NOTES TO CONDENSED FINANCIAL STATEMENTS

MARCH 31, 2015

(UNAUDITED)

NOTE 1 - ORGANIZATION

BUSINESS

Cabinet Grow, Inc. (the “Company” or “CG-NV”) began operations in California in 2008, doing business as Universal Hydro (“Hydro”). Prior to April 2014, the Company was a sole proprietorship owned by its current chief operating officer and stockholder. On April 28, 2014, the Company registered with the Secretary of State of California as Cabinet Grow, Inc. (“CG-CA”), and all of the business, assets and liabilities of Hydro were assigned to CG-CA. On May 14, 2014, the Company filed Articles of Incorporation with the Nevada Secretary of State. On May 15, 2014, CG-CA merged with CG-NV, with CG-NV being the surviving entity. All references herein to CG or the Company refer to CG-NV, CG-CA and Hydro.

The Company is a manufacturer and distributor of cabinet-based horticultural systems. The Company’s design and production of hydroponic and soil grow cabinets make the process of growing in a self-contained cabinet automated and simplified. The Company’s mission is to make hydroponic and soil growing simpler, more efficient and a better value than other products found on the market. Substantially all of the Company’s sales are to individuals in the United States via the Company’s website.

The Company became a public company by filing a Registration Statement on Form S-1 with the Securities and Exchange Commission (the “SEC”) for the sale of 5,000,000 shares of common stock at $0.40 per share. Upon clearance from the SEC, the Company filed with the SEC on December 24, 2014, its final, effective Prospectus on Form 424(b)(3). Pursuant to the Registration Statement the Company sold 602,000 (502,000 in 2015) shares of common stock at $0.40 per share and received proceeds of $240,800 ($200,800 in 2015).

On March 11, 2015 Glendale Securities, Inc. agreed to file an application on Form 15c2-11 on the Company’s behalf with the Financial Industry Regulatory Authority (“FINRA”) to receive a trading symbol for the Company’s common stock. The application was filed on March 24, 2015. As of May 13, 2015, FINRA was still processing the application.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying condensed financial statements have been prepared by the Company without audit. In the opinion of management, all adjustments necessary to present the financial position, results of operations and cash flows for the stated periods have been made. Except as described below, these adjustments consist only of normal and recurring adjustments. Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. These condensed financial statements should be read in conjunction with a reading of the Company’s consolidated financial statements and notes thereto. Interim results of operations for the three months ended March 31, 2015 are not necessarily indicative of future results for the full year. Certain amounts from the 2014 period have been reclassified to conform to the presentation used in the current period.

EMERGING GROWTH COMPANY

We qualify as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards. As an emerging growth company, we can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of the benefits of this extended transition period.

USE OF ESTIMATES

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reported period. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with an original term of three months or less to be cash equivalents.

ACCOUNTS RECEIVABLE

Substantially all individuals pay in advance of their product being shipped. Recently, the Company began shipping product with payment terms of 30 to 60 days to retailers. For these shipments, the Company records accounts receivable from amounts due from its customers upon the shipment of products. The allowance for losses is established through a provision for losses charged to expenses. Receivables are charged against the allowance for losses when management believes collectability is unlikely. The allowance (if any) is an amount that management believes will be adequate to absorb estimated losses on existing receivables, based on evaluation of the collectability of the accounts and prior loss experience. While management uses the best information available to make its evaluations, this estimate is susceptible to significant change in the near term.

INVENTORY

Inventory is valued at the lower of cost or market value. Cost is determined using the first in first out (FIFO) method. Provision for potentially obsolete or slow moving inventory is made based on management analysis or inventory levels and future sales forecasts. Inventory of $72,217 and $48,761 as of March 31, 2015 and December 31, 2014, respectively, was comprised of raw materials.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, and depreciation is provided by use of straight-line methods over the estimated useful lives of the assets. The estimated useful lives of property and equipment are as follows:

The Company's leasehold improvements and property and equipment consisted of the following at March 31, 2015 and December 31, 2014:

Depreciation and amortization expense of $7,239 and $218 was recorded for the three months ended March 31, 2015 and 2014, respectively.

REVENUE RECOGNITION

The Company recognizes revenue in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition. ASC 605 requires that the following four basic criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery of products and services has occurred, (3) the fee is fixed or determinable and (4) collectability is reasonably assured. The Company recognizes revenue during the period in which the product is shipped.

