending on the size of the project. Revenue from equipment sales on individual projects has been over $3,000,000 but most typically ranges from $500,000 to $1,500,000. Our target gross margin from equipment sales ranges from 25% to 60%, with services margins ranging from 10% to 20%.

Our Corporate Growth Strategy

We continue to build upon the significant momentum we experienced in 2019, prior to the business disruptions caused by the COVID 19 pandemic. As we navigated through these challenges in the first half of 2020, we have seen an encouraging return to the pre-COVID-19 momentum, as evidenced by our revenue growth from Q3 2020 to Q4 2021. We believe this validates our market opportunity and our business model, and we remain committed to growing revenue and margin.

To that end, our corporate strategy for growing the Company and increasing shareholder value are based on the following pillars:

Pursue Aggressive Organic Growth.

We serve a market for the construction and expansion of CEA facilities and businesses that is projected to grow at a 20%+ compound annual growth rate for the foreseeable future. Our primary vertical market of cannabis cultivation facilities has been joined by the similarly rapidly growing urban vertical farming market to create two market opportunity segments that we are positioned to serve.

In May of 2021 we announced a new strategy for our organic growth, which included the following elements.:

Identify and Pursue New markets

Non-cannabis CEA (vertical/urban farming). We have expanded our business development plan to pursue non-cannabis CEA facilities, at least doubling our total addressable market. We have served several non-cannabis CEA facilities in the past and present and we have expanded our marketing efforts to aggressively pursue this vertical market.

Expand Product & Services Offering

We decided to expand our product offerings from a focus on primarily environmental control offerings to one that offers all of the primary technologies and services required in a CEA facility: architectural design, lighting, benching, HVACD, sensing & control systems, CO2 enrichment and control, water filtration & condensate reclamation, irrigation & fertigation systems, wastewater treatment, air sanitation, preventative maintenance and odor mitigation. In the last four months alone, we have seen a broadening of our booked contract pipeline to include offerings of architectural design, lighting, benching, HVACD, sensing & control systems, CO2 control, water reclamation, air sanitation and preventative maintenance.

Enhance Brand Through New Corporate and Trade Name

In May of 2021 we adopted the trade name “Surna Cultivation Technologies” because we believe that the new name will more clearly identify our business to prospects and make us easier to find on various social media and search engines. In November of 2021, we changed our corporate name from Surna Inc. to CEA Industries Inc. In January of 2022, Surna Cultivation Technologies LLC was formed and is a wholly owned subsidiary of CEA Industries Inc. Our recent name change, and internal restructuring were affected to prepare us to acquire potential targets and to nurture internal growth initiatives.

Seek Strategic Relationships, Mergers, and Acquisitions to Add to our Existing Business.

We also intend to grow our business through mergers, acquisitions, and strategic partnerships that serve our goal of being a leading and rapidly-growing supplier to the CEA industry. Our strategy is to use our insight to select the right partners to align with and the right acquisition targets to pursue.

Our experience and engineering advantages. Our core expertise, developed over many years, is engineering the environmental controls of CEA facilities, which is a sophisticated engineering challenge due to the high humidity (latent heat) and heat load (sensible heat) within these facilities. Not only are the loads high, but the environmental conditions within these facilities must be held closely within limits that these facilities’ managers request. Engineering to meet these limits requires us to consider all of the primary components within the facility: lighting, irrigation, HVACD, fertigation, sensors, controls, CO2 dosing, monitoring and alarms, facility physical limits such as power availability, and energy consumption. This expertise uniquely informs our view on the requirements of CEA facilities.

Technical advantages as a strategic partner and acquirer. We believe that the expertise gained in engineering many of the primary technical components within a CEA facility provides us with a uniquely well-informed view of the efficacy of the many primary components on offer in the marketplace. We further believe that this knowledge will help us make wise choices when deciding on products to pursue for strategic relationships, and providers to potentially merge with or acquire.

Corporate advantages as a strategic partner and acquirer. For smaller component providers we believe that our publicly traded platform and our existing sales and marketing reach will make us an attractive partner. Our public status provides sources of capital, and our sales and marketing resources can help us bring other products to market.

Continue to Improve Our Public Profile and the Market for Our Securities

We recognize that the costs of being a public company are substantial. However, we believe that a public currency offers a wider audience to support our story and partnership opportunities to build that story. With that goal in mind, we continue to build our public brand through public capital markets, and as part of that effort, we completed two capital markets transactions that we believe will benefit our current and future shareholders.

First, effective February 10, 2022, trading of both shares of the Company’s common stock and certain of the Company’s warrants (which previously traded on the over-the-counter (“OTCQB”) market) commenced on the Nasdaq Capital Market (the “Uplist”). We believe an Uplist to the Nasdaq will contribute to our stock’s liquidity and offer a more visible and attractive equity currency to current and future investors.

Second, effective February 15, 2022, the Company received net proceeds of approximately $22 million from the sale of 5,811,138 shares of its common stock together with 5,811,138 warrants (the “Offering”). We believe the Offering will provide immediate liquidity to help fund the Company’s growth strategy through both organic development and opportunistic acquisitions. We also believe the expansion of our investor base created by the Offering will enhance our overall audience and strengthen the market for our securities.

Our Competitive Advantages

Customer Operations. First and foremost, we seek to help our customers build the most effective and efficient facility possible. We believe that we are uniquely positioned to engineer all of the complex components of a CEA facility into a holistic whole because of our dedicated engineering staff and our experience with over 800 cultivators including over 200 commercial facilities. Our 15 years in the business has provided us a wide network of technology vendors from which we curate a selection of the best products. In addition, we are the leading experts in applying the most challenging component of the technical infrastructure, the environmental controls, and we have the knowledge required to engineer the interactions among the required components. A PE license is required for all MEP engineering work, and this engineering competence is one of our greatest strengths.

Sustainability. Indoor cultivation facilities, like data centers, are resource intensive. Several U.S. states have implemented building code changes that place limits on the energy consumption allowed within cultivation facilities, and we anticipate that more states will do the same. Among our objectives is to provide our customers with the most energy-efficient alternatives for their infrastructure. Energy and resource efficiency is a high priority to us as engineers, and our most senior engineering staff hold the LEED (Leadership in Energy and Environmental Design) credential. Our CEO previously helped build a cleantech company, has been involved in the cleantech industry for over five years, and published a book on selling energy efficient technologies. We believe that we are in a position to lead the industry in sustainability initiatives which our customers will highly value.

Customer Acquisition. By offering Facility Selection & Design services we seek to build relationships with prospects at the earliest opportunity in the lifecycle of the cultivation business. By expanding our offerings to include nearly every piece of the technical infrastructure required in a facility we hope to engage at the earliest possible moment with the customer and earn the opportunity to provide all the products and services required for a facility. Our post-start-up, lifecycle services help us maintain a relationship with the customer as long as the facility is in operation. Our observation is that our customers want to focus on growing plants and entrust us to maintain the technical infrastructure of complex systems; we believe that they will accept our offer to do so, as some already have.

Revenue and Revenue Recurrence. We believe that our revenue can be expanded by offering most of the primary technical infrastructure components for a cultivation facility. For example, if we are able to provide all of the primary infrastructure components to a cultivation facility, our revenue on a project could be up to 200% higher than if we provided the environmental controls systems alone. In the past we did not have products or services to offer our customers after a facility was constructed. We have recently begun to offer preventative maintenance services, and we believe that by expanding this service offering we will be able to gain long-term recurring revenue on a subscription basis.

Our Competition

Our environmental control systems and our related engineering and design services compete with various national and local HVACD contractors and traditional HVACD equipment suppliers who traditionally resell, design, and implement climate control systems for commercial and industrial facilities, most of whom do not have the specific knowledge that we have about the complexities and challenges of CEA facilities. We have positioned ourselves to differ from these competitors by providing a broad range of engineering and design services and environmental control systems, across most major HVACD solutions, including chilled water systems, custom air handling units, split systems, and packaged roof-top units. Each is tailored specifically for managing the distinct challenges involved in CEA facilities. We believe our industry-specific applications and experience in the CEA market allow us to deliver the right solution to our cultivation customers. Unlike many of our competitors, our solutions are designed specifically for cultivators to provide tight temperature and humidity control, reduce bio-security risks, reduce energy requirements, and minimize maintenance complexity, costs and downtime. However, we are seeing more competitors enter the CEA market, focused on emulating the same types of crop-specific climate control systems and engineering services that we offer. We believe this increased competition may adversely impact our ability to obtain new facility projects from both MFOs and independent smaller growers and could require us to accept lower gross margins on our projects.

As the cannabis segment of the CEA industry continues to mature and develop and legalization becomes more prevalent, we expect to see more competition from agricultural product and service providers who seek to expand into this niche of the CEA market. Going forward, we intend to expand our focus to include non-cannabis crops grown in controlled environments such as leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables, ornamentals and small fruits (such as strawberries, blackberries and raspberries), bell peppers, cucumbers, and tomatoes. Companies already operating in the non-cannabis CEA industry may have longer operating histories, greater name recognition, larger client bases and significantly greater financial, technical, sales and marketing resources. These competitors may adopt more aggressive pricing policies and make more attractive offers to existing and potential clients, employees, strategic partners, distribution channels and advertisers. Increased competition is likely to result in price reductions, reduced gross margins and a potential loss of market share.

Intellectual Property

We rely on a combination of patent and trademark rights, licenses, trade secrets, and laws that protect intellectual property, confidentiality procedures, and contractual restrictions with our employees and others to establish and protect our intellectual property rights. While we have several issued patents, we do not believe that these issued patents currently provide us with a meaningful competitive advantage. We have registered trademarks around our core Surna brand in the United States and select foreign jurisdictions, as well as the Surna logo and the combined Surna logo and name in the United States. Our Surna trademark is also registered in the European Union and Canada. We also recently secured trademark registration for our proprietary SCA platform, SentryIQ, in the United States and Canada. Subject to ongoing use and renewal, trademark protection is potentially perpetual. We actively protect our inventions, new technologies, and product developments by maintaining trade secrets and, in limited circumstances, filing for patent protection.

Employees

We currently have 31 active full-time employees. However, we may engage, and have in the past utilized, the services of consultants, independent contractors, and other non-employee professionals. Additional employees may be hired in the future depending on need, available resources, and our achieved growth.

US Government Regulation

While we do not generate any revenue from the direct sale of cannabis products, we have historically, and continue to, offer our services and engineering solutions to indoor cultivators that are engaged in various aspects of the cannabis industry. Cannabis is a Schedule I controlled substance and is illegal under federal law. Even in those states in which specific uses of marijuana have been legalized, such as medical marijuana or for adult recreational purpose, its use remains a violation of federal laws.

A Schedule I controlled substance is defined as a substance that has no currently accepted medical use in the United States, a lack of safety for use under medical supervision and a high potential for abuse. The Department of Justice defines Schedule I controlled substances as “the most dangerous drugs of all the drug schedules with potentially severe psychological or physical dependence.” If the federal government decides to enforce the Controlled Substances Act with respect to cannabis, persons that are charged with distributing, possessing with intent to distribute, or growing cannabis could be subject to fines and terms of imprisonment, the maximum being life imprisonment and a $50 million fine. Any such change in the federal government’s enforcement of current federal laws could cause significant financial damage to us. While we do not intend to harvest, manufacture, distribute or sell cannabis or cannabis products, we may be irreparably harmed by a change in enforcement by the federal or state governments.

Previously, the Obama administration took the position that it was not an efficient use of resources to direct federal law enforcement agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana. The Trump administration revised this policy but made no major changes in enforcement through Attorney General Jeffrey Sessions rescinding the Cole Memorandum. The Department of Justice will continue to enforce the Controlled Substances Act with respect to cannabis under established principles in setting their law enforcement priorities to prevent:

• the distribution of cannabis products, such as marijuana, to minors;
• criminal enterprises, gangs and cartels receiving revenue from the sale of cannabis;
• the diversion of cannabis products from states where it is legal under state law to states where it is not legal under state law;
• the use of state-authorized cannabis activity as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
• violence and the use of firearms in the cultivation and distribution of cannabis products;
• driving while impaired and the exacerbation of other adverse public health consequences associated with cannabis product usage;
• the growing of cannabis on public lands; and
• cannabis possession or use on federal property.

Since the use of marijuana is illegal under federal law, most federally chartered banks will not accept deposit funds from businesses involved with marijuana. Consequently, businesses involved in the marijuana industry generally bank with state-chartered banks and credit unions to provide banking to the industry.

