10-K 1 phot_10k.htm ANNUAL REPORT Blueprint
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
 ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
 
For the fiscal year ended December 31, 2016
 
 TRANSACTION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
For the transaction period from ________ to ________
 
Commission file number 000-50385
GrowLife, Inc. 
(Exact name of registrant as specified in its charter) 
 
Delaware
(State or other jurisdiction of
incorporation or organization)
90-0821083
(I.R.S. Employer Identification No.)
 
5400 Carillon Point
Kirkland, WA 98033
(Address of principal executive offices and zip code)
 
(866) 781-5559
(Registrant’s telephone number, including area code)
 
Indicate by check mark 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 Exchange 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 Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes     No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes    No
 
Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes     No

 
 
 
 
 
As of June 30, 2016 (the last business day of our most recently completed second fiscal quarter), based upon the last reported trade on that date, the aggregate market value of the voting and non-voting common equity held by non-affiliates (for this purpose, all outstanding and issued common stock minus stock held by the officers, directors and known holders of 10% or more of the Company’s common stock) was $17,064,082.
 
As of March 31, 2017 there were 1,944,843,172 shares of the issuer’s common stock, $0.0001 par value per share, issued and outstanding,
 
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
The following discussion, in addition to the other information contained in this report, should be considered carefully in evaluating us and our prospects. This report (including without limitation the following factors that may affect operating results) contains forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933, as amended ("Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act") regarding us and our business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. Additionally, statements concerning future matters such as revenue projections, projected profitability, growth strategies, development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements.
 
Forward-looking statements in this report reflect the good faith judgment of our management and the statements are based on facts and factors as we currently know them. Forward-looking statements are subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, but are not limited to, those discussed below and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those discussed elsewhere in this report. Readers are urged not to place undue reliance on these forward-looking statements which speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report.
 
 
 
 
 
TABLE OF CONTENTS
 
 
 
Page
PART 1
 
 
 
 
 
ITEM 1.
Description of Business
2
 
 
 
ITEM 1A.
Risk Factors
7
 
 
 
ITEM 1B
Unresolved Staff Comments
16
 
 
 
ITEM 2.
Properties
16
 
 
 
ITEM 3.
Legal Proceedings
17
 
 
 
ITEM 4.
Mine Safety Disclosures
17
 
 
 
PART II
 
 
 
 
 
ITEM 5.
Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
18
 
 
 
ITEM 6.
Selected Financial Data
21
 
 
 
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
 
 
 
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
29
 
 
 
ITEM 8.
Financial Statements and Supplementary Data
29
 
 
 
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
29
 
 
 
ITEM 9A.
Controls and Procedures
29
 
 
 
ITEM 9B.
Other Information
30
 
 
 
PART III
 
 
 
 
 
ITEM 10.
Directors, Executive Officers and Corporate Governance
31
 
 
 
ITEM 11.
Executive Compensation
34
 
 
 
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
41
 
 
 
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
42
 
 
 
ITEM 14.
Principal Accounting Fees and Services
44
 
 
 
PART IV
 
 
 
 
 
ITEM 15.
Exhibits, Financial Statement Schedules
45
 
 
 
 
SIGNATURES
50
 
 
 
1
 
PART I
 
 
ITEM 1.    DESCRIPTION OF BUSINESS
 
THE COMPANY AND OUR BUSINESS
 
GrowLife, Inc. (“GrowLife” or the “Company”) is incorporated under the laws of the State of Delaware and is headquartered in Kirkland, Washington. We were founded in 2012 with the Closing of the Agreement and Plan of Merger with SGT Merger Corporation.
 
Our goal of becoming the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines continues to guide our decisions. Our mission is to 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 knowledgeable representatives, regional centers and its e-commerce website, GrowLife provides essential and hard-to-find goods including growing media, industry-leading hydroponics equipment, organic plant nutrients, and thousands more products to specialty grow operations across the United States.
 
We primarily sell through our 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.
 
We are focusing on future success. In that regard, we believe that the hydroponics supply industry will experience significant growth and, as a result, operating in this industry has become highly competitive, cash intensive and customer centric.  However, we have plans to address these challenges.  
 
First, the opportunity to sell both infrastructure equipment and recurring supplies to the indoor cultivation industry is constantly increasing as demand for indoor cultivation grows across the United States. GrowLife believes the demand will continue to grow and more and more states and municipalities, including California enact rules and regulations allowing for more indoor cultivation activities.   GrowLife continues with its multi-faceted distribution strategy, which we believe serves customers in the following manner: Direct sales to large commercial customers, retail in some markets for local convenience, and e-commerce via GrowLifeEco.com to fulfill orders across the nation from customers of all sizes.  
 
Second, serving what GrowLife sees as an increasing number of cultivators has become cash intensive because of the need for large inventory levels at retail, extensive e-commerce online marketing, and supporting payment terms to large accounts.  Currently, GrowLifeEco.com offers over 15,000 products, far beyond the 3,000 found in Greners.com, its former online store.  This on-line website was expanded by the fall of 2016.
 
Third, GrowLife’s customers come in different stages from caregiver cultivators to 80,000+ square foot commercial operations.  With the use of e-commerce, GrowLife endeavors to reach as many customers as possible in areas where we do not have stores or a direct sales presence.  Last year GrowLife built GrowLifeEco.com, our new e-commerce website, that is optimized for mobile devices.  GrowLife put web marketing in place to increase awareness, traffic and conversions.
 
GrowLife started the expansion of sales and store personnel and marketing efforts with the new funding vehicle with Chicago Venture Partners, L.P. Chicago Venture is supportive in the expansion of the sales and marketing teams in a growing market. GrowLife is expecting growth in several markets, including California. GrowLife receives funding twice a month for such costs. As the personnel were hired late in the December 2016 quarter, the impact is expected to start in the March 2017 quarter.
 
GrowLife also considered the lack of capital access since 2014 and the new funding vehicles with Chicago Venture Partners, L.P. Operations were significantly impacted during 2014- 2016 as a result of the lack of access to capital. GrowLife did not have cash to ship orders. With the addition of GrowLife’s new partners, we have access to capital and are growing our sales again.
 
Also, we recognize demand is increasing from small, aspiring cultivation consumers across the country seeking to learn and use a complete indoor growing solution.  To address this demand, we packaged GrowLife Cube, an entry-level offering for consumers to get hands-on experience with indoor growing.  Although many still buy the components separately, we are working on developing videos and supplier tools to attract them to this one-stop shop program.  Given the election results in California GrowLife Cube is expected to provide greater value and specialty services.
 
 
 
2
 
Resumed Trading of our Common Stock
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
Market Size and Growth
 
While there is a great deal of purchasing of indoor cultivation equipment for non-Cannabis cultivation, many of our investors have a high-interest in the direction of the Cannabis industry as it may directly affect GrowLife’s growth. Therefore, the following market information is provided.
 
Twenty eight states and the District of Columbia currently have laws legalizing marijuana in some form. Three other states will soon join them after recently passing measures permitting use of medical marijuana.
 
Seven states and the District of Columbia have adopted more expansive laws legalizing marijuana for recreational use. Most recently, California, Massachusetts, Maine and Nevada all passed measures in November legalizing recreational marijuana. California’s Prop. 64 measure allows adults 21 and older to possess up to one ounce of marijuana and grow up to six plants in their homes. Other tax and licensing provisions of the law will not take effect until January 2018.
 
Several legislatures in states recently passing legalization measures are debating regulatory proposals around the use and sale of marijuana. Massachusetts lawmakers are weighing bills that would lower the amount that residents can legally possess or place restrictions on retails stores. In Nevada, one proposal calls for businesses to obtain permits allowing for the public use of marijuana.
 
A number of states have also decriminalized the possession of small amounts of marijuana. Other states have passed medical marijuana laws allowing for limited use of cannabis. Some medical marijuana laws are broader than others, with types of medical conditions that allow for treatment varying from state to state. Others states (not shown on the map below) have passed laws allowing residents to possess cannabis oil if they suffer from certain medical illnesses.
 
Our map shows current state laws and recently-approved ballot measures legalizing marijuana for medical or recreational purposes. Medical marijuana laws recently passing in Arkansas, Florida and North Dakota have yet to become effective.
 
Information is current as of January 30, 2017.
 
 
Source: www.governing.com/gov-data/state-marijuana-laws-map-medical-recreational.html
 
GrowLife serves a new, yet sophisticated community of commercial and urban cultivators growing specialty crops including organics, greens and plant-based medicines. Unlike the traditional agricultural industry, these cultivators use innovative indoor growing techniques to produce specialty crops in highly controlled environments. This enables them to produce crops at higher yields without having to compromise quality - regardless of the season or weather and drought conditions.
 
Indoor growing is commonly used for plant-based medicines because they often require high-degree of regulation and controls including government compliance, security, and crop consistency. This makes indoor growing a preferred method. Cultivators of plant-based medicines often make a significant investment to design and build-out their facilities. They look to work with companies such as GrowLife who understand their specific needs, and can help mitigate risks that could jeopardize their crops.
 
Indoor growing techniques, however, are not limited to plant-based medicines. Vertical farms producing organic fruits and vegetables are beginning to emerge in the market due to a rising shortage of farmland, and environmental vulnerabilities including drought, other severe weather conditions and insect pests. Indoor growing techniques enables cultivators to grow crops all-year-round in urban areas, and take up less ground while minimizing environmental risks. Indoor growing techniques typically require a more significant upfront investment to design and build-out these facilities, than traditional farmlands. If new innovations lower the costs for indoor growing, and the costs to operate traditional farmlands continue to rise, then indoor growing techniques may be a compelling alternative for the broader agricultural industry.
 
 
 
3
 
 
 
State
Year Passed How Passed
(Yes Vote) Possession Limit
1.Alaska
1998 Ballot Measure 8 (58%)
1 oz usable; 6 plants (3 mature, 3 immature)
2.Arizona
2010 Proposition 203 (50.13%)
2.5 oz usable; 12 plants
3.Arkansas
2016 Ballot Measure Issue 6 (53.2%)
3 oz usable per 14-day period
4.California
1996 Proposition 215 (56%)
8 oz usable; 6 mature or 12 immature plants
5.Colorado
2000 Ballot Amendment 20 (54%)
2 oz usable; 6 plants (3 mature, 3 immature)
6.Connecticut
2012 House Bill 5389 (96-51 H, 21-13 S)
2.5 oz usable
7.Delaware
2011 Senate Bill 17 (27-14 H, 17-4 S)
6 oz usable
8.Florida
2016Ballot Amendment 2 (71.3%)
Amount to be determined
9.Hawaii
2000 Senate Bill 862 (32-18 H; 13-12 S)
4 oz usable; 7 plants
10.Illinois
2013 House Bill 1 (61-57 H; 35-21 S)
2.5 ounces of usable cannabis during a period of 14 days
11.Maine
1999 Ballot Question 2 (61%)
2.5 oz usable; 6 plants
12.Maryland
2014 House Bill 881 (125-11 H; 44-2 S)
30-day supply, amount to be determined
13.Massachusetts
2012 Ballot Question 3 (63%)
60-day supply for personal medical use (10 oz)
14.Michigan
2008 Proposal 1 (63%)
2.5 oz usable; 12 plants
15.Minnesota
2014 Senate Bill 2470 (46-16 S; 89-40 H)
30-day supply of non-smokable marijuana
16.Montana
2004 Initiative 148 (62%)
1 oz usable; 4 plants (mature); 12 seedlings
17.Nevada
2000 Ballot Question 9 (65%)
2.5 oz usable; 12 plants
18.New Hampshire
2013 House Bill 573 (284-66 H; 18-6 S)
Two ounces of usable cannabis during a 10-day period
19.New Jersey
2010 Senate Bill 119 (48-14 H; 25-13 S)
2 oz usable
20.New Mexico
2007 Senate Bill 523 (36-31 H; 32-3 S)
6 oz usable; 16 plants (4 mature, 12 immature)
21.New York
2014 Assembly Bill 6357 (117-13 A; 49-10 S)
30-day supply non-smokable marijuana
22.North Dakota
2016 Ballot Measure 5 (63.7%)
3 oz per 14-day period
23.Ohio
2016 House Bill 523 (71-26 H; 18-15 S)
Maximum of a 90-day supply, amount to be determined
24.Oregon
1998 Ballot Measure 67 (55%)
24 oz usable; 24 plants (6 mature, 18 immature)
25.Pennsylvania
2016 Senate Bill 3 (149-46 H; 42-7 S)
30-day supply
26.Rhode Island
2006 Senate Bill 0710 (52-10 H; 33-1 S)
2.5 oz usable; 12 plants
27.Vermont
2004 Senate Bill 76 (22-7) HB 645 (82-59)
2 oz usable; 9 plants (2 mature, 7 immature)
28.Washington
1998 Initiative 692 (59%)
8 oz usable; 6 plants
Washington, DC
2010
Amendment Act B18-622 (13-0 vote) 2 oz dried; limits on other forms to be determined
Source: Marijuana State Laws – Summary Chart from ProCon.org
 
 
 
4
 
Strategy
 
Our long-term strategy revolves around three premises: First, the indoor growing market for fruits, vegetables and medical plants is here to stay. We see an opportunity for it to double for several years, especially after last year’s election raising the number of states that support Cannabis; Second, GrowLife will continue to establish itself as a national brand to provide the much-needed advisory services and sell lighting, nutrients, mediums and other equipment, supplies and services to cultivators across the country; And third, the demand for more healthy, safer and economical ways to run indoor growing operations will dramatically increase and require innovative products to intelligently drive down costs without compromising quality. These are critical premises for the Company’s growth.
 
Our growth plan consists of adding more knowledgeable, talented and committed people, creating greater access to equipment and supplies, and offering more and better choices. We must sequence our steps in a timely and deliberate manner.
 
Our Base business provides GrowLife with a solid high-growth foundation, especially as we see interest increase for the GrowLife Retail License Program that was announced at the end of 2016. This License Program creates financial and operating efficiencies for GrowLife. We are shifting our retail store business from a fixed to variable cost structure, which allows us to apply our indoor cultivation competency to other retail partners, and reach more cultivators in markets across the US faster. The License Program offerings range from a Store-within-the-store, such as the one in place in Philadelphia at Fairmount Hardware, an Ace Hardware franchisee, located at 2011 Fairmount Ave, Philadelphia, PA, to partnering with retail investors who seek to set up new GrowLife-licensed hydroponic stores. We are pleased with the initial response and lessons learned from the License Program, which have helped refine our offerings, customer engagement and operating process.
 
The other two channels for our Base business, Online e-commerce and Direct Sales, continue to be refined as we apply more talent to them. We plan to serve the Base business with these channels by helping those price-sensitive customers drive down their equipment and supply costs. While this puts great price pressure on our manufacturers, we closely watch metrics move to the lowest cost per gram. One of the largest cultivators recently shifted their lights from a popular 1,000W to 315W where the electricity savings alone drove down their production cost by 35% and production increased by 20%.
 
In addition, our Expansion business efforts are equally capable of revenue growth. However, Expansion investments come with great risk not too different than building a start-up. Our Expansion efforts are intended to be game-changers.
 
The Cannabis industry itself is a game-changer. Many people are discovering great benefits with the plant that are far beyond its commercial growth. Even with all the government challenges we believe that both business and consumer will persevere because the demand and benefit of the plant are genuine based on scientific research conducted throughout the world. Consistent safety measures and standards are on their way. Therefore, we see the greatest opportunities and challenges to be in helping to address the mainstream acceptance and management of the plant…the game-changers.
 
GrowLife will therefore be pursuing such game-changers to help propel the industry forward on several fronts. Acquisitions may range from innovations that significantly drive down the operating costs for commercial cultivators to the desperately needed cloud-based tools for the government to extensively coordinate its policies with the industry in a safe and responsible manner. We expect to see some of these Expansion game-changers come to market in 2017. The caveat is that there are many moving parts and these game-changers may or may not come to pass.
 
GrowLife’s greatest growth may come from a business that is not a significant contributor today. We see three key areas that may be game-changers for us in 2017: Mergers & Acquisitions and Partnerships (MAP); Consumer with GrowLife Cube; and plant-related services. Each of these areas will require us to add the right people at the right time. Many talented individuals are ready to join GrowLife.
 
MAP in our Base business with Retail Licensing Program has quickly taught us to invest in new procedures and people. Growth from M&A is the most obvious expansion move. Over the last year we explored a half-a-dozen acquisition opportunities. However, we found that they were all over-priced. Even after factoring in the possible valuation lift to the PHOT share price, the risk/reward did not make sense.
 
The most visible example was Go Green Hydroponics, where we had entered into a non-binding letter of intent last year. We recently announced in an SEC 8-K/A filing that the non-binding letter of intent had expired and GrowLife does not expect to close the acquisition of Go Green Hydroponics. We will therefore not be pursuing this acquisition since our retail strategy has shifted to the GrowLife Retail Licensing Program.
 
Another area we are continuing to develop is demand from new consumers entering the industry, where they seek to learn how to build indoor operations. We have tested GrowLife Cube, an entry-level growing package that provides the basic set-up for an indoor farming operation. GrowLife provides all the necessary growing equipment and supplies. We have determined that there are many consumers without growing experience, knowledge and local access to hydroponic equipment and supplies. Therefore, we are tuning GrowLife Cube to more effectively reach and satisfy these new consumers.
 
 
 
5
 
 
 
Finally, in January we spent a few days at the Seed to Sale Show in Denver to explore the plant and seed business. Our conclusion is that it is an attractive business that needs to be further explored but in an indirect manner. GrowLife is not ready to directly touch the plant due to Federal interstate laws. We are instead considering how to legally support it through state based-partners.
 
We see the indoor cultivation industry as growing faster than other industries due to increasing demand for and legalization of non-toxic pain relief medicines. For years GrowLife has built its brand through experience with leading commercial cultivators. We continue to assemble the best team in the industry to create a great opportunity. Our investors and shareholders have shown strong loyalty and support even through difficult times.
 
Overall, GrowLife is in a stronger position than it has been for some time. With continued work and support, we are encouraged with the prospect of bringing growth back to the company and increase shareholder value.
 
