NOTES TO FINANCIAL STATEMENTS
For the for the nine months ended September 30, 2018 and year ended
December 31, 2017
NOTE 1 – DESCRIPTION OF BUSINESS AND
ORGANIZATION
EZ-Clone
Enterprises, Inc. (the “Company” or “EZ
Clone”) is as a California corporation founded in January
2000. EZ Clone is a manufacturer of multiple award-winning products
specifically designed for the commercial cloning and propagation
stage of indoor plant cultivation including cannabis, food, and
other hydroponic farming.
The
Company has proprietary products and services such as the
Commercial Pro System, Hobbyist Cloning Systems, Cloning Tents,
Coco Collars, Coco Seed Starters, Rooting Gel, and Clear Rez.
Technical Support, know-how and overall knowledge is also
considered proprietary.
The
Company trademarks are EZ CLONE and EZ CLONE CRIB.
Purchase and Sale Agreement
On
October 15, 2018, the Company closed the Purchase and Sale
Agreement with GrowLife, Inc., a Delaware corporation headquartered
in Kirkland, Washington. GrowLife provides essential and
hard-to-find goods including growing media, industry-leading
hydroponics equipment, organic plant nutrients, and thousands more
products through its knowledgeable representatives and our
distribution channels, to specialty grow operations across the
United States and Canada.
GrowLife
primarily sell supplies through our wholly owned subsidiary,
GrowLife Hydroponics, Inc. GrowLife also distributes and sells over
15,000 products along with a handful of its own branded products
through its e-commerce distribution channels, ShopGrowLife.com and
GrowLifeEco.com, as well as through GrowLife licensed retail
storefronts. GrowLife and its business units are organized and
directed to operate strictly in accordance with all applicable
state and federal laws.
GrowLife
acquired 51% of EZ Clone for $2,040,000, payable as follows: (i) a
cash payment of $645,000; and (ii) the issuance of 107,307,692
restricted shares of the Company’s common stock at a price of
$0.013 per share or $1,395,000.
GrowLife
has the obligation to acquire the remaining 49% of EZ Clone within
one year for $1,960,000, payable as follows: (i) a cash payment of
$855,000; and (ii) the issuance of 85,000,000 shares of the
Company’s common stock at the fair value price of $0.013 per
share or $1,105,000.
NOTE 2 – GOING CONCERN
The
accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The
Company incurred net losses of $107,560 and $126,962 for the nine
months ended September 30, 2018 and the year ended December 31,
2017, respectively. Net cash generated from operating activities
was $159,465 and $145,331 for the nine months ended September 30,
2018 and the year ended December 31, 2017,
respectively.
The
Company anticipates that it will record a loss from operations in
2018. As of September 30, 2018, the accumulated deficit was
$32,385. The audit opinion prepared by our independent
registered public accounting firm relating to our financial
statements for the nine months ended September 30, 2018 and the
year ended December 31, 2017 includes an explanatory paragraph
expressing the substantial doubt about our ability to continue as a
going concern.
Continuation
of the Company as a going concern may be dependent upon obtaining
additional working capital. The financial statements do
not include any adjustments that might be necessary if we are
unable to continue as a going concern.
NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -
The accompanying financial
statements include the accounts of the Company. The preparation of
these financial statements in conformity with U.S. generally
accepted accounting principles (“GAAP”).
Cash and Cash Equivalents
- The
Company classifies highly liquid temporary investments with an
original maturity of three months or less when purchased as cash
equivalents. The Company maintains cash balances at various
financial institutions. Balances at US banks are insured by the
Federal Deposit Insurance Corporation up to $250,000. The Company
has not experienced any losses in such accounts and believes it is
not exposed to any significant risk for cash on
deposit.
Accounts Receivable and Revenue -
Revenue is recognized at
the time the Company delivers ships products to the customer. This
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. Sales
terms include cash, credit card, terms of net 30 days or 50% down
with 50% due upon delivery to our customers. Accounts receivable
are reviewed periodically for collectability. The reserve for
uncollectible accounts was $0 as of September 30, 2018 and December
31, 2017, respectively.
Inventories -
Inventories are recorded on an average cost
basis. Inventory consists of raw materials, work in process and
purchased finished goods and components held for resale. Inventory
is valued at the lower of cost or market. The was no reserve for
inventory as of September 30, 2018 and December 31, 2017,
respectively.