SHIPPING AND HANDLING

Shipping and handling costs billed to customers are recorded in sales. For the three months ended March 31, 2015 and 2014, shipping and handling costs billed to customers were $14,896 and $23,088, respectively. Shipping costs incurred by the Company of $13,499 and $21,179 for the three months ended March 31, 2015 and 2014, respectively, are recorded in cost of sales.

RESEARCH AND DEVELOPMENT

Expenditures for research and development are charged to expense as incurred. Such expenditures amounted to $6,253 and $11,886 for the three months ended March 31, 2015 and 2014, respectively.

ADVERTISING

The Company records advertising costs as incurred. For the three months ended March 31, 2015 and 2014, advertising expense was $130,048 and $32,650, respectively.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value measurements are determined under a three-level hierarchy for fair value measurements that prioritizes the inputs to valuation techniques used to measure fair value, distinguishing between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”).

Fair value is the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company primarily uses prices and other relevant information generated by market transactions involving identical or comparable assets (“market approach”). The Company also considers the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity to identify transactions that are not orderly.

The highest priority is given to unadjusted quoted prices in active markets for identical assets (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Securities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The three hierarchy levels are defined as follows:

Level 1 – Quoted prices in active markets that is unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly;

Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

Credit risk adjustments are applied to reflect the Company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the Company’s own credit risk as observed in the credit default swap market.

The Company's financial instruments consist primarily of cash, accounts receivable, accounts payable and accrued expenses, note payable and convertible debt. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments.  The estimated fair value is not necessarily indicative of the amounts the Company would realize in a current market exchange or from future earnings or cash flows.

INCOME TAXES

Prior to May 2014, the Company was organized as a sole proprietorship and was not subject to income taxes.  Rather, the Company’s sole stockholder was subject to income taxes on the Company’s taxable activity.  In May 2014, the Company became subject to income taxes and will be subject to Federal and State income taxes as a corporation. 

The Company accounts for income taxes in accordance with ASC 740-10, Income Taxes. Deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at the tax rate expected to be in effect at the time of realization. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.

ASC 740-10 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. Interest and penalties are classified as a component of interest and other expenses. To date, the Company has not been assessed, nor paid, any interest or penalties.

Uncertain tax positions are measured and recorded by establishing a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Only tax positions meeting the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized.

EARNINGS PER SHARE

The Company reports earnings (loss) per share in accordance with ASC 260, "Earnings per Share." Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during each period. Diluted earnings per share is computed by dividing net income by the weighted-average number of shares of common stock, common stock equivalents and other potentially dilutive securities outstanding during the period. For the three months ended March 31, 2015, 10,025,000 shares of common stock underlying convertible debt and warrants have been excluded from the computation of diluted earnings per share. As of March 31, 2014, the Company did not have any outstanding common stock equivalents or any other potentially dilutive securities.

RECENT ACCOUNTING PRONOUNCEMENTS

Recent accounting pronouncements issued by the FASB and the SEC did not have, or are not believed by management to have, a material impact on the Company's present or future financial statements.

NOTE 3 – PURCHASE CONCENTRATION AND CONCENTRATION OF CREDIT RISK

CASH

Financial   instruments   that   potentially   subject   the   Company to concentrations of credit risk consist principally of cash. The Company maintains cash balances at one financial institution, which is insured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses in such accounts.

NOTE 4 – CONVERTIBLE NOTES PAYABLE

In May and June 2014 (the “May and June 2014 Notes”), the Company issued 3 convertible promissory notes, each in the amount of $22,000. The Company received proceeds of $60,000 in the aggregate. Each of the May and June 2014 Notes matured on the six month anniversary of its issuance date, carried interest at 10% and contained a 9.1% original issue discount (“OID”). The OID was amortized over the earlier of the conversion of the note or the maturity date. The holders of the note can convert the notes into shares of common stock at any time from the date of issuance to maturity at $0.20 per share. In December 2014, the Company received conversion notices from the holders of the May and June 2014 Notes and accordingly, recorded the conversion of $66,000 of principal and $4,177 of accrued and unpaid interest of the three convertible promissory notes and 352,242 shares of common stock to be issued at a conversion price of $0.20 per share. The shares were issued in January 2015.