Key Market Priorities
 
Our goal of becoming the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines requires GrowLife to (i) expand our nationwide, multi-channel sales network presence, (ii) offer the best terms for the full range of build-out equipment and consumable supplies, and (iii) deliver superior, innovative products.
 
First, we provide distribution through retail, e-commerce and direct sales to have national coverage and serve cultivators of all sizes. Each channel offers varying pricing for differing benefits. Retail sells at list price by offering inventory convenience, e-commerce provides lower prices without requiring local inventory, and direct sales delivers the best bid price for high-volume purchasers. Additional points of service may be added through existing distribution locations and services. This may be done in several manners and programs that may incorporate cultivator-centric locations with other retailer store owners.
 
Second, we serve the needs of all size cultivators and each one’s unique formulation, or ‘recipe’. We provide thousands of varieties of supplies from dozens of vendors and distributors. More importantly is our experience of knowing which products to recommend under each customer’s circumstance.
 
And third, our experience with hundreds of customers allows us to determine specific product needs and sources to test new designs. Lights, pesticides, nutrients, extraction and growing systems are some examples of products that GrowLife can provide. Popular name branded products are seeking to be part of the GrowLife company in many forms. In exchange, we can market their products in a unique manner over generic products.
 
Our company can expand with these strategies until it serves more indoor cultivators throughout the country. Once a customer is engaged, we can gradually expand their purchasing market share by providing greater economic benefit to the customers who buy more products from GrowLife than from other suppliers.
 
Employees
 
As of December 31, 2016, we had one full-time employee and one consultant at our Seattle, Washington office. Marco Hegyi, our Chief Executive Officer, is based in Kirkland, Washington. Mark E. Scott, our consulting CFO, is based primarily in Seattle, Washington. In addition, we have 10 employees located throughout the United States who operate our e-commerce, direct sales and retail businesses. None of our employees is subject to a collective bargaining agreement or represented by a trade or labor union. We believe that we have a good relationship with our employees.
 
Key Partners
 
Our key customers vary by state and are expected to be more defined as the company moves from its retail walk-in purchasing sales strategy to serving cultivation facilities directly and under predictable purchasing contracts.  
 
Our key suppliers include distributors such as HydroFarm, Urban Horticultural Supply and Sunlight Supply to product-specific suppliers. All the products purchased and resold are applicable to indoor growing for organics, greens, and plant-based medicines.
 
Competition
 
Certain large commercial cultivators have found themselves willing to assume their own equipment support by buying large volume purchased directly from certain suppliers and distributors such as Sunlight Supplies and HydroFarm. Other key competitors on the retail side consist of local and regional hydroponic resellers of indoor growing equipment. On the e-commerce business, GrowersHouse.com, Hydrobuilder.com, HorticultureSource.com and smaller online resellers using Amazon and eBay e-commerce market systems.
 
Intellectual Property and Proprietary Rights
 
Our intellectual property consists of brands and their related trademarks and websites, customer lists and affiliations, product know-how and technology, and marketing intangibles.
 
 
 
6
 
 
 
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.growlifeinc.com, www.growlifeeco.com and www.greners.com.
 
We have a policy of entering into confidentiality and non-disclosure agreements with our employees and some of our vendors and customers as necessary.
 
Government Regulation
 
Currently, there are twenty eight states plus the District of Columbia that have laws and/or regulation that recognize in one form or another legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. There are currently seven states that allow recreational use of cannabis. As of the date of this writing, the policy and regulations of the Federal government and its agencies is that cannabis has no medical benefit and a range of activities including cultivation and use of cannabis for personal use is prohibited on the basis of federal law and may or may not be permitted on the basis of state law. Active enforcement of the current federal regulatory position on cannabis on a regional or national basis may directly and adversely affect the willingness of customers of GrowLife to invest in or buy products from GrowLife. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect revenues and profits of the GrowLife companies.
 
All this being said, many reports show that the majority of the American public is in favor of making medical cannabis available as a controlled substance to those patients who need it. The need and consumption will then require cultivators to continue to provide safe and compliant crops to consumers. The cultivators will then need to build facilities and use consumable products, which GrowLife provides.
 
THE COMPANY’S COMMON STOCK
 
Our common stock traded on the grey market under the symbol “PHOT” through February 17, 2016. While the company was without a market maker, its stock does trade directly between buyers and sellers on the grey sheets. The quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not represent actual transactions. Consequently, the information provided below was not be indicative of our common stock price under different conditions.
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
PRIMARY RISKS AND UNCERTAINTIES
 
We are exposed to various risks related to legal proceedings, our need for additional financing, the sale of significant numbers of our shares, the potential adjustment in the exercise price of our convertible debentures and a volatile market price for our common stock. These risks and uncertainties are discussed in more detail below in Part II, Item 1A. 
 
WEBSITE ACCESS TO UNITED STATES SECURITIES AND EXCHANGE COMMISSION REPORTS
 
We file annual and quarterly reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any document we file at the SEC's Public Reference Room at 100 F Street, N.E., Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements and other information concerning filers. We also maintain a web site at http://www.growlifeinc.com that provides additional information about our Company and links to documents we file with the SEC. The Company's charters for the Audit Committee, the Compensation Committee, and the Nominating Committee; and the Code of Conduct & Ethics are also available on our website. The information on our website is not part of this Form 10-K.
 
ITEM 1A. RISK FACTORS
 
There are certain inherent risks which will have an effect on the Company’s development in the future and the most significant risks and uncertainties known and identified by our management are described below.
 
Risks Related to Our Business
 
Risks Associated with Securities Purchase Agreement with Chicago Venture
 
The Securities Purchase Agreement with Chicago Venture will terminate if we file protection from its creditors, a Registration Statement on Form S-1 is not effective, and our market capitalization or the trading volume of our common stock does not reach certain levels. If terminated, we will be unable to draw down all or substantially all of our $2,500,000 Chicago Venture Note.
 
 
7
 
 
 
Our ability to require Chicago Venture to fund the Chicago Venture Note is at our discretion, subject to certain limitations. Chicago Venture is obligated to fund if each of the following conditions are met; (i) the average and median daily dollar volumes of our common stock for the twenty (20) and sixty (60) trading days immediately preceding the funding date are greater than $100,000; (ii) our market capitalization on the funding date is greater than $17,000,000; (iii) we are not in default with respect to share delivery obligations under the note as of the funding date; and (iv) we are current in its reporting obligations.
 
There is no guarantee that we will be able to meet the foregoing conditions or any other conditions under the Securities Purchase Agreement and/or Chicago Venture Note or that we will be able to draw down any portion of the amounts available under the Securities Purchase Agreement and/or Chicago Venture Note.
 
If we not able to draw down all $2,500,000 available under the Securities Purchase Agreement or if the Securities Purchase Agreement is terminated, we may be forced to curtail the scope of our operations or alter our business plan if other financing is not available to us.
 
Risks Associated from TCA Global Credit Master Fund, LP (“TCA”) Funding Transactions.
 
We have entered into various funding transactions with TCA. On January 10, 2017, Chicago Venture, at our instruction, remitted funds of $1,495,901 to TCA in order to satisfy all debts to TCA. On or around January 11, 2017, we were 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 our assets. TCA has confirmed that it is paid in full and we are not aware of any other obligations that the we have as to TCA. The funds received under the Chicago Venture Agreements and previous Chicago Venture Agreements were used to pay-off TCA.
 
Failure to operate in accordance with the Agreements with TCA could result in the cancellation of these agreements, result in foreclosure on our assets in event of default and would have a material adverse effect on our business, results of operations or financial condition.
 
Suspension of trading of the Company’s securities.
 
On April 10, 2014, we received notice from the SEC that trading of our common stock on the OTCBB was to be suspended from April 10, 2014 through April 24, 2014. The SEC issued its order pursuant to Section 12(k) of the Securities Exchange Act of 1934. According to the notice received by us from the SEC: “It appears to the Securities and Exchange Commission that the public interest and the protection of investors require a suspension of trading in the securities of GrowLife, Inc. because of concerns regarding the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in GrowLife’s common stock.” To date, we have not received notice from the SEC that it is being formally investigated.
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
The suspension of trading eliminated our market makers, resulted in our trading on the grey sheets, resulted in legal proceedings and restricted our access to capital. This action had a material adverse effect on our business, financial condition and results of operations. If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business.
 
SEC charged outsiders with manipulating our securities.
 
On August 5, 2014, the SEC charged four promoters with ties to the Pacific Northwest for manipulating our securities. The SEC alleged that the four promoters bought inexpensive shares of thinly traded penny stock companies on the open market and conducted pre-arranged, manipulative matched orders and wash trades to create the illusion of an active market in these stocks.  They then sold their shares in coordination with aggressive third party promotional campaigns that urged investors to buy the stocks because the prices were on the verge of rising substantially.  This action has had a material adverse effect on our business, financial condition and results of operations. If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business.
 
On July 9, 2015, the SEC entered into settlements with two of the promoters. In connection with the settlement of their SEC action, the two men are liable for disgorgement of approximately $2.1 million and $306,000 in illicit profits, respectively. Earlier this year the two men were also sentenced to five and three years in prison, respectively, for their participation in the scheme.
 
We are involved in Legal Proceedings.
 
We are involved in the disputes and legal proceedings as discussed in this annual report. In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws. Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation. There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse on our business, results of operations or financial condition.
 
 
 
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Our Joint Venture Agreement with CANX USA, LLC is important to our operations.
 
On November 19, 2013, we entered into a Joint Venture Agreement with CANX, a Nevada limited liability company.  Under the terms of the Joint Venture Agreement, the Company and CANX formed Organic Growth International, LLC (“OGI”), a Nevada limited liability company, for the purpose of expanding our operations in its current retail hydroponic businesses and in other synergistic business verticals and facilitating additional funding for commercially financeable transactions of up to $40,000,000. 
 
We initially owned a non-dilutive 45% share of OGI and the Company could acquire a controlling share of OGI as provided in the Joint Venture Agreement. In accordance with the Joint Venture Agreement, the Company and CANX entered into a Warrant Agreement whereby the we delivered to CANX a warrant to purchase 140,000,000 shares of our common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires November 18, 2018. Also in accordance with the Joint Venture Agreement, on February 7, 2014, the Company issued an additional warrant to purchase 100,000,000 shares of our common stock that is convertible at $0.033 per share, subject to adjustment as provided in the warrant. The five-year warrant expires February 6, 2019.
 
GrowLife received the $1 million as a convertible note in December 2013, received the $1.3 million commitment but not executed and by January 2014 OGI had Letters of Intent with four investment and acquisition transactions valued at $96 million. Before the deals could close, the SEC put a trading halt on our stock on April 10, 2014, which resulted in the withdrawal of all transactions. The business disruption from the trading halt and the resulting class action and derivative lawsuits ceased further investments with the OGI joint venture. The Convertible Note was converted into our common stock as of the year ended December 31, 2016.
 
On July 10, 2014, we closed a Waiver and Modification Agreement, Amended and Restated Joint Venture Agreement, Secured Credit Facility and Secured Convertible Note with CANX and Logic Works LLC, a 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 loaning requiring approval in advance by CANX; (iii) confirmed that the five year warrants, subject to adjustment, at $0.033 per share for the purchase of 140,000,000 and 100,000,000 were fully earned and were not considered compensation for tax purposes by the Company; (iv) granted CANX five year warrants, subject to adjustment, to purchase 300,000,000 shares of common stock at the fair market price of $0.033 per share as determined by an independent appraisal; (v) warrants as defined in the Agreement related to the achievement of OGI milestones; and (vi) a four year term, subject to adjustment.
 
We entered into a Secured Convertible Note and Secured Credit Facility dated June 25, 2014 with Logic Works whereby Logic Works agreed to provide up to $500,000 in funding. Each funding required approval in advance by Logic Works, provides for interest at 6% with a default interest of 24% per annum and required repayment by June 26, 2016. The Note is convertible into common stock of the Company at the lesser of $0.0070 or (B) twenty percent (20%) of the average of the three (3) lowest daily VWAPs occurring during the twenty (20) consecutive Trading Days immediately preceding the applicable conversion date on which Logic Works elects to convert all or part of this 6% Convertible Note, subject to adjustment as provided in the Note. The 6% Convertible Note is collateralized by the assets of the Company. As of March 31, 2017, the outstanding balance on the Convertible Note was $39,251.
 
Failure to operate in accordance with the Agreements with CANX could result in the cancellation of these agreements, result in foreclosure on our assets in event of default and would have a material adverse effect on our business, results of operations or financial condition.
 
Our proposed business is dependent on laws pertaining to the marijuana industry.
 
Continued development of the marijuana industry is dependent upon continued legislative authorization of the use and cultivation of marijuana at the state level.  Any number of factors could slow or halt progress in this area.  Further, progress, while encouraging, is not assured.  While there may be ample public support for legislative action, numerous factors impact the legislative process.  Any one of these factors could slow or halt use of marijuana, which would negatively impact our proposed business.
 
As of December 31, 2016, twenty eight states and the District of Columbia allow its citizens to use medical marijuana.  Additionally, seven states have legalized cannabis for adult use.  The state laws are in conflict with the federal Controlled Substances Act, which makes marijuana use and possession illegal on a national level. The Obama administration previously effectively stated that it is not an efficient use of resources to direct law federal law enforcement agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana.  The Trump administration position is unknown. However, there is no guarantee that the Trump administration will not change current policy regarding the low-priority enforcement of federal laws.  Additionally, any new administration that follows could change this policy and decide to enforce the federal laws strongly.  Any such change in the federal government’s enforcement of current federal laws could cause significant financial damage to us and its shareholders.
 
 
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Further, while we do not harvest, distribute or sell marijuana, by supplying products to growers of marijuana, we could be deemed to be participating in marijuana cultivation, which remains illegal under federal law, and exposes us to potential criminal liability, with the additional risk that our business could be subject to civil forfeiture proceedings.
 
The marijuana industry faces strong opposition. 
 
It is believed by many that large, well-funded businesses may have a strong economic opposition to the marijuana industry.  We believe that the pharmaceutical industry clearly does not want to cede control of any product that could generate significant revenue.  For example, medical marijuana will likely adversely impact the existing market for the current “marijuana pill” sold by mainstream pharmaceutical companies.  Further, the medical marijuana industry could face a material threat from the pharmaceutical industry, should marijuana displace other drugs or encroach upon the pharmaceutical industry’s products.  The pharmaceutical industry is well funded with a strong and experienced lobby that eclipses the funding of the medical marijuana movement.  Any inroads the pharmaceutical industry could make in halting or impeding the marijuana industry harm our business, prospects, results of operation and financial condition.
 
Marijuana remains illegal under Federal law.  
 
Marijuana is a Schedule-I controlled substance and is illegal under federal law.  Even in those states in which the use of marijuana has been legalized, its use remains a violation of federal law.  Since federal law criminalizing the use of marijuana preempts state laws that legalize its use, strict enforcement of federal law regarding marijuana would harm our business, prospects, results of operation and financial condition.
 
Raising additional capital to implement our business plan and pay our debts will cause dilution to our existing stockholders, require us to restructure our operations, and divest all or a portion of our business.
 
We need additional financing to implement our business plan and to service our ongoing operations and pay our current debts. There can be no assurance that we will be able to secure any needed funding, or that if such funding is available, the terms or conditions would be acceptable to us.
 
If we raise additional capital through borrowing or other debt financing, we may incur substantial interest expense. Sales of additional equity securities will dilute on a pro rata basis the percentage ownership of all holders of common stock. When we raise more equity capital in the future, it will result in substantial dilution to our current stockholders.
 
If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business.
 
Potential Convertible Note Defaults.
 
Several of the Company’s convertible promissory notes remain outstanding beyond their respective maturity dates. This may trigger an event of default under the respective agreements. The Company is working with these noteholders to convert their notes into common stock and intends to resolve these outstanding issues as soon as practicable. Any default could have a significant adverse effect on our cash flows and should we be unsuccessful in negotiating an extension or other modification, we may have to restructure our operations, divest all or a portion of its business, or file for bankruptcy.
 
Closing of bank accounts could have a material adverse effect on our business, financial condition and/or results of operations.
 
As a result of the regulatory environment, we have experienced the closing of several of our bank accounts since March 2014. We have been able to open other bank accounts. However, we may have other banking accounts closed. These factors impact management and could have a material adverse effect on our business, financial condition and/or results of operations.
 
 
 
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Federal regulation and enforcement may adversely affect the implementation of medical marijuana laws and regulations may negatively impact our revenues and profits. 
 
Currently, there are twenty eight states plus the District of Columbia that have laws and/or regulation that recognize in one form or another legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. Many other states are considering legislation to similar effect. As of the date of this writing, the policy and regulations of the Federal government and its agencies is that cannabis has no medical benefit and a range of activities including cultivation and use of cannabis for personal use is prohibited on the basis of federal law and may or may not be permitted on the basis of state law. Active enforcement of the current federal regulatory position on cannabis on a regional or national basis may directly and adversely affect the willingness of customers of GrowLife to invest in or buy products from GrowLife that may be used in connection with cannabis. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect revenues and profits of the GrowLife companies.
 
Our history of net losses has raised substantial doubt regarding our ability to continue as a going concern. If we do not continue as a going concern, investors could lose their entire investment.
 
Our history of net losses has raised substantial doubt about our ability to continue as a going concern, and as a result, our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended December 31, 2016 and 2015 with respect to this uncertainty. Accordingly, our ability to continue as a going concern will require us to seek alternative financing to fund our operations. This going concern opinion could materially limit our ability to raise additional funds through the issuance of new debt or equity securities or otherwise. Future reports on our financial statements may include an explanatory paragraph with respect to our ability to continue as a going concern.
 
We have a history of operating losses and there can be no assurance that we can again achieve or maintain profitability.
 
We have experienced net losses since inception. As of December 31, 2016, we had an accumulated deficit of $124.4 million. There can be no assurance that we will achieve or maintain profitability.
 
We are subject to corporate governance and internal control reporting requirements, and our costs related to compliance with, or our failure to comply with existing and future requirements, could adversely affect our business.
 
