GROWLIFE, INC. - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period

September 30, 2022

For the transition period from _______ to _______

Commission file number 000-50385

11335 NE 122nd Way, Suite 105

Kirkland, WA 98034

(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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.0001

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically 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

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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

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 11, 2022, there were 4,385,306 shares of the issuer’s common stock, $0.0001 par value per share, outstanding. The Company completed a 150-to-1 reverse stock split effective October 7, 2022.

TABLE OF CONTENTS

  ITEM 1. FINANCIAL STATEMENTS  

GROWLIFE, INC. AND SUBSIDIARIES CONDENSED

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

GROWLIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 

  The accompanying notes are an integral part of these consolidated financial statements.

GROWLIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT   

The accompanying notes are an integral part of these consolidated financial statements.

GROWLIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                The accompanying notes are an integral part of these consolidated financial statements.

GROWLIFE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 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 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. As of December 4, 2020, the Company’s officers were dismissed from the case. The Plaintiffs are seeking rescission of the Purchase and Sale Agreement, unspecified damages in excess of ten thousand dollars, and other equitable relief. See Note 17 for description of Legal Proceedings.

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.

At September 30, 2022 and December 31, 2021, the Company had 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.

On November 5, 2021, the Company held its 2021 Annual Meeting of Stockholders, where stockholders approved an increase in the authorized shares of common stock (“Common Stock”) from 120,000,000 to 740,000,000 shares. As such, the Company filed a Certificate of Amendment of Certificate of Incorporation with the Secretary of State of the State of Delaware  on November 8, 2021. As a result of the increase, the Company an aggregate 750,000,000 authorized shares consisting of: (i) 740,000,000 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.

On October 7, 2022, FINRA (the Financial Industry Regulatory Authority) announced the Reverse Stock Split of 150-for-1 which was previously approved by the Company’s shareholders at the Company’s November 5, 2021 annual meeting of stockholders. All share and per share amounts have been adjusted in these condensed consolidated financial statements to reflect the effects of the reverse stock split.

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 $3,118,676 and $4,395,585 for the nine months ended September 30, 2022 and 2021, respectively. Net cash used in operating activities was $1,310,671 and $239,142 for the nine months ended September 30, 2022 and September 30, 2021, respectively.

The Company anticipates that it will record losses from operations for the foreseeable future. As of September 30, 2022, the Company’s accumulated deficit was $163 million.  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 Company believes it will require additional funding to execute its business plans. The Company needs additional financing to implement our business plan and to service our going 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. See Note 19 – Subsequent Events.

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES: ADOPTION OF ACCOUNTING STANDARDS

Basis of Presentation - The condensed consolidated financial statements of the Company and the accompanying notes included in this Quarterly Report on Form 10-Q are unaudited. In the opinion of management, all adjustments necessary for the fair presentation of the condensed consolidated financial statements have been included. Such adjustments are of a normal, recurring nature. The condensed consolidated financial statements, and the accompanying notes, are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and do not contain certain information included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. Therefore, the interim condensed consolidated financial statements should be read in conjunction with that Annual Report on Form 10-K.

The Company has evaluated subsequent events through the date of the filing of its Form 10-Q with the Securities and Exchange Commission. Other than those events disclosed in Note 19, the Company is not aware of any other significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on the Company’s financial statements.

Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly 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. 

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, 3% discount upon receipt within ten days and, we extend thirty-day terms to select customers. We have not incurred any costs to acquire contracts that would require capitalization as of September 30, 2022 and 2021. Accounts receivable are reviewed periodically for collectability. As of September 30, 2022 and December 31, 2021, the Company has an allowance for doubtful accounts totaling $4,000 and $10,000, respectively.

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.

Concentration of Credit and Sales Risk -

The Company had the following concentrations of credit and sales risk:

Customers with over 10% of sales - the Company had three customers of EZ-CLONE that represented approximately 10%, 13% and 30% of consolidated revenue for the nine months ended September 30, 2022.

Customers with over 10% of outstanding EZ-CLONE accounts receivable - as of September 30, 2022 three customers totaled 76%, and as of December 31, 2021 one customer totaled 85%.  All amounts from these customers were current for both periods.

Inventories - Inventories are recorded on a first in first out basis.  Inventories 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, 2022 or December 31, 2021.

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, 2022, and December 31, 2021 are based upon the short-term nature of the assets and liabilities. The Company’s derivative financial instruments are considered Level 3 instruments. See Note 12.

