UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2017March 31, 2018
OR
☐ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
☐QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 000-50385
GrowLife, Inc.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 90-0821083 (I.R.S. Employer Identification No.) |
5400 Carillon Point
Kirkland, WA 98033
(Address of principal executive offices and zip code)
(866) 781-5559
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2
| Large accelerated filer | ☐ | Accelerated filer | ☐ |
| Non-accelerated filer (Do not check if a smaller reporting company) | ☐ | Smaller reporting company | ☒ ☑ |
| Emerging growth company | ☐ | | |
| | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of November 2, 2017May 1, 2018, there were 2,161,362,4952,913,559,657 shares of the issuer’s common stock, $0.0001 par value per share, outstanding.
TABLE OF CONTENTS
| | Page Number |
| PART I FINANCIAL INFORMATION | |
| | |
| ITEM 1 Financial Statements (unaudited except as noted) | 3 |
| | |
| Consolidated Balance Sheets as of September 30, 2017March 31, 2018 and December 31, 20162017 (audited) | 3 |
| | |
| Consolidated Statements of Operations for the three and nine months ended September 30,March 31, 2018 and 2017 and 2016 | 4 |
| | |
| Consolidated Statements of Cash Flows for the ninethree months ended September 30,March 31, 2018 and 2017 and 2016 | 5 |
| | |
| Notes to the Consolidated Financial Statements | 6 |
| | |
ITEM 2 Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operation | 18 |
| | 17 |
| ITEM 3 Quantitative and Qualitative Disclosures About Market Risk | 29 |
| | 32 |
| ITEM 4 Controls and Procedures | 29 |
| | 32 |
| PART II OTHER INFORMATION | |
| ITEM 1 Legal Proceedings | | 33 |
ITEM 1. Legal Proceedings.IA Risk Factors | 30 |
| | |
ITEM 1A. Risk Factors | 30 |
| | 33 |
| ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds | 38 |
| | 41 |
| ITEM 3 Defaults Upon Senior Securities | 39 |
| | 42 |
| ITEM 4 Mine Safety Disclosures | 39 |
| | 42 |
ITEM 5 Other Informationinformation | 39 |
| | 42 |
| ITEM 6 Exhibits | 39 |
| | 43 |
| SIGNATURES | 4044 |
ITEM 1.
FINANCIAL STATEMENTS
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| | | | | |
| ASSETS | | | | |
| | | |
| CURRENT ASSETS: | | |
| Cash and cash equivalents | $211,770 | $103,070 | $608,710 | $69,191 |
| Inventory, net | 418,544 | 418,453 | 533,990 | 465,678 |
| Deposits | 9,308 | 11,163 | 24,308 |
| Total current assets | 639,622 | 532,686 | 1,167,008 | 559,177 |
| | | |
| EQUIPMENT, NET | - | 1,890 | 541,875 | 302,689 |
| | | |
| OTHER ASSETS: | | |
| Investment in purchased assets | 220,731 | - | |
| | | |
| TOTAL ASSETS | $860,353 | $534,576 | $1,708,883 | $861,866 |
| | | |
| LIABILITIES AND STOCKHOLDERS' (DEFICIT) | | |
| | | |
| CURRENT LIABILITIES: | | |
| Accounts payable - trade | $1,177,365 | $1,529,919 | $1,049,243 | $821,398 |
| Accounts payable - related parties | - | 10,952 | |
| Accrued expenses | 123,715 | 132,656 | 12,946 | 133,988 |
| Accrued expenses - related parties | 26,409 | 19,605 | 42,832 | 37,776 |
| Derivative liability | - | 2,701,559 | 294,475 | 2,660,167 |
| Current portion of convertible notes payable | 2,172,041 | 2,798,800 | 1,588,122 | 3,015,021 |
| Deferred revenue | 10,000 | 47,995 | 103,491 | 10,000 |
| Total current liabilities | 3,509,530 | 7,241,486 | 3,091,109 | 6,678,350 |
| | | |
| COMMITMENTS AND CONTINGENCIES | - | - |
| | | |
| STOCKHOLDERS' DEFICIT | | |
| Preferred stock - $0.0001 par value, 10,000,000 shares authorized, no shares | | |
| issued and outstanding | - | - |
| Series B Convertible Preferred stock - $0.0001 par value, 150,000 shares authorized, no | | |
| shares issued and outstanding | - | |
| Series C Convertible Preferred stock - $0.0001 par value, 51 shares authorized, no shares | | |
| and 51 shares issued and outstanding at 9/30/2017 and 12/31/2016, respectively | - | |
| Common stock - $0.0001 par value, 3,000,000,000 shares authorized, 2,161,362,495 | | |
| and 1,656,120,083 shares issued and outstanding at 9/30/2017 and 12/31/2016, respectively | 216,124 | 165,600 | |
| Common stock - $0.0001 par value, 6,000,000,000 shares authorized, 2,913,559,657 | | |
| and 2,367,634,022 shares issued and outstanding at 3/31/2018 and 12/31/2017, respectively | | 291,345 | 236,752 |
| Additional paid in capital | 122,723,135 | 117,537,822 | 132,299,609 | 123,678,069 |
| Accumulated deficit | (125,588,437) | (124,410,332) | (133,973,180) | (129,731,305) |
| Total stockholders' deficit | (2,649,177) | (6,706,910) | (1,382,226) | (5,816,484) |
| | | |
| TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT | $860,353 | $534,576 | $1,708,883 | $861,866 |
The accompanying notes are an integral part of these consolidated financial statements.
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | | |
| | | | | | | |
| | | |
| NET REVENUE | $661,444 | $199,760 | $1,650,367 | $929,108 | $708,936 | $467,565 |
| COST OF GOODS SOLD | 476,752 | 179,252 | 1,353,049 | 893,069 | 632,517 | 452,082 |
| GROSS PROFIT | 184,692 | 20,508 | 297,318 | 36,039 | 76,419 | 15,483 |
| GENERAL AND ADMINISTRATIVE EXPENSES | 588,969 | 437,170 | 1,501,924 | 1,351,111 | 1,179,457 | 413,262 |
| OPERATING LOSS | (404,277) | (416,662) | (1,204,606) | (1,315,072) | (1,103,038) | (397,779) |
| | | |
| OTHER INCOME (EXPENSE): | | |
| Change in fair value of derivative | - | 874,985 | 2,163,861 | 496,806 | 2,358,444 | 1,790,814 |
| Interest expense, net | (153,216) | (375,815) | (468,809) | (614,045) | (388,304) | (202,784) |
| Other (expense) income | - | (92,025) | - | 158,032 | |
| Loss on debt conversions | (198,706) | (464,473) | (1,668,551) | (464,473) | (5,108,977) | (1,367,400) |
| Total other (expense) income | (351,922) | (57,328) | 26,501 | (423,680) | (3,138,837) | 220,630 |
| | | |
| (LOSS) BEFORE INCOME TAXES | (756,199) | (473,990) | (1,178,105) | (1,738,752) | (4,241,875) | (177,149) |
| | | |
| Income taxes - current benefit | - | - |
| | | |
| NET (LOSS) | $(756,199) | $(473,990) | $(1,178,105) | $(1,738,752) | $(4,241,875) | $(177,149) |
| | | |
| Basic and diluted (loss) per share | $(0.00) | $(0.00) |
| | | |
| Weighted average shares of common stock outstanding- basic and diluted | 2,090,300,854 | 1,195,368,355 | 1,973,142,842 | 1,082,494,008 | 2,708,232,869 | 1,825,906,568 |
The accompanying notes are an integral part of these consolidated financial statements.
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | |
| | | | | |
| | | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | |
| Net loss | $(1,178,105) | $(1,738,752) | $(4,241,875) | $(177,149) |
| Adjustments to reconcile net loss to net cash (used in) | | |
| operating activities | | |
| Depreciation and amortization | 1,890 | 6,765 | 10,814 | 1,890 |
| Amortization of intangible assets | - | 79,911 | |
| Stock based compensation | 161,895 | 98,173 | 54,648 | 48,583 |
| Common stock issued for services | 51,000 | 125,000 | 153,206 | 15,000 |
| Amortization of debt discount | 121,395 | (99,081) | 249,329 | 61,610 |
| Change in fair value of derivative liability | (2,701,559) | (496,806) | (2,358,444) | (1,790,814) |
| Accrued interest on convertible notes payable | 317,392 | 323,489 | 32,827 | 113,045 |
| Loss on debt conversions | 1,668,551 | 464,473 | 5,108,977 | 1,367,400 |
| Write-off of derivative liability to additional paid in capital | 537,698 | - | |
| Changes in operating assets and liabilities: | | |
| Inventory | (91) | 78,613 | (68,312) | (41) |
| Deposits | 1,890 | - | |
| Accounts payable | (102,753) | 282,705 | 245,845 | (150,782) |
| Accrued expenses | (2,137) | 2,377 | (115,986) | (22,325) |
| Deferred revenue | (37,995) | (15,000) | 93,491 | (27,995) |
| CASH (USED IN) OPERATING ACTIVITIES | (1,160,929) | (888,133) | (835,480) | (561,578) |
| | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | |
| Investment in purchased assets | (220,731) | - | |
| | - | (250,000) | - |
| NET CASH (USED IN) INVESTING ACTIVITIES: | (220,731) | - | (250,000) | - |
| | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | |
| Cash provided from Convertible Promissory Note with Chicago Venture Partners, L.P. | 2,999,401 | 905,000 | 525,000 | 2,059,401 |
| Share issuances to St. George Investments LLC | | 1,100,000 | - |
| Cash payoff to TCA Global Credit Master Fund, LP | (1,509,041) | - | - | (1,515,901) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | 1,490,360 | 905,000 | 1,625,000 | 543,500 |
| | | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | 108,700 | 16,867 | 539,520 | (18,078) |
| | | |
| CASH AND CASH EQUIVALENTS, beginning of period | 103,070 | 60,362 | 69,191 | 103,070 |
| | | |
| CASH AND CASH EQUIVALENTS, end of period | $211,770 | $77,229 | $608,710 | $84,992 |
| | | |
| Supplemental disclosures of cash flow information: | | |
| Interest paid | $- | $- |
| Taxes paid | $- | $- |
| | | |
| Non-cash investing and financing activities: | | |
| Shares issued for convertible note and interest conversion | $1,147,923 | $2,423,729 | $2,468,590 | $1,544,044 |
| Shares issued for debt conversion | $- | $64,000 | |
| Shares issued for class action settlements | $- | $2,000,000 | |
| Shares issued for mezzanine equity | $- | $300,000 | |
| Series B Convertible Preferred Stock converted into convertible notes payable | $- | $(1,500,000) | |
| Series B Convertible Preferred Stock converted into convertible notes payable debt discount | $- | $315,669 | |
| Common shares issued for accounts payable | $260,753 | $- | $18,000 | $127,148 |
The accompanying notes are an integral part of these consolidated financial statements.
GROWLIFE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – DESCRIPTION OF BUSINESS AND ORGANIZATION
The accompanying unaudited consolidated condensed financial statements have been prepared by GrowLife, Inc. (“us,” “we,” or “our”) in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting and rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. In the opinion of our management, all adjustments, consisting of only normal recurring accruals, necessary for a fair presentation of the financial position, results of operations, and cash flows for the fiscal periods presented have been included.
These financial statements should be read in conjunction with the audited financial statements and related notes included in our Annual Report filed on Form 10-K for the year ended December 31, 2016.2017. The results of operations for the ninethree months ended September 30, 2017March 31, 2018 are not necessarily indicative of the results expected for the full fiscal year, or for any other fiscal period.
GrowLife, Inc. (“GrowLife” or the “Company”) is incorporated under the laws of the State of Delaware and is headquartered in Kirkland, Washington. The Company was founded in 2012 with the Closing of the Agreement and Plan of Merger with SGT Merger Corporation.
The Company’s goal of becoming the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines has not changed. The Company’s mission is to best serve more cultivators in the design, build-out, expansion and maintenance of their facilities with products of high quality, exceptional value and competitive price. Through a nationwide network of knowledgeable representatives, regional centers and its e-commerce website, GrowLife provides essential and hard-to-find goods including media (i.e., farming soil), industry-leading hydroponics equipment, organic plant nutrients, and thousands more products to specialty grow operations across the United States.
The Company primarily sells through its wholly owned subsidiary, GrowLife Hydroponics, Inc. GrowLife companies distribute and sell over 15,000 products through its e-commerce distribution channel, GrowLifeEco.com, and through our regional retail storefronts. GrowLife and its business units are organized and directed to operate strictly in accordance with all applicable state and federal laws.
On June 7, 2013, GrowLife Hydroponics completed the purchase of Rocky Mountain Hydroponics, LLC, a Colorado limited liability company (“RMC”), and Evergreen Garden Center, LLC, a Maine limited liability company (“EGC”). The effective date of the purchase was June 7, 2013.
On October 3, 2017, the Company closed the acquisition of 51% of the Purchased Assets from David Reichwein, a Pennsylvania resident, GIP International Ltd, a Hong Kong corporation and DPR International LLC, a Pennsylvania limited liability corporation. The Purchased Assets include intellectual property, copy rights and trademarks related to reflective tiles and flooring.
The Company did not acquire business, customer list or employees.
The Company acquired its 51% interest in the Purchased Assets for $400,000. The Company funded equipment and rent of an office lease. On February 16, 2018, the Company purchased allthe remaining 49% of the Purchased Assets in exchange for a one-time payment of $250,000. As of December 31, 2017, the Company had recorded investment in purchased assets and liabilities of the RMH and EGC Companies, and their retail hydroponics stores, which are located in Vail and Boulder, Colorado and Portland, Maine. The Company purchased RMC and EGC from Rob Hunt, who was appointed to the then Company’s Board of Directors and President of GrowLife Hydroponics, Inc.$302,689.
On October 17, 2017, the Company was informed by Alpine Securities Corporation (“Alpine”) that Alpine has demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for the Company’s common stock. The Company expects to filefiled an amended application with the OTC Markets to list the Company’s common stock on the OTCQB onceOTCQB. On March 20, 2018 the minimum share price of $0.01 per share is achieved. The Company currently tradesCompany’s Common Stock began trading on the OTC Pink Sheet market. On February 18, 2016, the Company’s common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on the Company's Form 15c2-11.OTCQB.
NOTE 2 – GOING CONCERN
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred net losses of $1,178,155,$4,241,875, $7,694,684 and $5,688,845 for the ninethree months ended September 30, 2017March 31, 2018 and the years ended December 31, 20162017 and 2015,2016, respectively. Our net cash used in operating activities was $1,160,929,$835,480, $2,082,493 and $1,212,192 and $1,375,891 for the ninethree months ended September 30, 2017March 31, 2018 and the years ended December 31, 20162017 and 2015,2016, respectively.
The Company anticipates that it will record losses from operations for the foreseeable future. As of September 30, 2017, ourMarch 31, 2018, the accumulated deficit was $125,588,437.$133,973,180. The Company has experienced recurring operating losses and negative operating cash flows since inception, and has financed its working capital requirements during this period primarily through the recurring issuance of convertible notes payable and advances from a related party. The audit reportopinion prepared by our independent registered public accounting firm relating to our financial statements for the year ended December 31, 20162017 and 20152016 filed with the SEC on March 31, 20172018 includes an explanatory paragraph expressing the substantial doubt about our ability to continue as a going concern.
Continuation of the Company as a going concern is dependent upon obtaining additional working capital. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.
NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES: ADOPTION OF ACCOUNTING STANDARDS
Basis of Presentation - The accompanying unaudited consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions have been eliminated. The preparation of these unaudited consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”).
Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly owned and majority-owned subsidiaries. Inter-Company items and transactions have been eliminated in consolidation.
Cash and Cash Equivalents - The Company classifies highly liquid temporary investments with an original maturity of nine months or less when purchased as cash equivalents. The Company maintains cash balances at various financial institutions. Balances at US banks are insured by the Federal Deposit Insurance Corporation up to $250,000. At March 31, 2018, the Company has cash in excess of FDIC in the amount of $395,000. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risk for cash on deposit.
Accounts Receivable and Revenue - Revenue is recognized on the sale of a product when the product is shipped, which is when the risk of loss transfers to our customers, the fee is fixed and determinable, and collection of the sale is reasonably assured. A product is not shipped without an order from the customer and the completion of credit acceptance procedures. The majority of our sales are cash or credit card; however, we occasionally extend terms to our customers. Accounts receivable are reviewed periodically for collectability.
Inventories - Inventories are recorded on a first in first out basis. Inventory consists of raw materials, purchased finished goods and components held for resale. Inventory is valued at the lower of cost or market. The reserve for inventory was $20,000 as of September 30, 2017March 31, 2018 and December 31, 2016,2017, respectively.
Long Lived Assets – The Company reviews its long-lived assets for impairment annually or when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets under certain circumstances are reported at the lower of carrying amount or fair value. Assets to be disposed of and assets not expected to provide any future service potential to the Company are recorded at the lower of carrying amount or fair value (less the projected cost associated with selling the asset). To the extent carrying values exceed fair values, an impairment loss is recognized in operating results.
Fair Value Measurements and Financial Instruments - ASC Topic 820 defines fair value, establishes a framework for measuring fair value, establishes a nine-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The nine levels are defined as follows:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The carrying value of cash, accounts receivable, investment in a related party, accounts payables, accrued expenses, due to related party, notes payable, and convertible notes approximates their fair values due to their short-term maturities.
Derivative financial instruments -The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations. For stock-based derivative financial instruments, the Company uses a weighted average Black-Scholes-Merton option pricing model to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
Sales Returns - We allow customers to return defective products when they meet certain established criteria as outlined in our sales terms and conditions. It is our practice to regularly review and revise, when deemed necessary, our estimates of sales returns, which are based primarily on actual historical return rates. We record estimated sales returns as reductions to sales, cost of goods sold, and accounts receivable and an increase to inventory. Returned products which are recorded as inventory are valued based upon the amount we expect to realize upon its subsequent disposition. As of September 30, 2017March 31, 2018 and December 31, 2016,2017, there was no reserve for sales returns, which are minimal based upon our historical experience.
Stock Based Compensation - The Company has share-based compensation plans under which employees, consultants, suppliers and directors may be granted restricted stock, as well as options and warrants to purchase shares of Company common stock at the fair market value at the time of grant. Stock-based compensation cost to employees is measured by the Company at the grant date, based on the fair value of the award, over the requisite service period under ASC 718. For options issued to employees, the Company recognizes stock compensation costs utilizing the fair value methodology over the related period of benefit. Grants of stock to non-employees and other parties are accounted for in accordance with the ASC 505.
Net (Loss) Per Share - Under the provisions of ASC 260, “Earnings per Share,” basic loss per common share is computed by dividing net loss available to common shareholders by the weighted average number of shares of common stock outstanding for the periods presented. Diluted net loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the income of the Company, subject to anti-dilution limitations. The common stock equivalents have not been included as they are anti-dilutive. As of September 30, 2017March 31, 2018, there are also (i) stock option grants outstanding for the purchase of 14,010,00059 million common shares at a $0.010$0.008 average exercise price; (ii) warrants for the purchase of 595 million common shares at a $0.031 average exercise price; and (iii) 138,790,556107 millionshares related to convertible debt that can be converted at $0.002535 per share. In addition, we have an unknown number of common shares to be issued under the Chicago Venture Partners, L.P. financing agreements. As of March 31, 2017, there are also (i) stock option grants outstanding for the purchase of 12,010,000 common shares at a $0.010 average strike price; (ii) warrants for the purchase of 595 million common shares at a $0.031 average exercise price; and (iii) 130,106,389 shares related to convertible debt that can be converted at $0.0036 per share. In addition, we have an unknown number of common shares to be issued under the Chicago Venture Partners, L.P. financing agreements. As of September 30, 2016, there are also (i) stock option grants outstanding for the purchase of 24,010,000 common shares at a $0.023 average strike price; (ii) warrants for the purchase of 565 million common shares at a $0.032 average exercise price; and (iii) 286,989,167 shares related to convertible debt that can be converted at 0.0036 per share. In addition, we have an unknown number of common shares to be issued under the TCA Global Credit Master Fund LP and Chicago Venture Partners, L.P. financing agreements.
Dividend Policy - The Company has never paid any cash dividends and intends, for the foreseeable future, to retain any future earnings for the development of our business. Our future dividend policy will be determined by the board of directors on the basis of various factors, including our results of operations, financial condition, capital requirements and investment opportunities.
Use of Estimates - In preparing these unaudited interim consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates and assumptions included in our consolidated financial statements relate to the valuation of long-lived assets, estimates of sales returns, inventory reserves and accruals for potential liabilities, and valuation assumptions related to derivative liability, equity instruments and share based compensation.
Recent Accounting Pronouncements
RecentA variety of proposed or otherwise potential accounting pronouncements, other thanstandards are currently under study by standard setting organizations and various regulatory agencies. Due to the tentative and preliminary nature of those below, issued by the FASB, the AICPA and the SEC didproposed standards, management has not or are not believed by managementdetermined whether implementation of such proposed standards would be material to have a material effect on the Company’s present or futureconsolidated financial statements.