In 2014, Congress passed a spending bill containing a provision (the Rohrabacher-Farr amendment, now referred to as the Rohrabacher-Blumenauer Amendment) blocking federal funds and resources allocated under the 2015 appropriations bill from being used to “prevent such States from implementing their own State medical marijuana laws.” The Rohrabacher-Blumenauer Amendment, however, did not codify any federal protections for medical marijuana patients and producers operating within state law. The Justice Department maintains that it can still prosecute violations of the federal cannabis laws and continue cases already in the courts. The Rohrabacher-Blumenauer Amendment must be re-enacted every year, and it was continued for 2016, 2017, 2018, 2019 and 2020, and currently, now known as the Joyce Amendment, remains in effect through December 3, 2021. The continued re-authorization of the Joyce Amendment cannot be assured. If the Joyce Amendment is no longer in effect, the risk of federal enforcement and override of state marijuana use and cannabis related laws would increase. However, state laws do not supersede the prohibitions set forth in the federal drug laws.

In order to participate in either the medical or the adult use aspects of the cannabis industry, all businesses and employees must obtain licenses from the state and, for businesses, local jurisdictions as well. As an example, Colorado issues four types of business licenses including cultivation, manufacturing, dispensing, and testing. In addition, all owners and employees must obtain an occupational license to be permitted to own or work in a facility. All applicants for licenses undergo a background investigation, including a criminal record check for all owners and employees.

Colorado has also enacted stringent regulations governing the facilities and operations of cannabis businesses that are involved with the plant and its products. All facilities are required to be licensed by the state and local authorities and are subject to comprehensive security and surveillance requirements. In addition, each facility is subject to extensive regulations that govern its businesses practices, which includes mandatory seed-to-sale tracking and reporting, health and sanitary standards, packaging and labeling requirements, and product testing for potency and contaminants.

Laws and regulations affecting the medical marijuana industry are constantly changing, which could detrimentally affect our proposed operations. Local, state and federal medical marijuana laws and regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated with compliance or alter our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our operations. It is also possible that regulations may be enacted in the future that will be directly applicable to our business. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can we determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our business.

Investing in our securities involves significant risks. Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should carefully consider the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occur, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our securities could decline, and you could lose part or all of your investment.

Summary Of Risk Factors

Our business is subject to a number of risks and uncertainties, including those risks discussed at length in the section below titled “Risk Factors.” These risks include, among others, the following:

• Historically, we have had limited revenues and operated our business with a working capital deficit. Additionally, our operating results have fluctuated over the years. With the completion of our February 2022 offering, we raised approximately $22 million in net proceeds, and we are confident that we will be able to fund our operations and certain grow strategies for a period beyond the next twelve months. Nonetheless, we anticipate that from time to time we will require additional capital as we pursue our business plan.
• We historically enter into contracts that are performed over a period of time; therefore, we have a contract backlog in differing amounts from quarter to quarter. Converting backlog to revenue depends on many factors, such as the customer obtaining financing, building permits and construction of their facility. We may not be able to convert all of our contracts representing backlog into revenue. We currently do not convert our backlog on a consistent basis quarter to quarter.
• Although our business is focused on the larger controlled environment agricultural sector and we are not cannabis plant touching, historically we have provided services and equipment to the cannabis industry segment. As a result, we may be subject to the changes within that sector and certain of the regulations and enforcement issues of the cannabis industry.
• We have material weaknesses in our controls and procedures for financial reporting.
• We are expanding our business and plan to undertake further strategic growth initiatives through product expansion and potential acquisitions. We may not be able to manage our growth effectively, which may affect our investors’ return on investment.
• We will need to expand our customer base, developing customers operating in the CEA industry, expanding and developing our products and services for these potential customers and increasing our marketing and achieving timely contract execution.
• Due to supply disruptions and competing demand for products, we continue to experience supply issues similar to other members of our industry. International trade disputes, tariffs, international shipping and domestic trucking issues all contribute to the challenges we face in obtaining the products we need for contract performance. We have experienced and may continue to experience inflationary effects on the cost of products, which may adversely affect our margins. The failure to procure the products we need to satisfy our customer contracts would disrupt our business, harm our reputation, result in losses and potently cause us to lose our market.
• We rely on third party manufacturers to supply the equipment we sell or lease. If the equipment does not perform to specifications or to our customers’ satisfaction, there may be an adverse impact on our business and our revenues.
• The build side of the CEA industry is very competitive. To be able to compete successfully, we will need to offer a wide range of products, have adequate capital for expansion, supply and execution, and develop robust marketing.
• As we expand, we will need to attract top quality talent. We are dependent on certain key sales, managerial and executive personnel for our current and future success.
• Cannabis remains illegal under federal law, and therefore, strict enforcement of federal laws regarding cannabis, particularly against our customers, would likely result in our inability to execute our business plan. We are subject to a number of laws focused on businesses that are peripheral to the cannabis industry. Variations in state and local regulation and enforcement in states that have legalized cannabis may impose certain restrictions on cannabis-related activities that may adversely impact our business. Public opinion against cannabis may have an adverse impact on our business.
• Public market trading of our common stock was infrequent on the OTCQB Marketplace. Effective February 10, 2022, trading commenced in the Company’s common stock and certain of the Company’s warrants on NASDAQ. There is no assurance that we will have an active trading market for our securities listed on NASDAQ. If there is a market, the prices of our publicly traded securities may be volatile, and the price may decrease substantially. We do not intend on paying dividends.

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Risk Factors

Risks Relating to Our Business

Our revenues have been limited, and we will need to obtain financing for future growth, and possibly our operations, which may not be available to us.

Historically, we have raised equity and debt capital to support our operations. We raised approximately $22 million from a public offering completed in February 2022. As of December 31, 2021, we had a working capital deficit of approximately $415,000 and our cash balance was $2,160,000. As of March 15, 2022, with the proceeds of our public offering of shares and warrants completed in February 2022, we had a cash balance of approximately $21 million, which we believe will fund our operations and growth plans for a period beyond the next 12 months. Notwithstanding the recent capital raise, we expect to need additional funds in the longer term, from time to time, to complete aspects of the overall development of our business plan, such as in connection with the acquisition of strategic assets. The precise amount and timing of our funding needs cannot be determined accurately at this time, and will depend on a number of factors, including market demand for our products and services, the success of our product development efforts, the timing of receipts for customer payments, the management of working capital, and the continuation of normal payment terms and conditions for our purchase of goods and services. The continuation of normal payment terms and conditions with our customers and suppliers, including our ability to obtain advance payments from our customers, significantly impacts our ability to fund our ongoing operations.

Any future equity offering will result in dilution to our shareholders; obtaining borrowed capital may not be possible for us.

To the extent that we raise equity and equity linked securities in any future offerings, our existing shareholders will experience a dilution in the voting power and ownership of their common stock, and our earnings per share, if any, would be impacted. Any borrowings made to finance operations, which are difficult to obtain from most traditional banks due to the federal laws prohibiting cannabis, could make us more vulnerable to a downturn in our operating results, a downturn in economic conditions, or increases in interest rates on borrowings that are subject to interest rate fluctuations. The amount and timing of 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.

The COVID-19 pandemic has adversely impacted, and may continue to adversely impact, the Company’s operations and financial results.

The COVID-19 pandemic has resulted in significant economic uncertainty and disruption. The extent to which our business and financial results are impacted will depend on numerous evolving factors which are uncertain and cannot be predicted, including: the duration and scope of the pandemic; governmental, business and individuals’ actions taken in response; the effect on our customers and customers’ demand for our services and products; the effect on our suppliers and disruptions to the global supply chain; our ability to sell and manufacture our products; disruptions to our operations resulting from the illness of any of our employees; restrictions or disruptions to transportation, including reduced availability of ground or air transport; the ability of our customers to pay for our services and products; and any closures of our facilities, our suppliers’ facilities, and our customers’ facilities. The effects of the COVID-19 pandemic have resulted and will result in additional expenses and lost or delayed revenue. We have been experiencing disruptions to our business as we implement modifications to travel, work locations and cancellation of events, among other modifications. In addition, the change in macroeconomic conditions may impact the proper functioning of financial and capital markets, foreign currency exchange rates, commodity and energy prices, and interest rates. All of the factors mentioned above are also expected to have an inflationary pressure on our cost of goods. Even after the COVID-19 pandemic subsides, we may continue to experience adverse impacts to our business and financial results due to any economic recession or depression that occurs, and due to any major public health crises, that may occur in the future.

Although our current accounting estimates contemplate current and expected future conditions, as applicable, it is reasonably possible that actual conditions could differ from our expectations, which could materially affect our results of operations and financial position. In particular, a number of estimates have been and will continue to be affected by the ongoing COVID-19 pandemic. The severity, magnitude and duration, as well as the economic consequences of the COVID-19 pandemic, are uncertain, rapidly changing and difficult to predict. As a result, our accounting estimates and assumptions may change over time in response to COVID-19. Such changes could result in future impairments of goodwill, intangible assets, long-lived assets, incremental credit losses on accounts receivable, or excess and obsolete inventory. Any of these events could amplify the other risks and uncertainties described in this Annual Report and could have an adverse effect on our business and financial results.

There is no assurance that we will be able to convert our backlog into revenue or make a profit.

We may be unable to convert the full contract value of our backlog in a timely manner, or at all. We inconsistently convert our backlog into revenue on a quarter-to-quarter basis. The performance of our obligations under a sales contract, and the timing of our revenue recognition, is dependent upon our customers’ ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can use our services and take possession of the equipment we provide. Our sales contracts currently are not time specific as to when our customers are required to take delivery of our services and equipment. More recently, we determined that some of our new construction facility projects are becoming larger and more complex and, as a result, delays were more likely due to licensing and permitting, lack of, or delay in, funding, staged facility construction, and/or the shifting priorities of certain customers with multiple facility projects in progress at one time. Even if we obtain more customers, or increase the average size of our projects, there is no guarantee that we will be able to generate a profit. Because we are a small company with limited capital, limited products and services, and limited marketing activities, we may not be able to generate sufficient revenue to operate profitably. If we cannot operate profitably, we may have to suspend or cease operations.

We may extend credit to our customers in the future and, if we are unable to collect these accounts receivable, our future profitability could be adversely impacted.

Historically, we had little exposure to the collection risk on accounts receivable since we typically received payments from our customers in advance of our performance of services or delivery of equipment. However, in certain situations, especially as we expand our products and services offering for a customer’s entire facility lifecycle, we may extend credit to our customers, in which case we are at risk for the collection of account receivables. Accordingly, we will be at greater risk for the collection of account receivables. Any customer credit arrangements are negotiated and may not protect us if a customer develops operational difficulty or incurs operating losses which could lead to a bankruptcy. In these cases, we may lose most of the outstanding balance due. In addition, we are typically not able to insure our accounts receivables. The risk is that we derive our revenue and profits from selling products and services to the emerging cannabis industry. The failure of our customers to pay the full amounts due to us could negatively affect future profitability.

Because we currently do not maintain effective internal controls over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our common stock may, therefore, be adversely impacted.

Our reporting obligations as a public company place significant requirements on our management, operational and financial resources, and systems, and will continue to do so for the foreseeable future. Annually, we are required to prepare a management report on our management’s assessment of the effectiveness of our internal control over financial reporting. Management has concluded that our internal control over financial reporting is currently not effective. In the event that our status with the U.S. Securities and Exchange Commission (“SEC”) changes to that of an accelerated filer from a smaller reporting company, our independent registered public accounting firm will be required to attest to and report on our management’s assessment of the effectiveness of our internal control over financial reporting. Under such circumstances, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may still decline to attest to our management’s assessment, or may issue a report that is qualified, if it is not satisfied with our controls, or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.

We have identified 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 and expanding within the CEA industry. 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:

• execute on our business plan and strategy;
• expand our products effectively or efficiently or in a timely manner;
• allocate our human resources optimally;
• meet our capital needs;
• identify and hire qualified employees or retain valued employees; or
• effectively incorporate the components of any business or product line that we may acquire in our effort to achieve growth.

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 services and products, industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers. As a result, period-to-period comparisons of our results of operations are unlikely to provide a good indication of our future performance.

