NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – DESCRIPTION OF BUSINESS AND
ORGANIZATION
The
accompanying unaudited consolidated condensed financial statements
have been prepared by GrowLife, Inc. “us,”
“we,” or “our”) in accordance with U.S.
generally accepted accounting principles (“GAAP”) for
interim financial reporting and rules and regulations of the
Securities and Exchange Commission. Accordingly, certain
information and footnote disclosures normally included in financial
statements prepared in accordance with GAAP have been condensed or
omitted. In the opinion of our management, all adjustments,
consisting of only normal recurring accruals, necessary for a fair
presentation of the financial position, results of operations, and
cash flows for the fiscal periods presented have been
included.
These
financial statements should be read in conjunction with the audited
financial statements and related notes included in our Annual
Report filed on Form 10-K for the year ended December 31, 2016. The
results of operations for the three months ended March 31, 2017 are
not necessarily indicative of the results expected for the full
fiscal year, or for any other fiscal period.
GrowLife,
Inc. (“GrowLife” or the “Company”) is
incorporated under the laws of the State of Delaware and is
headquartered in Seattle, Washington. The Company was founded in
2012 with the Closing of the Agreement and Plan of Merger with SGT
Merger Corporation
.
The
Company’s goal of becoming the nation’s largest
cultivation facility service provider for the production of
organics, herbs and greens and plant-based medicines has not
changed. The Company’s mission is to best serve more
cultivators in the design, build-out, expansion and maintenance of
their facilities with products of high quality, exceptional value
and competitive price. Through a nationwide network of
knowledgeable representatives, regional centers and its e-commerce
website, GrowLife provides essential and hard-to-find goods
including media (i.e., farming soil), industry-leading hydroponics
equipment, organic plant nutrients, and thousands more products to
specialty grow operations across the United States.
The
Company primarily sells through its wholly owned subsidiary,
GrowLife Hydroponics, Inc. GrowLife companies distribute and sell
over 15,000 products through its e-commerce distribution channel,
GrowLifeEco.com, and through our regional retail storefronts.
GrowLife and its business units are organized and directed to
operate strictly in accordance with all applicable state and
federal laws.
On June
7, 2013, GrowLife Hydroponics completed the purchase of Rocky
Mountain Hydroponics, LLC, a Colorado limited liability company
(“RMC”), and Evergreen Garden Center, LLC, a Maine
limited liability company (“EGC”). The effective date
of the purchase was June 7, 2013. The Company purchased all of the
assets and liabilities of the RMH and EGC Companies, and their
retail hydroponics stores, which are located in Vail and Boulder,
Colorado and Portland, Maine. The Company purchased RMC and EGC
from Rob Hunt, who was appointed to the then Company’s Board
of Directors and President of GrowLife Hydroponics,
Inc.
On February 18, 2016, the Company’s common stock resumed
unsolicited quotation on the OTC Bulletin Board after receiving
clearance from the Financial Industry Regulatory Authority
(“FINRA”) on our Form 15c2-11. The Company is currently
taking the appropriate steps to uplist to the OTCQB Exchange and
resume priced quotations with market makers as soon as it is
able.
NOTE 2
–
GOING CONCERN
The accompanying consolidated financial statements have been
prepared on a going concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the
normal course of business. The Company incurred net losses of
$7,694,684 and $5,688,845 for the years ended December 31, 2016 and
2015, respectively. Our net cash used in operating activities was
$1,212,192 and $1,375,891 for the years ended December 31, 2016 and
2015, respectively.
The Company anticipates that it will record losses from operations
for the foreseeable future. As of March 31, 2017, our accumulated
deficit was $124,587,481.
The Company has
experienced recurring operating losses and negative operating cash
flows since inception, and has financed its working capital
requirements during this period primarily through the recurring
issuance of convertible notes payable and advances from a related
party.
The audit report prepared by
our independent registered public accounting firm relating to our
financial statements for the year ended December 31, 2016 and 2015
filed with the SEC on March 31, 2017 includes an explanatory
paragraph expressing the substantial doubt about our ability to
continue as a going concern.
Continuation of the Company as a going concern is dependent upon
obtaining additional working capital. The financial
statements do not include any adjustments that might be necessary
if we are unable to continue as a going concern.
NOTE 3 –
SIGNIFICANT ACCOUNTING
POLICIES: ADOPTION OF ACCOUNTING STANDARDS
Basis of Presentation -
The accompanying unaudited
consolidated financial statements include the accounts of the
Company. Intercompany accounts and transactions have been
eliminated. The preparation of these unaudited consolidated
financial statements in conformity with U.S. generally accepted
accounting principles (“GAAP”).
Principles of Consolidation
-
The consolidated financial statements include the accounts of the
Company and its wholly owned and majority-owned subsidiaries.
Inter-Company items and transactions have been eliminated in
consolidation.
Cash and Cash Equivalents
- The
Company classifies highly liquid temporary investments with an
original maturity of 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 -
Revenue is recognized on
the sale of a product when the product is shipped, which is when
the risk of loss transfers to our customers, the fee is fixed and
determinable, and collection of the sale is reasonably assured. A
product is not shipped without an order from the customer and the
completion of credit acceptance procedures. The majority of our
sales are cash or credit card; however, we occasionally extend
terms to our customers. Accounts receivable are reviewed
periodically for collectability.
Inventories -
Inventories are recorded on a first in first
out basis. Inventory consists of raw materials, purchased finished
goods and components held for resale. Inventory is valued at the
lower of cost or market. The reserve for inventory was $20,000 as
of March 31, 2017 and Decem
ber
31,
2016, respectively.
Goodwill and Intangible Assets -
The Company evaluates the
carrying value of goodwill, intangible assets, and long-lived
assets during the fourth quarter of each year and between annual
evaluations if events occur or circumstances change that would more
likely than not reduce the fair value of the reporting unit below
its carrying amount. Such circumstances could include, but are not
limited to (1) a significant adverse change in legal factors or in
business climate, (2) unanticipated competition, (3) an adverse
action or assessment by a regulator, (4) continued losses from
operations, (5) continued negative cash flows from operations, and
(6) the suspension of trading of the Company’s securities.
When evaluating whether goodwill is impaired, the Company compares
the fair value of the reporting unit to which the goodwill is
assigned to the reporting unit’s carrying amount, including
goodwill. The fair value of the reporting unit is estimated using a
combination of the income, or discounted cash flows, approach and
the market approach, which utilizes comparable companies’
data. If the carrying amount of a reporting unit exceeds its fair
value, then the amount of the impairment loss must be measured. The
impairment loss would be calculated by comparing the implied fair
value of reporting unit goodwill to its carrying amount. In
calculating the implied fair value of reporting unit goodwill, the
fair value of the reporting unit is allocated to all of the other
assets and liabilities of that unit based on their fair values. The
excess of the fair value of a reporting unit over the amount
assigned to its other assets and liabilities is the implied fair
value of goodwill.
The
Company amortizes the cost of other intangible assets over their
estimated useful lives, which range up to ten years, unless such
lives are deemed indefinite. Intangible assets with indefinite
lives are tested in the fourth quarter of each fiscal year for
impairment, or more often if indicators warrant.
On
March 10, 2017, the Audit Committee
reviewed the GrowLife Hydroponics, Inc. operations
and based on the capital intensive nature of the business and
operating results determined that the goodwill value of $739,000
and intangible assets of $137,056 were impaired as of December 31,
2016. The Company recorded an impairment of goodwill and intangible
assets associated with GrowLife Hydroponics, Inc. of $876,056 as
general and administrative expenses during the three months ended
December 31, 2016.
Long Lived Assets
– The
Company reviews its long-lived assets for impairment annually or
when changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Long-lived assets under certain
circumstances are reported at the lower of carrying amount or fair
value. Assets to be disposed of and assets not expected to provide
any future service potential to the Company are recorded at the
lower of carrying amount or fair value (less the projected cost
associated with selling the asset). To the extent carrying values
exceed fair values, an impairment loss is recognized in operating
results.
Fair Value Measurements and Financial Instruments -
ASC
Topic 820 defines fair value, establishes a framework for measuring
fair value, establishes a three-level valuation hierarchy for
disclosure of fair value measurement and enhances disclosure
requirements for fair value measurements. The valuation hierarchy
is based upon the transparency of inputs to the valuation of an
asset or liability as of the measurement date. The three levels are
defined as follows:
Level 1
- Inputs to the valuation methodology are quoted prices
(unadjusted) for identical assets or liabilities in active
markets.
Level 2
- Inputs to the valuation methodology include quoted prices for
similar assets and liabilities in active markets, and inputs that
are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the financial
instrument.
Level 3
- Inputs to the valuation methodology are unobservable and
significant to the fair value measurement.
The
carrying value of cash, accounts receivable, investment in a
related party, accounts payables, accrued expenses, due to related
party, notes payable, and convertible notes approximates their fair
values due to their short-term maturities.
Derivative financial instruments -
The Company evaluates all
of its financial instruments to determine if such instruments are
derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are
accounted for as liabilities, the derivative instrument is
initially recorded at its fair value and is then re-valued at each
reporting date, with changes in the fair value reported in the
consolidated statements of operations. For stock-based derivative
financial instruments, the Company uses a weighted average
Black-Scholes-Merton option pricing model to value the derivative
instruments at inception and on subsequent valuation dates. The
classification of derivative instruments, including whether such
instruments should be recorded as liabilities or as equity, is
evaluated at the end of each reporting period. Derivative
instrument liabilities are classified in the balance sheet as
current or non-current based on whether or not net-cash settlement
of the derivative instrument could be required within twelve months
of the balance sheet date.
Sales Returns -
We allow customers to return defective
products when they meet certain established criteria as outlined in
our sales terms and conditions. It is our practice to regularly
review and revise, when deemed necessary, our estimates of sales
returns, which are based primarily on actual historical return
rates. We record estimated sales returns as reductions to sales,
cost of goods sold, and accounts receivable and an increase to
inventory. Returned products which are recorded as inventory are
valued based upon the amount we expect to realize upon its
subsequent disposition. As of March 31, 2017 and December 31, 2016,
there was no reserve for sales returns, which are minimal based
upon our historical experience.
Stock Based Compensation
- The
Company has share-based compensation plans under which employees,
consultants, suppliers and directors may be granted restricted
stock, as well as options and warrants to purchase shares of
Company common stock at the fair market value at the time of grant.
Stock-based compensation cost to employees is measured by the
Company at the grant date, based on the fair value of the award,
over the requisite service period under ASC 718. For options issued
to employees, the Company recognizes stock compensation costs
utilizing the fair value methodology over the related period of
benefit. Grants of stock to non-employees and other
parties are accounted for in accordance with the ASC
505.
Net (Loss) Per Share -
Under
the provisions of ASC 260, “Earnings per Share,” basic
loss per common share is computed by dividing net loss available to
common shareholders by the weighted average number of shares of
common stock outstanding for the periods presented. Diluted net
loss per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised
or converted into common stock or resulted in the issuance of
common stock that would then share in the income of the Company,
subject to anti-dilution limitations. The common stock equivalents
have not been included as they are anti-dilutive.