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. The variable conversion features of the Convertible Notes Payable are considered derivatives, see Note 12. For derivative financial instruments, the Company uses the Binomial pricing model to value the derivative instruments at inception and on subsequent valuation dates. The Company uses the following assumptions when using the model: (i) risk-free interest rate of 1%; (ii) expected life of one year; (iii) expected dividend of 0%; and (iv) expected volatility ranging from 109% – 155%.  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.

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 after September 30, 2015. We will evaluate our contracts based upon the earliest issuance date.

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.

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 as they are anti-dilutive.

As of September 30, 2022, there are no dilutive stock options or warrants outstanding. In addition, we have an unknown number of common shares to be issued under the convertible notes financing agreements because the number of shares ultimately issued depends on the price at which the holder converts its debt to shares and exercises its warrants. The lower the conversion or exercise prices, the more shares that will be issued to the holder upon the conversion of debt to shares. The Company will not know the exact number of shares of stock issued to the holder 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. 

Advertising – Advertising costs are charged to operating expenses as incurred. Advertising and marketing costs for the three and nine months ended September 30, 2022 were $5,950 and $45,451, respectively.

Comprehensive loss – Comprehensive loss is defined as the change in equity of a business during a period from non-owner sources. There were no differences between net loss for the three or nine months ended September 30, 2022 and 2021 and comprehensive loss for those periods.

Research and Development Expenses – There are no research and development expenses for the three and nine months ended

September 30, 2022 and 2021

Recent Accounting Pronouncements

—---

In August 2020, the FASB issued ASU No. 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40). The amendment is meant to simplify the accounting for convertible instruments by removing certain separation models in subtopic 470-20 for convertible instruments. The amendment also changed the method used to calculate dilutes EPS for convertible instruments and for instruments that may be settled in cash. The amendment is effective for years beginning after December 15, 2021, with early adoption for years beginning after December 15, 2020 including interim periods for those fiscal years. The Company adopted this standard on January 1, 2022, noting no material impact.

Based on the Company’s review of accounting standard updates issued, there have been no other newly issued or newly applicable accounting pronouncements that have had, or are expected to have, a significant impact on the Company’s consolidated financial statements.

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 payable in $1,500,000 cash and $2.5 million in stock.  At closing, we paid 51% of the purchase price, totaling $2,040,00 of which (i) a cash payment of $645,000; and (ii) issuing 715,385 restricted shares of our common stock, valued at $1,395,000. Per the Agreement the remaining 49% of the purchase price was to be delivered within one year, totaling $1,960,000 and payable via: (i) a cash payment of $855,000; and (ii) the issuance of the 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 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. As of December 4, 2020, the Company’s officers were dismissed from the case. The Plaintiffs are seeking rescission of the Purchase and Sale Agreement, unspecified damages in excess of ten thousand dollars, and other equitable relief. See Note 17 for description of Legal Proceedings.

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 October 15, 2018 the Company consolidated EZ-Clone given their control and treated its obligation to acquire the remaining interest in EZ-Clone. The Company considers EZ-Clone to be 100% owned. At September 30, 2022 and December 31, 2021 the Company has recorded $2,131,000 as a liability, $1,026,000 of which is due in cash and $1,105,000 is due in stock.

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, 2022 and December 31, 2021 consisted of the following:

Inventory consist of supplies for product lines at EZ-CLONE.

NOTE 6 – PROPERTY AND EQUIPMENT

Property and equipment as of September 30, 2022 and December 31, 2021 consists of the following:

Total depreciation expense was $41,963 and $37,152 for the nine months ended September 30, 2022 and December 31, 2021, respectively. All equipment is used for manufacturing, selling, general and administrative purposes and accordingly all depreciation is classified in operating expenses.

NOTE 7 – INTANGIBLE ASSETS

Intangible assets as of September 30, 2022 and December 31, 2021 consisted of the following: 

Total amortization expense was $459,002 and $671,716 for the nine months ended September 30, 2022 and December 31, 2021, respectively.

NOTE 8- LEASES

The Company previously entered into operating leases for a warehouse and corporate facilities. The leases terms are five years, and often includes an options to renew. These operating leases rights are listed as separate line items on the Company's September 30, 2022 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 September 30, 2022 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. As of September 30, 2022, total right-of-use assets and operating lease liabilities for remaining long-term lease was $257,382 and $277,353, respectively. During the nine months ended September 30, 2022 and 2021, the Company recognized approximately $172,107and $166,553respectively, in total lease costs for the leases.

NOTE 9- ACCOUNTS PAYABLE

Accounts payable were $948,921 and $1,146,344 as of September 30, 2022, and December 31, 2021, 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 $245,377 and $219,398 as of September 30, 2022, and December 31, 2021, respectively. Such liabilities consisted of amounts due to sales tax, payroll and restructuring expense liabilities.

