GROWLIFE, INC. - Quarter Report: 2020 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
For the quarterly period ended September 30, 2020
OR
☐
|
TRANSITION
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)
Securities
registered pursuant to Section 12(b) of the Act: None
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 ☐
CURRENT
REQ BY SEC. Indicate by check mark whether the registrant has
submitted electronically every Interactive Data File required to be
submitted pursuant to Rule 405 of Regulation S-T (§232.405 of
this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit 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 13, 2020, there were
44,715,790 shares of the issuer’s common stock, $0.0001 par
value per share, outstanding.
TABLE OF CONTENTS
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2
ITEM
1.
FINANCIAL STATEMENTS
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE
SHEETS
|
September
30,
2020
|
December
31,
2019
|
ASSETS
|
|
(Audited)
|
|
|
|
CURRENT
ASSETS:
|
|
|
Cash and cash
equivalents
|
$634,664
|
$40,834
|
Accounts receivable
- trade, net of allowance for doubtful accounts of $5,690 as of
9/30/2020 and 12/31/2019
|
326,792
|
101,806
|
Inventory,
net
|
675,063
|
600,674
|
Deposits
|
18,995
|
18,995
|
Total current
assets
|
1,655,514
|
762,309
|
|
|
|
PROPERTY AND
EQUIPMENT, NET
|
138,618
|
166,482
|
INTANGIBLE ASSETS,
NET
|
1,298,647
|
1,802,434
|
GOODWILL
|
781,749
|
781,749
|
OPERATING LEASE
RIGHT OF USE ASSET
|
422,205
|
537,522
|
TOTAL
ASSETS
|
$4,296,733
|
$4,050,496
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' (DEFICIT)
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
Accounts payable -
trade
|
$1,038,597
|
$1,157,090
|
Accrued
expenses
|
290,891
|
259,093
|
Accrued expenses -
related parties
|
97,061
|
31,485
|
Derivative
liability
|
1,329,089
|
1,300,915
|
Convertible notes
payable
|
2,786,632
|
2,884,279
|
Notes payable,
current portion
|
941,557
|
104,144
|
Acquisition
of EZ-CLONE Enterprises, Inc. payable in cash
|
1,026,000
|
1,026,000
|
Current portion of
operating lease right of use liability
|
140,772
|
140,772
|
Total current
liabilities
|
7,650,599
|
6,903,778
|
|
|
|
LONG TERM
LIABILITIES:
|
|
|
Deferred tax
liability
|
382,037
|
470,200
|
Notes payable, less
current portion
|
398,679
|
-
|
Long
term acquisition of EZ-CLONE Enterprises, Inc. payable in common
stock
|
1,105,000
|
900,000
|
Non-current portion
of operating lease right of use liability
|
305,155
|
410,734
|
Total long term
liabilities
|
2,190,871
|
1,780,934
|
|
|
|
COMMITMENTS AND
CONTINGENCIES (Note 15)
|
-
|
-
|
|
|
|
STOCKHOLDERS'
DEFICIT
|
|
|
Preferred stock -
$0.0001 par value, 10,000,000 shares authorized, no
shares
|
|
|
issued and
outstanding at 9/30/2020 and 12/31/2019, respectively
|
-
|
-
|
Common stock -
$0.0001 par value, 120,000,000 shares authorized, 38,905,790 and
28,677,147
|
|
|
shares issued and
outstanding at 9/30/2020 and 12/31/2019, respectively
|
387,293
|
386,269
|
Additional paid in
capital
|
145,495,095
|
143,441,047
|
Accumulated
deficit
|
(151,427,125)
|
(148,461,532)
|
Total stockholders'
deficit
|
(5,544,737)
|
(4,634,216)
|
|
|
|
TOTAL LIABILITIES
AND STOCKHOLDERS' DEFICIT
|
$4,296,733
|
$4,050,496
|
The accompanying notes are an integral part of these consolidated
financial statements.
3
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
OPERATIONS
|
Three Months
Ended,
|
Nine Months
Ended,
|
||
|
September
30,
2020
|
September
30,
2019
|
September
30,
2020
|
September
30,
2019
|
|
|
|
|
|
NET
REVENUE
|
$1,415,999
|
$2,298,792
|
$4,927,636
|
$6,743,804
|
COST OF GOODS
SOLD
|
919,421
|
1,552,892
|
3,049,782
|
4,551,223
|
GROSS
PROFIT
|
496,578
|
745,900
|
1,877,854
|
2,192,581
|
GENERAL AND
ADMINISTRATIVE EXPENSES
|
1,249,077
|
2,366,085
|
3,741,325
|
6,548,810
|
OPERATING
LOSS
|
(752,499)
|
(1,620,185)
|
(1,863,471)
|
(4,356,229)
|
|
|
|
|
|
OTHER INCOME
(EXPENSE):
|
|
|
|
|
Change in fair
value of derivative
|
130,268
|
(147,331)
|
(28,174)
|
361,179
|
Interest expense,
net
|
(324,752)
|
(182,323)
|
(765,999)
|
(409,666)
|
Loss on debt
conversions
|
(143,799)
|
(132,131)
|
(435,111)
|
(1,706,740)
|
Gain on
extinguishment of debt
|
-
|
-
|
39,000
|
-
|
Total other expense,
net
|
(338,283)
|
(461,785)
|
(1,190,284)
|
(1,755,227)
|
|
|
|
|
|
LOSS BEFORE INCOME
TAXES
|
(1,090,782)
|
(2,081,970)
|
(3,053,755)
|
(6,111,456)
|
|
|
|
|
|
Income taxes -
current benefit
|
29,388
|
-
|
88,163
|
-
|
|
|
|
|
|
NET
LOSS
|
(1,061,394)
|
(2,081,970)
|
(2,965,592)
|
(6,111,456)
|
|
|
|
|
|
Net loss
attrituable to noncontrolling interest in EZ-CLONE Enterprises,
Inc.
|
-
|
82,219
|
-
|
88,938
|
|
|
|
|
|
NET LOSS
ATTRIBUTABLE TO GROWLIFE, INC. AND SUBSIDIARIES
|
$(1,061,394)
|
$(1,999,751)
|
$(2,965,592)
|
$(6,022,518)
|
COMMON
SHAREHOLDERS
|
|
|
|
|
|
|
|
|
|
Basic and diluted
loss per share
|
$(0.03)
|
$(0.08)
|
$(0.08)
|
$(0.25)
|
|
|
|
|
|
Weighted average
shares of common stock outstanding- basic and diluted
|
36,670,186
|
25,408,052
|
36,385,060
|
24,664,128
|
The accompanying notes are an integral part of these consolidated
financial statements.
4
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' DEFICIT
|
|
|
|
|
Total
|
|
Common Stock
|
Additional Paid
|
Accumulated
|
Stockholders'
|
|
|
Shares
|
Amount
|
in
Capital
|
Deficit
|
(Deficit)
|
Balance as of January 1,
2019
|
22,917,327
|
$343,749
|
$139,331,067
|
$(141,176,087)
|
$(1,501,271)
|
Stock based compensation for stock
options
|
-
|
-
|
16,016
|
-
|
16,016
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for debt
conversion
|
-
|
-
|
-
|
-
|
-
|
Shares issued for services
rendered
|
139,441
|
2,092
|
163,308
|
-
|
165,400
|
Shares issued for convertible note
and interest conversion
|
561,041
|
8,416
|
726,731
|
-
|
735,147
|
Shares issued for purchase of
warrant
|
833,333
|
12,500
|
987,500
|
-
|
1,000,000
|
Noncontrolling interest in EZ-Clone
Enterprises, Inc.
|
-
|
-
|
-
|
(25,528)
|
(25,528)
|
Net loss for the three months ended
March 31, 2019
|
-
|
-
|
-
|
(2,338,325)
|
(2,338,325)
|
Balance as of March 31,
2019
|
24,451,143
|
366,757
|
141,248,622
|
(143,539,940)
|
(1,924,561)
|
Stock based compensation for stock
options
|
-
|
-
|
16,231
|
-
|
16,231
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for services
rendered
|
8,448
|
126
|
8,908
|
-
|
9,034
|
Shares issued for convertible note
and interest conversion
|
579,078
|
8,685
|
589,413
|
-
|
598,098
|
Warrant
exercise
|
26,111
|
392
|
(392)
|
-
|
-
|
Noncontrolling interest in EZ-Clone
Enterprises, Inc.
|
-
|
-
|
-
|
32,247
|
32,247
|
Net loss for the three months ended
June 30, 2019
|
-
|
-
|
-
|
(1,690,941)
|
(1,690,941)
|
Balance as of June 30,
2019
|
25,064,781
|
375,960
|
141,886,782
|
(145,198,634)
|
(2,935,892)
|
Stock based compensation for stock
options
|
-
|
-
|
16,356
|
-
|
16,356
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for convertible note
and interest conversion
|
623,140
|
9,347
|
422,784
|
-
|
432,131
|
Shares issued for convertible note
and commitment shares
|
33,333
|
500
|
24,500
|
-
|
25,000
|
Noncontrolling interest in EZ-Clone
Enterprises, Inc.
|
-
|
-
|
-
|
81,999
|
81,999
|
Net loss for the three months ended
September 30, 2019
|
-
|
-
|
-
|
(2,081,970)
|
(2,081,970)
|
|
|
|
|
|
|
Balance as of September 30,
2019
|
25,721,254
|
$385,807
|
$142,374,422
|
$(147,198,605)
|
$(4,438,376)
|
|
|
|
|
|
|
Balance as of January 1,
2020
|
28,677,147
|
$386,269
|
$143,441,047
|
$(148,461,532)
|
$(4,634,216)
|
Stock based compensation for stock
options
|
-
|
-
|
13,439
|
-
|
13,439
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for convertible note
and interest conversion
|
605,294
|
61
|
149,510
|
-
|
149,571
|
Warrant
exercise
|
146
|
-
|
460
|
-
|
460
|
Fractional shares issued related to
reverse stock split
|
15
|
-
|
-
|
-
|
-
|
Net loss for the three months ended
March 31, 2020
|
-
|
-
|
-
|
(1,293,675)
|
(1,293,675)
|
Balance as of March 31,
2020
|
29,282,602
|
386,330
|
143,628,456
|
(149,755,207)
|
(5,740,421)
|
Stock based compensation for stock
options
|
-
|
-
|
13,439
|
-
|
13,439
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for services
rendered
|
40,000
|
4
|
11,797
|
-
|
11,801
|
Shares issued for convertible note
and interest conversion
|
3,991,108
|
400
|
835,007
|
-
|
835,407
|
Warrant
exercise
|
8
|
-
|
25
|
-
|
25
|
Net loss for the three months ended
June 30, 2020
|
-
|
-
|
-
|
(610,524)
|
(610,524)
|
Balance as of June 30,
2020
|
33,313,718
|
386,734
|
144,512,724
|
(150,365,731)
|
(5,466,273)
|
Stock based compensation for stock
options
|
-
|
-
|
12,708
|
-
|
12,708
|
Stock based compensation for
warrants
|
-
|
-
|
24,000
|
-
|
24,000
|
Shares issued for convertible note
and interest conversion
|
5,592,072
|
559
|
945,664
|
-
|
946,223
|
Net loss for the three months ended
September 30, 2020
|
-
|
-
|
-
|
(1,061,394)
|
(1,061,394)
|
Balance as of September 30,
2020
|
38,905,790
|
$387,293
|
$145,495,096
|
$(151,427,125)
|
$(5,544,737)
|
The accompanying notes are an integral part of these consolidated
financial statements.
5
GROWLIFE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
CASH FLOWS
|
Nine Months
Ended,
|
|
|
September
30,
2020
|
September
30,
2019
|
|
|
|
CASH FLOWS FROM
OPERATING ACTIVITIES:
|
|
|
Net
loss
|
$(2,965,592)
|
$(6,022,518)
|
Adjustments to
reconcile net loss to net cash (used in)
|
|
|
operating
activities
|
|
|
Depreciation
|
27,864
|
68,655
|
Restructuring
Expense - stores & flooring
|
-
|
555,895
|
Amortization
of intangible assets
|
503,787
|
855,771
|
Stock
based compensation
|
111,586
|
120,603
|
Common
stock issued for services
|
11,801
|
174,435
|
Non
cash interest and amortization of debt discount
|
793,970
|
185,032
|
Change
in fair value of derivative liability
|
28,174
|
(361,179)
|
Loss on debt
conversions
|
396,110
|
1,706,740
|
Noncontrolling
interest in EZ-CLONE Enterprises, Inc.
|
-
|
88,938
|
Changes in
operating assets and liabilities:
|
|
|
Accounts
receivable
|
(224,986)
|
(409,575)
|
Inventory
|
(74,389)
|
86,982
|
Prepaids
costs
|
-
|
(37,459)
|
Deposits
|
-
|
8,500
|
Right of use,
net
|
9,738
|
9,738
|
Accounts
payable
|
(79,494)
|
336,010
|
Accrued
expenses
|
97,766
|
110,811
|
Deferred
revenue
|
-
|
(89,504)
|
Change in deferred
taxes
|
(88,163)
|
-
|
CASH (USED
IN) OPERATING ACTIVITIES
|
(1,451,828)
|
(2,612,125)
|
|
|
|
CASH FLOWS FROM
INVESTING ACTIVITIES:
|
|
|
Investment in
purchased assets
|
-
|
(5,319)
|
NET CASH (USED IN)
INVESTING ACTIVITIES:
|
-
|
(5,319)
|
|
|
|
CASH FLOWS FROM
FINANCING ACTIVITIES:
|
|
|
Repayment of
convertible notes payable
|
(167,846)
|
(659,205)
|
Proceeds from
Crossover Capital Fund I LLC Secured Advance Note
|
-
|
250,000
|
Proceeds from notes
payable
|
2,213,019
|
900,637
|
Repayment on
capital lease
|
-
|
(7,293)
|
Proceeds from the
issuance of common stock
|
485
|
-
|
NET CASH PROVIDED
BY FINANCING ACTIVITIES
|
2,045,658
|
484,139
|
|
|
|
NET INCREASE
(DECREASE) IN CASH AND CASH EQUIVALENTS
|
593,830
|
(2,133,305)
|
|
|
|
CASH AND CASH
EQUIVALENTS, beginning of period
|
40,834
|
2,334,377
|
|
|
|
CASH AND CASH
EQUIVALENTS, end of period
|
$634,664
|
$201,072
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
Non-cash investing
and financing activities:
|
|
|
Shares issued for
convertible note and interest conversion
|
$1,049,506
|
$745,000
|
Issuance of shares
for issuance costs
|
$349,020
|
$-
|
Shares issued for
purchase of warrant from CANX USA LLC
|
$-
|
$1,000,000
|
The accompanying notes are an integral part of these consolidated
financial statements.
6
GROWLIFE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
The
accompanying unaudited consolidated condensed financial statements
have been prepared by GrowLife, Inc. (“the Company”,
“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, 2019,
filed with the Securities and Exchange Commission
(“SEC”) on April 1, 2020. The results of operations for
the three or nine months ended September 30, 2020 are not
necessarily indicative of the results expected for the full fiscal
year, or for any other fiscal period.
NOTE 1 – DESCRIPTION OF BUSINESS AND
ORGANIZATION
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.
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. This is our commercial
business.
The
Company primarily sells its products through its wholly owned
subsidiary, GrowLife Hydroponics, Inc. GrowLife companies
distribute and sell over products through its e-commerce
distribution channels, www.shopgrowlife.com,
www.growlifeinc.com,
and www.greners.com,
and through its direct sales force. GrowLife and its business units
are organized and directed to operate strictly in accordance with
all applicable state and federal laws.