As of
March 31, 2017
, there are also
(i) stock option grants outstanding for the purchase of 12,010,000
common shares at a $0.010 average strike price; (ii) warrants for
the purchase of 595 million common shares at a $0.031 average
exercise price; and (iii) 130,106,389
shares related to convertible debt that can be
converted at $0.0036 per share. In addition, we have an unknown
number of common shares to be issued under the
Chicago
Venture Partners, L.P.
financing
agreements.
As of March 31, 2016, there are also (i) stock
option grants outstanding for the purchase of 29.0 million common
shares at a $0.028 average strike price; (ii) warrants for the
purchase of 565.0 million common shares at a $0.032 average
exercise price; (iii) 164.0 million
shares related to convertible debt that can be
converted at 0.007 per share; and (iv) 6.0 million shares that may
be issued to a former executive related to a severance agreement.
On April 6, 2016, we issued $2 million in common stock or
115,141,048 shares of our common stock pursuant to the settlement
of the Consolidated Class Action and Derivative Action lawsuits
alleging violations of federal securities laws that were filed
against the Company in United States District Court, Central
District of California. In addition, as of March 31, 2016 we had an
unknown number of common shares to be issued under the TCA
financing agreements.
Dividend Policy
- The Company
has never paid any cash dividends and intends, for the foreseeable
future, to retain any future earnings for the development of our
business. Our future dividend policy will be determined by the
board of directors on the basis of various factors, including our
results of operations, financial condition, capital requirements
and investment opportunities.
Use of Estimates -
In preparing these unaudited interim
consolidated financial statements in conformity with GAAP,
management is required to make estimates and assumptions that may
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of
the consolidated financial statements and the reported amount of
revenues and expenses during the reporting periods. Actual results
could differ from those estimates. Significant estimates and
assumptions included in our consolidated financial statements
relate to the valuation of long-lived assets, estimates of sales
returns, inventory reserves and accruals for potential liabilities,
and valuation assumptions related to derivative liability, equity
instruments and share based compensation.
Recent Accounting Pronouncements
A variety of proposed or otherwise potential accounting standards
are currently under study by standard setting organizations and
various regulatory agencies. Due to the tentative and preliminary
nature of those proposed standards, management has not determined
whether implementation of such proposed standards would be material
to the Company’s consolidated financial
statements.
NOTE 4 – TRANSACTIONS WITH CANX USA, LLC AND LOGIC WORKS
LLC
Transactions with CANX, LLC and Logic Works LLC
On
November 19, 2013, the Company entered into a Joint Venture
Agreement with CANX, a Nevada limited liability
company. Under the terms of the Joint Venture Agreement,
the Company and CANX formed Organic Growth International, LLC
(“OGI”), a Nevada limited liability company, for the
purpose of expanding the Company’s operations in its current
retail hydroponic businesses and in other synergistic business
verticals and facilitating additional funding for commercially
financeable transactions of up to $40,000,000.
The
Company initially owned a non-dilutive 45% share of OGI and the
Company could acquire a controlling share of OGI as provided in the
Joint Venture Agreement. In accordance with the Joint Venture
Agreement, the Company and CANX entered into a Warrant Agreement
whereby the Company delivered to CANX a warrant to purchase
140,000,000 shares of the Company common stock that is convertible
at $0.033 per share, subject to adjustment as provided in the
warrant. The five-year warrant expires November 18, 2018. Also, in
accordance with the Joint Venture Agreement, on February 7, 2014
the Company issued an additional warrant to purchase 100,000,000
shares of our common stock that is convertible at $0.033 per share,
subject to adjustment as provided in the warrant. The five-year
warrant expires February 6, 2019.
GrowLife
received the $1 million as a convertible note in December 2013,
received the $1.3 million commitment but not executed and by
January 2014 OGI had Letters of Intent with four investment and
acquisition transactions valued at $96 million. Before the deals
could close, the SEC put a trading halt on our stock on April 10,
2014, which resulted in the withdrawal of all transactions. The
business disruption from the trading halt and the resulting class
action and derivative lawsuits ceased further investments with the
OGI joint venture. The Convertible Note was converted into
GrowLife, Inc. common stock as of the year ended December 31,
2016.
On July
10, 2014, the Company closed a Waiver and Modification Agreement,
Amended and Restated Joint Venture Agreement, Secured Credit
Facility and Secured Convertible Note with CANX and Logic Works
LLC, a lender and shareholder of the Company.
The
Amended and Restated Joint Venture Agreement with CANX modified the
Joint Venture Agreement dated November 19, 2013 to provide for (i)
up to $12,000,000 in conditional financing subject to review by
GrowLife and approval by OGI for business growth development
opportunities in the legal cannabis industry for up to nine months,
subject to extension; (ii) up to $10,000,000 in working capital
loans, with each loan requiring approval in advance by CANX; (iii)
confirmed that the five year warrants, subject to adjustment, at
$0.033 per share for the purchase of 140,000,000 and 100,000,000
were fully earned and were not considered compensation for tax
purposes by the Company; (iv) granted CANX five year warrants,
subject to adjustment, to purchase 300,000,000 shares of common
stock at the fair market price of $0.033 per share as determined by
an independent appraisal; (v) warrants as defined in the Agreement
related to the achievement of OGI milestones; and (vi) a four year
term, subject to adjustment.
The
Company entered into a Secured Convertible Note and Secured Credit
Facility dated June 25, 2014 with Logic Works whereby Logic Works
agreed to provide up to $500,000 in funding. Each funding required
approval in advance by Logic Works, provided interest at 6% with a
default interest of 24% per annum and requires repayment by June
26, 2016. The Note is convertible into common stock of the Company
at the lesser of $0.0070 or (B) twenty percent (20%) of the average
of the three (3) lowest daily VWAPs occurring during the twenty
(20) consecutive Trading Days immediately preceding the applicable
conversion date on which Logic Works elects to convert all or part
of this 6% Convertible Note, subject to adjustment as provided in
the Note. The 6% Convertible Note is collateralized by the assets
of the Company.
As of
March 31, 2017, the outstanding balance on the Convertible Note was
$39,251.
OGI was
incorporated on January 7, 2014 in the State of Nevada and had no
business activities as of December 31, 2016.
NOTE 5 – INVENTORY
Inventory
as of March 31, 2017 and December 31, 2016 consists of the
following:
|
|
|
|
|
|
|
|
|
Finished
goods
|
$
438,494
|
$
438,453
|
Inventory
reserve
|
(20,000
)
|
(20,000
)
|
Total
|
$
418,494
|
$
418,453
|
Finished
goods inventory relates to product at the Company’s retail
stores, which is product purchased from distributors, and in some
cases directly from the manufacturer, and resold at our
stores.
The
Company reviews its inventory on a periodic basis to identify
products that are slow moving and/or obsolete, and if such products
are identified, the Company records the appropriate inventory
impairment charge at such time.
NOTE 6 – CONVERTIBLE NOTES PAYABLE, NET
Convertible
notes payable as of
March 31,
2017
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6%
Secured convertible note (2014)
|
$
39,251
|
$
221
|
$
-
|
$
39,472
|
7%
Convertible note ($850,000)
|
250,000
|
178,932
|
-
|
428,932
|
10%
OID Convertible Promissory Note with Chicago Venture Partners,
L.P.
|
1,539,063
|
18,333
|
(59,785
)
|
1,497,611
|
|
$
1,828,314
|
$
197,486
|
$
(59,785
)
|
$
1,966,015
|
Convertible
notes payable as of
December
31,
2016 consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6%
Secured convertible note (2014)
|
$
330,295
|
$
3,692
|
$
-
|
$
333,987
|
7%
Convertible note ($850,000)
|
250,000
|
164,137
|
-
|
414,137
|
Replacement
debenture with TCA ($2,830,210)
|
1,468,009
|
18,350
|
-
|
1,486,359
|
10%
OID Convertible Promissory Note with Chicago Venture Partners,
L.P.
|
683,042
|
2,670
|
(121,395
)
|
564,317
|
|
$
2,731,346
|
$
188,849
|
$
(121,395
)
|
$
2,798,800
|
Several of the Company’s convertible promissory notes remain
outstanding beyond their respective maturity dates. This may
trigger an event of default under the respective agreements. The
Company is working with these noteholders to convert their notes
into common stock and intends to resolve these outstanding issues
as soon as practicable.
As a result, the Company accrued
interest on these notes at the default rates. Furthermore, as a
result of being in default on these notes, the Holders could, at
their sole discretion, have called these notes. Although no such
action has been taken by the Holders, the Company classified these
notes as a current liability as of March 31, 2017 and December 31,
2016.
6% Secured Convertible Note and Secured Credit Facility
(2014)
The
Company entered into a Secured Convertible Note and Secured Credit
Facility dated June 25, 2014 with Logic Works whereby Logic Works
agreed to provide up to $500,000 in funding. Logic Works funded
$350,000. The funding provided for interest at 6% with a default
interest of 24% per annum and required repayment by June 26, 2016.
The Note is convertible into common stock of the Company at the
lesser of $0.007 or (B) twenty percent (20%) of the average of the
three (3) lowest daily VWAPs occurring during the twenty (20)
consecutive Trading Days immediately preceding the applicable
conversion date on which Logic Works elects to convert all or part
of this 6% Convertible Note, subject to adjustment as provided in
the Note. On February 28, 2017, Logic Works converted principal and
interest of $291,044 into 82,640,392 shares of our common stock at
a per share conversion price of $.004. As of March 31, 2017, the
outstanding principal on this 6% convertible note was $39,251 and
accrued interest was $221, which results in a total liability of
$39,472.
7% Convertible Notes Payable
On
October 11, 2013, the Company issued 7% Convertible Notes in the
aggregate amount of $850,000 to investors, including $250,000 to
Forglen LLC. The Note was due September 30, 2015. All other Notes
were converted in 2014. On
July 14, 2014, the Board of
Directors approved a Settlement Agreement and Waiver of Default
dated June 19, 2014 with Forglen related to the 7% Convertible
Note. The current annual rate of interest was increased to 24% per
annum. The conversion price was $0.007 per share, subject to
adjustment as provided in the Note. As of
March 31, 2017
, the outstanding principal
on this 7% convertible note was $250,000 and accrued interest was
$178,932, which results in a total liability of
$428,932.
Funding from Chicago Venture Partners, L.P. (“Chicago
Venture”)
The Company has the following funding transactions with Chicago
Venture:
Securities Purchase Agreement with Chicago Venture Partners,
L.P.
As of April 4, 2016, the Company entered into a
Securities Purchase Agreement and Convertible Promissory Note (the
“Chicago Venture Note”) with Chicago Venture, whereby
we agreed to sell, and Chicago Venture agreed to purchase an
unsecured convertible promissory note in the original principal
amount of $2,755,000. In connection with the transaction, the
Company received $350,000 in cash as well as a series of twelve
Secured Investor Notes for a total Purchase Price of $2,500,000.
The Note carries an Original Issue Discount (“OID”) of
$250,000 and we agreed to pay $5,000 to cover Purchaser’s
legal fees, accounting costs and other transaction
expenses.
Debt Purchase Agreement and First Amendment to Debt Purchase
Agreement and Note Assignment Agreement.