We must comply with corporate governance requirements under the Sarbanes-Oxley Act of 2002 and the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, as well as additional rules and regulations currently in place and that may be subsequently adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules, and regulations continue to evolve and may become increasingly stringent in the future. We are required to include management’s report on internal controls as part of our annual report pursuant to Section 404 of the Sarbanes-Oxley Act. We strive to continuously evaluate and improve our control structure to help ensure that we comply with Section 404 of the Sarbanes-Oxley Act. The financial cost of compliance with these laws, rules, and regulations is expected to remain substantial.
 
We cannot assure you that we will be able to fully comply with these laws, rules, and regulations that address corporate governance, internal control reporting, and similar matters. Failure to comply with these laws, rules and regulations could materially adversely affect our reputation, financial condition, and the value of our securities.
 
Our management has concluded that we have material weaknesses in our internal controls over financial reporting and that our disclosure controls and procedures are not effective.
 
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company's annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting. During the review of our financial statements for the year ended December 31, 2016, our management identified material weaknesses in our internal control over financial reporting. If these weaknesses continue, investors could lose confidence in the accuracy and completeness of our financial reports and other disclosures.
 
Our inability to effectively manage our growth could harm our business and materially and adversely affect our operating results and financial condition.
 
Our strategy envisions growing our business. We plan to expand our product, sales, administrative and marketing organizations. Any growth in or expansion of our business is likely to continue to place a strain on our management and administrative resources, infrastructure and systems. As with other growing businesses, we expect that we will need to further refine and expand our business development capabilities, our systems and processes and our access to financing sources. We also will need to hire, train, supervise and manage new and retain contributing employees. These processes are time consuming and expensive, will increase management responsibilities and will divert management attention. We cannot assure you that we will be able to:
 
 
expand our products effectively or efficiently or in a timely manner;
 
allocate our human resources optimally;
 
meet our capital needs;
 
identify and hire qualified employees or retain valued employees; or
 
incorporate effectively the components of any business or product line that we may acquire in our effort to achieve growth.
 
 
 
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Our inability or failure to manage our growth and expansion effectively could harm our business and materially and adversely affect our operating results and financial condition.
 
Our operating results may fluctuate significantly based on customer acceptance of our products. As a result, period-to-period comparisons of our results of operations are unlikely to provide a good indication of our future performance. Management expects that we will experience substantial variations in our net sales and operating results from quarter to quarter due to customer acceptance of our products. If customers don’t accept our products, our sales and revenues will decline, resulting in a reduction in our operating income.
 
Customer interest for our products could also be impacted by the timing of our introduction of new products. If our competitors introduce new products around the same time that we issue new products, and if such competing products are superior to our own, customers’ desire for our products could decrease, resulting in a decrease in our sales and revenues. To the extent that we introduce new products and customers decide not to migrate to our new products from our older products, our revenues could be negatively impacted due to the loss of revenue from those customers. In the event that our newer products do not sell as well as our older products, we could also experience a reduction in our revenues and operating income.
 
As a result of fluctuations in our revenue and operating expenses that may occur, management believes that period-to-period comparisons of our results of operations are unlikely to provide a good indication of our future performance. 
 
If we do not successfully generate additional products and services, or if such products and services are developed but not successfully commercialized, we could lose revenue opportunities.
 
Our future success depends, in part, on our ability to expand our product and service offerings. To that end we have engaged in the process of identifying new product opportunities to provide additional products and related services to our customers. The process of identifying and commercializing new products is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends our business could be harmed. We may have to commit significant resources to commercializing new products before knowing whether our investments will result in products the market will accept. Furthermore, we may not execute successfully on commercializing those products because of errors in product planning or timing, technical hurdles that we fail to overcome in a timely fashion, or a lack of appropriate resources. This could result in competitors providing those solutions before we do and a reduction in net sales and earnings.
 
The success of new products depends on several factors, including proper new product definition, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.
 
Our future success depends on our ability to grow and expand our customer base.  Our failure to achieve such growth or expansion could materially harm our business.
 
To date, our revenue growth has been derived primarily from the sale of our products and through the purchase of existing businesses. Our success and the planned growth and expansion of our business depend on us achieving greater and broader acceptance of our products and expanding our customer base. There can be no assurance that customers will purchase our products or that we will continue to expand our customer base. If we are unable to effectively market or expand our product offerings, we will be unable to grow and expand our business or implement our business strategy. This could materially impair our ability to increase sales and revenue and materially and adversely affect our margins, which could harm our business and cause our stock price to decline.
 
If we incur substantial liability from litigation, complaints, or enforcement actions resulting from misconduct by our distributors, our financial condition could suffer. We will require that our distributors comply with applicable law and with our policies and procedures. Although we will use various means to address misconduct by our distributors, including maintaining these policies and procedures to govern the conduct of our distributors and conducting training seminars, it will still be difficult to detect and correct all instances of misconduct. Violations of applicable law or our policies and procedures by our distributors could lead to litigation, formal or informal complaints, enforcement actions, and inquiries by various federal, state, or foreign regulatory authorities against us and/or our distributors. Litigation, complaints, and enforcement actions involving us and our distributors could consume considerable amounts of financial and other corporate resources, which could have a negative impact on our sales, revenue, profitability and growth prospects. As we are currently in the process of implementing our direct sales distributor program, we have not been, and are not currently, subject to any material litigation, complaint or enforcement action regarding distributor misconduct by any federal, state or foreign regulatory authority.
 
Our future manufacturers could fail to fulfill our orders for products, which would disrupt our business, increase our costs, harm our reputation and potentially cause us to lose our market.
 
 
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We may depend on contract manufacturers in the future to produce our products. These manufacturers could fail to produce products to our specifications or in a workmanlike manner and may not deliver the units on a timely basis. Our manufacturers may also have to obtain inventories of the necessary parts and tools for production. Any change in manufacturers to resolve production issues could disrupt our ability to fulfill orders. Any change in manufacturers to resolve production issues could also disrupt our business due to delays in finding new manufacturers, providing specifications and testing initial production. Such disruptions in our business and/or delays in fulfilling orders would harm our reputation and would potentially cause us to lose our market. 
 
Our inability to effectively protect our intellectual property would adversely affect our ability to compete effectively, our revenue, our financial condition and our results of operations.
 
We may be unable to obtain intellectual property rights to effectively protect our business. Our ability to compete effectively may be affected by the nature and breadth of our intellectual property rights. While we intend to defend against any threats to our intellectual property rights, there can be no assurance that any such actions will adequately protect our interests. If we are unable to secure intellectual property rights to effectively protect our technology, our revenue and earnings, financial condition, and/or results of operations would be adversely affected.
 
We may also rely on nondisclosure and non-competition agreements to protect portions of our technology. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that third parties will not otherwise gain access to our trade secrets or proprietary knowledge, or that third parties will not independently develop the technology.
 
We do not warrant any opinion as to non-infringement of any patent, trademark, or copyright by us or any of our affiliates, providers, or distributors. Nor do we warrant any opinion as to invalidity of any third-party patent or unpatentability of any third-party pending patent application. 
 
Our industry is highly competitive and we have less capital and resources than many of our competitors, which may give them an advantage in developing and marketing products similar to ours or make our products obsolete.
 
We are involved in a highly competitive industry where we may compete with numerous other companies who offer alternative methods or approaches, may have far greater resources, more experience, and personnel perhaps more qualified than we do. Such resources may give our competitors an advantage in developing and marketing products similar to ours or products that make our products obsolete. There can be no assurance that we will be able to successfully compete against these other entities.
 
Transfers of our securities may be restricted by virtue of state securities “blue sky” laws, which prohibit trading absent compliance with individual state laws. These restrictions may make it difficult or impossible to sell shares in those states.
 
Transfers of our common stock may be restricted under the securities or securities regulations laws promulgated by various states and foreign jurisdictions, commonly referred to as "blue sky" laws. Absent compliance with such individual state laws, our common stock may not be traded in such jurisdictions. Because the securities held by many of our stockholders have not been registered for resale under the blue sky laws of any state, the holders of such shares and persons who desire to purchase them should be aware that there may be significant state blue sky law restrictions upon the ability of investors to sell the securities and of purchasers to purchase the securities. These restrictions may prohibit the secondary trading of our common stock. Investors should consider the secondary market for our securities to be a limited one.
 
We are dependent on key personnel and we are default under Employment and Consulting Agreements
 
Our success depends to a significant degree upon the continued contributions of key management and other personnel, some of whom could be difficult to replace. We do not maintain key man life insurance covering our officers. Our success will depend on the performance of our officers and key management and other personnel, our ability to retain and motivate our officers, our ability to integrate new officers and key management and other personnel into our operations, and the ability of all personnel to work together effectively as a team. Our failure to retain and recruit officers and other key personnel could have a material adverse effect on our business, financial condition and results of operations.
 
We have limited insurance.
 
We have no directors’ and officers’ liability insurance and limited commercial liability insurance policies. Any significant claims would have a material adverse effect on our business, financial condition and results of operations.  
 
 
 
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Risks Related to our Common Stock
 
CANX and Logic Works and TCA could have significant influence over matters submitted to stockholders for approval.
 
CANX and Logic Works
 
As of December 31, 2016, CANX and Logic Works in the aggregate hold shares representing approximately 29.9% of our common stock on a fully-converted basis and could be considered a control group for purposes of SEC rules. However, their agreements limit their ownership to 4.99% individually and each of the parties disclaims its status as a control group or a beneficial owner due to the fact that their beneficial ownership is limited to 4.99% per their agreements. Beneficial ownership includes shares over which an individual or entity has investment or voting power and includes shares that could be issued upon the exercise of options and warrants within 60 days after the date of determination.
 
TCA and Chicago Venture
 
As a result of funding from TCA and Chicago Venture as previously detailed, they exercise significant control over us.
 
If these persons were to choose to act together, they would be able to significantly influence all matters submitted to our stockholders for approval, as well as our officers, directors, management and affairs. For example, these persons, if they choose to act together, could significantly influence the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of us on terms that other stockholders may desire.
 
Trading in our stock is limited by the lack of market makers and the SEC’s penny stock regulations.
 
On April 10, 2014, as a result of the SEC suspension in the trading of our securities, we lost all market makers and traded on the grey market of OTCBB. Until we complied with FINRA Rule 15c2-11, we traded on the grey market, which has limited quotations and marketability of securities. Holders of our common stock found it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market value of our common stock declined.
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
Our stock is categorized as a penny stock The SEC has adopted Rule 15g-9 which generally defines "penny stock" to be any equity security that has a market price (as defined) less than US$ 5.00 per share or an exercise price of less than US$ 5.00 per share, subject to certain exclusions (e.g., net tangible assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the last three years). The penny stock rules impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and accredited investors. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC, which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. Finally, broker-dealers may not handle penny stocks under $0.10 per share.
 
These disclosure requirements reduce the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules would affect the ability of broker-dealers to trade our securities if we become subject to them in the future. The penny stock rules also could discourage investor interest in and limit the marketability of our common stock to future investors, resulting in limited ability for investors to sell their shares.
 
FINRA sales practice requirements may also limit a shareholder’s ability to buy and sell our stock.
 
In addition to the “penny stock” rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
 
 
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The market price of our common stock may be volatile.
 
The market price of our common stock has been and is likely in the future to be volatile. Our common stock price may fluctuate in response to factors such as: 
 

Halting of trading by the SEC or FINRA.
 
 
Announcements by us regarding liquidity, legal proceedings, significant acquisitions, equity investments and divestitures, strategic relationships, addition or loss of significant customers and contracts, capital expenditure commitments, loan, note payable and agreement defaults, loss of our subsidiaries and impairment of assets,
 
 
Issuance of convertible or equity securities for general or merger and acquisition purposes,
 
 
Issuance or repayment of debt, accounts payable or convertible debt for general or merger and acquisition purposes,
 
 
Sale of a significant number of shares of our common stock by shareholders,
 
 
General market and economic conditions,
 
Quarterly variations in our operating results,
 
 
Investor relation activities,
 
 
Announcements of technological innovations,
 
 
New product introductions by us or our competitors,
 
 
Competitive activities, and
 
 
Additions or departures of key personnel.
 
These broad market and industry factors may have a material adverse effect on the market price of our common stock, regardless of our actual operating performance. These factors could have a material adverse effect on our business, financial condition, and/or results of operations.
 
The sale of a significant number of our shares of common stock could depress the price of our common stock.
 
Sales or issuances of a large number of shares of common stock in the public market or the perception that sales may occur could cause the market price of our common stock to decline. As of December 31, 2016, there were approximately 1.645 billion shares of our common stock issued and outstanding.  In addition, as of December 31, 2016, there are also (i) stock option grants outstanding for the purchase of 12 million common shares at a $0.010 average exercise price; (ii) warrants for the purchase of 595 million common shares at a $0.031 average exercise price; and (iii) 207.8 million shares related to convertible debt that can be converted at 0.0036 per share. Subsequent to December 31, 2016, (i) 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; (ii) During the three months ended March 31, 2017, Chicago Venture converted principal and interest of $1,253,000 into 190,189,197 shares of our common stock at a per share conversion price of $0.007; and (iii) 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.
 
In addition, we have an unknown number of common shares to be issued under the TCA and Chicago Venture financing agreements because the number of shares ultimately issued to TCA depends on the price at which TCA converts its debt to shares. The lower the conversion price, the more shares that will be issued to TCA or Chicago Venture upon the conversion of debt to shares. We won’t know the exact number of shares of stock issued to TCA or Chicago Venture until the debt is actually converted to equity. If all stock option grant, warrant and contingent shares are issued, approximately 2.471 billion of our currently authorized 3 billion shares of common stock will be issued and outstanding.  For purposes of estimating the number of shares issuable upon the exercise/conversion of all stock options, warrants and contingent shares, we assumed the number of shares and average share prices detailed above.
 
These stock option grant, warrant and contingent shares could result in further dilution to common stock holders and may affect the market price of the common stock.
 
Significant shares of common stock are held by our principal shareholders, other Company insiders and other large shareholders. As affiliates as defined under Rule 144 of the Securities Act or Rule 144 of the Company, our principal shareholders, other Company insiders and other large shareholders may only sell their shares of common stock in the public market pursuant to an effective registration statement or in compliance with Rule 144.
 
Some of the present shareholders have acquired shares at prices as low as $0.007 per share, whereas other shareholders have purchased their shares at prices ranging from $0.0036 to $0.78 per share.
 
 
15
 
 
These stock option grant, warrant and contingent shares could result in further dilution to common stock holders and may affect the market price of the common stock.
 
Some of our convertible debentures may require adjustment in the conversion price.
 
Our 7% Convertible Notes Payable and our 6% Convertible Secured Convertible Notes may require an adjustment in the current conversion price of $0.0036 per share if we issue common stock, warrants or equity below the price that is reflected in the convertible notes payable. The conversion price of the convertible notes will have an impact on the market price of our common stock. Specifically, if under the terms of the convertible notes the conversion price goes down, then the market price, and ultimately the trading price, of our common stock will go down. If under the terms of the convertible notes the conversion price goes up, then the market price, and ultimately the trading price, of our common stock will likely go up. In other words, as the conversion price goes down, so does the market price of our stock. As the conversion price goes up, so presumably does the market price of our stock. The more the conversion price goes down, the more shares are issued upon conversion of the debt which ultimately means the more stock that might flood into the market, potentially causing a further depression of our stock.
 
We do not anticipate paying any cash dividends on our capital stock in the foreseeable future.
 
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business, and we do not anticipate paying any cash dividends on our capital stock in the foreseeable future. In addition, the terms of any future debt agreements may preclude us from paying dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.
 
Anti-takeover provisions may limit the ability of another party to acquire our company, which could cause our stock price to decline.
 
Our certificate of incorporation, as amended, our bylaws and Delaware law contain provisions that could discourage, delay or prevent a third party from acquiring our company, even if doing so may be beneficial to our stockholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock.
 
We may issue preferred stock that could have rights that are preferential to the rights of common stock that could discourage potentially beneficially transactions to our common shareholders.
 
An issuance of additional shares of preferred stock could result in a class of outstanding securities that would have preferences with respect to voting rights and dividends and in liquidation over our common stock and could, upon conversion or otherwise, have all of the rights of our common stock.  Our Board of Directors' authority to issue preferred stock could discourage potential takeover attempts or could delay or prevent a change in control through merger, tender offer, proxy contest or otherwise by making these attempts more difficult or costly to achieve.  The issuance of preferred stock could impair the voting, dividend and liquidation rights of common stockholders without their approval.
 
If the company were to dissolve or wind-up, holders of our common stock may not receive a liquidation preference.
 
If we were too wind-up or dissolve the Company and liquidate and distribute our assets, our shareholders would share ratably in our assets only after we satisfy any amounts we owe to our creditors.  If our liquidation or dissolution were attributable to our inability to profitably operate our business, then it is likely that we would have material liabilities at the time of liquidation or dissolution.  Accordingly, we cannot give you any assurance that sufficient assets will remain available after the payment of our creditors to enable you to receive any liquidation distribution with respect to any shares you may hold.
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.     PROPERTIES
 
Operating Leases
 
On December 7, 2016, we entered into entered into a Consent to Judgement and Settlement Agreement related to our retail hydroponics store located in Portland, Maine. This Agreement provides for a monthly lease payment of $4,668 through May 2, 2017. If we are in compliance with the Settlement Agreement, we can extend the lease from May 2, 2017 to May 1, 2020 at the monthly lease payment of $5,373. We also agreed to a repayment schedule for past due rent of $70,013. We do not have an option to extend the lease after May 1, 2020.
 
On October 21, 2013, we entered into a lease agreement for retail space for our retail 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. We do not have an option to extend the lease.
 
 
16
 
 
 
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.
 
ITEM 3.    LEGAL PROCEEDINGS
 
We are involved in the disputes and legal proceedings described below. In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws. Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation. We accrue any contingent liabilities that are likely.
 
