CEA Industries Inc. Revenue Disclosure

Revenue Recognition

 

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606), Revenue from Contracts with Customers and all the related amendments (“ASC 606” or the “new revenue standard”) to all contracts and elected the modified retrospective method. The results for periods before 2018 were not adjusted for the new revenue standard and the cumulative effect of the change in accounting was recognized through accumulated deficit at the date of adoption. The comparative financial information presented has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company expects the impact of the adoption of the new revenue standard to be immaterial to its net income (loss) on an ongoing basis.

 

The cumulative effect of the changes made to the consolidated balance sheet for the adoption of the new revenue standard as of January 1, 2018 was as follows:

 

		Balance as of December 31, 2017				Adjustments Due to ASC 606				Balance as of January 1, 2018
Balance Sheet
Liabilities
Deferred Revenue		$	1,011,871			$	(56,912	)		$	954,959
Shareholders’ Equity
Accumulated deficit		$	(19,254,911	)		$	56,912			$	(19,197,999	)

 

In accordance with the new revenue standard’s requirements, the disclosure of the impact of adoption on the consolidated income statements and balance sheets for the year ended December 31, 2018 was as follows:

 

		For the Year Ended December 31, 2018
		As Reported				Balances Without Adoption of ASC 606				Effect of Change Higher/(Lower)
Income Statement
Revenues
Revenues		$	9,581,968			$	9,611,380			$	(29,412	)
Net loss		$	(4,743,745	)		$	(4,714,333	)		$	29,412
Balance Sheet
Liabilities
Deferred Revenue		$	641,798			$	669,298			$	(27,500	)
Shareholders’ Equity
Accumulated deficit		$	(24,346,361	)		$	(24,373,861	)		$	(27,500	)

 

The following table sets forth the Company’s revenue by source:

 

		For the Years Ended December 31,
		2018				2017
Equipment sales		$	8,288,102			$	6,255,150
Engineering and other services			1,040,764				588,849
Shipping and handling			243,072				238,908
Other revenue			10,030				127,334
Total revenue		$	9,581,968			$	7,210,241

 

The Company accounts for sales taxes and other related taxes on a net basis, excluding such taxes from revenue.

 

Revenue Recognition Accounting Policy Summary

 

The Company accounts for revenue in accordance with the new revenue standard. Under the new revenue standard, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Most of the Company’s contracts contain multiple performance obligations that include engineering and technical services as well as the delivery of a diverse range of climate control system equipment and components, which can span multiple phases of a customer’s project life-cycle from facility design and construction to equipment delivery and system installation and start-up. The Company does not provide construction services or system installation services. Some of the Company’s contracts with customers contain a single performance obligation, typically engineering only services contracts.

 

A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, the Company allocates the transaction price to each performance obligation based on standalone selling price. The Company determines the standalone selling price for each of the performance obligations at the inception of the contract and does not adjust the initial allocation for future changes in any selling prices. When estimating the selling price, the Company uses various observable inputs. The best observable input is the Company’s actual selling price for the same good or service, however, this input is generally not available for the Company’s contracts containing multiple performance obligations. For engineering services, the Company estimates the standalone selling price by reference to certain physical characteristics of the project, such as facility size and mechanical systems involved, which are indicative of the scope and complexity of the mechanical engineering services to be provided. For equipment sales, the standalone selling price is determined by forecasting the expected costs of the equipment and then adding an appropriate margin, based on a range of acceptable margins established by management. Depending on the nature of the performance obligations, the Company may use a combination of different methods and observable inputs if certain performance obligations have highly variable or uncertain standalone selling prices. Once the selling prices are determined, the Company applies the relative values to the total contract consideration and estimates the amount of the transaction price to be recognized as each promise is fulfilled.

 

Generally, satisfaction occurs when control of the promised goods is transferred to the customer or as services are rendered or completed in exchange for consideration in an amount for which the Company expects to be entitled. The Company recognizes revenue for the sale of goods when control transfers to the customer, which primarily occurs at the time of shipment. The Company’s historical rates of return are insignificant as a percentage of sales and, as a result, the Company does not record a reserve for returns at the time the Company recognizes revenue. The Company has elected to exclude from the measurement of the transaction price all taxes (e.g., sales, use, value added, and certain excise taxes) that are assessed by a governmental authority in connection with a specific revenue-producing transaction and collected by the Company from the customer. Accordingly, the Company recognizes revenue net of sales taxes. The revenue and cost for freight and shipping is recorded when control over the sale of goods passes to the Company’s customers.

 

The Company also has performance obligations to perform certain engineering services that are satisfied over a period of time. Performance obligations are satisfied over-time if the customer receives the benefits as the Company performs work, if the customer controls the asset as it is being produced, or if the product being produced for the customer has no alternative use and the Company has a contractual right to payment. Revenue is recognized from this type of performance obligation as services are rendered based on the percentage completion towards certain specified milestones.

 

The Company offers assurance-type warranties for its products and products manufactured by others to meet specifications defined by the contracts with customers and does not have any material separate performance obligations related to these warranties. The Company maintains a warranty reserve based on historical warranty costs.

