Kirsten Chapman - LHA Investor Relations Trent Doucet - CEO Stephen Keen - Director of Technology.

Analysts:.

Thank you for standing by. This is the conference operator. Welcome to the Surna's Second Quarter 2016 Conference Call. As a remainder all participants are in a listen-only mode and the conference is being recorded. [Operator Instruction] I would now like to turn the conference over to Kirsten Chapman. Please go ahead..

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 in 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, 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 additional fees, stricter operational guide 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 of CEO on June 30, and I am proud to be leading Surna at this exciting time in the market, in the company evolution.

During my brief tenure I have already worked with the team to fortify the foundation and create new opportunities for long term growth in shareholder value. I'll look forward to reviewing those with you today and in the future. Firstly, we’ve expanded our vision to leverage our priority technology.

Our goal is to become a leading provider of innovated products and solutions for indoor cultivations both, cannabis and food production, this vision defines our direction. My team and I had established the strategy that build 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 agricultures specializing in cannabis and expanding in the food growth production.

Developing energy-efficient y 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 align 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 [ph] for new and repeat business in companies mature to the point of expansion. Therefore we are empowering employees to deliver. During my time study in Surna, I’ve 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 insulation, which led to chillers being destroyed and the system having to be replaced.

As we guarantee our products we did the repairs for our customer which cost $455,000. This was fully incurred 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 improvements are our best long term interest, as is the warranty as it creating invaluable goodwill in the cannabis community. By leveraging our industry leading expertise and controlled environment climate control for growth of cannabis and similar plans 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 Clomezone owner Brian Lein [ph] has sued Surna’s climate-controlled equipment for over two years and cites the consistent quality of his crops as creating strong demand for Smokey Point production branded products.

While Clomezones operation is considered smaller with only 4,000 square feet of canopy, it is consistently among the top two percent of producers out of 700 in Washington State.

Lein [ph] us now advising Rolling Farms LLC, which is building a new 100,000 square foot cultivation facility that will be completely Surna equipped and grows the Smokey Point Productions brand. Surna and Rolling Farm’s general contractors signed a contract value at a $1 million.

Already we are well under-construction and operations are expected to begin in the few months. Additionally, we are working with several other repeat customers in Washington State and another customer with facility in Nevada and other regions.

Regarding new business, we are excited to have secured our first Hawaii contract as well as lands in Arizona, which we're also seeing increased activity. Expected innovation, we are improving our technology advances with our turnkey climate-controlled solutions, our breakthrough reflector and a revolutionary Hybrid Building.

Next we are evaluating extending our customer reach and lighting product 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 offer 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 in vertical gardens truly overlap with indoor cannabis cultivation, we have refined our mission to include indoor food production.

Fourth, our prioritizing developing energy efficient solutions for our customers, we enable them to cost effectively achieve consistent results and maximize production, this tentative has driven Surna's innovation which generated the reflectors and the Hybrid Building both which save energy, reduce waste and have been shown to increase volume and consistently a product.

Stephen will review our advantages in a few minutes. Fifth, optimizing our business, our single digit challenge in opportunities 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 has developed the products and services that will Surna's market leading position. In finance, we reduced cost and among other changes opted to use full time financial experts in derivatives, in SEC filings, in lieu of a full time resources.

In sales we are moving to a regional based sales model, combine with new training 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 are aware each state carries its own laws, time-tables, environmental concerns et cetera. Our new and improved team will be at the marijuana business daily in November in Los Vegas in full force.

Now I would like to review and comment on our market dynamics and relevant regulation updates in Q2 in this summer. In the process of establishing medically or adult use recreational market states [indiscernible] legalization, when approved they begin to establishing the protocols, administration and issue licenses.

This market development process seems to take about 18 to 24 months for states to become operational from medical marijuana. This can take less time on a state already has a medical program that extends to an adult use program.

As we witnessed in working with our customers over various selection cycles, producers and growers are beholding to the regulatory timeline and generally make cultivation equipment purchasing decisions towards the end of the licensing cycle. This trend is created a rather lumpy business cycle.

