Good afternoon, ladies and gentlemen. And welcome to the Surna Inc. Q3 2019 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments after the presentation. [Operator Instruction] It is now my pleasure to turn the floor over to your host, Tony McDonald.

Sir, the floor is yours..

Thank you and good afternoon. Welcome to Surna's third quarter 2019 earnings call. I'm Tony McDonald, the company's CEO. And I am joined today by Tim Keating, the company's Chairman, who will participate in our session today. Please refer to our investor presentation, which you can see on this webinar.

This presentation, together with our Investor Fact Sheet, has been filed with the SEC and is also available at the Investor Relations section of our website at www.surna.com. Before beginning I want to remind all listeners that they can sign up to be on our email distribution list by visiting www.surna.com/investor-relations.

This is the way to keep current on Surna news development and SEC filings. Before we begin, please be advised that this call may contain statements of a forward looking nature relating to future events. These forward-looking statements are subject to the inherit uncertainties in predicting future results and conditions.

These statements reflect our current beliefs and a number of important factors could cause actual results to differ materially from those expressed in this call, including the risk factors set forth in our Form 10-K, which we filed with the SEC in March.

Please refer to our SEC filings for more detailed discussion of the risks and uncertainties associated with our business. Please note that we filed our quarterly report and issued a press release announcing third quarter financial and operating results on November 12, 2019.

These documents can be found at our website at www.surna.com/investor-relations. While we will highlight some key information contained in the press release and the quarterly report, the primary purpose of this call are to articulate the progress we are making on our key operating metrics and strategic plans and to answer your questions.

Please now refer to the year-to-date report milestones achieved slide, which is on page three of our presentation. We are pleased to report that we achieved record revenue and net income in the third quarter, surpassing the previous records from last quarter. These are the highlights.

We had $5.5 million in quarterly revenue, a 31% increase from last quarter’s $4.2 million. Our gross profit margin was 28.6% compared to 34.4% last quarter, as we took advantage of some larger opportunistic sales. However year-to-date, our gross margin was 30.6%, which is 3.5 percentage points higher year-over-year compared to 2018.

We earned net income of $222,000, our first ever back-to-back quarters of positive net income. We also had $2.0 million in cash at quarter end, a slight increase from prior quarter end. And importantly, we reduced our working capital deficit to $771,000, a decrease over the last six months of $857,000.

We continue to focus on two key financial metrics, revenue growth and profitability. Let me make a couple of comments about our new product achievements over the first nine months. I am especially proud of the successful launch of our SentryIQ sensors, controls and automation platform. We have already sold seven SentryIQ projects for nearly $700,000.

This will be the foundation of our drive for technological innovation in 2020 by wrapping our platform around other growing systems such as lighting and fertigation, and creating the ability for remote access for our customers.

Our other new product introduction for 2019 are new custom designed, ducted air handling units geared to our larger facilities has become a resounding success. Year-to-date, we have sold $2.3 million of these units, which account for 20% of our revenue.

We have several other R&D projects in the works, which we hope to launch and share with you in 2020. Please now refer to the operating results slide on page four, which shows our income statements for the three and nine months ended September 30, 2019, and 2018. These are our year-to-date highlights.

Our year-to-date revenue was $11.5 million compared to $7.4 million in 2018, an increase of 56%. Our year-to-date gross profit margin was 31% compared to 27% in 2018, an increase of 4 percentage points. Our year-to-date loss was $539,000 compared to a prior period net loss of $3.9 million, a decrease of 86%.

I'm also pleased to report that we have turned an important corner having achieved a first time year-to-date adjusted net income of $247,000 compared to a prior period adjusted net loss of $1.8 million, a decrease of 114%.

Our adjusted net income, a key management metric for us is our GAAP net income after add back for our non-cash equity compensation expenses, depreciation expense and any debt related costs. Bottom line, we are operating at cash flow breakeven for the first time. Now turn to page five which illustrates our key financial metrics.

We are focused on four metrics, revenue, gross margin, operating income or loss and cash. With eight quarters results you can see the positive trends that have developed, especially over the last two quarters. Our third quarter revenue of $5.5 million was another quarterly record.

This includes $3.9 million recognized from two expansion project contracts we signed in Q2 with a single multi-facility operator. We remain focused on achieving a targeted gross margin of 30% plus, however, we will remain opportunistic.

We are also aggressively pursuing other new innovative proprietary products and services, which we believe are capable of generating higher gross margins. Valuations in the cannabis industry have collapsed in 2019. The growth at any cost mindset is out of favor and investors are placing a premium on profitability.

As noted earlier, and which we repeat for emphasis, Surna just completed two consecutive quarters of positive net income. Publicly traded cannabis companies have suffered in the market over the last six months due to lack of profitability, high cash burn and difficult capital market conditions.