Long Lived Assets
– The
Company reviews its long-lived assets for impairment annually or
when changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Long-lived assets under certain
circumstances are reported at the lower of carrying amount or fair
value. Assets to be disposed of and assets not expected to provide
any future service potential to the Company are recorded at the
lower of carrying amount or fair value (less the projected cost
associated with selling the asset). To the extent carrying values
exceed fair values, an impairment loss is recognized in operating
results.
Fair Value Measurements and Financial Instruments -
ASC
Topic 820 defines fair value, establishes a framework for measuring
fair value, establishes a three-level valuation hierarchy for
disclosure of fair value measurement and enhances disclosure
requirements for fair value measurements. The valuation hierarchy
is based upon the transparency of inputs to the valuation of an
asset or liability as of the measurement date. The three levels are
defined as follows:
Level 1
- Inputs to the valuation methodology are quoted prices
(unadjusted) for identical assets or liabilities in active
markets.
Level 2
- Inputs to the valuation methodology include quoted prices for
similar assets and liabilities in active markets, and inputs that
are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the financial
instrument.
Level 3
- Inputs to the valuation methodology are unobservable and
significant to the fair value measurement.
The
carrying value of cash, accounts receivable, , accounts payables,
accrued expenses, due to related party, notes payable approximates
their fair values due to their short-term maturities.
Sales Returns -
We allow customers to return defective
products when they meet certain established criteria as outlined in
our sales terms and conditions. It is our practice to regularly
review and revise, when deemed necessary, our estimates of sales
returns, which are based primarily on actual historical return
rates. We record estimated sales returns as reductions to sales,
cost of goods sold, and accounts receivable and an increase to
inventory. Returned products which are recorded as inventory are
valued based upon the amount we expect to realize upon its
subsequent disposition. As of September 30, 2018 and December 31,
2017, there was no reserve for sales returns.
Warranty Costs
– EZ Clone offers a limited lifetime
replacement warranty to the original purchaser of its
products.
Estimated
future warranty obligations related to certain products are
provided by charges to operations in the period in which the
related revenue is recognized. For the nine months ended September
30, 2018 and year ended December 31, 2017, warranty costs were
$8,027 and $6,274, respectively. There was no warranty reserve as
of September 30, 2018 and December 31, 2017,
respectively.
Concentration of Customer -
A significant portion of the
Company’s sales were made to two main customers, both of
which are distributors. If either of these customers experience
declining or delayed sales due to market, economic or competitive
conditions, the Company’s revenues could be negatively
impacted. For the nine months ended September 30, 2018 and year
ended December 31, 2017, the Company sales to these customers was
38% and 71%, respectively.
Concentration of Suppliers -
A significant portion of the
Company’s purchases are made from three suppliers. If any of
these vendors were to experience delays, capacity constraints or
quality control problems, product shipments to the Company's
customers could be delayed, or the Company's customers could
consequently elect to cancel the underlying product purchase order,
which would negatively impact the Company's revenue. For the nine
months ended September 30, 2018 and year ended December 31, 2017,
the Company purchased 55% and 63% of its inventory from three
suppliers, respectively.
Net Income (Loss) Per Share -
Under the provisions of ASC 260, “Earnings
per Share,” basic loss per common share is computed by
dividing net loss available to common shareholders by the weighted
average number of shares of common stock outstanding for the
periods presented. Diluted net loss per share reflects the
potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that would
then share in the income of the Company, subject to anti-dilution
limitations. The common stock equivalents have not been included as
they are anti-dilutive.
Dividend Policy
– As a Subchapter-S Corporation, the
Company has paid distributions to its Stockholders. After the sale
of 51% of the Company’s stock to GrowLife on October 10,
2018, the Company intends, for the foreseeable future, to retain
any future earnings for the development of our business. Our future
dividend policy will be determined by the board of directors on the
basis of various factors, including our results of operations,
financial condition, capital requirements and investment
opportunities.
Use of Estimates -
In preparing these unaudited interim
consolidated financial statements in conformity with GAAP,
management is required to make estimates and assumptions that may
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of
the consolidated financial statements and the reported amount of
revenues and expenses during the reporting periods. Actual results
could differ from those estimates. Significant estimates and
assumptions included in our consolidated financial statements
relate to the valuation of long-lived assets, estimates of sales
returns, inventory reserves and accruals for potential liabilities,
and valuation assumptions related to derivative liability, equity
instruments and share based compensation.