On August 24, 2016, the Company closed a Debt
Purchase Agreement and a First Amendment to Debt Purchase Agreement
and related agreements with Chicago Venture and
TCA.
On August 24, 2016, TCA closed an Assignment of Note Agreement and
related agreements with Chicago Venture. The referenced agreements
relate to the assignment of Company debt, in the form of
debentures, by TCA to Chicago Venture. The Company was a party to
the agreements between TCA and Chicago Venture because the Company
is the “borrower” under the TCA held
debentures.
Exchange Agreement, Convertible Promissory Note and related
Agreements with Chicago Venture.
On August 17, 2016, the Company closed an Exchange
Agreement and a Convertible Promissory Note and related agreements
with Chicago Venture whereby the Company agreed to the assignment
of debentures representing debt between the Company, on the one
hand, and with
TCA, on the other hand. Specifically, the
Company agreed that TCA could assign a portion of the
Company’s debt held by TCA to Chicago Venture.
On January 10, 2017, Chicago Venture, at the Company’s
instruction, remitted funds of $1,495,901 to TCA in order to
satisfy all debts to TCA. On or around January 11, 2017, the
Company was notified by TCA that $13,540 were due to TCA in order
for TCA to release its security interest in the Company’s
assets. On February 1, 2017, TCA notified the Company that all
funds were received and TCA would release its security interest in
Company’s assets. TCA has confirmed that it is paid in full
and the Company is not aware of any other obligations that the
Company has as to TCA. The funds received under the Chicago Venture
Agreements and previous Chicago Venture Agreements were used to
pay-off TCA.
Debt Purchase Agreement and First Amendment to Debt Purchase
Agreement and Note Assignment Agreement.
On August 24, 2016, the Company closed a Debt
Purchase Agreement and a First Amendment to Debt Purchase Agreement
and related agreements with Chicago Venture and
TCA.
On February 1, 2017, the Company closed the transactions described
below with Chicago Venture:
Securities Purchase Agreement, Secured Promissory Notes, Membership
Interest Pledge Agreement and Security Agreement
On January 9, 2017, the Company executed the following agreements
with Chicago Venture: (i) Securities Purchase Agreement; (ii)
Secured Promissory Notes; (iii) Membership Interest Pledge
Agreement; and (iv) Security Agreement (collectively the
“Chicago Venture Agreements”). The Company entered into
the Chicago Venture Agreements with the intent of paying its debt,
in full, to TCA Global Credit Master Fund, LP
(“TCA”).
The total amount of funding under the Chicago Venture Agreements is
$1,105,000. Each Convertible Promissory Note carries an original
issue discount of $100,000 and a transaction expense amount of
$5,000, for total debt of $1,105,000. The Company agreed to reserve
500,000,000 of its shares of common stock for issuance upon
conversion of the Debt, if that occurs in the future. If not
converted sooner, the Debt is due on or before January 9, 2018. The
Debt carries an interest rate of 10%. The Debt is convertible, at
Chicago Venture’s option, into the Company’s common
stock at $0.009 per share subject to adjustment as provided for in
the Secured Promissory Notes attached hereto and incorporated
herein by this reference.
Chicago Venture’s obligation to fund the Debt was secured by
Chicago Venture’s 60% interest in Typenex Medical, LLC, an
Illinois corporation, as provided for in the Membership Pledge
Agreement.
The Company’s obligation to pay the Debt, or any portion
thereof, is secured by all Company’s assets.
Payment of All TCA Obligations
On January 10, 2017, Chicago Venture, at the Company’s
instruction, remitted funds of $1,495,901 to TCA in order to
satisfy all debts to TCA. On or around January 11, 2017, the
Company was notified by TCA that $13,540 were due to TCA in order
for TCA to release its security interest in the Company’s
assets. On February 1, 2017, TCA notified the Company that all
funds were received and TCA released its security interest in
Company’s assets. TCA has confirmed that it is paid in full
and the Company is not aware of any other obligations that the
Company has as to TCA.
As
of March 31, 2017
, the
outstanding balance due to Chicago Venture is $1,539,063, accrued
interest was $18,333, net of the OID of $59,785, which results in a
net amount of $1,497,611. The OID has been recorded as a discount
to debt and $61,610 was amortized to interest expense during the
three months ended March 31, 2017.
During
the three months ended March 31, 2017, Chicago Venture converted
principal and accrued interest of $1,253,000 into 189,189,198
shares of our common stock at a per share conversion price of
$0.0066.
The
Company recognized $1,367,400 of loss on debt conversions during
the three months ended March 31, 2017.
NOTE 7 – DERIVATIVE LIABILITY
In
April 2008, the FASB issued a pronouncement that provides guidance
on determining what types of instruments or embedded features in an
instrument held by a reporting entity can be considered indexed to
its own stock for the purpose of evaluating the first criteria of
the scope exception in the pronouncement on accounting for
derivatives. This pronouncement was effective for financial
statements issued for fiscal years beginning after December 15,
2008. The adoption of these requirements can affect the accounting
for warrants and many convertible instruments with provisions that
protect holders from a decline in the stock price (or
“down-round” provisions). For example, warrants or
conversion features with such provisions are no longer recorded in
equity. Down-round provisions reduce the exercise price of a
warrant or convertible instrument if a company either issues equity
shares for a price that is lower than the exercise price of those
instruments or issues new warrants or convertible instruments that
have a lower exercise price.
Derivative
liability as of
March 31, 2017
is as follows:
|
|
|
|
|
|
Fair Value Measurements Using Inputs
|
|
Financial
Instruments
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Derivative
Instruments
|
$
-
|
$
910,745
|
$
-
|
$
910,745
|
|
|
|
|
|
Total
|
$
-
|
$
910,745
|
$
-
|
$
910,745
|
For the
three months ended March 31, 2017, the Company recorded non-cash
income of $1,790,814 related to the “change in fair value of
derivative” expense related to its 6% and 7% convertible
notes.