In July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this Update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments in Part I of this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company early adopted ASU 2017-11 and has reclassified it’s financial instrument with down round features to equity.
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting. The amendments in this Update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The amendments in this Update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. Management is currently assessing the impact the adoption of ASU 2017-09 will have on the Company’s Consolidated Financial Statements.
In March 2016, the FASB issued Accounting Standards Update No. 2016-09 (ASU 2016-09), Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early application is permitted for reporting periods where financial statements have not yet been made available for issuance. The ASU requires different transition methods and disclosures based on the type of amendment included in the ASU.). Management is currently assessing the impact the adoption of ASU 2016-09 will have on the Company’s Consolidated Financial Statements.
NOTE 4 – TRANSACTIONS WITH CANX USA, LLC AND LOGIC WORKS LLC
Transactions with CANX, LLC and Logic Works LLC
On November 19, 2013, the Company entered into a Joint Venture Agreement with CANX, a Nevada limited liability company. Under the terms of the Joint Venture Agreement, the Company and CANX formed Organic Growth International, LLC (“OGI”), a Nevada limited liability company, for the purpose of expanding the Company’s operations in its current retail hydroponic businesses and in other synergistic business verticals and facilitating additional funding for commercially financeable transactions of up to $40,000,000.
The Company initially owned a non-dilutive 45% share of OGI and the Company could acquire a controlling share of OGI as provided in the Joint Venture Agreement. In accordance with the Joint Venture Agreement, the Company and CANX entered into a Warrant Agreement whereby the Company delivered to CANX a warrant to purchase 140,000,000 shares of the Company common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires November 18, 2018. Also, in accordance with the Joint Venture Agreement, on February 7, 2014 the Company issued an additional warrant to purchase 100,000,000 shares of our common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires February 6, 2019.
GrowLife received the $1 million as a convertible note in December 2013, received the $1.3 million commitment but not executed and by January 2014 OGI had Letters of Intent with four investment and acquisition transactions valued at $96 million. Before the deals could close, the SEC put a trading halt on our stock on April 10, 2014, which resulted in the withdrawal of all transactions. The business disruption from the trading halt and the resulting class action and derivative lawsuits ceased further investments with the OGI joint venture. The Convertible Note was converted into GrowLife, Inc. common stock as of the year ended December 31, 2016.
On July 10, 2014, the Company closed a Waiver and Modification Agreement, Amended and Restated Joint Venture Agreement, Secured Credit Facility and Secured Convertible Note with CANX and Logic Works LLC, a lender and shareholder of the Company.
The Amended and Restated Joint Venture Agreement with CANX modified the Joint Venture Agreement dated November 19, 2013 to provide for (i) up to $12,000,000 in conditional financing subject to review by GrowLife and approval by OGI for business growth development opportunities in the legal cannabis industry for up to nine months, subject to extension; (ii) up to $10,000,000 in working capital loans, with each loan requiring approval in advance by CANX; (iii) confirmed that the five year warrants, subject to adjustment, at $0.033 per share for the purchase of 140,000,000 and 100,000,000 were fully earned and were not considered compensation for tax purposes by the Company; (iv) granted CANX five year warrants, subject to adjustment, to purchase 300,000,000 shares of common stock at the fair market price of $0.033 per share as determined by an independent appraisal; (v) warrants as defined in the Agreement related to the achievement of OGI milestones; and (vi) a four year term, subject to adjustment.
The Company entered into a Secured Convertible Note and Secured Credit Facility dated June 25, 2014 with Logic Works whereby Logic Works agreed to provide up to $500,000 in funding. Each funding required approval in advance by Logic Works, provided interest at 6% with a default interest of 24% per annum and requires repayment by June 26, 2016. The Note is convertible into common stock of the Company at the lesser of $0.0070 or (B) twenty percent (20%) of the average of the nine (3) lowest daily VWAPs occurring during the twenty (20) consecutive Trading Days immediately preceding the applicable conversion date on which Logic Works elects to convert all or part of this 6% Convertible Note, subject to adjustment as provided in the Note. The 6% Convertible Note is collateralized by the assets of the Company. As of September 30, 2017,March 31, 2018, the outstanding balance on the Convertible Note was $40,632.$0.
OGI was incorporated on January 7, 2014 in the State of Nevada and had no business activities as of September 30, 2017.
NOTE 5 – INVENTORY
Inventory as of September 30, 2017March 31, 2018 and December 31, 20162017 consists of the following:
| | | | | |
| | | | | |
| | | |
| Raw materials | | $178,311 | $110,000 |
| Finished goods | $438,544 | $438,453 | 375,679 | 375,678 |
| Inventory reserve | (20,000) | (20,000) |
| Total | $418,544 | $418,453 | $533,990 | $465,678 |
Finished goods inventory relates to product at the Company’s retail stores, which is product purchased from distributors, and in some cases directly from the manufacturer, and resold at our stores.
The Company reviews its inventory on a periodic basis to identify products that are slow moving and/or obsolete, and if such products are identified, the Company records the appropriate inventory impairment charge at such time.
NOTE 6 – PROPERTY AND EQUIPMENT
Property and equipment as of March 31, 2018 and December 31, 2017 consists of the following:
| | | |
| | | |
| | | |
| Machines and equipment | $552,689 | $365,861 |
| Furniture and fixtures | - | 49,787 |
| Computer equipment | - | 52,304 |
| Leasehold improvements | - | 56,965 |
| Total property and equipment | 552,689 | 524,917 |
| Less accumulated depreciation and amortization | (10,814) | (222,228) |
| Net property and equipment | $541,875 | $302,689 |
Fixed assets, net of accumulated depreciation, were $541,875 and $302,689 as of March 31, 2018 and December 31, 2017, respectively. Accumulated depreciation was $10,814 and $222,228 as of March 31, 2018 and December 31, 2017, respectively. Total depreciation expense was $10,814 and $1,890 for the three months ended March 31, 2017 and 2016, respectively. All equipment is used for manufacturing, selling, general and administrative purposes and accordingly all depreciation is classified in cost of goods sold, selling, general and administrative expenses. The Company will begin depreciation on the purchased machine January 1, 2018 when significant operations begin.
On October 3, 2017, the Company closed the acquisition of 51% of the Purchased Assets from David Reichwein, a Pennsylvania resident, GIP International Ltd, a Hong Kong corporation and DPR International LLC, a Pennsylvania limited liability corporation. The Purchased Assets include intellectual property, copy rights and trademarks related to reflective tiles and flooring.
The Company did not acquire business, customer list or employees.
The Company acquired its 51% interest in the Purchased Assets for $400,000. The Company funded equipment and rent of an office lease. On February 16, 2018, the Company purchased the remaining 49% of the Purchased Assets in exchange for a one-time payment of $250,000. As of March 31, 2018, the Company had recorded investment in purchased assets of $552,689. During the three months ended March 31, 2018, the Company retired fully depreciated assets of $222,228.
NOTE 6 –7– CONVERTIBLE NOTES PAYABLE, NET
Convertible notes payable as of September 30, 2017March 31, 2018 consisted of the following:
| | | | | |
| | | | | | | | | |
| | | | | | | | | |
| 6% Secured convertible note (2014) | $39,251 | $1,381 | $- | $40,632 | |
| 10% OID Convertible Promissory Note with Chicago Venture Partners, L.P. | | $1,748,023 | $115,059 | $(546,734) | $1,316,348 |
| 7% Convertible note ($850,000) | 250,000 | 209,014 | - | 459,014 | 270,787 | 987 | - | 271,774 |
| 10% OID Convertible Promissory Note with Chicago Venture Partners, L.P. | 1,667,373 | 5,022 | - | 1,672,395 | |
| | $1,956,624 | $215,417 | $- | $2,172,041 | $2,018,810 | $116,046 | $(546,734) | $1,588,122 |
Convertible notes payable as of December 31, 20162017 consisted of the following:
| | | | | |
| | | | | |
| | | | | |
| 6% Secured convertible note (2014) | $330,295 | $3,692 | $- | $333,987 |
| 7% Convertible note ($850,000) | 250,000 | 164,137 | - | 414,137 |
| Replacement debenture with TCA ($2,830,210) | 1,468,009 | 18,350 | - | 1,486,359 |
| 10% OID Convertible Promissory Note with Chicago Venture Partners, L.P. | 683,042 | 2,670 | (121,395) | 564,317 |
| | $2,731,346 | $188,849 | $(121,395) | $2,798,800 |
Several of the Company’s convertible promissory notes remain outstanding beyond their respective maturity dates. This may trigger an event of default under the respective agreements. The Company is working with these noteholders to convert their notes into common stock and intends to resolve these outstanding issues as soon as practicable. As a result, the Company accrued interest on these notes at the default rates. Furthermore, as a result of being in default on these notes, the Holders could, at their sole discretion, have called these notes. Although no such action has been taken by the Holders, the Company classified these notes as a current liability as of September 30, 2017 and December 31, 2016.| | | | | |
| | | | | |
| | | | | |
| 6% Secured convertible note (2014) | $39,251 | $1,974 | $- | $41,225 |
| 7% Convertible note ($850,000) | 250,000 | 321,652 | - | 571,652 |
| 10% OID Convertible Promissory Note with Chicago Venture Partners, L.P. | 2,980,199 | 120,492 | (698,547) | 2,402,144 |
| | $3,269,450 | $444,118 | $(698,547) | $3,015,021 |
6% Secured Convertible Note and Secured Credit Facility (2014)
TheOn March 13, 2018, the Company, entered intoreceived a Secured Convertible Note and Secured Credit Facility dated June 25, 2014 withNotice of Conversion from Logic Works whereby Logic Works agreed to provide up to $500,000 in funding. Logic Works funded $350,000. The funding provided for interest at 6% with a default interest of 24% per annum and required repayment by June 26, 2016. The Note is convertible into common stock of the Company at the lesser of $0.007 or (B) twenty percent (20%) of the average of the nine (3) lowest daily VWAPs occurring during the twenty (20) consecutive Trading Days immediately preceding the applicable conversion date on which Logic Works elects to convert all or part of this 6% Convertible Note, subject to adjustment as provided in the Note. On February 28, 2017, Logic Works convertedLLC converting principal and interest of $291,044$41,690 owed under that a 6% Convertible Note into 82,640,39216,445,609 shares of our common stock atwith a per share conversion pricefair value of $.004.$248,329. As of September 30, 2017,March 13, 2018, the outstanding principalbalance on this 6% convertible notethe Convertible Note was $39,251 and accrued interest was $1,381, which results in a total liability of $40,632.$0.
7% Convertible Notes Payable
On October 11, 2013, the Company issued 7% Convertible Notes in the aggregate amount of $850,000 to investors, including $250,000 to Forglen LLC. The Note was due September 30, 2015. All other Notes were converted in 2014. On July 14, 2014, the Board of Directors approved a Settlement Agreement and Waiver of Default dated June 19, 2014 with Forglen related to the 7% Convertible Note. The current annual rate of interest was increased to 24% per annum. The conversion price was $0.007 per share, subject to adjustment as provided in the Note. As of September 30,December 31, 2017, the outstanding principal on this 7% convertible note was $250,000 and accrued interest was $209,014,$321,652, which results in a total liability of $459,014.$571,652.
On February 12, 2018, the Company received a Notice of Conversion from Forglen LLC converting principal and interest of $321,945 owed under that certain 7% Convertible Note as amended June 19, 2014 into 127,000,000 shares of the Company’s common stock with a fair value of $2,235,200.
On February 23, 2018, the Company, submitted a Notice of Prepayment to Forglen LLC to prepay the balance owed under that certain 7% Convertible Note as amended June 19, 2014. In response to the Prepay Notice, Forglen submitted a Notice of Conversion on March 8, 2018 to convert the entire balance of the Note and all accrued interest. Upon negotiations between Forglen and the Company, the parties entered into a Second Amendment to the Note, dated March 12, 2018.
Pursuant to the Amendment, the Note’s maturity date has been extended to December 31, 2019, and interest on the Note shall accrue at 7% per annum, compounding on the maturity date. As consideration for the Amendment, the Company rescinded its Prepay Notice and Forglen rescinded its Conversion Notice. Additionally, after review of the Note and accrued interest, the Parties agreed that as of March 12, 2018, the outstanding balance on the Note was $270,787.
As of March 31, 2018, the outstanding principal on this 7% convertible note was $270,787 and accrued interest was $987, which results in a total liability of $271,774.
Funding from Chicago Venture Partners, L.P. (“Chicago Venture”)
The Company has the following funding transactions with Chicago Venture:
Securities Purchase Agreement with Chicago Venture Partners, L.P. As of April 4, 2016, the Company entered into a Securities Purchase Agreement and Convertible Promissory Note (the “Chicago Venture Note”) with Chicago Venture, whereby we agreed to sell, and Chicago Venture agreed to purchase an unsecured convertible promissory note in the original principal amount of $2,755,000. In connection with the transaction, the Company received $350,000 in cash as well as a series of twelve Secured Investor Notes for a total Purchase Price of $2,500,000. The Note carries an Original Issue Discount (“OID”) of $250,000 and we agreed to pay $5,000 to cover Purchaser’s legal fees, accounting costs and other transaction expenses.
Debt Purchase Agreement and First Amendment to Debt Purchase Agreement and Note Assignment Agreement.On August 24, 2016, the Company closed a Debt Purchase Agreement and a First Amendment to Debt Purchase Agreement and related agreements with Chicago Venture and TCA.
On August 24, 2016, TCA closed an Assignment of Note Agreement and related agreements with Chicago Venture. The referenced agreements relate to the assignment of Company debt, in the form of debentures, by TCA to Chicago Venture. The Company was a party to the agreements between TCA and Chicago Venture because the Company is the “borrower” under the TCA held debentures.
Exchange Agreement, Convertible Promissory Note and related Agreements with Chicago Venture.On August 17, 2016, the Company closed an Exchange Agreement and a Convertible Promissory Note and related agreements with Chicago Venture whereby the Company agreed to the assignment of debentures representing debt between the Company, on the one hand, and with TCA, on the other hand. Specifically, the Company agreed that TCA could assign a portion of the Company’s debt held by TCA to Chicago Venture.
On January 10, 2017, Chicago Venture, at the Company’s instruction, remitted funds of $1,495,901 to TCA in order to satisfy all debts to TCA. On or around January 11, 2017, the Company was notified by TCA that $13,540 were due to TCA in order for TCA to release its security interest in the Company’s assets. On February 1, 2017, TCA notified the Company that all funds were received and TCA would release its security interest in Company’s assets. TCA has confirmed that it is paid in full and the Company is not aware of any other obligations that the Company has as to TCA. The funds received under the Chicago Venture Agreements and previous Chicago Venture Agreements were used to pay-off TCA.
Debt Purchase Agreement and First Amendment to Debt Purchase Agreement and Note Assignment Agreement.On August 24, 2016, the Company closed a Debt Purchase Agreement and a First Amendment to Debt Purchase Agreement and related agreements with Chicago Venture and TCA.
On February 1, 2017, the Company closed the transactions described below with Chicago Venture:
Securities Purchase Agreement, Secured Promissory Notes, Membership Interest Pledge Agreement and Security Agreement
On January 9, 2017, the Company executed the following agreements with Chicago Venture: (i) Securities Purchase Agreement; (ii) Secured Promissory Notes; (iii) Membership Interest Pledge Agreement; and (iv) Security Agreement (collectively the “Chicago Venture Agreements”). The Company entered into the Chicago Venture Agreements with the intent of paying its debt, in full, to TCA Global Credit Master Fund, LP (“TCA”).
The total amount of funding under the Chicago Venture Agreements is $1,105,000. Each Convertible Promissory Note carries an original issue discount of $100,000 and a transaction expense amount of $5,000, for total debt of $1,105,000. The Company agreed to reserve 500,000,000 of its shares of common stock for issuance upon conversion of the Debt, if that occurs in the future. If not converted sooner, the Debt is due on or before January 9, 2018. The Debt carries an interest rate of 10%. The Debt is convertible, at Chicago Venture’s option, into the Company’s common stock at $0.009 per share subject to adjustment as provided for in the Secured Promissory Notes attached hereto and incorporated herein by this reference.
Chicago Venture’s obligation to fund the Debt was secured by Chicago Venture’s 60% interest in Typenex Medical, LLC, an Illinois corporation, as provided for in the Membership Pledge Agreement.
The Company’s obligation to pay the Debt, or any portion thereof, is secured by all Company’s assets.
Payment of All TCA Obligations
On January 10, 2017, Chicago Venture, at the Company’s instruction, remitted funds of $1,495,901 to TCA in order to satisfy all debts to TCA. On or around January 11, 2017, the Company was notified by TCA that $13,540 were due to TCA in order for TCA to release its security interest in the Company’s assets. On February 1, 2017, TCA notified the Company that all funds were received and TCA released its security interest in Company’s assets. TCA has confirmed that it is paid in full and the Company is not aware of any other obligations that the Company has as to TCA.
Securities Purchase Agreement, Secured Promissory Notes and Security Agreement
On August 11, 2017, the Company executed the following agreements with Chicago Venture: (i) Securities Purchase Agreement; (ii) Secured Promissory Notes; and (iii) Security Agreement (collectively the “Chicago Venture Agreements”). The Company entered into the Chicago Venture Agreements with the intent to acquire working capital to grow the Company’s business.
The total amount of funding under the Chicago Venture Agreements is $1,105,000.00 (the “Debt”). Each Convertible Promissory Note carries an original issue discount of $100,000 and a transaction expense amount of $5,000, for total debt of $1,105,000. We agreed to reserve 200,000,000 of its shares of common stock for issuance upon conversion of the Debt, if that occurs in the future. If not converted sooner, the Debt is due on or before August 11, 2018. The Debt carries an interest rate of ten percent (10%). The Debt is convertible, at Chicago Venture’s option, into our common stock at $0.009 per share subject to adjustment as provided for in the Secured Promissory Notes attached hereto and incorporated herein by this reference.
The Company’s obligation to pay the Debt, or any portion thereof, is secured by all of the Company’s assets.
As of September 30,December 31, 2017, the outstanding principal balance due to Chicago Venture is $1,667,373,was $2,980,199, accrued interest was $5,022,$120,492, net of the OIDdiscount of $0,$698,547, which results in a total amount of $1,672,395. The OID has been recorded as$2,402,144.
As of March 31, 2018, the outstanding principal balance due to Chicago Venture is $1,748,023, accrued interest was $115,059, net of the discount of $546,734, which results in a discount to debt and $344,635 was amortized to interest expense during the nine months ended September 30, 2017.total amount of $1,316,348.
During the ninethree months ended September 30, 2017,March 31, 2018, Chicago Venture converted principal and accrued interest of $2,153,000$1,877,668 into 382,622,126338,821,634 shares of the Company’sour common stock at a per share conversion price of $0.006.
$0.0055 with a fair value of $5,073,390. The Company recognized $1,668,551$3,195,722 of loss on debt conversions during the ninethree months ended September 30, 2017.March 31, 2018. The Company has $400,000 in available under this debt financing.
During the three months ended March 31, 2018, the Company recorded an OID debt discount expense of $249,329 to interest expense related to the Chicago Venture financing.
NOTE 78 – DERIVATIVE LIABILITY
In April 2008, the FASB issued a pronouncement that provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives. This pronouncement was effective for financial statements issued for fiscal years beginning after December 15, 2008.
If the conversion features of conventional convertible debt provide for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (BCF). A BCF is recorded by the Company as a debt discount pursuant to ASC Topic 470-20. Debt with Conversion and Other Options. In those circumstances, the convertible debt is recorded net of the discount related to the BCF and the Company amortizes the discount to interest expense over the life of the debt using the effective interest method. The adoptiondebt is convertible at the lesser of these requirements can affect65% of the fair value of the Company’s common stock or $0.009 requiring the conversion feature to be bifurcated from the host debt contract and accounting for warrants and many convertible instruments with provisions that protect holders fromseparately as a declinederivative, resulting in the stock price (or “down-round” provisions). For example, warrants or conversion features with such provisions are no longer recorded in equity. Down-round provisions reduce the exercise price of a warrant or convertible instrument if a company either issues equity shares for a price that is lower than the exercise price of those instruments or issues new warrants or convertible instruments that have a lower exercise price.periodic revaluations.
There was noa derivative liability of $294,475 as of March 31, 2018September 30, 2017.. For the ninethree months ended September 30, 2017,March 31, 2018, the Company recorded non-cash income of $2,163,861$2,358,444 related to the “change in fair value of derivative” expense related to its 6%the Chicago Venture financing. The income related to a decline in the share price and 7% convertible notes.Chicago Venture converted principal and interest of $1,877,668 into 338,821,634 shares of our common stock during the three months ended March 31, 2018.
Derivative liability as of DecemberMarch 31, 20162018 was as follows:
| | | | | |
| | Fair Value Measurements Using Inputs | | Fair Value Measurements Using Inputs | |
| Financial Instruments | | | | | | | | |
| | | | |
| Liabilities: | | | |
| Derivative Instruments | $- | $2,701,559 | $- | $2,701,559 | $- | $294,475 | $- | $294,475 |
| | | | |
| Total | $- | $2,701,559 | $- | $2,701,559 | $- | $294,475 | $- | $294,475 |
For the year ended December 31, 2016, the Company recorded non-cash income of $1,324,384 related to the “change in fair value of derivative” expense related to its 6%, 7% and 18% convertible notes.
The risk-free rate of return reflects the interest rate for the United States Treasury Note with similar time-to-maturity to that of the warrants.
7% Convertible Notes
As of December 31, 2016, the Company had outstanding 7% convertible notes with a remaining balance of $250,000 that the Company determined had an embedded derivative liability due to the “reset” clause associated with the note’s conversion price. The Company valued the derivative liability of these notes at $1,495,495 using the Black-Scholes-Merton option pricing model, which approximates the Monte Carlo and other binomial valuation techniques, with the following assumptions (i) dividend yield of 0%; (ii) expected volatility of 160.0%; (iii) risk free rate of .001%, (iv) stock price of $0.017, (v) per share conversion price of $0.0036, and (vi) expected term of .25 years, as the Company estimated that the balance of these notes will be converted during the year ended December 31, 2017.
6% Convertible Notes
As of December 31, 2016, the Company had outstanding unsecured 6% convertible notes for $330,295 that the Company determined had an embedded derivative liability due to the “reset” clause associated with the note’s conversion price. The Company valued the derivative liability of these notes at $1,206,064 using the Black-Scholes-Merton option pricing model, which approximates the Monte Carlo and other binomial valuation techniques, with the following assumptions (i) dividend yield of 0%; (ii) expected volatility of 160.0%; (iii) risk free rate of .001%, (iv) stock price of $0.017, (v) per share conversion price of $0.0036, and (vi) expected term of .25 years, as the Company estimates that these notes would be converted during the year ended December 31, 2017.
NOTE 89 – RELATED PARTY TRANSACTIONS AND CERTAIN RELATIONSHIPS
Related Party Transactions
Since January 1, 2017,2018, the Company engaged in the following reportable transaction belowtransactions with the Company’sour directors, executive officers, holders of more than 5% of our voting securities, and affiliates or immediately family members of our directors, executive officers and holders of more than 5% of our voting securities.
On February 4, 2017,7, 2018, the Company issued 1,000,0007,660,274 shares of the Company’s common stock to Michael E. Fasci, a Board Director, pursuant to a service award for $15,000.three directors. The shares were valued at the fair market price of $0.015$0.020 per share.
On April 27, 2017, the Company issued 1,000,000 shares of the Company’s to Michael E. Fasci, a Board Director, pursuant to a service award for $9,000.share or $153,205. The shares were valued atissued for annual director service to the fair market price of $0.009 per share.
On April 27, 2017, the Company issued 2,000,000 shares of the Company’s to Michael E. Fasci, a Board Director, pursuant to a consulting agreement for $18,000. The shares were valued at the fair market price of $0.009 per share.
On April 27, 2017, the Company issued 1,000,000 shares of the Company’s to Katherine McLain, a Board Director, pursuant to a service award for $9,000. The shares were valued at the fair market price of $0.009 per share.Company.
Certain Relationships
Please see the transactions with CANX, LLC and Logic Works in Note 5, TCA Global Credit Master Fund LP4, and Chicago Venture Partners, L.P. discussed in Note 4, 6, 7, 98 and 12.10.
NOTE 910 – EQUITY
Authorized Capital Stock
The Company has authorized 3,010,000,0006,010,000,000 shares of capital stock, of which 3,000,000,0006,000,000,000 are shares of voting common stock, par value $0.0001 per share, and 10,000,000 are shares of preferred stock, par value $0.0001 per share.On October 24, 2017 the Company filed a Certificate of Amendment of Certificate of Incorporation with the Secretary of State of the State of Delaware to increase the authorized shares of common stock from 3,000,000,000 to 6,000,000,000 shares.
Non-Voting Preferred Stock
Under the terms of our articles of incorporation, the Company’s board of directors is authorized to issue shares of non-voting preferred stock in one or more series without stockholder approval. The Company’s board of directors has the discretion to determine the rights, preferences, privileges and restrictions, dividend rights, conversion rights, redemption privileges and liquidation preferences, of each series of non-voting preferred stock.
The purpose of authorizing the Company’s board of directors to issue non-voting preferred stock and determine the Company’s rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The issuance of non-voting preferred stock, while providing flexibility in connection with possible acquisitions, future financings and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or could discourage a third party from seeking to acquire, a majority of our outstanding voting stock. Other than the Series B and C Preferred Stock discussed below, there are no shares of non-voting preferred stock presently outstanding and we have no present plans to issue any shares of preferred stock.
Series C Preferred Stock Designation
In connection with the Amended and Restated Securities Purchase Agreement with TCA, the Board of Directors, on October 21, 2015, approved the authorization of a Series C Preferred Stock as provided in the Company’s Certificate of Incorporation, as amended, and the issuance of 51 shares of Series C Preferred Stock. These shares only have voting rights in the event of a default by us under the Amended and Restated Transaction Documents. The Series C Preferred Stock is cancelled with the repayment of the TCA debt.
The Series C Preferred Stock Designation authorizes 51 shares of Series C Preferred Stock. Series C Preferred Stock is not entitled to dividend or liquidation rights and is not convertible into our common stock.
In connection with the closing of the Chicago Venture transactions which closed on February 1, 2017, TCA surrendered the Series C Preferred Stock.
Common Stock
Unless otherwise indicated, all of the following sales or issuances of Company securities were conducted under the exemption from registration as provided under Section 4(2) of the Securities Act of 1933 (and also qualified for exemption under 4(5), formerly 4(6) of the Securities Act of 1933, except as noted below). All of the shares issued were issued in transactions not involving a public offering, are considered to be restricted stock as defined in Rule 144 promulgated under the Securities Act of 1933 and stock certificates issued with respect thereto bear legends to that effect.
The Company has compensated consultants and service providers with restricted common stock during the development of our business and when our capital resources were not adequate to provide payment in cash.
Equity Issuances
During the ninethree months ended September 30, 2017,March 31, 2018, the Company had had the following sales of unregistered of equity securities to accredited investors unless otherwise indicated:
On January 2, 2017, Brighton CapitalFebruary 7, 2018, the Company issued 7,660,274 shares to three directors. The shares were valued at the fair market price of $0.020 per share or $153,205. The shares were issued for annual director service to the Company.
On February 12, 2018, the Company received a Notice of Conversion from Forglen LLC converting principal and interest of $321,945 owed under that certain 7% Convertible Note as amended June 19, 2014 into 127,000,000 shares of the Company’s common stock with a fair value of $2,235,200.
On February 16, 2018, the Company issued 900,000 shares of its common stock to a service provider pursuant to a conversion of debt totaling $18,000. The shares were valued at the fair market price of $0.020 per share.
On March 13, 2018, the Company, received a Notice of Conversion from Logic Works LLC converting principal and interest of $41,690 owed under that a 6% Convertible Note into 16,445,609 shares of our common stock with a fair value of $248,329. As of March 13, 2018, the outstanding balance on the Convertible Note was $0.
During the three months ended March 31, 2018, Chicago Venture converted debtprincipal and interest of $127,148$1,877,668 into 15,893,500338,821,634 shares of our common stock at a per share conversion price of $0.008.$0.0055 with a fair value of $5,073,390.
Securities Purchase Agreements with St. George Investments, LLC
On February 4, 2017,9, 2018, the Company executed the following agreements with St. George Investments LLC, a Utah limited liability company: (i) Securities Purchase Agreement; and (ii) Warrant to Purchase Shares of Common Stock. The Company entered into the St. George Agreements with the intent to acquire working capital to grow the Company’s businesses.
Pursuant to the St. George Agreements, the Company agreed to sell and to issue to St. George for an aggregate purchase price of $1,000,000: (a) 48,687,862 Shares of newly issued 1,000,000restricted Common Stock of the Company; and (b) the Warrant. St. George has paid the entire Purchase Price for the Securities.
The Warrant is exercisable for a period of five (5) years from the Closing, for the purchase of up to 48,687,862 shares of the Company’s common stock to Michael E. Fasci, a Board Director, pursuantCommon Stock at an exercise price of $0.05 per share of Common Stock. The Warrant is subject to a service award for $15,000. The shares were valuedcashless exercise option at the fair market priceelection of $0.015 per share.St. George and other adjustments as detailed in the Warrant.
On February 28, 2017, Logic Works converted principalMarch 20, 2018, the Company entered into and interestclosed on a Common Stock Purchase Agreement with St. George Investments, LLC, a Utah limited liability company.
Pursuant to the St. George Agreements, the Company sold and agreed to issue to St. George 6,410,256 shares of $291,044 into 82,640,392 sharesnewly issued restricted Common Stock of the Company at a purchase price of $0.0156 per share. The Purchase Price was paid at Closing and the Shares shall be issued upon the satisfaction of the Share Delivery Conditions as set forth in the Agreement. The Shares purchased represents less than 0.3% of the Company’s current issued and outstanding common stock at a per share conversion price of $.004.
On April 27, 2017, thestock. The Company issued 1,000,000 shares of the Company’s common stock to Michael E. Fasci, a Board Director, pursuant to a service award for $9,000. The shares were valued at the fair market price of $0.009 per share.
On April 27, 2017, the Company issued 2,000,000 shares of the Company’s common stock to Michael E. Fasci, a Board Director, pursuant to a consulting agreement for $18,000. The shares were valued at the fair market price of $0.009 per share.
On April 27, 2017, the Company issued 1,000,000 shares of the Company’s common stock to Katherine McLain, a Board Director, pursuant to a service award for $9,000. The shares were valued at the fair market price of $0.009 per share.
During the three months ended September 30, 2017, two vendors converted debt of $133,605 into 119,086,394 shares of the Company’s common stock at the fair market price of $0.007 per share.
During the nine months ended September 30, 2017, Chicago Venture converted principal and accrued interest of $2,153,000 into 382,622,126 shares of the Company’s common stock at a per share conversion price of $0.006.has $500,000 available from St. George.
Warrants
The Company did not issue any warrants during the ninethree months ended March 31, 2018September 30, 2017..
A summary of the warrants issued as of September 30, 2017March 31, 2018 is as follows:
| | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| Outstanding at beginning of period | 595,000,000 | $0.031 | 595,000,000 | $0.031 |
| Issued | - | - |
| Exercised | - | - |
| Forfeited | - | - |
| Expired | - | - |
| Outstanding at end of period | 595,000,000 | $0.031 | 595,000,000 | $0.031 |
| Exerciseable at end of period | 595,000,000 | | 595,000,000 | |
A summary of the status of the warrants outstanding as of September 30, 2017March 31, 2018 is presented below:
| | |
| | | | | | |
| | | | | | |
| | | | | | | | |
| | | | | | | | |
540,000,000 | 1.53 | $0.033 | 540,000,000 | $0.033 | 1.00 | $0.033 | 540,000,000 | $0.033 |
55,000,000 | 2.80 | 0.010 | 35,000,000 | 0.010 | 2.30 | 0.010 | 45,000,000 | 0.010 |
| | |
| | |
| 1.57 | $0.031 | 575,000,000 | $0.032 | 1.04 | $0.031 | 585,000,000 | $0.031 |
Warrants totaling 575,000,00055 million shares of common stock had noan intrinsic value of $301,500 as of September 30, 2017.March 31, 2018.
NOTE 10–11– STOCK OPTIONS
Description of Stock Option Plan
In fiscal year 2011,On October 23, 2017, the CompanyCompany’s Shareholders authorized a Stock Incentive Plan whereby a maximum of 18,870,184100,000,000 shares of the Company’s common stock could be granted in the form of Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, and Other Stock-Based Awards. On April 18, 2013, the Company’s Board of Directors voted to increase to 35,000,000 the maximum allowable shares of the Company’s common stock allocated to the 2011 Stock Incentive Plan. The Company has outstanding unexercised stock option grants totaling 14,010,00056,000,000 shares as of September 30,December 31, 2017. All grants are non-qualified asThe Company filed a registration statement on Form S-8 to register 100,000,000 shares of Company’s common stock related to the plan was not approved by the shareholders within one year of its adoption.2017 Stock Incentive Plan.
Determining Fair Value under ASC 505
The Company records compensation expense associated with stock options and other equity-based compensation using the Black-Scholes-Merton option valuation model for estimating fair value of stock options granted under our plan. The Company amortizes the fair value of stock options on a ratable basis over the requisite service periods, which are generally the vesting periods. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company estimates the volatility of our common stock based on the historical volatility of its own common stock over the most recent period corresponding with the estimated expected life of the award. The Company bases the risk-free interest rate used in the Black Scholes-Merton option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. The Company has not paid any cash dividends on our common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes-Merton option valuation model and adjusts share-based compensation for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate is recognized in the period the forfeiture estimate is changed.
Stock Option Activity
During the ninethree months ended September 30, 2017,March 31, 2018, the Company had the following stock option activity:
On June 28, 2017, the Company’s Compensation CommitteeFebruary 23, 2018, an employee was granted four advisory committee members each an option to purchase 500,0002,000,000 shares of the Company’s common stock under the Company’s 2011 Stock Incentive Plan at an exercise price of $0.009$0.020 per share, the fair marketshare. The stock option grant vests quarterly over two years and is exercisable for 5 years. The stock option grant was valued at $40,000.
On February 23, 2018, an employee was granted an option to purchase 1,000,000 shares of common stock at an exercise price on June 28, 2017.of $0.020 per share. The stock option grant vests quarterly over one year and is exercisable for 5 years. The stock option grant was valued at $20,000.
As of September 30,December 31, 2017, there are 14,010,00059,000,000 options to purchase common stock at an average exercise price of $0.010$0.008 per share outstanding under the 20112017 Stock Incentive Plan. The Company recorded $23,352$5,898 and $98,173$7,541 of compensation expense, net of related tax effects, relative to stock options for the ninethree months ended September 30,March 31, 2018 and 2017 and 2016 in accordance with ASC 505. Net loss per share (basic and diluted) associated with this expense was approximately ($0.00). As of September 30, 2017,March 31, 2018, there is $8,048$77,755 of total unrecognized costs related to employee granted stock options that are not vested. These costs are expected to be recognized over a period of approximately 2.223.87 years.
Stock option activity for the ninethree months ended September 30, 2017 March 31, 2018 and the years ended December 31, 20162017 and 20152016 is as follows:
| | | | | | | |
| | | | | | | |
| Outstanding as of December 31, 2014 | 40,720,000 | $0.058 | $2,356,000 | |
| Granted | - | (960,000) | |
| Exercised | - | |
| Forfeitures | (11,700,000) | (0.050) | (585,000) | |
| Outstanding as of December 31, 2015 | 29,020,000 | 0.028 | 811,000 | 29,020,000 | $0.03 | $811,000 |
| Granted | - | - |
| Exercised | - | - |
| Forfeitures | (17,010,000) | (0.041) | (690,500) | (17,010,000) | (0.041) | (690,500) |
| Outstanding as of December 31, 2016 | 12,010,000 | $0.010 | $120,500 | 12,010,000 | 0.01 | 120,500 |
| Granted | 2,000,000 | 0.009 | 18,000 | 44,000,000 | 0.006 | 280,000 |
| Exercised | - | - |
| Forfeitures | - | (10,000) | (0.050) | (500) |
| Outstanding as of September 30, 2017 | 14,010,000 | $0.010 | $138,500 | |
| Outstanding as of December 31, 2017 | | 56,000,000 | 0.007 | 400,000 |
| Granted | | 3,000,000 | 0.020 | 60,000 |
| Exercised | | - |
| Forfeitures | | - |
| Outstanding as of March 31, 2018 | | 59,000,000 | $0.008 | $460,000 |
The following table summarizes information about stock options outstanding and exercisable as of September 30, 2017: March 31, 2018:
| | | | | | | | |
| | | | | | | | |
| | | | | | | | | | |
| | | | | | |
$0.009 | 2,000,000 | 2.75 | $0.009 | - | $0.009 | |
$0.006 | | 32,000,000 | 4.50 | $0.006 | 13,666,667 | $0.006 |
0.007 | | 10,000,000 | 4.50 | 0.007 | 1,666,666 | 0.007 |
0.009 | | 2,000,000 | 2.25 | 0.009 | 500,000 | 0.009 |
0.010 | 12,000,000 | 2.13 | 0.010 | 10,000,000 | 0.010 | 12,000,000 | 1.63 | 0.010 | 12,000,000 | 0.010 |
0.050 | 10,000 | - | 0.050 | 9,167 | 0.050 | |
0.020 | | 3,000,000 | 5.00 | 0.020 | - | |
| 14,010,000 | 2.22 | $0.010 | 10,009,167 | $0.010 | 59,000,000 | 3.87 | $0.008 | 27,833,333 | $0.008 |
Stock option grants totaling 10,009,16756,000,000 shares of common stock had noan intrinsic value of $246,650 as of September 30, 2017.March 31, 2018.
NOTE 1112 – COMMITMENTS, CONTINGENCIES AND LEGAL PROCEEDINGS
Legal Proceedings
From time to time, the Company may become subject to various legal proceedings that are incidental to the ordinary conduct of its business. Although the Company cannot accurately predict the amount of any liability that may ultimately arise with respect to any of these matters, it makes provision for potential liabilities when it deems them probable and reasonably estimable. These provisions are based on current information and may be adjusted from time to time according to developments.
Sales, Payroll and Other than those certain legal proceedings as reported in our annual report on Form 10-K forTax Liabilities
On March 12, 2017, the year ended December 31, 2016 filedCompany entered into an Installment Agreement with the SEC onCity of Boulder, Colorado. This Agreement requires the Company to pay $5,000 per month over the next twenty four months or $119,217 for unpaid sales taxes. As of March 31, 2017,2018, we owe $114,217 in sales tax to the Companies knowsCity of no material, existing or pendingBoulder, CO.
Other Legal Proceedings
We may be sued for non-payment of lease payments at closed stores. We may be subject to legal proceedings against our Company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any director, officer or any affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.actions with various vendors.
Operating Leases
On December 7, 2016, the Company entered into entered into a Consent to Judgement and Settlement Agreement related to its retail hydroponics store located in Portland, Maine. This Agreement provides for a monthly lease payment of $5,373 through May 1, 2020. The CompanyWe also agreed to a repayment schedule for past due rent and owes $36,340owe $54,010 as of September 30,December 31, 2017. The Company isWe are past due on the repayment schedule by $36,340$54,010 as of September 30, 2017. The Company doesMarch 31, 2018. We do not have an option to extend the lease after May 1, 2020.
On October 21, 2013, the Company entered into a lease agreement for retail space for its hydroponics store in Avon (Vail), Colorado. The lease expires on September 30, 2018. Monthly rent for year one of the lease is $2,792 and increases 3.5% per year thereafter through the end of the lease. The Company terminated this lease agreement as of August 31, 2917.
On May 31, 2017, the Company rented space at 5400 Carillon Point, Kirkland, Washington 98033 for $499$623 per month for the Company’sour corporate office and use of space in the Regus network, including California. The Company’sOur agreement expires May 31, 2018 and is expected to be renewed.
On October 1, 2017, GrowLife Hydroponics, Inc. entered into a lease in Calgary, Canada. The monthly lease is approximately $1,997. The lease expires September 30, 2022.
On December 19, 2017, GrowLife Innovations, Inc. entered into a lease in Grand Prairie, Texas dated October 9, 2017, for the manufacturing and distribution of its flooring products. The monthly lease is approximately $15,000. The lease expires December 15, 2018 and can be extended.renewed.
The aggregate future minimum lease payments under operating leases, to the extent the leases have early cancellation options and excluding escalation charges, are as follows:
| Years Ended September 30, | | |
| 2018 | $104,810 | |
| Years Ended March 31, | | |
| 2019 | 102,092 | $278,683 |
| 2020 | - | 169,242 |
| 2021 | - | 58,422 |
| 2022 | - | - |
| 2023 | | - |
| Beyond | - | - |
| Total | $206,902 | $506,347 |
Employment and Consulting Agreements
First Addendum to Agreements with David Reichwein
On February 16, 2018, the Company entered into an Addendum to amend the terms between the Company and David Reichwein. Pursuant to the First Addendum, the Company purchased the remaining 49% of the Purchased Assets in exchange for a one-time payment of $250,000 and the cancellation of Reichwein’s right to receive a 10% commission on certain sales of Free Fit products as was set forth in Reichwein’s employment agreement. In exchange for the cancellation of the commission in the employment agreement, Reichwein was granted the opportunity to earn up to two $100,000 cash bonuses and an aggregate common stock bonus of up to 7,500,000 shares if certain revenue and gross margin goals are met in 2018.
