CEA Industries Inc (BNC) 2016 Q2 法說會逐字稿

Thank you for standing by. This is the conference operator. Welcome to the Surna second-quarter 2016 conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded.

(Operator Instructions)

I would now like to turn the conference over to Kirsten Chapman. Please go ahead.

Good day everyone. Welcome to Surna's second-quarter 2016 financial results conference call.

This is Kirsten Chapman from LHA Investor Relations. On behalf of the entire Surna team up I would like to thank you for joining us today.

On the call are CEO Trent Doucet and director of technology Stephen Keen. After the prepared remarks we will address questions submitted via email. A transcript of this call will be provided on our website later this week.

Before beginning the call I will read statements that you can find at the bottom of every Surna press release. Statements on this call may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such words as anticipate, believe, estimate, expect, intend and similar expressions as they relate to the Company or its management identify forward-looking statements.

These statements are based on current expectations, estimates and projections about the Company's business based in part on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and risks and results probably will differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors including those described above and those risks discussed from time to time in Surna's filings with the Securities and Exchange Commission.

In addition, such statements could be affected by risks and uncertainties related to Surna's product demand, market and customer acceptance of equipment and other goods, ability to obtain financing to expand its operations, ability to attract qualified personnel, competition, pricing, development difficulties, general industry and market conditions and growth rates and general economic conditions. Any forward-looking statements speak only as of the date on which they were made and the Company does not undertake any obligation to update any forward-looking statements to reflect events and/or circumstances after the date of this release or interview.

The use, possession, cultivation and distribution of cannabis is prohibited by federal law. This includes medical and recreational cannabis. Although certain states have legalized medical and recreational cannabis, companies and individuals involved in this sector are still at risks of being prosecuted by federal authorities.

Further, the landscape in the cannabis industry changes rapidly. What was the law last week is not the law today and what is the law today may not be the law next week. This means that any time city, county or state where cannabis is permitted can change the current laws and/or the federal government can supersede those laws and take prosecutorial action.

Given the uncertain legal nature of the cannabis industry it is imperative that investors understand the cannabis industry is a high risk investment. A change in the current laws or enforcement policy can negatively affect the state and operation of our business, require additional fees, stricter operational guides and unanticipated shutdowns.

With that it's my pleasure to introduce Surna's Chief Executive Officer Trent Doucet. Please go ahead, Trent.

Thank you, Kirsten, and thanks everyone for joining us today. As you know I was honored to take on the mantle as CEO on June 15. I'm very proud to be leading Surna at this exciting time in the market and the Company's evolution.

During my brief tenure I've already worked with the team to fortify the foundation and create new opportunities for long-term growth and shareholder value. I look forward to reviewing those with you today and in the future.

First, we have expanded our vision to leverage our proprietary technology. Our goal is to become a leading provider of innovative products and solutions for indoor cultivation, both cannabis and food production. This vision defines our direction.

My team and I have established a strategy that builds upon our unique position as a pioneer in controlled environments. We will focus our efforts on the following key areas: delivering exceptional customer service and after sales support and development, innovating through R&D and acquisition of emerging technologies, redefining our brand to be a leader in controlled environment agriculture specializing in cannabis and expanding into food production, developing energy-efficient solutions that reduce our customer's production cost while providing consistent results and maximize production and streamlining Surna's business to maximize profitability and growth potential. These efforts along with the strategic priorities we set for 2016 which include expanding sales of core products including our water chillers and dehumidifiers, commercializing our Reflector products, demonstrating our hybrid building concept in pilot form and capitalizing on the positive trends in the regulatory environment and ultimately creating shareholder value.

Allow me to elaborate. First, ensuring exceptional customer service and support is the bedrock to strong referrals for new and repeat business when companies mature to the point of expansion. Therefore, we are empowering employees to deliver.

During my time studying Surna I have identified both strengths to promote and areas to improve. We have enhanced our customer education, follow-up processes and controls to reduce customer issues and increase productivity.

For example, protocol is not followed during the customer installation, which led to chillers being destroyed and the system having to be replaced. Since we guarantee our products we did the repairs for our customer which cost $455,000. This was fully accrued in the second quarter with $145,000 paid in cash in Q2 and the remainder will be paid in Q3.

Now our customers' education procedures have been updated to include additional inspection to mitigate similar situations. Clearly our improvement's on our best long-term interest as is the warrantee as it creates invaluable goodwill in the cannabis community.

By leveraging our industry-leading expertise in controlled environment climate control for growth of cannabis and similar plants we are building additional business via word-of-mouth from current customers. It is important to note each state has different regulations, some of which allow people to only own one facility. However, some of the top performers are consulting for other cultivators and producers.