Derivative
liability as of
December 31,
2016
was as follows:
|
|
|
|
|
|
Fair Value Measurements Using Inputs
|
|
Financial
Instruments
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Derivative
Instruments
|
$
-
|
$
2,701,559
|
$
-
|
$
2,701,559
|
|
|
|
|
|
Total
|
$
-
|
$
2,701,559
|
$
-
|
$
2,701,559
|
For the year ended December 31,
2016, the Company recorded non-cash income of $1,324,384 related to
the “change in fair value of derivative” expense
related to its 6%, 7% and 18% convertible notes
The
risk-free rate of return reflects the interest rate for the United
States Treasury Note with similar time-to-maturity to that of the
warrants.
7% Convertible Notes
As of
December 31, 2015, the Company had outstanding 7% convertible notes
for $500,000 that the Company determined had an embedded derivative
liability due to the “reset” clause associated with the
note’s conversion price. The Company valued the derivative
liability of these notes at $105,515 using the Black-Scholes-Merton
option pricing model, which approximates the Monte Carlo and other
binomial valuation techniques, with the following
assumptions (i) dividend yield of 0%; (ii) expected volatility
of 133.2%; (iii) risk free rate of .001%, (iv) stock price of
$.005, (v) per share conversion price of $0.007, and (vi) expected
term of .25 years, as the Company estimated that these notes would
be converted by March 31, 2016.
As of
December 31,
2016, the Company
had outstanding 7% convertible notes with a remaining balance of
$250,000 that the Company determined had an embedded derivative
liability due to the “reset” clause associated with the
note’s conversion price. The Company valued the derivative
liability of these notes at $1,495,495 using the
Black-Scholes-Merton option pricing model, which approximates the
Monte Carlo and other binomial valuation techniques, with the
following assumptions (i) dividend yield of 0%; (ii) expected
volatility of 160.0%; (iii) risk free rate of .001%, (iv) stock
price of $0.017, (v) per share conversion price of $0.0036, and
(vi) expected term of .25 years, as the Company estimated that the
balance of these notes will be converted by March 31,
2017.
As of
March 31, 2017
, the Company had
outstanding 7% convertible notes with a remaining balance of
$250,000 that the Company determined had an embedded derivative
liability due to the “reset” clause associated with the
note’s conversion price. The Company valued the derivative
liability of these notes at $834,034 using the Black-Scholes-Merton
option pricing model, which approximates the Monte Carlo and other
binomial valuation techniques, with the following
assumptions (i) dividend yield of 0%; (ii) expected volatility
of 145.8%; (iii) risk free rate of .001%, (iv) stock price of
$0.010, (v) per share conversion price of $0.0036, and (vi)
expected term of .25 years, as the Company estimates that the
balance of these notes will be converted by June 30,
2017.
6% Convertible Notes
As of
December 31, 2015, the Company had outstanding unsecured 6%
convertible notes for $350,000 that the Company determined were a
derivative liability due to the “reset” clause
associated with the note’s conversion price. The Company
valued the derivative liability of these notes at $54,377 using the
Black-Scholes-Merton option pricing model. which approximates
the Monte Carlo and other binomial valuation techniques, with the
following assumptions (i) dividend yield of 0%; (ii) expected
volatility of 133.2%; (iii) risk free rate of 0.34%, (iv) stock
price of $0.005, (v) per share conversion price of $0.007, and (vi)
expected term of .56 years.
As of
December 31,
2016, the Company
had outstanding unsecured 6% convertible notes for $330,295 that
the Company determined had an embedded derivative liability due to
the “reset” clause associated with the note’s
conversion price. The Company valued the derivative liability of
these notes at $1,206,064 using the Black-Scholes-Merton option
pricing model, which approximates the Monte Carlo and other
binomial valuation techniques, with the following
assumptions (i) dividend yield of 0%; (ii) expected volatility
of 160.0%; (iii) risk free rate of .001%, (iv) stock price of
$0.017, (v) per share conversion price of $0.0036, and (vi)
expected term of .25 years, as the Company estimates that these
notes would be converted by March 31, 2017.
As of
March 31, 2017
, the Company had
outstanding unsecured 6% convertible notes for $39,251 that the
Company determined had an embedded derivative liability due to the
“reset” clause associated with the note’s
conversion price. The Company valued the derivative liability of
these notes at $76,710 using the Black-Scholes-Merton option
pricing model, which approximates the Monte Carlo and other
binomial valuation techniques, with the following
assumptions (i) dividend yield of 0%; (ii) expected volatility
of 145.8%; (iii) risk free rate of .001%, (iv) stock price of
$0.010, (v) per share conversion price of $0.0036, and (vi)
expected term of .25 years, as the Company estimates that the
balance of these notes will be converted by June 30,
2017.
NOTE 8 –
RELATED PARTY
TRANSACTIONS AND CERTAIN RELATIONSHIPS
Since
January 1, 2017, the Company engaged in the reportable transaction
below with the Company’s directors, executive officers,
holders of more than 5% of our voting securities, and affiliates or
immediately family members of our directors, executive officers and
holders of more than 5% of our voting securities.
On
February 4, 2017, the Company issued 1,000,000 shares of its common
stock to Michael E. Fasci, a Board Director, pursuant to a service
award for $15,000. The shares were valued at the fair market price
of $0.015 per share.
Certain Relationships
Please
see the transactions with CANX, LLC and Logic Works in Note 5, TCA
Global Credit Master Fund LP and Chicago Venture Partners, L.P.
discussed in Note 4, 6, 7 and 9.