Last week the Federal government rejected requests to remove cannabis from the Schedule I drug list. This does not impact our near to mid-term opportunity at all. Demand is great and thankfully the Schedule I rating deters entries from established companies that are willing to work with the current system.

As I said demand is large and growing, a number of legalization initiatives have secured spots on ballots for November including adult used 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. The Louisiana agreed to a medical marijuana program and offered the university a search letter refusal [ph] on cultivation programs and both LSU and Southern universities accepted.

And Maryland approved its initial 15 medical cultivation licenses. Also Arizona announced it will award more than 30 million medical cultivation licenses. Another promising area of growth for Surna is an indoor food production market mainly vertical farming.

A recent study by indoor agriculture 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 industries are building commercial scale vertical and rooftop greenhouses in the U.S. 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 control innovation. I'm confident that our strategy will help us successfully navigate these dynamics and deliver great growth. With that I will turn the call over to Steve..

Thank you, Trent. Surna has been a long time pioneer in controlling environment agriculture. Our years of working with commercial cultivators in addition to hobby gardeners has built an invaluable web of knowledge that cannot be bought.

We will plot our data to develop our climate control solutions, cooling, lighting, air sanitation and dehumidification which amount to the innovation and key advantages. Firstly entire portfolio in both turnkey with a [indiscernible] architecture. The structure drastically reduces the potential for contamination to ensure sanitary environment.

In addition 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 loads can be dispersed among the others, while maintenance is been completed. Cultivators prioritize this safety features as it can save crops, time and money. [Indiscernible] offers significant benefits over other lighting systems.

They provide more light on target that increases yield and uses less energy and not only is this green, those could get a big cost saver. This summer we began shipping the reflector.

Our current products uses HPS line as it has been the first choice for most growers, but now we’re in the process of evaluating LED version for producers who prefer that type of lighting system. And we're very excited about the possibilities of LED.

We're also reviewing what purification technology which is another area with room for improvement in our industry. We've talked about the progress we're making on the Hybrid Building Design as well. Which brings an indoor cultivation facility and a greenhouse.

We will formally launch this turnkey solution for climate control 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 is a strong part of portfolio that delivers unique energy resource efficient solutions that enabled cultivator to crease highly specific environment providing the ability to control temperature, humidity, light and process in a way no other technology has.

Surna's products and technologies help reduce costs, maintained consistency and improved yield. We build our promising pipeline of innovations that will fuel our future growth. With that, I'll turn the call back to Trent.

Thanks, Steven.

So on to the 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 from derivatives and SEC filings and I am very confident on our ability continue to manage costs and all of our accounting detail.

On the call today. I'll provide a brief summary of recent results compare to the same period in 2015. So from the quarter of 2016 with the second quarter 2016, we reported total sales of $1.9 million. Year-over-year revenue increased by 13% or $1.7 million.

Sequentially revenue decreased from $2.5 million as Q1 in higher equipment sales reflect in the program we had in Oregon. We are encouraged to see Q2 service revenue increased over the Q1 and year-to-date revenue grew 72% or 1.4 million up from 2.5 million in the same period last year.

And looking ahead, we believe the hot summer [Indiscernible] have a positive impact on our sales. Q2 2016 cost of revenue was $1.6 million with the aforementioned $455,000 warranty charge of which 145,000 was made cash and remainder occurred in cash payment in Q3.

Q2 2015 gross margin which included the impact of warranty charge was 17% compared to 21% year ago excluding the warranty gross margin would have been almost flat compare to 44% in first quarter this year. Year-to-date gross margin included the impact of the warranty charge increased 32% compared to 21.1% 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 cost related to our reflector.

And while management continues to seek lower operating expenses in the percentage of revenue absolute expenses were expected to increase. Year-to-date operating expenses decreased to 1.3 million from 2.1 million in the same period of last year.

Q2 2016 operating loss was $299,000 including the $455,000 warranty charge as compare 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 same period last year. Q2 2016 net loss was $704,000 compared to $977,000 year ago.