On June 3, 2014, the Board authorized the Company to enter into a Securities Purchase Agreement (“SPA”) with Chicago Venture Partners, L.P. (“CVP”). Pursuant to the SPA, the Company agreed to issue to CVP a Secured Convertible Promissory Note in the principal amount of $1,657,500 (the “Company Note”).

On June 6, 2014, the Company executed the SPA with CVP, for the sale of the Company Note in the principal amount of up to $1,657,500 (which includes CVP’s legal expenses in the amount of $7,500 and a $150,000 OID) for $1,500,000, consisting of $500,000 paid in cash on June 11, 2014 (the “Closing Date”), two $250,000 secured promissory notes and two $250,000 promissory notes (the “Investor Notes”), aggregating $1,000,000, bearing interest at the rate of 10% per annum. The Investor Notes are due 30 months from the Closing Date and may be prepaid, without penalty. 

The Company has no obligation to pay CVP any amounts on any unfunded Investor Notes, which totals $775,000 as of March 31, 2015. Accordingly, the Company initially recorded $557,500 of the convertible promissory note as a liability, comprised of the $500,000 funded, $50,000 OID and $7,500 for CVP’s legal expenses. On October 15, 2014, November 17, 2014 and December 19, 2014, CVP funded $62,500, $62,500 and $35,000, respectively, and the Company increased convertible promissory note by $176,000 including $16,000 of OID. The above OID’s of $66,000 were recorded as interest expense for the year ended December 31, 2014.

The Company has also not recorded the $775,000 remaining balance of the Investor Notes issued by CVP to the Company.

The Company Note bears interest at the rate of 10% per annum. All interest and principal must be repaid on the date that is 30 months after the Closing Date. The CVP Note may be converted at the option of the holder, on the date that is six months from the Trading Date (defined in the Purchase Agreement as the date on which the Common Stock is first trading on an Eligible Market, but in any event the Company shall cause its Common Stock to be trading on an Eligible Market within nine months of the Closing Date of June 11, 2014) or at any time thereafter at a conversion price of $0.1976. The conversion price is equal to $6,500,000 divided by 33,000,000 (the amount of fully diluted shares of Common Stock of the Company on the date the Company filed its’ Registration Statement). If the holder funds $1,500,000 and elects to convert the CVP Note into Common Stock, the number of shares issuable upon conversion will be 8,287,500. In the event the Company elects to prepay all or any portion of the Company Note, the Company is required to pay to CVP an amount in cash equal to 125% multiplied by the sum of all principal, interest and any other amounts owing.

The Company determined that the conversion feature of the convertible note did not meet the criteria of an embedded derivative and therefore the conversion feature was not bi-furcated and accounted for as a derivative because the Company was a private company, there was no quoted price and no active market for the Company’s common stock.

Since the convertible note included an embedded conversion feature that did not qualify to be bi-furcated as a derivative, management evaluated this feature to determine whether it meets the definition of a beneficial conversion feature (“BCF”) within the scope of ASC 470-20, “Debt with Conversion and Other Options”, and determined that a BCF existed.

During the three months ended March 31, 2015, the Company received $65,000 in new funding and increased the Company Note by $71,500 including $6,500 of OID. The Company recorded an initial discount against the new debt for the BCF in the amount of $65,000, to be amortized into interest expense over the term of the loan. Amortization of the discount for the three months ended March 31, 2015 was $1,399.

The Company also issued a five year warrant to CVP to purchase the number of shares equal to $420,000 divided by 70% of the average of the three lowest closing bid prices in the 20 trading days immediately preceding the applicable conversion. Based on the current discounted cash flow valuation, the Company estimated that CVP can purchase 6,000,000 shares of common stock, with an exercise price of $0.20 per share. As of March 31, 2015 and December 31, 2014, based on the Market Price, the Company estimated the number of shares that CVP can purchase to be 1,500,000.

Accounting Standard Codification “ASC” 815 –  Derivatives and Hedging , which provides guidance on determining what types of instruments or embedded features in an instrument issued by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives. These requirements can affect the accounting for warrants issued by the Company. As the conversion features within detachable warrants issued with the Note do not have fixed settlement provisions because their conversion and exercise prices may be lowered if the Company issues securities at lower prices in the future, we have concluded that the warrants are not indexed to the Company’s stock and are to be treated as derivative liabilities.