NOTE 9 – EQUITY
Authorized Capital Stock
The
Company has authorized 3,010,000,000 shares of capital stock, of
which 3,000,000,000 are shares of voting common stock, par value
$0.0001 per share, and 10,000,000 are shares of preferred stock,
par value $0.0001 per share.
Non-Voting Preferred Stock
Under
the terms of our articles of incorporation, the Company’s
board of directors is authorized to issue shares of non-voting
preferred stock in one or more series without stockholder approval.
The Company’s board of directors has the discretion to
determine the rights, preferences, privileges and restrictions,
dividend rights, conversion rights, redemption privileges and
liquidation preferences, of each series of non-voting preferred
stock.
The
purpose of authorizing the Company’s board of directors to
issue non-voting preferred stock and determine the Company’s
rights and preferences is to eliminate delays associated with a
stockholder vote on specific issuances. The issuance of non-voting
preferred stock, while providing flexibility in connection with
possible acquisitions, future financings and other corporate
purposes, could have the effect of making it more difficult for a
third party to acquire, or could discourage a third party from
seeking to acquire, a majority of our outstanding voting stock.
Other than the Series B and C Preferred Stock discussed below,
there are no shares of non-voting preferred stock presently
outstanding and we have no present plans to issue any shares of
preferred stock.
Series C Preferred Stock Designation
In
connection with the Amended and Restated Securities Purchase
Agreement with TCA, the Board of Directors, on October 21, 2015,
approved the authorization of a Series C Preferred Stock as
provided in the Company’s Certificate of Incorporation, as
amended, and the issuance of 51 shares of Series C Preferred Stock.
These shares only have voting rights in the event of a default by
us under the Amended and Restated Transaction Documents. The Series
C Preferred Stock is cancelled with the repayment of the TCA
debt.
The
Series C Preferred Stock Designation authorizes 51 shares of Series
C Preferred Stock. Series C Preferred Stock is not entitled to
dividend or liquidation rights and is not convertible into our
common stock.
In
connection with the closing of the Chicago Venture transactions
which closed on February 1, 2017, TCA surrendered the Series C
Preferred Stock.
Common Stock
Unless otherwise indicated, all of the following sales or issuances
of Company securities were conducted under the exemption from
registration as provided under Section 4(2) of the Securities Act
of 1933 (and also qualified for exemption under 4(5), formerly 4(6)
of the Securities Act of 1933, except as noted below). All of the
shares issued were issued in transactions not involving a public
offering, are considered to be restricted stock as defined in Rule
144 promulgated under the Securities Act of 1933 and stock
certificates issued with respect thereto bear legends to that
effect.
The Company has compensated consultants and service providers with
restricted common stock during the development of our business and
when our capital resources were not adequate to provide payment in
cash.
During the three months ended March 31, 2017, the Company had had
the following sales of unregistered of equity securities to
accredited investors unless otherwise indicated:
On
January 2, 2017, Brighton Capital LLC converted debt of $127,148
into 15,893,500 shares of our common stock at a per share
conversion price of $0.008.
On
February 4, 2017, the Company issued 1,000,000 shares of its common
stock to Michael E. Fasci, a Board Director, pursuant to a service
award for $15,000. The shares were valued at the fair market price
of $0.015 per share.
On
February 28, 2017, Logic Works converted principal and interest of
$291,044 into 82,640,392 shares of our common stock at a per share
conversion price of $.004.
During
the three months ended March 31, 2017, Chicago Venture converted
principal and interest of $1,253,000 into 189,189,197 shares of our
common stock at a per share conversion price of
$0.007.
Warrants
The
Company did not issue any warrants during the three months ended
March 31, 2017.
A
summary of the warrants issued as of
March 31, 2017
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at beginning of period
|
595,000,000
|
$
0.031
|
Issued
|
-
|
-
|
Exercised
|
-
|
-
|
Forfeited
|
-
|
-
|
Expired
|
-
|
-
|
Outstanding
at end of period
|
595,000,000
|
$
0.031
|
Exerciseable
at end of period
|
595,000,000
|
|
A
summary of the status of the warrants outstanding as of
March 31, 2017
is presented
below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
540,000,000
|
2.03
|
$
0.033
|
540,000,000
|
$
0.033
|
55,000,000
|
3.29
|
0.010
|
35,000,000
|
0.010
|
|
|
|
|
|
|
|
|
|
|
595,000,000
|
2.07
|
$
0.031
|
575,000,000
|
$
0.032
|
Warrants
totaling 35,000,000 shares of common stock had no intrinsic value
as of
March 31,
2017
.
NOTE 10– STOCK OPTIONS
Description of Stock Option Plan
In
fiscal year 2011, the Company authorized a Stock Incentive Plan
whereby a maximum of 18,870,184 shares of the Company’s
common stock could be granted in the form of Non-Qualified Stock
Options, Incentive Stock Options, Stock Appreciation Rights,
Restricted Stock, Restricted Stock Units, and Other Stock-Based
Awards. On April 18, 2013, the Company’s Board of Directors
voted to increase to 35,000,000 the maximum allowable shares of the
Company’s common stock allocated to the 2011 Stock Incentive
Plan. The Company has outstanding unexercised stock option grants
totaling 12,010,000 shares as of March 31, 2017. All grants are
non-qualified as the plan was not approved by the shareholders
within one year of its adoption.
Determining Fair Value under ASC 505
The Company records compensation expense associated with stock
options and other equity-based compensation using the
Black-Scholes-Merton option valuation model for estimating fair
value of stock options granted under our plan. The Company
amortizes the fair value of stock options on a ratable basis over
the requisite service periods, which are generally the vesting
periods. The expected life of awards granted represents the period
of time that they are expected to be outstanding. The
Company estimates the volatility of our common stock based on the
historical volatility of its own common stock over the most recent
period corresponding with the estimated expected life of the award.