For example, The Clone Zone owner, Brian Lade has used Surna's climate control equipment for over two years and cites the consistent quality of his crops as creating strong demand for his Smokey Point Productions brand of the products. While the Clone Zone's operation is considered smaller with only 4,000 square feet of canopy it is consistently among the top 2% of producers out of 700 in Washington state.

Lade is now advising Rolling Farms, LLC which is building a new 100,000 square-foot cultivation facility that will be completely Surna equipped and grow the Smokey Point Productions brand. Surna and Rolling Farms' general contractors signed a contract valued at $1 million. Already we are well into construction and operations are expected to begin in a few months.

Additionally, we are working with several other repeat customers in Washington state and another customer with a facility in Nevada and other regions. Regarding new business we are excited to have secured our first Hawaii contract as well as wins in Arizona which we're also seeing increased activity.

Second, innovation. We have proven our technology advances with our turnkey climate control solutions, our breakthrough Reflector and our revolutionary hybrid building.

Next, we are evaluating extending our customer reach and lighting product line with LED light variations. We are open to acquire specific technologies that complement our product line as well as fostering R&D. Stephen will elaborate.

This is part of a larger vision to be a full service provider that offers lighting, cooling, dehumidifying and maintenance in concert. This turnkey approach in equipment or building enables us to help our customers generate significant operating efficiencies for both cannabis and indoor food production.

Third, we are leveraging knowledge in controlled environment agriculture, our invested dollars and our innovation to expand our market opportunity. As indoor farming and vertical gardens truly overlap with indoor cannabis cultivation, we have refined our mission to include indoor food production.

Fourth, by prioritizing developing energy-efficient solutions for our customers we enable them to cost-effectively achieve consistent results and maximize production. This tenant has driven Surna's innovation which generated the Reflectors and the hybrid building, both which save energy, reduce waste and have been installed to increase the volume and consistency of product. Stephen will review our advantages in a few minutes.

Fifth, optimizing our business. Our single biggest challenge and opportunity is to accelerate growth that's profitable, consistent and achieved in a responsible way. While we run lean for an operating business this quarter we took actions to improve our Company alignment even further.

As previously noted, Stephen will focus on his passion and what he does best which is develop the products and services that will ensure Surna's market-leading position. In finance we reduced cost and among other changes opted to use full-time financial experts and derivatives and SEC filings in lieu of a full-time resource. In sales we are moving to a regional-based sales model.

Combined with new trainings and sales tactics we expect this to drive sales growth because each representative will be an expert in his or her other state. We believe this will be a game changer because, as you're aware, each state carries its own laws, timetables, environmental concerns, etc. Our new and improved team will be at the Marijuana Business Daily in November in Las Vegas in full force.

Now I'd like to review and comment on our market dynamics and relevant regulation updates in Q2 and this summer. In the process of establishing the medically or adult use recreational market states first vote on legalization. When approved they begin establishing the protocols, administration and issue licenses.

This market development process seems to take about 18 to 24 months for states to become operational for medical marijuana. This can take less time when a state already has a medical program and expands to an adult use program. As we have witnessed in working with our customers over various election cycles, producers and growers are beholden to the regulatory timeline and generally make cultivation equipment purchasing decisions toward the end of the licensing cycle.

This trend has created a rather lumpy business cycle. Last week the federal government rejected a request to remove cannabis from the Schedule 1 drug list. This does not impact our new to midterm opportunity at all. Demand is great and, frankly, the Schedule 1 rating deters entries from established companies that are willing to work with the current system.

As I've said, demand is large and growing. A number of legalization initiatives have secured spots on ballots for November including adult use recreational measures in California, Nevada, Maine, Massachusetts and Arizona as well as medical marijuana measures in both Florida and Arkansas.

Further into the lifecycle both Pennsylvania and Ohio recently signed a medical marijuana program into law and they're expected to be operational in two years time. Louisiana agreed to a medical marijuana program and offered the universities first right of refusal on cultivation programs and both LSU and Southern University has accepted. And Maryland approved its initial 15 medical cultivation licenses.

Also Arizona announced it will award more than 30 new medical cultivation licenses. Another promising area of growth for Surna is in the indoor food production market, mainly vertical farming. A recent study by indoor agricultural conference organizers, founders and partners determined the indoor agriculture sector has only met a fraction of its overall potential, which could end up at four times the size of the medical marijuana market.

It's noteworthy that local food demand was estimated to grow from $1 billion to $7 billion between 2005 and 2014. To address this market investors are building commercial scale, vertical and rooftop greenhouses in the US today.