NOTE 11 –NOTES PAYABLE

Notes Payable as of September 30, 2022 consisted of the following:

Notes payable as of December 31, 2021 consisted of the following:

Government Assistance Notes Payable

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). The interest rate is one percent (1%).   The Company is utilizing the funds in accordance with the legal requirements. The loan is due April 17, 2025

On September 19, 2020, the Company, including its EZ-CLONE subsidiary, received two loans totaling $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 monthly principal and interest totaling approximately $1,392 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 the EIDL loans. One of the EIDL loans was forgiven in February 2022.

On February 3, 2021, the Company received $337,050 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). The interest rate is one percent (1%).  The Company is utilizing the funds in accordance with the legal requirements.  The loan is due February 3, 2026

Convertible Promissory Notes

FirstFire Global Opportunities Fund, LLC

On October 2, 2020, the Company executed the following agreements with FirstFire Global Opportunities Fund, LLC: (i) Securities Purchase Agreement; and (ii) Self-Amortization Promissory Note for $156,600 (“Note”). The Note has an interest rate of twelve percent (12%).  The Company makes monthly payments in the amount of $13,851.  The final payment was made on January 12, 2022.

Silverback Capital Corporation

On February 12, 2021 Silverback purchased a Note from Odyssey Research & Trading LLC (“Odyssey”) that was originally issued to Odyssey on July 22, 2019. Silverback assumed the terms and conditions of the original note. The Company typically issues original issuance discount notes that have 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 recognized 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 derivative liability was written off  at the end of 2021 due to Silverback asserting the loan in default as the Company was not maintaining the share reserves provided for the Note Agreement.  See Legal Proceedings in PART II OTHER INFOMRATION.

The 10% Notes are convertible at the holder’s option into the Company’s common stock at 50% of the current fair market value of the stock.  During the nine months ended September 30, 2022, Silverback converted principal of $469,350 into1,302,000 shares of our common stock at an average per share conversion price of $0.36.  

Dublin Holdings LLC

On February 26, 2021, the Company executed the following agreements with Bucktown Capital LLC: (i) Securities Purchase Agreement; (ii) Secured Convertible Promissory Note; and (iii) Security Agreement. During September 2022 Bucktown assigned all of its debt interests with the Company to Dublin Holdings LLC (“Dublin Agreements”).

The total amount of funding under the Dublin Agreements is $3,088,000 as represented in the Secured Convertible Promissory Note (“Note”). The total purchase price for this Note is $2,850,000; the Note carries an aggregate original issue discount of $228,000 and a transaction expense amount of $10,000. The Note is comprised of two (2) tranches (each, a “Tranche”), consisting of (i) an initial Tranche in an amount equal to $928,000 and any interest, costs, fees or charges accrued thereon or added thereto under the terms of the Note and the Dublin Agreements (the “Initial Tranche”), and (ii) an additional Tranche, which is exclusively dedicated for the purchase of the remaining equity interest in EZ-CLONE, in the amount of $2,160,000.00, plus any interest, costs, fees or charges accrued thereon or added thereto under the terms of the Note and the Dublin Agreements (the “Subsequent Tranche”). The Initial Tranche shall correspond to $68,000 of the OID and the Transaction Expense Amount and may be converted into shares of Common Stock at any time after the Purchase Price Date. The Subsequent Tranche corresponds to the Investor Note and $160,000 of the aggregate OID.

If not converted sooner, the Note is due on or before February 26, 2022. The Note has an interest rate of eight percent (8%). The Note is convertible, at Dublin’s option, into the Company’s common stock at $45.00 per share (“Lender Conversion Price”), subject to adjustment as provided for in the Note. However, in the event the Market Capitalization (as defined in the Note) falls below the Minimum Market Capitalization the Lender Conversion Price shall equal the lower of the Lender Conversion Price and the Market Price as of any applicable date of Conversion.

On August 25, 2021 and on November 5, 2021, the Company entered into the following agreements with Bucktown Capital LLC which were subsequently assigned to Dublin: (i) Securities Purchase Agreements; (ii) Secured Convertible Promissory Notes; and (iii) Security Agreements. The total amount for these Notes is $560,000; the Notes carry an aggregate original issue discount of $50,000 and a transaction expense amount of $10,000.  The Notes have an interest rate of eight percent (8%).  The Note is convertible, at Dublin’s option, into the Company’s common stock at $15.00 per share (“Lender Conversion Price”), subject to adjustment as provided for in the Note. However, in the event the Market Capitalization (as defined in the Note) falls below the Minimum Market Capitalization the Lender Conversion Price shall equal the lower of the Lender Conversion Price and the Market Price as of any applicable date of Conversion.