The Company bases the risk-free interest rate used in the Black
Scholes-Merton option valuation model on the implied yield
currently available on U.S. Treasury zero-coupon issues with an
equivalent remaining term equal to the expected life of the award.
The Company has not paid any cash dividends on our common stock and
does not anticipate paying any cash dividends in the foreseeable
future. Consequently, the Company uses an expected dividend yield
of zero in the Black-Scholes-Merton option valuation model and
adjusts share-based compensation for changes to the estimate of
expected equity award forfeitures based on actual forfeiture
experience. The effect of adjusting the forfeiture rate is
recognized in the period the forfeiture estimate is
changed.
Stock Option Activity
During the three months ended March 31, 2017, the Company had the
following stock option activity:
As of March 31, 2017, there are 12,010,000 options to purchase
common stock at an average exercise price of $0.010 per share
outstanding under the 2011 Stock Incentive Plan. The Company
recorded $7,541 and $32,520 of compensation expense, net of related
tax effects, relative to stock options for the three months ended
March 31, 2017 and 2016 in accordance with ASC 505. Net loss per
share (basic and diluted) associated with this expense was
approximately ($0.00). As of March 31, 2017, there is $15,090 of
total unrecognized costs related to employee granted stock options
that are not vested. These costs are expected to be recognized over
a period of approximately 2.63 years.
Stock option activity for the three months ended March 31, 2017 and
the years ended December 31, 2016 and 2015 is as
follows:
|
|
|
|
|
|
|
|
Outstanding
as of December 31, 2014
|
40,720,000
|
$
0.058
|
$
2,356,000
|
Granted
|
-
|
-
|
(960,000
)
|
Exercised
|
-
|
-
|
-
|
Forfeitures
|
(11,700,000
)
|
(0.050
)
|
(585,000
)
|
Outstanding
as of December 31, 2015
|
29,020,000
|
0.028
|
811,000
|
Granted
|
-
|
-
|
-
|
Exercised
|
-
|
-
|
-
|
Forfeitures
|
(17,010,000
)
|
(0.041
)
|
(690,500
)
|
Outstanding
as of December 31, 2016
|
12,010,000
|
$
0.010
|
$
120,500
|
Granted
|
-
|
-
|
-
|
Exercised
|
-
|
-
|
-
|
Forfeitures
|
-
|
-
|
-
|
Outstanding
as of March 31, 2017
|
12,010,000
|
$
0.010
|
$
120,500
|
The following table summarizes information about stock options
outstanding and exercisable as of March 31,
2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
0.05
|
10,000
|
2.86
|
$
0.050
|
7,500
|
$
0.050
|
0.01
|
12,000,000
|
2.63
|
0.010
|
8,944,444
|
0.010
|
|
12,010,000
|
2.63
|
$
0.010
|
8,951,944
|
$
0.010
|
Stock
option grants totaling 12,010,000 shares of common stock had no
intrinsic value as of March 31, 2017.
NOTE 11 –
COMMITMENTS,
CONTINGENCIES AND 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.
Other than those certain legal proceedings as reported in our
annual report on Form 10-K filed with the SEC on March 31, 2017,
the Companies knows of no material, existing or pending legal
proceedings against our Company, nor are we involved as a plaintiff
in any material proceeding or pending litigation. There are no
proceedings in which any director, officer or any affiliates, or
any registered or beneficial shareholder, is an adverse party or
has a material interest adverse to our interest.
Operating Leases
On
December 7, 2016, the Company entered into entered into a Consent
to Judgement and Settlement Agreement related to its retail
hydroponics store located in Portland, Maine. This Agreement
provides for a monthly lease payment of $4,668 through May 2, 2017.
If the Company is in compliance with the Settlement Agreement, it
can extend the lease from May 2, 2017 to May 1, 2020 at the monthly
lease payment of $5,373. The Company also agreed to a repayment
schedule for past due rent of $70,013. The Company does not have an
option to extend the lease after May 1, 2020.
On
October 21, 2013, the Company entered into a lease agreement for
retail space for its hydroponics store in Avon (Vail), Colorado.
The lease expires on September 30, 2018. Monthly rent for year one
of the lease is $2,606 and increases 3.5% per year thereafter
through the end of the lease. The Company does not have an option
to extend the lease.
On May
31, 2016, the Company rented space at
5400 Carillon Point, Kirkland, Washington 98033
for $1,539 per month
for its corporate office. The
Company’s agreement expires May 31, 2017 and can be
extended.
The aggregate future minimum lease payments under operating leases,
to the extent the leases have early cancellation options and
excluding escalation charges, are as follows:
Years Ended March 31,
|
|
2017
|
$
84,428
|
2018
|
7,203
|
2019
|
-
|
2020
|
-
|
2021
|
-
|
Beyond
|
-
|
Total
|
$
91,631
|
NOTE 12 – SUBSEQUENT EVENTS
The Company evaluates subsequent events, for the purpose of
adjustment or disclosure, up through the date the financial
statements are available.
Subsequent to
March 31, 2017
,
the following material transactions occurred:
Equity Issuances
Subsequent
to March 31, 2017, Chicago Venture converted principal and interest
of $150,000 into 49,069,544 shares of our common stock at a per
share conversion price of $0.0061.
On
April 27, 2017, the Company issued 3,000,000 shares of its common
stock to Michael E. Fasci, a Board Director, or an entity
controlled by Michael Fasci pursuant to service awards for $27,000.
The shares were valued at the fair market price of $0.009 per
share.