On October 15, 2018, the Company closed the Purchase and Sale
Agreement with EZ-CLONE Enterprises, Inc., a California corporation
(the “Agreement”). On November 5, 2019, the
Company amended the Agreement with one 24.5% shareholder of
EZ-CLONE Enterprises, Inc. (“EZ-CLONE”), to extend the
date to purchase the remaining 49% of stock of EZ-CLONE in exchange
for a 20% extension fee (a total of $171,000 for the 49% or $85,500
for each 24.5% shareholder) of the $855,000 cash payable at the
earlier of the closing of $2,000,000 in funding or nine months
(July 2020). The Company did not close the purchase of the
remaining 49% of stock of EZ-CLONE by the extended
deadline.
On September 15, 2020, the Company received notice that William
Blackburn and Brad Mickelsen (“Plaintiffs”), minority
shareholders of EZ-CLONE Enterprises, Inc., a majority owned
subsidiary of the Company, filed a complaint against the Company
and its officers Marco Hegyi and Mark Scott
(“Officers”), in the Superior Court of California,
County of Sacramento (“Complaint”) for claims related
to breach under the Purchase and Sale Agreement dated October 15,
2018 between the Company and Plaintiffs. See Note 17 for
description of Legal Proceedings.
As of
September 30, 2020, the Company has recorded a liability of
$2,131,000 for acquisition payable of which a $1,105,000 is payable
in stock and $1,026,000 is payable in cash.
As of March 4, 2019, the Company began to trade on the
Pink
Sheet stocks system. Our
bid price had closed below $0.01 for more than 30 consecutive
calendar days. As of March 17, 2020, the Company
commenced trading on the
OTCQB Market ("OTCQB") after successfully up-listing from the OTC
Pink Market.
On
October 9, 2019, the Company approved the reduction of authorized
capital stock, whereby the total number of the Company’s
authorized common stock decreased from 6,000,000,000 by a ratio of
1 for 50, to 120,000,000 shares. On
November 20, 2019, the Company filed a Certificate of Amendment of
Certificate of Incorporation with the Secretary of State of the
State of Delaware. As a result of the reduction, the Company
an aggregate 130,000,000 authorized shares consisting of: (i)
120,000,000 shares of common stock, par value $0.0001 per share,
and (ii) 10,000,000 shares of preferred stock, par value $0.0001
per share.
The reverse stock split of 1 for 150 was effective at the open of
business on November 27, 2019 whereupon the shares of common stock
began trading on a split-adjusted basis. The Company’s CUSIP
number for the Company’s common stock changed to
39985X203. All
warrant, option, share and per share information in this Form 10-Q
gives retroactive effect to the 1-for-150 reverse split with all
numbers rounded up to the nearest whole share.
7
NOTE 2 –
GOING CONCERN
The
accompanying 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 $2,860,592 and $7,374,383 and
$11,473,136 for
the nine months ended September 30, 2020 and the
years ended December 31, 2019 and 2018, respectively. Net cash used
in operating activities was $1,451,828, $2,909,811 and $3,854,505
for the nine months ended September 30, 2020 and the years ended
December 31, 2019 and 2018, respectively.
The
Company anticipates that it will record losses from operations for
the foreseeable future. As of September 30, 2020, the
Company’s accumulated deficit was $151,322,125. The
Company has limited capital resources, and operations to date have
been funded with the proceeds from private equity and debt
financings. These conditions raise substantial doubt about our
ability to continue as a going concern. The audit report prepared
by the Company’s independent registered public accounting
firm relating to our consolidated financial statements for the year
ended December 31, 2019 includes an explanatory paragraph
expressing the substantial doubt about the Company’s ability
to continue as a going concern.
The
Company believes that its cash on hand will be sufficient to fund
our operations only until December 31, 2020. The Company needs 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
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 may seek additional
capital through a combination of private and public equity
offerings, debt financings and strategic collaborations. Debt
financing, if obtained, may involve agreements that include
covenants limiting or restricting our ability to take specific
actions, such as incurring additional debt, and could increase our
expenses and require that our assets secure such debt. Equity
financing, if obtained, could result in dilution to the
Company’s then-existing stockholders and/or require such
stockholders to waive certain rights and preferences. If such
financing is not available on satisfactory terms, or is not
available at all, the Company may be required to delay, scale back,
eliminate the development of business opportunities and our
operations and financial condition may be materially adversely
affected.
NOTE 3 – SIGNIFICANT ACCOUNTING
POLICIES: ADOPTION OF ACCOUNTING STANDARDS
Basis of Presentation - The accompanying consolidated
financial statements include the accounts of the Company.
Intercompany accounts and transactions have been eliminated. The
preparation of these 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. Non-controlling interest represents the portion of
ownership which the Company does not own.
Cash and Cash Equivalents - We
classify highly liquid temporary investments with an original
maturity of three 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. The Company
has not experienced any losses in such accounts and believes it is
not exposed to any significant risk for cash on
deposit. At September 30, 2020, the Company had
uninsured deposits in the amount of $384,664.
Accounts Receivable and Revenue – The company
recognizes revenue in accordance with ASC Topic 606, Revenue from
Contracts with Customers, which requires the application of the
five-step-principles-based-accounting-model for revenue
recognition. These steps include (1) a legally enforceable
contract, written or unwritten is identified; (2) performance
obligations in the contracts are identified; (3) the transaction
price reflecting variable consideration, if any, is identified; (4)
the transaction price is allocated to the performance obligations;
and (5) revenue is recognized when the control of goods is
transferred to the customer at a particular time or over time. Our
hydroponic sales are cash or credit card. Our EZ-CLONE sales
include credit cash, payments in advance, 3% discount upon receipt
and, we extend thirty day terms to select customers. Accounts
receivable are reviewed periodically for
collectability. As of
September 30, 2020 and December 31, 2019, the Company has an
allowance for doubtful accounts totaling $5,690.
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, 2020 and December 31,
2019, there was a reserve for sales returns of $20,000,
respectively, which is minimal based upon our historical
experience.
8
Inventories - Inventories are recorded on a first in first
out basis Inventory consists of raw materials, work in process and
finished goods and components sold by EZ-CLONE to it distribution
customers. 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.
Property and Equipment –
Equipment consists of machinery, equipment, tooling, computer
equipment and leasehold improvements, which are stated at cost less
accumulated depreciation and amortization. Depreciation is computed
by the straight-line method over the estimated useful lives or
lease period of the relevant asset, generally 3-10 years, except
for leasehold improvements which are depreciated over the lesser of
the life of the lease or 10 years.
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.
Intangible Assets – Intangible assets are capitalized
and amortized on a straight-line basis over their estimated useful
life, if the life is determinable. If the life is not determinable,
amortization is not recorded. We regularly perform reviews to
determine if facts and circumstances exist which indicate that the
useful lives of our intangible assets are shorter than originally
estimated or the carrying amount of these assets may not be
recoverable. When an indication exists that the carrying amount of
intangible assets may not be recoverable, we assess the
recoverability of our assets by comparing the projected
undiscounted net cash flows associated with the related asset or
group of assets over their remaining lives against their respective
carrying amounts. Such impairment test is based on the lowest level
for which identifiable cash flows are largely independent of the
cash flows of other groups of assets and liabilities. Impairment,
if any, is based on the excess of the carrying amount over the
estimated fair value of those assets.
Goodwill-The Company reviews
its acquired goodwill for impairment annually or more frequently if
events or changes in circumstances indicate that the carrying
amount may not be recoverable. In reviewing its goodwill, the
Company performs a qualitative analysis to determine if it is
more-likely-than-not that the goodwill is impaired. If the
qualitative analysis indicates that goodwill is likely impaired,
the Company calculates the fair value of its goodwill by allocating
the fair value of the business unit containing the goodwill to all
its tangible and intangible assets and liabilities, with the
residual fair value allocated to goodwill. The excess, if any, of
the goodwill carrying value in excess of its fair value would be
recognized as an impairment loss. Management has concluded that,
based on a qualitative analysis, it is more-likely-than-not that
goodwill has not been impaired as of September 30, 2020 and
December 31, 2019.
Fair Value Measurements and Financial Instruments
– ASC Topic 820, Fair Value Measurement and Disclosures,
defines fair value as the exchange price that would be received for
an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the
measurement date. This topic also establishes a fair
value hierarchy, which requires classification based on observable
and unobservable inputs when measuring fair value. The
fair value hierarchy distinguishes between assumptions based on
market data (observable inputs) and an entity’s own
assumptions (unobservable inputs). The hierarchy
consists of three levels:
Level 1
– Quoted prices in active markets for identical assets and
liabilities;
|
Level 2
– Inputs other than level one inputs that are either directly
or indirectly observable; and.
Level 3
- Inputs to the valuation methodology are unobservable and
significant to the fair value measurement.
|
The
recorded value of other financial assets and liabilities, which
consist primarily of cash and cash equivalents, accounts
receivable, other current assets, and accounts payable and accrued
expenses approximate the fair value of the respective assets and
liabilities as of September 30, 2020 and December 31, 2019 are
based upon the short-term nature of the assets and
liabilities.
Derivative Financial Instruments –Pursuant to ASC 815
“Derivatives and Hedging”, the Company evaluates all of
its financial instruments to determine if such instruments are
derivatives or contain features that qualify as embedded
derivatives. The Company then determines if embedded derivative
must bifurcated and separately accounted for. 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
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.
9
Stock Based Compensation – We have share-based compensation plans
under which employees, consultants, suppliers and directors may be
granted restricted stock, as well as options to purchase shares of
our common stock at the fair market value at the time of grant.
Stock-based compensation cost is measured by us at the grant date,
based on the fair value of the award, over the requisite service
period using an estimated forfeiture rate. For options issued to
employees, we recognize stock compensation costs utilizing the fair
value methodology over the related period of
benefit. Grants of stock options and stock to
non-employees and other parties are accounted for in accordance
with the ASC 718.
Convertible Securities –
Based upon ASC 815-15, we have adopted a sequencing approach
regarding the application of ASC 815-40 to convertible securities
issued subsequent to September 30, 2015. We will evaluate our
contracts based upon the earliest issuance
date.
Net Loss Per Share - Under the
provisions of ASC Topic 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 because their impact is
antidilutive.
As of
September 30, 2020, there are also (i) stock option grants
outstanding for the purchase of 506,667 common shares at a $1.496
average exercise price; and (ii) warrants for the purchase of
2,418,680 shares of common
shares at a $3.465 average exercise price. In addition, we have an unknown number of common
shares to be issued under the Crossover, 12% convertible promissory
note financing and Labrys agreements in the case of default. In
addition, we have an unknown number of common shares to be issued
under the Chicago Venture, Iliad and St. George 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 and exercises its warrants. The lower
the conversion or exercise prices, the more shares that will be
issued to Chicago Venture upon the conversion of debt to shares. We
will not know the exact number of shares of stock issued to Chicago
Venture until the debt is actually converted to
equity.
As of
September 30, 2019, there are also (i) stock option grants
outstanding for the purchase of 550,000 common shares at a $1.491 average
exercise price; (ii) warrants for the purchase of 2,418,680 common shares at a $3.465 average
exercise price; and (iii) 789,565 shares
related to convertible debt that can be converted at $0.38 per
share.
In addition, we have an unknown number of common shares to be
issued under the Crossover financing agreements in the case of
default. In addition, we have an unknown number of common shares to
be issued under the Chicago Venture, Iliad and St. George 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 and exercises its warrants. The lower
the conversion or exercise prices, the more shares that will be
issued to Chicago Venture upon the conversion of debt to shares. We
will not know the exact number of shares of stock issued to Chicago
Venture until the debt is actually converted to
equity.
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 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
The Company has not adopted any new accounting pronouncements. A
variety of proposed or otherwise potential accounting standards are
currently under study by standard setting organizations and various
regulatory agencies. Due to the tentative and preliminary nature of
those proposed standards, management has not determined whether
implementation of such proposed standards would be material to the
Company’s consolidated financial statements.
10
NOTE 4 –BUSINESS COMBINATIONS, ACQUISITION PAYABLE AND OTHER
TRANSACTION
Acquisition of EZ-CLONE Enterprises, Inc.
On October 15, 2018, the Company closed the Purchase and Sale
Agreement with EZ-CLONE Enterprises, Inc. (“EZ-CLONE”),
a California corporation (the
“Agreement”). The total purchase price was $4 million
of which $1,500,000 is payable in cash and $2.5 million payable in
stock. At closing, we paid 51% of this amount totaling
$2,040,000 via a (i) a cash payment of $645,000; and (ii) the
issuance of 715,385 restricted shares of our common stock valued
$1,395,000. The Agreement called for the Company, upon delivery of
the remaining 49% of EZ-Clone stock, to acquire such stock within
one year for $1,960,000, payable as follows: (i) a cash payment of
$855,000; and (ii) the issuance of Company’s common stock at
a value of $1,105,000.
On November 5, 2019, the Company amended the Agreement with one
24.5% shareholder of EZ-CLONE to extend the date to purchase the
remaining 49% of stock of EZ-CLONE in exchange for a 20% extension
fee (a total of $171,000 for the 49% or $85,500 for each 24.5%
shareholder) of the $855,000 cash payable at the earlier of the
closing of $2,000,000 in funding or nine months (July 2020). The
Company did not close the purchase of the remaining 49% of stock of
EZ-CLONE by the extended deadline.
On September 15, 2020, the Company received notice that William
Blackburn and Brad Mickelsen (“Plaintiffs”), minority
shareholders of EZ-CLONE Enterprises, Inc., a majority owned
subsidiary of the Company, filed a complaint against the Company
and its officers Marco Hegyi and Mark Scott
(“Officers”), in the Superior Court of California,
County of Sacramento (“Complaint”) for claims related
to breach under the Purchase and Sale Agreement dated October 15,
2018 between the Company and Plaintiffs. See Note 17 for
description of Legal Proceedings.
As of
September 30, 2020 and December 31, 2019, the Company has recorded
a liability of $2,131,000 for acquisition payable of which a
$1,105,000 is payable in stock and $1,026,000 is payable in
cash.
This acquisition has accelerated the Company’s revenue
growth, increased the Company gross margins and added additional
manufacturing and research and development personnel.
The
Company accounted for the acquisition in accordance with ASC 805,
“Business Combinations”. ASC 805 defines the acquirer
in a business combination as the entity that obtains control of one
or more businesses in a business combination and establishes the
acquisition date as the date that the acquirer achieves control.
ASC 805 requires an acquirer to recognize the assets acquired, the
liabilities assumed, and any non-controlling interest in the
acquiree at the acquisition date, measured at their fair values as
of that date.
For
accounting purposes, from the October 15, 2018 acquisition date and
through November 4, 2019, the Company consolidated EZ-Clone given
their control and treated its ability to acquire the remaining 49%
interest in EZ-Clone as a de facto option to buy and has thus
categorized it as a non-controlling interest until November 5, 2019
when the amended purchase agreement obligates the Company to
purchase the remaining 49%. Effective in the quarter beginning
October 1, 2019, the Company for accounting purposes, considers
EZ-Clone to be 100% owned and thus eliminated the non-controlling
interest and recorded an acquisition payable related to the balance
owed. As of December 31, 2019, the Company has an acquisition
payable totaling $1,926,000, of which $1,026,000 is current and
$900,000 is categorized as long term since stock is expected to be
issued to settle this and will not utilize current assets. The
total liability consists of the discounted value of the future
payments of $1,960,000 and the $171,000 extension fee payable. The
Company accreted the difference between the carrying value of the
acquisition payable and the contractual obligations as interest
expense through July 2020 when payment was due. The Company
recorded the $171,000 as a financing fee and expensed it as
interest expense in 2019. During the fourth quarter of 2019, the
Company recorded a noncash financing charge as interest expense
totaling approximately $410,000 to recognize the acquisition
payable and to eliminate the non-controlling interest. During the
nine months ended September 30, 2020 the Company recognized an
additional $205,000 of interest expense to accrete the acquisition
payable to $1,105,000.