During the nine months ended September 30, 2022, Dublin converted principal of $295,000 into 442,954 shares of our common stock at a per share conversion price of $0.67.       

The Company’s obligation to pay the Notes, or any portion thereof, are secured by all the Company’s assets.

1800 Diagonal Lending LLC

On January 4, 2022, and on March 11, 2022, the Company entered into the following agreements with 1800 Diagonal Lending LLC, formerly known as Sixth Street Lending LLC: (i) Securities Purchase Agreements; and (ii) Secured Convertible Promissory Notes.  The total amount for these Notes is $310,200; the Note carries an aggregate original issue discount of $32,500 and a transaction expense amount of $7,700.  The Notes have an interest rate of eight percent (8%).  The Note is convertible, at the holder’s option, into the Company’s common stock at a 25% discount from the market price.  Based on the variable conversion price, the Company recorded initial derivative liabilities and an increase in the debt discount of approximately $182,000.

During the nine months ended September 30, 2022, 1800 Diagonal converted principal of $200,050 into 648,728 shares of our common stock at a per share conversion price of $0.31.

On September 28, 2022 these notes were paid off from the proceeds of a note entered into with AJB Capital. The derivative liability was written off as a result of the pay off.

AJB Capital Investments LLC

On May 17, 2022, the Company entered into the following agreements with AJB Capital Investments LLC: (i) Securities Purchase Agreement; and (ii) Promissory Note; (iii) Common Stock Purchase Warrant; and (iv) Security Agreement.   The total amount of the Note is $750,000; the Note carries an aggregate original issue discount of $75,000 and transaction expenses of $56,000.  The Note carries an interest rate of ten percent (10%) per annum and matures on November 17, 2022. Should the Note be extended at that time the interest rate increases to fifteen percent (15%).  Upon default by the Company, the Note is convertible by AJB Capital into the Company’s common stock at the lesser of the lowest trading price during the previous twenty trading days either (i) ending on the date of conversion of the Note or (ii) the date of the Note. In connection with executing the Note the Company will issue 50,000 shares of its common stock as an initial commitment fee.  Should the Note be extended, the Company will issue an additional 33,333 shares as an extension commitment fee.  The Warrant agreement allows for AJB to purchase 40,000 shares at $07.50 per share and has a five-year term. The Company recorded an original issue discount of approximately $252,000 related to the original issue discount, shares issued and warrants.  Amortization of the debt discount of approximately $128,000 for the nine months ended September 30, 2022.

On September 28, 2022, the Company entered into the following agreements with AJB Capital Investments LLC: (i) Securities Purchase Agreement; and (ii) Promissory Note; (iii) Common Stock Purchase Warrant; and (iv) Security Agreement.   The total amount of the Note is $220,000; the Note carries an aggregate original issue discount of $20,000 and transaction expenses of $5,000.  The Note carries an interest rate of ten percent (10%) per annum and matures on May 28, 2023. Should the Note be extended at that time the interest rate increases to fifteen percent (15%).  Upon default by the Company, the Note is convertible by AJB Capital into the Company’s common stock at the lesser of the lowest trading price during the previous twenty trading days either (i) ending on the date of conversion of the Note or (ii) the date of the Note. In connection with executing the Note the Company will issue 53,334 shares of its common stock as an initial commitment fee.  $151,048 of the proceeds from this Note were used to payoff the outstanding balance due 1800 Diagonal.

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 a range of  between 25% to 50% discount to the fair value of the Company’s common stock --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 $1,755,260 and $1,698,272 as of September 30, 2022 and December 31, 2021, respectively. For the nine months ended September 30, 2022, the Company recorded non-cash expense of $390,069 related to the “change in fair value of derivative” expense related to the convertible note financing. These were the only changes in level 3 fair value instruments during such periods. 

Derivative liability as of September 30, 2022 was as follows:

NOTE 13 – RELATED PARTY TRANSACTIONS AND CERTAIN RELATIONSHIPS

Notes Receivable from Related Parties

EZ-CLONE had $161,000 due from its two founders at September 30, 2022 and December 31, 2021.  The notes bear interest at 3% and are due in July 2041.

NOTE 14 – EQUITY

Authorized Capital Stock

On November 5, 2021, the Company held its 2021 Annual Meeting of Stockholders, where stockholders approved an increase in the authorized shares of common stock (“Common Stock”) from 120,000,000 to 740,000,000 shares. As such, the Company filed a Certificate of Amendment of Certificate of Incorporation with the Secretary of State of the State of Delaware  on November 8, 2021. As a result of the increase, the Company an aggregate 750,000,000 authorized shares consisting of: (i) 740,000,000 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.