Class Actions Alleging Violations of Federal Securities Laws
 
Beginning on April 18, 2014, three class action lawsuits alleging violations of federal securities laws were filed against the Company in United States District Court, Central District of California (the “Court”). On May 15, 2014 and August 4, 2014, respectively two shareholder derivative lawsuits were filed against the Company with the Court (the “Derivative Actions”). On October 20, 2014, AmTrust North America, our insurer, filed a lawsuit contesting insurance coverage on the above legal proceedings. We accrued $2,000,000 as settlement of the Consolidated Class Action and Derivative Action lawsuits alleging violations of federal securities laws that were filed against the Company during the year ending December 31, 2015. We issued $2 million in common stock or 115,141,048 shares of our common stock on April 6, 2016 pursuant to the settlement of the Consolidated Class Action and Derivative Action lawsuits alleging violations of federal securities laws that were filed against us in United States District Court, Central District of California.
 
Sales, Payroll and Other Tax Liabilities
 
As of December 31, 2016, we owe approximately $129,000 in sales tax.
 
Potential Convertible Note Defaults
 
Several of our convertible promissory notes remain outstanding beyond their respective maturity dates. This may trigger an event of default under the respective agreements. We are working with these noteholders to convert their notes into common stock and intends to resolve these outstanding issues as soon as practicable.
 
Other Legal Proceedings
 
We have been sued for non-payment of lease payments at closed stores in Boulder, Colorado and Plaistow, New Hampshire. We are currently subject to legal actions with various vendors.
 
It is possible that additional lawsuits may be filed and served on us.
 
ITEM 4.    MINE SAFETY DISCLOSURES
 
Not applicable. 
 
 
 
17
 
PART II
 
ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
General
 
The following description of our capital stock and provisions of our articles of incorporation and bylaws are summaries and are qualified by reference to our articles of incorporation and the bylaws. We have filed copies of these documents with the SEC as exhibits to our Form 10-K.
 
Authorized Capital Stock
 
We have 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.
 
Capital Stock Issued and Outstanding
 
As of December 31, 2016, we have issued and outstanding securities on a fully diluted basis, consisting of:
 
● 1,656,120,083 shares of common stock;
● Stock option grants for the purchase of 12,010,000 shares of common stock at average exercise price of $0.010;
● Warrants to purchase an aggregate of 595,000,000 shares of common stock with expiration dates between November 2018 and October 2013 at an exercise price of $0.031 per share;
● 207,812,222 shares of common stock to be issued for the conversion of Convertible Notes Payables at a conversion price of $0.0036 per share; and
● An unknown number of common shares to be issued under the TCA Global Credit Master Fund LP and Chicago Venture Partners, L.P. financing agreements.
 
Voting Common Stock
 
Holders of our 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.
 
Non-Voting Preferred Stock
 
Under the terms of our articles of incorporation, our board of directors is authorized to issue shares of non-voting preferred stock in one or more series without stockholder approval. Our board of directors has the discretion to determine the rights, preferences, privileges and restrictions, dividend rights, conversion rights, redemption privileges and liquidation preferences, of each series of non-voting preferred stock.
 
The purpose of authorizing our board of directors to issue non-voting preferred stock and determine our rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The issuance of non-voting preferred stock, while providing flexibility in connection with possible acquisitions, future financings and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or could discourage a third party from seeking to acquire, a majority of our outstanding voting stock. 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 B Preferred Stock Designation
 
In connection with the Amended and Restated Securities Purchase Agreement, the Board of Directors, on October 21, 2015, approved the authorization of a Series B Preferred Stock as provided in our Certificate of Incorporation, as amended.
 
The Series B Preferred Stock has authorized 150,000 shares with a stated value equal to $10.00 per share. Dividends payable to other classes of stock are restricted until repayment of the aggregate value of Series B Preferred Stock. Upon our liquidation or dissolution, Series B Preferred Stock has no priority or preference with respect to distributions of any assets by us. The Series B Preferred Stock is convertible into common stock by dividing the stated value of the shares being converted by 100% of the average of the five lowest closing bid prices for the common stock during the ten consecutive trading days immediately preceding the conversion date as quoted by Bloomberg, LP.
 
 
18
 
 
TCA was issued 150,000 shares of Series B Preferred Stock. However, in no event will Purchaser be entitled to hold in excess of 4.99% of the outstanding shares of common stock of the Company.
 
In connection with the First Amendment to Amended and Restated Securities Purchase Agreement, TCA surrendered the Series B Preferred Stock.
 
Series C Preferred Stock Designation
 
In connection with the Amended and Restated Securities Purchase Agreement, the Board of Directors, on October 21, 2015, approved the authorization of a Series C Preferred Stock as provided in our 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 the event of a default under the Amended and Restated Transaction Documents, each share of Series C Preferred Stock shall have voting votes equal to 0.019607 multiplied by the total issued and outstanding common stock and preferred stock eligible to vote divided by .49 minus the numerator. For example, if the total issued and outstanding common stock eligible to vote is 5,000,000, the voting rights of one share of Series C Preferred Stock shall be equal to 102,036 (e.g. ((0.019607 x 5,000,000/0.49) – (0.019607 x 5,000,000) = 102,036). In the event of a default under the Amended and Restated TCA Transaction Documents, TCA can exercise voting control over our common stock.
 
On February 1, 2017, GrowLife, Inc., a Delaware corporation (the “Company”), closed the transactions described below with Chicago Venture Partners, L.P. (“Chicago Venture”).
 
In connection with the closing of the Chicago Venture transactions which closed on February 1, 2017, TCA surrendered the Series C Preferred Stock.
 
Warrants to Purchase Common Stock
 
As of December 31, 2016, we had warrants to purchase 595,000,000 shares of common stock with expiration dates between November 2018 and October 2013 at an exercise price of $0.031 per share.
 
Options to Purchase Common Stock
 
In fiscal year 2011, we 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. After the exercise of stock option grants, we have 27,522,626 shares available for issuance. We have outstanding unexercised stock option grants totaling 12,010,000 shares at an average exercise price of $0.010 per share as of December 31, 2016. All grants are considered non-qualified until the increase is approved by the shareholders.
 
Dividend Policy
 
We have not previously paid any cash dividends on our common stock and do not anticipate or contemplate paying dividends on our common stock in the foreseeable future. We currently intend to use all of our available funds to develop our business. We can give no assurances that we will ever have excess funds available to pay dividends.
 
Change in Control Provisions
 
Our articles of incorporation and by-laws provide for a maximum of nine directors, and the size of the Board cannot be increased by more than three directors in any calendar year.  There is no provision for classification or staggered terms for the members of the Board of Directors.
 
Our articles of incorporation also provide that except to the extent the provisions of Delaware General Corporation Law require a greater voting requirement, any action, including the amendment of the Company’s articles or bylaws, the approval of a plan of merger or share exchange, the sale, lease, exchange or other disposition of all or substantially all of the Company’s property other than in the usual and regular course of business, shall be authorized if approved by a simple majority of stockholders, and if a separate voting group is required or entitled to vote thereon, by a simple majority of all the votes entitled to be cast by that voting group.
 
Our bylaws provide that only the Chief Executive Officer or a majority of the Board of Directors may call a special meeting.  The bylaws do not permit the stockholders of the Company to call a special meeting of the stockholders for any purpose. 
 
 
 
19
 
 
Articles of Incorporation and Bylaws Provisions
 
 
Our articles of incorporation, as amended, and bylaws contain provisions that could have the effect of discouraging potential acquisition proposals or tender offers or delaying or preventing a change in control, including changes a stockholder might consider favorable. In particular, our articles of incorporation and bylaws among other things:
 
● permit our board of directors to alter our bylaws without stockholder approval; and
● provide that vacancies on our board of directors may be filled by a majority of directors in office, although less than a quorum.
 
Such provisions may have the effect of discouraging a third party from acquiring us, even if doing so would be beneficial to our stockholders. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by them, and to discourage some types of transactions that may involve an actual or threatened change in control of our company. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal and to discourage some tactics that may be used in proxy fights. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure our company outweigh the disadvantages of discouraging such proposals because, among other things, negotiation of such proposals could result in an improvement of their terms.
 
However, these provisions could have the effect of discouraging others from making tender offers for our shares that could result from actual or rumored takeover attempts. These provisions also may have the effect of preventing changes in our management.
 
Market Price of and Dividends on Common Equity and Related Stockholder Matters
 
Our common stock traded on the grey market under the symbol “PHOT” through February 17, 2016. While the company was without a market maker, its stock does trade directly between buyers and sellers on the grey sheets. The quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not represent actual transactions. Consequently, the information provided below was not be indicative of our common stock price under different conditions.
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
Period Ended
 
High
 
 
Low
 
Year Ending December 31, 2016
 
 
 
 
 
 
December 31, 2016
 $0.021 
 $0.007 
September 30, 2016
 $0.020 
 $0.006 
June 30, 2016
 $0.027 
 $0.015 
March 31, 2016
 $0.058 
 $0.003 
 
    
    
Year Ending December 31, 2015
    
    
December 31, 2015
 $0.020 
 $0.003 
September 30, 2015
 $0.180 
 $0.010 
June 30, 2015
 $0.060 
 $0.010 
March 31, 2015
 $0.350 
 $0.020 
 
As of March 27, 2017, the closing price of the company's common stock was $0.010 per share. As of March 31, 2017, there were 1,944,843,172 shares of common stock issued and outstanding. We have approximately 112 stockholders of record. This number does not include up to approximately 15,000-80,000 beneficial owners whose shares are held in the names of various security brokers, dealers, and registered clearing agencies.
 
Transfer Agent 
 
The transfer agent for our common stock is Issuer Direct Corporation located 500 Perimeter Park, Suite D, Morrisville NC 27560, and their telephone number is (919) 481-4000. 
 
Dividends 
 
We have not previously paid any cash dividends on our common stock and do not anticipate or contemplate paying dividends on our common stock in the foreseeable future. We currently intend to use all of our available funds to develop our business. We can give no assurances that we will ever have excess funds available to pay dividends.
 
 
 
 
20
 
Recent Sales of Unregistered Securities
 
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(a)(2) of the Securities Act of 1933. 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 December 31, 2016, we had the following sales of unregistered sales of equity securities.
 
On October 21, 2016, an entity affiliated with Mr. Scott, our Chief Financial Officer, converted $40,000 in accrued consulting fees and expenses into 4,000,000 shares of our common stock at $0.01 per share. The price per share was based on the thirty-day trailing average. On October 21, 2016, an entity affiliated with Mr. Scott was granted 6,000,000 shares of our common stock at $0.01 per share. The price per share was based on the thirty-day trailing average. On October 21, 2016, an entity affiliated with Mr. Scott cancelled stock option grants totaling 12,000,000 shares of our common stock at $0.01 per share.
 
On October 12, 2016, we issued 4,000,000 shares of its common stock to an entity affiliated with Marco Hegyi, Chief Executive Officer pursuant to a conversion of debt for $40,000. The shares were valued at the fair market price of $0.01 per share.
 
On October 21, 2016, we issued 5,020,000 shares to two former directors and a supplier (unaccredited) for services provided. We valued the 5,020,000 shares at $0.01 per share or $50,200.
 
During the three months ended December 31, 2016, we issued 5,000,000 shares of its common stock to a service provider pursuant to conversions of $50,000. The shares were valued at the fair market price of $0.010 per share.
 
During the three months ended December 31, 2016, Holders of our Convertible Notes Payables, converted principal and accrued interest of $235,682 into 65,467,127 shares of our common stock at a per share conversion price of $0.004.
 
During the three months ended December 31, 2016, Old Main converted principal and accrued interest of $44,208 into 12,365,872 shares of our common stock at a per share conversion price of $0.004.
 
During the three months ended December 31, 2016, Chicago Venture converted principal and accrued interest of $1,275,599 into 242,300,607 shares of our common stock at a per share conversion price of $0.0053.
 
EQUITY COMPENSATION PLAN INFORMATION
 
The following table provides information as of December 31, 2016 related to the equity compensation plan in effect at that time.

 
 
(a)
 
 
(b)
 
 
(c)
 
Plan Category
 
Number of securities
to be issued upon
exercise of outstanding options, warrants and rights
 
 
Weighted-average
exercise price of
outstanding options, warrants and rights
 
 
Number of securities remaining available
for future issuance
under equity compensation plan (excluding securities reflected in column (a))
 
Equity compensation plan
 
 
 
 
 
 
 
 
 
approved by shareholders
  - 
  - 
  - 
Equity compensation plans
    
    
    
not approved by shareholders
  12,010,000 
  0.010 
  - 
Total
  12,010,000 
  0.010 
  - 
 
ITEM 6.    SELECTED FINANCIAL DATA
 
In the following table, we provide you with our selected consolidated historical financial and other data. We have prepared the consolidated selected financial information using our consolidated financial statements for the years ended December 31, 2016 and 2015. When you read this selected consolidated historical financial and other data, it is important that you read along with it the historical financial statements and related notes in our consolidated financial statements included in this report, as well as Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
 
21
 
 
 
 
Years Ended December 31,
 
 
 
2016
 
 
2015
 
 
2014
 
 
2013
 
 
2012
 
 
 
(Audited)
 
 
(Audited)
 
 
(Audited)
 
 
(Audited)
 
 
(Audited)
 
STATEMENT OF OPERATIONS DATA:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net revenue
 $1,231 
 $3,500 
 $8,538 
 $4,859 
 $1,451 
Cost of goods sold
  1,276 
  2,981 
  7,173 
  4,006 
  1,039 
Gross profit
  (45)
  519 
  1,365 
  853 
  412 
General and administrative expenses
  2,764 
  2,684 
  7,851 
  11,796 
  1,683 
Operating (loss)
  (2,809)
  (2,165)
  (6,486)
  (10,943)
  (1,271)
Other expense
  (4,886)
  (3,524)
  (80,140)
  (10,437)
  (915)
Net (loss)
 $(7,695)
 $(5,689)
 $(86,626)
 $(21,380)
 $(2,186)
Net (loss) per share
 $(0.01)
 $(0.01)
 $(0.10)
 $(0.04)
 $(0.01)
Weighted average number of shares
  1,197,565,907 
  884,348,627 
  834,503,868 
  593,034,693 
  245,420,970 
 
ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Our goal of becoming the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines continues to guide our decisions. Our mission is to 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 knowledgeable representatives, regional centers and its e-commerce website, GrowLife provides essential and hard-to-find goods including growing media, industry-leading hydroponics equipment, organic plant nutrients, and thousands more products to specialty grow operations across the United States.
 
We primarily sell through our 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.
 
We are focusing on future success. In that regard, we believe that the hydroponics supply industry will experience significant growth and, as a result, operating in this industry has become highly competitive, cash intensive and customer centric.  However, we have plans to address these challenges.  
 
First, the opportunity to sell both infrastructure equipment and recurring supplies to the indoor cultivation industry is constantly increasing as demand for indoor cultivation grows across the United States. We believe the demand will continue to grow and more and more states and municipalities enact rules and regulations allowing for more indoor cultivation activities.   We plan to continue with our multi-faceted distribution strategy, which we believe serves customers in the following manner: Direct sales to large commercial customers, retail in some markets for local convenience, and e-commerce via GrowLifeEco.com to fulfill orders across the nation from customers of all sizes.  
 
Second, serving what we see as an increasing number of cultivators has become cash intensive because of the need for large inventory levels at retail, extensive e-commerce online marketing, and supporting payment terms to large accounts.  We need to arrange for financing support to be competitive.  We have learned that retail success is about having the right products on hand, knowledgeable and experienced talent, accessible advisory services and superior turn-over ratios.  Currently, GrowLifeEco.com offers over 15,000 products, far beyond the 3,000 found in Greners.com, its former online store.  
 
Third, our customers come in different stages from caregiver cultivators to 80,000 square foot commercial operations.  With the use of e-commerce, we endeavor to reach as many customers as possible in areas where we do not have stores or a direct sales presence.  Earlier this year GrowLife built GrowLifeEco.com, our new e-commerce website, that is optimized for mobile devices.  Our next step is to put web marketing in place to increase awareness, traffic and conversions.  
 
Also, we recognize demand is increasing from small, aspiring cultivation consumers across the country seeking to learn and use a complete indoor growing solution.  To address this demand, we packaged GrowLife Cube, a development-stage annual subscription service, for consumers to get hands-on experience with indoor growing.  Although many still buy the components separately, we are working on developing videos and supplier tools to attract them to this one-stop shop subscription program.  Given the election results in California the GrowLife Cube subscription service will evolve with greater value and specialty services to be announced in the fourth quarter.
 
Resumed Trading of our Common Stock
 
On February 18, 2016, our common stock resumed unsolicited quotation on the OTC Bulletin Board after receiving clearance from the Financial Industry Regulatory Authority (“FINRA”) on our Form 15c2-11. We are currently taking the appropriate steps to uplist to the OTCQB Exchange and resume priced quotations with market makers as soon as it is able.
 
 
 
 
22
 
 
 
RESULTS OF OPERATIONS
 
The following table presents certain consolidated statement of operations information and presentation of that data as a percentage of change from year-to-year.
 