As of
the acquisition date in October 2018, the Company recognized
approximately $3.4 million of intangible assets and began
amortizing them over 3 years. In the fourth quarter of 2019, the
Company completed its evaluation of assets acquired and finalized
its asset valuation. The finalized valuation resulted in lower
intangible assets from the original assessment, allocating some of
the intangible to Goodwill and determined that the life of definite
life intangibles to be 5 years (See Note 7). The Company adjusted
the cost basis and accumulated amortization, reducing both, but did
not change 2019 amortization expense that had been recorded through
September 30, 2019 which was in excess of $800,000.The change in
the purchase accounting also resulted in the recording of a
deferred tax liability and the lowering of non-controlling interest
by $587,750 and such reclassification was made to the December 31,
2018 balance sheet. During the nine months ended September 30,
2020, the Company recorded a tax benefit of $88,163 related to book
versus tax basis difference from the purchase
accounting.
11
The
summary of assets acquired and liabilities assumed is based upon
the Company final evaluation done in the fourth quarter of 2019 and
is detailed below.
Intangible
assets
|
$2,351,000
|
Goodwill
|
781,749
|
Net working
capital
|
551,000
|
Propety and
equipment
|
318,000
|
Deferred tax
liability
|
(587,750)
|
|
$3,413,999
|
The fair value of the intangible assets associated with the assets
acquired was $2,351,000 estimated by using a discounted cash flow
approach based on future economic benefits. In summary, the
estimate was based on a projected income approach and related
discounted cash flows over five years, with applicable risk factors
assigned to assumptions in the forecasted results.
NOTE 5 – INVENTORY
Inventory
as of September 30, 2020 and December 31, 2019 consisted of the
following:
|
September 30,
|
December 31,
|
|
2020
|
2019
|
|
|
|
Raw
materials
|
$486,024
|
$329,482
|
Work
in process
|
85,293
|
49,253
|
Finished
goods
|
21,581
|
92,703
|
Inventory
deposits
|
82,166
|
129,236
|
Total
|
$675,063
|
$600,674
|
Raw
materials consist of supplies for product lines at
EZ-CLONE.
Finished
goods inventory relates to product lines at EZ- CLONE.
NOTE 6 – PROPERTY AND EQUIPMENT
Property
and equipment as of September 30, 2020 and December 31, 2019
consists of the following:
|
September 30,
|
December 31,
|
|
2020
|
2019
|
|
|
|
Machinery,
equipment and tooling
|
$356,867
|
$356,867
|
Computer
equipment
|
16,675
|
16,675
|
Leasehold
improvements
|
14,702
|
14,702
|
Total
property and equipment
|
388,244
|
388,244
|
Less
accumulated depreciation and amortization
|
(249,626)
|
(221,763)
|
Net
property and equipment
|
$138,618
|
$166,482
|
Total depreciation expense was $27,864 and $68,655 for the nine months ended September 30, 2020 and
2019, 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.
12
NOTE 7 – INTANGIBLE
ASSETS
Intangible assets as of September 30, 2020 and December 31, 2019
consisted of the following:
|
Estimated Useful
Lives
|
September
30,
2020
|
December
31,
2019
|
|
|
|
|
Customer
Lists
|
5
Years
|
$1,297,000
|
$1,297,000
|
Intellectual
Property
|
5
Years
|
1,054,000
|
1,054,000
|
less accumulated
amortization
|
|
(1,052,353)
|
(548,566)
|
Net Intangible
assets-definitive life
|
|
1,298,647
|
1,802,434
|
|
|
|
|
Goodwill-indefinite
life
|
N/A
|
781,749
|
781,749
|
|
|
|
|
Total intangible
assets and goodwill
|
|
$2,080,396
|
$2,584,183
|
As of
the acquisition date in October 2018, the Company originally
recognized approximately $3.4 million of intangible assets and
began amortizing them over 3 years. In the fourth quarter of 2019,
the Company completed its evaluation of assets acquired and
finalized its asset valuation. The finalized valuation resulted in
lower intangible assets from the original assessment, allocated
some of the intangible to Goodwill and determined that the life of
definite life intangibles to be 5 years. In the 4th quarter of 2019,
The Company adjusted the cost basis and accumulated amortization,
reducing both, but did not change 2019 amortization expense that
had been recorded through September 30, 2019 which was in excess of
$800,000.
Total amortization expense was $503,787 and $855,771 for the nine months ended September 30, 2020 and
2019, respectively.
NOTE 8- LEASES
The
Company previously entered into operating leases for retail and
corporate facilities. These leases have terms which range from two
to five years, and often include options to renew. These operating
leases are listed as separate line items on the Company's December
31, 2018 Consolidated Balance Sheet and represent the
Company’s right to use the underlying asset for the lease
term. The Company’s obligation to make lease payments are
also listed as separate line items on the Company's December 31,
2018 Consolidated Balance Sheet. Based on the present value of the
lease payments for the remaining lease term of the Company's
existing leases, the Company recognized right-of-use assets and
lease liabilities for operating leases of approximately $1,378,000
on January 1, 2019. Operating lease right-of-use assets and
liabilities commencing after January 1, 2019 are recognized at
commencement date based on the present value of lease payments over
the lease term. During the three months ended September 30, 2019
the Company cancelled all but one lease and has recognized the rent
and termination fees related to the cancelled leases as an expense
in the quarter ended September 30, 2019. As of September 30, 2020
and December 31, 2019, total right-of-use assets and operating
lease liabilities for remaining long term lease was $445,927 and
$481,120, respectively. During the nine months ended September 30,
2020 and 2019, the Company recognized approximately $167,000 in
total lease costs for the lease.
Because
the rate implicit in each lease is not readily determinable, the
Company uses its incremental borrowing rate to determine the
present value of the lease payments.
Information
related to the Company's operating right-of-use assets and related
lease liabilities as of and for the nine months ended September 30,
2020 were as follows:
Cash paid for ROU
operating lease liability $157,500
Weighted-average
remaining lease term 3 years
Weighted-average
discount rate 10%
Year Ended
|
|
September 30, 2020
|
$
|
2021
|
$216,300
|
2022
|
222,792
|
2023
|
117,984
|
|
|
|
557,076
|
Imputed
interest
|
(111,149)
|
Total lease
liability
|
$445,927
|
13
NOTE 9- ACCOUNTS PAYABLE
Accounts payable were $1,038,597 and $1,157,090 as of September 30, 2020 and December 31, 2019,
respectively. Such liabilities consisted of amounts due to vendors
for inventory purchases, audit, legal and other expenses incurred
by the Company.
NOTE 10- ACCRUED EXPENSES
Accrued expenses were $290,891 and $259,093 as of September 30, 2020 and
December 31, 2019, respectively. Such liabilities consisted of
amounts due to sales tax,
payroll and restructuring expense liabilities. As of
September 30, 2019, the Company closed retail stores in Portland,
Maine, Encino, California and Calgary, Canada. The Company is
negotiating with the landlords and the Company has recorded
restructuring reserves of $209,577 as of September 30, 2020 and
December 31, 2019, respectively.
NOTE 11 – CONVERTIBLE NOTES PAYABLE AND NOTES
PAYABLE
Convertible
notes payable as of September 30,
2020 consisted of the following:
|
Principal
|
Accrued
Interest
|
Debt
Discount
|
Balance
As
of
September
30,
2020
|
Convertible Notes
Payable-
|
|
|
|
|
10% OID Convertible
Promissory Notes
|
$2,040,907
|
$427,400
|
$-
|
$2,468,307
|
Secured Advance
Note
|
87,526
|
10,251
|
-
|
97,777
|
12% Convertible
Promissory Notes
|
221,100
|
7,759
|
(8,311)
|
220,548
|
Total Convertible
Notes Payable, short term
|
$2,349,533
|
$445,410
|
$(8,311)
|
$2,786,632
|
Convertible
notes payable as of December
31, 2019 consisted of the following:
|
Principal
|
Accrued
Interest
|
Debt
Discount
|
Balance
As of
December 31,
2019
|
Convertile
Notes Payable-
|
|
|
|
|
10% OID Convertible
Promissory Notes
|
$2,195,007
|
$220,980
|
$-
|
$2,415,987
|
Secured
Advance Note
|
205,228
|
-
|
-
|
205,228
|
12%
Convertible Promissory Notes
|
281,600
|
3,055
|
(21,591)
|
263,064
|
|
$2,681,835
|
$224,035
|
$(21,591)
|
$2,884,279
|
10% OID Convertible Promissory Notes
Funding from Chicago Venture Partners, L.P. (“Chicago
Venture”), Iliad Research and Trading, L.P.
(“Iliad”) and Odyssey Research and Trading, LLC,
(“Odyssey”). The Company typically issues original
issuance discount notes with these parties that has a stated
interest rate of typically 10%. Accrued interest represents the
interest to be accreted over the remaining term of the notes. These
notes contain terms and conditions that are deemed beneficial
conversion features and the Company recognizes a derivative
liability related to these terms until the notes are converted.
Upon the conversion of these notes, the Company records a loss on
debt conversion and reduces their derivative liability. The notes
may be converted to common stock after six months until they are
converted.
As
of December 31, 2019, the
outstanding principal balance due to Chicago Venture, Iliad and
Odyssey was $2,195,007 and accrued interest was $220,980, which
results in a total amount of $2,415,987.
During
the year ended December 31, 2019, Chicago Venture and Iliad
converted principal and accrued interest of $1,357,872 into
3,120,521 shares of our common stock at a per share conversion
price of $0.766 with a fair value of $2,284,081. The Company
recognized $926,208 loss on debt conversions during the year ended
December 31, 2019.
As
of September 30, 2020, the
outstanding principal balance due to Chicago Venture, Iliad and
Odyssey was $1,650,007 and accrued interest was $423,888, which
results in a total amount of $2,073,895.
14
During
the nine months ended September 30, 2020, the Company received
loans of $500,000 from Chicago Venture. Also, Chicago Venture
converted principal and accrued interest of $600,000 into 4,882,919
shares of our common stock at a per share conversion price of
$0.123 with a fair value of $1,006,518. The Company recognized
$287,466 loss on debt conversions during the nine months ended
September 30, 2020.
On
September 1, 2020, Iliad sold a Note for $500,000 to Silverback
Capital Corporation. As of September
30, 2020, the outstanding principal balance due to
Silverback was $390,900 and accrued interest was $3,512, which
results in a total amount of $394,412. During the nine months ended
September 30, 2020, Silverback converted principal and accrued
interest of $109,100 into 1,000,000 shares of our common stock at a
per share conversion price of $0.109 with a fair value of $158,000.
The Company recognized $44,900 loss on debt conversions during the
nine months ended September 30, 2020.
Securities Purchase Agreement, Secured Promissory Notes and
Security Agreement with Chicago Venture Partners, L.P (Chicago
Venture or CVP)
On January 30, 2020, the Company executed the following agreements
with Chicago Venture: (i) Securities Purchase Agreement; (ii)
Secured Convertible Promissory Notes (“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 businesses.
The total amount of funding under the CVP Agreements is $500,000 in
various tranches. The Notes carry an original issue discount of
$50,000 and a transaction expense amount of $5,000, for total debt
of $555,000 (“Debt”). The Company agreed to reserve
53,333 shares of its 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 29, 2021. The Debt carries an
interest rate of ten percent (10%). The Debt is convertible, at
CVP’s option, into the Company’s common stock at $0.30
per share subject to adjustment as provided for in the Notes. The
Company received approximately $500,000 of funding under the CVP
agreements in 2020.
The Company’s obligation to pay the Debt, or any portion
thereof, is secured by all of the Company’s
assets.
Secured Advance Note with Crossover Capital Fund I LLC
(“Crossover”)
On
September 20, 2019, the Company closed a Secured Advance Note with
Crossover Capital Fund I LLC (the “Crossover Note”).
The Company entered into the Crossover Note with the intent to
acquire working capital to grow the Company’s businesses. The
total amount of funding under the Crossover Note is $250,000. The
Crossover Note carries an original issue discount of $57,400 and a
transaction expense amount of $7,000, for total debt of $308,400.
On December 22, 2019, the Note increased by $25,700. The original
issue discount was immediately recorded as interest expense due to
the note maturity being less than one year. The Company agreed to
reserve three times the number of shares based on the conversion
value in case of default under the Crossover Note, if that occurs
in the future. The Crossover Note is due in nine months and is
repayable weekly at $9,205. The Crossover Note is convertible into
the Company’s common stock at the market value share price
subject to adjustment as provided for in the Crossover Note in the
case of default. The Company’s obligation to pay the
Crossover Note, or any portion thereof, is secured by all of the
Company’s assets. As of December
31, 2019, the outstanding principal balance due Crossover
was $205,228. The Company also issued 33,333 shares of common stock
to Crossover as a commitment fee that was valued at fair market
value at $25,000 or $0.75 per share and expensed as interest
expense during the year ended December 31, 2019.
On
January 14, 2020, the Note increased by $25,700. On August 31,
2020, Crossover converted debt and accrued interest of $95,000 into
500,000 shares of common stock at $0.19 per share. As of September
30, 2020, $66,412 was recorded for late and default fees. As
of September 30, 2020, the
outstanding principal balance due to Crossover was $87,526 and
accrued interest was $10,251, which results in a total amount of
$97,777. The Company recognized no loss on debt conversions during
the nine months ended September 30, 2020.
The Company’s obligation to pay the Debt, or any portion
thereof, is secured by all of the Company’s
assets.
12% Convertible Promissory Notes
The
Company entered into Convertible Promissory Notes with PowerUp
Lending Group Ltd on November 18, 2019 for $140,800 to fund
short-term working capital. The Notes accrues interest at a rate of
12% per annum and became due in one year and are convertible into
common stock at 75% of market value after six
months. The Company received cash of $125,000, and
recorded interest expense of $2,037, a transaction expense amount
of $3,000 and amortization of debt discount of $15,191. The Company
recorded as interest expense in 2019 the value of the beneficial
conversion feature of $46,933 related to the potential conversion
at a discount after six months. During the nine months ended
September 30, 2020, the Company recorded interest expense of $5,643
and amortization of debt discount of $10,409. During the nine
months ended September 30, 2020, the Company issued 1,004,625
shares of the Company’s common stock at $0.148 related to
conversion of principal and interest under the $140,800 Promissory
Note.
15
The
Company entered into Convertible Promissory Notes with PowerUp
Lending Group Ltd on December 9, 2019 for $140,800 to fund
short-term working capital. The Notes accrues interest at a rate of
12% per annum and became due in one year and are convertible into
common stock at 75% of market value after six
months. The Company received cash of $125,000, and
recorded interest expense of $1,018, a transaction expense amount
of $3,000 and amortization of debt discount of $14,418. The Company
recorded as interest expense in 2019 the value of the beneficial
conversion feature of $46,933 related to the potential conversion
at a discount after six months. During the nine months ended
September 30, 2020, the Company recorded interest expense of
$22,001 and amortization of debt discount of $11,182. During the
nine months ended September 30, 2020, the Company repaid $85,000
and issued 628,659 shares of the Company’s common stock at
$0.125 related to conversion of principal and interest under the
remaining $78,819 Promissory Note.
The
Company entered into Convertible Promissory Note with PowerUp
Lending Group Ltd on January 14, 2020 for $58,300 to fund
short-term working capital. The Notes accrues interest at a rate of
12% per annum and became due in one year and are convertible into
common stock at 75% of market value after six
months. The Company received cash of $50,000, and
recorded interest expense of $1,495, a transaction expense amount
of $3,000 and beneficial conversion feature of $19,433 related to
the potential conversion at a discount after six months. During the
nine months ended September 30, 2020, the Company recorded interest
expense of $3,180 and amortization of debt discount of $5,300.
During the nine months ended September 30, 2020, the Company issued
510,271 shares of the Company’s common stock at $0.12 related
to conversion of principal and interest under the remaining $61,480
Promissory Note.