At the time of the report publishing, the number was expected to grow from 15 indoor facilities to 45 by 2015. To do that, cultivators need energy-efficient climate controlled innovation. I'm confident that our strategy will help us successfully navigate these dynamics and deliver great growth.

With that about turn the call over to Stephen.

Thank you, Trent. Surna has been a longtime pioneer in controlled environment agriculture. Our years of working with commercial cultivators in addition to hobby gardeners has build an invaluable wealth of knowledge that cannot be bought.

We have applied our data to develop our climate controlled solutions, cooling, lighting, air sanitation and dehumidification which are known for their innovation and key advantages. First, the entire portfolio in both turnkey with a ductless architecture. This structure drastically reduces the potential for contamination to ensure sanitary environment.

In addition, the system reduces energy, uses less space and is easily scalable for the cultivators that are ready to expand. Our products are tailored to the commercial gardener versus the hobby gardener.

Regarding our chillers, we have built-in redundancy if one chiller goes out. The heat load can be dispersed amongst the others while maintenance is being completed. Cultivators prioritize this safety feature as it can save crops, time and money.

Our Reflectors offer significant benefit over other lighting systems. We provide more light on target that increases yields and uses less energy. Not only is this green, this can be a big cost saver.

This summer we began shipping the Reflector. Our current product uses HPS light, as it has been the first choice for most growers, but now we're in the process of evaluating an LED version for producers who prefers that type of lighting system. And we are very excited about the possibilities with LED.

We are also reviewing water purification technologies which is another area with room for improvement in our industry. We're excited about the progress we are making on the hybrid building design as well which blends an indoor cultivation facility and a greenhouse.

We will formally launch this turnkey solution for climate controlled buildings at the Marijuana Business Daily conference in November. Please visit us our booth to see the scale model constructed by the team of engineers from Colorado University.

Overall, Surna has a strong product portfolio that delivers unique energy resource efficient solutions that enable cultivators to create highly specific environments, providing the ability to control temperature, humidity, light and process in a way no other technology has. Surna's products and technologies help reduce cost, maintain consistency and improve yield. We believe our promising pipeline of innovations will fuel our future growth.

With that I will turn the call back over to Trent.

Thank you, Stephen. So on to a review of our financial statements.

First, I'd like to note that during the quarter we chose a new structure for our finance group. So rather than hire a full-time CFO we have hired consultants with expertise in derivatives and SEC filings. I'm very confident in our ability to continue to manage cost in all of our accounting detail.

On the call today I'll provide a brief summary of recent results compared to the same periods in 2015. So for the quarter of 2016, for the second quarter of 2016, we reported total sales of $1.9 million year-over-year revenue increased by 13% from $1.7 million. Sequentially revenue decreased from $2.5 million as Q1 had higher equipment sales reflecting the program ramped in Oregon.

We are encouraged to see Q2 service revenue increase over Q1. Our year-to-date revenue grew 72% to $4.4 million, up from $2.5 million in the same periods last year. And looking ahead we believe the hot summer months in Q3 will have a positive impact on our sales.

Q2 2016 cost of revenue was $1.6 million and included the aforementioned $455,000 warranty charge of which $145,000 was paid in cash and the remainder accrued for cash payment in Q3. The Q2 2016 gross margin, which included the impact of the warranty charge, was 17% compare to 21% a year ago. Excluding the warranty, gross margin would have been almost flat compared to 44% in the first quarter of this year.

Year to date, gross margin including the impact of the warranty charge increased to 32% compared to 21.1% in the same period last year. Q2 2016 total operating expenses decreased $614,000 compared to $1 million in the same quarter last year, reflecting our overall focus on cost containment, our reduction in advertising and the timing of R&D costs related to our Reflector. And while management continues to seek lower operating expenses as a percentage of revenue, absolute expenses are expected to increase.

Year to date, operating expenses decreased to $1.3 million from $2.1 million in the same period last year. Q2 2016 operating loss was $299,000 including the $455,000 warranty charge. This compares to a loss of $691,000 in Q2 of 2015.

Year to date, operating income was $66,000, improving from an operating loss of $1.6 million in the same period last year. Q2 2016 net loss was $704,000 compared to $977,000 a year ago. Year to date, net loss was $1.4 million or $0.01 a share compared to $2.4 million or $0.02 per share in the same period last year.

Now turning to the balance sheet, cash was $303,000 at June 30, 2016 compared to $331,000 at December 31, 2015. Deferred revenues grew to $1.7 million at June 30, 2016, up from $1 million at year-end. We are evaluating opportunities to further reduce our cost of capital or improve our access to capital.