The warrants were valued using the Black-Scholes option pricing model. In order to calculate the fair value of the warrants, certain assumptions were made regarding components of the model, including the closing price of the underlying common stock, risk-free interest rate, volatility, expected dividend yield, and expected life. Changes to the assumptions could cause significant adjustments to valuation. The Company estimated a volatility factor utilizing a weighted average of comparable published volatilities of peer companies. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of the grant for treasury securities of similar maturity. The warrants associated with the Note were initially valued and recorded a derivative liability of $577,100 using the Black-Scholes valuation methodology and the Company also recorded an initial derivative liability expense of $77,100 and a discount to the Note of $500,000. On December 31, 2014, the Company revalued the warrant at $581,373 using the Black- Scholes option pricing model. On March 31, 2015, the Company revalued the warrant at $560,154 using the Black – Scholes option pricing model and recorded a credit to derivative liability expense of $21,219 for the three months ended March 31, 2015.

The portion of derivative liabilities related to outstanding warrants was valued using the Black-Scholes option using the following assumptions:

The Company amortized $97,908 of the Note discount to interest expense for the three months ending March 31, 2015 and the carrying amount of the Company Note as of March 31, 2015, was $461,887, net of unamortized discounts of $343,113, and as of December 31, 2014, was $357,478, net of the unamortized discount of $376,022.

A summary of the convertible note payable balance as of March 31, 2015 and December 31, 2014 is as follows:

As security for the Company Note, the Company’s CEO and COO each pledged to CVP their 50 shares of Class A Preferred Stock (see Note 8). The pledge immediately expires upon the shares of common stock of the Company being publicly traded and listed or designated for quotation on any of The New York Stock Exchange, NYSE Amex, the Nasdaq Global Select Market, the Nasdaq Global Market, the Nasdaq Capital Market, the OTC Bulletin Board, the OTCQX, or the OTCQB.

NOTE 5 – NOTE PAYABLE, STOCKHOLDER

For the three months ended March 31, 2015 and 2014, a stockholder loaned the Company various amounts for Company expenses. Included in the advances and repayments that follow is the activity from several credit cards that are in the name of the stockholder but were used for Company purposes. The terms of the note include an interest rate of 15% per annum and monthly payments beginning May 15, 2014 of $1,500 through March 15, 2015 and the balance due in a balloon payment on or before April 15, 2015. Interest expense of $229 and $217 was recorded for the three months ended March 31, 2015 and 2014, respectively. The activity for the three months ended March 31, 2015 and for the year ended December 31, 2014 is as follows:

As of March 31, 2015 and December 31, 2014, the Company owed $4,500 to each of the CEO and COO and $2,500 to the CFO, for accrued and unpaid fees, and accordingly $11,500 is included in accounts payable and accrued liabilities, stockholders, on the balance sheets presented herein.

The Company’s COO loaned the Company various amounts for Company expenses. Included in the advances and repayments is the activity from several credit cards that are in the name of the stockholder but were used for Company purposes (see note 6   ). The Company recorded interest expense of $229 and $217 for the three months ended March 31, 2015 and 2014, respectively. As of March 31, 2015 and December 31, 2014, the COO was owed accrued interest of $2,882 and $2,653, respectively, which is included in accounts payable and accrued liabilities, stockholders, on the balance sheets presented herein.

NOTE 7 – COMMITMENTS AND CONTINGENCIES

LEASE AGREEMENTS

Beginning January 1, 2011, the Company (through its COO) leased approximately 1,850 square feet of office and manufacturing space in an industrial complex in Irvine California. The initial lease term expired July 31, 2012. Since that date through July 2014, the Company leased the property on a month to month basis at a cost of $2,138 per month. Effective August 1, 2014, the Company moved into a 4,427 square foot facility under a new lease agreement, in the same industrial complex. The Company entered into a 26 month lease, pursuant to which (i) there is no base rent for the first two months, (ii) beginning October 1, 2014, the monthly lease is $4,870 plus common area maintenance charges of $354, and (iii) beginning October 1, 2015, the monthly rent increases to $5,091. The Company is straight lining the 24 month costs over the 26 month term of the lease. Rent expense was $14,106 and $6,415 for the three months ended March 31, 2015 and 2014, respectively. For the three months ended March 31, 2015 and 2014, the Company allocated $5,642 and $2,566, respectively, of rent expense to cost of goods sold for the space utilized in manufacturing and $8,464 and $3,849 is included in general and administrative expenses for the three months ended March 31, 2015 and 2014, respectively.