Management expects that, under typical operating conditions, we will experience substantial variations in our revenues and operating results from quarter to quarter. Our revenue recognition is dependent upon shipment of the equipment portions of our sales contracts, which, in many cases, may be delayed while our customers complete permitting, prepare their facilities for equipment installation or obtain project financing. Industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of our control, make it difficult for us to predict when we will recognize revenue. If customers are unable to obtain licensing, permitting or financing, our sales and revenue will decline, resulting in a reduction in our operating income or possible increase in losses. Also, because of the coronavirus responses and our own cost savings actions, we cannot predict the course of our revenues and operating results with accuracy at this time.

Our business is focused on providing engineering design, and equipment integration into CEA facilities. To date, the majority of our revenues have been generated from clients that operate in the legal cannabis industry in the United States and Canada.

Although we are implementing a plan to broaden our market reach beyond the legal cannabis industry and we are pursuing sales efforts to expand into the rapidly growing non-cannabis CEA vertical farming segment, we continue to provide the majority of our facility engineering design and equipment integration and solutions to facilities in the legal cannabis industry.

Now that the non-cannabis CEA segment is gaining strong momentum in the agricultural industry, and since almost all of the equipment systems that we sell originate in the general horticulture industry and are agnostic to the crop grown in a facility, we believe that the proportion of non-cannabis revenues will increase over time, commensurate with our sales efforts and success. Notwithstanding our expansion plans, a decrease in demand in the legal cannabis industry could have a material adverse effect on our revenues and the success of our business.

The cannabis industry has been an emerging industry over the last several years, and cannabis has only been legalized in some states and remains illegal in other states and under U.S. federal law, making it difficult to accurately forecast the demand for our engineering and product solutions in this specific industry. Losing clients from the cannabis industry may have a material adverse effect on our revenues and the success of our business.

The cannabis industry is still in its early stages of development in the United States and while the vast majority of U.S. states now have legal cannabis and it remains illegal under U.S. federal law, making it difficult to accurately predict and forecast the demand for our engineering and product solutions. If the U.S. Department of Justice (“DOJ”) did take action against the cannabis industry, we believe those of our clients operating in the legal cannabis industry would be lost to us.

In our operations, we rely heavily upon the various U.S. federal governmental memos issued in the past, including the memorandum issued by the DOJ on October 19, 2009, known as the “Ogden Memorandum”, the memorandum issued by the DOJ on August 29, 2013, known as the “Cole Memorandum” and other guidance, in the attempt to keep our operations acceptable to those state and federal entities that regulate, enforce, or choose to defer enforcement of certain current regulations regarding cannabis. By doing this, we seek to avoid the many possible consequences of providing grow equipment to the cannabis industry as our customers continue to comply with their state and local jurisdictional laws, rules and regulations and the interpretations of relevant authorities.

The legal cannabis industry is not yet well-developed, and many aspects of this industry’s development and evolution cannot be accurately predicted, and therefore, the loss of any of our current clients or our inability to capture new client contracts may have a material adverse effect on our business. While we have attempted to identify our business risks in the legal cannabis industry, you should carefully consider that there are other risks that cannot be foreseen or are not described in this report, which could materially and adversely affect our business and financial performance.

There is heightened scrutiny by Canadian regulatory authorities related to the cannabis industry.

We seek grower customers in the CEA Canadian market, some of which are cannabis growers. Therefore, our existing and future operations may become the subject of heightened scrutiny by those regulators and other authorities in Canada that oversee the cannabis industry. As a result, we may become subject to direct and indirect interaction with public officials in one or both the United States and Canada. No assurance can be provided that any heightened scrutiny will not in turn lead to the imposition of restrictions on our ability to operate in Canada, in addition to those described herein.

If we do not successfully develop additional products and services, or if those 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 CEA (including 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.

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 our sales efforts will be successful. There can be no assurance that customers will purchase our services or products or that we will continue to expand our customer base. If we are unable to effectively market or expand our product and service offerings, we will be unable to grow and expand our business or implement our business strategy. This could materially impair our ability to increase sales and revenue, and materially and adversely affect our margins, which could harm our business and cause our stock price to decline.

Our suppliers could fail to fulfill our orders for parts used to assemble our products, which would disrupt our business, increase our costs, harm our reputation, and potentially cause us to lose our market.

We depend on third party suppliers around the world, including those in The People’s Republic of China, for materials used to assemble our products. Any of these suppliers could fail to produce products to our specifications or in a workmanlike manner and may not deliver the material or products on a timely basis. Our suppliers may also have to obtain inventories of the necessary parts and tools for production. Any change in our suppliers’ approach to resolving production issues could disrupt our ability to fulfill orders and could also disrupt our business due to delays in finding new suppliers, providing specifications and testing initial production.

Our suppliers could experience uncontrollable delays in delivering our products.

We have experienced some unexpected and uncontrollable delays with our international supply of products and shipments from vendors due to a significant increase in shipments to U.S. ports, less cargo being shipped by air, unavailability of truckers and a general shortage of containers. We expect this to continue for some time. These disruptions are also causing price increases, which may become an inflationary force in the marketplace.

Equipment failures or poor performance may negatively impact our business.

We rely on third party manufacturers for equipment which we sell or lease. From time to time, such equipment may not perform to specifications or to our customers’ satisfaction. Such equipment deficiencies may lead to down time impacting our revenue. Further, frequent downtime at customers’ sites due to equipment failures may result in such customers generating less revenue and increasing credit default risk. In addition, these failures may also result in additional time spent by our personnel, decreasing profit margins on certain ancillary services.

International trade disputes could result in tariffs and other protectionist measures that could adversely affect the Company’s business.

Tariffs could increase the cost of our products and the components and raw materials that go into making them. These increased costs could adversely impact the gross margin that we earn on sales of our products. Tariffs could also make our products more expensive for customers, which could make our products less competitive and reduce customer demand. Countries may also adopt other protectionist measures that could limit our ability to offer our products and services.

Our inability to effectively protect our intellectual property would adversely affect our ability to compete effectively, our revenue, our financial condition, and our results of operations.

We may be unable to obtain intellectual property rights to effectively protect our branding, products, and other intangible assets. Our ability to compete effectively may be affected by the nature and breadth of our intellectual property rights. While we intend to defend against any threats to our intellectual property rights, there can be no assurance that any such actions will adequately protect our interests. If we are unable to secure intellectual property rights to effectively protect our branding, products, and other intangible assets, our revenue and earnings, financial condition, or results of operations could be adversely affected.

We also rely on non-disclosure and non-competition agreements to protect portions of our intellectual property portfolio. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that third parties will not otherwise gain access to our trade secrets or proprietary knowledge, or that third parties will not independently develop competitive products with similar intellectual property.

We may become subject to additional regulation of CEA facilities.

Our engineering and design services and solutions are focused on CEA facilities that are able to grow a wide variety of crops such as leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables and small fruits (such as strawberries, blackberries and raspberries), bell peppers, cucumbers, and tomatoes. Some of these crops and their growing methodologies are subject to regulation by the United States Food and Drug Administration, environmental agencies, public utility agencies and other federal, state or foreign agencies. Changes to any regulations and laws that complicate the design and engineering of a subject CEA facility, such as waste water treatment and electricity-related mandates, make it possible that potential related zoning and enforcement could decrease the demand for our services, and in turn negatively impact our revenues and business opportunities.

The CEA industry is highly competitive, and we have less capital and resources than many of our competitors, which may give them an advantage in developing and marketing services and products similar to ours or make our services and products obsolete.

There are many competitors in the CEA industry, including some companies that focus on the cannabis industry. These companies generally offer products and services similar or the same as those offered by us. There can be no guarantees that in the future other companies will not enter this arena by developing products that are in direct competition with us or even superior in quality or price. The barriers to entry into the CEA industry are not overly significant. Over time we anticipate growth in our competition. Some of our current and future competition may have longer operating histories, greater name recognition, larger client bases and significantly greater financial, technical, sales and marketing resources. One or more of these qualities may allow them to respond more quickly than us to market opportunities. They may be able to devote greater resources to the marketing, promotion and sale of their products and/or services. Competitors may also adopt more aggressive pricing policies and make more attractive offers to clients, employees, strategic partners, distribution channels and advertisers. Increased competition is likely to result in price reductions, reduced gross margins and a potential loss of market share.

While we believe we are better positioned to meet the exacting demands of a controlled cultivation environment through precise temperature, humidity, light, and process controls and to satisfy the evolving code and regulatory requirements being imposed at the state and local levels, there can be no assurance that we will be able to successfully compete against these other contractors and suppliers.

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.

We are dependent upon certain key sales, managerial and executive personnel for our future success. If we lose any of our key personnel, our ability to implement our business strategy could be significantly harmed.

We depend on the industry knowledge, technical and financial skill, and network of business contacts of certain key employees. Our future success will depend on the continued service of these key employees or our ability to engage others who are similarly situated in the industry. While we may have employment agreements with certain of these key employees, they are free to terminate their employment with us at any time, although they may be subject to certain restrictive covenants on their post-termination activities. We do not carry key-man life insurance on the lives of our key employees. The departure of any one of our key employees could have a material adverse effect on our ability to achieve our business objective and maintain the specialized services that we offer our customers.

System security risks, data protection breaches, cyber-attacks and systems integration issues could disrupt our internal operations or services provided to customers, and any such disruption could reduce our expected revenue, increase our expenses, damage our reputation and adversely affect our stock price.

Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack or otherwise exploit any security vulnerabilities of the products that we may sell in the future, especially our recently launched SentryIQ® sensors, controls and automation platform. The costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and our efforts to address these problems may not be successful and could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our engineering, sales, manufacturing, distribution or other critical functions.

Portions of our IT infrastructure may also experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource intensive. Such disruptions could adversely impact our ability to fulfill orders and interrupt other processes. Delayed sales, lower profits, or lost customers resulting from these disruptions could adversely affect our financial results, stock price and reputation.

We incur significant costs as a result of being a public company, which will make it more difficult for us to achieve profitability.

As a public company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as additional corporate governance requirements, including requirements under the Sarbanes-Oxley Act, and other rules implemented by the SEC. These costs will make it more difficult for us to achieve profitability.

Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.

U.S. generally accepted accounting principles (“GAAP”) and related pronouncements, implementation guidelines and interpretations with regard to a wide variety of matters that are relevant to our business, such as, but not limited to, revenue recognition, stock-based compensation, trade promotions, and income taxes are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes to these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported results.

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

As of December 31, 2021, the Company has U.S. federal and state net operating losses (“NOLs”) of approximately $21,091,000, of which $11,196,000 will expire, if not utilized, in the years 2034 through 2037. However, the balance of $9,895,000 NOLs generated subsequent to December 31, 2017, do not expire but may only be used against taxable income to 80%. In response to the novel coronavirus COVID-19, the Coronavirus Aid, Relief, and Economic Security Act temporarily repealed the 80% limitation for NOLs arising in 2018, 2019 and 2020. A number of states in which we operate have not conformed to this newly enacted federal tax law. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), and corresponding provisions of state law, if a corporation undergoes an “ownership change,” which is generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income or taxes may be limited. We have experienced ownership changes in the past and we may experience additional ownership changes in the future as a result of subsequent shifts in our stock ownership, some of which may be outside of our control. Our September 2021 and February 2022 securities sales also will have to be taken into account for determination of any “ownership change” that we have undergone during a determination period. If an ownership change occurs and our ability to use our net operating loss carryforwards is materially limited, it would harm our future bottom-line operating results by effectively increasing our future tax obligations.

We may not be able to successfully identify, consummate or integrate acquisitions or to successfully manage the impacts of such transactions on our operations.

Part of our business strategy includes pursuing synergistic acquisitions. We have expanded, and plan to continue to expand, our business by making strategic alliances and acquisitions and regularly seeking suitable working partners and acquisition targets to enhance our growth. Material acquisitions and other strategic transactions involve a number of risks, including: (i) the potential disruption of our ongoing business; (ii) the distraction of management away from the ongoing oversight of our existing business activities; (iii) incurring additional indebtedness; (iv) the anticipated benefits and cost savings of those transactions not being realized fully, or at all, or taking longer to realize than anticipated; (v) an increase in the scope and complexity of our operations; and (vi) the loss or reduction of control over certain of our assets.

The pursuit of acquisitions may pose certain risks to us. We may not be able to identify acquisition candidates that fit our criteria for growth and profitability. Even if we are able to identify such candidates, we may not be able to acquire them on terms or financing satisfactory to us. We will incur expenses and dedicate attention and resources associated with the review of acquisition opportunities, whether or not we consummate such acquisitions.