Income Taxes-
The Company is a Subchapter-S Corporation for
federal and state income tax purposes with all income tax
liabilities and/or benefits of the Company being passed through to
the shareholders. As such, no recognition of federal or state
income taxes for the Company has been provided for in the
accompanying consolidated financial statements. Any uncertain tax
position taken by the shareholders is not an uncertain position of
the Company.
Recent Accounting Pronouncements
In
February 2016, the FASB issued ASU 2016-02, “Leases,”
Topic 842, “Leases” (ASU 2016-02). ASU No. 2016-02
requires lessees to recognize a right-of-use asset and
corresponding lease liability for all leases with terms of more
than 12 months. Recognition, measurement and presentation of
expenses will depend on classification as a finance or operating
lease. ASU 2016-02 also requires certain quantitative and
qualitative disclosures. The provisions of ASU 2016-02 are
effective for the Company’s first quarter of the fiscal year
ending September 30, 2020, with early adoption permitted. The
Company will apply the transition provisions of ASU 2016-02 at its
adoption date, rather than the earliest comparative period
presented in the financial statements, as permitted by ASU 2018-11,
“Leases,” Topic 842, “Targeted
Improvements,” released in July 2018.
The
adoption of ASU 2016-02 may result in a material increase to the
Company’s balance sheets for lease liabilities and
right-of-use assets. The Company is also performing a comprehensive
review of its current processes to determine and implement changes
required to support the adoption of this standard. The Company is
currently evaluating the other effects the adoption of ASU 2016-02
will have on its consolidated financial statements.
In May
2014, the FASB issued ASU 2014-09, “Revenue from Contracts
with Customers,” Topic 606, “Revenue from Contracts
with Customers” (ASU 2014-09). ASU 2014-09 provides guidance
for revenue recognition and will replace most existing revenue
recognition guidance in GAAP when it becomes effective. ASU
2014-09’s core principle is that a company will recognize
revenue when it transfers promised goods or services to customers
in an amount that reflects the consideration to which the company
expects to be entitled for the transfer of those goods or services.
ASU 2014-09 permits the use of either the retrospective or
cumulative effect transition method. Additionally, the amendments
in this ASU provide a practical expedient for entities to recognize
the incremental costs of obtaining a contract as an expense when
incurred if the amortization period of the asset that the entity
otherwise would have recognized is one year or less, The Company
plans to elect this practical expedient upon adoption.
In July
2015, the FASB issued ASU 2015-14, “Revenue from Contracts
with Customers – Deferral of the Effective Date.” The
FASB approved the deferral of ASU 2014-09, by extending the new
revenue recognition standard’s mandatory effective date by
one year and permitting public companies to apply the new revenue
standard to annual reporting periods beginning after December 15,
2017. The guidance in ASU 2014-09 will be effective for the Company
in the first quarter of the fiscal year ending September 30,
2019.
Further
to ASU 2014-09 and ASU 2015-14, the FASB issued ASU 2016-08,
“Revenue from Contracts with Customers,” Topic 606,
“Principal versus Agent Considerations (Reporting Revenue
Gross versus Net)” (ASU 2016-08) in March 2016, ASU 2016-12,
“Revenue from Contracts with Customers,” Topic 606,
“Narrow-Scope Improvements and Practical Expedients”
(ASU 2016-12) in May 2016 and ASU 2016-20, “Revenue from
Contracts with Customers,” Topic 606, “Technical
Corrections and Improvements” (ASU 2016-20) in December 2016.
The amendments in ASU 2016-08 clarify the implementation guidance
on principal versus agent considerations, including indicators to
assist an entity in determining whether it controls a specified
good or service before it is transferred to the customers. ASU
2016-12 addresses narrow-scope improvements to the guidance on
collectability, non-cash consideration, and completed contracts at
transition. Additionally, the amendments in this ASU provide a
practical expedient for contract modifications at transition and an
accounting policy election related to the presentation of sales
taxes and other similar taxes collected from customers. The Company
plans to make such election. The Company also plans to elect the
practical expedient in ASU 2016-20 that provides entities do not
need to disclose the transaction price allocated to performance
obligations when the related contracts have a duration of one year
or less. This includes loyalty rewards, which can be redeemed in
the month subsequent to the quarter earned, and marketing
promotions that cross accounting periods. Both of these classes of
transactions are currently immaterial to the Company. The effective
date and transition requirements for ASU 2016-08, ASU 2016-12 and
ASU 2016-20 are the same as for ASU 2014-09.
The
Company does not plan to early adopt the new revenue recognition
guidance; adoption will be on the modified retrospective basis
beginning in fiscal year 2019. The Company has substantially
concluded its assessment of the impact of the adoption of this
standard on its consolidated financial statements. Most of the
Company’s revenue is expected to continue to be generated
from point-of-sale transactions, which ASU 2014-09 treats generally
consistent with current accounting standards. The Company does not
expect this standard will have a material impact on the accounting
for point-of-sale transactions or related areas including the right
of return and customer incentives. Although the impact on the
consolidated financial statements is not expected to be material,
additional disclosures will be required.
NOTE 4 – INVENTORY
Inventory
as of September 30, 2018 and December 31, 2017 consists of the
following:
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw
materials
|
$
413,905
|
$
210,742
|
|
Work
in process
|
47,251
|
170,193
|
|
Finished
goods
|
32,989
|
168,694
|
|
Total
|
$
494,145
|
$
549,629
|
Raw
materials and work-in-process includes materials used in the
manufacturing of EZ Clone hobbyist and commercial products and EZ
Clone finished goods include completed products as well as certain
items purchased and resold.
The
Company reviews its inventory on a periodic basis to identify
products that are slow moving and/or obsolete, and if such products
are identified, the Company records the appropriate inventory
impairment charge at such time.
NOTE 5 – PROPERTY AND EQUIPMENT
Property
and equipment as of September 30, 2018 and December 31, 2017
consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobiles
|
$
135,928
|
$
135,928
|
|
Furniture
and fixtures
|
16,675
|
16,675
|
|
Leasehold
improvements
|
14,703
|
14,703
|
|
Shop
equipment
|
130,769
|
130,769
|
|
Tooling
equipment
|
259,868
|
243,613
|
|
Total
property and equipment
|
557,943
|
541,688
|
|
Less
accumulated depreciation and amortization
|
(240,209
)
|
(189,824
)
|
|
Net
property and equipment
|
$
317,734
|
$
351,864
|
Fixed assets, net of accumulated depreciation, were $317,734 and
$351,864 as of September 30, 2018 and December 31, 2017,
respectively. Accumulated depreciation was $240,209 and $189,824 as
of September 30, 2018 and December 31, 2017, respectively. Total
depreciation expense was $50,385 and $67,466 for the nine months
ended September 30, 2018 and the year ended December 31, 2017,
respectively. All equipment is used for manufacturing, selling,
general and administrative purposes and accordingly all
depreciation is classified in cost of goods sold, selling, general
and administrative expenses. Fixed assets are depreciated over
three to ten years.
During
the nine months ended September 30, 2018 and the year ended
December 31, 2017, the Company retired fully depreciated assets of
$0 and $45,128, respectively.
NOTE 6- ACCOUNTS PAYABLE
Accounts payable were $191,529 and $147,661 as of September
30, 2018 and December 31, 2017, respectively. Such liabilities
consisted of amounts due to vendors for inventory purchases, audit,
legal and other expenses incurred by the Company.
NOTE 7- ACCRUED EXPENSES
Accrued
expenses were $78,125 and $37,110 as of September 30, 2018 and
December 31, 2017, respectively. Such liabilities consisted of
amounts due for sales tax, payroll liabilities, customer deposits
and inventory receipt’s in process.
NOTE 8- NOTES PAYABLE – RELATED PARTY
From
time to time the Company’s owners and family have advanced
various amounts to the Company. Those amounts are unsecured, bear
interest and are due on demand. As of September 30, 2018 and
December 31, 2017, the balance on such advances was $99,041 at 5.0%
and $2,595 at 3.0%, and $85,397 at 5.0% and $3,734 at 3.0%,
respectively. The holders have not made a demand for
payment.
NOTE 9 - NOTES PAYABLE AND CAPITAL LEASE
In
April 2016, the Company borrowed $550,000 on an SBA loan with
Plumas Bank. The note has a variable interest rate of 2% over
prime. The note requires monthly payments of $5,970 per month and
matures in April 2026. The loan is secured by all Company
assets.