(dollars in thousands)
 
 
 
Year Ended December 31,
 
 
 
2016
 
 
2015
 
 
$ Variance
 
 
% Variance
 
Net revenue
 $1,231 
 $3,500 
 $(2,269)
  -64.8%
Cost of goods sold
  1,276 
  2,981 
  (1,705)
  57.2%
Gross profit
  (45)
  519 
  (564)
  -108.7%
General and administrative expenses
  2,764 
  2,684 
  80 
  -3.0%
Operating loss
  (2,809)
  (2,165)
  (644)
  -29.7%
Other income (expense):
    
    
    
    
Change in fair value of derivative
  (1,324)
  1,679 
  (3,003)
  -178.9%
Interest expense, net
  (817)
  (1,119)
  302 
  27.0%
Other income (expense), primarily related to TCA funding
  145 
  (2,003)
  2,148 
  107.2%
Loss on debt conversions
  (2,890)
  - 
  (2,890)
  -100.0%
Loss on class action lawsuit settlements
  - 
  (2,081)
  2,081 
  100.0%
Total other (expense) income
  (4,886)
  (3,524)
  (1,362)
  38.6%
(Loss) before income taxes
  (7,695)
  (5,689)
  (2,006)
  -35.3%
Income taxes - current benefit
  - 
  - 
  - 
  0.0%
Net (loss)
 $(7,695)
 $(5,689)
 $(2,006)
  -35.3%
 
YEAR ENDED DECEMBER 31, 2016 COMPARED TO THE YEAR ENDED DECEMBER 31, 2015
 
Revenue
 
Net revenue for the year ended December 31, 2016 decreased $2,269,000 to $1,231,000 as compared to $3,500,000 for the year ended December 31, 2015. The decrease was due to (i) lower revenue from the retail stores acquired by GrowLife Hydroponics’ acquisition of Rocky Mountain Hydroponics and Evergreen Garden Center on September 7, 2013; (ii) closure of the unprofitable Peabody, Massachusetts, Woodland Hills, California and Plaistow, New Hampshire stores; and (iii) lack of liquidity. During the year ended December 31, 2016, we transitioned funding from TCA funding to Chicago Venture. During the transition, we experienced difficulties in purchasing product and lost or canceled sales.
 
Cost of Goods Sold
 
Cost of sales for the year ended December 31, 2016 decreased $1,705,000 to $1,276,000 as compared to $2,981,000 for the year ended December 31, 2015. The decrease was due to (i) lower revenue from the retail stores acquired by GrowLife Hydroponics’ acquisition of Rocky Mountain Hydroponics and Evergreen Garden Center on September 7, 2013; (ii) closure of the unprofitable Peabody, Massachusetts, Woodland Hills, California and Plaistow, New Hampshire stores; and (iii) lack of liquidity. During the year ended December 31, 2016, we transitioned funding from TCA funding to Chicago Venture. During the transition, we experienced difficulties in purchasing product and ordered product at higher costs and lost or canceled sales.
 
Gross profit was ($45,000) for the year ended December 31, 2016 as compared to $519,000 for the year ended December 31, 2015. The gross margin was (3.6%) for the year ended December 31, 2016 as compared to 14.8% for the year ended December 31, 2015. During the year ended December 31, 2016, we transitioned funding from TCA funding to Chicago Venture. During the transition, we experienced difficulties in purchasing product and ordered product at higher costs and lost or canceled sales.
 
General and Administrative Expenses
 
General and administrative expenses for the year ended December 31, 2016 increased $80,000 to $2,764,000 as compared to $2,684,000 for the year ended December 31, 2015. The increase was due to (i) the impairment of GrowLife Hydro, Inc. long-lived assets of $876,000; (ii) and an increase in sales and marketing of $76,000; offset by (iii) reduced legal expense of $48,000; (iv) reduced wages of $260,000; (v) reduced insurance expense of $188,000; (vi) reduced consulting expenses of $143,000; (vii) reduced rent of $78,000; and (viii) reduced other general expenses of $243,000. As part of the general and administrative expenses for the year ended December 31, 2016, we did not record any public relation, investor relation or business development expenses.
 
Non-cash general and administrative expenses for the year ended December 31, 2016 were $1,422,000 including (i) depreciation and amortization of $115,000; (ii) stock based compensation of $146,000 related to stock option grants; (iii) common stock issued for services of $285,000; and (iv) the impairment of GrowLife Hydro, Inc. long-lived assets of $876,000.
 
 
23
 
 
Non-cash general and administrative expenses for the year ended December 31, 2015 was $531,000, with (i) depreciation and amortization of $120,000; (ii) stock based compensation of $176,000 related to stock option grants; (iii) common stock issued for services of $211,000; and (iii) other of $24,000.
 
Other Income/ Expense
 
Other expense for the year ended December 31, 2016 was $4,886,000 as compared to other expense of $3,524,000 for the year ended December 31, 2015. The other expense for the year ended December 31, 2016 included (i) interest expense of $817,000; (ii) loss on debt conversions of $2,890,000; (iii) change in derivative liability of $1,324,000; offset by (iv) and other income of $145,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The non-cash interest related to the amortization of the debt discount associated with our convertible notes and accrued interest expense related to our notes payable. The loss on debt conversions related to the conversion of our notes payable at prices below the market price.
 
The other expense for the year ended December 31, 2015 included change in derivative liability of $1,679,000, offset by interest expense of $1,119,000, other expense of $2,003,000 and loss on class action lawsuit settlements of $2,081,000. The change in derivative liability is the non-cash change in the fair value and relates to our derivative instruments. The non-cash interest related to the amortization of the debt discount associated with our convertible notes, accrued interest expense related to our notes payable. The other expense is primarily related to the TCA funding. We accrued $2,081,000 as loss on class action lawsuits and contingent liabilities as of December 31, 2015.
 
Net (Loss)
 
Net loss for the year ended December 31, 2016 was $7,695,000 as compared to a net loss of $5,689,000 for the year ended December 31, 2015 for the reasons discussed above.
 
Net loss for the year ended December 31, 2016 included non-cash expense of $6,271,000, including (i) depreciation and amortization of $115,000; (ii) stock based compensation of $146,000 related to stock option grants; (iii) common stock issued for services of $285,000; (iv) the impairment of GrowLife Hydro, Inc. long-lived assets of $876,000; (v) accrued interest and amortization of debt discount on convertible notes payable of $635,000; (v) loss on debt conversions of $2,890,000; and (vi) change in derivative liability of $1,324,000.
 
Net loss for the year ended December 31, 2015 included non-cash expense of $3,759,000, including (i) depreciation and amortization of $120,000; (ii) stock based compensation of $176,000 related to stock option grants; (iii) common stock issued for services of $211,000; (iv) interest expense of $1,120,000, (v) loss on class action lawsuit settlements of $2,000,000; (vi) preferred shares issued for services of $300,000; (vii) issuance of Series B Convertible Preferred Stock of $1,500,000; and (viii) other of $176,000, offset by (ix) change in derivative liability of $724,000.
 
We expect losses to continue as we implement our business plan.
 
LIQUIDITY AND CAPITAL RESOURCES
 
We had cash of $103,000 and a net working capital deficit of approximately $4,007,000 (excluding the derivative liability- warrants of $2,702,000 as of December 31, 2016.  We expect losses to continue as we grow our business. Our cash used in operations for the years ended December 31, 2016 and 2015 was $1,212,000, $1,376,000, respectively.
 
Shortly after the SEC suspended trading of our securities on April 10, 2014, some of our primary suppliers rescinded our credit terms and required us to pay cash for our product purchases and pay down our outstanding balance with these suppliers.
 
We will need to obtain additional financing in the future. There can be no assurance that we will be able to secure funding, or that if such funding is available, the terms or conditions would be acceptable to us. If we are unable to obtain additional financing, we may need to restructure our operations, divest all or a portion of our business or file for bankruptcy.
 
We have financed our operations through the issuance of convertible debentures and the sale of common stock.
 
February 1, 2017 Funding Agreements with Chicago Venture Partners, L.P.
 
On February 1, 2017, we closed the transactions described below with Chicago Venture Partners, L.P. (“Chicago Venture”).
 
 
 
24
 
 
Securities Purchase Agreement, Secured Promissory Notes, Membership Interest Pledge Agreement and Security Agreement
 
On January 9, 2017, the Company executed the following agreements with Chicago Venture: (i) Securities Purchase Agreement; (ii) Secured Promissory Notes; (iii) Membership Interest Pledge Agreement; and (iv) Security Agreement (collectively the “Chicago Venture Agreements”). The Chicago Venture Agreements are attached hereto, collectively, filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on February 7, 2017, and incorporated herein by reference. The Company entered into the Chicago Venture Agreements with the intent of paying its debt, in full, to TCA Global Credit Master Fund, LP (“TCA”), which included any TCA affiliates.
 
The total amount of funding under the Chicago Venture Agreements is $1,105,000 (the “Debt”). Each Convertible Promissory Note carries an original issue discount of $100,000 and a transaction expense amount of $5,000, for total debt of $1,105,000. The Company agreed to reserve 500,000,000 of its shares of common stock for issuance upon conversion of the Debt, if that occurs in the future. If not converted sooner, the Debt is due on or before January 9, 2018. The Debt carries an interest rate of ten percent (10%). The Debt is convertible, at Chicago Venture’s option, into the Company’s common stock at $0.009 per share subject to adjustment as provided for in the Secured Promissory Notes attached hereto and incorporated herein by this reference. As of the date of this report on Form 8-K, Chicago Venture has funded the entire amount of the Debt.
 
Chicago Venture’s obligation to fund the Debt was secured by Chicago Venture’s 60% interest in Typenex Medical, LLC, an Illinois corporation, as provided for in the Membership Pledge Agreement attached hereto and incorporated herein by this reference.
 
Payment of All TCA Obligations
 
On January 10, 2017, Chicago Venture, at the Company’s instruction, remitted funds of $1,495,901 to TCA in order to satisfy all debts to TCA. On or around January 11, 2017, the Company was notified by TCA that $13,540 were due to TCA in order for TCA to release its security interest in the Company’s assets. On February 1, 2017, TCA notified the Company that all funds were received and TCA would release its security interest in Company’s assets. TCA has confirmed that it is paid in full and the Company is not aware of any other obligations that the Company has as to TCA. The funds received under the Chicago Venture Agreements and previous Chicago Venture Agreements were used to pay-off TCA.
 
Prior Funding Agreements with Chicago Venture Partners, L.P.
 
Entry into Securities Purchase Agreement with Chicago Venture Partners, L.P. As of April 4, 2016, we 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, we 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.
 
The Secured Investor Notes are payable (i) $50,000 upon filing of a Registration Statement on Form S-1; (ii) $100,000 upon effectiveness of the Registration Statement; and (iii) up to $200,000 per month over the 10 months following effectiveness at our sole discretion, subject to certain conditions. We agreed to file the Registration Statement within forty-five (45) days of the Closing and agreed to register shares of our common stock for the benefit of Chicago Venture in exchange for the payments under the Secured Investor Notes.
 
Chicago Venture has the option to convert the Note at 65% of the average of the three (3) lowest volume weighted average prices in the twenty (20) Trading Days immediately preceding the applicable conversion (the “Conversion Price”). However, in no event will the Conversion Price be less than $0.02 or greater than $0.09. In addition, beginning on the date that is the earlier of six (6) months or five (5) days after the Registration Statement becomes effective, and on the same day of each month thereafter, the Company will re-pay the Note in monthly installments in cash, or, subject to certain Equity Conditions, in our common stock at 65% of the average of the three (3) lowest volume weighted average prices in the twenty (20) Trading Days immediately preceding the applicable conversion (the “Installment Conversion Price”).
 
As discussed above, once effective, we have the discretion to require Chicago Venture to sell to us up to $200,000 per month over the next 10 months on the above terms. We would then have the option to issue shares registered under this Registration Statement to Chicago Venture. Through this prospectus, the selling stockholder may offer to the public for resale shares of our common stock that we may issue to Chicago Venture pursuant to the Chicago Venture Note.
 
For a period of no more than 36 months from the effective date of the Registration Statement, we may, from time to time, at our sole discretion, and subject to certain conditions that we must satisfy, draw down funds under the Chicago Venture Note.
 
Our ability to require Chicago Venture to fund the Chicago Venture Note is at our discretion, subject to certain limitations. Chicago Venture is obligated to fund if each of the following conditions are met; (i) the average and median daily dollar volumes of our common stock for the twenty (20) and sixty (60) trading days immediately preceding the funding date are greater than $100,000; (ii) our market capitalization on the funding date is greater than $17,000,000; (iii) we are not in default with respect to share delivery obligations under the note as of the funding date; and (iv) we are current in its reporting obligations. Chicago Venture’ obligations under the equity line are not transferable.
 
 
25
 
 
The issuance of our common stock under the Chicago Venture Note will have no effect on the rights or privileges of existing holders of common stock except that the economic and voting interests of each stockholder will be diluted as a result of any such issuance. Although the number of shares of common stock that stockholders presently own will not decrease, these shares will represent a smaller percentage of our total shares that will be outstanding after any issuances of shares of common stock to Chicago Venture. If we draw down amounts under the Chicago Venture Note when our share price is decreasing, we will need to issue more shares to repay the same amount than if our stock price was higher. Such issuances will have a dilutive effect and may further decrease our stock price.
 
There is no guarantee that we will be able to meet the foregoing conditions or any other conditions under the Securities Purchase Agreement and/or Chicago Venture Note or that we will be able to draw down any portion of the amounts available under the Securities Purchase Agreement and/or Chicago Venture Note. However, we do believe there is a strong likelihood, as long as we can meet the various conditions to funding, that we will receive the full amount of funding under the equity line of credit. Given our financial challenges and the competitive nature of our business, we also believe we will need the full amount of funding under the equity line of credit in order to fully realize our business plans.
 
A portion of the funds received from Chicago Venture will be used to pay off TCA Global Credit Master Fund, LP (“TCA”), a previous equity financing partner and a portion will be invested in our business. Specifically, we anticipate that approximately $1,400,000 is expected to be used to pay TCA and the remaining funds, if any, will be used for general business purposes such as marketing, product development, expansion and administrative costs. We are not aware of any relationship between TCA and Chicago Venture. We have had no previous transactions with Chicago Venture or any of Chicago Venture’ affiliates. We cannot predict whether the Chicago Venture transaction will have either a positive or negative impact on our stock price. However, in addition to the fact that each Chicago Venture conversion, when and if it occurs, has a dilutive effect on our stock, that should Chicago Venture convert large portions of the debt into registered shares and then sells those shares on the market, that our stock price could be depressed.
 
Debt Purchase Agreement and First Amendment to Debt Purchase Agreement and Note Assignment Agreement. On August 24, 2016, we 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, we closed an Exchange Agreement and a Convertible Promissory Note and related agreements with Chicago Venture whereby we agreed to the assignment of debentures representing debt between the Company, on the one hand, and with TCA, on the other hand. Specifically, we agreed that TCA could assign a portion of the Company’s debt held by TCA to Chicago Venture.
 
According to the Exchange Agreement, the debt is to be assigned in tranches, with the first tranche of debt assigned from TCA to Chicago Venture being $128,000 which is represented by an Initial Exchange Note as defined in the Exchange Agreement.
 
Funding from TCA Global Credit Master Fund, LP (“TCA”).
 
The First TCA SPA. On July 9, 2015, we closed a Securities Purchase Agreement and related agreements with TCA Global Credit Master Fund LP (“TCA”), an accredited investor, whereby we agreed to sell and TCA agreed to purchase up to $3,000,000 of senior secured convertible, redeemable debentures, of which $700,000 was purchased on July 9, 2015 and up to $2,300,000 may be purchased in additional closings. The closing of the transaction (the “First TCA SPA”) occurred on July 9, 2015. Effective as of May 4, 2016, the Company and TCA entered into a First Amendment to the First TCA SPA whereby the parties agreed to amend the terms of the First TCA SPA in exchange for TCA’s forbearance of existing defaults by the Company.
 
The Second TCA SPA. On August 6, 2015, we closed a second Securities Purchase Agreement and related agreements with TCA whereby we agreed to sell and TCA agreed to purchase a $100,000 senior secured convertible redeemable debenture and we agreed to issue and sell to TCA, from time to time, and TCA agreed to purchase from us up to $3,000,000 of the Company’s common stock pursuant to a committed equity facility. The closing of the transaction (the “Second TCA SPA”) occurred on August 6, 2015. On April 11, 2016, we agreed with TCA to mutually terminate the Second TCA SPA.
 
Amendment to the First TCA SPA. On October 27, 2015, we entered into an Amended and Restated Securities Purchase Agreement and related agreements with TCA whereby we agreed to sell, and TCA agreed to purchase $350,000 of senior secured convertible, redeemable debentures. This was an amendment to the First TCA SPA (the “Amendment to the First TCA SPA”.) As of October 27, 2015, we sold $1,050,000 in Debentures to TCA and up to $1,950,000 in Debentures remain for sale by us. The closing of the Amendment to the First TCA SPA occurred on October 27, 2015. In addition, TCA has advanced us an additional $100,000 for a total of $1,150.000.
 
 
26
 
 
Issuance of Preferred Stock to TCA. Also, on October 21, 2015 we issued 150,000 Series B Preferred Stock at a stated value equal to $10.00 per share to TCA. The Series B Preferred Stock is convertible into common stock by dividing the stated value of the shares being converted by 100% of the average of the five (5) lowest closing bid prices for the common stock during the ten (10) consecutive trading days immediately preceding the conversion date as quoted by Bloomberg, LP. On October 21, 2015, we also issued 51 shares of Series C Preferred Stock at $0.0001 par value per share to TCA. The Series C Preferred Stock is not convertible into our common stock. In the event of a default under the Amended and Restated TCA Transaction Documents, TCA can exercise voting control over our common stock with their Series C Preferred Stock voting rights.
 
TCA’s Forbearance. Due to our default on its repayment obligations under the TCA SPA’s and related documents, the parties agreed to restructure the SPA’s whereby TCA agreed to forbear from enforcement of our defaults and to restructure a payment schedule for repayment of debt under the SPAs. We defaulted because our operating results were not as expected and we were unable to generate sufficient revenue through its business operations to serve the TCA debt. Specifically, the First Amendment to Amended and Restated Securities Purchase Agreement made the following material modifications to the existing SPA’s:
 
All unpaid debentures were modified as described in more detail below.
 
Payments on the debentures shall be made by (i) debt purchase agreement(s) to be entered into by TCA, (ii) through proceeds raised from the transaction(s) with Chicago Venture; or (iii) by the Company directly.
 
The due date of the debentures was extended to April 28, 2018.
 
TCA agreed that it shall not enforce and shall forbear from pursuing enforcement of any existing defaults by us unless and until a future Company default occurs.
 
In furtherance of TCA’s forbearance, effective as of May 4, 2016, we issued Second Replacement Debenture A in the principal amount of $150,000 and Second Replacement Debenture B in the principal amount of $2,681,209.82 (collectively, the “Second Replacement Debentures”).
 