Risks Related to the Cannabis Industry

Cannabis remains illegal under federal law, and therefore, strict enforcement of federal laws regarding cannabis, particularly against our customers, would likely result in our inability to execute our business plan.

All but three U.S. states have legalized, to some extent, cannabis for medical purposes. Thirty-eight states, the District of Columbia, Puerto Rico and Guam have legalized some form of whole-plant cannabis cultivation, sales and use for certain medical purposes (medical states). Nineteen of those states and the District of Columbia and Northern Mariana have also legalized cannabis for adults for non-medical purposes (sometimes referred to as adult use). Ten additional states have legalized low-tetrahydrocannabinol (“THC”)/high-CBD extracts for select medical conditions (CBD states).

Under U.S. federal law, however, those activities are illegal. Cannabis, other than hemp (defined by the U.S. government as Cannabis sativa L. with a THC concentration of not more than 0.3% on a dry weight basis), is a Schedule I controlled substance under the U.S. Controlled Substances Act (21 U.S.C. § 801, et seq.) (the “CSA”). Even in states or territories that have legalized cannabis to some extent, the cultivation, possession, and sale of cannabis all violate the CSA and are punishable by imprisonment, substantial fines and forfeiture. Moreover, individuals and entities may violate federal law if they aid and abet another in violating the CSA, or conspire with another to violate the law, and violating the CSA is a predicate for certain other crimes, including money laundering laws and the Racketeer Influenced and Corrupt Organizations Act. The U.S. Supreme Court has ruled that the federal government has the authority to regulate and criminalize the sale, possession and use of cannabis, even for individual medical purposes, regardless of whether it is legal under state law. For over six years, however, the U.S. government has not enforced those laws against companies complying with state cannabis law and their vendors.

The likelihood of any future adverse enforcement against companies complying with state cannabis laws remains uncertain. In 2018, then-U.S. Attorney General Jeff Sessions rescinded the DOJ’s previous guidance (the Cole Memo) that had given federal prosecutors discretion not to enforce federal law in states that legalized cannabis, as long as the state’s legal regime adequately addressed specified federal priorities. The Sessions Memo, which remains in effect, states that each U.S. Attorney’s Office should follow established principles that govern all federal prosecutions when deciding which cannabis activities to prosecute. As a result, federal prosecutors could and still can use their prosecutorial discretion to decide to prosecute even state-legal cannabis activities. Since the Sessions Memo was issued nearly three years ago, however, U.S. Attorneys have not targeted state law compliant entities. The policy of not prosecuting companies complying with state cannabis laws is likely to continue under current U.S. Attorney General Merrick Garland. At his confirmation hearing, Attorney General Garland stated that he did not see enforcement of federal cannabis law as a high priority use of resources for the DOJ:

“This is a question of the prioritization of our resources and prosecutorial discretion. It does not seem to me a useful use of limited resources that we have, to be pursuing prosecutions in states that have legalized and that are regulating the use of marijuana, either medically or otherwise. I don’t think that’s a useful use. I do think we need to be sure there are no end-runs around the state laws that criminal enterprises are doing. So that kind of enforcement should be continued. But I don’t think it’s a good use of our resources, where states have already authorized. That only confuses people, obviously, within the state.”

Additionally, since 2014, versions of the U.S. omnibus spending bill have included a provision prohibiting the DOJ, which includes the Drug Enforcement Administration, from using appropriated funds to prevent states from implementing their medical-use cannabis laws. In USA vs. McIntosh, the U.S. Court of Appeals for the Ninth Circuit held that the provision prohibits the DOJ from spending funds to prosecute individuals who engage in conduct permitted by state medical-use cannabis laws and who strictly comply with such laws. The court noted that, if the spending bill provision were not continued, prosecutors could enforce against conduct occurring during the statute of limitations even while the provision was previously in force. Other courts that have considered the issue have ruled similarly, although courts disagree about which party bears the burden of proof of showing compliance or noncompliance with state law.

While the omnibus spending bill affords some protection to medical cannabis businesses, our policies do not prohibit our state-licensed cannabis customers from engaging in the cannabis business for adult use that is permissible under state and local laws. Consequently, certain of our customers currently (and may in the future) sell adult-use cannabis, if permitted by such state and local laws now or in the future, and therefore may be outside any protections extended to medical-use cannabis under the spending bill provision. This could subject our customers to greater and/or different federal legal and other risks as compared to businesses where cannabis is sold exclusively for medical use, which could in turn materially adversely affect our business. Furthermore, any change in the federal government’s enforcement posture with respect to state-licensed cannabis sales, including the enforcement postures of individual federal prosecutors in judicial districts where we operate, would result in our inability to execute our business plan, and we would likely suffer significant losses with respect to our customer base, which would adversely affect our operations, cash flow and financial condition.

While President Biden’s campaign position on cannabis falls short of full legalization, he campaigned on a platform of relaxing enforcement of cannabis proscriptions, including decriminalization generally. According to the Biden campaign website, it was stated: “A Biden Administration will support the legalization of cannabis for medical purposes and reschedule cannabis as a CSA Schedule II drug so researchers can study its positive and negative impacts. This will include allowing the VA to research the use of medical cannabis to treat veteran-specific health needs.” He pledged to “decriminalize” cannabis, which could prompt his U.S. Attorney General to issue policy guidance to U.S. Attorneys that they should not enforce federal cannabis prohibition against state law compliant entities and others legally transacting business with them. While President Biden’s promise to decriminalize likely would mean that the federal government would not criminally enforce the Schedule II status against state legal entities and would expand opportunities for cannabis research in the U.S., the implications of the potential re-scheduling are not entirely clear for state legal commercial cannabis operators. Although the U.S. Attorney General could issue policy guidance to federal prosecutors that they should not interfere with cannabis businesses operating in compliance with states’ laws, any such guidance would not have the force of law. The President alone cannot legalize medical cannabis, and as states have demonstrated, legalizing medical cannabis can take many different forms. While rescheduling cannabis to the CSA’s Schedule II would ease certain research restrictions, it would not make the state medical or adult-use programs federally legal.

Furthermore, while industry observers are hopeful that a Democrat-controlled Senate, along with a Biden presidency, will increase the chances of federal cannabis policy reform, such as the Marijuana Opportunity Reinvestment and Expungement Act (or MORE Act), which was originally co-sponsored by now Vice President Harris in the Senate, or banking reform, such as the SAFE Banking Act, which passed the House of Representatives but has not yet passed the Senate, we cannot provide assurances about the content, timing or chances of passage of a bill legalizing cannabis and the related aspects of the cannabis business. Accordingly, we cannot predict the timing of any change in federal law or possible changes in federal enforcement. In the unlikely event that the federal government were to reverse its long-standing hands-off approach to the state legal cannabis markets and start more broadly enforcing federal law regarding cannabis, we would likely be unable to execute our business plan, and our business and financial results would be adversely affected.

We are and will be subject to applicable anti-money laundering laws and regulations.

We are subject to a variety of laws and regulations in the United States and Canada that involve money laundering, financial recordkeeping and proceeds of crime, including the U.S. Currency and Foreign 125 Transactions Reporting Act of 1970 (commonly known as the Bank Secrecy Act), as amended by Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada), as amended and the rules and regulations thereunder, and any related or similar rules, regulations or guidelines, issued, administered or enforced by governmental authorities in the United States, Canada and internationally. Further, under U.S. federal law, banks or other financial institutions that provide a cannabis business with a checking account, debit or credit card, small business loan, or any other service could be found guilty of money laundering if certain other elements are met.

Despite these laws, the FinCEN Memorandum states that in some circumstances, it is permissible for banks to provide services to cannabis-related businesses without risking FinCEN enforcement. It refers to and incorporates supplementary Cole Memo guidance issued to federal prosecutors relating to the prosecution of money laundering offenses predicated on cannabis-related violations of the CSA on the same day.

Notwithstanding former Attorney General Sessions’ revocation of the Cole Memo, the status of the FinCEN Memorandum has not been affected, nor has the Department of the Treasury given any indication that it intends to rescind the FinCEN Memorandum itself. Though it was originally intended for the Cole Memo and the FinCEN Memorandum to work in tandem, the FinCEN Memorandum appears to remain in effect as a standalone document which explicitly lists the eight enforcement priorities originally cited in the rescinded Cole Memo. Although the FinCEN Memorandum remains intact, indicating that the Department of the Treasury and FinCEN intend to continue abiding by its guidance, it is unclear whether the current administration will continue to follow the guidelines of the FinCEN Memorandum.

We face risks related to civil asset forfeiture due to the regulatory environment of the cannabis industry in the United States.

Because the cannabis industry remains illegal under U.S. federal law, any property owned by participants in the cannabis industry, which are either used in the course of conducting such business, or are the proceeds of such business, could be subject to seizure by law enforcement and subsequent civil asset forfeiture. Even if the owner of the property were never charged with a crime, the property in question could still be seized and subject to an administrative proceeding by which, with minimal due process, it could be subject to forfeiture. As a result, the equipment that we lease to our customers in the United States may be subject to such seizure and forfeiture. Additionally, a broad interpretation of the law could potentially result in the seizure and forfeiture of proceeds we generate.

Public opinion and perception of the cannabis industry may have an adverse effect on our business reputation.

Government policy changes or public opinion may also result in a significant influence over the regulation of the cannabis industry in the United States, Canada, or elsewhere. Public opinion and support for medical and adult-use marijuana has traditionally been inconsistent and varies from jurisdiction to jurisdiction. While public opinion and support appears to be improving for legalizing medical and adult-use marijuana, it remains a controversial issue subject to differing opinions surrounding the level of legalization (for example, medical marijuana as opposed to legalization in general). A negative shift in the public’s perception of cannabis in the United States or any other applicable jurisdiction could affect future legislation or regulation. Among other things, such a shift could cause state jurisdictions to abandon initiatives or proposals to legalize medical and/or adult-use cannabis, thereby limiting the number of new state jurisdictions into which we could expand. Any inability to fully implement our expansion strategy may have a material adverse effect on our business, results of operations or prospects.

We may have difficulty accessing bankruptcy courts.

Because cannabis is illegal under federal law, federal bankruptcy protection is currently not available to parties who engage in the cannabis industry or cannabis-related businesses. Recent bankruptcy rulings have denied bankruptcies for dispensaries upon the justification that businesses cannot violate federal law and then claim the benefits of federal bankruptcy for the same activity and upon the justification that courts cannot ask a bankruptcy trustee to take possession of and distribute cannabis assets as such action would violate the CSA. Therefore, we may not be able to seek the protection of the bankruptcy courts, and this could materially affect our business or our ability to obtain credit.

Our business efforts in Canada present opportunities, but no assurance can be given that our revenues and earnings will be improved on the basis of our addressing the Canadian business.

In addition to U.S. operations, we seek to sell products and services to CEA and cannabis growers in Canada, where medical and recreational cannabis has been legal since 2018 across the country both federally and provincially (subject to certain restrictions relating to CBD). We believe Canada, with its federal legal regime, represents a business opportunity for us, but we have noticed softening demand from Canadian prospects due, in part, to limited capital being available for new facilities and an overbuilding of cultivation capacity following federal legalization. As a result, Canada now appears to be in a period of correction. There can be no assurance that we will be able to make any additional sales of products or services in Canada.

Variations in state and local regulation and enforcement in states that have legalized cannabis may impose certain restrictions on cannabis-related activities that may adversely impact our revenue and earnings.

Variations exist among states that have legalized, decriminalized, or created medical cannabis programs. For example, Alaska and Colorado have limits on the number of cannabis plants that can be grown by an individual in the home. In most states, the cultivation of cannabis for personal use continues to be prohibited except by those states that allow small-scale cultivation by the individual in possession of cannabis for medicinal purposes or that person’s caregiver. Active enforcement of state laws that prohibit personal cultivation of cannabis may indirectly and adversely affect our revenue and earnings.

The cannabis industry could face strong opposition from other industries.

We believe that established businesses in other industries may have a strong economic interest in opposing the development of the cannabis industry. Cannabis may be seen by companies in other industries as an attractive alternative to their products, including recreational marijuana as an alternative to alcohol, and medical marijuana as an alternative to various commercial pharmaceuticals. Many industries that could view the emerging cannabis industry as an economic threat are well established, with vast economic and United States federal and state lobbying resources. It is possible that companies within these industries could use their resources to attempt to slow or reverse legislation legalizing cannabis. Any inroads these companies make in halting or impeding legislative initiatives that would be beneficial to the cannabis industry could have a detrimental impact on our clients and, in turn on our operations.