On September 17, 2022, the Company’s Board approved the implementation of a one-for-one hundred and fifty (1:150) reverse stock split of all of the Company’s issued and outstanding common stock (the “Reverse Stock Split”). The number of authorized shares will not change as a result of the Reverse Stock Split. The Reverse Stock Split was effective on October 7,2022 upon announcement by FINRA (the Financial Industry Regulatory Authority).

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. Other than the Series B and C Preferred Stock discussed below, there are no shares of preferred stock presently outstanding, and we have no present plans to issue any shares of preferred 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.

Warrants  

At December 31, 2021 the Company had 4,578 warrants outstanding at a weighted average exercise price of $246.00, all of which were exercisable.  These warrants were forfeited effective June 30, 2022.  At September 30, 2022 the Company had 40,000 warrants outstanding at an exercise price of $7.50 which were issued for short term borrowings. See Note 11.

The Black-Scholes model was used to calculate the fair value of the warrants, which amounted to $27,417.

NOTE 15– STOCK OPTIONS

Description of Stock Option Plan

On November 5, 2021, at our annual shareholder meeting the Second Amended and Restated 2017 Stock Incentive Plan was adopted to increase the shares issuable under the plan from 1,333,333 to 75,000,000 shares. All terms of the Plan shall remain the same with the exception of the amount of shares reserved for issuance under the Plan. We have 75,000,000 shares available for issuance under the Second Amended and Restated 2017 Stock Incentive Plan.

Stock Option Activity

At September 30, 2022 and December 31, 2021 there were no stock options issued or outstanding.

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 the Company’s 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, 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, minority shareholders of EZ-CLONE Enterprises, Inc. (“Plaintiffs”), a majority owned subsidiary of the Company, filed a complaint against the Company and its 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. This injunction provides Plaintiffs with operating control of EZ-CLONE and this control assures that GrowLife will have little if any involvement in operations and that GrowLife will be denied cash distributions for the foreseeable future. After reviewing all pleadings and oral arguments at the hearing, the Court issued a ruling granting Plaintiffs’ request for a preliminary injunction. The parties provided legal briefs to the Federal court to determine if rescission should be granted. The Court did not reach a decision on this issue, and denied without prejudice, the Company’s effort to reverse the preliminary injunction. The Company is currently reviewing all options in this matter including settlement discussions.

As of December 4, 2020, our officers, both current and former, were dismissed from the case. 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 predict the outcome of these proceedings at this time.

At September 30, 2022, the Company 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 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.

NOTE 18 – INCOME TAXES

The Company has incurred losses since inception, which have generated net operating loss carryforwards.  The net operating loss carryforwards arise solely from United States sources.  EZ-CLONE currently files its own separate tax return as it does not meet the qualifications for being included in the Company’s consolidated tax returns. During 2021 and 2020 EZ-CLONE generated taxable income and our tax expense relates to estimated taxes owed by EZ-CLONE.  For the nine months ended September 30, 2022 EZ-CLONE incurred a loss, and a tax benefit was recorded in the amount of $146,000.

At December 31, 2021 the Company has net operating loss carryforwards of approximately $24.9 million which expire in 2022-2038. Because it is more likely than not that sufficient tax earnings will be generated to utilize the net operating loss carryforwards, the deferred tax asset related to the net operating loss carryforwards has a corresponding 100% valuation allowance.  Additionally, under the Tax Reform Act of 1986, the amounts of, and benefits from, net operating losses may be limited in certain circumstances, including a change in control.

Section 382 of the Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in its stock ownership. There can be no assurance that the Company will be able to utilize any net operating loss carryforwards in the future. The Company is subject to possible tax examination for the years 2014 through 2021. 

NOTE 19 SUBSEQUENT EVENTS

Reverse Stock Split

On October 7, 2022, FINRA (the Financial Industry Regulatory Authority) announced the Reverse Stock Split which was previously approved by the Company’s shareholders at the Company’s November 5, 2021 annual meeting of stockholders. All share and per share amounts have been adjusted in these condensed consolidated financial statements to reflect the effects of the reverse stock split.

As a result of the Reverse Stock Split, every one hundred and fifty (150) shares of the issued and outstanding common stock of the Company will be converted into one (1) share of common stock. Any and all fractional shares resulting from the Reverse Split which are less than 1 (one) whole share, shall not be rounded up to the next whole share and rather such Holder shall receive a fractional pro-rata cash payment equal to 120% of the closing market price on the Record Date. Any and all fractional shares created by the Reverse Stock Split which are greater than one (1) whole share will be rounded up to the nearest whole share. The number of authorized shares will not change as a result of the Reverse Stock Split.