Per the First Amendment to Amended and Restated Securities Purchase Agreement, the Second Replacement Debentures were combined, and apportioned into two separate replacement debentures. The Second Replacement Debentures were intended to act in substitution for and to supersede the debentures in their entirety. It was the intent of the Company and TCA that while the Second Replacement Debentures replace and supersede the debentures, in their entirety, they were not in payment or satisfaction of the debentures, but rather were the substitute of one evidence of debt for another without any intent to extinguish the old debt. The maximum number of shares subject to conversion under the Second Replacement Debentures is 383,028,714. This is an approximation. The estimation of the maximum number of shares issuable upon the conversion of the Second Replacement Debentures was calculated using an estimated average price of $.013 per share.
 
The Second Replacement Debentures contemplate TCA entering into debt purchase agreement(s) with third parties whereby TCA may, at its election, sever, split, divide or apportion the Second Replacement Debentures to accomplish the repayment of the balance owed to TCA by Company. The Second Replacement Debentures are convertible at 85% of the lowest daily volume weighted average price (“VWAP”) of our common stock during the five (5) business days immediately prior to a conversion date.
 
In connection with the above agreements, the parties acknowledged and agreed that certain advisory fees previously paid to TCA as provided in the SPAs in the amount of $1,500,000 have been added and included within the principal balance of the Second Replacement Debentures. The advisory fees related to financial, merger and acquisition and regulatory services provided to us. The conversion price discount on the Second Replacement Debentures will not apply to the advisory fees added to the Second Replacement Debentures. TCA also agreed to surrender its Series B Preferred Stock in exchange for the $1,500,000 being added to the Second Replacement Debenture.
 
As more particularly described below, we remain in debt to TCA for the principal amount of $1,500,000. The remaining $1,400,000 of principal debt was assigned to Old Main Capital, LLC (see discussion immediately below.) We intend to use the funds generated from the Chicago Venture transaction to fuel its business operations and business plans which, in turn, will presumably generate revenues sufficient to avoid another default in the remaining TCA obligations. If we are unable to raise sufficient funds through the Chicago Venture transaction and/or generate sales sufficient to service the remaining TCA debt then we will be unable to avoid another default. Failure to operate in accordance with the various agreements with TCA could result in the cancellation of these agreements, result in foreclosure on our assets in an event of default which would have a material adverse effect on our business, results of operations or financial condition.
 
 
 
27
 
 
TCA Assignment of Debt to Old Main Capital, LLC
 
On September 9, 2016, we closed a Debt Purchase Agreement and related agreements (the “Old Main Transaction Documents”) with TCA and Old Main Capital, LLC (“Old Main”) whereby TCA agreed to sell and Old Main agreed to purchase in multiple tranches $1,400,000 in senior secured convertible, redeemable debentures (the “Assigned Debt”) (the “Old Main Transaction”). The Assigned Debt was our debt incurred in the TCA financing transactions that closed in 2015. We were required to execute the Old Main Transaction Documents as we are the “borrower” on the Assigned Debt.
 
Debt Purchase Agreement. As set forth above, we entered into the Debt Purchase Agreement on September 9, 2015 with TCA and Old Main whereby Old Main agreed to purchase, in tranches, $1,400,000 of debt previously held by TCA. We executed the Debt Purchase Agreement as it was the “borrower” under the Assigned Debt and was required to make certain representations and warranties regarding the Assigned Debt. The Assigned Debt is represented by a new “10% Senior Convertible Promissory Note” entered into by and between Old Main and the Company (more particularly described below.)
 
Exchange Agreement. In conjunction with the Debt Purchase Agreement, on September 9, 2016, we entered into an Exchange Agreement whereby we agreed to exchange, in tranches, the Assigned Debt, as well as any amendments thereto, with a 10% Senior Convertible Promissory Note (the “Note”) having a principal balance of $1,400,000. The closing dates for the exchanges, scheduled to occur in tranches, are set forth in Schedule 1 attached to the Exchange Agreement.
 
10% Senior Convertible Promissory Note. Pursuant to the Exchange Agreement, we entered into a 10% Senior Convertible Promissory Note dated September 9, 2016 with Old Main whereby the Company agreed to be indebted to Old Main for the Assigned Debt. We promised to pay Old Main, by no later than the maturity date of September 9, 2017 the outstanding principal of the Assigned Debt together with interest on the outstanding principal amount under the Note, at the rate of ten percent (10%) per annum simple interest.
 
At any time after September 9, 2016, and while the Note is still outstanding and at the sole option of Old Main, Old Main may convert all or any portion of the outstanding principal, accrued and unpaid interest redemption premium and any other sums due and payable hereunder or under any of the other Transaction Documents into shares of our Common Stock at a price equal to the lower of: (i) sixty-five percent (65%) of the lowest traded price of the Company’s Common Stock during the thirty (30) trading days prior to the Conversion Date; or (ii) sixty-five percent (65%) of the lowest traded price of the Common Stock in the thirty (30) Trading Days prior to the Closing Date.
 
Option Agreement. In connection with the Old Main Transaction Documents, TCA and Old Main entered into an Option Agreement dated September 8, 2016 whereby TCA agreed to grant Old Main an option to purchase the Assigned Debt, or any portion thereof, under the terms and conditions of the Debt Purchase Agreement. In consideration, Old Main agreed to pay the Option Payment as more particularly described in the Option Agreement.
 
On August 24, 2016, TCA terminated its Debt Purchase Agreement and related agreements with Old Main. The specific termination date is September 25, 2016, and Old Main had a right to purchase an additional $300,000 in debt from TCA.
 
Operating Activities
 
Net cash used in operating activities for the year ended December 31, 2016 was $1,212,000. This amount was primarily related to a net loss of $7,695,000, offset by (i) an increase in inventory of $20,000; (ii) an increase in accounts payable and accrued expenses of $174,000; (iii) other of $17,000; and non-cash expenses of $6,271,000 including (i) depreciation and amortization of $115,000; (ii) stock based compensation of $146,000 related to stock option grants; (iii) common stock issued for services of $285,000; (iv) the impairment of GrowLife Hydro, Inc. long-lived assets of $876,000; (v) accrued interest and amortization of debt discount on convertible notes payable of $635,000; (v) loss on debt conversions of $2,890,000; and (vi) change in derivative liability of $1,324,000.
 
Financing Activities
 
Net cash provided by financing activities for the year ended December 31, 2016 was $1,255,000. The amount related to funding provided by Chicago Venture.
 
Our contractual cash obligations as of December 31, 2016 are summarized in the table below:

Contractual Cash Obligations
 
Total
 
 
Less Than
1 Year
 
 
1-3 Years
 
 
3-5 Years
 
 
Greater Than
5 Years
 
Operating leases
 $130,784 
 $115,205 
 $15,579 
 $- 
 $- 
Convertible notes payable
  2,920,196 
  2,920,196 
  - 
  - 
  - 
Capital expenditures
  25,000 
  25,000 
  - 
  - 
  - 
 
 $3,075,980 
 $3,060,402 
 $15,579 
 $- 
 $- 
 
 
 
28
 
 
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.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
The application of GAAP involves the exercise of varying degrees of judgment. On an ongoing basis, we evaluate our estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that of our significant accounting policies (see summary of significant accounting policies more fully described in Note 3 to Form 10-K for the year ended December 31, 2016), the following policies involve a higher degree of judgment and/or complexity:
 
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. We have 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. We record a provision for excess and obsolete inventory whenever an impairment has been identified. The reserve for inventory was $20,000 at December 31, 2016 and 2015, respectively.
 
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).  
 
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 and warrants to purchase shares of our common stock at the fair market value at the time of grant. Stock-based compensation cost to employees is measured by us 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, we recognize 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.
 
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
As a smaller reporting company, we are not required to provide the information required by this Item. Nevertheless, we have no investments in any market risk sensitive instruments either held for trading purposes or entered into for other than trading purposes.
 
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Reference is made to our consolidated financial statements beginning on page F-1 of this report.
 
ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
Not applicable.
 
ITEM 9A. CONTROLS AND PROCEDURES
 
 
 
 
29
 
 
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. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we assessed the effectiveness of our internal control over financial reporting as of the end of the period covered by this report based on the framework in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, our principal executive officer and principal financial officer concluded that our internal control over financial reporting were not effective to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with United States generally accepted accounting principles.
 
Pursuant to Regulation S-K Item 308(b), this Annual Report on Form 10-K does not include an attestation report of our company’s registered public accounting firm regarding internal control over financial reporting. The effectiveness of our internal control over financial reporting as of December 31, 2016 has not been audited by SD Mayer & Associates, LLP, an independent registered public accounting firm.
 
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.
 
 
 
 
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 December 31, 2016 that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses in our internal controls over financial reporting discussed immediately below.
 
Identified Material Weakness
 
A material weakness in our internal control over financial reporting is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
 
Management identified the following material weakness during its assessment of internal controls over financial reporting:
 
Audit Committee:
 
On June 3, 2014, we formed an Audit Committee and appointed an audit committee financial expert as defined by SEC and as adopted under the Sarbanes-Oxley Act of 2002. Prior to this, we did not have an Audit Committee to oversee financial reporting and used external service providers to ensure compliance with the SEC requirements. The current Audit Committee has one independent directors. We expect to expand this committee during 2017.
 
Other Weaknesses:
 
Our information systems lack sufficient controls limiting access to key applications and data.
Our inventory system lacked standardized product descriptions and effective controls to ensure the accuracy, valuation, and timeliness of the financial accounting process around inventory, including a lack of accuracy and basis for valuation resulting in adjustments to the amount of cost of revenues and the carrying amount of inventory.
 
b) Changes in Internal Control over Financial Reporting
 
During the quarter ended December 31, 2016, there were no changes in our internal controls over financial reporting during this fiscal quarter, which were identified in connection with our management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that materially affected, or is reasonably likely to have a materially affect, on our internal control over financial reporting.
 
ITEM 9B. OTHER INFORMATION
 
There were no disclosures of any information required to be filed on Form 8-K during the three months ended December 31, 2016 that were not filed.  
 
 
 
 
 
30
 
PART III
 
ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
The following changes in directors and named executive officers occurred during the year ending December 31, 2015 and 2016:
 
Marco Hegyi was appointed President on December 4, 2013 and Director on December 9, 2013. Mr. Hegyi was appointed Chairman of the Board and CEO on April 1, 2016.
Mark Scott was appointed Director on May 21, 2014, Chairman of the Audit Committee on June 3, 2014 and Consulting Chief Financial Officer on July 31, 2014. Mr. Scott resigned as Director and Chairman of the Audit Committee on October 18, 2015. Mr. Mark Scott was re-appointed to the Board of Directors and Secretary of GrowLife, Inc. on February 14, 2017.
Joseph Barnes was appointed Senior Vice President of Business Development on October 10, 2014.
Michael Fasci was appointed Director on October 27, 2015 and Chairman of the Audit and Compensation Committees on November 11, 2015. Mr. Fasci was appointed Secretary on April 1, 2016, which he resigned from on February 14, 2017.
Tara Antal was appointed Director on October 27, 2015 and resigned on March 4, 2016.
Brad Fretti was appointed Director on October 27, 2015 and Chairman of the Compensation Committee on November 11, 2015. Mr. Fretti resigned as Director and Chairman of the Compensation Committee on March 4, 2016.
 
Directors and Executive Officers
 
        The following table sets forth certain information about our current directors and executive officers:
 
Name
Age
Director/ Executive Officer
 
 
 
 
Marco Hegyi
59
Chairman of the Board, CEO, President and Nominations and Governance Committee Chairman (1)
 
 
 
 
Mark E. Scott
63
Consulting Chief Financial Officer
 
 
 
 
Michael E. Fasci
58
Director, Audit Committee Chairman and Secretary (2)(3)
 
 
 
 
Joseph Barnes
44
Senior Vice President of Business Development
 
* Independent director
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
(3) Member of the Nominations and Governance Committee.
 
All directors hold office until their successors are duly appointed or until their earlier resignation or removal.
 
Marco Hegyi Mr. Hegyi joined GrowLife as its President on December 4, 2013 and a Member of its Board of Directors on December 9, 2013 and was appointed as Chairman of the Nominations and Governance Committee and a member of the Compensation Committee on June 3, 2014.  Mr. Hegyi was appointed as CEO and Chairman of GrowLife effective on April 1, 2016. Mr. Hegyi has served as an independent director of Visualant, Inc. since February 14, 2008 and as Chairman of the Board from May 2011, and served at the Chairman of the Audit and Compensation committees until his departure on February 2015. Previously, Mr. Hegyi was a principal with the Chasm Group from 2006 to January 2014, where he has provided business consulting services.  As a management consultant, Mr. Hegyi applied his extensive technology industry experience to help early-stage companies and has been issued 10 US patents.  
 
Prior to working as a consultant in 2006, Mr. Hegyi served as Senior Director of Global Product Management at Yahoo! Prior to Yahoo!, Mr. Hegyi was at Microsoft leading program management for Microsoft Windows and Office beta releases aimed at software developers from 2001 to 2006.  While at Microsoft, he formed new software-as-a-service concepts and created operating programs to extend the depth and breadth of the company’s unparalleled developer eco-system, including managing offshore, outsource teams in China and India, and being the named inventor of a filed Microsoft patent for a business process in service delivery.
 
During Mr. Hegyi’s career, he has served as President and CEO of private and public companies, Chairman and director of boards, finance, compensation and audit committee chair, chief operating officer, vice-president of sales and marketing, senior director of product management, and he began his career as a systems software engineer.  
 
Mr. Hegyi earned a Bachelor of Science degree in Information and Computer Sciences from the University of California, Irvine, and has completed advanced studies in innovation marketing, advanced management, and strategy at Harvard Business School, Stanford University, UCLA Anderson Graduate School of Management, and MIT Sloan School of Management. 
 
 
31
 
 
Mr. Hegyi’s prior experience as Chairman and Chief Executive Officer of public companies, combined with his advanced studies in business management and strategy, were the primary factors in the decision to add Mr. Hegyi to the Company’s Board of Directors.
 
Michael E. Fasci – Mr. Fasci joined GrowLife as a Member of its Board of Directors on October 27, 2015 and was appointed Audit Committee Chairman on November 11, 2015. On April 1, 2016, Mr. Fasci was appointed as the Secretary of the Company, but resigned on February 14, 2017. Mr. Fasci is a 30-year veteran in the finance sector having served as an officer and director of many public and private companies.  Mr. Fasci is a seasoned operator across various industries and has served in both CEO and CFO capacities for both growth and turnaround situations. Mr. Fasci began his career as a field engineer and then manager of various remediation filtration and environmental monitoring projects globally before focusing his efforts on the daily operations, accounting and financial reporting and SEC compliance of the numerous companies he has served.  Mr. Fasci resides in East Taunton, Massachusetts and studied Electrical Engineering at Northeastern University and maintains his qualification as an Enrolled Agent of the Internal Revenue Service. 
 
Mr. Fasci was appointed to the Board of Directors based on his financial, SEC and governance skills.
 
Mark E. Scott Mr. Mark Scott was re-appointed to the Board of Directors and Secretary of GrowLife, Inc. on February 14, 2017. Mr. Scott was previously a member of the Board of Directors and Secretary of GrowLife, Inc. from May 2014 until his resignation on October 18, 2015. Mr. Scott was appointed our Consulting Chief Financial Officer on July 31, 2014.
 
Mr. Scott served as (i) Chief Financial Officer, Secretary and Treasurer of Visualant, Inc., from May 2010 to August 31, 2016. Mr. Scott was Chief Financial Officer of U.S. Rare Earths, Inc., a consulting position he held December 19, 2011 to April 30, 2014 and Chief Financial Officer of Sonora Resources Corporation, a consulting position he held from June 15, 2011 to August 31, 2014. Also, Mr. Scott was Chief Financial Officer, Secretary and Treasurer of WestMountain Gold from February 28, 2011 to December 31, 2013 and was a consultant from December 2010 to February 27, 2011. Mr. Scott previously served as Chief Financial Officer and Secretary of IA Global, Inc. from October 2003 to June 2011. Mr. Scott also provides consulting services to other non-public entities from time to time. Mr. Scott has significant financial, capital market and relations experience in public and private microcap companies.   Mr. Scott is a certified public accountant and received a Bachelor of Arts in Accounting from the University of Washington.
 
Mr. Scott was appointed to the Board of Directors based on his financial, SEC and governance skills.
 
Joseph Barnes- Mr. Barnes was appointed Senior Vice President of Business Development for GrowLife, Inc. on October 10, 2014. Mr. Barnes works from our Avon (Vail), Colorado store. Mr. Barnes joined GrowLife in 2010 and is responsible for all national sales operations including direct sales, retail and e-commerce. He led the sales team that recorded sales in 2014 of more than $8 million, a 100% increase from the previous year. 
 
Mr. Barnes made the progressive and entrepreneurial decision to work with GrowLife after seeing the agricultural benefits of indoor growing. He is deeply passionate about clean and sustainable grows, and has deep relationships with many trusted cultivators. He holds extensive knowledge of indoor growing methods with concentrating on maximizing the yields for clean and healthy crops. 
 
Barnes was a highly regarded snowboard instructor in Vail, Colorado prior to joining GrowLife. He worked with many top snowboard professionals, and received a Level 1 certification from American Association Snowboard Instructors (AASI). Before his days on the slopes, Barnes was also a recruiting manager focusing on placing senior executives with international pharmaceutical/biotech companies. He also owned and operated Chrome Night Life Arena, a 20,000 square foot indoor/outdoor venue based in Philadelphia with more than 65 employees. 
 
Certain Significant Employees
 
There are no significant employees required to be disclosed under Item 401(c) of Regulation S-K.
 
Family Relationships
 
There are no family relationships among our directors and executive officers.
 