Changing legislation and evolving interpretations of law, could negatively impact our clients and, in turn, our operations.

Laws and regulations affecting the medical and adult-use marijuana industry are constantly changing, which could detrimentally affect our clients involved in that industry and, in turn, our operations. Local, state and federal cannabis laws and regulations are often broad in scope and subject to constant evolution and inconsistent interpretations, which could require our clients and ourselves to incur substantial costs associated with modification of operations to ensure compliance. In addition, violations of these laws, or allegations of such violations, could disrupt our clients’ business and result in a material adverse effect on our operations. In addition, it is possible that regulations may be enacted in the future that will limit the amount of cannabis growth or related products that our commercial clients are authorized to produce. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can it determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our operations.

The fact that we provide products and services to companies in the cannabis industry may impact our ability to raise adequate capital for future expansion, which could hinder our growth potential as well as our revenue and earnings.

A very large percentage, 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 setbacks before achieving success. While there may be ample public support for legislative proposals, key support must be created in the relevant legislative committee, or a bill may never advance to a vote. Numerous factors impact the legislative process. Any one of these factors could slow or halt the progress and adoption of cannabis for recreational and/or medical purposes, which would limit the overall available market for our products and services, which could adversely impact our business, revenue and earnings.

Our customers may have difficulty accessing the service of banks, which may make it difficult for them to purchase our products and services.

As a result of the federal illegality of marijuana, many banks do not provide banking services to the cultivation and distribution segments of the cannabis industry, the argument being that they would be accepting for deposit funds derived from the operation of a federally illegal business. On February 14, 2014, the U.S. Department of the Treasury Financial Crimes Enforcement Network (“FinCEN”) released guidance to banks “clarifying Bank Secrecy Act (“BSA”) expectations for financial institutions seeking to provide services to marijuana-related businesses.” In addition, there have been legislative attempts to allow banks to transact business with state-authorized cannabis businesses. While these are positive developments, there can be no assurance that legislation will be successful, or that, even with the FinCEN guidance, banks will decide to do business with cannabis companies, or that, in the absence of actual legislation, state and federal banking regulators will not strictly enforce current prohibitions on banks handling funds generated from an activity that is illegal under federal law. Moreover, the FinCEN guidance may be rescinded or amended at any time in order to reconcile the now conflicting guidance of the Sessions Memo. At present, few banks have taken advantage of the FinCEN guidance, resulting in many cannabis businesses still operating on an all-cash basis. This makes it difficult for cannabis businesses to manage their businesses and pay their employees and taxes; in addition, having so much cash on hand creates significant public safety issues. Many ancillary businesses that service cannabis businesses have to deal with the unpredictability of their clients or customers not having a bank account. The inability of our customers to open bank accounts and otherwise access the services of banks, including obtaining credit, may make it more difficult and costly for them to operate and more difficult for such customers to purchase our products and services, which could materially harm our business, revenue and earnings.

We are subject to certain federal regulations relating to cash reporting.

The BSA, enforced by FinCEN, requires us to report currency transactions in excess of $10,000, including identification of the customer by name and social security number, to the Internal Revenue Service. This regulation also requires us to report certain suspicious activity, including any transaction that exceeds $5,000 that we know, suspect or have reason to believe involves funds from illegal activity or is designed to evade federal regulations or reporting requirements and to verify sources of funds. Substantial penalties can be imposed against us if we fail to comply with this regulation. If we fail to comply with these laws and regulations, the imposition of a substantial penalty could have a material adverse effect on our business, financial condition and results of operations.

State and municipal governments in which our customers do business or seek to do business may have or may adopt laws that adversely affect our ability to do business with such customers.

While the federal government has the right to regulate and criminalize cannabis, state and municipal governments may adopt or amend additional laws and regulations that further criminalize or adversely affect cannabis businesses. States that currently have laws that decriminalize or legalize certain aspects of cannabis, such as medical marijuana, could in the future, reverse course and adopt new laws that further criminalize or adversely affect cannabis businesses. Additionally, municipal governments in certain states may have laws that adversely affect cannabis businesses, even though there are no such laws at the state level. For example, municipal governments may have zoning laws that restrict where cannabis operations can be located and the manner and size of which they can expand and operate. These municipal laws, like the federal laws, may adversely affect our customers’ ability to do business. Also, given the complexity and rapid change of the federal, state and local laws pertaining to cannabis, our customers may incur substantial legal costs associated with complying with these laws and in acquiring the necessary state and local licenses required by their business endeavors. All of the foregoing may impact our customers’ ability to purchase our products and services, which may adversely affect our business, revenue and earnings.

Most, if not all, of our customers are impacted by Section 280E of the Code, which limits certain expenses marijuana companies can deduct. This negative impact could affect the financial condition of our customers, which in turn may negatively affect the ability of our customers to purchase our products and services.

Section 280E of the Code forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the CSA. The Internal Revenue Service (the “IRS”) has subsequently applied Section 280E to state-legal cannabis businesses since marijuana is still a Schedule I substance. Section 280E states that no deductions should be allowed on any amount “in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.” Section 280E affects all businesses that engage in the cultivation, sale or processing of marijuana. This includes cultivators, medical dispensaries, marijuana retail stores and infused product manufacturers, as well as marijuana-derived concentrates and oil manufacturers. Because Section 280E limits certain deductions, it can have a dramatic effect on the profitability of these businesses, which in turn may adversely affect their ability to purchase our products and services. Such result may adversely impact our revenue and earnings.

There may be difficulty enforcing certain of our commercial agreements and contracts.

Courts will not enforce a contract deemed to involve a violation of law or public policy. Because cannabis remains illegal under U.S. federal law, parties to contracts involving the state legal cannabis industry have argued that the agreement was void as federally illegal or against public policy. Some courts have accepted this argument in certain cases, usually against the company trafficking in cannabis. While courts have enforced contracts related to activities by state-legal cannabis companies, and the trend is generally to enforce contracts with state-legal cannabis companies and their vendors, there remains doubt and uncertainty that we will be able to enforce our commercial agreements in court for this reason. We cannot be assured that we will have a remedy for breach of contract, which would have a material adverse effect on our business.

Due to our involvement in the cannabis industry, we may have a difficult time obtaining the various insurances that are desired to operate our business, which may expose us to additional risk and financial liability.

Insurance that is otherwise readily available, such as general liability and directors’ and officers’ insurance, is more difficult for us to find, and more expensive, because we are product and service providers to companies in the cannabis industry. There are no guarantees that we will be able to find such insurances in the future, or that the cost will be affordable to us. If we are forced to go without such insurances, it may prevent us from entering into certain business sectors, may inhibit our growth, and may expose us to additional risk and financial liabilities.

A drop in the retail price of cannabis products may negatively impact our business.

The fluctuations in economic and market conditions that impact the prices of commercially grown cannabis, such as increases in the supply of cannabis and decreases in demand for cannabis, could have a negative impact on our clients that are cannabis producers, and therefore could negatively impact our business.

Risks Related to Our Common Stock

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

The public trading prices of our securities fluctuate, in some cases substantially, and we expect that they will continue to do so. The price of our securities in the market on any particular day depends on many factors including, but not limited to, the following:

• price and volume fluctuations in the overall stock market from time to time;
• investor demand for our shares and warrants;

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• significant volatility in the market price and trading volume of companies in the cannabis industry;
• variations in our operating results and market conditions specific to our business;
• the emergence of new competitors or new technologies;
• operating and market price performance of other companies that investors deem comparable;
• changes in our Board of Directors (the “Board”) or management;
• sales or purchases of our securities by insiders, including sales of our common stock issued to employees, directors and consultants under our equity incentive plans which were registered under the Securities Act of 1933, as amended (the “Securities Act”) under our S-8 registration statement;
• commencement of, or involvement in, litigation;
• changes in governmental regulations, in particular with respect to the cannabis industry;
• actual or anticipated changes in our earnings, and fluctuations in our quarterly operating results;
• market sentiments about the cannabis industry;
• general economic conditions and trends; and
• departures of any of our key employees.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Due to the potential volatility of our securities prices, we may therefore be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business.

In addition, if the market for equity stocks of companies in our industry, or the stock market in general, experiences a loss of investor confidence, the market price of our securities could decline for reasons unrelated to our business, financial condition, or results of operations. If any of the foregoing occurs, it could cause the price of our securities to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to our Board of Directors and management.

Our Board of Directors is authorized to reclassify any unissued shares of our preferred stock into one or more classes, which could convey special rights and privileges to its owners.

Our articles of incorporation permit our Board of Directors to reclassify any authorized but unissued shares of preferred stock into one or more classes. Our Board of Directors will generally have broad discretion over the size and timing of any such classification, subject to a finding that the classification and issuance of preferred stock is in our best interests. In the event our Board of Directors opts to classify a portion of our unissued shares of preferred stock into a class of preferred stock, those preferred shares would have a preference over our common stock with respect to dividends and liquidation. The class voting rights of any preferred shares we may issue could make it more difficult for us to take some actions that may, in the future, be proposed by the Board of Directors and/or the holders of our common stock, such as a merger, exchange of securities, liquidation, or alteration of the rights of a class of our securities, if these actions were perceived by the holders of preferred shares as not in their best interests. These effects, among others, could have an adverse effect on your investment in our common stock.

Registration rights and Rule 144 sales contain risks for certain shareholders.

From time to time, we issue our securities on an unregistered basis, which may be eligible for resale under SEC Rule 144 promulgated under the Securities Act or may require us to register with the SEC the securities for resale. In the event there are securities outstanding that can be sold under Rule 144 or under a registration statement for resale, there may be market pressure on our stock to absorb the securities in respect of the then market value of the company.

We have a substantial number of options and warrants outstanding, which if exercised for shares of common stock, may put pressure on the market price of a share.

We have sold to public and private investors a substantial number of warrants to purchase common stock from time to time over the next several years. In addition, we have a substantial number of options and warrants outstanding held by investment bankers who provided us with underwriting and placement services that were issued warrants and employees that were issued options. To the extent that these are exercised for shares, there may be pressure on our stock price while the market absorbs them. The potential of exercise may also have the same effect. Investors should expect that the options and warrants will be exercised when the stock price is substantially above the exercise price.

We do not anticipate paying any cash dividends on our common stock in the foreseeable future.

We currently intend to retain our future earnings, if any, for the foreseeable future, to repay indebtedness and to fund the development and growth of our business. We do not intend to pay any dividends to holders of our common stock in the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, any legal or contractual limitations on our ability to pay dividends under our loan agreements or otherwise. As a result, if our Board does not declare and pay dividends, the capital appreciation in the price of our common stock, if any, will be your only source of gain on an investment in our common stock, and you may have to sell some or all of your common stock to generate cash flow from your investment.

The market price of our securities may be adversely affected by the sale of shares by our management or large stockholders.

Sales of our shares of common stock by our officers or senior managers through 10b5-1 plans or otherwise or by large stockholders could adversely and unpredictably affect the price of our common stock. Additionally, the price of our shares of common stock could be affected even by the potential for sales by these persons. We cannot predict the effect that any future sales of our common stock, or the potential for those sales, will have on our share price. Furthermore, due to relatively low trading volume of our stock, should one or more large stockholders seek to sell a significant portion of their stock in a short period of time, the price of our stock may decline.

An active, liquid trading market for our common stock and warrants may not develop or be sustained, and as a result, investors may not be able to sell their common stock at or above their acquisition price, or at all.

Prior to February 10, 2022, our common stock was quoted on the OTC Markets Group, Inc., OTCQB. Trading on the OTCQB marketplace was infrequent and in limited volume. Although our common stock is now listed on Nasdaq, along with our public warrants, an active trading market for these securities may never develop or be sustained. If an active trading market does not develop, investors will have difficulty selling their shares of common stock and warrants at an attractive price, or at all. An inactive market may also impair our ability to raise capital and may impair our ability to expand our business by using our common stock and common stock related securities as consideration in an acquisition.

You may be diluted by future issuances of preferred stock or additional common stock in connection with our incentive plans, acquisitions or otherwise; future sales of such shares in the public market, or the expectations that such sales may occur, could lower our stock price.

Our articles of incorporation authorizes us to issue shares of our common stock and options, rights, warrants and appreciation rights relating to our common stock for the consideration and on the terms and conditions established by our Board in its sole discretion. We could issue a significant number of shares of common stock in the future in connection with investments or acquisitions. Any of these issuances could dilute our existing stockholders, and such dilution could be significant. Moreover, such dilution could have a material adverse effect on the market price for the shares of our common stock.

The future issuance of shares of preferred stock with voting rights may adversely affect the voting power of the holders of shares of our common stock, either by diluting the voting power of our common stock if the preferred stock votes together with the common stock as a single class, or by giving the holders of any such preferred stock the right or ability to block an action on which they have a separate class vote, even if the action were approved by the holders of our shares of our common stock.

The future issuance of shares of preferred stock with dividend or conversion rights, liquidation preferences or other economic terms favorable to the holders of preferred stock, when compared to the rights of the common stockholders, could adversely affect the market price for our common stock by making an investment in the common stock less attractive. For example, investors in the common stock may not wish to purchase common stock at a price above the conversion price of a series of convertible preferred stock because the holders of the preferred stock would effectively be entitled to purchase common stock at the lower conversion price, causing economic dilution to the holders of common stock.

We own no real property. On July 28, 2021, we executed a lease, which became effective November 1, 2021, for our manufacturing and headquarters office space at 385 S. Pierce Avenue, Suite C, Louisville, Colorado 80027. The term of the lease commenced November 1, 2021, and continues through January 31, 2027. Our leased space is approximately 11,491 square feet. We believe that our lease is at market rates and that there is sufficient space available in the Louisville, Colorado area to obtain additional or other space if and when required.

The Company settled a litigation with a former employee effective March 30, 2021. While the Company disputed the merits of the claims, the Company agreed to issue an aggregate of 6,667 shares of common stock of the Company, as part of the settlement. These shares were issued on April 8, 2021, as “restricted securities,” subject to a lock-up agreement of six months, without registration rights, and pursuant to a private placement exemption. The settlement agreement also included mutual releases and no admission of liability. The cost to the Company of this settlement, $107,000, in total, has been recognized in full in Other Expenses during the year ended December 31, 2021. The issuance of the 6,667 shares of common stock (valued at $67,000) has been recognized in common stock issued during the year ended December 31, 2021.

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.

The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information included elsewhere in this Annual Report, which include additional information about our accounting policies, practices, and the transactions underlying our financial results. In addition to historical information, this Annual Report contains forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under “Cautionary Statements” appearing elsewhere herein and the risks and uncertainties described or identified in “Item 1A – Risk Factors” in this Annual Report.

Please also refer to “Non-GAAP Financial Measures” discussed elsewhere in this Annual Report.

The following discussion should be read in conjunction with Item 1 – Business in this Annual Report, and our consolidated financial statements and accompanying notes to consolidated financial statements included in this Annual Report. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is segregated into four sections, including:

Executive Overview. This section provides a summary of our operating performance and cash flows, industry trends and our strategic initiatives.

Critical Accounting Policies and Estimates. This section describes the accounting areas where management makes critical estimates to report our financial condition and results of operations.

Results of Operations. This section provides an analysis of our consolidated results of operations for the two comparative periods presented in our consolidated financial statements.

Liquidity, Capital Resources and Financial Position. This section provides an analysis of cash flow, contractual obligations, and certain other matters affecting our financial position.

Executive Overview

CEA Industries Inc. is a technology, engineering, and services provider to the global controlled environment agriculture (CEA) industry. The CEA industry is one of the fastest-growing sectors of the United States’ economy. From leafy greens (kale, Swiss chard, mustard, cress), microgreens (leafy greens harvested at the first true leaf stage), ethnic vegetables, ornamentals, and small fruits (such as strawberries, blackberries and raspberries) to bell peppers, cucumbers, tomatoes, and cannabis, some producers grow crops indoors in response to market dynamics or as part of their preferred farming practice. In service of the CEA, our principal service and product offerings include: (i) floor plans and architectural design of cultivation facilities, (ii) licensed mechanical, electrical, and plumbing (MEP) engineering of commercial scale environmental control systems specific to cultivation facilities, (iii) process cooling systems and other climate control systems, (iv) air handling equipment and systems, (v) LED lighting, (vi) benching and racking solutions for indoor cultivation, (vii) automation and control devices, systems and technologies used for environmental, lighting and climate control, and (viii) preventive maintenance services for CEA facilities. Our customers include commercial, state- and provincial-regulated CEA growers in the U.S. and Canada as well as in other international locations. Customers are those growers building new facilities and those expanding or retrofitting existing facilities, with both ranging in size from several thousand to more than 100,000 square feet.

Historically, our revenue stream is derived primarily from supplying our products, services and technologies to commercial indoor facilities that grow cannabis, but we have served facilities growing other crops and we intend to pursue such facilities more in the future.

We have three core assets that we believe are important to our going-forward business strategy. First, we have multi-year relationships with customers and others in the CEA industry, notably in the cannabis segment. Second, we have specialized engineering know-how and experience gathered from designing environmental control systems for CEA cultivation facilities since 2016. Third, we have a line of proprietary and curated environmental control products, which we are in the process of expanding.

Historically, nearly all of our customers have been in the cannabis cultivation business. We believe our employees have more experience than most other MEP firms serving this industry. Our customers engage us for their environmental and climate control systems because they want experts to design their facilities, and they come to us because of our reputation. We leverage our reputation and know-how against the many local contractors and MEP engineers who collectively constitute our largest competitors.

The three key pillars of our corporate strategy for growing the Company and increasing shareholder value are:

1. Pursue Organic growth. We serve a market for the construction and expansion of controlled environment agriculture (CEA) facilities and businesses that is projected to grow at a 20%+ compound annual growth rate for the foreseeable future. Our primary vertical market of cannabis cultivation facilities has been joined by the similarly rapidly growing urban vertical farming market to create two market opportunity segments that we are positioned to serve.

In May of 2021 we announced a new strategy for our organic growth, which included:

New markets. Expanding our business development plan to pursue non-cannabis CEA facilities, at least doubling our total addressable market.

New products & services. Expanding our product offerings from primarily environmental control to now offer all of the primary technologies and services required in a CEA facility. Our primary objective in expanding our service and product offerings is to improve our customers’ operations and sustainability, increase customer acquisition, and enhance our revenue and revenue recurrence. Our expanded offerings now or will include: architectural design, lighting, benching and racking, HVACD, sensing & control systems, CO2 enrichment and control, water filtration & condensate reclamation, irrigation & fertigation systems, wastewater treatment, air sanitation, preventative maintenance and odor mitigation. In the last four months alone, we have seen a broadening of our booked contract pipeline to include offerings of architectural design, lighting, benching, HVACD, sensing & control systems, CO2 control, water reclamation, air sanitation and preventative maintenance.

New trade name. In May of 2021 we adopted the trade name Surna Cultivation Technologies instead of Surna Inc. because we believe that the new name will more clearly identify our business to prospects and make us easier to find on various social media and search engines. In January of 2022, Surna Cultivation Technologies LLC was formed and is a wholly owned subsidiary of CEA Industries Inc.

Customer Operations – first and foremost we seek to help our customers build the most effective and efficient facility possible. We believe that we are uniquely positioned to engineer all of the complex components of a CEA facility into a holistic whole because of our dedicated engineering staff and our experience including over 200 commercial facilities. Our 15 years in the business has provided us a wide network of technology vendors from which we curate a selection of the best products. In addition, we are the leading experts in applying the most challenging component of the technical infrastructure, the environmental controls, and we have the knowledge required to engineer the interactions among the required components. A professional engineer (PE) license is required for all MEP engineering work, and this engineering competence is one of our greatest strengths.

Sustainability – indoor cultivation facilities, like data centers, are resource intensive. Several U.S. states have implemented building code changes that place limits on the energy consumption allowed within cultivation facilities, and we anticipate that more states will do the same. Among our objectives is to provide our customers with the most energy-efficient alternatives for their infrastructure. Energy and resource efficiency is a high priority to us as engineers, and our most senior engineering staff hold the LEED (Leadership in Energy and Environmental Design) credential. Our CEO previously helped build a cleantech company, has been involved in the cleantech industry for over five years, and published a book on selling energy efficient technologies. We believe that we are in a position to lead the industry in sustainability initiatives which our customers will highly value.

Customer Acquisition – By offering Facility Selection & Design services we seek to build relationships with prospects at the earliest opportunity in the lifecycle of the cultivation business. By expanding our offerings to include nearly every piece of the technical infrastructure required in a facility we hope to engage at the earliest possible moment with the customer and earn the opportunity to provide all the products and services required for the facility. Our post-start-up, lifecycle services will help us maintain a relationship with the customer as long as the facility is in operation. Our observation is that our customers want to grow plants, not maintain the technical infrastructure of complex systems, and we believe that they will accept our offer to do so, as some already have.

Revenue and Revenue Recurrence – We believe that our revenue can be expanded by offering most of the primary technical infrastructure components for a cultivation facility. For example, if we are able to provide all of the primary infrastructure components to a cultivation facility, our revenue on a project could be up to 200% higher than if we provided the environmental controls systems alone. In the past we did not have products or services to offer our customers after a facility was constructed. We have recently begun to offer preventative maintenance services, and we believe that by expanding this service offering we will be able to gain long-term recurring revenue on a subscription basis.

2. Seek strategic relationships, mergers, and acquisitions to add to our existing business. We enjoy wide brand recognition in the cannabis cultivation industry because of our longevity in the market segment (15 years) and the number of cultivation projects (over 200 commercial projects) we have served. Our core expertise is engineering the environmental controls of these facilities, which is a sophisticated engineering challenge due to the high humidity (latent heat) and heat load (sensible heat) within these facilities. Not only are the loads high, but the environmental conditions within these facilities must be held closely within limits that the facility’s managers request. Engineering to meet these limits requires us to consider all of the primary components within the facility: lighting, irrigation, HVACD, fertigation, sensors, controls, CO2 dosing, monitoring and alarms, facility physical limits such as power availability, and energy consumption. We believe that the expertise gained in working with many of the primary components provides us with a uniquely well-informed view of the efficacy of the many primary components on offer in the marketplace. We further believe that this knowledge will help us make wise choices of which products to pursue for strategic relationships, and which providers to potentially merge with or acquire. For smaller component providers we believe that our publicly traded platform and our existing sales and marketing reach will make us an attractive partner.

3. Continue to Improve Our Profile and the Market for Our Securities We recognize that the costs of being a public company are substantial. However, we believe that a public currency offers a wider audience to support our story and partnership opportunities to build that story. With that goal in mind, we continue to build our public brand through public capital markets, and as part of that effort ((and as further discussed in Note 17 Subsequent Events in our consolidated financial statements below, we completed two capital markets transactions that we believe will benefit our current and future shareholders. First, effective February 10, 2022, trading of both shares of the Company’s common stock and certain of the Company’s warrants (which previously traded on the over-the-counter (OTCQB) market) commenced on the Nasdaq Capital Market (the “Uplist”). We believe an Uplist to the Nasdaq will contribute to our stock’s liquidity and offer a more visible and attractive equity currency to current and future investors. Second, effective February 15, 2022, the Company received net proceeds of approximately $22 million from the sale of 5,811,138 shares of its common stock together with 5,811,138 warrants (the “Offering”). We believe the Offering will provide immediate liquidity to help fund the Company’s growth strategy through both organic development and opportunistic acquisitions. We also believe the expansion of our investor base created by the Offering will enhance our overall audience and promote liquidity and strengthen the overall market for our securities.

Our revenue for the year ended December 31, 2021 was approximately $13,639,000 compared to approximately $8,514,000 for the year ended December 31, 2020, an increase of $5,125,000, or 57%. Overall, we had a net loss of approximately $1,338,000 for the year ended December 31, 2021 as compared to a net loss of approximately $1,759,000 for the year ended December 31, 2020, a decrease of $421,000, or 24%. Our 2021 adjusted net loss was $889,000 compared to a 2020 adjusted net loss of $1,239,000. Our adjusted net income (loss) is our GAAP net income (loss) after addback for our non-cash equity compensation expenses, debt-related items and depreciation expense. Historically, one of the most significant financial challenges we face is the inconsistent and unpredictable revenue we generate quarter-over-quarter, and our revenue and cash flow remain difficult to predict.

Impact of the COVID-19 Pandemic on Our Business

The COVID-19 pandemic has prompted national, regional, and local governments, including those in the markets that the Company operates in, to implement preventative or protective measures to control its spread. As a result, there have been disruptions in business operations around the world, with an impact on our business.

In response to the COVID-19 pandemic and the associated government and business response, the Company took and continues to take measures to adjust its operations as necessary. In early 2020 the Company responded to reduced orders by reducing expenses in an effort to preserve cash. Many expenses, including travel, marketing, headcount, work hours, and compensation were reduced, deferred, or eliminated while still allowing us to meet our customer obligations and develop new business. As 2020 progressed and our sales rebounded, and we were able to obtain additional funds through a forgivable bank loan, we restored our workforce and compensation. Many of these expense reductions were reversed by the end of 2021 when orders picked up and the overall business climate improved. Because the pandemic continues in different parts of the world and in different ways in the United States, the Company continues to actively monitor its operations.

We are experiencing unexpected and uncontrollable delays with our international supply of products and shipments from vendors due to a significant increase in shipments to U.S. ports, less cargo being shipped by air, a general shortage of containers, and domestic truck driver availability. While these delays have moderately improved in recent months, we, along with many other importers of goods across all industries, continue to experience severe congestion and extensive wait times for carriers at ports across the United States. In addition, restrictions imposed by local, state and federal agencies due to the COVID-19 pandemic have led to reduced personnel of importers, government staff and others in our supply chain. We have been working diligently with our network of freight partners and suppliers to expedite delivery dates and provide solutions to reduce further impact and delays. However, we are unable to determine the full impact of these delays and how long they will continue as they are out of our control.

While the Company is continuing to navigate the financial, operational, and personnel challenges presented by the COVID-19 pandemic, the full extent of the impact on our operational and financial performance will depend on future developments, including the duration and spread of the pandemic, the potential uncertainty related to and proliferation of new strains, and related actions taken by the U.S. government, state and local government officials, and international governments to prevent disease spread, all of which are uncertain, out of our control and cannot be predicted at this time.

Revenue. Our 2021 revenue was approximately $13,639,000. Our 2021 revenue represents an increase of 60% compared to 2020. One of our MFO customers accounted for 24% of our 2021 revenue. We believe, among other things, that we need to build a diversified sales pipeline of MFOs, which we believe will increase our consistency and predictability of revenue.

Gross Margin. Our 2021 gross margin was 21.5%, an increase from 18.2% in 2020. This increase was primarily due to our fixed cost base, offset by, a lower margin on equipment sales as described in Results of Operations below.

Profitability. Our 2021 adjusted net loss was approximately $889,000 compared to a 2020 adjusted net loss of approximately $1,239,000. Our adjusted net income (loss) is a key management metric and point of focus for us because it provides a proxy for the cash we generate from operations.

Capital Resources. The effects of the COVID-19 pandemic on our business presented major challenges for us in 2021 and we expect this to be a source of further uncertainty to our business. As discussed elsewhere in this Annual Report, we have taken steps during 2021 to focus on the Company’s core strategy and reduce our operating costs and general and administrative expenses to manage these challenges. We have also taken steps to address overall liquidity via the Offering (as further described in Note 16 Subsequent Events).

Nonetheless, there remain risks and uncertainties regarding our ability to grow revenue and generate sufficient revenues and cash flows. and there can be no assurances that we will be able to raise future capital on commercially reasonable terms, or at all.

Contract Bookings. Our bookings increased in 2021, and our backlog at December 31, 2021, was $10,818,000, an increase of $2,370,000, or 28%, from our December 31, 2020 backlog. During 2021, we had net bookings of $16,009,000, consisting of: (i) $13,543,000 of new sales contracts executed in 2021, (ii) $3,863,000 net positive changes orders, and (iii) $1,397,000 in project cancellations.

The following table sets forth: (i) our beginning backlog (the remaining contract value of outstanding sales contracts for which we have received an initial deposit as of the previous period), (ii) our net bookings for the period (new sales contracts executed during the period for which we received an initial deposit, net of any adjustments including cancellations and change orders during the period), (iii) our recognized revenue for the period, and (iv) our ending backlog for the period (the sum of the beginning backlog and net bookings, less recognized revenue). Based on the current economic climate and our cost cutting measures, there is no assurance that we will be able to continue to obtain the level of bookings that we have had in the past and or fulfill our current backlog, and we may experience contract cancellations, project scope reductions and project delays.

The completion of a customer’s new build facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for these customers to complete a new build project, which corresponds to when we are able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price tag and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays that are typical in completing any construction project.

As has historically been the case at each quarter-end, there remains significant uncertainty regarding the timing of revenue recognition of our backlog as of December 31, 2021. As of December 31, 2021, $411,000 of our backlog, or 4%, was attributable to customer contracts for which we have only received an initial advance payment to cover our engineering services (“engineering only paid contracts”). There are always risks that the equipment portion of our engineering only paid contracts will not be completed or will be delayed, which could occur if the customer is dissatisfied with the quality or timeliness of our engineering services, there is a delay or abandonment of the project due to the customer’s inability to obtain project financing or licensing, or the customer determines not to proceed with the project due to economic factors, such as declining cannabis wholesale prices in the state.

In contrast, after the customer has made an advance payment for a portion of the equipment to be delivered under the contract (“partial equipment paid contracts”), we typically are better able to estimate the timing of revenue recognition since the risks and delays associated with licensing, permitting and project funding are typically mitigated once the initial equipment payment is received. As of December 31, 2021, 96% of our backlog was attributable to partial equipment paid contracts.

We have provided an estimate in our consolidated financial statements of when we expect to recognize revenue on our remaining performance obligations (i.e., our Q4 2021 backlog), using separate time bands, with respect to engineering only paid contracts and partial equipment paid contracts. However, there continues to be significant uncertainty regarding the timing of our recognition of revenue in our Q4 2021 backlog. Refer to the Revenue Recognition section of Note 2 in our consolidated financial statements, included as part of this Annual Report for additional information on our estimate of future revenue recognition on our remaining performance obligations.

Our backlog, remaining performance obligations and net bookings may not be indicative of future operating results, and our customers may attempt to renegotiate or terminate their contracts for a number of reasons, including delays in, or inability to, obtain project financing or licensing or abandonment of the project entirely. Accordingly, there can be no assurance that contracts included in backlog or remaining performance obligations will actually generate revenues or when the actual revenues will be generated. Net bookings and backlog are considered non-GAAP financial measures, and therefore, they should be considered in addition to, rather than as a substitute for, our GAAP measures for recognized revenue, deferred revenue and remaining performance obligations. Further, we can provide no assurance as to the profitability of our contracts reflected in remaining performance obligations, backlog and net bookings.

Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain accounting policies are particularly important to the understanding of our financial position and results of operations and require the application of significant judgment by our management or can be materially affected by changes from period to period in economic factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In applying these policies, management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms of existing contracts, observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate. Actual results could materially differ from those estimates. For information regarding our critical accounting policies as well as recent accounting pronouncements, see Note 2 of our consolidated financial statements.

Our management has discussed the development and selection of critical accounting estimates with the Board of Directors and the Board of Directors has reviewed our disclosure relating to critical accounting estimates in this Annual Report. We believe the following are the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Allowance for accounts receivable. Accounts receivables are recorded at the invoiced amount or based on revenue earned for items not yet invoiced, and generally do not bear interest. An allowance for doubtful accounts is established, as necessary, based on past experience and other factors, which, in management’s judgment, deserve current recognition in estimating bad debts. Based on its review, we establish or adjust the allowance for specific customers and the accounts receivable portfolio as a whole. As of December 31, 2021, and December 31, 2020, the allowance for doubtful accounts was $181,942 and $165,098, 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 net realizable value. The inventory is valued based on a first-in, first-out (“FIFO”) basis. Lower of cost or net realizable value is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolescence or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for that inventory is established; subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. As of December 31, 2021, and December 31, 2020, the allowance for excess and obsolete inventory was $91,379 and $93,045, 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 Innovations 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, 2021 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, 2021, and December 31, 2020, we had an accrued warranty reserve amount of $186,605 and $173,365, 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, 2021, and December 31, 2020. Based on the available evidence, we believe it is more likely than not that we will be unable to utilize our net deferred tax assets in the foreseeable future. We intend to maintain valuation allowances until sufficient evidence exists to support the reversal of such valuation allowances. We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans. Should the actual amounts differ from our estimates, the carrying value of our deferred tax assets could be materially impacted.

Share-based compensation. We recognize the cost resulting from all share-based compensation arrangements, including stock options, restricted stock awards and restricted stock units that we grant under our equity incentive plan in our consolidated financial statements based on their grant date fair value. The expense is recognized over the requisite service period or performance period of the award. The service inception date is typically the grant date, but the service inception date may be prior to the grant date. Awards with a graded vesting period based on service are expensed on a straight-line basis for the entire award. Awards with performance-based vesting conditions which require the achievement of a specific company financial performance goal at the end of the performance period and required service period are recognized over the performance period. Each reporting period, we reassess the probability of achieving the respective performance goal. If the goals are not expected to be met, no compensation cost is recognized, and any previously recognized amount recorded is reversed. If the award contains market-based vesting conditions, the compensation cost is based on the grant date fair value and expected achievement of market condition and is not subsequently reversed if it is later determined that the condition is not likely to be met or is expected to be lower than initially expected. The grant date fair value of stock options is based on the Black-Scholes Model. The Black-Scholes Model requires judgmental assumptions including volatility and expected term, both based on historical experience. The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected term of the option.

Allocation of transaction price; standalone selling price. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the transaction price to each performance obligation based on standalone selling price. When estimating the selling price, we use various observable inputs. The best observable input is our actual selling price for the same good or service. For engineering services, we estimate the standalone selling price by reference to certain physical characteristics of the project, such as facility size and mechanical systems involved, which are indicative of the scope and complexity of the mechanical engineering services to be provided. For equipment sales, the standalone selling price is determined by forecasting the expected costs of the equipment and then adding an appropriate margin, based on a range of acceptable margins established by management. Depending on the nature of the performance obligations, we may use a combination of different methods and observable inputs if certain performance obligations have highly variable or uncertain standalone selling prices. Once the selling prices are determined, we apply the relative values to the total contract consideration and estimates the amount of the transaction price to be recognized as each performance obligation is fulfilled.

Remaining performance obligations. The revenue standard requires certain quantitative and qualitative disclosures about our remaining performance obligations, which are defined as performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period, including (i) the aggregate amount of the transaction price allocated to the remaining performance obligations, and (ii) when we expect to recognize as revenue with respect to such amounts on either: (x) a quantitative basis using appropriate time bands for the duration of the remaining performance obligations, or (y) by using qualitative information. Industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of our control, make it difficult for us to predict when we will recognize revenue on our remaining performance obligations. There are risks that we may not realize the full contract value on customer projects in a timely manner or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when we are able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the significant price and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays that are typical in completing any construction project. Further, based on the current economic climate, the uncertainty regarding the COVID-19 virus, and the Company’s recent cost cutting measures, there is no assurance that the Company will be able to fulfill its backlog, and the Company may experience contract cancellations, project scope reductions and project delays.

There is significant uncertainty regarding the timing of our recognition on all remaining performance obligations as of December 31, 2021. Customer contracts for which we have only received an initial advance payment to cover the allocated value of our engineering services (“engineering only paid contracts”) carry enhanced risks that the equipment portion of these contracts will not be completed or will be delayed, which could occur if the customer is dissatisfied with the quality or timeliness of our engineering services or there is a delay or abandonment of the project due to the customer’s inability to obtain project financing or licensing. In contrast, after the customer has made an advance payment for a portion of the equipment to be delivered under the contract (“partial equipment paid contracts”), we are typically better able to estimate the timing of revenue recognition since the risks and delays associated with licensing, permitting and project funding are typically mitigated once the initial equipment payment is received.

Commitments and contingencies. In the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of our business, that cover a wide range of matters, including, among others, customer disputes, government investigations and tax matters. An accrual for a loss contingency is recognized when it is probable that an asset has been impaired, or a liability has been incurred and the amount of loss can be reasonably estimated.

Results of Operations

Comparison of Years ended December 31, 2021 and 2020

Revenues and Cost of Goods Sold

Revenue for the year ended December 31, 2021 was $13,639,000 compared to $8,514,000 for the year ended December 31, 2020, an increase of $5,125,000, or 60%. This revenue increase was partly the result of our increased net bookings in 2021 which grew from $7,405,000 in 2020 to $16,009,000 in 2021, or 116%. Our revenue conversion is largely dependent on customer-centric factors—outside of our control—such as industry uncertainty, project financing concerns, the licensing and qualification of our prospective customers, and other reasons such as a challenging business climate including an overall post-COVID-19 economic downturn, which makes it difficult for us to predict when we will recognize revenue on our backlog.