The
Company entered into Convertible Promissory Notes with PowerUp
Lending Group Ltd on June 1, 2020 for $140,800 to fund short-term
working capital. The Notes accrues interest at a rate of 12% per
annum and became due in one year and are convertible into common
stock at 75% of market value after six
months. The Company received cash of $125,000, and
recorded interest expense of $1,389, a transaction expense amount
of $3,000 and amortization of debt discount of $14,910. The Company
recorded as interest expense in 2020 the value of the beneficial
conversion feature of $46,933 related to the potential conversion
at a discount after six months. During the nine months ended
September 30, 2020, the Company recorded interest expense of $5,647
and amortization of debt discount of $8,540.
The
Company entered into Convertible Promissory Notes with PowerUp
Lending Group Ltd on July 13, 2020 for $80,300 to fund short-term
working capital. The Notes accrues interest at a rate of 12% per
annum and became due in one year and are convertible into common
stock at 75% of market value after six
months. The Company received cash of $70,000, and
recorded interest expense of $2,112, a transaction expense amount
of $3,000 and an original interest discount of 7,300. The Company
recorded amortization of debt discount of $3,209. The Company
recorded as interest expense in 2020 the value of the beneficial
conversion feature of $26,767 related to the potential conversion
at a discount after six months.
During
the nine months ended September 30, 2020, PowerUp Lending Group Ltd
converted principal and accrued interest of $288,779 into 2,143,555
shares of our common stock at a per share conversion price of
$0.135 with a fair value of $410,029. The Company recognized
$107,746 loss on debt conversions during the nine months ended
September 30, 2020.
Notes Payable
Notes
payable as of September 30,
2020 consisted of the following:
|
Principal
|
Accrued
Interest
|
Debt
Discount
|
Balance
As
of
September
30,
2020
|
Notes
Payable-
|
|
|
|
|
1% Note Payble
under Paycheck Protection Program
|
$565,829
|
$2,529
|
$-
|
$568,358
|
3.75% Economic
Injury Disaster Loan
|
299,800
|
3,204
|
-
|
303,004
|
12% Self-Amortizing
Promissory Note
|
750,000
|
7,644
|
(392,914)
|
364,730
|
Parties related to
shareholders of EZ-CLONE Enterprises, Inc.
|
104,144
|
-
|
-
|
104,144
|
Total Notes
Payable
|
1,719,773
|
13,377
|
(392,914)
|
1,340,236
|
Less Long Term
Notes Payable
|
(401,883)
|
3,204
|
-
|
(398,679)
|
Short Term Notes
Payable
|
$1,317,890
|
$16,581
|
$(392,914)
|
$941,557
|
16
Notes
payable as of December 31, 2019
consisted of the following:
|
Principal
|
Accrued
Interest
|
Debt
Discount
|
Balance
As
of
December
31,
2020
|
Notes Payable
-
|
|
|
|
|
Parties related to
shareholders of EZ-CLONE Enterprises, Inc.
|
$104,144
|
$-
|
$-
|
$104,144
|
On April 17, 2020, the Company received $362,500 under the
Paycheck Protection Program of the U.S. Small Business
Administration’s (SBA) 7(a) Loan Program pursuant to the
Coronavirus, Aid, Relief and Economic Security Act (CARES
Act), Pub. Law 116-136, 134 Stat. 281 (2020). During the nine
months ended September 30, 2020, the Company recorded interest
expense of $1,688 at 1%. The Company is utilizing the funds in
accordance with the legal requirements and expects this loan to be
forgiven during 2020.
On May 7, 2020, EZ-CLONE received $203,329 under the
Paycheck Protection Program of the U.S. Small Business
Administration’s 7(a) Loan Program pursuant to the
Coronavirus, Aid, Relief and Economic Security Act (CARES
Act), Pub. Law 116-136, 134 Stat. 281 (2020). During the nine
months ended September 30, 2020, the Company recorded interest
expense of $841 at 1%. The Company is utilizing the funds in
accordance with the legal requirements and expects this loan to be
forgiven during 2020.
On June
19, 2020, the Company received $299,800 under the Economic Injury
Disaster Loan Program of the U.S. Small Business
Administration’s 7(a) Loan Program pursuant to the
Coronavirus, Aid, Relief and Economic Security Act (CARES Act),
Pub. Law 116-136, 134 Stat. 281 (2020). Repayment terms on the
loans are over a 30-year term at 3.75%. In addition, the loan
contains a 12-month payment deferral beginning on the loan date.
There is no prepayment penalty on an EIDL loan. During the nine
months ended September 30, 2020, the Company recorded interest
expense of $3,204. These loans were long term as of September 30,
2020.
12% Self-Amortization Promissory Note with Labrys Fund, L.P, a
Delaware limited partnership (“Labrys”)
On
August 31, 2020, we executed the following agreements with Labrys:
(i) Securities Purchase Agreement; and (ii) Self-Amortization
Promissory Note (“Note”); (collectively the
“Labrys Agreements”). The Company entered into the
Labrys Agreements with the intent to acquire working capital to
grow the Company’s businesses and complete the EZ-CLONE
Enterprises, Inc. acquisition.
The
total amount of funding under the Labrys Agreements is $632,750.
The Notes carry an original issue discount of $75,000, a
transaction expense amount of $8,500, and a fee to J. H. Darbie
& Co. of $33,750, for total debt of $750,000
(“Debt”). The Note has an amortization schedule of
$250,000 on November 30, 2020 and $51,042 at each month end from
December 2020 through November 30, 2021. The Company issued
commitment shares of 1,662,000 shares related to the Labrys
Agreements at $0.21 or $349,020. We agreed to reserve 5,043,859
shares of its common stock for issuance if any Debt is converted.
The Debt is due on or before November 30, 2021. The Debt carries an
interest rate of twelve percent (12%). In the case of default, the
debt is convertible into the Company’s common stock at the
closing price the day before the conversion, subject to adjustment
as provided for in the Note.
As
of September 30, 2020, the
outstanding principal balance due Labrys was $750,000, accrued
interest was $7,644 and the unamortized debt discount of $392,914,
which results in a total amount of $364,730. During the nine months
ended September 30, 2020, the Company recorded interest expense of
$7,644 and amortization of debt discount of $74,250.
EZ-CLONE
has $104,144 due to relatives of the two selling shareholders as of
September 30, 2020 and December 31, 2019,
respectively.
17
NOTE 12 – DERIVATIVE LIABILITY
The
Convertible Notes payable include a conversion feature that
pursuant ASC 815 “Derivatives and Hedging”, has been
identified as an embedded derivative financial instrument and which
the Company accounts for under the fair value method of accounting.
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 debt is convertible at the lesser of 65% of
the fair value of the Company’s common stock or $1.35
requiring the conversion feature to be bifurcated from the host
debt contract and accounting for separately as a derivative,
resulting in periodic revaluations. The notes underlying the
derivatives are short term in nature and generally converted to
stock in less than one year. The derivative is valued at period end
with the key inputs being current stock price and the conversion
feature.
There
was a derivative liability of $1,329,088 and $1,300,915 as of
September 30, 2020 and December 31, 2019, respectively. For the nine months ended September 30,
2020 and 2019, the Company recorded non-cash expense $28,173 and
non-cash income of $361,179 related to the “change in fair
value of derivative” expense related to the Chicago Venture
and Iliad financing. These were the only changes in level 3 fair
value instruments during such periods.
Derivative
liability as of September 30,
2020 was as follows:
|
|
|
|
Carrying
|
|
Fair Value Measurements Using Inputs
|
Amount at
September 30,
|
||
Financial Instruments
|
Level 1
|
Level 2
|
Level 3
|
2020
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Derivative
Instruments
|
$-
|
$-
|
$1,329,088
|
$1,329,088
|
|
|
|
|
|
Total
|
$-
|
$-
|
$1,329,088
|
$1,329,088
|
Derivative
liability as of December 31,
2019 was as follows:
|
|
|
|
Carrying
|
|
Fair
Value Measurements Using Inputs
|
Amount
at
December
31,
|
||
Financial
Instruments
|
Level
1
|
Level
2
|
Level
3
|
2019
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Derivative
Instruments
|
$-
|
$-
|
$1,300,915
|
$1,300,915
|
|
|
|
|
|
Total
|
$-
|
$-
|
$1,300,915
|
$1,300,915
|
NOTE 13 – RELATED PARTY
TRANSACTIONS AND CERTAIN RELATIONSHIPS
Since
January 1, 2019, the Company engaged in the following reportable
transactions with our 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.
18
Certain Relationships
Please
see the transactions with Chicago Venture Partners, L.P. discussed
in Notes 11 and 12.
Related Party Transactions
Transactions with Katherine McLain
On
February 22, 2019, the Company issued 54,054 shares of the
Company’s common stock to Katherine McLain valued at $1.11
per share or $60,000. This issuance was an annual award for
independent director services. On April 16, 2020, the Company
issued 20,000 shares of the Company’s common stock to
Katherine McLain valued at $0.295 per share or $5,900. This
issuance was an annual award for independent director
services.
Transaction with Thom Kozik
On
February 22, 2019, the Company issued 54,054 shares of the
Company’s common stock to Mr. Kozik valued at $1.11 per share
or $60,000. On April 16, 2020, the Company issued 20,000 shares of
the Company’s common stock to Thom Kozik valued at $0.295 per
share or $5,900. This issuance was an annual award for independent
director services.
Notes Payable to Related Parties
EZ-CLONE
has $104,144 due to relatives of the two selling shareholders as of
September 30, 2020 and December 31, 2019,
respectively.
NOTE 14 – EQUITY
Authorized Capital Stock
On
October 9, 2019, the Company approved the reduction of authorized
capital stock, whereby the total number of the Company’s
authorized common stock decreased from 6,000,000,000 by a ratio of
1 for 50, to 120,000,000 shares. On
November 20, 2019, the Company filed a Certificate of Amendment of
Certificate of Incorporation with the Secretary of State of the
State of Delaware. As a result of the reduction, we have an
aggregate 130,000,000 authorized shares consisting of: (i)
120,000,000 shares of common stock, par value $0.0001 per share,
and (ii) 10,000,000 shares of preferred stock, par value $0.0001
per share.
The reverse stock split of 1 for 150 was effective at the open of
business on November 27, 2019 whereupon the shares of the
Company’s common stock began trading on a split-adjusted
basis. Our CUSIP number will change to 39985X203.
Non-Voting Preferred Stock
Under
the terms of our articles of incorporation, our board of directors
is authorized to issue shares of non-voting preferred stock in one
or more series without stockholder approval. Our 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 our board of directors to issue non-voting
preferred stock and determine our 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. There are no shares of non-voting
preferred stock presently outstanding and we have no present plans
to issue any shares of preferred stock.
19
Capital Stock Issued and Outstanding
As
of September 30, 2020, the Company had issued and outstanding
securities of 38,905,790 shares of common stock.
Voting Common Stock
Holders
of the Company’s common stock are entitled to one vote for
each share held on all matters submitted to a vote of stockholders
and do not have cumulative voting rights. An election of directors
by our stockholders shall be determined by a plurality of the votes
cast by the stockholders entitled to vote on the election. On all
other matters, the affirmative vote of the holders of a majority of
the stock present in person or represented by proxy and entitled to
vote is required for approval, unless otherwise provided in our
articles of incorporation, bylaws or applicable law. Holders of
common stock are entitled to receive proportionately any dividends
as may be declared by our board of directors, subject to any
preferential dividend rights of outstanding preferred
stock.
In the
event of our liquidation or dissolution, the holders of common
stock are entitled to receive proportionately all assets available
for distribution to stockholders after the payment of all debts and
other liabilities and subject to the prior rights of any
outstanding preferred stock. Holders of common stock have no
preemptive, subscription, redemption or conversion rights. The
rights, preferences and privileges of holders of common stock are
subject to and may be adversely affected by the rights of the
holders of shares of any series of preferred stock that we may
designate and issue in the future.
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.
During the nine months ended September 30, 2020, the Company had
the following issuances of unregistered equity securities to
accredited investors unless otherwise indicated:
Debt
and accrued interest of $1,092,879 was converted into 8,526,474
shares of our common stock at an average per share conversion price
of $0.128.
The
Company issued 15 shares related to a previous reverse stock
split.
The
Company issued 154 shares of common stock related to the exercise
of warrants for $485, or $3.151 per share.
On
April 16, 2020, the Company issued 20,000 shares of the
Company’s common stock each to Katherine McLain and Thom
Kozik, directors valued at $0.295 per share or $5,900. This
issuance was an annual award for independent director
services.
On
August 31, 2020, the Company issued commitment shares of 1,662,000
shares related to the Labrys Agreements at $0.21 or
$349,020.
20
Warrants
The
Company no warrant activity during the nine months ended September
30, 2020.
A
summary of the warrants issued as of September 30, 2020 is as
follows:
|
September 30, 2020
|
|
|
|
Weighted
|
|
|
Average
|
|
|
Exercise
|
|
Shares
|
Price
|
Outstanding
at January 1, 2020
|
2,418,834
|
$3.465
|
Issued
|
-
|
$-
|
Exercised
|
(154)
|
$(3.151)
|
Forfeited
|
-
|
$-
|
Expired
|
-
|
$-
|
Outstanding
at September 30, 2020
|
2,418,680
|
$3.465
|
Exerciseable
at September 30, 2020
|
2,312,168
|
$-
|
A
summary of the status of the warrants outstanding as of September
30, 2020 is presented below:
|
September 30, 2020
|
|||
|
Weighted
|
Weighted
|
|
Weighted
|
|
Average
|
Average
|
|
Average
|
Number of
|
Remaining
|
Exercise
|
Shares
|
Exercise
|
Warrants
|
Life
|
Price
|
Exerciseable
|
Price
|
366,667
|
5.91
|
$1.500
|
366,667
|
$1.500
|
320,000
|
4.10
|
1.800
|
213,333
|
1.800
|
1,407,428
|
1.08
|
3.150
|
1,407,582
|
3.150
|
324,586
|
2.25
|
7.500
|
324,586
|
7.500
|
-
|
-
|
-
|
-
|
-
|
2,418,680
|
2.00
|
$3.465
|
2,312,168
|
$3.374
|
Warrants
had no intrinsic value as of September 30, 2020.
The
warrants were valued using the following assumptions:
Dividend yield
|
0%
|
Expected life
|
1-5 Years
|
Expected volatility
|
70-200%
|
Risk free interest rate
|
0.78-2.6%
|
21
NOTE 15– STOCK OPTIONS
Description of Stock Option Plan
The
Company has 1,333,333 shares available for issuance under the First
Amended and Restated 2017 Stock Incentive Plan. The Company has
outstanding unexercised stock option grants totaling 506,667 shares
at an average exercise price of $1.496 per share as of September
30, 2020. The Company filed registration statements on Form S-8 to
register 1,333,333 shares of our common stock related to the 2017
Stock Incentive Plan and First Amended and Restated 2017 Stock
Incentive Plan.
Determining Fair Value under ASC 718
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
The Company had the following stock option transactions during the
nine months ended September 30, 2020:
During the nine months ended September 30, 2020, executives and
employees forfeited stock option grants for 43,333 shares
with an exercise price of
$1.431 per share.
There are currently 506,667 options to purchase common stock at an average
exercise price of $1.496 per
share outstanding as of September 30, 2020 under 2017 Stock Incentive Plan and First
Amended and Restated 2017 Stock Incentive Plan. The Company recorded $39,587 and $48,693 of
compensation expense, net of related tax effects, relative to stock
options for the nine months ended September 30, 2020 and 2019 and
in accordance with ASC 718. As of September 30,
2020, there is approximately
$29,051, net of forfeitures, 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 2.98 years.