 
 
32
 
 
Involvement in Certain Legal Proceedings
 
None of our current directors or executive officers has, to the best of our knowledge, during the past ten years:
 
● Had any petition under the federal bankruptcy laws or any state insolvency law filed by or against, or had a receiver, fiscal agent, or similar officer appointed by a court for the business or property of such person, or any partnership in which he was a general partner at or within two years before the time hereof, or any corporation or business association of which he was an executive officer at or within two years before the time hereof;
 
● Been convicted in a criminal proceeding or a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses);
 
● Been the subject of any order, judgment, or decree, not subsequently reversed, suspended, or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining him from, or otherwise limiting, the following activities:
 
● Acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity;
 
● Engaging in any type of business practice; or
 
● Engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of federal or state securities laws or federal commodities laws;
 
● Been the subject of any order, judgment, or decree, not subsequently reversed, suspended, or vacated, of any federal or state authority barring, suspending, or otherwise limiting for more than 60 days the right of such person to engage in any activity described in (i) above, or to be associated with persons engaged in any such activity;
 
● Been found by a court of competent jurisdiction in a civil action or by the SEC to have violated any federal or state securities law, where the judgment in such civil action or finding by the SEC has not been subsequently reversed, suspended, or vacated; or
 
● Been found by a court of competent jurisdiction in a civil action or by the Commodity Futures Trading Commission to have violated any federal commodities law, where the judgment in such civil action or finding by the Commodity Futures Trading Commission has not been subsequently reversed, suspended, or vacated.
 
Committees of the Board of Directors
 
The Board has three standing committees to facilitate and assist the Board in the execution of its responsibilities. The committees are currently the Audit Committee, the Nominations and Governance Committee, and the Compensation Committee. The Committees were formed on June 3, 2014 by the current board of directors. The Audit Committee, Compensation and Nominations and Governance Committees each have two management directors.  The table below shows current membership for each of the standing Board committees.
 
Audit
 
Compensation
 
Nominations and Governance
Michael E. Fasci (Chairman)
 
Michael E. Fasci (Chairman)
 
Marco Hegyi (Chairman)
 
Compensation Committee Interlocks and Insider Participation
 
None of our executive officers serves as a member of the board of directors or compensation committee, or other committee serving an equivalent function, of any other entity that has one or more of its executive officers serving as a member of our board of directors or our compensation committee.
 
Code of Conduct and Ethics 
 
We have adopted conduct and ethics standards titled the code of ethics, which is available at www.growlifeinc.com. These standards were adopted by our board of directors to promote transparency and integrity. The standards apply to our board of directors, executives and employees. Waivers of the requirements of our code of ethics or associated polices with respect to members of our board of directors or executive officers are subject to approval of the full board.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Our executive officers, directors and 10% stockholders are required under Section 16(a) of the Exchange Act to file reports of ownership and changes in ownership with the SEC. Copies of these reports must also be furnished to us.
 
Except as follows, based solely on a review of copies of reports furnished to us, as of December 31, 2016 our executive officers, directors and 10% holders complied with all filing requirements.
 
 
 
33
 
 

Person
 
Filing Type
 
 Transaction
Date
 
 
Required
File
Date
 
 
Actual
File
Date
 
Michael E. Fasci
   4 
   5/25/2016 
   5/27/2016
   5/31/2016 
Marco Hegyi
  4 
  10/21/2017
  10/2/2016 
  10/25/2016
 
CANX and Logic Works Ownership
 
On July 10, 2014, we entered into 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.
 
CANX does not consider itself a beneficial owner due to its position that it has a 4.99% ownership limit. CANX further disclaims it has acted as a control group with Logic Works Therefore, CANX has not made any Section 16(a) filings. Likewise, at this time, we do not consider CANX a control party under SEC Rules.
 
ITEM 11. EXECUTIVE COMPENSATION
 
Compensation Discussion and Analysis
 
Overview of Compensation Program
 
This Compensation Discussion and Analysis describes the material elements of compensation awarded to, earned by or paid to each of our executive officers named in the Compensation Table on page 26 under “Remuneration of Executive Officers” (the “Named Executive Officers”) who served during the year ended December 31, 2016. This compensation discussion primarily focuses on the information contained in the following tables and related footnotes and narrative for the last completed fiscal year. We also describe compensation actions taken after the last completed fiscal year to the extent that it enhances the understanding of our executive compensation disclosure. The principles and guidelines discussed herein would also apply to any additional executive officers that the Company may hire in the future.
 
The Compensation Committee of the Board has responsibility for overseeing, reviewing and approving executive compensation and benefit programs in accordance with the Compensation Committee’s charter.  The member of the Compensation Committee is Michael E. Fasci. We expect to appoint two independent Directors to serve on the Compensation Committee during 2017.
 
Compensation Philosophy and Objectives
 
The major compensation objectives for the Company’s executive officers are as follows:
 
 
 
 
to attract and retain highly qualified individuals capable of making significant contributions to our long-term success;
 
 
 
 
to motivate and reward named executive officers whose knowledge, skills, and performance are critical to our success;
 
 
 
 
to closely align the interests of our named executive officers and other key employees with those of its shareholders; and
 
 
 
 
to utilize incentive based compensation to reinforce performance objectives and reward superior performance.
 
Role of Chief Executive Officer in Compensation Decisions
 
The Board approves all compensation for the chief executive officer. The Compensation Committee makes recommendations on the compensation for the chief executive officer and approves all compensation decisions, including equity awards, for our executive officers. Our chief executive officer makes recommendations regarding the base salary and non-equity compensation of other executive officers that are approved by the Compensation Committee in its discretion.
 
Setting Executive Compensation
 
The Compensation Committee believes that compensation for the Company’s executive officers must be managed to what we can afford and in a way that allows for us to meet our goals for overall performance. During 2016 and 2015, the Compensation Committee and the Board compensated its Chief Executive Officers, President and Chief Financial Officer at the salaries indicated in the compensation table. This compensation reflected the financial condition of the Company. The Compensation Committee does not use a peer group of publicly-traded and privately-held companies in structuring the compensation packages.
 
 
 
34
 
 
Executive Compensation Components for the Year Ended December 31, 2016
 
The Compensation Committee did not use a formula for allocating compensation among the elements of total compensation during the year that ended December 31, 2016. The Compensation Committee believes that in order to attract and retain highly effective people it must maintain a flexible compensation structure. For the year that ended December 31, 2016, the principal components of compensation for named executive officers were base salary.
 
Base Salary
 
Base salary is intended to ensure that our employees are fairly and equitably compensated. Generally, base salary is used to appropriately recognize and reward the experience and skills that employees bring to the Company and provides motivation for career development and enhancement. Base salary ensures that all employees continue to receive a basic level of compensation that reflects any acquired skills which are competently demonstrated and are consistently used at work.
 
Base salaries for the Company’s named executive officers are initially established based on their prior experience, the scope of their responsibilities and the applicable competitive market compensation paid by other companies for similar positions. Mr. Hegyi and Mr. Scott were compensated as described above based on the financial condition of the Company.
 
Performance-Based Incentive Compensation
 
The Compensation Committee believes incentive compensation reinforces performance objectives, rewards superior performance and is consistent with the enhancement of stockholder value. All of the Company’s Named Executive Officers are eligible to receive performance-based incentive compensation. The Compensation Committee did not recommend or approve payment of any performance-based incentive compensation to the Named Executive Officers during the year ended December 31, 2016 based on our financial condition.
 
Ownership Guidelines
 
The Compensation Committee does not require our executive officers to hold a minimum number of our shares. However, to directly align the interests of executive officers with the interests of the stockholders, the Compensation Committee encourages each executive officer to maintain an ownership interest in the Company.
 
Stock Option Program
 
Stock options are an integral part of our executive compensation program. They are intended to encourage ownership and retention of the Company’s common stock by named executive officers and employees, as well as non-employee members of the Board. Through stock options, the objective of aligning employees’ long-term interest with those of stockholders may be met by providing employees with the opportunity to build a meaningful stake in the Company.
 
The Stock Option Program assists us by:
 
- enhancing the link between the creation of stockholder value and long-term executive incentive compensation;
 
- providing an opportunity for increased equity ownership by executive officers; and
 
- maintaining competitive levels of total compensation.
 
Stock option award levels are determined by the Compensation Committee and vary among participants’ positions within the Company. Newly hired executive officers or promoted executive officers are generally awarded stock options, at the discretion of the Compensation Committee, at the next regularly scheduled Compensation Committee meeting on or following their hire or promotion date. In addition, such executives are eligible to receive additional stock options on a discretionary basis after performance criteria are achieved.
 
Options are awarded at the closing price of our common stock on the date of the grant or last trading day prior to the date of the grant. The Compensation Committee’s policy is not to grant options with an exercise price that is less than the closing price of our common stock on the grant date.
 
Generally, the majority of the options granted by the Compensation Committee vest quarterly over two to three years or annually over five years of the 5-10-year option term. Vesting and exercise rights cease upon termination of employment and/or service, except in the case of death (subject to a one year limitation), disability or retirement. Stock options vest immediately upon termination of employment without cause or an involuntary termination following a change of control. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents.
 
The Named Executive Officers received stock option grants and warrants during the year ended December 31, 2016 as outlined below.
 
 
35
 
 
 
Retirement and Other Benefits
 
We have no other retirement, savings, long-term stock award or other type of plans for the Named Executive Officers.
 
Perquisites and Other Personal Benefits
 
During the year ended December 31, 2016, we provided the Named Executive Officers with medical insurance. The Company paid $10,273 in life insurance for Mr. Hegyi and $9,755 in insurance for Mr. Scott. No other perquisites or other personal benefits were provided to Named Executive Officers. The committee expects to review the levels of perquisites and other personal benefits provided to Named Executive Officers annually.
 
Employment and consulting agreements are discussed below.
 
Tax and Accounting Implications
 
Deductibility of Executive Compensation
 
Subject to certain exceptions, Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code") generally denies a deduction to any publicly held corporation for compensation paid to its chief executive officer and its three other highest paid executive officers (other than the principal financial officer) to the extent that any such individual's compensation exceeds $1 million. “Performance-based compensation” (as defined for purposes of Section 162(m)) is not taken into account for purposes of calculating the $1 million compensation limit, provided certain disclosure, shareholder approval and other requirements are met. We periodically review the potential consequences of Section 162(m) and may structure the performance-based portion of our executive compensation to comply with certain exceptions to Section 162(m). However, we may authorize compensation payments that do not comply with the exceptions to Section 162(m) when we believe that such payments are appropriate and in the best interests of the stockholders, after taking into consideration changing business conditions or the officer's performance
 
Accounting for Stock-Based Compensation
 
We account for stock-based payments including its Stock Option Program in accordance with the requirements of ASC 718, “Compensation-Stock Compensation.”
 
COMPENSATION COMMITTEE REPORT
 
The Compensation Committee, sets and administers policies that govern the Company's executive compensation programs, and incentive and stock programs. The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Proxy Statement.
 
THE COMPENSATION COMMITTEE
 
Michael E. Fasci (Chairman)
 
EXECUTIVE COMPENSATION
 
REMUNERATION OF EXECUTIVE OFFICERS
 
The following table provides information concerning remuneration of the chief executive officer, the chief financial officer and another named executive officer for the years ended December 31, 2016 and 2015:
 
Summary Compensation Table
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-EquityIncentive
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock
 
 
Plan
 
 
Option
 
 
Other
 
 
 
 
 
 
 
Salary
 
 
Bonus
 
 
Awards
 
 
Compensation
 
 
Awards
 
 
Compensation
 
 
Total
 
Principal Position
 
 
($)
 
 
($)
 
 
($) (1)
 
 
($)
 
 
($)
 
 
($)
 
 
($)
 
Marco Hegyi, President and Director (2)
12/31/2016
 $250,000 
 $- 
 $- 
 $- 
 $- 
 $34,231 
 $284,231 
 
12/31/2015
 $250,000 
 $- 
 $- 
 $- 
 $- 
 $8,561 
 $258,561 
 
    
    
    
    
    
    
    
Mark E. Scott, Consulting Chief Financial Officer (3)
12/31/2016
 $156,250 
 $- 
 $60,000 
 $- 
 $- 
 $9,755 
 $226,005 
 
12/31/2015
 $156,250 
 $- 
 $- 
 $- 
 $7,312 
 $- 
 $163,562 
 
    
    
    
    
    
    
    
Joseph Barnes, Senior Vice President of Business
12/31/2016
 $120,000 
 $- 
 $- 
 $- 
 $- 
 $- 
 $120,000 
    Development (4)
12/31/2015
 $90,000 
 $- 
 $- 
 $- 
 $- 
 $- 
 $90,000 
 
 
 
36
 
 
(1) For 2013, reflects the aggregate grant date fair value of stock awards granted during the relevant fiscal year calculated in accordance with FASB ASC Topic 718 as reflected in the terms of the August 12, 2012 Compensation Plan. For 2014, these amounts reflect the grant date market value as required by Regulation S-K Item 402(n)(2), computed in accordance with FASB ASC Topic 718.
 
(2) Mr. Hegyi was paid a salary of $250,000 during the year ended December 31, 2016 and $250,000 (cash salary of $203,500 and accrued salary of $46,500) during the year ended December 31, 2015. This 2015 accrual was based on the tight cash flow of the Company and agreed to by Mr. Hegyi, but there was no formal deferral agreement. There was no accrued interest paid on the unpaid salary.
 
On April 15, 2016, an entity controlled by Marco Hegyi converted $20,000 of accrued salary into 1,000,000 shares of our common stock at the market price of $0.020 per share. On October 12, 2016, an entity controlled by Marco Hegyi converted $40,000 of accrued salary into 4,000,000 shares of our common stock at the market price of $0.010 per share. The shares were valued at the fair market price of $0.01 per share.
 
We paid life insurance of $10,273 and $8,561 for Mr. Hegyi during the years ended December 31, 2016 and 2015, respectively. On October 21, 2016, Mr. Hegyi received a Warrant to purchase up to 10,000,000 shares of our common stock at an exercise price of $0.01 per share. In addition, Mr. Hegyi received Warrants to purchase up to 10,000,000 shares of our common stock at an exercise price of $0.01 per share which vest on October 21, 2017 and 2018. The Warrants are exercisable for 5 years. The warrants were valued at $390,000 and we recorded $23,958 of compensation expense for the warrants that had vested as of December 31, 2016.
 
(3) Mark E. Scott was appointed consulting Chief Financial Officer on July 31, 2014. Mr. Scott was paid a consulting fee of $156,250 during the year ended December 31, 2016 and $156,250 (cash salary of $105,000 and accrued salary of $51,250 during the year ended December 31, 2015. This accrual was based on the tight cash flow of the Company and agreed to by Mr. Scott, but there was no formal deferral agreement. There was no accrued interest paid on the unpaid consulting fee.
 
On January 4, 2016, an entity controlled by Mr. Scott converted $30,000 of accrued consulting fees and expenses into 3,000,000 shares of our common stock at the market price $0.010 per share. On October 21, 2016, an entity controlled by Mr. Scott converted $40,000 in accrued consulting and expenses into 4,000,000 shares of our common stock at $0.01 per share. The price per share was based on the thirty-day trailing average.
 
Mr. Scott was reimbursed $9,755 for insurance expenses during the year ended December 31, 2016. On October 21, 2016, Mr. Scott was granted 6,000,000 shares of the Company’s common stock at $0.01 per share or $60,000. The price per share was based on the thirty-day trailing average. An entity controlled by Mr. Scott had a two million share stock option that was previously issued vest on April 18, 2016 upon the Company securing a market maker with an approved 15c2-11 resulting in the Company’s relisting on OTCBB. The option was valued at $7,312.
 
Grants of Stock Based Awards during the year ended December 31, 2016
 
The Compensation Committee approved the following performance-based incentive compensation to the Named Executive Officers for the year ended December 31, 2016:

 
 
 
 
 
 
 
 
Estimated Future Payouts Under 
 
 
Estimated Future Payouts Under 
 
 
Stock Awards; 
 
 
  Number of
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Non-Equity Incentive Plan
 
 
 Equity Incentive Plan
 
 
 Number of
 
 
 Securities
 
 
 Exercise or
 
 
 Grant Date
 
 
 
 
 
   
 
Awards
 
 
 Awards
 
 
 Shares of
 
 
 Underlying
 
 
 Base Price of
 
 
 Fair Value of
 
 
 
Grant
 
 
 Threshold
 
 
 Target
 
 
 Maximum
 
 
 Threshold
 
 
 Target
 
 
 Maximum
 
 
 Stock or Units
 
 
 Options
 
 
 Option Awards
 
 
 Stock and
 
Name
 
Date

 
 ($)
 
 
 ($)
 
 
 ($)
 
  (#) 
  (#) 
  (#) 
  (#) 
  (#) 
 
 ($/Sh) (1)
 
 
 Option Awards
 
Marco Hegyi
  - 
 $- 
  - 
 $- 
  - 
  - 
  - 
  - 
  - 
 $- 
 $- 
 
    
    
    
    
    
    
    
    
    
    
    
Mark E. Scott (2)
  - 
 $- 
  - 
 $- 
  - 
  - 
  - 
  6,000,000 
  - 
 $0.010 
 $60,000 
 
    
    
    
    
    
    
    
    
    
    
    
Joseph Barnes
  - 
 $- 
  - 
 $- 
  - 
  - 
  - 
  - 
  - 
 $- 
 $- 
 
(1) These amounts reflect the grant date market value as required by Regulation S-K Item 402(n)(2), computed in accordance with FASB ASC Topic 718.
 
(2)     On October 21, 2016, an entity controlled by Mr. Scott, our Chief Financial Officer, was granted 6,000,000 shares of our common stock at $0.01 per share. The price per share was based on the thirty-day trailing average.
 