Consulting Agreement with an Entity Controlled by Michael E. Fasci
On March 20, 2018, the Company terminated a Consulting Agreement dated October 21, 2016 with an entity controlled by Michael E. Fasci. Mr. Fasci agreed to provide services related to lender management, financing and acquisitions.
NOTE 1213 – SUBSEQUENT EVENTS
The Company evaluates subsequent events, for the purpose of adjustment or disclosure, up through the date the financial statements are available.
SubsequentThere are no material events subsequent to September 30, 2017, the following material transactions occurred:March 31, 2018.
Lease in Calgary, Canada
On October 1, 2017, GrowLife Hydroponics, Inc. entered into a lease in Calgary, Canada. The monthly lease is approximately $1,997. The lease expires September 30, 2022. The Company expects to sale its products at this lease location.
Offer Letter with David Reichwein
On October 1, 2017, the “Company entered into an Offer Letter with David Reichwein pursuant to which the Company engaged Mr. Reichwein as its Vice-President of Research and Development on an at will basis.
Per the terms of the Reichwein Agreement, Mr. Reichwein’s compensation is $150,000 on an annual basis. Starting on the first quarter 2018, Mr. Reichwein is eligible to earn a quarterly commission based on 10% of tile gross margin dollars.
Mr. Reichwein was granted an option to purchase twenty million shares of our common stock under our 2011 Stock Incentive Plan at $0.006 per share. The shares vest as follows:
| | |
| i | Ten million shares vested immediately; |
| | |
| ii | Ten million shares vest on a quarterly basis over two years beginning on the date of grant.
|
All options will have a five-year life and allow for a cashless exercise. The stock option grant is subject to the terms and conditions of our Stock Incentive Plan, including vesting requirements. In the event that Mr. Reichwein’s continuous status as employee to us is terminated by us without Cause or Mr. Reichwein terminates his employment with us for Good Reason as defined in the Reichwein Agreement, in either case upon or within twelve months after a Change in Control as defined in our Stock Incentive, then 100% of the total number of shares shall immediately become vested.
Mr. Reichwein was entitled to participate in all group employment benefits that are offered by the Company to our senior executives and management employees from time to time, subject to the terms and conditions of such benefit plans, including any eligibility requirements. Finally, Mr. Reichwein is entitled to fifteen days of vacation annually and has certain insurance and travel employment benefits.
Mr. Reichwein may receive severance benefits and our obligation under a termination by the Company without Cause or Mr. Reichwein terminates his employment for Good Reason are discussed above.
Acquisition of 51% of the Purchased Assets
On October 3, 2017, the Company closed the acquisition of 51% of the Purchased Assets from David Reichwein, a Pennsylvania resident, GIP International Ltd, a Hong Kong corporation and DPR International LLC, a Pennsylvania limited liability corporation. The Purchased Assets include intellectual property, copy rights and trademarks related to reflective tiles and flooring.
This acquisition of assets is expected to drive the growth of innovative products and services with high margin gross margins for the Company’s distribution channels, including the design and manufacturing of products and services for the indoor cultivation industry including building materials for other industries.
The Company acquired its 51% interest in the Purchased Assets for $400,000. The Company funded $75,000 of the Purchase Price by September 30, 2017 for the down payment for equipment and funding of the rent and security deposit of an office lease. The balance of the Purchase Price shall be payable to Seller between October 1, 2017 and December 31, 2017.
The Company has the Option to purchase the remaining 49% of the rights, title, and interest in and to the Purchased Assets free and clear of any Encumbrances on or before December 31, 2017 by paying $350,000 in seven monthly payments of $50,000 per month beginning on January 31, 2018 after the Option is exercised and with a final payment on July 31, 2018.
As of September, the Company had recorded investment in purchased assets of $220,731. Funding for the acquisition of the Purchased Assets is expected to be provided by Chicago Venture Partners, L.P. under the August 11, 2017 Securities Purchase Agreement with Chicago Venture.
FINRA Rule 15c2-11 Notice
On October 17, 2017, the Company was informed by Alpine Securities Corporation (“Alpine”) that Alpine has demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for the Company’s common stock. The Company expects to file an amended application with the OTC Markets to list the Company’s common stock on the OTCQB once the minimum share price of $0.01 per share is achieved. The Company currently trades on the OTC Pink Sheet market.
Certificate of Elimination for Series B and C Preferred Stock
On October 24, 2017, the “Company filed a Certificate of Elimination with the Secretary of State of the State of Delaware to eliminate the Series B Convertible Preferred Stock and Series C Preferred Stock of the Company (the “Certificate of Elimination”). None of the authorized shares of either the Series B or Series C Preferred Stock were outstanding.
The Certificate of Elimination, effective upon filing, had the effect of eliminating from the Company's Certificate of Incorporation, as amended, all matters set forth in the Certificate of Designations of the Series B Convertible Preferred Stock and Series C Preferred Stock with respect to each respective series, which were both previously filed by the Company with the Secretary of State on October 22, 2015. Accordingly, the 150,000 shares of Series B Preferred Stock and 51 shares of Series C Preferred Stock previously reserved for issuance under their respective Certificates of Designation resumed their status as authorized but unissued shares of undesignated preferred stock of the Company upon filing of the Certificate of Elimination.
Share Exchange Agreement with Soja, Inc.
On October 19, 2017, the Company signed a Share Exchange Agreement amongst the Company, GrowLife Hydroponics, Inc. and Soja, Inc. whereby the ownership of Soja, Inc. (“Soja”) was transferred from GrowLife Hydroponics, Inc. to GrowLife, Inc. in exchange for 100 shares of the Company’s Common Stock. As a result, Soja is now a wholly owned subsidiary of the Company.
Certificate of Amendment of Certificate of Incorporation
On October 24, 2017 the Company filed a Certificate of Amendment of Certificate of Incorporation with the Secretary of State of the State of Delaware to increase the authorized shares of common stock from 3,000,000,000 to 6,000,000,000 shares.
Appointment of Independent Chairman of the Board
On October 23, 2017, the Board of Directors, appointed Michael E. Fasci, an independent director, Chairman of the Board of Directors. Marco Hegyi, remains Chief Executive Officer and President and a Director.
Annual Shareholder Meeting
The Company held its 2017 Annual Meeting of Stockholders on October 23, 2017. The results of the Annual Meeting are set forth below. The matters considered at the annual meeting were described in detail in the definitive proxy statement on Schedule 14A that the Company filed with the Securities and Exchange Commission on August 16, 2017. All matters were approved by the shareholders as follows:
| | | |
| Description | | |
1 | To elect four nominees to serve on the Board until the 2018 Annual Meeting of Stockholders- | | |
| Marco Hegyi | 207,273,269 | 27,049,202 |
| Mark E. Scott | 209,651,220 | 24,671,251 |
| Michael E. Fasci | 220,228,468 | 14,094,003 |
| Katherine McLain | 210,317,864 | 24,004,607 |
| | | | |
| Description | | | |
2 | To adopt and approve the 2017 Stock Incentive Plan | 176,242,001 | 49,469,472 | 8,602,498 |
3 | To approve an amendment to the Company’s Certificate of Incorporation to increase the | 1,099,163,437 | 694,964,528 | 27,270,936 |
| authorized shares of common stock (“Common Stock”) from 3,000,000,000 to 6,000,000,000 | | | |
4 | To ratify the appointment of SD Mayer and Associates, LLP of Seattle, Washington as the | 1,586,873,838 | 76,838,085 | 157,686,979 |
| Company’s independent registered public accounting firm for the fiscal years ending | | | |
| December 31, 2016 and 2017 | | | |
5 | To approve, on a non-binding advisory basis, the compensation paid to the Company’s | 161,084,619 | 63,393,490 | 9,835,862 |
| named executive officers | | | |
| Description | | | | |
6 | To vote, on a non-binding advisory basis, on the frequency (i.e., every one, two, or three years) | 110,133,612 | 16,013,697 | 93,296,845 | 14,888,317 |
| of holding an advisory shareholder vote to approve the compensation paid to the Company’s | | | | |
| named executive officers | | | | |
| | | | | |
| | | | |
| | | 2,064,907,125.00 | 1,821,398,902.00 | 88.2% |
Committee Assignments
On October 23, 2017 the Company’s Board of Directors, approved the following committee assignments:
Audit | | Compensation | | Nominations and Governance |
Michael E. Fasci (Chairman) | | Michael E. Fasci (Chairman) | | Katherine McLain (Chairman) |
Thom Kozik | | Katherine McLain | | Thom Kozik |
All committees now consist of independent directors.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking statements in this report reflect the good-faith judgment of our management and the statements are based on facts and factors as we currently know them. Forward-looking statements are subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, but are not limited to, those discussed below as well as those discussed elsewhere in this report (including in Part II, Item 1A (Risk Factors)). Readers are urged not to place undue reliance on these forward-looking statements because they speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report.
THE COMPANY AND OUR BUSINESS
GrowLife, Inc. (“GrowLife” or the “Company”) is incorporated under the laws of the State of Delaware and is headquartered in Kirkland, Washington. We were founded in 2012 with the Closing of the Agreement and Plan of Merger with SGT Merger Corporation.
OurGrowLife’s goal of becomingis to become the nation’s largest cultivation facility service provider
for the production of organics, herbs and greens and plant-based medicines continues to guide our decisions. Our mission is to measure our success by our customer’s success; serving cultivators of all sizes as a reliable business partner and our shareholders with value and trust. Through knowledgeable representatives and our e-commerce website, medicines.
GrowLife provides essential and hard-to-find goods including growing media, industry-leading hydroponics equipment, organic plant nutrients, and thousands more products through its knowledgeable representatives and our distribution channels, to specialty grow operations across the United States and Canada.
We primarily sell supplies through our wholly owned subsidiary, GrowLife Hydroponics, Inc. GrowLife companies distributealso distributes and sellsells over 15,000 products along with a handful of its own branded products through its e-commerce distribution channel,channels, ShopGrowLife.com, Greners.com and GrowLifeEco.com, andas well as through ourGrowLife licensed retail storefronts. GrowLife and its business units are organized and directed to operate strictly in accordance with all applicable state and federal laws.
The GrowLife mission is to measure its success by its customer’s success;
serving cultivators of all sizes as a reliable business partner and its shareholders with value and trust.
The ‘their success is our success’ focus has helped us understand the pains and needs our customers are enduring and the many products and services we can provide to help them grow. We recognize that the cost of customer acquisition is 10x higher than retention so it is in GrowLife’s best interest to retain its customers by supporting their needs with innovative offerings, lower pricing and reliable delivery. The indoor cultivation industry, primarily driven by indoor Cannabis farming, is in its formative stages where it is developing a recurring track record. Due to the conflicting laws and policies throughout the United States our customers consist mostly of smaller, early-stage companies that face unusual challenges not experienced in most larger established industries.
As a result, agility takes the place over predictability and trust surpasses price and convenience. Therefore, there are focusingfew public or billion dollar companies operating in this industry. Thus, the GrowLife mission of aligning itself with the success of its customer’s.
GrowLife’s vision of indoor cultivation is that it is
inevitable; not another gardening alternative.
We seek to support the mission of GrowLife helping its customers be successful by minimizing the operating costs of indoor cultivators of fruits, vegetables and Cannabis so they can better serve their markets and customers.
Outdoor farming is a wasteful, destructive and an inefficient use of precious resources. Current water, land and harvest cycles are limited and, if left unchecked, will fail to support the world’s population growth. However, indoor cultivation allows our customers to replicate nature in a controllable manner that uses a fraction of water and land while providing 2–5 times the crop cycles of outdoor. The challenge is in getting the economics right. Subsidies are not the answer. Even many large-scale indoor grow operations with large capital investments have had a difficult time staying in business because the poor economic models fail to deliver a profit. Fruits and vegetables have limited revenue benefit due to their low prices and saturated supply from international and domestic growers.
Cannabis on the other hand currently has an attractive revenue model and valuation multiple but modest demand of about 5% of the population due to shadows cast by interstate commerce restrictions, banking issues and threatening federal laws. However, Cannabis laws are not the only expected changes. We must prepare for significantly lower prices if Cannabis is to become a mainstream alternative to beer, wine and other alcohol in the future. Expecting a $12 Cannabis cigarette to drop to $1 over the next couple of years is not unreasonable.
Therefore, as an indoor cultivation industry, we must lower production costs to provide local, safer, healthier and affordable food and Cannabis crops. We see this as the game changer: Over time we must support a production cost at 10% of the current price point. This means increasing efficiencies, scaling up production volumes and driving down indoor operating costs. Given this vision of the future, lowering our customer’s production costs serves as our compass to mergers, acquisitions and partnerships.
To profitably achieve such a goal, we see GrowLife building out five strategic pillars. These pillars represent unfulfilled needs, which if capitalized upon, can provide PHOT investors with a lasting diversified portfolio of products and services.
GrowLife’s five pillars of planned growth are 1) direct commercial sales, 2) products, 3) online markets, 4) consumer GrowLife Cube, and 5) retail --- are organized across four audience-centric divisions. We sell to commercial customers through our GrowLife Commercial division to large-scale customers for both hydroponics and FreeFit, our business materials products.
GrowLife will continue to provide growing supplies to cultivators, known as “picks and shovels” to the green rush industry, we are investing in developing proprietary products that will enhance higher gross profit, differentiation and a greater ecological benefit and value to the industry through GrowLife Innovations, Inc., a whole-owned subsidiary. For example, GrowLife recently acquired FreeFit building material assets which bring several benefits to the Company: Revenue, higher gross profits and intellectual properties that will serve as the foundation to upcoming products including complete GrowLife room solutions. These solutions are aimed at providing lower production costs for our legal commercial customers that are growing at large scales. Over the last three months the Company organized its operating structure into four divisions to be aligned with its business initiatives towards focused growth.
The other GrowLife divisions will continue to distribute and sell over 15,000 products and FreeFit through its e-commerce distribution channel, ShopGrowLife.com.New products will be developed by GrowLife Innovations Inc., the research and development arm of the company, and GrowLife Retail will drive our licensed retail storefronts. GrowLife, Inc. and its divisions are organized and directed to operate strictly in accordance with all applicable state and federal laws.
We focus on customer success. In that regard, we believe that the indoor cultivation industry will continue to experience significant growth and, as a result, serving this industry has become highly competitive, cash intensive and customer centric. However, we have plans to address these challenges.
First, the opportunity to sell both infrastructure equipment and recurring supplies to the indoor cultivation industry is constantly increasing as demand for indoor cultivation grows across the United States and Canada. GrowLife believes the demand will continue to grow and more states and municipalities will enact laws and regulations allowing for greater indoor cultivation activities. GrowLife continues with its multi-faceted distribution strategy, which we believe serves customers in the following manner: Direct sales to large commercial customers through GrowLife Hydroponics, retail licensing through licensed partners for local convenience, and e-commerce via GrowLifeEco.comShopGrowLife.com to fulfill orders across the nation from customers of all sizes.
Second, selling withthrough multiple channels with readily available products is foundational to GrowLife, however differentiation comes from unique products that are uniquely available only from GrowLife and benefiting our customers. We recentlyGrowLife. In October 2017 we formed GrowLife Innovations, Inc., which is where we housed our recently acquired building material assets. FreeFit® is a patented product line of eco-friendly and easy to install vinyl floor tiles with patterns and prints that can provide passive (no resource demands such as power) benefits to our customers. GrowLife is currently testing custom configurations with cultivators to quantify its economic value to customers. Building materials is a starting point for GrowLife Innovations. Other products and services are being developed and tested with plans to bring them to market over the next few months.
Third, GrowLife’s customers come in different stages from small caregiver cultivators to large 80,000+ square foot commercial operations. Along with our business-to-business (B2B) focus we have been expanding to the business-to-consumer (B2C) by offering the GrowLife Cube subscription products. We recognize demand is increasing from small, aspiring cultivation consumers across the country seeking to learn and use a complete indoor growing solution. To address this demand, we packaged GrowLife Cube, an entry-level offering for consumers to get hands-on experience with indoor growing. Although many still buy the components separately, we are working on developing videos and supplier tools to attract them to this one-stop shop program. Many states are giving individuals the legal freedom to cultivate crops in their own home and GrowLife Cube gives them the necessary tools.
GrowLife started the expansion of sales and store personnel and marketing efforts with continued funding from Chicago Venture Partners, L.P. Chicago Venture is supportive in the expansion of the sales and marketing teams in a growing market. GrowLife is growing in several markets including California and Canada. GrowLife received funding on an$1 million in equity financing in February 2018 for expansion in addition to continuing as-needed basiscapital for suchoperating costs. As the personnel were hired late in the December 2016 quarter, the impact started in the March 2017 quarter.
GrowLife also considered the lack of capital access since 2014 and the new funding vehicles with Chicago Venture Partners, L.P. Operations were significantly impacted during 2014- 2016 as a result of the lack of access to capital. GrowLife did not have cash to ship all orders. With the addition of GrowLife’s new partners, we have access to capital and are growing our sales again.
Resumed Trading of our Common Stock
OnOn October 17, 2017, we were informed by Alpine Securities Corporation (“Alpine”) that Alpine hashad demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for the Company’s common stock. We expect to filefiled an amended application with the OTC Markets to list the Company’s common stock on the OTCQB once the minimum share price of $0.01 per share is achieved. We currentlyand began to trade on the OTC Pink Sheet market.
this market as of March 20, 2018.
Market Size and Growth
While there is a great deal of purchasing of indoor cultivation equipment for non-Cannabis cultivation, many of our investors have a high-interest in the direction of the Cannabis industry as it may directly affect GrowLife’s growth. Therefore, the following market information is provided.
Twenty-nine states and the District of Columbia currently have laws broadly legalizing marijuana in some form.
Seven states and the District of Columbia have adopted the most expansive laws legalizing marijuana for recreational use. Most recently, California, Massachusetts, Maine and Nevada all passed measures in November legalizing recreational marijuana. California’s Prop. 64 measure allows adults 21 and older to possess up to one ounce of marijuana and grow up to six plants in their homes. Other tax and licensing provisions of the law will not take effect until January 2018.
Several legislatures in states recently passing legalization measures are debating regulatory proposals around the use and sale of marijuana. Massachusetts lawmakers were weighing bills earlier this year that would lower the amount residents can legally possess and place restrictions on retail stores.
A number of states have also decriminalized the possession of small amounts of marijuana. Some medical marijuana laws are broader than others, with types of medical conditions that allow for treatment varying from state to state. Several states (not shown on the map below) have passed narrow laws allowing residents to possess cannabis only if they suffer from certain rare medical illnesses.
Our map shows current state laws and recently-approved ballot measures legalizing marijuana for medical or recreational purposes. Final rules for recently-passed medical marijuana laws are pending in Arkansas, Florida and North Dakota.
Information is current as of October 2017.
Source: www.governing.com/gov-data/state-marijuana-laws-map-medical-recreational.htmlMarkets Serviced
GrowLife serves a new, yet sophisticated communityInc. is engaged in the business of commercialoffering general hydroponic growing equipment including complete indoor lighting systems, growing mediums, soils, tools for cutting and urban cultivatorspropagation, hydroponics systems, growing specialty crops including organics, greensaccessories, bulbs, ballasts, reflectors, meters and plant-based medicines. Unliketimers and climate control equipment for the traditional agricultural industry, these cultivators use innovative indoor growing techniques to produce specialty crops in highly controlled environments. This enables them to produce crops at higher yields without having to compromise quality - regardlessplant cultivation and cannabis industries.
Additionally, GrowLife, through its recent asset acquisition, has begun servicing the Luxury Vinyl Tile market segment of the season or weather and drought conditions.Floor Covering industry, which it will use in its GrowLife clean grow room initiative.
Indoor growing is commonly used for plant-based medicines because they often require high-degree of regulation and controls including government compliance, security, and crop consistency. This makes indoor growing a preferred method. Cultivators of plant-based medicines often make a significant investment to design and build-out their facilities. They look to work with companies such as GrowLife who understand their specific needs, and can help mitigate risks that could jeopardize their crops.Hydroponic Growing Equipment (US)
IndoorIndustry Definition:
The Hydroponic Growing Equipment industry is primarily engaged in selling hydroponic horticulture equipment. Hydroponics is a method of growing techniques, however,plants using mineral nutrient solutions in water without the use of soil.
2017 Key Industry Statistics:
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In 2017, the Hydroponic Growing Equipment Stores industry generated $689.7 million in gross revenue with total profits of $26.9 million.
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The industry grew 4.4% from 2012 to 2017 and is expected to continuing growing at a rate of 1.7% through 2022.
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As of 2017, there are not limited to plant-based medicines. Vertical farms producing organic fruits and vegetables are beginning to emergeapproximately 1,948 businesses engaged in the industry, which contribute $210 million in wages and salaries to the nation’s economy.
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No companies have been identified as “major players”.
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Household consumers comprise the largest market due to a rising shortage of farmland, and environmental vulnerabilities including drought, other severe weather conditions and insect pests. Indoor growing technology and techniques enable cultivators to grow crops all-year-round in urban areas, and take up less ground while minimizing environmental risks. However, indoor growing techniques typically require a more significant upfront investment to design and build-out these facilities, than traditional farmlands. If new innovations lower the costs for indoor growing, and the costs to operate traditional farmlands continue to rise, then indoor growing techniques may be a compelling alternativesegment for the broader agricultural industry.industry, accounting for 48.1% of the market in 2017, with farms and agriculture representing 37.2% of the market and 14.7% represented by other types including: retail establishments, equipment wholesalers, repair shops, industrial companies, and government bodies.
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The industry’s average profit margin, defined as earnings before interest and taxes, has increased since 2012; profit margins are expected to have expanded from 1.8% of industry revenue in 2012 to 3.9% in 2017.
Product and Service Segmentation:
State | Year Passed How Passed
(Yes Vote) Possession Limit
|
1.Alaska
| 1998 Ballot Measure 8 (58%)
1 oz usable; 6 plants (3 mature, 3 immature)
|
2.Arizona
| 2010 Proposition 203 (50.13%)
2.5 oz usable; 12 plants
|
3.Arkansas
| 2016 Ballot Measure Issue 6 (53.2%)
3 oz usable per 14-day period
|
4.California
| 1996 Proposition 215 (56%)
8 oz usable; 6 mature or 12 immature plants
|
5.Colorado
| 2000 Ballot Amendment 20 (54%)
2 oz usable; 6 plants (3 mature, 3 immature)
|
6.Connecticut
| 2012 House Bill 5389 (96-51 H, 21-13 S)
2.5 oz usable
|
7.Delaware
| 2011 Senate Bill 17 (27-14 H, 17-4 S)
6 oz usable
|
8.Florida
| 2016 Ballot Amendment 2 (71.3%)
Amount to be determined
|
9.Hawaii
| 2000 Senate Bill 862 (32-18 H; 13-12 S)
4 oz usable; 7 plants
|
10.Illinois
| 2013 House Bill 1 (61-57 H; 35-21 S)
2.5 ounces of usable cannabis during a period of 14 days
|
11.Maine
| 1999 Ballot Question 2 (61%)
2.5 oz usable; 6 plants
|
12.Maryland
| 2014 House Bill 881 (125-11 H; 44-2 S)
30-day supply, amount to be determined
|
13.Massachusetts
| 2012 Ballot Question 3 (63%)
60-day supply for personal medical use (10 oz)
|
14.Michigan
| 2008 Proposal 1 (63%)
2.5 oz usable; 12 plants
|
15.Minnesota
| 2014 Senate Bill 2470 (46-16 S; 89-40 H)
30-day supply of non-smokable marijuana
|
16.Montana
| 2004 Initiative 148 (62%)
1 oz usable; 4 plants (mature); 12 seedlings
|
17.Nevada
| 2000 Ballot Question 9 (65%)
2.5 oz usable; 12 plants
|
18.New Hampshire
| 2013 House Bill 573 (284-66 H; 18-6 S)
Two ounces of usable cannabis during a 10-day period
|
19.New Jersey
| 2010 Senate Bill 119 (48-14 H; 25-13 S)
2 oz usable
|
20.New Mexico
| 2007 Senate Bill 523 (36-31 H; 32-3 S)
6 oz usable; 16 plants (4 mature, 12 immature)
|
21.New York
| 2014 Assembly Bill 6357 (117-13 A; 49-10 S)
30-day supply non-smokable marijuana
|
22.North Dakota
| 2016 Ballot Measure 5 (63.7%)
3 oz per 14-day period
|
23.Ohio
| 2016 House Bill 523 (71-26 H; 18-15 S)
Maximum of a 90-day supply, amount to be determined
|
24.Oregon
| 1998 Ballot Measure 67 (55%)
24 oz usable; 24 plants (6 mature, 18 immature)
|
25.Pennsylvania
| 2016 Senate Bill 3 (149-46 H; 42-7 S)
30-day supply
|
26.Rhode Island
| 2006 Senate Bill 0710 (52-10 H; 33-1 S)
2.5 oz usable; 12 plants
|
27.Vermont
| 2004 Senate Bill 76 (22-7) HB 645 (82-59)
2 oz usable; 9 plants (2 mature, 7 immature)
|
28.Washington
| 1998 Initiative 692 (59%)
8 oz usable; 6 plants
|
29.Washington, DC
| 2010 Amendment Act B18-622 (13-0 vote)
2 oz dried
|
Source: Marijuana State Laws – Summary Chart from ProCon.org |
Of total product sales in 2017, 35.8% of products sold were nutrients, solution chemicals and other treatments, 30.4% were hydroponic systems and equipment, 20% were other accessories, additions, supplies and merchandise, and 13.8% were hardware, tools, plumping and electrical supplies.
Key Industry Drivers:
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Much of the industry’s sudden popularity is the result of heightened consumer interest in locally grown and organic produce; many producers of hydroponic fruits and vegetables strive to use sustainable business practices and natural nutrients and pesticides
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Consumer interest in organic foods and hydroponic growing has also increased as disposable income continues to rise.
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Given the discretionary nature of the industry’s products, demand is heavily influenced by fluctuations in the overall level of consumer disposable income and consumer confidence in the economy. Over the five years to 2017, per capita disposable income is anticipated to grow an annualized 1.4%. Rising disposable income increases consumers’ willingness to purchase luxuries such as high-priced hydroponic growing equipment and organic foods.
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Impact of the Cannabis Industry
o
According to data released by Forbes, the medical marijuana market is expected to generate $6.7 billion in 2017 alone. Given the size of the medical marijuana market, a rising number of entrepreneurs have invested in hydroponic growing equipment to be part of the medical marijuana gold rush. This investment has been one of the primary drivers of the aggressive growth that this industry has experienced over the past five years.
o
In certain states, patients with medical marijuana cards are also allowed to grow limited quantities of marijuana for personal use. This has encouraged patients to purchase hydroponic growing equipment and pursue small-scale marijuana cultivation.
Competitive advantages:
-
Most hydroponic growing equipment stores are small business operations that serve their immediate geographic areas. GrowLife serves a nationwide audience with expansion into Canada.
Growth Outlook:
“The industry is growing faster than overall GDP”
IBIS World expects the Cannabis industry revenue to grow an annualized 1.7% to $750.2 million over the five years to 2022.
Factors:
-
Increasing consumer focus on healthy eating habits will likely spur demand as more consumers seek out organic and pesticide-free produce and opt to grow their own or purchase locally produced organic foods made with hydroponic growing equipment.
-
Medical and recreational marijuana is expected to be approved in an increasing number of US states over the next five years, which will lead more patients and entrepreneurs to buy marijuana and hydroponic growing equipment to fulfill demand for this growing market.
-
This industry will also continue to benefit from risk-averse local farmers wishing to break their reliance on weather conditions that may be increasingly volatile.
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IBIS World estimates that per capita disposable income will rise at an annualized rate of 2.7% over the five years to 2022.
Strategy-
Our long-term strategy revolves around three key premises: First, the indoor growing market for fruits, vegetables and medical plants is here to stay. We see an opportunity for it to double for several years, especially after last year’s election raisingThe US Department of Agriculture reported in 2016 that the number of statescertified organic food operators increased nearly 12.0% from 2015, and this growth is expected to remain high over the next five years.
-
IBIS World expects profitability to fall somewhat over the next five years as price-based competition accelerates.
Competitive Advantages
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IBIS World anticipates that support Cannabis; Second, GrowLifethe number of industry establishments will increase at an annualized rate of 5.1% to 3,123 over the five years to 2022 earning it the rating of “Highly competitive”
-
Market share concentration is low with only one company representing over 1% of market share.
-
Barriers to Entry in this industry are Low
Medical and Recreational Marijuana Growing Industry
Industry Definition:
This emerging industry pertains to those engaged in the practice of cultivating and producing legal marijuana plants for the medical and recreational consumer markets.
US 2016 Key Industry Statistics:
-
In 2016, the Medical and Recreational Marijuana Growing industry generated $3.5 billion in gross revenue with total profits of $233.4 million.
-
The industry grew 28.3% from 2011 to 2016 and is expected to continuing growing at a rate of 33.5% through 2021.
-
As of 2016, there are approximately 148,294 businesses engaged in the industry, which contribute $957.6 million in wages and salaries to the nation’s economy.
-
No companies have been identified as “major players”.
-
Medical Marijuana patients with severe pain comprise the largest market segment for the industry, accounting for 64.6% of the market in 2016, with recreational consumers accounting for 14.1% of the market. The remaining market share is shared by consumers purchasing products for treatment of other various medical conditions.
-
The industry’s average profit margin, defined as earnings before interest and taxes, varies greatly across the industry because of the myriad of laws governing medical and recreational marijuana from state to state. Industry-wide margins have grown on account of the legalization of recreational marijuana in Colorado and Washington and are expected to grow as more legalization takes effect including California.
Key Industry Drivers:
-
Medical marijuana growers continue to establish itselfbenefit from the steadily aging population. Chronic illnesses have become more prevalent as a national brandthe population continues to provide the much-needed advisory services and sell lighting, nutrients, mediums and other equipment, supplies and services to cultivators across the country; And third, theage, driving demand for more healthy, safer and economical ways to run indoor growing operations will dramatically increase and require innovative products to intelligently drive down costs without compromising quality. These are critical premises for the Company’s growth.medical marijuana.
Our growth plan consists-
An estimated 2.6 million people use marijuana for medicinal purposes, and this segment of adding more knowledgeable, talented and committed people, creating greater accessthe US population is anticipated to equipment and supplies, and offering more and better choices. We must sequence our steps in a timely and deliberate manner. We attract and retain such talent by offering healthcare benefits along with a pay-for-performance compensation model that appeals to high performers.increase drastically over the next five years.
Our base business provides GrowLife with-
More than two-thirds of Americans now live in jurisdictions that have legalized either the medical or adult use of marijuana.
Growth Outlook:
“The industry is growing at a solid high-growth foundation, especially as we see interest increase for the GrowLife Retail License Program that was announced at the end of 2016. This License Program creates financial and operating efficiencies for GrowLife. We are shifting our retail store business from a fixed to variable cost structure, which allows us to apply our indoor cultivation competency to other retail partners, and reach more cultivators in markets acrossfaster rate than the US faster. The License Program offerings range from a Store-within-the-store, such as the one in place in Philadelphia at Fairmount Hardware, an Ace Hardware franchisee, located at 2011 Fairmount Ave, Philadelphia, PA, to partnering with retail investors who seek to set up new GrowLife-licensed hydroponic stores. We are pleased with the initial response and lessons learned from the License Program, which have helped refine our offerings, customer engagement and operating process.economy”
The other two channels for our base business, Online e-commerce and Direct Sales, continue-
Industry revenue is estimated to be refined as we apply more talentincrease at an annualized rate of 33.5% to them. We plan$15.0 billion over the five years to serve the base business with these channels by helping those price-sensitive customers drive down their equipment and supply costs. While this puts great price pressure on our manufacturers, we closely watch metrics move to the lowest cost per gram. One of the largest cultivators recently shifted their lights from a popular 1,000W to 315W where the electricity savings alone drove down their production cost by 35% and production increased by 20%.2021.
In addition, our expansion business efforts are equally capable of revenue growth. However, expansion investments come with great risk not too different than building a start-up. Our expansion efforts are intended to be game-changers.
The Cannabis industry itself is a game-changer. Many people are discovering great benefits with the plant that are far beyond its commercial growth. Even with all the government challenges we believe that both business and consumer will persevere because the demand and benefit of the plant are genuine based on scientific research conducted throughout the world. Consistent safety measures and standards are on their way. Therefore, we see the greatest opportunities and challenges to be in helping to address the mainstream acceptance and management of the plant…the game-changers.
GrowLife will therefore be pursuing such game-changers to help propel the industry forward on several fronts. Acquisitions may range from innovations that significantly drive down the operating costs for commercial cultivators to the desperately needed cloud-based tools for the government to extensively coordinate its policies with the industry in a safe and responsible manner. We expect to see some of these expansion game-changers come to market in 2017 such as the recent asset acquisition of building materials. The caveat is that there are many moving parts and these game-changers may or may not come to pass.
GrowLife’s greatest growth may come from a business that is not a significant contributor today. We see key areas that may be game-changers for us in 2017: Mergers & Acquisitions and Partnerships (MAP); Consumer with GrowLife Cube; and plant-related services. Each of these areas will require us to add the right people at the right time. Many talented individuals are ready to join GrowLife.
MAP in our base business with Retail Licensing Program has quickly taught us to invest in new procedures and people. Growth from M&A is the most obvious expansion move. Over the last year, we explored a half-a-dozen acquisition opportunities. However, we found that they were all over-priced. Even after factoring in the possible valuation lift to the PHOT share price, the risk/reward did not make sense.
The most visible example was Go Green Hydroponics, where we had entered into a non-binding letter of intent last year. In February 2017, we announced in an SEC 8-K/A filing that the non-binding letter of intent had expired and GrowLife does not expect to close the acquisition of Go Green Hydroponics. We will therefore not be pursuing this acquisition since our retail strategy has shifted to the GrowLife Retail Licensing Program.
Another area we are continuing to develop is demand from new consumers entering the industry, where they seek to learn how to build indoor operations. We have tested GrowLife Cube, an entry-level growing package that provides the basic set-up for an indoor farming operation. GrowLife provides all the necessary growing equipment and supplies. We have determined that there are many consumers without growing experience, knowledge and local access to hydroponic equipment and supplies. Therefore, we are tuning GrowLife Cube to more effectively reach and satisfy these new consumers.
Finally,Factors:
-
Continued legalization on the state level will increase accessibility to medical and recreational marijuana, increasing nationwide demand.
-
Growing acceptance of the marijuana products will increase demand. According to a poll conducted by Gallup, 36.0% of Americans between the ages of 18 to 29 have tried marijuana in January we spent time at2013, compared with just 8.0% in 1969.
-
The level of household income determines consumers’ ability to purchase medical marijuana products. While prescription products can be essential for health and therefore less susceptible to changes in consumer expenditure, the Seedunconventional nature of the industry’s products make it subject to Sale Showchanges in Denverdisposable income. As a result, an increase in disposable income will boost demand for medical marijuana growers.
Floor Covering Industry: Segment Luxury Vinyl Tile (LVT) (US)
Industry Definition:
The Floor Covering industry is segmented by product type including wood, rugs, resilient (which includes the Luxury Vinyl Tile or “LVT” segment), carpet, tile, laminate and rubber subcategories. GrowLife is engaged in luxury vinyl tile manufacturing and is participating in this market by selling through business-to-business and business-to-consumer channels.
2016 Key Industry Statistics:
-
In 2016, the U.S. flooring market grew an estimated 5.1%, according to exploreMarket Insights, with total revenues of $21.174 billion.
-
North America flooring market will witness gains over 5% up to 2024 according to Global Market Insights.
Luxury Vinyl Tile
-
LVT now accounts for 16.5% of the planttotal flooring market in dollars and seed business. Our conclusion18.8% in volume after a 6.5% rise in units to 3.537 billion square feet. In 2015, resilient held a 13.3% market share in terms of dollars, which was up from 12.2% in 2014, 11.9% in 2013 and 11.2% in 2012 respectively.
-
Sales have gone from nearly $750 million in 2012 to $948 million in 2013, $1.142 billion in 2014, $1.651 billion in 2015 and $2.161 in 2016. That represents respective gains of 26.4%, 20.5%, 27.1% and 30.9% respectively
-
LVT sales have more than doubled in three years.
-
LVT increased significantly in both residential and commercial markets—dollars and square feet—in 2016. Residential LVT saw a 68.3% increase in square footage from 760 million in 2015 to 1.04 billion (including WPC), making up 76.1% of the LVT market. This number was 71% a year ago and 55% two years ago.
-
The commercial market rose from 297.2 million square feet to 326.3 million square feet, a 9.8% increase. While residential brought in more dollars—$1.512 billion—last year, commercial LVT still performed well, posting a 12.5% increase, rising from $576.4 million in 2015 to $648.6 million in ’16.
https://www.rocsearch.com/samples/PDFs/Market%20Landscape-Global-Commercial-Vinyl-Flooring-Market-Landscape.pdf
Competitive advantages:
-
GrowLife’s LVT product FreeFit® features significant competitive advantages including:
o
20k+ HD imaging, “Real Touch” texture technology, fully customizable platform, “Seriously Easy to Install” design, made in the US, waterproof, lifespan 3x longer than traditional vinyl, 4mmm thickness and 22mil wear layer and wear and stain resistance
-
Direct to consumer sales model that major competitors cannot execute on due to resale agreements
Growth Outlook:
The global vinyl flooring market is thatexpected to reach an estimated $16.2 billion by 2023, and it is an attractive business that needsforecast to be further explored but in an indirect manner. GrowLife is not readygrow at a CAGR of 4.4% from 2018 to directly touch the plant due to Federal interstate laws. We are instead considering how to legally support it through state based-partners.
We see the indoor cultivation industry as growing faster than other industries due to increasing demand for and legalization of non-toxic pain relief medicines. For years GrowLife has built its brand through experience with leading commercial cultivators. We continue to assemble the best team in the industry to create a great opportunity. Our investors and shareholders have shown strong loyalty and support even through difficult times.
Overall, GrowLife is in a stronger position than it has been for some time. With continued work and support, we are encouraged with the prospect of bringing growth back to the company and increase shareholder value.2023.
Key Market Priorities
Our goal of becoming the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines requires GrowLife toto: (i) expand our nationwide, multi-channel sales network presence, (ii) offer the best terms for the full range of build-out equipment and consumable supplies, and (iii) deliver superior, innovative products.
First, we provide distribution through retail, e-commerce and direct sales to have national coverage and serve cultivators of all sizes. Each channel offers varying pricing for differing benefits. Retail sells at list price by offering inventory convenience, e-commerce provides lower prices without requiring local inventory, and direct sales delivers the best bid price for high-volume purchasers. Additional points of service may be added through existing distribution locations and services. This may be done in several manners and programs that may incorporate cultivator-centric locations with other retailer store owners.
Second, we serve the needs of all size cultivators and each one’s unique formulation, or ‘recipe’. We provide thousands of varieties of supplies from dozens of vendors and distributors. More importantly is our experience of knowing which products to recommend under each customer’s circumstance.
And third, our experience with hundreds ofextensive customers allows us to determine specific product needs and sources to test new designs. Lights, pesticides, nutrients, building materials and growing systems are some examples of products that GrowLife can provide. Popular name branded products are seeking to be part of the GrowLife companyCompany in many forms. In exchange, we can market their products in a unique manner over generic products.
Our company can expand with these strategies until it serves more indoor cultivators throughout the country. Once a customer is engaged, we can gradually expand their purchasing market share by providing greater economic benefit to the customers who buy more products from GrowLife than from other suppliers.
Employees
As of September 30, 2017March 31, 2018, we had twenty one full-time employee and one consultant at our Seattle, Washington office.part-time employees. Marco Hegyi, our Chief Executive Officer, is based in Kirkland, Washington. Mark E. Scott, our CFO,Chief Financial Officer, is based primarily in Seattle, Washington. In addition, we have approximately 8nineteen full and part time employeesconsultants located throughout the United States and Canada who operate our businesses. None of our employees isare subject to a collective bargaining agreement or represented by a trade or labor union. We believe that we have a good relationship with our employees.
Key Partners
Our key customers vary by state and are expected to be more defined as the company moves from its retail walk-in purchasing sales strategy to serving cultivation facilities directly and under predictable purchasing contracts.
Our key suppliers include distributors such as HydroFarm, Urban Horticultural Supply and Sunlight Supply to product-specific suppliers. All the products purchased and resold are applicable to indoor growing for organics, greens, and plant-based medicines.
Competition
Certain large commercial cultivators have found themselves willing to assume their own equipment support by buying large volume purchased directly from certain suppliers and distributors such as Sunlight Supplies and HydroFarm. Other key competitors on the retail side consist of local and regional hydroponic resellers of indoor growing equipment. On the e-commerce business, GrowersHouse.com, Hydrobuilder.com HorticultureSource.com and smaller online resellers using Amazon and eBay e-commerce market systems.
Intellectual Property and Proprietary Rights
Our intellectual property consists of brands and their related trademarks and websites, customer lists and affiliations, product know-how and technology, and marketing intangibles.
Our other intellectual property is primarily in the form of trademarks and domain names. We also hold rights to several website addresses related to our business including websites that are actively used in our day-to-day business such as www.shopgrowlife.com, www.freefit.com, www.growlifeinc.com, www.growlifeeco.com and www.greners.com.
On October 3, 2017, we closed the acquisition of 51% of the Purchased Assets from David Reichwein, a Pennsylvania resident, GIP International Ltd, a Hong Kong corporation and DPR International LLC, a Pennsylvania limited liability corporation. The Purchased Assets include intellectual property, copy rights and trademarks related to reflective tiles and flooring.
On February 16, 2018, we entered into an Addendum (the “First Addendum”) to amend the terms between the Company and David Reichwein. Pursuant to the First Addendum, we purchased the remaining 49% of the Purchased Assets in exchange for a one-time payment of $250,000 and the cancellation of Mr. Reichwein’s right to receive a 10% commission on certain sales of Free Fit products as was set forth in Mr. Reichwein’s employment agreement. In exchange for the cancellation of the commission in the employment agreement, Mr. Reichwein was granted the opportunity to earn up to two $100,000 cash bonuses and an aggregate common stock bonus of up to 7,500,000 shares if certain revenue and gross margin goals are met in 2018.
We have a policy of entering into confidentiality and non-disclosure agreements with our employees, and some of our vendors and customers as necessary.
Government Regulation
Currently, there are twenty ninethirty states plus the District of Columbia that have laws and/or regulation that recognize in one form or another legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. There are currently eight states and the District of Columbia that allow recreational use of cannabis. As of the date of this writing,March 28, 2018, the policy and regulations of the Federal government and its agencies is that cannabis has no medical benefit and a range of activities including cultivation and use of cannabis for personal use is prohibited on the basis of federal law and may or may not be permitted on the basis of state law. Active enforcement of the current federal regulatory position on cannabis on a regional or national basis may directly and adversely affect the willingness of customers of GrowLife to invest in or buy products from GrowLife. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect revenues and profits of the GrowLife companies.
All this being said, many reports show that the majority of the American public is in favor of making medical cannabis available as a controlled substance to those patients who need it. The need and consumption will then require cultivators to continue to provide safe and compliant crops to consumers. The cultivators will then need to build facilities and use consumable products, which GrowLife provides.
THE COMPANY’S COMMON STOCK
On April 10, 2014, we received notice from the SEC that trading of our common stock on the OTCBB was to be suspended from April 10, 2014 through April 24, 2014. The SEC issued its order pursuant to Section 12(k) of the Securities Exchange Act of 1934. According to the notice received by us from the SEC: “It appears to the Securities and Exchange Commission that the public interest and the protection of investors require a suspension of trading in the securities of GrowLife, Inc. because of concerns regarding the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in GrowLife’s common stock.” We never received notice from the SEC that and we were formally being investigated.
The suspension of trading eliminated our market makers, resulted in our trading on the grey sheets, resulted in legal proceedings and restricted our access to capital.
OnOn October 17, 2017, we were informed by Alpine Securities Corporation (“Alpine”) that Alpine has demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for our common stock. We expect to filefiled an amended application with the OTC Markets to list the Company’s common stock on the OTCQB once the minimum share price of $0.01 per share is achieved. We currentlyand begin to trade on the OTC Pink Sheet market. On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11.this market as of March 20, 2018.
PRIMARY RISKS AND UNCERTAINTIES
We are exposed to various risks related to legal proceedings, our need for additional financing, the sale of significant numbers of our shares, the potential adjustment in the exercise price of our convertible debentures and a volatile market price for our common stock. These risks and uncertainties are discussed in more detail below in Part II, Item 1A.
RESULTS OF OPERATIONS
The following table presents certain consolidated statement of operations information and presentation of that data as a percentage of change from period-to-period.
(dollars in thousands)
| | Three Months September 30, | Three Months Ended March 31, |
| | | | | | | | | |
| Net revenue | $661 | $200 | $461 | 230.5% | $709 | $467 | $242 | 51.8% |
| Cost of goods sold | 476 | 179 | 297 | -165.9% | 633 | 452 | 181 | -40.0% |
| Gross profit | 185 | 21 | 164 | 781.0% | 76 | 15 | 61 | 406.7% |
| General and administrative expenses | 589 | 438 | 151 | -34.5% | 1,179 | 413 | 766 | -185.5% |
| Operating loss | (404) | (417) | 13 | 3.1% | (1,103) | (398) | (705) | -177.1% |
| Other income (expense): | | |
| Change in fair value of derivative | - | 875 | (875) | -100.0% | 2,358 | 1,791 | 567 | 31.7% |
| Interest expense, net | (153) | (376) | 223 | 59.3% | (388) | (203) | (185) | -91.1% |
| Other income | - | (92) | 92 | 100.0% | |
| Loss on debt conversions | (199) | (464) | 265 | 57.1% | (5,109) | (1,367) | (3,742) | -273.7% |
| Total other expense | (352) | (57) | (295) | 517.5% | |
| Total other (expense) income | | (3,139) | 221 | (3,360) | -1520.4% |
| (Loss) before income taxes | (756) | (474) | (282) | -59.5% | (4,242) | (177) | (4,065) | -2296.6% |
| Income taxes - current benefit | - | 0.0% | - | 0.0% |
| Net (loss) | $(756) | $(474) | $(282) | -59.5% | $(4,242) | $(177) | $(4,065) | -2296.6% |
THREE MONTHS ENDED SEPTEMBER 30, 2017 MARCH 31, 2018 AS COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2016 MARCH 31, 2017
Revenue
Net revenue for the three months ended September 30, 2017March 31, 2018 increased $461,000$242,000 to $661,000$709,000 as compared to $200,000$467,000 for the three months ended September 30, 2016.March 31, 2017. The increase resulted from increased sales personnel, andincreased channels of distribution.distribution, opening a store in Canada and the development of the reflective tiles and flooring product line.
Cost of Goods Sold
Cost of sales for the three months ended September 30, 2017March 31, 2018 increased $297,000$181,000 to $476,000$633,000 as compared to $179,000$452,000 for the three months ended September 30, 2016.March 31, 2017. The increase was due increased sales, offset by lower cost of sales related to favorable product mix and increased supplier discounts.
Gross profit was $185,000$76,000 for the three months ended September 30, 2017March 31, 2018 as compared to a gross profit of $21,000$15,000 for the three months ended September 30, 2016.March 31, 2017. The gross profit percentage was 27.9%10.8% for the three months ended September 30, 2017March 31, 2018 as compared to 10.3%3.3% for the three months ended September 30, 2016.March 31, 2017. The gross profit increase was due increased sales, offset by lower cost of sales related to favorable product mix and increased supplier discounts.
General and Administrative Expenses
General and administrative expenses for the three months ended September 30, 2017March 31, 2018 increased $151,000$766,000 to $589,000$1,179,000 as compared to $438,000$413,000 for the three months ended September 30, 2016.
March 31, 2017. The variances were as follows: (i) an increase was due to thein insurance of $50,000; (ii) an increase in rent of $46,000; (iii) an increase in payroll of $242,000; (iv) an increase in public relations of $5,000; (v) an increase in legal expense of our annual shareholder meeting.$102,000; (vi) an increase in stock based compensation of $144,000; (vii) an increase in sales, marketing and trade show expenses of $38,000; (viii) an increase in depreciation of $11,000; and (ix) and an increase in other expenses of $128,000. As part of the general and administrative expenses for the three monthsyear ended September 30,December 31, 2017, we did not record anyrecorded public relation, investor relation or business development expenses.expenses of $5,000, $0 and $0 respectively. The increase resulted from increased sales personnel, increased channels of distribution, opening a store in Canada and the development of the reflective tiles and flooring product line.
Non-cash general and administrative expenses for the three months ended September 30, 2017March 31, 2018 were $57,000$218,000 including (i) depreciation and amortization of $11,000; (ii) stock based compensation of $54,000 related to stock based compensation.option grants and warrants; and (iii) common stock issued for services of $153,000.
Non-cash general and administrative expenses for the three months ended September 30, 2016 was $123,000, with March 31, 2017 were $65,000 including (i) depreciation and amortization of $30,000;$2,000; (ii) stock based compensation of $33,000$48,000 related to stock option grants; (iii) and common stock issued for services of $60,000.$15,000.
Other Expense(Expense) Income
Other expense for the three months ended September 30, 2017March 31, 2018 was $352,000$3,139,000 as compared to $57,000other income of $221,000 for the three months ended September 30, 2016.March 31, 2017. The other expense for the three months ended September 30, 2017March 31, 2018 included (i) interest expense of $153,000$388,000; and (ii) loss on debt conversions of $199,000.$5,109,000; offset by (iii) change in fair value of derivative of $2,358,000 The non-cash interest related to the amortization of the debt discount associated with our convertible notes and accrued interest expense related to our notes payable. The loss on debt conversions related to the conversion of our notes payable at prices below the market price.
The other expenseincome for the three months ended September 30, 2016 included other expense of $92,000, interest expense of $376,000, and loss on debt conversions of $464,000, offset change in derivative liability of $875,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The non-cash interest related to the amortization of the debt discount associated with our convertible notes and accrued interest expense related to our notes payable. The loss on debt conversions related to the conversion of our notes payable at prices below the market price.
Net (Loss)
Net loss for the three months ended September 30, 2017 was $756,000 as compared to $474,000 for the three months ended September 30, 2016 for the reasons discussed above.
Net loss for the three months ended September 30, 2017 included non-cash expenses of $407,000 including (i) stock based compensation of $57,000 related to stock option grants and warrants; (ii) accrued interest and amortization of debt discount on convertible notes payable of $151,000; (iii) loss on debt conversions of $199,000;
(iv) reclassification of derivative instruments to additional paid in capital to of $538,000; and offset by (v) change in derivative liability of $538,000.
Net loss for the nine months ended September 30, 2016 included non-cash expense of $59,000 including (i) depreciation and amortization of $30,000; (ii) stock based compensation of $33,000 related to stock option grants; (iii) common stock issued for services of $60,000; (iv) accrued interest and amortization of debt discount on convertible notes payable of $222,000; (v) loss on debt conversions of $464,000; offset by (vi) change in derivative liability of $875,000.
We expect losses to continue as we implement our business plan.
NINE MONTHS ENDED SEPTEMBER 30, 2017 AS COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2016
The following table presents certain consolidated statement of operations information and presentation of that data as a percentage of change from period-to-period.
(dollars in thousands)
| | Nine Months Ended September 30, |
| | | | | |
| Net revenue | $1,650 | $929 | $721 | 77.6% |
| Cost of goods sold | 1,353 | 893 | 460 | -51.5% |
| Gross profit | 297 | 36 | 261 | 725.0% |
| General and administrative expenses | 1,502 | 1,351 | 151 | -11.2% |
| Operating loss | (1,205) | (1,315) | 110 | 8.4% |
| Other income (expense): | | | | |
| Change in fair value of derivative | 2,164 | 497 | 1,667 | 335.4% |
| Interest expense, net | (468) | (614) | 146 | -23.8% |
| Other income | - | 157 | (157) | -100.0% |
| Loss on debt conversions | (1,669) | (464) | (1,205) | -259.7% |
| Total other income (expense) | 27 | (424) | 451 | 106.4% |
| (Loss) before income taxes | (1,178) | (1,739) | 561 | 32.3% |
| Income taxes - current benefit | - | - | - | 0.0% |
| Net (loss) | $(1,178) | $(1,739) | $561 | 32.3% |
Revenue
Net revenue for the nine months ended September 30, 2017 increased $721,000 to $1,650,000 as compared to $929,000 for the nine months September 30, 2016. The increase resulted from increased sales personnel and channels of distribution.
Cost of Goods Sold
Cost of sales for the nine months ended September 30, 2017 increased $460,000 to $1,353,000 as compared to $893,000 for the nine months ended September 30, 2016. The increase was due increased sales, offset by lower cost of sales related to favorable product mix and increased supplier discounts.
Gross profit was $297,000 for the nine months ended September 30, 2017 as compared to $36,000 for the nine months ended September 30, 2016. The gross profit percentage was 18.0% for the nine months ended September 30, 2017 as compared to 3.9% for the nine months ended September 30, 2016. The gross profit increase was due increased sales, offset by lower cost of sales related to favorable product mix and increased supplier discounts.
General and Administrative Expenses
General and administrative expenses for the nine months ended September 30, 2017 were $1,502,000 as compared to $1,351,000 for the nine months ended September 30, 2016. The variances were as follows: (i) an increase in insurance of $42,000; (ii) expense of our annual shareholder meeting of $125,000; (iii) an increase in payroll of $45,000; and (iv) and an increase in other expenses of $82,000; offset by (v) a decrease in legal expense of $95,000; and (vi) a decrease in rent of $48,000. As part of the general and administrative expenses for the nine months ended September 30, 2017, we did not record any public relation, investor relation or business development expenses.
Non-cash general and administrative expenses for the nine months ended September 30, 2017 were $214,000 including (i) depreciation and amortization of $2,000; (ii) stock based compensation of $161,000 related to stock option grants and warrants; and (iii) common stock issued for services of $51,000.
Non-cash general and administrative expenses for the nine months ended September 30, 2016 was $310,000 including (i) depreciation and amortization of $87,000; (ii) stock based compensation of $98,000 related to stock option grants; (iii) common stock issued for services of $125,000.
Other Income/ Expense
Other income for the nine months ended September 30, 2017 was $27,000 as compared to other expense of $424,000 for the nine months ended September 30, 2016. The other income for the nine months ended September 30,March 31, 2017 included (i) change in derivative liability of $2,164,000;$1,791,000; offset by (ii) interest expense of $468,000;$203,000; and (iii) loss on debt conversions of $1,669,000.$1,367,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The non-cash interest related to the amortization of the debt discount associated with our convertible notes and accrued interest expense related to our notes payable. The loss on debt conversions related to the conversion of our notes payable at prices below the market price.
Other expense for the nine months ended September 30, 2016 was $424,000 as compared to other expense of $1,714,000 for the nine months ended September 30, 2015. The other expense for the nine months ended September 30, 2016 included interest expense of $614,000 and loss on debt conversions of $464,000, offset by change in derivative liability of $497,000 and other income of $157,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The non-cash interest related to the amortization of the debt discount associated with our convertible notes and accrued interest expense related to our notes payable. The loss on debt conversions related to the conversion of our notes payable at prices below the market price.
Net (Loss)
Net loss for the ninethree months ended September 30, 2017March 31, 2018 was $1,178,000$4,242,000 as compared to $1,739,000$177,000 for the ninethree months ended September 30, 2016March 31, 2017 for the reasons discussed above.
Net loss for the ninethree months ended September 30, 2017March 31, 2018 included non-cash expenses of $158,000$3,251,000 including (i) depreciation and amortization of $2,000;$11,000; (ii) stock based compensation of $162,000$54,000 related to stock option grants and warrants; (iii) common stock issued for services of $51,000;$153,000 (iv) accrued interest and amortization of debt discount on convertible notes payable of $439,000;$282,000; (v) write-off of additional paid in capital to of $538,000; and (vi) loss on debt conversions of $1,668,000,$5,109,000; offset by (vii)(vi) change in derivative liability of $2,702,000.$2,358,000 and (vii) an increase in working capital of $156,000.
Net loss for the ninethree months ended September 30, 2016March 31, 2017 included non-cash expense of $502,000$184,000 including (i) depreciation and amortization of $87,000;$2,000; (ii) stock based compensation of $98,000$49,000 related to stock option grants;grants and warrants; (iii) common stock issued for services of $125,000;$15,000; (iv) accrued interest and amortization of debt discount on convertible notes payable of $223,000;$176,000; (v) loss on debt conversions of $464,000; and$1,367,000, offset by (vi) change in derivative liability of $497,000.$1,791,000.
We expect losses to continue in 2018 as we implement our business plan.plan and grow sales, margins and ultimately profits. We have increased sales personnel, channels of distribution, opened a store in Canada and are developing the reflective tiles and flooring product line.
LIQUIDITY AND CAPITAL RESOURCES
We had cash of $212,000$609,000 and a net working capital deficit of approximately $2,870,000$62,000 (net of derivative liability, convertible notes payable and deferred revenue) as of September 30, 2017.March 31, 2018. We expect losses to continue as we grow our business. Our cash used in operations for the ninethree months ended September 30, 2017March 31, 2018 and the years ended December 31, 2017 and 2016 was $835,000, $2,082,000 and 2015 was $1,161,000, $1,212,000, and $1,376,000, respectively.
Shortly after the SEC suspended trading of our securities on April 10, 2014, some of our primary suppliers rescinded our credit terms and required us to pay cash for our product purchases and pay down our outstanding balance with these suppliers.
We will need to obtain additional financing in the future. There can be no assurance that we will be able to secure funding, or that if such funding is available, the terms or conditions would be acceptable to us. If we are unable to obtain additional financing, we may need to restructure our operations, divest all or a portion of our business or file for bankruptcy.
We have financed our operations through the issuance of convertible debentures and the sale of common stock.
Funding Agreements with Chicago Venture Partners, L.P.(“Chicago Venture”)
We have closed several financing transactions with Chicago Venture since 2016. We have $400,000 in available under this debt financing.
Securities Purchase Agreements with St. George Investments, LLC(“St. George”)
On February 1, 2017, we closed the transactions described below with Chicago Venture Partners, L.P. (“Chicago Venture”).
Securities Purchase Agreement, Secured Promissory Notes, Membership Interest Pledge Agreement and Security Agreement
On January 9, 2017, the Company executed the following agreements with Chicago Venture: (i) Securities Purchase Agreement; (ii) Secured Promissory Notes; (iii) Membership Interest Pledge Agreement; and (iv) Security Agreement (collectively the “Chicago Venture Agreements”). The Chicago Venture Agreements are attached hereto, collectively, filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on February 7, 2017, and incorporated herein by reference. The Company entered into the Chicago Venture Agreements with the intent of paying its debt, in full, to TCA Global Credit Master Fund, LP (“TCA”), which included any TCA affiliates.
The total amount of funding under the Chicago Venture Agreements is $1,105,000 (the “Debt”). Each Convertible Promissory Note carries an original issue discount of $100,000 and a transaction expense amount of $5,000, for total debt of $1,105,000. The Company agreed to reserve 500,000,000 of its shares of common stock for issuance upon conversion of the Debt, if that occurs in the future. If not converted sooner, the Debt is due on or before January 9, 2018. The Debt carries an interest rate of ten percent (10%). The Debt is convertible, at Chicago Venture’s option, into the Company’s common stock at $0.009 per share subject to adjustment as provided for in the Secured Promissory Notes attached hereto and incorporated herein by this reference. As of the date of this report, Chicago Venture has funded the entire amount of the Debt.
Chicago Venture’s obligation to fund the Debt was secured by Chicago Venture’s 60% interest in Typenex Medical, LLC, an Illinois corporation, as provided for in the Membership Pledge Agreement attached hereto and incorporated herein by this reference.
Payment of All TCA Obligations
On January 10, 2017, Chicago Venture, at the Company’s instruction, remitted funds of $1,495,901 to TCA in order to satisfy all debts to TCA. On or around January 11, 2017, the Company was notified by TCA that $13,540 were due to TCA in order for TCA to release its security interest in the Company’s assets. On February 1, 2017, TCA notified the Company that all funds were received and TCA would release its security interest in Company’s assets. TCA has confirmed that it is paid in full and the Company is not aware of any other obligations that the Company has as to TCA. The funds received under the Chicago Venture Agreements and previous Chicago Venture Agreements were used to pay-off TCA.
Securities Purchase Agreement, Secured Promissory Notes and Security Agreement
On August 11, 2017,2018, we executed the following agreements with Chicago Venture:St. George Investments LLC, a Utah limited liability company: (i) Securities Purchase Agreement; and (ii) Secured Promissory Notes;Warrant to Purchase Shares of Common Stock.
Pursuant to the St. George Agreements, the Company agreed to sell and (iii) Security Agreement (collectivelyto issue to St. George for an aggregate purchase price of $1,000,000: (a) 48,687,862 Shares of newly issued restricted Common Stock of the “Chicago Venture Agreements”). The Company entered intoCompany; and (b) the Chicago Venture Agreements withWarrant. St. George has paid the intent to acquire working capital to growentire Purchase Price for the Company’s business.Securities.
The total amountWarrant is exercisable for a period of fundingfive (5) years from the Closing, for the purchase of up to 48,687,862 shares of the Company’s Common Stock at an exercise price of $0.05 per share of Common Stock. The Warrant is subject to a cashless exercise option at the election of St. George and other adjustments as detailed in the Warrant.
On March 20, 2018, we entered into and closed on a Common Stock Purchase Agreement with St. George Investments, LLC, a Utah limited liability company.
Pursuant to the St. George Agreements, we sold and agreed to issue to St. George 6,410, 256 shares of newly issued restricted Common Stock of the Company at a purchase price of $0.0156 per share. The Purchase Price was paid at Closing and the Shares shall be issued upon the satisfaction of the Share Delivery Conditions as set forth in the Agreement. We expect an additional $500,000 under the Chicago Venture Agreements is $1,105,000.00 (the “Debt”). Each Convertible Promissory Note carries an original issue discount of $100,000 and a transaction expense amount of $5,000, for total debt of $1,105,000. We to reserve 200,000,000 of its shares of common stock for issuance upon conversion of the Debt, if that occurs in the future. If not converted sooner, the Debt is due on or before August 11, 2018. The Debt carries an interest rate of ten percent (10%). The Debt is convertible, at Chicago Venture’s option, into our common stock at $0.009 per share subject to adjustment as provided for in the Secured Promissory Notes attached hereto and incorporated herein by this reference.
Our obligation to pay the Debt, or any portion thereof, is secured by all of our assets.St. George Agreements.
Operating Activities
Net cash used in operating activities for the ninethree months ended September 30, 2017March 31, 2018 was $1,161,000.$835,000. This amount was primarily related to a net loss of $1,178,000, (i) a decrease in accounts payable and accrued expenses of $105,000; (ii) a reduction in deferred revenue of $38,000;$4,242,000, offset by (iii) non-cash expenses of $158,000$3,251,000 including (i) depreciation and amortization of $2,000;$11,000; (ii) stock based compensation of $162,000$54,000 related to stock option grants and warrants; (iii) common stock issued for services of $51,000;$153,000 (iv) accrued interest and amortization of debt discount on convertible notes payable of $439,000;$282,000; (v) reclassification of derivatives instruments to additional paid in capital to of $538,000; and (vi) loss on debt conversions of $1,668,000,$5,109,000; offset by (vii)(vi) change in derivative liability of $2,702,000.$2,358,000 and (vii) an increase in working capital of $156,000.
Investment Activities
Net cash used in investing activities for the ninethree months ended September 30, 2017March 31, 2018 was $221,000. This amount was primarily related to $250,000. On February 16, 2018, we purchased the prepayment of expenses related to the acquisition of 51%remaining 49% of the Purchased Assets on October 3, 2017 from David Reichwein,in exchange for a Pennsylvania resident, GIP International Ltd, a Hong Kong corporation and DPR International LLC, a Pennsylvania limited liability corporation. The Purchased Assets include intellectual property, copy rights and trademarks related to reflective tiles and flooring.one-time payment of $250,000.
Financing Activities
Net cash provided by financing activities for the ninethree months ended September 30, 2017March 31, 2018 was $1,490,000.$1,625,000. The amount related to funding provided of $2,999,000$525,000 by Chicago Venture and $1,100,000 by St. George to us and $1,509,000 paid to TCA to in order to satisfy all debts to TCA.us.
Our contractual cash obligations as of September 30, 2017March 31, 2018 are summarized in the table below:
| | | | | | | | | |
| Contractual Cash Obligations | | | | | | | | | | |
| Operating leases | $206,902 | $104,810 | $102,092 | $- | $506,347 | $278,683 | $169,242 | $58,422 | $- |
| Convertible notes payable | 2,172,041 | - | 1,558,122 | - |
| Capital expenditures | 25,000 | - | 300,000 | 100,000 | - |
| | $2,403,943 | $2,301,851 | $102,092 | $- | $2,364,469 | $1,936,805 | $269,242 | $158,422 | $- |
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
This item is not applicable.
ITEM 4.
CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures
We conducted an evaluation under the supervision and with the participation of our management, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (“Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive and principal financial officers concluded as of September 30, 2017,March 31, 2018, that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses in our internal controls over financial reporting discussed immediately below.
Identified Material Weakness
A material weakness in our internal control over financial reporting is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
Management identified the following material weakness during its assessment of internal controls over financial reporting:
Audit Committee:
On June 3, 2014, we formed an Audit Committee and appointed an audit committee financial expert as defined by SEC and as adopted under the Sarbanes-Oxley Act of 2002. Prior to this, we did not have an Audit Committee to oversee financial reporting and used external service providers to ensure compliance with the SEC requirements. The current Audit Committee has one independent director. We expect to expand this committee during 2017 and 2018.
b) Changes in Internal Control over Financial Reporting
During the ninethree months ended September 30, 2017March 31, 2018, there were no changes in our internal controls over financial reporting during this fiscal quarter, which were identified in connection with our management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that materially affected, or is reasonably likely to have a materially affect, on our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, we may become subject to various legal proceedings that are incidental to the ordinary conduct of its business. Although we cannot accurately predict the amount of any liability that may ultimately arise with respect to any of these matters, it makes provision for potential liabilities when it deems them probable and reasonably estimable. These provisions are based on current information and may be adjusted from time to time according to developments.
Other than those certain legal proceedings as reported in our annual report on Form 10-K filed with the SEC on March 31, 2017,28, 2018, we know of no material, existing or pending legal proceedings against our Company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any director, officer or any affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.
Item 1A. Risk Factors.
There are certain inherent risks which will have an effect on the Company’s development in the future and the most significant risks and uncertainties known and identified by our management are described below.
Risks Related to Our Business
There are certain inherent risks which will have an effect on the Company’s development in the future and the most significant risks and uncertainties known and identified by our management are described below.
Risks Associated with Securities Purchase Agreement with Chicago Venture
The Securities Purchase Agreement with Chicago Venture will terminate if we file protection from its creditors, a Registration Statement on Form S-1 is not effective, and our market capitalization or the trading volume of our common stock does not reach certain levels. If terminated, we will be unable to draw down all or substantially all of our $2,500,000 Chicago Venture Note.Notes.
Our ability to require Chicago Venture to fund the Chicago Venture Note is at our discretion, subject to certain limitations. Chicago Venture is obligated to fund if each of the following conditions are met; (i) the average and median daily dollar volumes of our common stock for the twenty (20) and sixty (60) trading days immediately preceding the funding date are greater than $100,000; (ii) our market capitalization on the funding date is greater than $17,000,000; (iii) we are not in default with respect to share delivery obligations under the note as of the funding date; and (iv) we are current in itsour reporting obligations.
There is no guarantee that we will be able to meet the foregoing conditions or any other conditions under the Securities Purchase Agreement and/or Chicago Venture Note or that we will be able to draw down any portion of the amounts available under the Securities Purchase Agreement and/or Chicago Venture Note.
If we not able to draw down all $2,500,000 availabledue under the Securities Purchase Agreement or if the Securities Purchase Agreement is terminated, we may be forced to curtail the scope of our operations or alter our business plan if other financing is not available to us.
Suspension of trading of the Company’s securities.
On April 10, 2014, we received notice from the SEC that trading of our common stock on the OTCBB was to be suspended from April 10, 2014 through April 24, 2014. The SEC issued its order 2014,pursuant to Section 12(k) of the Securities Exchange Act of 1934. According to the notice received by us from the SEC: “It appears toSEC the Securities and Exchange Commission that the public interest and the protection of investors require a suspension of trading in the securities of GrowLife, Inc. because ofwas. due to concerns regarding the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in GrowLife’sour common stock.” We never received notice from the SEC that we were formally being investigated.
The suspension of trading eliminated our market makers, resulted in our trading on the grey sheets, resulted in legal proceedings and restricted our access to capital.
OnOn October 17, 2017, we were informed by Alpine Securities Corporation (“Alpine”) that Alpine has demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for our common stock. We expect to filefiled an amended application with the OTC Markets to list the Company’s common stock on the OTCQB once the minimum share price of $0.01 per share is achieved. We currentlyand begin to trade on the OTC Pink Sheet market. On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11.
this market as of March 20, 2018.
This action had a material adverse effect on our business, financial condition and results of operations. If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business.
We are involved in Legal Proceedings.
We are involved in the disputes and legal proceedings as discussed in the section title “Legal Proceedings” within our annual report on Form 10-K filed Marchfor year ended December 31, 2017. In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws. Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation. There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse on our business, results of operations or financial condition.
Our Joint Venture Agreement with CANX USA, LLC and Logic Works may be important to our operations.
On November 19, 2013, we entered into a Joint Venture Agreement with CANX, a Nevada limited liability company. Under the terms of the Joint Venture Agreement, the Company and CANX formed Organic Growth International, LLC (“OGI”), a Nevada limited liability company, for the purpose of expanding our operations in its current retail hydroponic businesses and in other synergistic business verticals and facilitating additional funding for commercially financeable transactions of up to $40,000,000.
We initially owned a non-dilutive 45% share of OGI and the Company could acquire a controlling share of OGI as provided in the Joint Venture Agreement. In accordance with the Joint Venture Agreement, the Company and CANX entered into a Warrant Agreement whereby the we delivered to CANX a warrant to purchase 140,000,000 shares of our common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires November 18, 2018. Also in accordance with the Joint Venture Agreement, on February 7, 2014, the Company issued an additional warrant to purchase 100,000,000 shares of our common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires February 6, 2019.
GrowLife received the $1 million as a convertible note in December 2013, received the $1.3 million commitment but not executed and by January 2014 OGI had Letters of Intent with four investment and acquisition transactions valued at $96 million. Before the deals could close, the SEC put a trading halt on our stock on April 10, 2014, which resulted in the withdrawal of all transactions. The business disruption from the trading halt and the resulting class action and derivative lawsuits ceased further investments with the OGI joint venture. The Convertible Note was converted into our common stock as of the year ended December 31, 2016.
On July 10, 2014, we closed a Waiver and Modification Agreement, Amended and Restated Joint Venture Agreement, Secured Credit Facility and Secured Convertible Note with CANX and Logic Works LLC, a former lender and current shareholder of the Company.
The Amended and Restated Joint Venture Agreement with CANX modified the Joint Venture Agreement dated November 19, 2013 to provide for (i) up to $12,000,000 in conditional financing subject to review by GrowLife and approval by OGI for business growth development opportunities in the legal cannabis industry for up to nine months, subject to extension; (ii) up to $10,000,000 in working capital loans with each loaning requiring approval in advance by CANX; (iii) confirmed that the five year warrants, subject to adjustment, at $0.033 per share for the purchase of 140,000,000 and 100,000,000 were fully earned and were not considered compensation for tax purposes by the Company; (iv) granted CANX five year warrants, subject to adjustment, to purchase 300,000,000 shares of common stock at the fair market price of $0.033 per share as determined by an independent appraisal; (v) warrants as defined in the Agreement related to the achievement of OGI milestones; and (vi) a four year term, subject to adjustment.
We entered into a Secured Convertible Note and Secured Credit Facility dated June 25, 2014 with Logic Works whereby Logic Works agreed to provide up to $500,000 in funding. Each funding required approval in advance by Logic Works, provides for interest at 6% with a default interest of 24% per annum and required repayment by June 26, 2016. The Note is convertible into common stock of the Company at the lesser of $0.0070 or (B) twenty percent (20%) of the average of the three (3) lowest daily VWAPs occurring during the twenty (20) consecutive Trading Days immediately preceding the applicable conversion date on which Logic Works elects to convert all or part of this 6% Convertible Note, subject to adjustment as provided in the Note. The 6% Convertible Note is collateralized by the assets of the Company. As of September 30, 2017, the outstanding balance on the Convertible Note was $40,632.
Failure to operate in accordance with the Agreements with CANX could result in the cancellation of these agreements, result in foreclosure on our assets in event of default and would have a material adverse effect on our business, results of operations or financial condition.
We may engage in acquisitions, mergers, strategic alliances, joint ventures and divestures that could result in final results that are different than expected.
In the normal course of business, we engage in discussions relating to possible acquisitions, equity investments, mergers, strategic alliances, joint ventures and divestitures. Such transactions are accompanied by a number of risks, including the use of significant amounts of cash, potentially dilutive issuances of equity securities, incurrence of debt on potentially unfavorable terms as well as impairment expenses related to goodwill and amortization expenses related to other intangible assets, the possibility that we may pay too much cash or issue too many of our shares as the purchase price for an acquisition relative to the economic benefits that we ultimately derive from such acquisition, and various potential difficulties involved in integrating acquired businesses into our operations.
From time to time, we have also engaged in discussions with candidates regarding the potential acquisitions of our product lines, technologies and businesses. If a divestiture such as this does occur, we cannot be certain that our business, operating results and financial condition will not be materially and adversely affected. A successful divestiture depends on various factors, including our ability to effectively transfer liabilities, contracts, facilities and employees to any purchaser; identify and separate the intellectual property to be divested from the intellectual property that we wish to retain; reduce fixed costs previously associated with the divested assets or business; and collect the proceeds from any divestitures.
If we do not realize the expected benefits of any acquisition or divestiture transaction, our financial position, results of operations, cash flows and stock price could be negatively impacted.
Our proposed business is dependent on laws pertaining to the marijuana industry.
Continued development of the marijuana industry is dependent upon continued legislative authorization of the use and cultivation of marijuana at the state level. Any number of factors could slow or halt progress in this area. Further, progress, while encouraging, is not assured. While there may be ample public support for legislative action, numerous factors impact the legislative process. Any one of these factors could slow or halt use of marijuana, which would negatively impact our proposed business.
Currently, twenty eightthirty states and the District of Columbia allow its citizens to use medical marijuana.cannabis. Additionally, seveneight states and the District of Columbia have legalized cannabis for adult use. The state laws are in conflict with the federal Controlled Substances Act, which makes marijuana use and possession illegal on a national level. The Obama administration previously effectively stated that it is not an efficient use of resources to direct law federal law enforcement agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana. The Trump administration position is unknown. However, there is no guarantee that the Trump administration will not change current policy regarding the low-priority enforcement of federal laws. Additionally, any new administration that follows could change this policy and decide to enforce the federal laws strongly. Any such change in the federal government’s enforcement of current federal laws could cause significant financial damage to us and its shareholders.
Further, while we do not harvest, distribute or sell marijuana, by supplying products to growers of marijuana, we could be deemed to be participating in marijuana cultivation, which remains illegal under federal law, and exposes us to potential criminal liability, with the additional risk that our business could be subject to civil forfeiture proceedings.
The marijuana industry faces strong opposition.
It is believed by many that large, well-funded businesses may have a strong economic opposition to the marijuana industry. We believe that the pharmaceutical industry clearly does not want to cede control of any product that could generate significant revenue. For example, medical marijuana will likely adversely impact the existing market for the current “marijuana pill” sold by mainstream pharmaceutical companies. Further, the medical marijuana industry could face a material threat from the pharmaceutical industry, should marijuana displace other drugs or encroach upon the pharmaceutical industry’s products. The pharmaceutical industry is well funded with a strong and experienced lobby that eclipses the funding of the medical marijuana movement. Any inroads the pharmaceutical industry could make in halting or impeding the marijuana industry harm our business, prospects, results of operation and financial condition.
Marijuana remains illegal under Federal law.
Marijuana is a Schedule-I controlled substance and is illegal under federal law. Even in those states in which the use of marijuana has been legalized, its use remains a violation of federal law. Since federal law criminalizing the use of marijuana preempts state laws that legalize its use, strict enforcement of federal law regarding marijuana would harm our business, prospects, results of operation and financial condition.
Raising additional capital to implement our business plan and pay our debts will cause dilution to our existing stockholders, require us to restructure our operations, and divest all or a portion of our business.
We need additional financing to implement our business plan and to service our ongoing operations and pay our current debts. There can be no assurance that we will be able to secure any needed funding, or that if such funding is available, the terms or conditions would be acceptable to us.
If we raise additional capital through borrowing or other debt financing, we may incur substantial interest expense. Sales of additional equity securities will dilute on a pro rata basis the percentage ownership of all holders of common stock. When we raise more equity capital in the future, it will result in substantial dilution to our current stockholders.
If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business.
Potential Convertible Note Defaults.
Several of the Company’s convertible promissory notes remain outstanding beyond their respective maturity dates. This may trigger an event of default under the respective agreements. The Company is working with these noteholders to convert their notes into common stock and intends to resolve these outstanding issues as soon as practicable. Any default could have a significant adverse effect on our cash flows and should we be unsuccessful in negotiating an extension or other modification, we may have to restructure our operations, divest all or a portion of its business, or file for bankruptcy.
Closing of bank accounts could have a material adverse effect on our business, financial condition and/or results of operations.
As a result of the regulatory environment, we have experienced the closing of several of our bank accounts since March 2014. We have been able to open other bank accounts. However, we may have other banking accounts closed. These factors impact management and could have a material adverse effect on our business, financial condition and/or results of operations.
Federal regulation and enforcement may adversely affect the implementation of medical marijuana laws and regulations may negatively impact our revenues and profits.
Currently, there are twenty eightthirty states plus the District of Columbia that have laws and/or regulation that recognize in one form or another legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. Many other states are considering legislation to similar effect. As of the date of this writing, the policy and regulations of the Federal government and its agencies is that cannabis has no medical benefit and a range of activities including cultivation and use of cannabis for personal use is prohibited on the basis of federal law and may or may not be permitted on the basis of state law. Active enforcement of the current federal regulatory position on cannabis on a regional or national basis may directly and adversely affect the willingness of customers of GrowLife to invest in or buy products from GrowLife that may be used in connection with cannabis. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect revenues and profits of the GrowLife companies.
Our history of net losses has raised substantial doubt regarding our ability to continue as a going concern. If we do not continue as a going concern, investors could lose their entire investment.
Our history of net losses has raised substantial doubt about our ability to continue as a going concern, and as a result, our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended December 31, 20162017 and 20152016 with respect to this uncertainty. Accordingly, our ability to continue as a going concern will require us to seek alternative financing to fund our operations. This going concern opinion could materially limit our ability to raise additional funds through the issuance of new debt or equity securities or otherwise. Future reports on our financial statements may include an explanatory paragraph with respect to our ability to continue as a going concern.
We have a history of operating losses and there can be no assurance that we can again achieve or maintain profitability.
We have experienced net losses since inception. As of September 30, 2017,March 31, 2018, we had an accumulated deficit of $125.6134.0 million. There can be no assurance that we will achieve or maintain profitability.
We are subject to corporate governance and internal control reporting requirements, and our costs related to compliance with, or our failure to comply with existing and future requirements, could adversely affect our business.
We must comply with corporate governance requirements under the Sarbanes-Oxley Act of 2002 and the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, as well as additional rules and regulations currently in place and that may be subsequently adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules, and regulations continue to evolve and may become increasingly stringent in the future. We are required to include management’s report on internal controls as part of our annual report pursuant to Section 404 of the Sarbanes-Oxley Act. We strive to continuously evaluate and improve our control structure to help ensure that we comply with Section 404 of the Sarbanes-Oxley Act. The financial cost of compliance with these laws, rules, and regulations is expected to remain substantial.
We cannot assure you that we will be able to fully comply with these laws, rules, and regulations that address corporate governance, internal control reporting, and similar matters. Failure to comply with these laws, rules and regulations could materially adversely affect our reputation, financial condition, and the value of our securities.
Our management has concluded that we have material weaknesses in our internal controls over financial reporting and that our disclosure controls and procedures are not effective.
A material weakness is a deficiency,inability or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company's annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting. During the review of our financial statements for the year ended September 30, 2017, our management identified material weaknesses in our internal control over financial reporting. If these weaknesses continue, investors could lose confidence in the accuracy and completeness of our financial reports and other disclosures.
Our inabilityfailure to effectively manage our growth could harm our business and materially and adversely affect our operating results and financial condition.
Our strategy envisions growing our business. We plan to expand our product, sales, administrative and marketing organizations. Any growth in or expansion of our business is likely to continue to place a strain on our management and administrative resources, infrastructure and systems. As with other growing businesses, we expect that we will need to further refine and expand our business development capabilities, our systems and processes and our access to financing sources. We also will need to hire, train, supervise and manage new and retain contributing employees. These processes are time consuming and expensive, will increase management responsibilities and will divert management attention. We cannot assure you that we will be able to:
| | ● | expand our products effectively or efficiently or in a timely manner; |
| | ● | allocate our human resources optimally; |
| | ● | meet our capital needs; |
| | ● | identify and hire qualified employees or retain valued employees; or |
| | ● | incorporate effectively the components of any business or product line that we may acquire in our effort to achieve growth. |
Our inability or failure to manage our growth and expansion effectively could harm our business and materially and adversely affect our operating results and financial condition.
Our operating results may fluctuate significantly based on customer acceptance of our products. As a result, period-to-period comparisons of our results of operations are unlikely to provide a good indication of our future performance. Management expects that we will experience substantial variations in our net sales and operating results from quarter to quarter due to customer acceptance of our products. If customers don’t accept our products, our sales and revenues will decline, resulting in a reduction in our operating income.
Customer interest for our products could also be impacted by the timing of our introduction of new products. If our competitors introduce new products around the same time that we issue new products, and if such competing products are superior to our own, customers’ desire for our products could decrease, resulting in a decrease in our sales and revenues. To the extent that we introduce new products and customers decide not to migrate to our new products from our older products, our revenues could be negatively impacted due to the loss of revenue from those customers. In the event that our newer products do not sell as well as our older products, we could also experience a reduction in our revenues and operating income.
As a result of fluctuations in our revenue and operating expenses that may occur, management believes that period-to-period comparisons of our results of operations are unlikely to provide a good indication of our future performance.
If we do not successfully generate additional products and services, or if such products and services are developed but not successfully commercialized, we could lose revenue opportunities.
