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SRNA > SEC Filings for SRNA > Form 10-Q on 19-Nov-2013All Recent SEC Filings

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Form 10-Q for SURNA INC.


19-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion and analysis of our financial condition and results of operations together with the information in our consolidated financial statements (unaudited) for the current period and our consolidated annual audited financial statements for the last fiscal year as filed on Form 10-K, and the notes thereto and other financial information incorporated by reference. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of our last annual report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Liquidity and Capital resources

We are a start-up company and have not yet generated significant revenues from our business operations. Our auditors have issued a going concern opinion; this means that our auditors believe there is substantial doubt that we can continue as an on-going business for the next twelve months unless we obtain additional capital. Accordingly, we must raise cash from sources other than operations. Our only other source of funds at this time is further investment in our company by existing shareholders or others. If we need additional funds and cannot raise them, we will either have to suspend operations until we raise sufficient capital, or cease operations entirely.

Since inception, we have sold 75,000,000 shares of common stock to 7bridge Capital Management Limited for $15,000. From September through November, the company placed 4,175,000 shares to 51 individuals at $0.02 per shares and raised $83,500 excluding expenses.

We issued 79,175,000 shares of common stock, 75,000,000 shares pursuant to the exemption from registration contained in Regulation S of the Securities Act of 1933 and 4,175,000 shares pursuant to our public offering. Both were accounted for as sales of common stock. On May 16, 2011 we declared a stock dividend of 4 new shares for each 1 share held, with a record date of May 18, 2011. On May 18, 2011 our Board of Directors approved an increase in authorized capital from 100,000,000 common shares to 350,000,000 common shares.

There is limited historical financial information about us upon which to base an evaluation of our performance. We are in a start-up stage of operations and have not generated significant revenues and are subject to risks inherent in the establishment of a new business enterprise, including limited capital resources. We have no assurance that future financing will be available to us on acceptable terms. If financing is not available on satisfactory terms, we may be unable to continue, develop or expand our operations. Equity financing could result in additional dilution to existing shareholders.

As of December 31, 2012, our total current assets were $1,447 and our total current liabilities were $2,455,370, hence a working capital deficit of $2,453,923.

As of September 30, 2013, our total current assets were $646 and our total current liabilities were $2,636,195 hence a working capital deficit of $2,635,549.

Results of Operations

We are a start-up stage corporation and have not generated or realized significant revenues from our business operations. To meet our initial need for cash we raised money from our public offering. Our only other source for cash at this time is investments by others in our company, and if we can not rely on loans from our officers, shareholders or others in order for us to maintain our operations we may need to find alternative sources, like a second public offering or a private placement of securities. At present, if we cannot generate sufficient revenues to continue operations or if we do not secure any additional funding we may either have to suspend operations until we do raise funds, or cease operations entirely.

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Sale of a subsidiary and change in operating segments

Previously Surna Inc. had two direct operating subsidiaries: Surna Media Inc. ("Surna Media") and Surna Networks, Inc. ("Surna Networks"). Surna Media's principal business is the development of web and mobile games and social networks. Surna Network's principal business is telecommunications services, IT support services and open-source software development.

Surna Networks had been established to develop and provide a range of information technology and network services for potential customers, including game companies inside and outside of the PRC, but its business had focused solely on wholesale carrier services utilizing VoIP telecommunications, which is also referred to as International Simple Resale ("ISR"). Results of the ISR business were disappointing, and we did not foresee it being self-supporting or profitable without further significant investment. Upon further review we determined that it is not relevant to our core business or future plans, and that the best strategy was the sale or winding-up of this business line. On March 27, 2012 we entered into an agreement for the sale of all of the issued and outstanding shares of Surna Networks. The Board of Directors determined that there was no intrinsic value in the current operations of Surna Networks, and therefore accepted an offer to purchase the company for the par value of the issued shares of US$1.00.