As of
September 30, 2018 and
December 31,
2017
, the outstanding principal due on an SBA loan with
Plumas Bank was $446,227 and $482,565, respectively. The interest
rate increased from 6.5% on December 31, 2017 to 6.75% on April 1,
2018 and 7.0% on July 1, 2018. Subsequent to September 30, 2018,
the Plumas Bank loan was paid in-full (see Note 13 - Subsequent
Events).
As of
September 30, 2018 and December 31, 2017, the outstanding principal
due on two loans secured by automobiles was $90,891 and $105,306,
respectively.
The
Company entered into a leased purchase agreement with Marlin Bank
for equipment in the amount of $37,070. The interest rate is 14%,
monthly payments of $823 and matures November 1, 2019.
As of
September 30, 2018 and December 31, 2017, the outstanding principal
due on a capitalized equipment lease with Marlin Bank was $10,704
and $16,844, respectively.
NOTE 10 –
RELATED PARTY
TRANSACTIONS AND CERTAIN RELATIONSHIPS
Related Party Transactions
See
Note 9 and 12 for related party transactions.
NOTE 11 – EQUITY
Authorized Capital Stock
The
Company has authorized 100,000 shares of capital stock, of which
50,000 are outstanding, no par value, and 10,000,000 are shares of
preferred stock, par value $0.0001 per share.
During the year ended December 31, 2017, a $60,000 loan was
recorded as contributed capital upon the death of the
holder.
NOTE 12 –
COMMITMENTS,
CONTINGENCIES AND LEGAL PROCEEDINGS
Legal Proceedings
From time to time, the Company may become subject to various legal
proceedings that are incidental to the ordinary conduct of its
business. Although the Company cannot accurately predict the amount
of any liability that may ultimately arise with respect to any of
these matters, it makes provision for potential liabilities when it
deems them probable and reasonably estimable. These provisions are
based on current information and may be adjusted from time to time
according to developments.
Operating Leases
On January 17, 2017, the Company entered into a Lease Agreement
with Pensco Trust Company for the Company’s corporate office,
research and development lab and warehouse. The monthly lease is
approximately $15,739. The lease term is June 1, 2018 to May 31,
2028.
Subsequent
to September 30, 2018, the Lease Agreement was replaced with a new
lease and the lessee was changed to GrowLife. (see Note 13 -
Subsequent Events).
NOTE 12 – SUBSEQUENT EVENTS
The Company evaluates subsequent events, for the purpose of
adjustment or disclosure, up through the date the financial
statements are available.
There were material events subsequent to
September 30,
2018:
Purchase and Sale Agreement - GrowLife, Inc.
On October 10, 2018, the
Company closed the Purchase and Sale Agreement with GrowLife, Inc.,
a Delaware corporation headquartered in Kirkland, Washington.
Through a nationwide network of representatives, regional centers
and its e-commerce website, GrowLife provides goods including media
(i.e., farming soil), industry-leading hydroponics equipment,
organic plant nutrients, and thousands more products to specialty
grow operations across the United States. GrowLife acquired 51% of
EZ Clone for $2,040,000, payable as follows: (i) a cash payment of
$645,000; and (ii) the issuance of 107,307,692 restricted shares of
the Company’s common stock at a price of $0.013 per share or
$1,395,000.
GrowLife
has the obligation to acquire the remaining 49% of EZ Clone within
one year for $1,960,000, payable as follows: (i) a cash payment of
$855,000; and (ii) the issuance of 85,000,000 shares of the
Company’s common stock at a price of $0.013 per share or
$1,105,000.
Mr.
William Blackburn will remain as President of EZ
Clone.
Payoff of Plumas Bank Loan
On
October 16, 2018, the Company paid off the outstanding balance of
$448,873 on the SBA loan at Plumas Bank.
Corporate Office Lease Agreement
On
December 14, 2018, the Lease Agreement was renegotiated and the
lessee on the Company’s corporate office and warehouse lease
was changed to GrowLife effective January 1, 2019. The lease term
is five years and has a monthly payment of $17,500, with a 3%
increase on January 1 of years 2-5.
William Blackburn Consulting Agreement
On
October 15, 2018, William Blackburn entered into a Consulting
Agreement with the Company. The Agreement expires with the second
closing and provides for a monthly consulting fee of $10,000. On
November 26, 2018, the Consulting Agreement was cancelled when Mr.
Blackburn entered into an Employment Agreement with GrowLife,
Inc.