Financing

On October 17, 2022, the Company entered into a Convertible Note Agreement with 1800 Diagonal in the principal amount of $88,000, with an aggregate funded amount of $76,500. The Note matures on October 17, 2023, and bears interest at 8% annually.   The Note may be converted at any time after 180 days from execution at Seventy-Five Percent (75%) of the average of the three lowest trading prices for the proceeding 15 trading days prior to conversion. 

On November 2, 2022, the Company entered into a Note Purchase Agreement (the “NPA”) with Quick Capital, LLC, a Wyoming Limited Liability Company (“QCL”) and issued a Convertible Promissory Note in the principal amount of $95,555.55, with an aggregate funded amount of $86,000.00 (the “QCL Note”) to QCL pursuant to the NPA, and 100,000 restricted origination shares (the “Origination Shares”). The Note matures 8 months after the issue date (“Maturity Date”), bears interest at 12% annually, and is convertible, in whole or in part, at any time and from time to time before the Maturity at the option of the holder at the Conversion Price that shall equal the lesser of: a) $0.06 or b) Seventy-Five Percent (75%) of the average of the lowest two lowest trading prices for the proceeding 15 trading days prior to conversion.  Additionally, the Company issued to QCL a 5-year Common Stock Purchase Warrant granting QCL the right to purchase up to 1,911,111 shares of the Company common stock at an exercise price of $0.05 per share, subject to adjustments as fully set forth therein (the “QCL Warrant”).

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

For the nine months ended September 30, 2022, GrowLife is reporting a 72% decline in EZ-CLONE revenue compared to the same period of the prior year. Gross profit for the nine months ended September 30, 2022 declined to 46% compared to 47% for the same period the prior year.  Operating expenses decreased 10% to $2,767,000 compared to the same period the prior year. As a result, the loss from operations increased to $2,122,000 for the nine months ended September 30, 2022 compared to $683,000 for the nine months ended September 30, 2021.

Other expenses include changes in derivative liability, interest expenses, loss on debt conversions, fair value of warrants issued and gain on debt forgiveness.  Other expenses had a significant improvement in the nine months ended September 30, 2022 from the same period the prior year as they were reduced from a $3,391,000 net expense to $ 1,221,000 net expense. The improvement results from a decline in interest expense.

GrowLife has spent much of 2022 extensively seeking new business expansion opportunities for the Company while continuing to explore options to resolve and settle the EZ-CLONE litigation. On September 2, 2022 we announced our agreement with Bridgetown Mushrooms and the Company’s forward looking strategy.  It is the Company’s belief that moving into the mushroom cultivation space is a natural progression for GrowLife.   The work with Bridgetown is the perfect illustration of how we are leveraging our long history of cultivation expertise to bring innovative and high-demand products to emerging markets. We believe our shareholders may benefit by GrowLife moving forward and capitalizing on the opportunities available to the Company. 

Employees

As of September 30, 2022, we had 8 full-time and part-time employees. David Dohrmann, our Chief Executive Officer, is based in Kirkland, Washington. In addition, we employ 6 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.

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.    

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, and www.growlifeinc.com.We have a policy of entering into confidentiality and non-disclosure agreements with our employees, some of our vendors and customers as necessary.

OUR COMMON STOCK

As of March 17, 2020, we commenced trading on the OTCQB Market ("OTCQB") after successfully up-listing from the OTC Pink Market.

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.

THREE MONTHS ENDED SEPTEMBER 30, 2022, AS COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2021

Net Revenue

Net revenue for the three months ended September 30, 2022, decreased by $1,006,000 to $226,000 from $1,232,000 for the three months ended September 30, 2021. The decreased performance of EZ-CLONE revenue is being experienced throughout the industry.

Cost of Goods Sold

Cost of sales for the three months ended September 30, 2022, decreased by $666,000 to $150,000 from $816,000 for the three months ended September 30, 2021. The decrease was due to the decreased EZ-CLONE sales, as discussed above.

Gross profit was $76,00 for the three months ended September 30, 2022, as compared to a gross profit of $416,000 for the three months ended September 30, 2021. The gross profit percentage was 34% for the three months ended September 30, 2022 and 2021..

Operating Expenses 

Operating expenses for the three months ended September 30, 2022, were $692,000 as compared to $925,000 for the three months ended September 30, 2021.In September 2022 EZ-CLONE terminated six employees.