Our future success depends, in part, on our ability to expand our product and service offerings. To that end we have engaged in the process of identifying new product opportunities to provide additional products and related services to our customers. The process of identifying and commercializing new products is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends our business could be harmed. We may have to commit significant resources to commercializing new products before knowing whether our investments will result in products the market will accept. Furthermore, we may not execute successfully on commercializing those products because of errors in product planning or timing, technical hurdles that we fail to overcome in a timely fashion, or a lack of appropriate resources. This could result in competitors providing those solutions before we do and a reduction in net sales and earnings.
The success of new products depends on several factors, including proper new product definition, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.
Our future success depends on our ability to grow and expand our customer base. Our failure to achieve such growth or expansion could materially harm our business.
To date, our revenue growth has been derived primarily from the sale of our products and through the purchase of existing businesses. Our success and the planned growth and expansion of our business depend on us achieving greater and broader acceptance of our products and expanding our customer base. There can be no assurance that customers will purchase our products or that we will continue to expand our customer base. If we are unable to effectively market or expand our product offerings, we will be unable to grow and expand our business or implement our business strategy. This could materially impair our ability to increase sales and revenue and materially and adversely affect our margins, which could harm our business and cause our stock price to decline.
If we incur substantial liability from litigation, complaints, or enforcement actions resulting from misconduct by our distributors, our financial condition could suffer. We will require that our distributors comply with applicable law and with our policies and procedures. Although we will use various means to address misconduct by our distributors, including maintaining these policies and procedures to govern the conduct of our distributors and conducting training seminars, it will still be difficult to detect and correct all instances of misconduct. Violations of applicable law or our policies and procedures by our distributors could lead to litigation, formal or informal complaints, enforcement actions, and inquiries by various federal, state, or foreign regulatory authorities against us and/or our distributors. Litigation, complaints, and enforcement actions involving us and our distributors could consume considerable amounts of financial and other corporate resources, which could have a negative impact on our sales, revenue, profitability and growth prospects. As we are currently in the process of implementing our direct sales distributor program, we have not been, and are not currently, subject to any material litigation, complaint or enforcement action regarding distributor misconduct by any federal, state or foreign regulatory authority.
Our future manufacturers could fail to fulfill our orders for products, which would disrupt our business, increase our costs, harm our reputation and potentially cause us to lose our market.
We may depend on contract manufacturers in the future to produce our products. These manufacturers could fail to produce products to our specifications or in a workmanlike manner and may not deliver the units on a timely basis. Our manufacturers may also have to obtain inventories of the necessary parts and tools for production. Any change in manufacturers to resolve production issues could disrupt our ability to fulfill orders. Any change in manufacturers to resolve production issues could also disrupt our business due to delays in finding new manufacturers, providing specifications and testing initial production. Such disruptions in our business and/or delays in fulfilling orders would harm our reputation and would potentially cause us to lose our market.
Our inability to effectively protect our intellectual property would adversely affect our ability to compete effectively, our revenue, our financial condition and our results of operations.
We may be unable to obtain intellectual property rights to effectively protect our business. Our ability to compete effectively may be affected by the nature and breadth of our intellectual property rights. While we intend to defend against any threats to our intellectual property rights, there can be no assurance that any such actions will adequately protect our interests. If we are unable to secure intellectual property rights to effectively protect our technology, our revenue and earnings, financial condition, and/or results of operations would be adversely affected.
We may also rely on nondisclosure and non-competition agreements to protect portions of our technology. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that third parties will not otherwise gain access to our trade secrets or proprietary knowledge, or that third parties will not independently develop the technology.
We do not warrant any opinion as to non-infringement of any patent, trademark, or copyright by us or any of our affiliates, providers, or distributors. Nor do we warrant any opinion as to invalidity of any third-party patent or unpatentability of any third-party pending patent application.
Our industry is highly competitive and we have less capital and resources than many of our competitors, which may give them an advantage in developing and marketing products similar to ours or make our products obsolete.
We are involved in a highly competitive industry where we may compete with numerous other companies who offer alternative methods or approaches, may have far greater resources, more experience, and personnel perhaps more qualified than we do. Such resources may give our competitors an advantage in developing and marketing products similar to ours or products that make our products obsolete. There can be no assurance that we will be able to successfully compete against these other entities.
Transfers of our securities may be restricted by virtue of state securities “blue sky” laws, which prohibit trading absent compliance with individual state laws. These restrictions may make it difficult or impossible to sell shares in those states.
Transfers of our common stock may be restricted under the securities or securities regulations laws promulgated by various states and foreign jurisdictions, commonly referred to as "blue sky" laws. Absent compliance with such individual state laws, our common stock may not be traded in such jurisdictions. Because the securities held by many of our stockholders have not been registered for resale under the blue sky laws of any state, the holders of such shares and persons who desire to purchase them should be aware that there may be significant state blue sky law restrictions upon the ability of investors to sell the securities and of purchasers to purchase the securities. These restrictions may prohibit the secondary trading of our common stock. Investors should consider the secondary market for our securities to be a limited one.
We are dependent on key personnel and we are default under Employment and Consulting Agreements
Our success depends to a significant degree upon the continued contributions of key management and other personnel, some of whom could be difficult to replace. We do not maintain key man life insurance covering our officers. Our success will depend on the performance of our officers and key management and other personnel, our ability to retain and motivate our officers, our ability to integrate new officers and key management and other personnel into our operations, and the ability of all personnel to work together effectively as a team. Our failure to retain and recruit officers and other key personnel could have a material adverse effect on our business, financial condition and results of operations.
We have limited insurance.
We have limited directors’ and officers’ liability insurance and limited commercial liability insurance policies. Any significant claims would have a material adverse effect on our business, financial condition and results of operations.
Risks Related to our Common Stock
CANX and Chicago Venture could have significant influence over matters submitted to stockholders for approval.
CANX and Logic Works
As of September 30, 2017,March 31, 2018, CANX holds shareswarrants representing approximately 20.0%15.6% of our common stock on a fully-converted basis and could be considered a control group for purposes of SEC rules. However, their agreements limit their ownership to 4.99% individually and each of the parties disclaims its status as a control group or a beneficial owner due to the fact that their beneficial ownership is limited to 4.99% per their agreements. Beneficial ownership includes shares over which an individual or entity has investment or voting power and includes shares that could be issued upon the exercise of options and warrants within 60 days after the date of determination.
Chicago Venture
As a result of funding from Chicago Venture as previously detailed, they exercise significant control over us.
If these persons were to choose to act together, they would be able to significantly influence all matters submitted to our stockholders for approval, as well as our officers, directors, management and affairs. For example, these persons, if they choose to act together, could significantly influence the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of us on terms that other stockholders may desire.
Trading in our stock is limited by the lack of market makers and the SEC’s penny stock regulations.
On April 10, 2014, as a result of the SEC suspension in the trading of our securities, we lost all market makers and traded on the grey market of OTCBB. Until we complied with FINRA Rule 15c2-11, we traded on the grey market, which has limited quotations and marketability of securities. Holders of our common stock found it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market value of our common stock declined.
On October 17, 2017, we were informed by Alpine Securities Corporation (“Alpine”) that Alpine has demonstrated compliance with the Financial Industry Regulatory Authority (“FINRA”) Rule 6432 and Rule 15c2-11 under the Securities Exchange Act of 1934. As a result, Alpine may initiate an unpriced quotation for our common stock. We expect to file an amended application with the OTC Markets to list the Company’s common stock on the OTCQB once the minimum share price of $0.01 per share is achieved. We currently trade on the OTC Pink Sheet market. On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11.
Our stock is categorized as a penny stock The SEC has adopted Rule 15g-9 which generally defines "penny stock" to be any equity security that has a market price (as defined) less than US$ 5.00 per share or an exercise price of less than US $5.00 per share, subject to certain exclusions (e.g., net tangible assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the last three years). The penny stock rules impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and accredited investors. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC, which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. Finally, broker-dealers may not handle penny stocks under $0.10 per share.
These disclosure requirements reduce the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules would affect the ability of broker-dealers to trade our securities if we become subject to them in the future. The penny stock rules also could discourage investor interest in and limit the marketability of our common stock to future investors, resulting in limited ability for investors to sell their shares.
FINRA sales practice requirements may also limit a shareholder’s ability to buy and sell our stock.
In addition to the “penny stock” rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
The market price of our common stock may be volatile.
The market price of our common stock has been and is likely in the future to be volatile. Our common stock price may fluctuate in response to factors such as:
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| Halting of trading by the SEC or FINRA. |
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| ● | Announcements by us regarding liquidity, legal proceedings, significant acquisitions, equity investments and divestitures, strategic relationships, addition or loss of significant customers and contracts, capital expenditure commitments, loan, note payable and agreement defaults, loss of our subsidiaries and impairment of assets, |
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| ● | Issuance of convertible or equity securities for general or merger and acquisition purposes, |
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| ● | Issuance or repayment of debt, accounts payable or convertible debt for general or merger and acquisition purposes, |
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| ● | Sale of a significant number of shares of our common stock by shareholders, |
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| ● | General market and economic conditions, |
| ● | Quarterly variations in our operating results, |
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| ● | Investor relation activities, |
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| ● | Announcements of technological innovations, |
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| ● | New product introductions by us or our competitors, |
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| ● | Competitive activities, and |
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| ● | Additions or departures of key personnel. |
These broad market and industry factors may have a material adverse effect on the market price of our common stock, regardless of our actual operating performance. These factors could have a material adverse effect on our business, financial condition, and/or results of operations.
The sale of a significant number of our shares of common stock could depress the price of our common stock.
Sales or issuances of a large number of shares of common stock in the public market or the perception that sales may occur could cause the market price of our common stock to decline. As of September 30, 2017,March 31, 2018, there were approximately 2.162.914 billion shares of our common stock issued and outstanding. In addition, as of September 30, 2017,March 31, 2018, there are also (i) stock option grants outstanding for the purchase of 1459 million common shares at a $0.010$0.008 average exercise price; (ii) warrants for the purchase of 595 million common shares at a $0.031 average exercise price; and (iii) 139107.2 million shares related to convertible debt that can be converted at 0.00360.002535 per share. During the nine months ended September 30, 2017, Chicago Venture converted principal and accrued interest of $2,153,000 into 382.6 million shares of our common stock at a per share conversion price of $0.006; and (iii) Logic Works converted principal and interest of $291,000 into 82.6 million shares of our common stock at a per share conversion price of $.004.
In addition, we have an unknown number of common shares to be issued under the Chicago Venture financing agreements because the number of shares ultimately issued to Chicago Venture depends on the price at which Chicago Venture converts its debt to shares. The lower the conversion price, the more shares that will be issued to Chicago Venture upon the conversion of debt to shares. We won’t know the exact number of shares of stock issued to Chicago Venture until the debt is actually converted to equity. If all stock option grant and warrant and contingent shares are issued, approximately 2.682 billion of our currently authorized 36 billion shares of common stock will be issued and outstanding. For purposes of estimating the number of shares issuable upon the exercise/conversion of all stock options, warrants and contingent shares, we assumed the number of shares and average share prices detailed above.
These stock option grant, warrant and contingent shares could result in further dilution to common stock holders and may affect the market price of the common stock.
Significant shares of common stock are held by our principal shareholders, other Company insiders and other large shareholders. As affiliates as defined under Rule 144 of the Securities Act or Rule 144 of the Company, our principal shareholders, other Company insiders and other large shareholders may only sell their shares of common stock in the public market pursuant to an effective registration statement or in compliance with Rule 144.
Some of the present shareholders have acquired shares at prices as low as $0.007 per share, whereas other shareholders have purchased their shares at prices ranging from $0.0036 to $0.78 per share.
These stock option grant, warrant and contingent shares could result in further dilution to common stock holders and may affect the market price of the common stock.
Some of our convertible debentures may require adjustment in the conversion price.
Our 7% Convertible Notes Payable and our 6% Convertible Secured Convertible Notes may require an adjustment in the current conversion price of $0.0036$0.002535 per share if we issue common stock, warrants or equity below the price that is reflected in the convertible notes payable. The conversion price of the convertible notes will have an impact on the market price of our common stock. Specifically, if under the terms of the convertible notes the conversion price goes down, then the market price, and ultimately the trading price, of our common stock will go down. If under the terms of the convertible notes the conversion price goes up, then the market price, and ultimately the trading price, of our common stock will likely go up. In other words, as the conversion price goes down, so does the market price of our stock. As the conversion price goes up, so presumably does the market price of our stock. The more the conversion price goes down, the more shares are issued upon conversion of the debt which ultimately means the more stock that might flood into the market, potentially causing a further depression of our stock.
We do not anticipate paying any cash dividends on our capital stock in the foreseeable future.
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business, and we do not anticipate paying any cash dividends on our capital stock in the foreseeable future. In addition, the terms of any future debt agreements may preclude us from paying dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.
Anti-takeover provisions may limit the ability of another party to acquire our company, which could cause our stock price to decline.
Our certificate of incorporation, as amended, our bylaws and Delaware law contain provisions that could discourage, delay or prevent a third party from acquiring our company, even if doing so may be beneficial to our stockholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock.
We may issue preferred stock that could have rights that are preferential to the rights of common stock that could discourage potentially beneficially transactions to our common shareholders.
An issuance of additional shares of preferred stock could result in a class of outstanding securities that would have preferences with respect to voting rights and dividends and in liquidation over our common stock and could, upon conversion or otherwise, have all of the rights of our common stock. Our Board of Directors' authority to issue preferred stock could discourage potential takeover attempts or could delay or prevent a change in control through merger, tender offer, proxy contest or otherwise by making these attempts more difficult or costly to achieve. The issuance of preferred stock could impair the voting, dividend and liquidation rights of common stockholders without their approval.
If the company were to dissolve or wind-up, holders of our common stock may not receive a liquidation preference.
If we were too wind-up or dissolve the Company and liquidate and distribute our assets, our shareholders would share ratably in our assets only after we satisfy any amounts we owe to our creditors. If our liquidation or dissolution were attributable to our inability to profitably operate our business, then it is likely that we would have material liabilities at the time of liquidation or dissolution. Accordingly, we cannot give you any assurance that sufficient assets will remain available after the payment of our creditors to enable you to receive any liquidation distribution with respect to any shares you may hold.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unless otherwise indicated, all of the following sales or issuances of Company securities were conducted under the exemption from registration as provided under Section 4(2) of the Securities Act of 1933 (and also qualified for exemption under 4(5), formerly 4(6) of the Securities Act of 1933, except as noted below). All of the shares issued were issued in transactions not involving a public offering, are considered to be restricted stock as defined in Rule 144 promulgated under the Securities Act of 1933 and stock certificates issued with respect thereto bear legends to that effect.
We have compensated consultants and service providers with restricted common stock during the development of our business and when our capital resources were not adequate to provide payment in cash.
Equity Issuances
During the three months ended September 30, 2017, weMarch 31, 2018, the Company had had the following sales of unregistered of equity securities to accredited investors unless otherwise indicated:
During theOn February 7, 2018, we issued 7,660,274 shares to three months ended September 30, 2017, two vendors converted debt of $133,605 into 119,086,394directors. The shares of our common stockwere valued at the fair market price of $0.007$0.020 per share or $153,205. The shares were issued for annual director service to us.
On February 12, 2018, we received a Notice of Conversion from Forglen LLC converting principal and interest of $321,945 owed under that certain 7% Convertible Note as amended June 19, 2014 into 127,000,000 shares of our common stock with a fair value of $2,235,200.
On February 16, 2018, we issued 900,000 shares of its common stock to a service provider pursuant to a conversion of debt totaling $18,000. The shares were valued at the fair market price of $0.020 per share.
On March 13, 2018, we received a Notice of Conversion from Logic Works LLC converting principal and interest of $41,690 owed under that a 6% Convertible Note into 16,445,609 shares of our common stock with a fair value of $248,329. As of March 13, 2018, the outstanding balance on the Convertible Note was $0.
During the three months ended September 30, 2017,March 31, 2018, Chicago Venture converted principal and accrued interest of $450,000$1,877,668 into 113,999,429338,821,634 shares of our common stock at a per share conversion price of $0.004.$0.0055 with a fair value of $5,073,390.
Securities Purchase Agreements with St. George Investments, LLC
On February 9, 2018, we executed the following agreements with St. George Investments LLC, a Utah limited liability company: (i) Securities Purchase Agreement; and (ii) Warrant to Purchase Shares of Common Stock.
Pursuant to the St. George Agreements, the Company agreed to sell and to issue to St. George for an aggregate purchase price of $1,000,000: (a) 48,687,862 Shares of newly issued restricted Common Stock of the Company; and (b) the Warrant. St. George has paid the entire Purchase Price for the Securities.
The Warrant is exercisable for a period of five (5) years from the Closing, for the purchase of up to 48,687,862 shares of the Company’s Common Stock at an exercise price of $0.05 per share of Common Stock. The Warrant is subject to a cashless exercise option at the election of St. George and other adjustments as detailed in the Warrant.
On March 20, 2018, we entered into and closed on a Common Stock Purchase Agreement with St. George Investments, LLC, a Utah limited liability company.
Pursuant to the St. George Agreements, we sold and agreed to issue to St. George 6,410, 256 shares of newly issued restricted Common Stock of the Company at a purchase price of $0.0156 per share. The Purchase Price was paid at Closing and the Shares shall be issued upon the satisfaction of the Share Delivery Conditions as set forth in the Agreement. The Shares purchased represents less than 0.3% of the Company’s current issued and outstanding common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There have been no events which are required to be reported under this item.
ITEM 4. MINE SAFETY DISCLOSURES
N/A.
ITEM 5.OTHER INFORMATION
This item is not applicable.
ITEM 6. EXHIBITS
The exhibits required to be filed herewith by Item 601 of Regulation S-K, as described in the following index of exhibits, are attached hereto unless otherwise indicated as being incorporated by reference, as follows:
Exhibit No. | | Description |
| | Certificate of Incorporation. Filed as an exhibit to the Company’s Form 10-SB General Form for Registration of Securities of Small Business Issuers filed with the SEC on December 7, 2007, and hereby incorporated by reference. |
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| | Amended and Restated Bylaws. Filed as an exhibit to the Company’s Form 8-K filed with the SEC on June 9, 2014, and hereby incorporated by reference. |
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| | Second Amended and Restated Bylaws of GrowLife, Inc. dated October 16, 2015. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on October 26, 2015, and hereby incorporated by reference. |
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| | Certificate of Designation for Series B Preferred Stock. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on October 29, 2015, and hereby incorporated by reference. |
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| | Certificate of Designation for Series C Preferred Stock. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on October 29, 2015, and hereby incorporated by reference. |
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| | GrowLife, Inc. 2011 Stock Incentive Plan filed as an exhibit to the Company’s Registration Statement on Form S-1 filed with the SEC on June 8, 2011, and hereby incorporated by reference. |
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| | Compilation ofSecurities Purchase Agreement Secured Promissory Notes, and Security AgreementWarrant to Purchase Common Stock dated August 11, 2017,February 9, 2018, entered into by and between GrowLife, Inc. and Chicago Venture Partners, L.P.St. George Investments LLC. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on August 17, 2017,February 15, 2018, and hereby incorporated by reference. |
| | First Addendum to Asset Purchase Agreement and Employment Agreement dated February 18, 2018 amongst Growlife, Inc. and David Reichwein, GIP International Ltd and DPR International LLC. (filed herewith). |
| | Second Amendment to Forglen LLC 7% Convertible Promissory Note. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on March 16, 2018, and hereby incorporated by reference. |
| | Common Stock Purchase Agreement dated March 20, 2018 entered into by and between GrowLife, Inc. and St. George Investments LLC. Filed as an exhibit to the Company’s Form 8-K and filed with the SEC on March 23, 2018, and hereby incorporated by reference. |
| | Certification of Principal Executive Officer Pursuant to Rule 13a-14 | Filed herewith. |
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| | Certification of Principal Financial Officer Pursuant to Rule 13a-14 | Filed herewith. |
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| | CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act | Filed herewith. |
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| | CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act | Filed herewith. |
| 101.INS* | | |
101.INS* | XBRL Instance Document |
| 101.SCH* | | XBRL Taxonomy Extension Schema Document |
| 101.CAL* | | XBRL Taxonomy Extension Calculation Linkbase Document |
| 101.LAB* | | XBRL Taxonomy Extension Labels Linkbase Document |
| 101.PRE* | | XBRL Taxonomy Extension Presentation Linkbase Document |
| 101.DEF* | | XBRL Taxonomy Extension Definition Linkbase Document |
*Filed Herewith. Pursuant to Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
SIGNATURES
In accordance with Section 13 or 15(d) requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GROWLIFE, INC.
(Registrant)
| | | | |
Date: November 2, 2017May 1, 2018 | By: | /s/ Marco Hegyi | |
| | | Marco Hegyi | |
| | | Chief Executive Officer and President | |
| | | (Principal Executive Officer) | |
| | | | |
Date: November 2, 2017May 1, 2018 | By: | /s/ Mark Scott | |
| | | Mark Scott | |
| | | Chief Financial Officer | |
| | | (Principal Financial and Accounting Officer) | |
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