Stock option activity for the nine months ended September 30, 2020
and the year ended December 31, 2019 were as follows:
|
Options
|
Weighted Average
|
Option
|
|
Shares
|
Exercise Price
|
$
|
Outstanding
as of January 1, 2019
|
666,667
|
$1.410
|
$940,000
|
Granted
|
23,333
|
1.457
|
34,000
|
Exercised
|
(26,111)
|
(0.900)
|
(23,500)
|
Forfeitures
|
(113,889)
|
(1.146)
|
(130,500)
|
Outstanding
as of December 31, 2019
|
550,000
|
1.491
|
820,000
|
Granted
|
-
|
-
|
-
|
Exercised
|
-
|
-
|
-
|
Forfeitures
|
(43,333)
|
(1.431)
|
(62,000)
|
Outstanding
as of September 30, 2020
|
506,667
|
$1.496
|
$758,000
|
22
The following table summarizes information about stock options
outstanding and exercisable at September 30,
2020:
|
|
Weighted
|
|
|
Weighted
|
|
|
Average
|
Weighted
|
|
Average
|
Range of
|
Number
|
Remaining Life
|
Average
|
Number
|
Exercise Price
|
Exercise Prices
|
Outstanding
|
In Years
|
Exercise Price
|
Exerciseable
|
Exerciseable
|
$0.90
|
80,000
|
2.50
|
$0.90
|
80,000
|
$0.90
|
1.05
|
66,667
|
2.50
|
1.05
|
66,667
|
1.05
|
1.50
|
106,665
|
2.41
|
1.50
|
106,666
|
1.50
|
1.80
|
253,335
|
3.50
|
1.80
|
147,778
|
1.80
|
|
506,667
|
2.98
|
$1.496
|
401,111
|
$1.42
|
Stock
option grants totaling 506,667 shares of common stock had no
intrinsic value as of September 30, 2020.
The
stock option grants were valued using the following
assumptions:
Dividend yield
|
0%
|
Expected life
|
1-5 Years
|
Expected volatility
|
70-200%
|
Risk free interest rate
|
0.78-2.6%
|
16. SEGMENT REPORTING
The
management of the Company considers the business to have two
operating segments (i) the distribution of GrowLife
products and (ii)
EZ-CLONE, a manufacturer of cloning
products. EZ-CLONE has provided the majority of the Company’s
gross margins during 2019 and 2020. The financial results from
GrowLife products has been diminishing with the Company’s
focus on EZ-CLONE.
The
reporting for the three and nine months ended September 30, 2020
and 2019 was as follows (in thousands):
|
|
|
Segment
|
|
|
|
Gross
|
Operating
|
Segment
|
Segment
|
Revenue
|
Margin
|
Profit (Loss)
|
Assets
|
Three
Months Ended September 30, 2020
|
|
|
|
|
GrowLife
distribution products
|
$211
|
$35
|
$(680)
|
$416
|
EZ-CLONE
cloning manufacturing (1)
|
1,205
|
462
|
(72)
|
3,881
|
Total
segments
|
$1,416
|
$497
|
$(752)
|
$4,297
|
|
|
|
|
|
Three
Months Ended September 30, 2019
|
|
|
|
|
GrowLife
distribution products
|
$1,156
|
$170
|
$(1,504)
|
$992
|
EZ-CLONE
cloning manufacturing (1)
|
1,143
|
576
|
(116)
|
3,664
|
Total
segments
|
$2,299
|
$746
|
$(1,620)
|
$4,656
|
|
|
|
Segment
|
|
|
|
Gross
|
Operating
|
Segment
|
Segment
|
Revenue
|
Margin
|
Profit (Loss)
|
Assets
|
Nine
Months Ended September 30, 2020
|
|
|
|
|
GrowLife
distribution products
|
$1,540
|
$293
|
$(1,944)
|
$416
|
EZ-CLONE
cloning manufacturing (2)
|
3,388
|
1,585
|
81
|
3,881
|
Total
segments
|
$4,928
|
$1,878
|
$(1,863)
|
$4,297
|
|
|
|
|
|
Nine
Months Ended September 30, 2019
|
|
|
|
|
GrowLife
distribution products
|
$3,745
|
$728
|
$(3,829)
|
$992
|
EZ-CLONE
cloning manufacturing (2)
|
2,999
|
1,465
|
(527)
|
3,664
|
Total
segments
|
$6,744
|
$2,193
|
$(4,356)
|
$4,656
|
(1)
Includes $75,000
per quarter for EZ-CLONE expenses recorded at GrowLife for 2020.
This also includes all acquisition balances discussed in Note
4.
(2)
Includes $75,000
per quarter for EZ-CLONE expenses recorded at GrowLife for 2020.
This also includes all acquisition balances discussed in Note
4.
23
NOTE 17 – 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.
As of
September 30, 2019, the Company closed retail stores in Portland,
Maine, Encino, California and Calgary, Canada. The Company has
recorded restructuring reserves related to the store closures. The
Company cannot determine the outcome of these
proceedings.
On October 15, 2018, the Company closed the Purchase and Sale
Agreement with EZ-CLONE Enterprises, Inc., a California corporation
(the “Agreement”). On November 5, 2019, the
Company amended the Agreement with one 24.5% shareholder of
EZ-CLONE Enterprises, Inc. (“EZ-CLONE”), to extend the
date to purchase the remaining 49% of stock of EZ-CLONE in exchange
for a 20% extension fee (a total of $171,000 for the 49% or $85,500
for each 24.5% shareholder) of the $855,000 cash payable at the
earlier of the closing of $2,000,000 in funding or nine months
(July 2020). The Company did not close the purchase of the
remaining 49% of stock of EZ-CLONE by the extended
deadline.
On September 15, 2020, the Company received notice that William
Blackburn and Brad Mickelsen (“Plaintiffs”), minority
shareholders of EZ-CLONE Enterprises, Inc., a majority owned
subsidiary of the Company, filed a complaint against the Company
and its officers Marco Hegyi and Mark Scott
(“Officers”), in the Superior Court of California,
County of Sacramento (“Complaint”) for claims related
to breach under the Purchase and Sale Agreement dated October 15,
2018 between the Company and Plaintiffs. On September 15,
2020, the Company filed a notice of removal with the California
Superior Court, County of Sacramento and the United States District
Court for the Eastern District of California. The case was
removed to Federal District Court for the Eastern District of
California and Plaintiffs filed an Ex Parte Application for TRO and
an Order for Preliminary Injunction with the Federal Court.
The TRO was granted on September 16, 2020 and a preliminary
injunction hearing was scheduled for September 29, 2020.
After reviewing all pleadings and oral arguments at the hearing,
the Court issued a ruling granting Plaintiffs’ request for a
preliminary injunction. Subsequent to September 29, 2020, the
parties are providing legal briefs to the Federal court to
determine if rescission should be granted.
The Complaint also alleges that the Company and its Officers made
certain false representations and other claims to consummate the
Transaction and as a result has failed to complete the second
closing as required under Purchase and Sale Agreement. The
Plaintiffs are seeking rescission of the Purchase and Sale
Agreement, unspecified damages in excess of ten thousand dollars,
and other equitable relief. The Company cannot determine the
outcome of these proceedings.
As of
September 30, 2020, the Company has recorded a liability of
$2,131,000 for acquisition payable of which a $1,105,000 is payable
in stock and $1,026,000 is payable in cash.
Operating Leases
The Company is obligated under the following leases for its various
facilities.
On May
31, 2020, the Company rented space at 5400 Carillon Point, Kirkland, Washington 98033
for $623 per month for the Company’s corporate office
and use of space in the Regus network, including California. The
Company’s agreement expires May 31, 2021.
On December 14, 2018, GrowLife, Inc. entered into a lease agreement
with Pensco Trust Company for a 28,000 square feet industrial space
at 10170 Croydon Way, Sacramento, California 95827 used for the
assembly and sales of plastic parts by EZ-CLONE. The monthly lease
payment is $17,500 and increases approximately 3% per year. The
lease expires on December 31, 2023.
24
NOTE 18 – SUBSEQUENT EVENTS
The Company evaluates subsequent events, for the purpose of
adjustment or disclosure, up through the date the financial
statements are available.
There were the following material events subsequent to
September 30, 2020:
Purchase and Sale
Agreement with EZ-CLONE Enterprises,
Inc.
On October 15, 2018, the Company closed the Purchase and Sale
Agreement with EZ-CLONE Enterprises, Inc., a California corporation
(the “Agreement”). On November 5, 2019, we
amended the Agreement with one 24.5% shareholder of EZ-CLONE
Enterprises, Inc. (“EZ-CLONE”), to extend the date to
purchase the remaining 49% of stock of EZ-CLONE in exchange for a
20% extension fee (a total of $171,000 for the 49% or $85,500 for
each 24.5% shareholder) of the $855,000 cash payable at the earlier
of the closing of $2,000,000 in funding or nine months (July 2020).
The Company did not close the purchase of the remaining 49% of
stock of EZ-CLONE by the extended deadline and is in discussions
with the 24.5% shareholder.
On September 15, 2020, GrowLife, Inc. (the “Company”)
received notice that William Blackburn and Brad Mickelsen, minority
shareholders of EZ-CLONE Enterprises, Inc.
(“Plaintiffs”), a majority owned subsidiary of the
Company, filed a complaint against the Company and its officers
Marco Hegyi and Mark Scott (“Officers”), in the
Superior Court of California, County of Sacramento
(“Complaint”) for claims related to breach under the
Purchase and Sale Agreement dated October 15, 2018 between the
Company and Plaintiffs. On September 15, 2020, the Company
filed a notice of removal with the California Superior Court,
County of Sacramento and the United States District Court for the
Eastern District of California. The case was removed to
Federal District Court for the Eastern District of California and
Plaintiffs filed an Ex Parte Application for TRO and an Order for
Preliminary Injunction with the Federal Court. The TRO was
granted on September 16, 2020 and a preliminary injunction hearing
was scheduled for September 29, 2020. After reviewing all
pleadings and oral arguments at the hearing, the Court issued a
ruling granting Plaintiffs’ request for a preliminary
injunction. Subsequent to September 29, 2020, the parties are
providing legal briefs to the Federal court to determine if
rescission should be granted.
The Complaint also alleges that the Company and its Officers made
certain false representations and other claims to consummate the
Transaction and as a result has failed to complete the second
closing as required under Purchase and Sale Agreement. The
Plaintiffs are seeking rescission of the Purchase and Sale
Agreement, unspecified damages in excess of ten thousand dollars,
and other equitable relief.
Securities Purchase Agreement and Self-Amortization Promissory Note
with EMA Financial LLC, a Delaware limited liability company
(“EMA”)
On
October 2, 2020, the Company executed the following agreements with
EMA: (i) Securities Purchase Agreement; and (ii) Self-Amortization
Promissory Note (“Note”); (collectively the “EMA
Agreements”). The Company entered into the EMA Agreements
with the intent to acquire working capital to grow the
Company’s businesses and complete the EZ-CLONE Enterprises,
Inc. acquisition.
The
total amount of funding under the EMA Agreements is $183,455. The
Notes carry an original issue discount of $21,100, a transaction
expense amount of $6,500, and a fee to J. H. Darbie & Co. of
$21,150, for total debt of $221,000 (“Debt”). The Note
has an amortization schedule of $19,550 on January 2, 2021 and
monthly from February 2021 through January 2022. The Company issued
commitment shares of 550,000 shares related to the EMA Agreements.
The Company agreed to reserve 1,486,258 shares of its common stock
for issuance if any Debt is converted. The Debt is due on or before
January 2, 2022. The Debt carries an interest rate of twelve
percent (12%). In the case of default, the debt is convertible into
the Company’s common stock at the closing price the day
before the conversion, subject to adjustment as provided for in the
Note.
Securities Purchase Agreement and Self-Amortization Promissory Note
with FirstFire Global Opportunities Fund, LLC, a Delaware limited
liability company (“FF”)
On
October 2, 2020, the Company executed the following agreements with
FF: (i) Securities Purchase Agreement; and (ii) Self-Amortization
Promissory Note (“Note”); (collectively the “FF
Agreements”). The Company entered into the FF Agreements with
the intent to acquire reduce debt.
The
total amount of funding under the FF Agreements is $130,000. The
Notes carry an original issue discount of $14,952, a transaction
expense amount of $4,600, and a fee to J. H. Darbie & Co. of
$7,050, for total debt of $156,602 (“Debt”). The Note
has an amortization schedule of $13,853 on January 11, 2021 and
monthly from February 2021 through January 2022. The Company issued
commitment shares of 450,000 shares related to the FF Agreements.
The Company agreed to reserve 1,486,258 shares of its common stock
for issuance if any Debt is converted. The Debt is due on or before
January 12, 2022. The Debt carries an interest rate of twelve
percent (12%). In the case of default, the debt is convertible into
the Company’s common stock at the closing price the day
before the conversion, subject to adjustment as provided for in the
Note.
Debt Conversion
Silverback
Capital Corporation converted principal and accrued interest of
$358,332 into 4,500,000 shares of the Company’s common stock
at a per share conversion price of $0.080.
25
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.
FINANCIAL PERFORMANCE
GrowLife operates and provides essential business services and
products on a state-by-state basis, as determined by state laws
amid the COVID-19 pandemic. We had prepared for the planting season
for many hemp farmers across the country in the first half of 2020.
It was imperative for GrowLife to support these farmers by keeping
EZ-CLONE and all GrowLife products available to them. Starting
March 2020, we experienced growing sales for EZ-CLONE systems so
much so that production could not keep up due to Covid-19 pandemic
supplier delays and low shipments out of EZ-CLONE Enterprises. In
the end, we completed the quarter ended September 30, 2020 with a
record sales order backlog of $1.9 million for shipments in the
fourth quarter.
The
almost $2 million in sales not shipped in Q3 lowered our reported
year over year revenue to $1.4 million as compared to $2.3 million
for three months ended September 30, 2019. Yet, our gross profits,
or revenue after our cost of sales, was reported at $0.5 million
for three months ended September 30, 2020 as compared to last
year’s $0.7 million. GrowLife blended gross margins of 38.1%
for the nine months September 30, 2020 were up from 32.5% during
the three months ended September 30, 2019.
In a
scenario where we would have been able to ship what was sold,
approximately $3.3 million would have been reported. However, that
is not the case. Nor was the scenario of $1.2 million in gross
margin at 36% realized, which may have brought us to profitability.
Both of these scenarios were obtained on the sales side of GrowLife
but not realized due to what we would attribute to ‘growing
pains’, or our ability to scale-up EZ-CLONE production fast
enough to satisfy the demand. As many people say, “it’s
the problem we all want to have.”
Our
cost controls are due to cost reductions implemented during the
year ended December 31, 2019. We reduced operating expenses by $2.8
million during the nine months ended September 30, 2020 and reduced
cash used in operations by $0.5 million from $2.0 million to $1.5
million. This enabled us to focus on the EZ-CLONE growth, which is
proving out, making profitability attainable from this base
business, and preparing us for our Hemp CBD expansion.
BRIDGING THE BASE AND EZ-CLONE WITH EXPANSION BUSINESS
GrowLife
consists of a base business where it sells customers all growing
equipment necessary to cultivate indoor and outdoor. We continue to
deliver products as we have done so since 2012. The Company also
produces the EZ-CLONE systems through our majority owned subsidiary
EZ-CLONE ENTERPRISES. This Sacramento team assembles and ships the
EZ-CLONE products to our customers. As a result, this base business
combined with the EZ-CLONE sales represents over $3 million for Q3,
including the backlog.
Our
intention for expansion remains on the Hemp CBD business with plant
starters (for example, seeds, clones and seedlings) where we have
licensed multi-year exclusive genetics for assuring high-yielding,
consistently preforming hemp plants that resist extreme heat/cold
and most importantly, not going ‘hot’, i.e. not
violating the THC threshold. Our confidence level for this
expansion business remains high because the demand for CBD and
other cannabinoids derived from hemp are strong. GrowLife is
already working on its 2021 systems, offerings and
partnerships.
EXPANSION BEYOND HEMP CBD
Earlier this month it was stated: “The House will vote on the
MORE Act to decriminalize cannabis,” according to House
Majority Leader Steny Hoyer. More than a third of Americans now
live in states with full legalization, and a record 68 percent
support federal cannabis legalization, according to Gallup. The
movement with a new Administration is signaling legalization,
again. While the promise is not new, what is new is how GrowLife is
positioned to capitalize on such a change.