Outstanding Equity Awards as of December 31, 2016
 
The Named Executive Officers had the following outstanding equity awards as of December 31, 2016:
 
 
 
37
 
 
 
 
Option Awards
 
 
Stock Awards
 
 
 
Number of
 
 
Number of
 
 
Number of
 
 
 
 
 
 
 
 
 
 
 
 
Number of
 
 
Market or
 
 
 
Securities
 
 
Securities
 
 
Securities
 
 
 
 
 
 
Number of
 
 
Market Value
 
 
Unearned Shares,
 
 
Payout Value of
 
 
 
Underlying
 
 
Underlying
 
 
Underlying
 
 
 
 
 
 
Shares or Units
 
 
of Shares or
 
 
Units or Other
 
 
Unearned Shares,
 
 
 
Unexercised
 
 
Unexercised
 
 
Unexercised
 
 
 Option
 
 
 
of Stock
 
 
Units of
 
 
Rights That
 
 
Units, or Other
 
 
 
Options
 
 
Options
 
 
Unearned
 
 
 Exercise
 
Option
 
That Have Not
 
 
Stock That
 
 
Have Not
 
 
Rights That Have
 
 
 
Exercisable
 
 
Unexerciseable
 
 
Options
 
 
 Price
 
Expiration
 
Vested
 
 
Have Not Vested
 
 
Vested
 
 
Not Vested
 
Name
  (#) 
  (#) 
  (#) 
 
 ($) (1)
 
Date
  (#) 
 
($)
 
  (#) 
 
($)
 
Marco Hegyi (2)
  - 
  - 
  - 
 $- 
 
  - 
 $- 
  - 
 $- 
 
    
    
    
    
 
    
    
    
    
Mark E. Scott (3)
  1,777,778 
  2,222,222 
  - 
 $0.01 
7/30/2019
  - 
 $- 
  - 
 $- 
 
    
    
    
    
 
    
    
    
    
Joseph Barnes (4)
  6,500,000 
  1,500,000 
  - 
 $0.01 
10/9/2019
  - 
 $- 
  - 
 $- 
 
(1) These amounts reflect the grant date market value as required by Regulation S-K Item 402(n)(2), computed in accordance with FASB ASC Topic 718.
 
(2)     On October 21, 2016, an entity controlled by Mr. Scott cancelled stock option grants totaling 12,000,000 shares of our common stock at $0.01 per share. An entity controlled by Mr. Scott has an additional 2,000,000 share stock option grant which continues to vest monthly over 36 months and a 2,000,000 share stock option grant which vests upon the achievement of certain performance goals related to acquisitions.
 
(3)     Mr. Barnes stock option grant consists of 6,500,000 shares of our common stock which vest quarterly over three years beginning October 1, 2014 and 2,000,000 shares of our common stock that vested October 10, 2014. On October 12, 2016, we amended the exercise price of the stock option grants for Mr. Barnes to $0.010 per share.
 
Option Exercises and Stock Vested for the year ended December 31, 2016
 
Mr. Hegyi, Scott and Barnes did not have any option exercised or stock that vested during the year ended December 31, 2016.
 
Pension Benefits
 
We do not provide any pension benefits. 
 
Nonqualified Deferred Compensation
 
We do not have a nonqualified deferral program. 
 
Employment and Consulting Agreements
 
Employment Agreement with Marco Hegyi
 
On October 21, 2016, we entered into Agreement with Marco Hegyi pursuant to which the Company engaged Mr. Hegyi as its Chief Executive Officer through October 20, 2018. Mr. Hegyi’s previous Employment Agreement was dated December 4, 2013 and which was set to expire on December 4, 2016.
 
Mr. Hegyi’s annual compensation is $250,000. Mr. Hegyi is also entitled to receive an annual bonus equal to four percent (4%) of the Company’s EBITDA for that year. The annual bonus shall be paid no later than 31 days following the end of each calendar year.
 
Mr. Hegyi received a Warrant to purchase up to 10,000,000 shares of common stock of the Company at an exercise price of $0.01 per share. In addition, Mr. Hegyi received Warrants to purchase up to 10,000,000 shares of common stock of the Company at an exercise price of $0.01 per share which vest on October 21, 2017 and 2018. The Warrants are exercisable for 5 years.
 
Mr. Hegyi will be entitled to participate in all group employment benefits that are offered by us to our senior executives and management employees from time to time, subject to the terms and conditions of such benefit plans, including any eligibility requirements. In addition, we will purchase and maintain during the Term an insurance policy on Mr. Hegyi’s life in the amount of $2,000,000 payable to Mr. Hegyi’s named heirs or estate as the beneficiary.
 
If we terminate Mr. Hegyi’s employment at any time prior to the expiration of the Term without Cause, as defined in the Employment Agreement, or if Mr. Hegyi terminates his employment at any time for “Good Reason” or due to a “Disability”, Mr. Hegyi will be entitled to receive (i) his Base Salary amount through the end of the Term; and (ii) his Annual Bonus amount for each year during the remainder of the Term. 
 
 
38
 
 
If there has been a “Change in Control” and the Company (or its successor or the surviving entity) terminates Mr. Hegyi’s employment without Cause as part of or in connection with such Change in Control (including any such termination occurring within one (1) month prior to the effective date of such Change in Control), then in addition to the benefits set forth above, Mr. Hegyi will be entitled to (i) an increase of $300,000 in his annual base salary amount (or an additional $25,000 per month) through the end of the Term; plus (ii) a gross-up in the annual base salary amount each year to account for and to offset any tax that may be due by Mr. Hegyi on any payments received or to be received by Mr. Hegyi under this Agreement that would result in a “parachute payment” as described in Section 280G of the Internal Revenue Code of 1986, as amended. If we (or its successor or the surviving entity) terminate Mr. Hegyi’s employment without Cause within twelve (12) months after the effective date of any Change in Control, or if Mr. Hegyi terminates his employment for Good Reason within twelve (12) months after the effective date of any Change in Control, then in addition to the benefits set forth above, Mr. Hegyi will be entitled to (i) an increase of $300,000 in his annual base salary amount (or an additional $25,000 per month), which increased annual base salary amount shall be paid for the remainder of the Term or for two (2) years following the Change in Control, whichever is longer; (ii) a gross-up in the annual base salary amount each year to account for and to offset any tax that may be due by Mr. Hegyi on any payments received or to be received by Mr. Hegyi under this Letter Agreement that would result in a “parachute payment” as described in Section 280G of the Internal Revenue Code of 1986, as amended; (iii) payment of Mr. Hegyi’s annual bonus amount as set forth above for each year during the remainder of the Term or for two (2) years following the Change in Control, whichever is longer; and (iv) health insurance coverage provided for and paid by the Company for the remainder of the Term or for two (2) years following the Change in Control, whichever is longer.
 
Consulting Chief Financial Officer Agreement with an Entity Controlled by Mark E. Scott
 
On July 31, 2014, we engaged Mr. Scott as its Consulting CFO from July 1, 2014 through September 30, 2014, and continuing thereafter until either party provides sixty-day notice to terminate the Letter or Mr. Scott enters into a full-time employment agreement.
 
Per the terms of the Scott Agreement, Mr. Scott’s compensation is $150,000 on an annual basis for the first year of the Scott Agreement. Mr. Scott is also entitled to receive an annual bonus equal to two percent of the Company’s EBITDA for that year. Our Board of Directors granted Mr. Scott an option to purchase sixteen million shares of our Common Stock under our 2011 Stock Incentive Plan at an exercise price of $0.07 per share, the fair market price on July 31, 2014. On December 18, 2015, we reduced the exercise price to $0.01 per share. The shares vest as follows:
 
 
 
 
 
i
Two million shares vest immediately upon securing a market maker with an approved 15c2-11 resulting in our relisting on OTCBB (earned as of February 18, 2016);
 
 
 
 
ii
Two million shares vest immediately upon the successful approval and effectiveness of our S-1 (not earned as of December 31, 2016);
 
 
 
 
iii
Two million shares vest immediately upon our resolution of the class action lawsuits (earned as of August 17, 2015); and,
 
 
 
 
iv
Ten million shares will vest on a monthly basis over a period of three years beginning on the July 1, 2014.

On October 21, 2016, Mr. Scott cancelled stock option grants totaling 12,000,000 shares of our common stock at $0.01 per share. Mr. Scott has an additional 2,000,000 share stock option grant which continues to vest monthly over 36 months and a 2,000,000 share stock option grant which vests upon the achievement of certain performance goals related to acquisitions.
 
All options will have a five-year life and allow for a cashless exercise. The stock option grant is subject to the terms and conditions of our Stock Incentive Plan, including vesting requirements.  In the event that Mr. Scott’s continuous status as consultant to the Company is terminated by us without Cause or Mr. Scott terminates his employment with us for Good Reason as defined in the Scott Agreement, in either case upon or within twelve months after a Change in Control as defined in our Stock Incentive Plan except for CANX USA, LLC, then 100% of the total number of shares shall immediately become vested.
 
Mr. Scott will be entitled to participate in all group employment benefits that are offered by us to our senior executives and management employees from time to time, subject to the terms and conditions of such benefit plans, including any eligibility requirements. In addition, we are required to purchase and maintain an insurance policy on Mr. Scott’s life in the amount of $2,000,000 payable to Mr. Scott’s named heirs or estate as the beneficiary. Finally, Mr. Scott is entitled to twenty days of vacation annually and has certain insurance and travel employment benefits.
 
If, prior to the expiration of the Term, we Mr. Scott’s employment for Cause, or if Mr. Scott voluntarily terminates his employment without Good Reason, or if Mr. Scott’s employment is terminated by reason of his death, then all of our obligations hereunder shall cease immediately, and Mr. Scott will not be entitled to any further compensation beyond any pro-rated base salary due and bonus amounts earned through the effective date of termination. Mr. Scott will also be reimbursed for any expenses incurred prior to the date of termination for which he was not previously reimbursed. Mr. Scott may receive severance benefits and our obligation under a termination by the Company without Cause or Mr. Scott terminates his employment for Good Reason are discussed above.
 
 
39
 
 
Promotion Letter with Joseph Barnes
 
On October 10, 2014, we entered into a Promotion Letter with Joseph Barnes which was effective October 1, 2014 pursuant to which we engaged Mr. Barnes as its Senior Vice-President of Business Development from October 1, 2014 on an at will basis. This Promotion Letter supersedes and canceled the Manager Services Agreement with Mr. Barnes dated August 1, 2013.
 
Per the terms of the Barnes Agreement, Mr. Barnes’s compensation is $90,000 on an annual basis. On January 1, 2016, Mr. Barnes salary was increased to $120,000 per year. Mr. Barnes received a bonus of $6,500 and is also entitled to receive a quarterly bonus based on growth of our growth margin dollars. No quarterly bonuses were earned under this Promotion Letter. Mr. Barnes was granted an option to purchase eight million shares of our common stock under our 2011 Stock Incentive Plan at $0.050 per share. The shares vest as follows:
 
 
 
 
i
Two million shares vested immediately;
 
 
 
 
iv
Six million shares vest on a monthly basis over a period of three years beginning on the date of grant.
 
On October 12, 2016, we amended the exercise price of the stock option grants for Mr. Barnes to $0.010 per share.
 
All options will have a five-year life and allow for a cashless exercise. The stock option grant is subject to the terms and conditions of our Stock Incentive Plan, including vesting requirements.  In the event that Mr. Barnes’s continuous status as employee to us is terminated by us without Cause or Mr. Barnes terminates his employment with us for Good Reason as defined in the Barnes Agreement, in either case upon or within twelve months after a Change in Control as defined in our Stock Incentive, then 100% of the total number of shares shall immediately become vested.
 
Mr. Barnes was entitled to participate in all group employment benefits that are offered by us to our senior executives and management employees from time to time, subject to the terms and conditions of such benefit plans, including any eligibility requirements. Finally, Mr. Barnes is entitled to fifteen days of vacation annually and has certain insurance and travel employment benefits.
 
Mr. Barnes may receive severance benefits and our obligation under a termination by the Company without Cause or Mr. Barnes terminates his employment for Good Reason are discussed above.
 
Potential Payments upon Termination or Change in Control 
 
The Company’s Employment Agreement with Marco Hegyi has provisions providing for severance payments as detailed below.
 
 
 
 
 
 
Early
 
 
Not For Good
 
 
Change in
 
 
 
 
Executive
 
For Cause
 
 
or Normal
 
 
Cause
 
 
Control
 
 
Disability
 
Payments Upon
 
Termination
 
 
Retirement
 
 
Termination
 
 
Termination
 
 
or Death
 
Separation
 
on 12/31/16
 
 
on 12/31/16
 
 
on 12/31/16
 
 
on 12/31/16
 
 
on 12/31/16
 
Compensation:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Base salary (1)
 $- 
 $- 
 $468,750 
 $600,000 
 $- 
Performance-based incentive
    
    
    
    
    
    compensation
 $- 
 $- 
 $- 
 $- 
 $- 
Stock options
 $- 
 $- 
 $- 
 $- 
 $- 
 
    
    
    
    
    
Benefits and Perquisites:
    
    
    
    
    
Health and welfare benefits
 $- 
 $- 
 $- 
 $- 
 $- 
Accrued vacation pay
 $- 
 $- 
 $- 
 $- 
 $- 
 
    
    
    
    
    
Total
 $- 
 $- 
 $468,750 
 $600,000 
 $- 
 
(1)
Reflects amounts to be paid upon termination without cause and upon termination in a change of control, less any months worked.
 
Mr. Scott and Mr. Barnes currently do not have amounts to be paid upon termination without cause and upon termination in a change of control. There outstanding stock options vests fully vest under certain conditions.
 
DIRECTOR COMPENSATION
 
We primarily use stock options grants to incentive compensation to attract and retain qualified candidates to serve on the Board. This compensation reflected the financial condition of the Company. In setting director compensation, we consider the significant amount of time that Directors expend in fulfilling their duties to the Company as well as the skill-level required by our members of the Board. During year ended December 31, 2016, Marco Hegyi did not receive any compensation for his service as director. The compensation disclosed in the Summary Compensation Table on page 36 represents the total compensation.
 
 
 
40
 
 
Director Summary Compensation
 
 
 
 
 
 
 
 
 
 
 
 
Non-Equity
 
 
Non-Qualified
 
 
 
 
 
 
 
 
 
Fees Earned
 
 
 
 
 
 
 
 
Incentive
 
 
Deferred
 
 
 
 
 
 
 
 
 
or Paid in
 
 
 
 
 
 
 
 
Plan
 
 
Compensation
 
 
Other
 
 
 
 
 
 
Cash
 
 
Stock
 
 
Option
 
 
Compensation
 
 
Earnings
 
 
Compensation
 
 
 
 
Name
 $  
 
Awards (1)
 
 
Awards
 
 
($)
 
 $  
 
($)
 
 
Total
 
Marco Hegyi
 $- 
 $- 
 $- 
 $- 
 $- 
 $- 
 $- 
 
    
    
    
    
    
    
    
Michael E. Fasci (2)
  - 
  65,000 
  - 
  - 
  - 
  - 
  65,000 
 
    
    
    
    
    
    
    
Tara Antal (3)
  - 
  - 
  - 
  - 
  - 
  - 
  - 
 
    
    
    
    
    
    
    
Brad Fretti (4)
  - 
  - 
  - 
  - 
  - 
  - 
  - 
 
    
    
    
    
    
    
    
 
 $- 
 $65,000 
 $- 
 $- 
 $- 
 $- 
 $65,000 
 
(1) These amounts reflect the grant date market value as required by Regulation S-K Item 402(n)(2), computed in accordance with FASB ASC Topic 718.
 
(2) On January 27, 2016, we issued 1,500,000 shares of its common stock to Michael E. Fasci pursuant to a service award for $15,000. The shares were valued at the fair market price of $0.01 per share. On May 25, 2016, we issued 2,500,000 shares of its common stock to Michael E. Fasci pursuant to a service award for $50,000. The shares were valued at the fair market price of $0.02 per share.
 
(3)     Ms. Antal resigned as a director on March 4, 2016. She did not receive any compensation as a director.
 
(4)     Mr. Fretti resigned as a director on March 4, 2016. He did not receive any compensation as a director.
 
Compensation Paid to Board Members
 
Our independent non-employee directors are not compensated in cash.  The only compensation has been in the form of stock awards. There is no stock compensation plan for independent non-employee directors. There was no Director compensation during the year ended December 31, 2016.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The following table sets forth certain information regarding the ownership of our common stock as of December 31, 2016 by:
 
 
each director and nominee for director;
 
 
 
 
each person known by us to own beneficially 5% or more of our common stock;
 
 
 
 
each officer named in the summary compensation table elsewhere in this report; and
 
 
 
 
all directors and executive officers as a group.
 
The amounts and percentages of common stock beneficially owned are reported on the basis of regulations of the SEC governing the determination of beneficial ownership of securities. Under the rules of the SEC, a person is deemed to be a “beneficial owner” of a security if that person has or shares voting power,” which includes the power to vote or to direct the voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has the right to acquire beneficial ownership within 60 days. Under these rules more than one person may be deemed a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which such person has no economic interest.
 
Unless otherwise indicated below, each beneficial owner named in the table has sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. The address of each beneficial owner is 5400 Carillon Point, Kirkland, WA 98033 and the address of more than 5% of common stock is detailed below.
 
 
41
 
 
 
 Shares Beneficially Owned
 
Name of Beneficial Owner
 
Number
 
 
  Percentage (1)
 
Directors and Named Executive Officers
     
     
Marco Hegyi (2)
  40,000,000 
  2.4%
Mark E. Scott (3)
  14,777,778 
  0.9%
Michael E. Fasci (4)
  5,500,000 
  * 
Joseph Barnes (5)
  6,800,000 
  * 
Total Directors and Officers (4 in total)
  67,077,778 
  4.1%
 
* Less than 1%.
 
(1)
Based on 1,656,120,083 shares of common stock outstanding as of December 31, 2016.
 
(2) Reflects the shares beneficially owned by Marco Hegyi, including warrants to purchase 35,000,000 shares of our common stock at $0.01 per share/
 
(3) Reflects the shares beneficially owned by Mark E. Scott, including stock option grants totaling 1,777,778 shares that Mr. Scott has the right to acquire in sixty days.
 
(4) Reflects the shares beneficially owned by Michael E. Fasci.
 
(5) Reflects the shares beneficially owned by Joseph Barnes, including stock option grants totaling 6,500,000 shares that Mr. Barnes has the right to acquire in sixty days.
 
 
 
 Shares Beneficially Owned
 
Name and Address of Beneficial Owner
 
 Number
 
 
Percentage
 
CANX USA LLC (1)
 
 
 
 
 
 
410 South Rampart Blvd., Suite 350
  540,000,000 
  24.6