CEA Industries Inc. - Quarter Report: 2012 March (Form 10-Q)

4

PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

Surna Inc.

Consolidated Balance Sheets

(Unaudited)

See accompanying notes to the consolidated financial statements

F1

Surna Inc.

Consolidated Statement of Operations and Comprehensive Income

(Unaudited)

See accompanying notes to the consolidated financial statements

F2

Surna Inc.

Consolidated Statement of Cash Flows

(Unaudited)

See accompanying notes to the consolidated financial statements

F3

Surna Inc.

(A Development Stage Company)

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 - BASIS OF PRESENTATION AND INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The accounting policies and methods followed in preparing these unaudited consolidated financial statements are those used by Surna Inc (the “Company”) as described in Note 1 of the notes to consolidated financial statements included in the Annual Report on Form 10-K. The unaudited consolidated financial statements for the three-month periods ended March 31, 2012 and 2011 and for the transition one-month period ended December 31, 2011 have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission and do not conform in all respects to the disclosure and information that is required for annual consolidated financial statements. These interim consolidated financial statements should be read in conjunction with the most recent 10-K for m of the Company filed on March 13, 2012.

In opinion of management, all adjustments, all of which are of a normal recurring nature, considered necessary for fair statement have been included in these interim consolidated financial statements.

F4

 The results of discontinued operations of Surna Network Inc. and Surna Netwrok Ltd for the one month ended December 31, 2011 and the three months ended March 31, 2012 are summarized below:

NOTE 5 - SIGNIFICANT CONCENTRATIONS, RISKS AND UNCERTAINTIES

The majority of the Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC's economy.

The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results 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.

NOTE 6 - RELATED PARTY TRANSACTIONS

As of March 31, 2012 and December 31, 2011, the Company had a balance due to related parties of $1,874,384 and $1,685,363, respectively. This balance is from various advances from the Company’s directors and which are non-interest bearing, unsecured and due on demand.

NOTE 7 - RESTATEMENT IN PRIOR YEAR

On September 1, 2011, we acquired Surna Media, Inc for 20,000,000 common shares, and such acquisition included a partially-developed game acquired by that company as of May 1, 2011. We incorrectly reported that acquisition accounted for as an entity under common control and it should have been accounted for under the purchase method.  Under the purchase method, $15,000,000 is the fair value of the consideration paid based on the market trading price of our stock issued as the purchase price. Approximately $5,000 was allocated to assets, $1.35 million to liabilities and $16.35 million is recognized as compensation expense, since the stock was issued to control shareholders of the Company.  Paid in capital and the deficit accumulated during the development stage have both been adjusted for this correction.

F5

NOTE 8 - SERVICE AGREEMENT

F6

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 share 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, 2011, our total assets were $39,118 and our total liabilities were $1,709,008.

As of March 31, 2012, our total assets were $79,060 and our total liabilities were $1,899,312.

Results of Operations

During the three months ended March 31, 2012, we generated approximately $50,000 of revenue. 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.  

11

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 27 March 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.

Strategy

We intend to engage in the further development of our online games that can be played through a browser or on a mobile device. According to reports from the China Internet Network Information Center (“CNNIC”) of the Chinese Academy of Sciences, the number of users for networked games in China in 2011 was 120 million, 66.32 million of whom were paying users (the report can be accessed through cgigc.com.cn - in Chinese).

CNNIC estimated that revenues in 2011 in the PRC from browser games  - that is, games accessed through a web browser and excluding those that require downloaded software - exceeded RMB 5.54 billion (approximately US$ 880 million), and forecast a compound annual growth rate (CAGR) for 2012 to 2016 of 18.6%. Revenues for mobile games in 2011 were estimated at RMB 1.7 billion (approximately US$ 270 million), with a  CAGR 34.6% expected for 2012 to 2016.

To-date, our development efforts have focused to a large extent on games that are not targeted at the traditional customers for these products, which are typically teenage and young-adult males. We believe that the super-deformed cartoon style (known as “SD”) employed in our online game Demon Immortal is likely to appeal to female and younger users.  In addition to Demon Immortal, we are currently developing other gaming products:

·

Hamsterland, a social network and online game designed for young children and pre-teens with characters licensed from a children’s cartoon series that is expected to air on national TV in China during 2012.

·

Serica, an ARPG online game based on a Chinese and Central Asian theme and featuring realistic-style graphics and martial art fighting.

·

A Hamsterland-related game for the iPhone mobile platform.

·

A game, currently with the code-name Cobalt, based on the core of Demon Immortal and incorporating characters from kung-fu novels, which will be targeted at a more general audience.

·

A game, currently with the code-name Jubilee, incorporating ARPG and strategy elements and cartoon characters, targeted primarily for teenaged girls and young women.

12

The development of Hamsterland has been contracted to Flying Cloud by Shuren Limited, a BVI corporation (“Shuren”), which is owned and controlled by Lim Clarke & Co Limited, a BVI corporation controlled by our Directors and which is the majority shareholder of Surna Inc (“Lim Clarke”). Shuren holds a license to utilize the hamster cartoon characters for online games, mobile games and social networks. Development work on Hamsterland is on-going, but its release will be coordinated with the launch of the TV series, the schedule for which has not yet been finalized. It is intended that the iPhone version of the Hamsterland game will be released at the same time.

All of these games are expected to be free-to-play for the user, with revenue being generated through the purchase by the player of in-game items and upgrades. Depending on the negotiated commercial terms, game publishers would normally undertake to support marketing and other operating costs, and the game developer would receive a revenue and/or profit share from them. There are currently no contractual arrangements in place for Hamsterland, and while it is not certain that we will be able to secure any on acceptable commercial terms, we expect the experience and connections of our PRC personnel in the industry will be able to secure licensing of these in greater China and Asia-Pacific region. If we cannot secure any such contractual arrangements, we will not be able to derive any significant revenues from these games.

Licensing for Serica

Publishing rights for the Simplified Chinese, Traditional Chinese and Korean versions of the game have been licensed to Beijing Kunlun World Wide Technology Share Co., Ltd., an enterprise organized under the laws of the PRC (“Kunlun”). On 19 March 2012, our subsidiary corporation in the PRC, Flying Cloud Information Technology Co. Ltd. (“Flying Cloud”) entered into a Technical Services agreement (the “Technical Services Contract”) with Jurun Information Technology (Shanghai) Co. Ltd. (“Jurun”), in a transaction that is effectively a licensing of the Simplified Chinese version of the game. 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 Flying Cloud, as a foreign-owned entity, would not be possible. Accordingly, the copyright, for the PRC only, for Serica is held in-trust for Flying Cloud by Jurun as a domestic PRC company. Jurun is incorporated in Pudong, 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 52% owned and controlled by Lim Clarke.

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. 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. An exclusive, global 5-year license to publish Traditional Chinese and Korean versions of the game has also been granted by our subsidiary Surna Hongkong Limited (“Surna HK”) to Kunlun’s Hong Kong company Koram Games Limited. 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 Interactive (Beijing) Technology Co. Ltd., a company controlled by Yeah YE, a consultant to Flying Cloud. Serica completed two beta-tests in March and the Simplified Chinese version is expected to commence commercial operations in May 2012.

Game engines

The 2.5D ARPG games (except Serica) use our Tempest game and client engines. Game engines are a core software component for online games running on the web server, and provide the main processing functions for the computation and display of on-screen action. Our Tempest game engine is written in the C++ programming language and its features include load balancing, module message distribution, attributes server, particle effects and real-time data backup. The client engine features centralized management and monitoring, map editors, dynamic map loading and rendering and custom attributes. Serica utilizes an engine we refer to as Tempest A (MudRV) that was developed by YouQu, and for which we have been granted a license for its use in the game. An updated Tempest

13

2 engine is in development which will include support for new block-inclined isometric geometry and extra effects editors.

Target Markets

We plan to develop further games and social communities 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.

Taxation

Nevada

Surna Inc. and Surna Networks, Inc. are each required to pay an annual fee to the Nevada Secretary of State of $165.00. 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.

British Virgin Islands

14

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.

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

15

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.

Period Ended March 31, 2012 and March 31, 2011

Our revenues from Continuing Operation for the period ended March 31, 2012 were $47,831 which was from our online games. The net loss from continuing operations for the period ended March 31, 2012 was $161,919 of which includes $143,331 for Salaries, $17,433 for Product development cost and $48,986 for general and administration expense.  The income from discontinued operations is $11,607 and the net loss is $150,312 for the period ended March 31, 2012. We had a loss from operation for the period ended March 31, 2011 of $15,199 of which $15,199 is general office administration expense.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information under this item.

16

ITEM 4.  CONTROLS AND PROCEDURES.

Under the supervision and with the participation of our management, including the Principal Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that these disclosure controls and procedures are not effective because of the identification of a material weakness in our internal control over financial reporting which is identified below, which we view as an integral part of our disclosure controls and procedures.

·

The Company lacks proper segregation of duties. We believe that the lack of proper segregation of duties is due to our limited resources.

·

The Company does not have a comprehensive and formalized accounting and procedures manual.

Our management does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by individual acts or collusion between two or more people, or by management or board override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

17

PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

We are not presently a party to any litigation.

ITEM 1A.  RISK FACTORS.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4.  MINE SAFETY DISCLOSURES.

None.

ITEM 5.  OTHER INFORMATION.

None.

ITEM 6.  EXHIBITS.

Incorporated by reference to the Exhibit index attached hereto.

18

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing of this Form 10-Q and has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 21st day of May, 2012.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the Registrant and in the capacities.

19

EXHIBIT INDEX

20