While such legislation would take time to implement,
GrowLife’s base business in supplies and EZ-CLONE expect to
benefit with such a change. However, the more exciting opportunity
is that our new venture in starters with genetics in seeds and
clones and partners has anticipated this possibility. We are
prepared to expand with licensed partners into Cannabis along with
Hemp CBD so long as the Federal laws support our ability to do
so.
26
MOVING FORWARD
We
believe that through our strategic investment in EZ-CLONE, we have
positioned ourselves well to capitalize on this expanding market
opportunity. Where EZ-CLONE was able to create a quality product
with steady growth, GrowLife has propelled it into an international
brand being utilized by some of the largest grow operations in the
world. We intend to continue to grow its production capabilities to
meet demand.
Through
a network of knowledgeable representatives, GrowLife continues to
provide essential and hard-to-find goods including media,
industry-leading hydroponics equipment, organic plant nutrients,
and thousands more products to specialty grow operations across the
United States.
Genetics
are the key to successfully serving farmers, both outdoor and
indoor, with starters for CBx and beyond. We intend to secure and
test the best genetics for the long run. To do so we will work with
university researchers and obtain rights to high-value
derivatives.
Please
follow our shareholder updates as we seek to increase our
manufacturing capacity, hiring additional sales and support staff
and actualize on our vision of being the leading source of plant
starter genetics and equipment for the hemp and cannabis market and
meet the demand as it continues to rise.
Employees
As of
September 30, 2020, we had
twenty-two full-time and part-time employees. Marco Hegyi, our
Chief Executive Officer, is based in Kirkland, Washington. Mark E.
Scott, our Chief Financial Officer, is based primarily in Seattle,
Washington. We have approximately 9 full and part time employees
located throughout the United States who operate our businesses. We
employ 11 full-time and part-time employees at EZ-CLONE in
Sacramento, CA. None of our employees are 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 and manufacturers. All the products
purchased and resold are applicable to indoor growing for organics,
greens, and plant-based medicines.
Competition
Covering
two countries across all cultivator segments creates competitors
that also serve as partners. 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 Hawthorne 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 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.growlifeinc.com,
and www.greners.com.We
have a policy of entering into confidentiality and non-disclosure
agreements with our employees, some of our vendors and customers as
necessary.
27
Acquisition of EZ-CLONE
On October 15, 2018, we closed the Purchase and Sale Agreement with
EZ-CLONE Enterprises, Inc., a California corporation (the
“Agreement”). On November 5, 2019, we amended the
Agreement with one 24.5% shareholder of EZ-CLONE Enterprises, Inc.
(“EZ-CLONE”), to extend the date to purchase the
remaining 49% of stock of EZ-CLONE in exchange for a 20% extension
fee (a total of $171,000 for the 49% or $85,500 for each 24.5%
shareholder) of the $855,000 cash payable at the earlier of the
closing of $2,000,000 in funding or nine months (July 2020). The
Company did not close the purchase of the remaining 49% of stock of
EZ-CLONE by the extended deadline.
On September 15, 2020, GrowLife, Inc. (the “Company”)
received notice that William Blackburn and Brad Mickelsen
(“Plaintiffs”), minority shareholders of EZ-CLONE
Enterprises, Inc., a majority owned subsidiary of the Company,
filed a complaint against the Company and its officers Marco Hegyi
and Mark Scott (“Officers”), in the Superior Court of
California, County of Sacramento (“Complaint”) for
claims related to breach under the Purchase and Sale Agreement
dated October 15, 2018 between the Company and Plaintiffs. The
Complaint also alleges that the Company and its Officers made
certain false representations and other claims to consummate the
Transaction and as a result has failed to complete the second
closing as required under Purchase and Sale Agreement. The
Plaintiffs are seeking rescission of the Purchase and Sale
Agreement, unspecified damages in excess of ten thousand dollars,
and other equitable relief.
On
September 15, 2020, the Company filed a notice of removal with the
California Superior Court, County of Sacramento and the United
States District Court for the Eastern District of California.
The case was removed to Federal District Court for the Eastern
District of California and Plaintiffs filed an Ex Parte Application
for TRO and an Order for Preliminary Injunction with the Federal
Court. The TRO was granted on September 16, 2020 and a
preliminary injunction hearing was scheduled for September 29,
2020. After reviewing all pleadings and oral arguments at the
hearing, the Court issued a ruling granting Plaintiffs’
request for a preliminary injunction. Presently the parties
are providing legal briefs to the Federal court to determine if
rescission should be granted.
As of
September 30, 2020, the Company has recorded a liability of
$2,131,000 for acquisition payable of which a $1,105,000 is payable
in stock and $1,026,000 is payable in cash.
Government Regulation
Currently,
there are thirty five 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 fifteen
states and the District of Columbia that allow recreational use of
cannabis. As of September 30, 2020, 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.
OUR COMMON STOCK
As of March 4, 2019, we began to trade
on the Pink Sheet stocks
system. Our bid price had
closed below $0.01 for more than 30 consecutive calendar
days. As of March 17, 2020, we commenced trading on the
OTCQB Market ("OTCQB") after successfully up-listing from the OTC
Pink Market.
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.
28
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
Ended September 30,
|
|||
|
2020
|
2019
|
$
Variance
|
%
Variance
|
Net
revenue
|
$1,416
|
$2,299
|
$(883)
|
-38.4%
|
Cost of goods
sold
|
919
|
1,553
|
(634)
|
40.8%
|
Gross
profit
|
497
|
746
|
(249)
|
-33.4%
|
General and
administrative expenses
|
1,249
|
2,366
|
(1,117)
|
47.2%
|
Operating
loss
|
(752)
|
(1,620)
|
868
|
53.6%
|
Other income
(expense):
|
|
|
|
|
Change
in fair value of derivative
|
130
|
(147)
|
277
|
188.4%
|
Interest
expense, net
|
(325)
|
(183)
|
(142)
|
-77.6%
|
Loss on debt
conversions
|
(144)
|
(132)
|
(12)
|
-9.1%
|
Total other
expense, net
|
(339)
|
(462)
|
123
|
26.6%
|
Loss before income
taxes
|
(1,091)
|
(2,082)
|
991
|
47.6%
|
Income taxes -
current benefit
|
29
|
-
|
29
|
100.0%
|
Net
loss
|
$(1,062)
|
$(2,082)
|
$1,020
|
49.0%
|
THREE MONTHS ENDED SEPTEMBER
30, 2020 AS COMPARED TO THE THREE
MONTHS ENDED SEPTEMBER 30, 2019
Revenue
Net
revenue for the three months ended September 30, 2020 decreased by
$883,000 to $1,416,000 from $2,299,000 for the three months ended
September 30, 2019. Our September 30, 2020 quarter was impacted
by the Covid-19 pandemic and low shipments at EZ-CLONE. However, we
have a sales order backlog of $1,929,000 into the fourth quarter. The
GrowLife distribution revenue for the three months ended September
30, 2020 was $211,000 as compared to $1,156,000 for the three
months ended September 30, 2019. The EZ-CLONE revenue for the three
months ended September 30, 2020 was $1,205,000 as compared to
$1,143,000 for the three months ended September 30,
2019.
The
decrease was related primarily to lower revenue from GrowLife
distribution products. Our September 30, 2020 quarter was impacted
by the Covid-19 pandemic and lower than expected of shipments at
EZ-CLONE. However, we have a sales order backlog of
$1,929,000 for
shipment in the fourth quarter.
Cost of Goods Sold
Cost of
sales for the three months ended September 30, 2020 decreased by
$634,000 to $919,000 from $1,553,000 for the three months ended
September 30, 2019.
Gross profit was $497,000 for
the three months ended September 30, 2020 as compared to a gross profit of $746,000
for the three months ended
September 30, 2019. The gross profit
percentage was 35.1% for the
three months ended September 30, 2020 as compared to 32.4% for the three months
ended September 30, 2019. The increase in gross profit margin
related to favorable product mix related to the acquisition of EZ-CLONE on October 15,
2018. EZ-CLONE reported a gross
profit percentage of 38.4% during the three months ended September
30, 2020 as compared to 50.4% for the three months ended
September 30, 2019.
General and Administrative Expenses
General
and administrative expenses for the three months ended September
30, 2020 were $1,249,000 as compared to $2,366,000 for the three
months ended September 30, 2019. The variances were as follows: (i)
a decrease in non-cash and restructuring and amortization expenses
of $996,000; (iii) a decrease in rent expense of $72,000; (iv) a
decrease in sales and marketing expenses of $68,000; (v) decreased
insurance of $38,000; offset by (vi) increased other expenses of
$57,000. As part of the general and administrative expenses for the
three months ended September 30, 2020, we recorded public relation,
investor relation or business development expenses of $500. We
implemented a cost reduction program during the year ended December
31, 2019.
29
Non-cash
general and administrative expenses for the three months ended
September 30, 2020 included non-cash expenses of $214,000 including
(i) depreciation of $9,000; (ii) amortization of intangible assets
of $168,000; and (iii) stock based compensation of $37,000 related
to stock option grants and warrants.
The
decrease in non-cash and restructuring and amortization expenses of
$996,000 related primarily to the closure of retail stores in
Portland, Maine, Encino, California and Calgary, Canada and online
sales as of September 30, 2019. Also, we closed the sale of the
flooring division located in Grand Prairie, Texas. As of September
30, 2019, we recorded restructuring expense of $306,000 for the
sale of the flooring division and $250,000 for the closure of the
retail stores and online sales.
Non-cash
general and administrative expenses for the three months ended
September 30, 2019 included non-cash expenses of $310,000 including
(i) depreciation of ($16,000); (ii) amortization of intangible
assets of $285,000; and (iii) stock based compensation of $41,000
related to stock option grants and warrants.
Other Expense
Other
expense for the three months ended September 30, 2020 was $339,000
as compared to other expense of $462,000 for the three months ended
September 30, 2019. The other expense for the three months ended
September 30, 2020 included (i) reduction in derivative liability
of $130,000; offset by (ii) interest expense of $325,000; and (iii)
loss on debt conversions of $144,000. 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
accrued interest expense and amortization of issuance costs on our
notes payable. The loss on debt conversions related to the
conversion of our notes payable at prices below the market
price.
The
other expense for the three months ended September 30, 2019
included (i) increase in derivative liability of $147,000; (ii)
interest expense of $183,000; and (iii) loss on debt conversions of
$132,000. 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 accrued interest expense on 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, 2020 was $1,062,000
as compared to $2,082,000 for the three months ended September 30,
2019 for the reasons discussed above.
Net
loss for the three months ended September 30, 2020 included
non-cash expenses of $477,000 including (i) depreciation of $9,000;
(ii) amortization of intangible assets of $168,000; (iii) stock
based compensation of $37,000 related to stock option grants and
warrants; (iv) accrued interest and amortization of issuance costs
on convertible notes payable of $250,000; and (v) loss on debt
conversions of $143,000; offset by (vi) gain from change in
derivative liability of $130,000.
Net
loss for the three months ended September 30, 2019 included
non-cash expenses of $1,286,000 including (i) depreciation of
$15,000; (ii) restructuring reserve- retail stores, on line sales
and flooring division of $555,000; (iii) amortization of intangible
assets of $285,000; (iv) stock based compensation of $41,000
related to stock option grants and warrants; (v) accrued interest
on convertible notes payable of $58,000; (vi) loss on debt
conversions of $132,000; (vii) noncontrolling interest in EZ-CLONE
Enterprises, Inc. of $82,000; and (viii) change in derivative
liability of $148,000.
We
expect losses to continue as we implement our business
plan.
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,
|
|||
|
2020
|
2019
|
$
Variance
|
%
Variance
|
Net
revenue
|
$4,928
|
$6,744
|
$(1,816)
|
-26.9%
|
Cost of goods
sold
|
3,050
|
4,551
|
(1,501)
|
33.0%
|
Gross
profit
|
1,878
|
2,193
|
(315)
|
-14.4%
|
General and
administrative expenses
|
3,741
|
6,549
|
(2,808)
|
42.9%
|
Operating
loss
|
(1,863)
|
(4,356)
|
2,493
|
57.2%
|
Other income
(expense):
|
|
|
|
|
Change
in fair value of derivative
|
(28)
|
361
|
(389)
|
-107.8%
|
Interest
expense, net
|
(767)
|
(410)
|
(357)
|
-87.1%
|
Loss on debt
conversions
|
(435)
|
(1,706)
|
1,271
|
74.5%
|
Gain on
extinguishment of debt
|
39
|
-
|
39
|
100.0%
|
Total other
expense, net
|
(1,191)
|
(1,755)
|
564
|
32.1%
|
Loss before income
taxes
|
(3,054)
|
(6,111)
|
3,057
|
50.0%
|
Income taxes -
current benefit
|
88
|
-
|
88
|
100.0%
|
Net
loss
|
$(2,966)
|
$(6,111)
|
$3,145
|
51.5%
|
30
NINE
MONTHS ENDED SEPTEMBER 30, 2020 AS COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2019
Revenue
Net
revenue for the nine months ended September 30, 2020 decreased by
$1,816,000 to $4,928,000 from $6,744,000 for the nine months ended
September 30, 2019. The nine months ended September 30, 2020
was impacted by the
Covid-19 pandemic and low shipments at EZ-CLONE. However, we have a
sales order backlog of $1,929,000 for shipment in the fourth
quarter. The
GrowLife distribution revenue for the nine months ended September
30, 2020 was $1,540,000 as compared to $3,745,000 for the nine
months ended September 30, 2019. The EZ-CLONE revenue for the nine
months ended September 30, 2020 was $3,388,000 as compared to
$2,999,000 for the nine months ended September 30,
2019.
Cost of Goods Sold
Cost of
sales for the nine months ended September 30, 2020 decreased by
$1,501,000 to $3,050,000 from $4,551,000 for the nine months ended
September 30, 2019.
Gross profit was $1,878,000 for
the nine months ended September 30, 2020 as compared to a gross profit of $2,193,000
for the nine months ended
September 30, 2019. The gross profit
percentage was 38.1% for the
nine months ended September 30, 2020 as compared to 32.5% for the nine months
ended September 30, 2019. The increase in gross profit margin was
due to favorable product mix related to the acquisition of EZ-CLONE on October 15,
2018. EZ-CLONE reported a gross
profit percentage of 46.8% during the nine months ended September
30, 2020 as compared to 51.1% for the nine months ended
September 30, 2019.
General and Administrative Expenses
General
and administrative expenses for the nine months ended September 30,
2020 were $3,741,000 as compared to $6,549,000 for the nine months
ended September 30, 2019. The variances were as follows: (i) a
decrease in non-cash, restructuring and amortization expenses of
$1,120,000; (ii) a decrease in payroll expenses of $378,000; (iii)
a decrease in rent expense of $261,000; (iv) a decrease in sales
and marketing expenses of $221,000; (v) decreased insurance of
$115,000; (vi) decreased consulting of $122,000; and (vii)
decreased other expenses of $593,000. As part of the general and
administrative expenses for the nine months ended September 30,
2020, we recorded public relation, investor relation or business
development expenses of $1,500. We implemented a cost reduction
program during the year ended December 31, 2019.
Non-cash
general and administrative expenses for the nine months ended
September 30, 2020 included non-cash expenses of $656,000 including
(i) depreciation of $28,000; (ii) amortization of intangible assets
of $504,000; (iii) stock based compensation of $112,000 related to
stock option grants and warrants; and (iv) common stock issued for
services of $12,000.
The
decrease in non-cash and restructuring and amortization expenses of
$1,120,000 related primarily to the closure of retail stores in
Portland, Maine, Encino, California and Calgary, Canada and online
sales as of September 30, 2019. Also, we closed the sale of the
flooring division located in Grand Prairie, Texas. As of September
30, 2019, we recorded restructuring expense of $306,000 for the
sale of the flooring division and $250,000 for the closure of the
retail stores and online sales.
Non-cash
general and administrative expenses for the nine months ended
September 30, 2019 included non-cash expenses of $1,220,000
including (i) depreciation of $69,000; (ii) amortization of
intangible assets of $856,000; (iii) stock based compensation of
$121,000 related to stock option grants and warrants; and (iv)
common stock issued for services of $174,000.
Other Expense
Other
expense for the nine months ended September 30, 2020 was $1,191,000
as compared to other expense of $1,755,000 for the nine months
ended September 30, 2019. The other expense for the nine months
ended September 30, 2020 included (i) loss from the increase in
derivative liability of $28,000; (ii) interest expense of $767,000;
and (iii) loss on debt conversions of $435,000; and (iv) offset by
gain on extinguishment of $39,000. 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
accrued interest expense on our notes payable. The loss on debt
conversions related to the conversion of our notes payable at
prices below the market price.
The
other expense for the nine months ended September 30, 2019 included
(i) reduction in derivative liability of $361,000; offset by (ii)
interest expense of $410,000; and (iii) loss on debt conversions of
$1,706,000. 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 accrued interest expense on our
notes payable. The loss on debt conversions related to the
conversion of our notes payable at prices below the market
price.
31
Net Loss
Net
loss for the nine months ended September 30, 2020 was $2,966,000 as
compared to $6,111,000 for the nine months ended September 30, 2019
for the reasons discussed above.
Net
loss for the nine months ended September 30, 2020 included non-cash
expenses of $1,769,000 including (i) depreciation of $28,000; (ii)
amortization of intangible assets of $504,000; (iii) stock based
compensation of $112,000 related to stock option grants and
warrants; (iv) common stock issued for services of $12,000; (v)
accrued interest and amortization of issuance costs on convertible
notes payable of $689,000; (vi) change in derivative liability of
$28,000; and (vii) loss on debt conversions of
$395,000.
Net
loss for the nine months ended September 30, 2019 included non-cash
expenses of non-cash expenses of $3,395,000 including (i)
depreciation of $69,000; (ii) restructuring reserve- retail stores,
on line sales and flooring division of $555,000; (v) amortization
of intangible assets of $856,000; (vi) stock based compensation of
$121,000 related to stock option grants and warrants; (vii) common
stock issued for services of $174,000; (viii) accrued interest on
convertible notes payable of $185,000; (ix) loss on debt
conversions of $1,707,000; and (x) noncontrolling interest in
EZ-CLONE Enterprises, Inc. of $89,000; offset by (xi) change in
derivative liability of $(361,000).
We
expect losses to continue as we implement our business
plan.
LIQUIDITY AND CAPITAL RESOURCES
We
adopted the Financial Accounting Standards Board’s
(“FASB”) Accounting Standard Codification
(“ASC”) Topic 205-40, Presentation of Financial
Statements – Going Concern, which requires that management
evaluate whether there are relevant conditions and events that, in
the aggregate, raise substantial doubt about the entity’s
ability to continue as a going concern and to meet its obligations
as they become due within one year after the date that the
financial statements are issued.
The
accompanying financial statements have been prepared assuming that
we will continue as a going concern. However, since inception, we
have sustained significant operating losses and such losses are
expected to continue for the foreseeable future. As of September
30, 2020, we had an accumulated deficit of $151.4 million, cash and cash equivalents
of $634.7 thousand and a working capital deficit of $1.74 million
excluding derivative liability, convertible debt, right of use
liability and deferred revenue). Additionally, we used cash in
operating activities of $1,452,000, $2,910,000
and $3,855,000 for the nine months ended September 30, 2020 and the
years ended December 31, 2019 and 2018 respectively. We will
require additional cash funding to fund operations beyond September
30, 2020. Accordingly, management has concluded that we do not have
sufficient funds to support operations within one year after the
date the financial statements are issued and, therefore, we
concluded there was substantial doubt about the Company’s
ability to continue as a going concern.
To fund
further operations, we will need to raise additional capital. We
may obtain additional financing in the future through the issuance
of its common stock, or through other equity or debt financings.
Our ability to continue as a going concern or meet the minimum
liquidity requirements in the future is dependent on its ability to
raise significant additional capital, of which there can be no
assurance. If the necessary financing is not obtained or achieved,
we will likely be required to reduce its planned expenditures,
which could have an adverse impact on the results of operations,
financial condition and our ability to achieve its strategic
objective. There can be no assurance that financing will be
available on acceptable terms, or at all. The financial statements
contain no adjustments for the outcome of these uncertainties.
These factors raise substantial doubt about our ability to continue
as a going concern and have a material adverse effect on our future
financial results, financial position and cash flows.
Securities Purchase Agreement and Self-Amortization Promissory Note
with EMA Financial LLC, a Delaware limited liability company
(“EMA”)
On
October 2, 2020, we executed the following agreements with EMA: (i)
Securities Purchase Agreement; and (ii) Self-Amortization
Promissory Note (“Note”); (collectively the “EMA
Agreements”). The Company entered into the EMA Agreements
with the intent to acquire working capital to grow the
Company’s businesses and complete the EZ-CLONE Enterprises,
Inc. acquisition.
The
total amount of funding under the EMA Agreements is $183,455. The
Notes carry an original issue discount of $21,100, a transaction
expense amount of $6,500, and a fee to J. H. Darbie & Co. of
$21,150, for total debt of $221,000 (“Debt”). The Note
has an amortization schedule of $19,550 on January 2, 2021 and
monthly from February 2021 through January 2022. We issued
commitment shares of 550,000 shares related to the EMA Agreements.
We agreed to reserve 1,486,258 shares of its common stock for
issuance if any Debt is converted. The Debt is due on or before
January 2, 2022. The Debt carries an interest rate of twelve
percent (12%). In the case of default, the debt is convertible into
our common stock at the closing price the day before the
conversion, subject to adjustment as provided for in the
Note.
32
Securities Purchase Agreement and Self-Amortization Promissory Note
with FirstFire Global Opportunities Fund, LLC, a Delaware limited
liability company (“FF”)
On
October 2, 2020, we executed the following agreements with FF: (i)
Securities Purchase Agreement; and (ii) Self-Amortization
Promissory Note (“Note”); (collectively the “FF
Agreements”). The Company entered into the FF Agreements with
the intent to acquire reduce debt.
The
total amount of funding under the FF Agreements is $130,000. The
Notes carry an original issue discount of $14,952, a transaction
expense amount of $4,600, and a fee to J. H. Darbie & Co. of
$7,050, for total debt of $156,602 (“Debt”). The Note
has an amortization schedule of $13,853 on January 11, 2021 and
monthly from February 2021 through January 2022. We issued
commitment shares of 450,000 shares related to the FF Agreements.
We agreed to reserve 1,486,258 shares of its common stock for
issuance if any Debt is converted. The Debt is due on or before
January 12, 2022. The Debt carries an interest rate of twelve
percent (12%). In the case of default, the debt is convertible into
our common stock at the closing price the day before the
conversion, subject to adjustment as provided for in the
Note.
Operating Activities
Net
cash used in operating activities for the nine months ended
September 30, 2020 was $1,452,000. This amount was primarily
related to a (i) net loss of $2,966,000, and (ii) net working
capital increase of $360,000; offset by (iii) non-cash expenses of
$1,769,000 including (iv) depreciation of $28,000; (v) amortization
of intangible assets of $504,000; (vi) stock based compensation of
$112,000 related to stock option grants and warrants; (vii) common
stock issued for services of $12,000; (viii) accrued interest and
amortization of issuance costs on convertible notes payable of
$689,000; (ix) change in derivative liability of $28,000; and (x)
loss on debt conversions of $395,000.
Financing Activities
Net
cash provided by financing activities for the nine months ended
September 30, 2020 was $2,046,000. The amount related to proceeds
from note payable of $2,213,000, offset by repayment of convertible
notes payable of $167,000.
Our contractual cash obligations as of September 30, 2020 are
summarized in the table below:
|
|
Less
Than
|
|
|
Contractual Cash
Obligations
|
Total
|
1
Year
|
1-3
Years
|
4-5
Years
|
Operating lease
cash payments
|
$688,569
|
$214,983
|
$422,129
|
$51,457
|
Convertible notes
payable and accrued interest
|
2,786,632
|
2,786,632
|
-
|
-
|
Notes
payable
|
1,340,236
|
941,557
|
398,679
|
-
|
Acquisition of 49%
of EZ-CLONE Enterprises, Inc.
|
1,026,000
|
1,026,000
|
-
|
-
|
|
$5,841,437
|
$4,969,172
|
$820,808
|
$51,457
|
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, 2020, 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.
33
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:
The current Audit Committee has two independent directors, but the
Chairman is an interim Named Executive Officer. We expect to expand
this committee during 2020.
b) Changes in Internal Control over Financial
Reporting
During
the quarter ended September 30,
2020, 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.
As of
September 30, 2019, we closed retail stores in Portland, Maine,
Encino, California and Calgary, Canada. We have recorded
restructuring reserves related to the store closures. We cannot
determine the outcome of these proceedings.
On October 15, 2018, we closed the Purchase and Sale Agreement with
EZ-CLONE Enterprises, Inc., a California corporation (the
“Agreement”). On November 5, 2019, the Company
amended the Agreement with one 24.5% shareholder of EZ-CLONE
Enterprises, Inc. (“EZ-CLONE”), to extend the date to
purchase the remaining 49% of stock of EZ-CLONE in exchange for a
20% extension fee (a total of $171,000 for the 49% or $85,500 for
each 24.5% shareholder) of the $855,000 cash payable at the earlier
of the closing of $2,000,000 in funding or nine months (July 2020).
We did not close the purchase of the remaining 49% of stock of
EZ-CLONE by the extended deadline.
On September 15, 2020, we received notice that William Blackburn
and Brad Mickelsen, minority shareholders of EZ-CLONE Enterprises,
Inc. (“Plaintiffs”), a majority owned subsidiary of the
Company, filed a complaint against the Company and its officers
Marco Hegyi and Mark Scott (“Officers”), in the
Superior Court of California, County of Sacramento
(“Complaint”) for claims related to breach under the
Purchase and Sale Agreement dated October 15, 2018 between the
Company and Plaintiffs. On September 15, 2020, the Company
filed a notice of removal with the California Superior Court,
County of Sacramento and the United States District Court for the
Eastern District of California. The case was removed to
Federal District Court for the Eastern District of California and
Plaintiffs filed an Ex Parte Application for TRO and an Order for
Preliminary Injunction with the Federal Court. The TRO was
granted on September 16, 2020 and a preliminary injunction hearing
was scheduled for September 29, 2020. After reviewing all
pleadings and oral arguments at the hearing, the Court issued a
ruling granting Plaintiffs’ request for a preliminary
injunction. Subsequent to September 29, 2020, the parties are
providing legal briefs to the Federal court to determine if
rescission should be granted. We cannot determine the outcome
of these proceedings.
The Complaint also alleges that the Company and its Officers made
certain false representations and other claims to consummate the
Transaction and as a result has failed to complete the second
closing as required under Purchase and Sale Agreement. The
Plaintiffs are seeking rescission of the Purchase and Sale
Agreement, unspecified damages in excess of ten thousand dollars,
and other equitable relief.
As of
September 30, 2020, we recorded a liability of $2,131,000 for
acquisition payable of which a $1,105,000 is payable in stock and
$1,026,000 is payable in cash.
34
Item 1A. Risk Factors.
There are certain inherent risks which will have an effect on our
development in the future and the most significant risks and
uncertainties known and identified by our management are described
below.
Risks
Related to Pandemics
The effects of the recent COVID-19 coronavirus pandemic are not
immediately known, but may adversely affect our business, results
of operations, financial condition, liquidity, and cash
flow.
Presently,
the impact of COVID-19 has not shown any imminent adverse effects
on our business. This notwithstanding, it is still unknown and
difficult to predict what adverse effects, if any, COVID-19 can
have on our business, or against the various aspects of same, or
how COVID-19 will continue to effect the world as the virus case
numbers rise and fall.
As of
the date of this Quarterly Report, COVID-19 coronavirus has been
declared a pandemic by the World Health Organization, has been
declared a National Emergency by the United States Government and
has resulted in several states being designated disaster zones.
COVID-19 coronavirus caused significant volatility in global
markets. The spread of COVID-19 coronavirus has caused public
health officials to recommend precautions to mitigate the spread of
the virus, especially as to travel and congregating in large
numbers. In addition, certain states and municipalities have
enacted, and additional cities are considering, quarantining and
“shelter-in-place” regulations which severely limit the
ability of people to move and travel and require non-essential
businesses and organizations to close. While some states are
considering lifting their “shelter-in-place”
restrictions and travel bans, as they are removed there is no
certainty that an outbreak will not occur and additional
restrictions imposed again in response.
It is
unclear how such restrictions, which will contribute to a general
slowdown in the global economy, will affect our business, results
of operations, financial condition and our future strategic
plans.
Recent
shelter-in-place and essential-only travel regulations could
negatively impact our customers. In addition, while our products
are manufactured in the United States, we still could experience
significant supply chain disruptions due to interruptions in
operations at any or all of our suppliers’ facilities or
downline suppliers. If we experience significant delays in
receiving our products we will experience delays in fulfilling
orders and ultimately receiving payment, which could result in loss
of sales and a loss of customers, and adversely impact our
financial condition and results of operations. The current status
of COVID-19 coronavirus closures and restrictions could also
negatively impact our ability to receive funding from our existing
capital sources as each business is and has been affected
uniquely.
If any of our employees, consultant, customers, or visitors were to
become infected we could be forced to close our operations
temporarily as a preventative measure to prevent the risk of spread
which could also negatively impact our ability to receive funding
from our existing capital sources as each business is and has been
affected uniquely
In addition, our headquarters are located in Seattle, Washington
and EZ-Clone is located in Sacramento, California, each of which
have experienced restrictions on individuals and business shutdowns
as the result of COVID-19. It is unclear at this time how these
restrictions will be continued and/or amended as the pandemic
evolves. We are hopeful that COVID-19 closures will have only a
limited effect on our operations and revenues.
General securities market uncertainties resulting from the COVID-19
pandemic.
Since
the outset of the pandemic the United States and worldwide national
securities markets have undergone unprecedented stress due to the
uncertainties of the pandemic and the resulting reactions and
outcomes of government, business and the general population. These
uncertainties have resulted in declines in all market sectors,
increases in volumes due to flight to safety and governmental
actions to support the markets. As a result, until the pandemic has
stabilized, the markets may not be available to the Company for
purposes of raising required capital. Should we not be able
to obtain financing when required, in the amounts necessary to
execute on our plans in full, or on terms which are economically
feasible we may be unable to sustain the necessary capital to
pursue our strategic plan and may have to reduce the planned future
growth and/or scope of our operations.
Risks Related to Our Business
Risks Associated with EZ-CLONE Enterprises, Inc.
On October 15, 2018, we closed the Purchase and Sale Agreement with
EZ-CLONE Enterprises, Inc., a California corporation (the
“Agreement”). On November 5, 2019, the Company
amended the Agreement with one 24.5% shareholder of EZ-CLONE
Enterprises, Inc. (“EZ-CLONE”), to extend the date to
purchase the remaining 49% of stock of EZ-CLONE in exchange for a
20% extension fee (a total of $171,000 for the 49% or $85,500 for
each 24.5% shareholder) of the $855,000 cash payable at the earlier
of the closing of $2,000,000 in funding or nine months (July 2020).
We did not close the purchase of the remaining 49% of stock of
EZ-CLONE by the extended deadline.