We expect to optimize our overall liquidity position and are confident in our ability to address our convertible debt by its expiration in December 2016. Overall, we continue to be committed to strengthening our balance sheet to support profitable growth and increase shareholder value.

Before we review our questions I'll reiterate our opportunity and vision. We are very excited to be on the ground floor of a completely new industry with our cannabis cultivation as well as enter another emerging industry, indoor food cultivation. We believe the industries have unlimited potential.

For example, the sales for the cannabis industry have grown from $1.6 billion in 2013 to $5.4 billion in 2015 for some form of legalization, be it either medical or adult use recreational in less than half the other states. Clearly growth will be exponential with additional populous states like California and Florida poised to enter the market.

The Indoor Agriculture Conference organizers, founders and partners believe the addressable market size of the commercial scale indoor farms will grow to 17 times its current size, setting the industry up for billions of dollars of growth as it matures. Our vision is to become a leading provider of innovative products and solutions for indoor cultivation, specializing in cannabis and expanding into indoor food production.

By creating a culture of accountability, empowering our team and dealing with passion for excellence we have reinvigorated the Company. We expect to achieve our outlined goals and develop Surna into a dynamic global leader and innovator for the future.

That concludes our prepared remarks. Kirsten, please go ahead with any questions.

Thank you, Trent. Now for our first question.

Your [email] debt comes due in December. What actions are you taking to ensure that you have the funds?

So we're working with our lenders and others to evaluate certain options and I'm confident that we will have a resolution by December.

Thank you. The next question is how many Reflectors have been shipped and is there a problem with the New Leaf deal? Do you have any other deals in the works?

I will take that one, Trent. As the initial batch of Reflectors has been shipped to New Leaf and those are being tested in the facility to determine if there are any other changes that need to be made before we ship the remaining Reflectors. But I think the delays are finally starting to come to an end.

And I'd like to add that we do have a large amount of outstanding proposals for Reflectors. So we'd hope to see an increase in our sales going forward for Q3 and Q4.

Thank you. The third question is regarding Schedule 1. How is the decision to leave cannabis classified as a Schedule 1 drug impact Surna?

With the current legislation there's more than enough growing demand to fuel our growth. Additionally, this deters large corporations who have may have been eyeing the cannabis market to hold off for the reclassification. And, obviously, minimal competition is clearly beneficial for Surna.

The next question is please review the warranty issue and has this been fully resolved?

So the issue was the result of an improper installation by a third-party mechanical installer. The installer walked away from the situation and rather than abandoning our customers we made the decision to fully support them and correct the situation.

We have also agreed to work jointly with our customer to attempt to recoup these costs from the responsible party through whatever means necessary. So this is fully resolved for the $455,000, all of which was expensed for this quarter, $145,000 of which was paid in cash and the remainder will be accrued going forward.

Thank you. Next question.

Why did Ellen leave? Was there a problem with the financial statements?

So please be confident there is no problem with our financial statements. We've simply decided to take a different path to leverage financial experts and derivatives and SEC filings as well as to leverage the expertise of our in-house finance team.

Next question, why are you expanding into food production? It seems honorable but premature as you are small Company that has yet to provide consistent top-line growth and bottom-line facility? Can you elaborate please?

I'll take that one, Trent. There's a lot of similarities between indoor cannabis cultivation and indoor food production.

Many of the products that we develop for cannabis will work and can be sold right now into the food industry. So this is simply just widens the base of sales and allows us to sell our same product to an emerging industry, as well, which is indoor food production.

Thank you. The final question -- did you have anything else to add?

No, well, actually what I was going to say as I mentioned earlier we're open to acquiring specific technologies that complement our product line and that includes evaluating options used in the indoor food production industry which is being cited by experts as one of the most promising fields in agriculture these days. So vertical farming entails growing crops in controlled climates with specialized lighting and stacked layered racks. And some people believe that the market has the opportunity to be much larger than the marijuana market.

Thank you. Your final question was you had net income for Q1 and a net loss for Q2. Do you expect this trend going forward?

Well, while we don't provide guidance I can comment on history and trends. Q2 was impacted majorly by the warranty. I think going forward we expect our strict cost management will help us achieve our goal and as I've stated earlier we believe sales related to the hot summer months will fuel growth for the third quarter.

Thank you very much. Do you have any closing comments?

Yes, our vision is to become a leading provider of innovative products and solutions for indoor cultivation, specializing in cannabis and expanding into food production. Our team members have a renewed enthusiasm to achieve our goals and I look forward to discussing with you further next quarter.

Thank you everyone. This concludes our conference call for the day.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.