With the sale of Surna Networks we now operate in only one distinct segment, that being Surna Media's online and mobile games and social networks development business.

Sales of mobile games

Sales to customers via Apple's AppStore comprised 100% of our revenues of $10 and $46 for the three and nine months ended September 30, 2013. At September 30, 2013, our accounts receivable from its primary customer was $69.We believe that, in the event that its primary customer is unable or unwilling to continue to purchase Surna Inc.'s production, there are a substantial number of alternative buyers for its production at comparable prices.

Strategy

Our development efforts have focused on two main areas that span both the web and mobile platforms: firstly, games developed in conjunction with animated television series; and secondly, more traditional products targeted at a teenage and young-adult male audience. Results from our game development business in the PRC have to-date been disappointing but it is our intention to continue to pursue opportunities in game publishing, focusing at present on mobile games and then on opportunities in web-game publishing in other markets. In summary, the current status of our game development projects is:

Ori-Princess: Spring Cleaning: Development of the iPhone version was completed in October 2012 and it was published on the Apple Appstore from October 25, 2012. Sales from release through September 30, 2013 totaled $69. We have continued to have discussions with third-party mobile publishers in the PRC about an advertising supported version of ths game, but to date these have not resulted in any final contracts.

Ori-Princess: Development work on the Ori-Princess role-playing game was suspended indefinitely on November 9, 2012. It was our intention to explore options for either working with other game developers to complete this project or engaging new development personnel to restart the development program, but to date we have not reached any arrangements for this. Given the time that has passed since the initial development was suspended, it is our view that it is increasing less likely that a suitable and interested partner can be found for this project.

Serica: Publishing rights for the Simplified Chinese version of the game were licensed to Kunlun (through Jurun) in March 2012, with the first payment of RMB 300,000 due on April 1, 2012, and with subsequent payments of RMB 500,000 in May and RMB 200,000 in July, 2012. Kunlun commenced charging for the game on July 12, 2012, which constituted the start of commercial operations. To-date no payment has been received from Kunlun for any part of the licensing of the game. On January 7, 2013 Jurun, as the official licensor, engaged Receivables Management Services (HK), Limited ("RMS") to attempt to recover all or some of the amounts owed. RMS's collection efforts have to-date not met with success, and we continue to evaluate what further actions it is advisable to pursue in the PRC to recover these funds.

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Qia Ke Zhong Shi (Legend of the Kung-Fu Masters): As of August 2012 development work on this game had largely been completed, however YouQu refused to continue any further with its contracted development work or provide the game or agree to support the finished product. Flying Cloud requested from YouQu delivery or return of all the contracted work product, including up-to-date source code, documentation and art work on September 25, 2012; but to date this has not been forthcoming. We are still evaluating what further actions it would be beneficial for us to pursue, including its continued development, and licensing or selling it to a third-party developer or publisher.

Contractual arrangements for character licensing and game development

Development work on Serica and Qia Ke Zhong Shi was contracted by Flying Cloud to YouQu Interactive (Beijing) Technology Co. Ltd., a company controlled by Yeah YE, a former consultant to Flying Cloud ("YouQu"). The completion date to beta-test stage for Serica was April 2012 and for Qia Ke Zhong Shi in August 2012. Development work on Ori-Princess: Spring Cleaning was contracted by Flying Cloud to Guangzhou Nine Leaf Network Technology Co. Ltd.

Online Game publishing in the PRC

As the copyright ownership of online games that are to be distributed in the PRC is restricted to domestic PRC entities (that is, a natural person who is a citizen or corporations that are not foreign-invested), commercial distribution of any products that are the copyright of our subsidiary corporation in the PRC, Flying Cloud Information Technology Co. Ltd. ("Flying Cloud") as a foreign-owned entity, would not be possible. Accordingly, the copyright, for the PRC only, for our online games is held in-trust for Flying Cloud by Jurun Information Technology (Shanghai) Co. Ltd. ("Jurun"). Jurun is incorporated in Shanghai and its equity interest is owned by two PRC citizens, who hold the company in-trust for a British Virgin Islands ("BVI") corporation, Evident Games Limited ("Evident"), through a series of contractual arrangements that make Jurun a Variable Interest Entity ("VIE") of Evident. Evident is in turn controlled by Lim Clarke & Co, the majority shareholder of Surna Inc.