35
On September 15, 2020, we received notice that William Blackburn
and Brad Mickelsen (“Plaintiffs”), minority
shareholders of EZ-CLONE Enterprises, Inc., a majority owned
subsidiary of the Company, filed a complaint against the Company
and its officers Marco Hegyi and Mark Scott
(“Officers”), in the Superior Court of California,
County of Sacramento (“Complaint”) for claims related
to breach under the Purchase and Sale Agreement dated October 15,
2018 between the Company and Plaintiffs. The Complaint also alleges
that the Company and its Officers made certain false
representations and other claims to consummate the Transaction and
as a result has failed to complete the second closing as required
under Purchase and Sale Agreement. The Plaintiffs are seeking
rescission of the Purchase and Sale Agreement, unspecified damages
in excess of ten thousand dollars, and other equitable
relief.
On
September 15, 2020, the Company filed a notice of removal with the
California Superior Court, County of Sacramento and the United
States District Court for the Eastern District of California.
The case was removed to Federal District Court for the Eastern
District of California and Plaintiffs filed an Ex Parte Application
for TRO and an Order for Preliminary Injunction with the Federal
Court. The TRO was granted on September 16, 2020 and a
preliminary injunction hearing was scheduled for September 29,
2020. After reviewing all pleadings and oral arguments at the
hearing, the Court issued a ruling granting Plaintiffs’
request for a preliminary injunction.
Presently
the parties are providing legal briefs to the Federal court to
determine if rescission should be granted. If we are unsuccessful and the court grants
Plaintiffs’ request for rescission the resulting actions are
speculative at this time but could include the return of the
consideration exchanged as part of the acquisition subject to
certain adjustments as the result of several variables which the
court will consider. If the court denies Plaintiffs request for
rescission the litigation will continue regarding the breach
of contract claims and contractual remedies for breach and the
Court may or may not dissolve the preliminary injunction as a
result.
A decision to grant rescission could materially harm our business
as EZ-Clone represents a significant
portion of our operations.
As of
September 30, 2020, we recorded a liability of $2,131,000 for
acquisition payable of which a $1,105,000 is payable in stock and
$1,026,000 is payable in cash.
Our acquisition of EZ-CLONE thus far has been positive for our
overall results of operations. Additionally, we have spent a
significant amount of time and effort modifying our business plans
and focuses toward the clone industry. If we fail to close on the
remaining 49% of EZ-CLONE or settle the above legal action, we may
experience direct consequences including, but not limited to,
claims for breach of contract for failure to close on a contractual
obligation, possible rescission of the EZ-CLONE acquisition,
damages, and other equitable relief.
Risks Associated with Securities Purchase Agreements with
Chicago Venture
Partners, L.P. (“Chicago Venture”), Iliad Research and Trading, L.P.
(“Iliad”) and Odyssey Research and Trading, LLC,
(“Odyssey”) and
Silverback Capital Corporation.
The
Securities Purchase Agreements with Chicago Venture, Iliad and
Odyssey 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 Notes.
Our
ability to require Chicago Venture, Iliad and Odyssey to fund the
Notes is at mutual discretion, subject to certain limitations.
Chicago Venture, Iliad and Odyssey are 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 our reporting
obligations.
On
September 1, 2020, Iliad sold a Note for $500,000 to Silverback
Capital Corporation.
There
is no guarantee that we will be able to meet the foregoing
conditions or any other conditions under the Securities Purchase
Agreements and/or Notes or that we will be able to draw down any
portion of the amounts available under the Securities Purchase
Agreements and/or Notes.
If we
are not able to draw down all amounts possible under the Securities
Purchase Agreements or if the Securities Purchase Agreements are
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.
36
Our common stock.
As of March 4, 2019, we began to trade on the OTC
Pink
Sheet stocks system because our bid price had closed below $0.01 for
more than 30 consecutive calendar days. As of March 17, 2020,
we commenced trading on the
OTCQB Market ("OTCQB") after successfully up-listing from the OTC
Pink Market.
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 have been involved in Legal Proceedings.
We have
been involved in certain disputes and legal proceedings as
discussed in the section title “Legal Proceedings”.
Defending such litigation may be lengthy and costly, strain our
resources and divert management’s attention from their core
responsibilities, which would have a negative impact on our
business. 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.
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.
As of November 4, 2020, thirty five states and the District of
Columbia allow its citizens to use medical
cannabis. Additionally, fifteen 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.
37
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.
●
Arizona,
Montana, South Dakota, New Jersey passed adult use
legislation
●
Mississippi
passed medicinal use legislation set to go into effect in
2021.
●
The
total count is 35 + DC for Medicinal. 15 + DC for adult
use.
●
Additionally,
Georgia, Virginia, Kentucky, Iowa, Texas, and Indiana allow very
low level THC based oil for medicinal purposes, but are generally
not included in the count. Language is updated
above.
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.
Closing of bank and merchant processing 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 and merchant processing accounts. 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 thirty seven 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.
38
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 years ended December 31, 2019 and 2018 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, 2020,
we had an accumulated deficit of $151.4 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 inability or failure 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
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 do not 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.
39
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
and 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.
40
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.
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 no insurance.
We have
no 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
Chicago Venture, Iliad and Odyssey could have significant influence
over matters submitted to stockholders for approval.
As a
result of funding from Chicago Venture, Iliad and Odyssey as
previously detailed, they exercise significant control over
us.
While
there are limits on the ownership by each party, if these companies
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 companies, 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 SEC’s penny stock
regulations.
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.
41
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:
●
Halting
of trading by the SEC or FINRA.
●
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,
●
Issuance
of convertible or equity securities for general or merger and
acquisition purposes,
●
Issuance
or repayment of debt, accounts payable or convertible debt for
general or merger and acquisition purposes,
●
Sale of
a significant number of shares of our common stock by
shareholders,
●
General
market and economic conditions,
●
Quarterly
variations in our operating results,
●
Investor
relation activities,
●
Announcements
of technological innovations,
●
New
product introductions by us or our competitors,
●
Competitive
activities, and
●
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, 2020, there are also (i) stock option grants outstanding for
the purchase of 506,667 common shares at a $1.496 average exercise
price; and (ii) warrants for the purchase of 2,418,680 shares of common shares at a
$3.465 average exercise price. In
addition, we have an unknown number of common shares to be issued
under the Crossover, 12% convertible promissory note financing and
Labrys agreements in the case of default. In addition, we have an
unknown number of common shares to be issued under the Chicago
Venture, Iliad and St. George 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 and
exercises its warrants. The lower the conversion or exercise
prices, the more shares that will be issued to Chicago Venture upon
the conversion of debt to shares. We will not know the exact number
of shares of stock issued to Chicago Venture until the debt is
actually converted to equity.
42
These
stock option grant, warrant and contingent shares could result in
further dilution to common stockholders 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.
These
stock option grant, warrant and contingent shares could result in
further dilution to common stockholders and may affect the market
price of the common stock.
Some of our convertible debentures and warrants may require
adjustment in the conversion price.
Our
Convertible Notes Payable may require an adjustment in the current
conversion price of $0.102 per share if we issue common stock,
warrants or equity below the price that is reflected in the
convertible notes payable. Our warrant with St. George may require
an adjustment in the exercise price. The conversion price of the
convertible notes and warrants 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.
43
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.
During the three months ended September 30, 2020, we had the
following sales of unregistered sales of equity
securities:
Debt
and accrued interest of $465,580 was converted into 3,930,072
shares of our common stock at a per share conversion price of
$0.118.
On
August 31, 2020, we issued commitment shares of 1,662,000 shares
related to the Labrys Agreements at $0.21 or $349,020.
ITEM 3. DEFAULTS
UPON SENIOR SECURITIES
There
have been no events which are required to be reported under this
item.
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:
(a)
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Exhibits
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Exhibit No.
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Description
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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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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 Amendment of Certificate of Incorporation of
GrowLife, Inc. dated October 23, 2017 to increase the authorized shares of Common Stock
from 3,000,000,000 to 6,000,000,000 shares. Filed as an
exhibit to the Company’s Form 8-K and filed with the SEC on
October 24, 2017, and hereby incorporated by
reference.
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Amendment
to Articles of Incorporation dated November 20, 2019. Filed as an
exhibit to the Company’s Form 8-K and filed with the SEC on
November 26, 2019, and hereby incorporated by
reference.
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GrowLife,
Inc. 2017 Stock Incentive Plan filed as an Annex 1 to the
Company’s Preliminary Schedule 14A filed with the SEC on June
30, 2017, and hereby incorporated by reference.
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Form of
Warrants. Filed as exhibits to the Company’s Form 8-K and
filed with the SEC on February 28, 2020, and hereby incorporated by
reference.
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Compilation
of Securities Purchase Agreement and
Warrant to Purchase Common Stock dated February 9, 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 February 15, 2018, and hereby
incorporated by reference.
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Compilation
of Securities Purchase Agreement,
Secured Promissory Notes, and Security Agreement by and between
GrowLife, Inc.. and Iliad Research and Trading , L.P. Filed
as an exhibit to the Company’s Form 8-K and filed with the
SEC on August 16, 2018, and hereby incorporated by
reference.
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44
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Rights
Offering to Shareholders filed in Amendment No.1 of Form S-1. Filed
with the SEC on September 18, 2018, and hereby incorporated by
reference. Filed as an exhibit to the Company’s Form 8-K and
filed with the SEC on September 21, 2018, and hereby incorporated
by reference.
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Rights
Offering to Shareholders filed in Amendment No.1 of Form S-1. Filed
with the SEC on September 18, 2018, and hereby incorporated by
reference. Filed as an exhibit to the Company’s Form 8-K and
filed with the SEC on September 21, 2018, and hereby incorporated
by reference.
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Purchase
and Sale agreement dated October 10, 2018 by and between GrowLife,
Inc. and EZ-CLONE Enterprises LLC. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on October 18,
2018, and hereby incorporated by reference.
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10.6
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Compilation
of Securities Purchase Agreement,
Warrant, Secured Promissory Notes, and Security Agreement by and
between GrowLife, Inc.. and Iliad Research and Trading ,
L.P. Filed as an exhibit to the Company’s Form 8-K and
filed with the SEC on October 17, 2018, and hereby incorporated by
reference.
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Marco
Hegyi Employment Agreement dated October 15, 2018. Filed as an
exhibit to the Company’s Form 8-K and filed with the SEC on
October 17, 2018, and hereby incorporated by
reference.
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Mark E.
Scott Employment Agreement dated October 15, 2018. Filed as an
exhibit to the Company’s Form 8-K and filed with the SEC on
October 17, 2018, and hereby incorporated by
reference.
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Joseph
Barnes Employment Agreement dated October 15, 2018. Filed as an
exhibit to the Company’s Form 8-K and filed with the SEC on
October 17, 2018, and hereby incorporated by
reference.
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Prospectus
Supplement dated November 8, 2018 to Rights Offering to Shareholders filed in 424(b)(4)
Prospectus filed with the SEC on October 18, 2018, and hereby
incorporated by reference. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on November 16,
2018, and hereby incorporated by reference.
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Prospectus
Supplement dated November 16, 2018 to Rights Offering to Shareholders filed in 424(b)(4)
Prospectus filed with the SEC on October 18, 2018, and hereby
incorporated by reference. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on November 16,
2018, and hereby incorporated by reference.
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Standard
and Industrial Multi-Tenant Lease dated December 18, 2018 by and
between Pensco Trust Company and GrowLife, Inc. Filed as an exhibit
to the Company’s Form 10-K and filed with the SEC on March 8,
2019, and hereby incorporated by reference.
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Termination
of Existing Agreements and Release Agreement accepted February 15,
2019 entered into by and between GrowLife, Inc. and CANX USA LLC.
Filed as an exhibit to the Company’s Form 8-K and filed with
the SEC on February 20, 2019, and hereby incorporated by
reference.
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Compilation
of Securities Purchase Agreement,
Secured Promissory Notes, and Security Agreement by and
between GrowLife, Inc. and Odyssey Research and Trading,
LLC. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on July 30, 2019,
and hereby incorporated by reference.
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45
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Amendment No. 1 to Purchase and Sale Agreement dated October 23,
2019, entered into by and between GrowLife, Inc. and William
Blackburn. Filed as an exhibit to the Company’s Form
8-K and filed with the SEC on November 12, 2019, and hereby
incorporated by reference.
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Settlement
and Release Agreement dated October 22, 2019 and which closed
November 14, 2019 by and Between GrowLife Innovations, Inc. and All
Commercial Floors, Inc. Filed as an exhibit to the Company’s
Form 8-K and filed with the SEC on November 20, 2019, and hereby
incorporated by reference.
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Intellectual
Property Assignment Agreement dated October 22, 2019 and which
closed November 14, 2019 by and Between GrowLife Innovations, Inc.
and All Commercial Floors, Inc. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on November 20,
2019, and hereby incorporated by reference.
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Compilation
of Securities Purchase Agreement, Secured Promissory Notes, and
Security Agreement. Filed as an exhibit to the Company’s Form
8-K and filed with the SEC on February 5, 2020, and hereby
incorporated by reference.
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Compilation
of Labrys Securities Purchase Agreement, Self-Amortization
Promissory Note and Other Agreements. Filed as an exhibit to the
Company’s Form 8-K and filed with the SEC on October 15,
2020, and hereby incorporated by reference
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Compilation
of EMA Securities Purchase Agreement, Self-Amortization Promissory
Note and Other Agreements.
Filed as an exhibit to the Company’s Form 8-K and filed with
the SEC on October 15, 2020, and hereby incorporated by
reference
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Compilation
of FF Securities Purchase Agreement, Self-Amortization Promissory
Note and Other Agreements.
Filed as an exhibit to the Company’s Form 8-K and filed with
the SEC on October 15, 2020, and hereby incorporated by
reference
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Code of
Conduct and Ethics dated May 15, 2014. Attached as an exhibit to
the Company’s Form 8-K filed and with the SEC on June 9,
2014, and hereby incorporated by reference.
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Letter
dated October 3, 2019 from SD Mayer and Associates, LLP. Filed as
an exhibit to the Company’s Form 8-K and filed with the SEC
on October 8, 2019, and hereby incorporated by
referene.
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Certification
of Principal Executive Officer Pursuant to Rule 13a-14
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Filed
herewith.
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Certification
of Principal Financial Officer Pursuant to Rule 13a-14
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Filed
herewith.
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CEO
Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
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Filed
herewith.
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CFO
Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
|
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Filed
herewith.
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Audited
Financial Statements of EZ-CLONE Enterprises, Inc. Filed as an
exhibit to the Company’s Form 8-K/A and filed with the SEC on
January 24, 2019, and hereby incorporated by
reference.
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46
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Unaudited
Pro Forma Financial Information of GrowLife, Inc. and EZ-CLONE
Enterprises, Inc. Filed as an exhibit to the Company’s Form
8-KA and filed with the SEC on January 24, 2019, and hereby
incorporated by reference.
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Amended
and Restated Audit Committee Charter, dated October 16, 2015.
Attached 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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Compensation
Committee Charter dated May 15, 2014. Attached as an exhibit to the
Company’s Form 8-K dated June 3, 2014 and filed with the SEC
on June 9, 2014, and hereby incorporated by reference.
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Amended
and Restated Nominations and Governance Charter, dated October 16,
2015.Attached 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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Amended
and Restated Insider Trading Policy, dated October 16, 2015.
Attached 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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101.INS*
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XBRL
Instance Document
|
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101.SCH*
|
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XBRL
Taxonomy Extension Schema Document
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101.CAL*
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XBRL
Taxonomy Extension Calculation Linkbase Document
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101.LAB*
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XBRL
Taxonomy Extension Labels Linkbase Document
|
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101.PRE*
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XBRL
Taxonomy Extension Presentation Linkbase Document
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101.DEF*
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XBRL
Taxonomy Extension Definition Linkbase Document
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*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.
47
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)
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Date: November 13, 2020
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By:
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/s/ Marco Hegyi
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Marco Hegyi
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Chief Executive Officer and President
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(Principal Executive Officer)
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Date: November 13, 2020
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By:
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/s/ Mark Scott
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Mark Scott
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Chief Financial Officer
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(Principal Financial and Accounting Officer)
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48