Year-to-date net loss was 1.4 million or $0.01 per share compared to 2.4 million or $0.02 per share at the same period last year. Now turning to the balance sheet, cash was $303,000 at June 30, 2016 compare to $331,000 at December 31, 2015. Deferred revenue grew to $1.7 million at June 30, 2016 up from $1 million at yearend.

We are evaluating opportunities to further reduce our cost of capital and 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 [indiscernible] in December of 2016.

Overall, we continue to be committed to strengthening our balance to support profitable growth and increased 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 the completely new industry with our cannabis cultivation as well as into 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 to some form of legalization be it either medical or adult use for recreational in less than half of the other states.

Clearly growth will be exponential with additional popular states by California and Florida poised to enter the market.

The indoor agriculture conference organizers, founders and partners believe the addressable market size and the commercial scale indoor farms will grow to 17 times its current size, setting the industry up for billions of dollars growth as it matures.

Our vision is to become a leading provider of innovative products and solutions for indoor cultivation, specialize in cannabis and expanding into indoor food production. By creating a culture of connubiality, empowering our team and viewing the passion for excellence, we have reinvigorated the company.

We expect to achieve our outline goal and develop Surna into a dynamic global leader and innovator for the future. That concludes our prepared remarks. Kristen, please go ahead with any questions..

Thank you, Trent. Now for our first question.

Your [indiscernible] debt comes due December, what actions are you taking to ensure that you have the funds?.

So we are working with our lenders and others to evaluate certain options, and I am confident that we will have the resolution by December..

Thank you.

The next question is, how many reflectors have been shipped and is there a problem with the new lease deal? Do you have any other deals in the work?.

I’ll take that one Trent. The initial batch of reflectors have been shipped in Italy and those are being tested in the facility to terminate [ph] for any other changes that need to be make before we ship to many reflectors. But I think the delay is probably is starting to come an end..

I would like to add that we do have a large amount of outstanding proposals for reflectors. So we hope to see an increase on sales going forward for Q3 and Q4..

Thank you.

The third question is regarding, schedule one, how is the decision to leave cannabis classified as a Schedule I drug impact Surna?.

Yes, with the current legislation, there is more than enough growing demand to fuel our growth. Additionally, this deters large corporations who may have been eyeing to get on this market. So 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 revolved result?.

So the issue with the results of an improper installation by third party mechanical installer, the installer walked away from the situation and then rather that banning our customers, we have made the decision to fully support them and correct the situation.

We have also agreed to work jointly with customers to attempt the repeat the installs and responsible party to whatever mean is necessary. So this is fully resolve for the $435,000 all of which was expense for this quarter, $145,000 of which was paid in cash and the remaining will be incurred going forward..

Next question, why did Alan leave, was there a problem with the financial statements?.

So, please be confident, there was no problem with our financial statements. We've simply decided to take a different path to leverage its financial experts and derivatives in some SEC filings as well as to level his expertise of our in-house financing..

Next, question, why are you expanding into the food production, it seems honorable but premature as you're small company that’s yet to provide consistent top line growth and bottom line futility.

Can you elaborate please?.

There's a lot of similarities between indoor cannabis cultivation and indoor food production and many of the products that we develop for cannabis will work and can be sold right now into the food industry.

So, this simply just wideness basis [indiscernible], it allows us to sell our same products our emerging industry as well which is indoor food production..

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

No, well actually I was going to say as I’ve mentioned earlier we’ve open to acquiring specific technologies that complement our product line and that includes evaluating options used from 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 control climate of specializing lighting and stacked layered racks and some people believe that the market has the opportunity to be much large than the marijuana market..

Thank you.

Your final question was, you've net income for Q1 and a net loss for Q2, do you expect this trend going forward?.

Well, 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 then expanding into food production. Our team members have a renewed enthusiasm to achieve our goals. And I look forward to discussing with you for the next quarter..

Thank you, every one. This concludes our conference call for today..

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