NOTE 8 – STOCKHOLDERS’ EQUITY

COMMON STOCK

The Company’s Registration Statement on Form S-1 with the SEC became effective on December 22, 2014. During the three months ended March 31, 2015, the Company sold 502,000 shares of common stock and received $200,800.

CLASS A PREFERRED STOCK

On June 3, 2014, the Company’s Board of Directors adopted and approved the Class A Preferred Stock Certificate of Designation, establishing the terms, conditions and relative rights of the Class A Preferred Stock, including that the holders of the Class A Preferred Stock (the “Class A Holders”) shall have limited voting rights and powers compared to the voting rights and powers of holders of Common Stock and other series of Preferred Stock. The Class A Holders shall be entitled to notice of any shareholders meeting in accordance with the Bylaws of the Corporation, and shall be entitled to vote, but only with respect to the following matters (collectively, the “Class A Voting Matters”): (i) the appointment and/or removal of any member of the Company’s board of directors, (ii) any matter related to or transaction (or series of transactions) pursuant to which the Company would sell or license all or substantially all of its assets or the stockholders of the Company would sell all or substantially all of their shares of the Company’s stock or where the Company would merge with or into any other entity, (iii) causing the Company to register its Common Stock for trading pursuant to the Securities Exchange Act of 1934, as amended, including by filing a Registration Statement on Form S-1 with the Securities Exchange Commission and filing and obtaining FINRA approval of a Form 15c2-11, and (iv) with respect to any matter involving a transaction whereby the Company will become part of or merge into an existing public company. For so   long as Class A Preferred Stock is issued and outstanding, the holders of Class A Preferred Stock shall vote together as a single class with the holders of the Corporation’s Common Stock and the holders of any other class or series of shares entitled to vote with the Common Stock, with the holders of Class A Preferred Stock being entitled to fifty-one percent (51%) of the total votes on   only Class A Preferred Voting Matters regardless of the actual number of shares of Class A Preferred Stock then outstanding, and the holders of Common Stock and any other shares entitled to vote being entitled to their proportional share of the remaining 49% of the total votes based on their respective voting power for any Class A Preferred Voting Matter. The Board also approved the issuance of 50 shares each of the Class A Preferred Stock to the Company’s Chief Executive Officer and Chief Operating Officer.

WARRANTS

The Company issued a five year warrant (which expires on June 30, 2019) to CVP to purchase the number of shares equal to $420,000 divided by 70% of the average of the three lowest closing bid prices in the 20 trading days immediately preceding the applicable conversion. Based on the current discounted cash flow valuation, the Company estimated that CVP can purchase 6,000,000 shares of common stock, with an exercise price of $0.20 per share. See note 5.

NOTE 9 – GOING CONCERN

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As of March 31, 2015 the Company had an accumulated deficit of $2,117,266 and a working capital deficit of $611,510. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Management’s Plans

The Company maintains daily operations and capital needs through the receipts of sales of product and from the proceeds received from the issuance of convertible promissory notes. As of March 31, 2015, the Company has $775,000 of Investor Notes that may be available to be advances to the Company.

We are presently working on introducing an array of product extensions, new products, and subscription based service offerings. We plan to introduce a higher level of automation options as well as expand the offering of scalable packages and accessories. We have developed several innovative product enhancements that we are considering incorporating to our line of products and we may seek to apply for intellectual property protection. An increasing emphasis will be placed on supplies such as nutrients and grow medium which are consumed by system users with each grow cycle and represent a captive recurring revenue opportunity. We are introducing an automated contact and reorder system for our customer base to help grow this revenue stream. We are planning to expand our current line of LEDs for uses in cabinets and also as a standalone offering for larger scale growers. We also plan to offer and expand our premium support services and education. Support and education can be packaged as a monthly subscription service offering live support, advanced training, and even an auto resupply of nutrients and grow media.

In March 2015, the Company introduced its wholesale program, whereby retailers would be able to purchase our products for resale. While the Company’s entire product line is available, the program and product was designed to allow for the retailer to carry a basic cabinet and work with their customer to custom design a cabinet that fits their needs.