And while we have been profitable for two straight quarters, we continue to manage our cash resources carefully. Unlike many companies in the space that are burning cash, we are laser focused on generating cash from our operating activities. Over the past two quarters, we have also reduced our working capital deficit.

Our business for multi-facility operators and our retrofit and expansion projects has and will improve our operating cash flow. Slide six shows our bookings backlog and revenue conversion. In Q3 we had $2.6 million in net bookings.

Q3 bookings were negatively impacted by delays on certain Canadian projects whose access to capital has recently tightened due to market conditions in Canada. Our Q3 revenue conversion was 42%, which means we converted 42% of our backlog at the end of Q2 into revenue in Q3.

Slide seven, expanded market focus illustrates our Q3 year-to-date results by customer type, be it multi-facility operator versus independent small growers and project type, new build, expansion and retrofit.

This project segmentation is important because these different projects tend to have different risk profiles, which impact project completion and the timing of revenue recognition.

Please note that the data presented on this slide are only for commercial scale projects, which we define as those greater than $100,000 in contract value, and that we signed and booked in the first nine months of this year. This information excludes any projects we signed prior to 2019, as well as smaller projects.

So let's look briefly at these data, starting with the top section for multi-facility operators. During 2019, we booked six projects with multi-facility operators, with a total contract value of $7.9 million. Through September 30th, we have recognized $7.1 million in revenue on these projects, or a 90% conversion on the total contract value.

These strong results and high conversion are largely due to our expansion projects, two of which were from a single multi-facility operator for who we also completed a retrofit project. These contracts have been a significant contributor to our strong revenue and operating results in the last two quarters.

Our future success will be dependent on our ability to expand our business with other multi-facility operators. Now let's look at the data for the Independent and Small Grower or ISG segment. During the first nine months of 2019, we signed 10 new build projects for a total value of $5.9 million, with two of these contracts exceeding $1 million.

Our historical market focus has been on these new build projects or ISGs, which have a higher risk profile in general. Because of the many uncertainties associated with ISG projects this business line is not as desirable compared to the multi-facility operator segment.

This is clear when you compare the 10% conversion rate on the 13 ISG projects booked in 2019 meaning we only recognized $700,000 in revenue on the total booked contract value of $6.9 million, compared to the 90% conversion rate for multi-facility operators above.

The ISG business remains important to us and we are developing strategies to obtain additional retrofit business from the 3,000 to 5,000 indoor growth facilities operated by ISGs. A portion of which will always be considering HVAC improvements. Slide eight explains our concept of the trusted climate control advisor.

We have presented this slide in the past and it remains relevant today. Whether we are pursuing MFOs or ISGs, our go-to-market strategy is focused on three pillars.

First, leveraging our strong brand name and cannabis specific experience; Second, positioning ourselves as the trusted advisor in climate controls management; And finally, expanding our products and services to meet a broader range of our customers’ needs over the full lifecycle of their facility.

Our key objective is to increase revenue by selling more climate control products and services to our customers. Specifically, please direct your attention to the second silo titled construction. In developing our 2020 marketing strategy we had 3 goals in mind.

First, we want to sharpen and expand our market outreach to increase the quantity and quality of our sales leads. As a climate control leader in the industry, having been involved in over 800 projects, it is critical that we get in front of growers before they make their mechanical design and climate control system buying decisions.

We are improving our marketing methodology, and have added three new sales representatives as part of this effort. Second, we will be leveraging our marketing efforts with the introduction of several new products to the market including to our customer air handlers, 4-pipe fan coil units and our SentryIQ control system.

This will allow us to offer a good better best product array in several categories. Finally, and equally important, we will be expanding the range of climate control systems that we sell beyond our traditional chilled water systems.

While we believe these systems are optimal for indoor cannabis growing, there are many factors that go into system design and selection including geographical location, complexity costs and desired efficiency.

In 2020, we plan to offer prospective customers rooftop units, mini splits and variable refrigerant flow, and other alternative climate control systems. I will now hand the mic over to our Chairman, Tim Keating. .

Thank you, Tony. Slide nine provides a high level corporate profile including important data on our capitalization and the market for our stock. A couple of things to note, one, our stock price of $0.082 is as of September 30, 2019. Based on this stock price our market cap is $18.7 million.

We continue to believe we are undervalued relative to our comparable peer group, and a derived calculation of intrinsic value. We have zero debt and our cap table is pristine, as we have no convertible securities of any kind. Second, moreover, we have successfully operated this business this year without raising a single dollar of capital.

The only increase is in the share count of our common stock this year were issuances in connection with our equity incentive plan, totaling just over 3 million shares. Slide 10 shows our market comparables.