 

Other Judgments and Assumptions

 

The Company typically receives customer payments in advance of its performance of services or transfers of goods. Under the new revenue standard, the Company is required to adjust the promised amount of consideration for a significant financing component to recognize revenue at an amount that reflects the price that a customer would have paid for the promised goods or services if the customer had paid cash for those goods or services when (or as) they transfer to the customer (that is, the cash selling price). Applying the practical expedient in ASC 606-10-32-18, which the Company has elected, the Company does not adjust the promised amount of consideration for the effects of a significant financing component since the Company expects, at contract inception, that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. Accordingly, the remaining performance obligations related to customer contracts does not consider the effects of the time value of money.

 

Applying the practical expedient in ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred since the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs include certain sales commissions and incentives, which are included in selling, general and administrative expenses, and are payable only when associated revenue has been collected and earned by the Company. For sake of clarity, net revenues are considered earned only after the service/product has been completed/shipped to the Company’s customer and the Company is able to recognize such net revenue on its financial statement in accordance with generally accepted accounting principles.

 

Contract Assets and Contract Liabilities

 

Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers based on the terms established in its contracts.

 

Contract assets include unbilled amounts where revenue recognized exceeds the amount billed to the customer and the right of payment is conditional, subject to completing a milestone, such as a phase of a project. The Company typically does not have material amounts of contract assets since revenue is recognized as control of goods are transferred or as services are performed. As of December 31, 2018 and 2017, the Company had no contract assets.

 

Contract liabilities consist of advance payments in excess of revenue recognized. The Company’s contract liabilities are recorded as a current liability in deferred revenue in the consolidated balance sheets since the timing of when the Company expects to recognize revenue is generally less than one year. As of December 31, 2018 and 2017, deferred revenue, which was classified as a current liability, was $641,798 and $1,011,871, respectively.

 

For the year ended December 31, 2018, the Company recognized revenue of $876,350 related to the deferred revenue at January 1, 2018, or 87%.

 

Remaining Performance Obligations

 

Remaining performance obligations, or backlog, represents the aggregate amount of the transaction price allocated to the remaining obligations that the Company has not performed under its customer contracts. The Company has elected not to use the optional exemption in ASC 606-10-50-14, which exempts an entity from such disclosures if a performance obligation is part of a contract with an original expected duration of one year or less. Accordingly, the information disclosed about remaining performance obligations includes all customer contracts, including those with an expected duration of one year or less.

 

Industry uncertainty, project financing concerns, and the licensing and qualification of our prospective customers, which are out of the Company’s control, make it difficult for the Company to predict when it will recognize revenue on its remaining performance obligations. There are risks that the Company may not realize the full contract value on customer projects in a timely manner or at all, and completion of a customer’s cultivation facility project is dependent upon the customer’s ability to secure funding and real estate, obtain a license and then build their cultivation facility so they can take possession of the equipment. Accordingly, the time it takes for customers to complete a project, which corresponds to when the Company is able to recognize revenue, is driven by numerous factors including: (i) the large number of first-time participants interested in the indoor cannabis cultivation business; (ii) the complexities and uncertainties involved in obtaining state and local licensure and permitting; (iii) local and state government delays in approving licenses and permits due to lack of staff or the large number of pending applications, especially in states where there is no cap on the number of cultivators; (iv) the customer’s need to obtain cultivation facility financing; (v) the time needed, and coordination required, for our customers to acquire real estate and properly design and build the facility (to the stage when climate control systems can be installed); (vi) the large price tag and technical complexities of the climate control and air sanitation system; (vii) the availability of power; and (viii) delays that are typical in completing any construction project.

 

As of December 31, 2018, the Company’s remaining performance obligations, or backlog, was $8,529,000, of which $6,997,000, or 82%, was attributable to customer contracts for which the Company has only received an initial advance payment to cover the allocated value of the Company’s engineering services (“engineering only paid contracts”). There are enhanced risks that the equipment portion of these engineering only paid contracts will not be completed or will be delayed, which could occur if the customer is dissatisfied with the quality or timeliness of the Company’s engineering services or there is a delay or abandonment of the project because of the customer’s inability to obtain project financing or licensing or other reasons. After the customer has made an advance payment for a portion of the equipment to be delivered under the contract (“partial equipment paid contracts”), the Company is typically better able to estimate the timing of revenue recognition since the risks and delays associated with licensing, permitting and project funding are typically mitigated once the initial equipment payment is received. There is significant uncertainty regarding the timing of the Company’s recognition of revenue on its remaining performance obligations, and there is no certainty that these will result in actual revenues. The remaining performance obligations expected to be recognized through 2021 are as follows:

 

		2019				2020				2021				Total
Remaining performance obligations related to engineering only paid contracts		$	4,164,000			$	198,000			$	2,635,000			$	6,997,000
Remaining performance obligations related to partial equipment paid contracts		$	1,141,000			$	391,000			$	-			$	1,532,000
Total remaining performance obligations		$	5,305,000			$	589,000			$	2,635,000			$	8,529,000