Other Expense

Other expense for the three months ended September 30, 2022, was $288,000 as compared to $130,000 for the three months ended September 30, 2021. The decrease in other income (expense) for the three months ended September 30, 2022 compared to the same period the prior year, included (i) a decrease in the change in fair value of the derivative liability of $213,000; and (ii) a decrease in net interest expense of $55,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The increase in non-cash interest related to accrued interest expense on our notes payable. The loss on debt conversions related debt conversion of our notes payable at prices below the market price.

Net Loss

Net loss for the three months ended September 30, 2022 was $826,000 as compared to $610,000 for the three months ended September 30, 2021, for the reasons discussed above.

NINE MONTHS ENDED SEPTEMBER 30, 2022, AS COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2021

Net Revenue

Net revenue for the nine months ended September 30, 2022, decreased by $3,674,000 to $1,401,000 from $5,075,000 for the nine months ended September 30, 2021. The decreased performance of EZ-CLONE revenue is a result of a decrease in the business environment for the products.

Cost of Goods Sold

Cost of sales for the nine months ended September 30, 2022, decreased by $1,928,000 to $756,000 from $2,684,000 for the nine months ended September 30, 2021. The decrease was due to the decreased EZ-CLONE sales, as discussed above.

Gross profit was $645,000 for the nine months ended September 30, 2022, as compared to a gross profit of $2,391,000 for the nine months ended September 30, 2021. The gross profit percentage was 46% for the nine months ended September 30, 2022, as compared to, 47% for the nine months ended September 30, 2021. The decrease was due to a significant decline in EZ-CLONE revenue and an increase freight costs.

Operating Expenses 

Operating expenses for the nine months ended September 30, 2022, were $2,767,000 as compared to $3,074,000 for the nine months ended September 30, 2021. The decrease was related to a decrease in compensation and related benefit costs and advertising costs during the three months ended September 30, 2022

Other Expenses

Other expenses for the nine months ended September 30, 2022, were $1,221,000 as compared to $3,391,000 for the nine months ended September 30, 2021. The decrease in other income (expense) for the nine months ended September 30, 2022 compared to the same period the prior year, included (i) a decrease in the change in fair value of the derivative liability of $223,000; and (ii) a decrease in interest expense, net of $2,393,000.The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The increase in non-cash interest relates to the accrued interest expense on our notes payable. The loss on debt conversions relates to the debt conversion of our notes payable at prices below the market price.

Net Loss

Net loss for the nine months ended September 30, 2022 was $3,119,000 as compared to $4,395,000 for the nine months ended September 30, 2021, for the reasons discussed above.

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, 2022, we had an accumulated deficit of $163 million, cash and cash equivalents of $40,000 and a working capital deficit of $3,366,000, excluding derivative liability, convertible debt, acquisition costs payable in stock and right of use liability. Net cash used in operating activities was $1,505,000 for the nine months ended September 30, 2022.

The Company believes it will require additional funding in order to execute its business plans The majority of the Company’s cash is currently held at EZ-CLONE and as a result of the ongoing litigation with EZ-CLONE Founder’s, such cash is not accessible for general corporate use. 

To fund further GrowLife 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.

Operating Activities

Net cash used in operating activities for the nine months ended September 30, 2022, was $1,311,000. This amount was primarily related to a (i) net loss of $3,119,000; and (ii) a net working capital increase of $342,000; (iii) depreciation of $42,000; (iv) amortization of intangible assets of $459,000; (v) accrued interest of $691,000; (vi) gain on debt conversion of $165,000; (vii) change in derivative liability of $623,000; and (viii)) gain on forgiveness of debt of $183,000.

Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2022, was $17,000. The amount related to purchase of capital equipment.

Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2022, was $1,004,000 compared to $1,078,000 for nine months ended September 30, 2021. The amount related to proceeds from note payable of $1,418,000 (less financing costs of $194,000) offset by repayment of notes payable of $220,000 for the nine months ended September 30, 2022, was $1,198,000.

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, 2022, that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses in our internal controls over financial reporting discussed immediately below.

Identified Material Weaknesses

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 weaknesses during its assessment of internal controls over financial reporting:

Audit Committee:

The current Audit Committee has one independent director, and the Chairman is an interim Named Executive Officer. In early January 2021 an additional independent director resigned from the board and audit committee. We expect to expand this committee during 2022 once a qualified candidate is identified.

Personnel:  We do not employ a full time Chief Financial Officer. Mr. Dohrmann has served as both Chief Executive Officer and Interim Chief Financial Officer since July 1, 2022. We utilize a consultant to assist with our financial reporting. There are limited personnel to assist with the accounting and financial reporting function, which results in: (i) a lack of segregation of duties and (ii) controls that may not be adequately designed or operating effectively and have not been formally documented. Despite the existence of material weaknesses, the Company believes the financial information presented herein is materially correct and fairly presents the financial position and operating results of the nine months ended September 30, 2022, in accordance with GAAP.

Contractual Terms and Obligations

The Company entered into various financing agreements involving stock purchase agreements, notes and warrants. The terms of these legal instruments contain complex legal terms, conditions and calculations. Managements understanding of certain terms and conditions of the warrant agreements was not adequate to insure proper accounting  and disclosure of the warrant terms.

(b) Management's Report on Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed by, or under the supervision of, our CEO and CFO, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (GAAP). Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2022. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in the 2013 Internal Control-Integrated Framework. Based on its evaluation, management has concluded that the Company’s internal control over financial reporting was not effective as of September 30, 2022.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. A control system, no matter how well designed and operated can provide only reasonable, but not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their cost.

c) Changes in Internal Control over Financial Reporting

The Company has a small accounting and finance team. Consulting services provided by independent consultants have been an important element of internal control during this transition.  There were no other changes 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.

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.

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). 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 officer 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. This injunction provides Plaintiffs with operating control of EZ-CLONE and this control assures that GrowLife will have little if any involvement in operations and that GrowLife will be denied cash distributions for the foreseeable future.   The parties provided legal briefs to the Federal court to determine if rescission should be granted. The Court did not reach a decision on this issue, and denied without prejudice, the Company’s effort to reverse the preliminary injunction. The Company is currently reviewing all options in this matter including settlement discussions.

As of December 4, 2020, our officers, both current and former, were dismissed from the case. 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 predict the outcome of these proceedings at this time.

As of September 30, 2022 and December 31, 2021, 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.

On April 19, 2022, EZ-CLONE received notice that Brad Mickelsen filed a complaint against EZ-CLONE and unnamed parties in the Superior Court of California, County of Sacramento (“Complaint”) for claims related to breach of contract entered into between the parties dated October 18, 2018. EZ Clone filed an Answer on September 15, 2022. A Case Management Conference was set for September 16, 2022.

On April 23, 2021, we were notified that the Company was in default on its notes held by Silverback Capital Corporation.  The reason for the default was the Company’s inability to provide the reserve share requirement as specified in the notes. The penalty for the reserve share default was an increase in the outstanding note balances by 15%, an increase in the conversion discount by 5% and a default interest rate on the outstanding note balances of 22%. The penalty resulted in an increase to the outstanding principal balance of $146,157. See Note 11 – NOTES PAYABLE.

As a result of the reserve share default, on May 7, 2021, Silverback demanded immediate payment in full of all of their notes. On May 10, 2021, when Silverback had not been paid in full, Silverback presented another default notice for lack of payment. The penalty for the non-payment default was an increase in the outstanding note balances by another 15%, an additional increase in the conversion discount by 5%. The penalty resulted in an increase to the outstanding principal balance of $168,656. See Note 11 – NOTES PAYABLE.

On April 15, 2022, we were notified that the Company was in default on its notes held by Silverback Capital Corporation (which totaled $1,360,286 at September 30, 2021. The reason for the default was the Company’s inability to file the Form-10K for the year 2021 timely, a requirement as specified in the notes. The penalty for the reserve share default was an increase in the outstanding note balances by 15%, an increase in the conversion discount by 5%. The penalty resulted in an increase to the outstanding principal balance of $122,734. See Note 11 – NOTES PAYABLE.

On May 22, 2022, we were notified that the Company was in default on its notes held by Silverback Capital Corporation. The reason for the default was the Company’s inability to provide the reserve share requirement as specified in the notes. The penalty for the reserve share default was an increase in the outstanding note balances by 5%, there was no additional increase to the conversion discount rate. The penalty resulted in an increase to the outstanding principal balance of $47,048. See Note 11 – NOTES PAYABLE.

ITEM 1A. Risk Factors.

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

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

Unless otherwise indicated, all of the following sales or issuances of Company securities were conducted under the exemption from registration as provided under Section 4(2) of the Securities Act of 1933 (and also qualified for exemption under 4(5), formerly 4(6) of the Securities Act of 1933, except as noted below). All of the shares issued were issued in transactions not involving a public offering, are considered to be restricted stock as defined in Rule 144 promulgated under the Securities Act of 1933 and stock certificates issued with respect thereto bear legends to that effect. 

We have compensated consultants and service providers with restricted common stock during the development of our business and when our capital resources were not adequate to provide payment in cash.

During the three months ended September 30, 2022, we had the following sales of unregistered sales of equity securities:

Debt of $484,100 was converted into 2,206,571 shares of our common stock at a per share conversion price of $0.37.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES 

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) Exhibits