Publishing rights for the Simplified Chinese versions of the game were licensed by Jurun to Beijing Kunlun World Wide Technology Share Co., Ltd., an enterprise organized under the laws of the PRC ("Kunlun"). On March 19, 2012, Flying Cloud entered into a Technical Services agreement (the "Technical Services Contract") with Jurun, in a transaction that is effectively a licensing of the Simplified Chinese version of the game. An exclusive, global license to publish the Simplified Chinese version of the game has been granted by Jurun to Kunlun for a term of 5 years from date of the commencement of commercial operations, which was July 12, 2012 The terms of the Technical Services Contract between Jurun and Flying Cloud mirror the terms of Jurun's licensing agreement with Kunlun, and provide for Flying Cloud to receive the full economic benefit of the licensing of the Simplified Chinese version of the game. Under the terms of the contract for development work that was undertaken on the game, 20% of the income derived from the game by Surna is due to YouQu. It was expected at the time that licenses for the Traditional Chinese and Korean versions of the game would be granted to Kunlun as well, but in the end Jurun did not proceed with finalizing these agreements.

Mobile game publishing in the PRC

There are no similar restrictions in the PRC on the publishing of games for mobile devices, and therefore these games are the copyright of Surna Inc. worldwide, including in China, and will be published on the Apple Appstore and Google Play and other Android app markets by Surna. It is our intention to transition these operations to our newly incorporated subsidiary Qoo Games Limited in 2013.

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Target Markets

We plan to develop further games for children, pre-teens and teens, female players and young-adults over the next two years. These will include online and mobile games and we intend, whenever possible, to work with the producers of cartoon TV-series and movies in the PRC on licensing and product tie-ins. At present we have limited financial resources and this may restrict or render ineffective the marketing and advertising program that we will need to undertake, which may materially effect our operations. Our primary target for online gaming customers are children and young adults, female game players, students and office workers. As game developers we intend to reach the end-user through the licensing of our products to independent publishers, however we may at some point choose to supplement there efforts with online advertising, including display ads, paid search ads, and social media marketing campaigns.

Factors affecting results of our operations in China

The majority of our operations are carried out in the PRC and the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments, and by the general state of the PRC's economy and of the online games industry there. For example, we benefit from the overall economic growth in China in the past several years, which has resulted in increases in disposable income and discretionary consumer spending; the increasing use of the Internet; the growing popularity of online games in comparison with other forms of entertainment; and favorable demographic trends. Our results of operations may be adversely affected by an economic slowdown in China and other countries and regions where our games are operated, or the arrival of additional competition in the markets where we operate. They may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Regulation imposed by the government of China and other countries on the online game industries may also have significant impact on our results of operations in the future.

Our operating results are more directly affected by company-specific factors including the following:

our cost of developing and marketing online games;

the speed at which we develop and launch new online games and related in-game items;

the popularity of our games and in-game items compared with those of our competitors;

the amount of our licensing revenues inside of China; and

the success of investments and merger and acquisition activities.

Our future growth will depend significantly upon our ability to continually and successfully develop and market additional online games that are attractive to players and to increase the monetization of our existing and future games in China.

Share Exchange Agreement

On July 23, 2013 we entered into a Share Exchange Agreement to acquire all of the issued and outstanding shares of common stock of Six Gun City, Inc., a New Hampshire corporation ("Six Gun"), from the shareholders of Six Gun. To acquire Six Gun we agreed to issue 10,000,000 shares of our Class A Preferred Stock, on a 20,000:1 basis in exchange for all of the 500 issued and outstanding shares of Six Gun. Six Gun owns and operates an "Old West" theme park in Jefferson, New Hampshire. Closing was to be within 45 days and subject to completion of final documentation. As Six Gun and the Six Gun shareholders failed to complete the transaction within the proscribed time this acquisition was not undertaken by the Company and was all undertakings relating to this ceased to be effective on the expiry of the 45 day closing period.

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Changes in Directors and Officers

On July 17, 2013 Richard Clarke gave notice of his intention to resign as Director and Secretary, as well as a director and officer with any subsidiaries of the Company, resignation which was accepted as of July 17, 2013. In resigning Mr. Clarke had no disputes over our operations, policies, or practices.

On July 19, 2013 Charlie Rodriguez was appointed as a Director of the Company and Robert G. Clarke was appointed Director of the Company as well as President, Treasurer and Secretary and Chief Financial Officer. Mr. Clarke replaced Man-Chor Poon as Chief Financial Officer, principal financial officer and principal accounting officer. Mr. Clarke was selected for the foregoing positions as a result of his experience with public company operations.

On July 19, 2013 Ms. Cherry Ping-Wai Lim gave notice of her intention to resign as Director and principal executive officer, resignation which was accepted as of July 19, 2013. In resigning Ms. Lim had no disputes over our operations, policies, or practices.

The Company has not entered into any compensation arrangements with Mr. Clarke and Mr. Rodriguez as of the date of this report.

Taxation

Nevada

Surna Inc. and Surna Networks, Inc. are each required to pay an annual fee to the Nevada Secretary of State of $165. Nevada has no corporate income taxes. Although the majority of our operations are outside the United States, we may be subject to federal or other U.S. taxation in the future.

Surna Media is incorporated in the BVI. Under current laws, it is not subject to income or capital gains tax. In addition, payment of dividends to its shareholder, Surna Inc., is not subject to withholding tax.

Hong Kong

Our subsidiary in Hong Kong is subject to a profit tax at the rate of 16.5% on assessable profit determined under relevant Hong Kong tax regulations.

According to the Mainland and Hong Kong Special Administrative Region Arrangement on the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, or the Tax Agreement, dividends paid by a foreign-invested enterprise in mainland China to its corporate shareholder in Hong Kong will be subject to withholding tax at a maximum rate of 5.0%, provided however that such Hong Kong company directly owns at least 25.0% of the equity interest in the mainland foreign-invested enterprise. However, under the new Enterprise Income Tax Law ("EIT") and its implementation rules, as well as Circular No. 601 issued by SAT in October 2009 (or "Circular 601), dividends from our PRC subsidiary paid to us through Surna HK may be subject to withholding tax at a rate of 10.0% if Surna HK is not considered to be the "beneficial owner" of the dividends distributed by a resident enterprise of the PRC.

Surna HK currently holds all the equity interest in our PRC operating company Flying Cloud. To the extent that Surna HK is considered a "non-resident enterprise" of the PRC under the Tax Agreement, dividends paid by Flying Cloud may be subject to a maximum withholding tax rate of 10.0%. Dividends paid by Surna HK to its shareholder will not be subject to any Hong Kong withholding tax.

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China - PRC Enterprise Income Tax

Prior to January 1, 2008, companies established in China were generally subject to state and local EIT at statutory rates of 30% and 3% respectively. On March 16, 2007, the National People's Congress of China enacted a new regulation, the PRC Enterprise Income Tax Law, which took effect beginning January 1, 2008. On December 6, 2007, the State Council also adopted the Implementing Rules for the Enterprise Income Tax Law, or the Implementing Rules, which also took effect beginning January 1, 2008. Under the PRC EIT Law, foreign invested enterprises (or "FIEs"), and Chinese domestic companies are subject to EIT at a uniform rate of 25%. On February 22, 2008, the Ministry of Finance and the State Administration of Taxation, or the SAT, promulgated the Notice on Several Preferential Policies in Respect of Enterprise Income Tax (or "Notice No. 1 2008"), reiterating the policy that a software enterprise newly established within China may, upon determination, be exempted from income taxes for its first two profit-making years and shall be subject to the income tax at half the standard rate for the next three years.

Qualification as a "software enterprise" is however subject to an annual assessment by the relevant government authorities in China. We may be classified as a "resident enterprise" for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise income tax. Under the PRC EIT Law and the Implementing Rules, dividends generated from the business of our PRC subsidiary and payable to us may be subject to a withholding tax rate of 10% if we are considered a non-resident enterprise incorporated outside of the PRC unless there is an applicable tax treaty with China that provides for a different withholding arrangement and we are deemed to be entitled to such favorable treatment. If we were to be classified as a "resident enterprise" for PRC enterprise income tax purposes, this would result in our global income becoming subject to 25% PRC enterprise income tax.

Foreign currency and foreign currency translation

Foreign currency may have a major impact on our financial results. The functional currency of the Company is the United States Dollars ("USD"). The functional currency of the Company's operating subsidiary, Surna HK, is the Hong Kong Dollar ("HKD").The functional currency of the Surna HK's operating subsidiary in PRC, Flying Cloud, is the Renminbi ("RMB"), the PRC's currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income (loss) for the respective periods.

For financial reporting purposes, the consolidated financial statements of the Company are translated into the Company's reporting currency, United States Dollars ("USD"). Balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using the average exchange rate prevailing during the reporting period.

Adjustments resulting from the translation, if any, are included in accumulated other comprehensive income (loss) in stockholders' equity.

Going Concern

The accompanying unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company currently has $2,635,549 working capital deficit (current liabilities exceeds current assets), minimal sources of recurring revenue and has generated cumulative net losses of $2,758,175 during the period from inception through September 30, 2013.

In the course of its development activities, the Company has sustained and continues to sustain losses. The Company cannot predict if and when the Company will generate profits. The Company expects to finance its operations primarily through debt or equity financing.

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These conditions raise substantial doubt about the Company's ability to continue as a going concern. The Company's continuation as a going concern is dependent on its ability to meet its obligations, to obtain additional financing as may be required until such time as it can generate sources of recurring revenues and to ultimately attain profitability. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The report of the Company's independent registered public accounting firm relating to the December 31, 2012 consolidated financial statements states that there is substantial doubt about the Company's ability to continue as a going concern.

Three Months Ended September 30, 2013 and September 30, 2012

Our revenues from Continuing Operation for the period ended September 30, 2013 were $10 which was from our online games. The net loss from continuing operations for the period ended September 30, 2013 was $14,389 of which includes $3,333 for depreciation and $11,066 for general and administration expense. The gross margin from continuing operations for the three months period ended September 30, 2012 was $111,030 and the net loss from continuing operations for the three months period ended September 30, 2012 was $84,983 of which includes $3,333 for depreciation, $10,348 for product development and $182,332 for general and administration expense. The decrease in net loss for 2013 compared with the same period in 2012 was due to decrease in general and administrative expenses.

Nine Months Ended September 30, 2013 and September 30, 2012

Our revenues from Continuing Operation for the period ended September 30, 2013 were $46 which was from our online games. The net loss from continuing operations for the period ended September 30, 2013 was $175,723 of which includes $6,666 for depreciation and $165,770 for general and administration expense. The gross margin from continuing operations for the nine months period ended September 30, 2012 was $158,861 and the net loss from continuing operations for the nine months period ended September 30, 2012 was $479,613 of which includes $6,666 for depreciation, $39,620 for product development and $588,855 for general and administration expense. The decrease in net loss for 2013 compared with the same period in 2012 was due to decrease in general and administrative expenses.

Income from discontinued operation for the nine months period ended September 30, 2012 is $11,607, with no such comparative figure for three months period ended September 30, 2012.

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