Cost of revenue increased by $3,751,000 from $6,961,000 for the year ended December 31, 2020 to $10,713,000 for the year ended December 31, 2021. The factors impacting this change are discussed below.

The gross profit for the year ended December 31, 2021 was $2,926,000 compared to $1,553,000 for the year ended December 31, 2020. Gross profit margin increased by approximately 3 percentage points from 18.2% for the year ended December 31, 2020 to 21.5% for the year ended December 31, 2021. This decrease was primarily due to our fixed cost base, offset by a lower margin on equipment sales.

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 $1,342,000, or 9.8% of total revenue, for the year ended December 31, 2021, as compared to $1,167,000, or 13.7% of total revenue, for the year ended December 31, 2020. The increase of $175,000 was primarily due to an increase in salaries and benefits (including stock-based compensation) of $191,000, offset by a decrease of $16,000 in fixed overhead. The variable cost component, which represents our cost of equipment, outside engineering costs, shipping and handling, travel and warranty costs, totaled $9,371,000, or 68.7% of total revenue, in the year ended December 31, 2021, as compared to $5,795,000, or 68.1% of total revenue, in the year ended December 31, 2020. In the year ended December 31, 2021, as compared to the prior year, our cost of equipment increased by $3,821,000 primarily due to the increase in revenue and a decrease in our equipment margin of 4.9 percentage points. Additionally in the year ended December 31, 2021 as compared to the year ended December 31, 2020: (i) our travel costs increased by $82,000 and, (ii) our outside engineering costs increased by $38,000, which were offset by (iii) a reduction in warranty expense of $275,000, (iv) a reduction in excess and obsolete inventory expense of $39,000, (v) a decrease in other overhead of $28,000 and, (vi) decreased shipping and handling costs of $23,000.

Operating Expenses

Operating expenses increased by 25% from $3,916,000 for the year ended December 31, 2020 to $4,905,000 for the year ended December 31, 2021, an increase of $989,000. The operating expense increase consisted of: (i) an increase in selling, general and administrative expenses (“SG&A expenses”) of $567,000, (ii) an increase in advertising and marketing expenses of $342,000 and, (iii) an increase in product development expenses of $80,000.

The increase in SG&A expenses for the year ended December 31, 2021 compared to the year ended December 31, 2020, was due primarily to: (i) an increase of $327,000 in salaries, benefits and other employee related costs, (ii) an increase of $184,000 in internal commissions and third-party referral fees, (iii) an increase in investor relations of $109,000, (iv) an increase in loss on fixed asset disposals of $63,000, (v) an increase of $52,000 for facility and office expenses, (vi) an increase in travel of $12,000, (vii) an increase in accounting and other professional fees of $8,000, offset by, (viii) a decrease of $75,000 for bad debt expense, (ix) a decrease in stock based compensation of $56,000, and (x) a decrease of $56,000 in depreciation.

The increase in marketing expenses were due primarily to: (i) an increase in advertising and promotion of $131,000, (ii) an increase of $125,000 for industry trade shows and events, (iii) an increase in salaries and benefits of $102,000, (iv) an increase of $13,000 for travel, offset by (v) a decrease of $15,000 in outside marketing services, and (vi) a decrease of $13,000 for web development and other marketing expenses.

The increase in product development costs was primarily due to (i) an increase for consulting of $56,000, and (ii) an increase in material costs of $26,000.

Operating Loss

We had an operating loss of $1,979,000 for the year ended December 31, 2021, as compared to an operating loss of $2,363,000 for the year ended December 31, 2020, a decrease of $384,000, or 16%. The operating loss included $324,000 of non-cash, stock-based compensation expenses and $58,000 for depreciation and amortization in the year ended December 31, 2021, as compared to $406,000 for stock-based compensation and $114,000 of depreciation and amortization for the year ended December 31, 2020. Excluding these non-cash items, our operating loss decreased by $247,000.

Other Income (Expense)

Our other income (net) increased by $37,000 from $604,000 for the year ended December 31, 2020, to $641,000 for the year ended December 31, 2021. The other income for 2021 primarily consisted of (i) $517,000 for loan forgiveness, (ii) $138,000 for ERC credits, (iii) $66,000 in rental income from the sub-lease of a portion of our previous facility, (iv) a $16,000 gain on lease termination, (v) a $13,000 gain from a contract cancellation from 2018, offset by (vi) expense for a legal settlement of $107,000. The 2020 income was primarily due to loan forgiveness of $557,000 and income from a legal judgement of $35,000.

Net Loss

Overall, we had a net loss of $1,338,000 for the year ended December 31, 2021, as compared to a net loss of $1,759,000 for the year ended December 31, 2020, a decrease of $421,000. The net loss included $391,000 of non-cash, stock-based compensation costs and depreciation and amortization expense of $58,000 in the year ended December 31, 2021, as compared to non-cash, stock-based compensation expense of $406,000 and depreciation and amortization of $114,000 in the year ended December 31, 2020. Excluding these non-cash items, our net loss decreased by $351,000.

Liquidity, Capital Resources and Financial Position

Cash and Cash Equivalents

As of December 31, 2021, we had cash and cash equivalents of $2,160,000, compared to cash and cash equivalents of $2,285,000 as of December 31, 2020, a decrease of 5%. The $125,000 decrease in cash and cash equivalents during the year ended December 31, 2021 was primarily the result of cash used in our operating activities and cash provided by our financing activities. Our cash is held in bank depository accounts with certain financial institutions. We currently have deposits with financial institutions that exceed the federally insured amount.

On February 15, 2022, we received the net proceeds from the offering of shares of common stock and warrants to purchase common stock in the amount of $22,029,184.

As of December 31, 2021, we had accounts receivable (net of allowance for doubtful accounts) of $179,000, inventory (net of excess and obsolete allowance) of $378,000, and prepaid expenses and other of $1,274,000 (including $1,069,000 in advance payments on inventory purchases). While we typically require advance payment before we commence engineering services or ship equipment to our customers, we have made exceptions requiring us to record accounts receivable, which carry a risk of non-collectability, especially since most of our customers are funded on an as-needed basis to complete facility construction. We expect this exposure to accounts receivable risk to increase as we pursue larger projects.

As of December 31, 2021, we had no indebtedness, total accounts payable and accrued liabilities of $1,346,000, deferred revenue of $2,840,000, accrued equity compensation of $84,000, and the current portion of operating lease liability of $100,000. As of December 31, 2021, we had a working capital deficit of $415,000, compared to a working capital deficit of $2,220,000 as of December 31, 2020.

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

Because of the economic situation that developed during 2021, we cannot predict the continuing level of working capital that we will have in the future. Additionally, we cannot predict that our future financial position will not deteriorate due to cancelled or delayed contract fulfillment, reduced sales and our ability to perform our contracts.

Summary of Cash Flows

The following summarizes our cash flows for the years ended December 31, 2021 and 2020:

Operating Activities

We incurred a net loss for the year ended December 31, 2021 of $1,338,000 compared to a net loss for the year ended December 31, 2020 of $1,759,000. We had an accumulated deficit of $28,782,000 as of December 31, 2021.

Cash used in operations for the year ended December 31, 2021 was $3,207,000 compared to cash provided by operations of $818,000 for the year ended December 31, 2020, an increase in cash usage of $4,025,000. The increase was primarily attributable to: (i) an increase in cash used for working capital of $4,300,000, (ii) an increase in non-cash operating charges of $146,000, offset by, (iii) a decrease in net loss of $421,000. Significant non-cash items included: (i) a gain on note payable forgiveness of $517,000, (ii) stock-related compensation of $308,000, (iii) $68,000 for loss on disposal of assets, and (iv) depreciation and amortization expense of $65,000.

Investing Activities

Cash used in investing activities for the year ended December 31, 2021 was $57,000, compared to cash used in investing activities of $9,000 for the year ended December 31, 2020. The change was related to purchases of property and equipment.

Financing Activities

For the years ended December 31, 2021 and 2020, cash from financing activities was $3,139,000 and $554,000, respectively. Cash flows from financing activities during the year ended December 31, 2021, was the result of cash proceeds from the sale of preferred stock and warrants (net of issuance costs) of $2,625,000. Additionally, the Company entered into a note payable with its current bank in the principal amount of $514,000, for working capital purposes. During the year ended December 31, 2020, the Company entered into a note payable with its current bank in the principal amount of $554,000, for working capital purpose. See Note 8 – Note Payable and Accrued Interest.

February Common Stock Issuance

As more specifically addressed in Note 16 - Subsequent Events in our consolidated financial statements below, the Company was able to raise approximately $22 million through a sale of common stock and warrants. That transaction closed on February 15, 2022.

Capital Raising

Since inception, we have incurred significant operating losses and have funded our operations primarily through issuances of equity securities, debt, and operating revenue. As of December 31, 2021, we had an accumulated deficit of $28,781,566, a working capital deficit of $415,171, and negative stockholders’ equity of $3,570,533. On February 15, 2022, the Company issued 5,811,138 shares of its common stock together with 5,811,138 warrants for net proceeds of approximately $22 million. The Company issued a further 1,052,227 warrants to its placement agent: 290,557 in respect of their fees and 761,670 on the exercise of the substantial majority of the 15% overallotment available to them. The 290,557 warrants issued in respect of the placement agent’s fees vest after six months, have a term of 5 years and an exercise price of $5.1625. The 761,670 warrants issued in respect of the overallotment vest immediately, have a term of 5 years and an exercise price of $5.00.

We plan to use these funds to accelerate our organic growth through key employee hires and key investments in product development (such as our controls and preventative maintenance) as well as seek accretive growth through acquisitions and expand our geographic footprint.

Inflation

We have experienced and are likely to continue to face inflationary increases on the cost of products, which may adversely affect our margins. Management will continue to monitor inflation and evaluate the possible future effects of inflation on our business and operations.

Contractual Payment Obligations

Refer to Note 3 – Leases of our consolidated financial statements, which are included as part of this Annual Report for further details on our obligations under a lease for our manufacturing and office space.

Commitments and Contingencies

Litigation

The Company settled a litigation with a former employee effective March 30, 2021. While the Company disputed the merits of the claims, the Company agreed to issue an aggregate of 6,667 shares of common stock of the Company, as part of the settlement. These shares were issued on April 8, 2021, as “restricted securities,” subject to a lock-up agreement of six months, without registration rights, and pursuant to a private placement exemption. The settlement agreement also included mutual releases and no admission of liability. The cost to the Company of this settlement, $107,000, in total, has been recognized in full in Other Expenses during the year ended December 31, 2021. The issuance of the 6,667 shares of common stock (valued at $67,000) has been recognized in common stock issued during the year ended December 31, 2021.

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.

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, 2021, we had no off-balance sheet arrangements. During 2021 and 2020, we did not engage in any off-balance sheet financing activities.

Recent Developments

Refer to Note 16 - Subsequent Events of our consolidated financial statements, included as part of this Annual Report, for the more significant events occurring since December 31, 2021.

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.

Evaluation of Disclosure Controls and Procedures

Our management conducted an evaluation, with the participation of our Chief Executive Officer and our Principal Financial and Accounting Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, our Chief Executive Officer and our Principal Financial and Accounting Officer concluded that as a result of the material weakness in our internal control over financial reporting described below, our disclosure controls and procedures were not effective as of December 31, 2021.

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, 2021, 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, 2021:

The Company did not maintain effective controls over certain aspects of the financial reporting process because: (i) we lack a sufficient complement of personnel with a level of accounting expertise and an adequate supervisory review structure that is commensurate with our financial reporting requirements, (ii) there is inadequate segregation of duties due to our limited number of accounting personnel, and (iii) we have insufficient controls and processes in place to adequately verify the accuracy and completeness of spreadsheets that we use for a variety of purposes including revenue, taxes, stock-based compensation and other areas, and place significant reliance on, for our financial reporting.

We intend to take appropriate and reasonable steps to make the necessary improvements to remediate these deficiencies. We are committed to 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, 2021, remained unchanged from December 31, 2020. Management believes that the material weaknesses set forth above did not have an effect on our financial reporting for the year ended December 31, 2021.

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, 2021, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.