In selecting public company comparables two basic principles guided us, one, the companies must be in the cannabis ancillary products and services sector; and two, the companies must not be principally involved in cultivation, extraction, distribution or consumer branding, which have outsized and therefore distorting multiples.

This quarter we added Akerna Corp. [ph], which consolidates cannabis technology companies to connect data points in the global cannabis supply chain as a new comp. In August 2019, the average price to revenue multiple of our selected comparables was 5.1 times, just 60 days later in November that ratio had been cut nearly in half to 2.6 times.

But during the same time period Surna’s price to revenue multiple stayed constant at 1.6 times.

While we expect the public cannabis market to remain volatile, as state legalization changes, new regulatory frameworks develop and sector winners and losers emerge we are focused on delivering the fundamentals upward trending more consistent revenue quarter-over-quarter and cash operating profitability.

If we can accomplish these objectives, we believe our price to revenue multiple will expand to a level closer to the 2.6 times of our peer group and based on our last 12 months revenue of $13.7 million results in an internally calculated derived intrinsic value closer to $35 million. Slide 11, illustrates the potential for value accretion.

Based on a stock price of about $0.10 a share as of November 14, 2019, this shows a derived market cap for Surna of $22.6 million. In the bottom chart, we are illustrating various value increments based on movement from our current multiple to the expanded multiple of our selected market comps as well as an illustrated increase in revenue of 25%.

Of course, there's no assurance that we will trade at the higher multiple, or generate increased revenue.

Slide 12 lays out our strategic plan, we will likely face hurdles in achieving cash operating breakeven on a consistent basis, especially as we invest in marketing, product development and staffing to grow top line revenue and cover our costs of being a public company.

So, to address some of the issues we face as a smaller publicly reporting company, we have identified several business verticals or silos that we believe could be logical and natural compliments to our climate control business including, one, lighting; two, fertigation, which is the automated process of delivering nutrients and water to plants; three, benches, which are customized systems to optimize use of the growing space; four, cultivation management technology, meaning primarily software; and five, consumables such as growing packaging, facility and lab supplies; and six, operational improvement analytics, including modeling, data aggregation and artificial intelligence.

Initially, we will seek strategic alliances such as distribution, reseller, co-marketing or product development agreements that fit with our strategic direction. Through at least the first half of 2020 our strategic focus will be to establish these types of strategic alliances with select companies, which we hope will generate revenue in 2020.

Over time some of these strategic alliances may evolve into acquisition targets, under the right circumstances and at the appropriate time we believe acquisitions and related capital infusions of growth equity, combined with the proper execution of our growth plan can accelerate our progress towards consistent cash operating profitability.

Our goal for 2021 is to add $10 million to $20 million of annual revenue through acquisitions, obtain a NASDAQ listing and implement an aftermarket support program that will result in a widely held actively traded and fully valued company.

Of course, there's no assurance that we'd be able to consummate any alliances or acquisitions in furtherance of this strategy. Tony, I'll turn it back to you so that you can open up the call for questions..

Thanks, Tim. This concludes today's prepared remarks. At this time, I would like to ask our operator to provide instructions for the Q&A session and open the floor for questions..

[Operator Instructions].

As we wait for people to enter the queue, I will field some questions received by email and the webcast. We have one question that’s come in previously, and we'll deal with that when online and then we'll open it up to see if there's any live questions. So Tony, do you want to take the first question..

Sure. The question was, congrats on a great Q3 and Surna’s growth in second quarter profitability. Can you provide any guidance or an outlook for 2020? And thank you for the question. We are focused on continuing to drive revenue growth, while maintaining profitability and there are several points worth mentioning.

First, our year-to-date 2019 revenue was up 56% from the prior year and we hope we can achieve similar growth during 2020. Based on our Q3 backlog of over $10 million, our third highest in history and exceeding our 2019 beginning backlog of $8.5 million, we are hoping for a good Q4 and a strong start for 2020.

Second, we are excited about the launch of several new products in 2019, such as our technology and innovation focused SentryIQ product line, about 25% of our year-to-date 2019 revenue comes from these new products and we expect to gain additional traction in these new products in 2020, and beyond.

Lastly, to attain our growth targets in 2020, we need to continue to expand our multi-facility operator business, which has been critical to our 2019 success. We closed six multi-facility operator projects through September and we have already signed three more new multi-facility operator contracts in Q4.

As mentioned in the call these customers typically have larger projects with shorter construction timetables, which means we recognize larger revenue sooner. I believe that should give you good insight into our outlook for 2020..

Operator, do we have any live questions?.

We have no questions in the lines at this time. [Operator Instructions].

Well concludes today’s conference call. We look forward to continuing our engagement with you in 2020. Thank you for your continued interest in Surna, and we wish you all a happy Thanksgiving..

An audio replay of this call will be available tomorrow on surna.com/investor-relations until February 1, 2020. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation..