CEA Industries Inc. Common Stock (BNC) Q1 2016 Earnings Report, Transcript and Summary

Good day, everyone. Welcome to Surna's First Quarter Financial Results Conference Call. This is Kirsten Chapman from LHA Investor Relations. At this time, all participants are in listen-only mode. On behalf of the entire Surna team, I would like to thank you for joining us today. On the call are Stephen Keen, CEO; Trent Doucet, COO; and Ellen White, CFO. After the prepared remarks, we will address questions submitted by email. A transcript of this call will be provided on our Web site later this week. Before beginning the call, I will read statements that you can find at the bottom of every press release: Statements on this call that may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as anticipate, believe, estimate, expect, intend and similar expressions as they relate to the company or its management identifies 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 results may, and 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 its equipment and other goods, ability to obtain financing to expand its operations, ability to attract qualified personnel, competition, pricing, and development difficulties, and 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 are made, and the company does not undertake any obligation to update any forward-looking statement to reflect events and/or circumstances after the date of this release or interview. The use, possession, and 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 risk of being prosecuted by Federal authorities. Further, the landscape in the cannabis industry changes rapidly, what was law last week is not the law today, and what is the law today may not be law next week. This means that at any time the City, County or State where cannabis is permitted can change the current laws and/or the Federal government can supersede those laws and take prosecutorial actions. Given the uncertain legal nature of the cannabis industry, it is imperative that our investors understand that the cannabis industry is a high risk investment. A change in the current laws or enforcement policy can negatively affect the status and operation of our business; require addition fees, stricter operational guidelines and unanticipated shutdowns. With that, it's my pleasure to introduce Surna's Chief Executive Officer, Stephen Keen. Please go ahead, Stephen.

Thank you Kirsten, and thanks everyone for joining us today. We're excited to update you about Surna. When I assumed the role of CEO, I focused the company on developing proprietary technology, innovating compelling products, and writing the infrastructure. I believe we have accomplished that. In the first quarter of 2016, we nearly tripled our revenue over last year, and reporting operating income for the first time in the company's history. We also continue to advance our products, strengthen our business, and involve our go-to-market strategy in the constantly growing controlled environment agricultural markets, and more specifically, the cannabis market segment. I'll briefly review the actions we've undertaken in 2015 and through the beginning of 2016 to ensure Surna captures opportunities that drive revenue, growth, profitability, and shareholder value. It's important to note, we differentiate Surna by offering a complete cultivation package, as well as individual component that improves yield, reduce risk of contamination, save energy, and lower operating costs for cannabis producers. We continue to make progress in our innovation. We invest our efforts to commercialize our R&D, including the rollout of the reflector products. We strengthened our intellectual property. Our reflectors product's design patents have been granted and other patents are pending. And we have released the first images of our proprietary Hybrid Building's plan. It was the turnkey solution for climate controlled buildings as a mix of indoor cultivation facility and Greenhouse. Now, we're working on introducing this ground-breaking technology to the industry. We also continue to improve operations. We implemented new supplier agreements that enable us to better monetize our service components. Additionally, we employed measures to ensure better quality production, which is improving customer satisfaction and reducing overall costs, and we enhanced our leadership team. Ellen White joined as our new CFO, and has improved our internal controls and protocols. Bryan Merritt is our new General Manager, and has significant management experience in the technology sector, including the development and deployment of technology to our team. When I became CEO, it was my intention to ride the ship and identify the best person to commercialize our products. I reached out to Trent, who I've known for 20 years and I've seen build successful company. He's been an entrepreneur and a management consultant in the technology industry since 1999, and his experience spans from technology disciplines such as post software, file computing, and manage the IT services to industries including aviation and in manufacture of environmentally-friendly consumer products. Trent began advising Surna in April of 2015, and was hired as COO in November of 2015, and was appointed Director shortly after. And you saw in the press release earlier today, the Board named Trent to succeed me as CEO. During his tenure with us, Trent has already demonstrated his ability to lead, and his dedication to Surna's success. I trust him implicitly with my investments. Over the next 60 days I'll work with Trent in managing this important transition. I will remain with the company focused on Surna's innovation and product development. As a Founder, I'm extremely passionate about Surna and our differentiating technology. I'm fully committed to capturing our very exciting opportunity. With that, I'll turn the call over to Trent.

Thanks, Steven. I'm truly excited to be part of such a talented and dedicated team. Under Steven's leadership, we took some very important steps to strengthen our operational foundation, advance our technology leadership, and focus our strategy. I am honored and humbled by the opportunity to lead the company into its next stage of growth. Our overarching pain [ph] for 2016 is focused execution and continued improvement. Our strategic priorities are expanding sales of core products including our water chillers and dehumidifiers, commercializing our central reflector products, demonstrating our Hybrid Building concept in pilot form, capitalizing on the positive trends in the regulatory environment, and ultimately advancing our strategy to create shareholder value. Let me review our recent progress. Our commercial chillers, air handlers, dehumidifiers, and air sanitizers are all optimized for the indoor grow environment. They offer our customers state-of-the-art technology to provide ideal solutions to enhance the performance of their facilities. Late in 2015, we improved our supplier relationships, both expanding our overall capacity and lowering production costs. As a result, we reduced our cost of goods sold. Furthermore, we laid the groundwork to expand our engineering and consulting services. We are accelerating the commercialization of our Surna reflector. The reflector delivers highly differentiated technology that we believe will lead the way of energy-efficient cultivation. We offer three patent pending models including vented fan cooled, and water cooled. The reflector offers both improved sliding [ph] and thermodynamic characteristics, in addition to providing more direct light, or light on target which delivers higher production yields. The products features also translate into lower energy costs for the operators. In fact, we estimate the total costs of the Surna reflector can be recovered within the first year of installation. During the quarter, we received four new U.S. design patents for our reflector products, which demonstrates the uniqueness of our technology and furthers our efforts to bring innovation to the cannabis cultivation industry. Last fall, we received our first purchase order from New Leaf for over 400 reflectors. New Leaf recognizes the long-term benefits of our technology and is excited to be our first adopter. We believe a commercial facility of this magnitude will be an optimal venue for our first installation as we can carefully manage protocol and scale. As typical with any new construction, there have been delays, and New Leaf asked that we postpone delivery. We continue to believe it will be in the company's best interest to conduct our first installation with New Leaf. Therefore, we devoted this time to improve protocol and further advance the reflector by incorporating an interactive control system that will allow for facility temperature control using the cooling power of the reflector itself. We expect to begin shipping reflectors this quarter, and believe the installation will provide important validation of our products and technology. One of our long-term initiatives is to offer cultivators a turnkey package for building and operating their facilities, and what we call, our Hybrid Building Design, which is in complete engineered environment optimized for energy efficiency that combines the best qualities of the Greenhouse and that of an indoor cultivation facility. We work closely with our senior engineering team at the University of Colorado in designing a scale model that demonstrates the unique features of the building, including proprietary ceiling structure which allows for sunlight to reach plant cannabis and the sealed environment which minimizes the negative effects of outside air contamination such as pest and pathogens. The Hybrid Building was designed to optimize cost savings, which is a hallmark of Surna's technology solutions. We envision selling to operators who want to start extremely productive, cost efficient, and energy saving cultivation facilities. We are evaluating partners for the development of the first Hybrid Building. After we select a partner, we would then assist in the construction of their facility using our proprietary technology. Once completed, this first Hybrid Building would serve as an invaluable demonstration of our packaged offering, enabling potential customers to see how each of our products and technologies work individually, as well as a unit. We expect this will be a key differentiator for Surna, as we will be the only technology company to offer this completely engineered energy-optimized and field cultivation environment. Turning to review of the regulatory environment, we are seeing public sentiment and Federal and State laws involved in our favor. For example, the DEA has recently approved the first-ever trial of medical marijuana as a treatment for PTSD for veterans. Pennsylvania became the 24th state in the country to legalize medical marijuana. Additionally, the Federal government is evaluating de-scheduling cannabis with the status equal to that of prescription drugs. This is very exciting. However, it is important to remember the go-to-market cycle is also long as there is always a lag time from voting to state implementation to sales. The key to this trend of increasing legalization and production of both medicinal and recreational marijuana is its impact on the price for cannabis. Seasonally, we expect to continue to see cannabis prices fluctuate with weather, particularly as summer heat can dramatically increase air conditioning costs. However, following general macroeconomic theory, over time we expect the cost per gram to decrease. This pricing pressure will require cultivators to lower cost production. We believe Surna has a significant advantage for the product and technologies we specifically developed to improve performance while reducing cost associated with the cultivation of cannabis. This provides us with an important first-to-market advantage and a key competitive differentiator. Now, I'd like to hand the call to Ellen for a review of our financials.

Thank you, Trent. Our financial results for the quarter are beginning to demonstrate our efforts. We reported gross revenues of $2.5 million, up from $819,000 in the first quarter of 2015. Foremost, our sales momentum is increasing. Additionally, the price adjustments made last fall, including those for engineering services are starting to be reflected in our top line. Also during the fourth quarter, we adjusted our policy to ship only upon receipt of payment. This improved the collectability of accounts receivables, and created some pent-up demand at December 31. We are working to drive ongoing revenue growth. However, we expect to see similar seasonal revenue effects with increases in the summer months and a slight drop-off in the cooler months when air conditioning is not top of mind. I will compare our expenses to the first quarter of 2015. Cost of good sold was $1.4 million compared to $731,000. Gross profit was $1.1 million compared to $88,000 and gross margin reached 43.6%, up from 10.8%. Improvements in the first quarter 2016 reflects several factors, we benefited from our new pricing schedule, better terms with vendors for large chillers, as well as to outsource production of our 25-ton chillers and a number of large high margin deals during the quarter. We expect margins will fluctuate based on product mix and where the product is and its lifecycle. Total expenses were $724,000 compared to $968,000 in the first quarter of 2015. Advertising and marketing expenses were $14,000 down compared to $31,000 reflecting prioritization and cost management. Advertising and marketing expense is expected to increase in the second half of the year when we have more large tradeshows. Product development costs decreased to a $106,000, compared to $181,000 as the reflector moved from R&D to production. SG&A expenses were reduced to $604,000, compared to $756,000 as management improved operating efficiencies, reduced personnel costs, and focused on cost containment. Overall, we plan to maintain a streamlined cost structure, while ensuring we continue to invest in our growth. As such, we will continually evaluate initiatives that best align our resources with our gross objectives. This includes reassigning, and reducing certain staff, while also looking to hire for key roles. Operating income of $365,000 improved $1.2 million, from an operating loss of $880,000 in the first quarter of last year. Net loss was $746,000 or $0.1 per share, compared to $1.4 million or $0.1 per share in the first quarter of 2015. We recorded a non-cash derivative mark-to-market charge of $422,000 in the first quarter of 2016, compared to a gain of $48,000 in the first quarter of 2015. Now turning to our balance sheet, cash, with $1.1 million at March 31, 2016, compared to $331,000 at December 31, 2015. For the respective periods, inventory improved to $1.1 million, down from $1.3 million, and accounts payable also improved to $1.8 million, down from $2.1 million. Deferred revenue was $1.4 million, up over 40% compared to $986,000 in the first quarter of 2015. As a reminder, deferred revenue represents contracts that are in progress, as the company recognizes revenue as products are shifted where services are performed. Looking ahead, we are committed to further strengthening our balance sheet to support profitable growth and increase shareholder value. We continue to evaluate and pursue opportunities to further reduce our cost of capital, improve our access to capital, and optimize our overall liquidity position. Now, I will turn the call back to Trent.

Thanks Ellen. Surna is focused on creating shareholder value by being the leading technology company, engineering state-of-the-art equipment for controlled environment agriculture, with special expertise in cannabis, and we are making progress with increased sales, improved operations, and industry recognition. In December, The Denver Post recognized Surna with the Cannabis Innovation Award. And in April, the University of Colorado Boulder Annual Spring Design Expo gave the Peoples' Choice Award to the team that built the Surna hybrid building model. Our priorities are to expand sales, commercialize R&D, and capitalize on our market opportunity. To this end, we will attend a number of industry trade shows, including the NCIA Cannabis Business Summit held in June, in Oakland, California, and the Marijuana Business Daily Conference, in November, in Las Vegas. In summary, Surna has established a reputation for creating unique energy and resource-efficient solutions that allow cultivators to easily meet the highly specific demands of cannabis cultivation environment. Our products and technologies help cultivators control temperature, humidity, light, and process in a way no other technology can. We believe we have a strong product portfolio, along with a promising pipeline of innovations that will fuel our future growth. In addition, as we look to advance our technology and leadership position, we will continually invest in developing next-generation technologies and products. That concludes our prepared remarks. Kirsten, would you mind fielding the questions?

Thank you, Trent. Now for our first question; why is it taking so long to get reflectors to the market? Are you selling any now? Will you make the revenue guidance that you gave in August 2015, of over $7 million from reflectors in 2016?

That's a good question. I think the guidance you mentioned was provided by the prior management team last summer. And since then, we've installed a new management team. At this time we will not provide guidance for several different reasons. We're commercializing product lines in an emerging industry, and we expect orders to ebb and flow. And furthermore, installations are relying on construction that was frequently delayed, and leads to requests to postpone delivery. Example of that would be our New Leaf order was delayed. While we could've aggressively pursued a replacement for the initial order, we choose to use the time to improve our product and maintain our mutually beneficial relationship with New Leaf. We believe an installation of a commercial facility of this magnitude enables us to test and manage protocol and scale. We expect to begin shipments this quarter. As you can see from our first quarter results, we're making great progress. Our revenue nearly tripled from last year's, and we delivered operating income for the first time in the company's history.

Well, congrats on the operating income. Should we expect it to continue?

Ellen, would you like to take that?

Sure. Thank you. We were pleased to deliver operating income this quarter. This reflected sales momentum, favorable product mix, and the benefit of our cost-containment program. We do expect future results to be somewhat erratic, as there are factors outside of our control, such as legislation. Other factors that cause results to fluctuate include timing of shipments, seasonality, quarterly product mix, and our investments in sales, marketing, and R&D.

Thank you. The next email asks, can you comment on competition?

Stephen, you want to take that?

Sure. Our industry is fragmented with many local HVAC providers selling to our industry. We continue to see HVAC companies in our chiller and dehumidifier market fighting companies in the reflector market, and real-estate agents in the building market. None of them have our expertise in cannabis, which gives us a huge advantage. For example, our chillers and dehumidifiers are energy-optimized for cultivation and make redundancy easy. On the other hand, air conditioners are made for comfort cooling, not year-round use. They do a poor job of dehumidification and heat-removal. Essentially, our products are more reliable, more cost-effective, and energy-efficient, resulting in higher yield and greater cost savings.

Okay. [Indiscernible] investor wants to know what does the sales pipeline look like, is the company working off of backlog, or is it book and ship?

That's a good question. Our sales pipeline is increasing, and we're working to drive growth. We're in the process of improving our sales organization. We continue to attend trade shows, and are getting great feedback. Also, we're expanding from the hobbyist to the commercial market. As we engage in bigger deals, our sales cycle is lengthening as we engage. While we are a contract-to-manufacture business, we do have a bit of a backlog. Most notably, of course, is our purchase order for the 400 reflectors that we expect to begin shipping this quarter to New Leaf.

Okay, great. Next question is what is the geographic customer concentration?

Ellen, you want to take that?

Thanks, Trent. Our sales definitely follow the path of legalization. The vast majority are in the U.S., and we have a small number of customers in Canada, as well as a few in Europe.

Okay. An investor would like you to review the status of the Hybrid Building.

So we're really excited about the hybrid building, and it's receiving a lot of interest today. As discussed, we intend to use the first hybrid building as a pilot for prospects. So to do this right, we need to be methodical, and pick the right partner. The plan is for Surna to be involved in the construction, most likely with certain team members, including Stephen to be on-site. This way we can ensure protocols are followed to support the success of our customers, and of Surna. Stephen, do you want to add anything?

Yes, I mean, I'm extremely excited about the hybrid building project, I mean, just to say the least. It's the only design of its kind. We took the best of both worlds, and combined them for the best growing environment possible for cannabis. They use the sun as its primary light source, and high-powered LEDs as supplemental lighting. It's completely climate-controlled and sealed off from outside contaminants, and also contains disorders [ph], because of that we can officially add CO2 to increase production by up to 30%. It also incorporates a complete water reclamation system, making it an option for food production in drought-stricken areas of the world. The production estimate for a 15,000-square-foot entry-level facility is 5000 pounds a year. Increasing the building to only 22,000 square feet should double that production, but doesn't double the cost of the building. Other companies claim to have their own version of our hybrid facility, but I can assure you the technologies are vastly different in the way we supplement lighting in our proprietary thermal management strategy. We believe no other hybrid facility will come close to the energy efficiency of our design.

Okay, thank you. The last question came in. Stephen, why are you leaving so quickly after becoming CEO?

And I'm happy to answer this question. As a cofounder, I have everything invested into this company. We have many people that work for Surna that are dependent on our success, which we don't take lightly. Most recently, I took the role of CEO, because I didn't like the direction the company was headed, and I was concerned about our future. This is a sacrifice for me, as my passion is creating and building new products. I'm still like CEO is the best value I can bring to Surna. I'm a hands-on guy that understands cannabis cultivation in a way that few people do in the world. I understand the needs of the plant, and I also understand the mechanics of cultivation facility. That's what really sets on our part. I brought Trent in last year to run the company. He needed me to take the role of CEO that he could have the opportunity to correct operations first, and also learn about the industry. I've known Trent for 20 years, I trust him completely with my investments. I watched him operate within Surna for months, and my confidence with him is higher than ever. I'm looking forward to working under his leadership. I set the goal of operational profitability before I was ready to pass the torch. Now that we have achieved this, which is a huge step for the company, I need to get back to what I do best, come back to what I love.

And Keen, that was our last question, I will turn the call back to you.

Okay. Well, thanks again for your agendas today. We appreciate your continued support, and we're very excited about our progress and our opportunities, and look forward to speaking with you again soon. Have a good day.