Did Share-Based Compensation Trigger Growlife's Suspension?

Apr.11.14 | About: Growlife Inc. (PHOT)

Summary

Growlife compensated its outside directors with two million shares per year at two cents per share.

No matter the stock price on the day of the compensation, the expense would be recorded at two cents per share.

This has had the effect of reducing Growlife's quarterly compensation expenses, and the difference may have raised a flag at the SEC.

When the SEC suspended trading of Growlife, Inc. (OTC:PHOT) before the markets opened on April 10, 2014, it may have been because various recent filings from PHOT, including its 10-K, revealed that the company was awarding its outside directors 2,000,000 shares of stock per year and expensing the stock at two cents per share, despite significantly higher stock prices on the days of the payouts.

This apparent understatement of expenses might be what the SEC meant when it said in its release that it had "... temporarily suspended trading in the securities of PHOT because of questions that have been raised about the accuracy and adequacy of information in the marketplace and potentially manipulative transactions in PHOT's common stock."

Let's look into how Growlife compensates its independent directors, and where the company might have run afoul of the SEC.

PHOT filed its 10-K for fiscal year 2013 on March 31, 2014.

On page 93, with regard to the compensation of the outside board members, the company lists all of the compensation issued to independent directors:

During the twelve months ended December 31, 2013, the Company issued 1,500,000 shares of its common stock to Eric Shevin, an independent member of the Company's Board of Directors, as consideration for his service as a Board member from April 1, 2013 through December 31, 2013. The shares were valued at $30,000 in the aggregate.

During the twelve months ended December 31, 2013, the Company issued 1,683,333 shares of its common stock to Bob Kurilko, a former independent member of the Company's Board of Directors, as consideration for his service as a Board member from January 1, 2013 through November 2, 2013. The shares were valued at $33,667 in the aggregate.

During the twelve months ended December 31, 2013, the Company issued 500,000 shares of its common stock to Craig Ellins, a former independent member of the Company's Board of Directors, as consideration for his service as a Board member from January 1, 2013 through March 31, 2013. The shares were valued at $10,000 in the aggregate.

On December 31, 2013, the Company issued 83,333 shares of its common stock to Alan Hammer, an independent member of the Company's Board of Directors, as consideration for his service as a Board member from December 17, 2013 through December 31, 2013. The shares were valued at $1,667 in the aggregate.

On December 31, 2013, the Company issued 72,222 shares of its common stock to Anthony Ciabattoni, an independent member of the Company's Board of Directors, as consideration for his service as a Board member from December 19, 2013 through December 31, 2013. The shares were valued at $1,444 in the aggregate. Mr. Ciabattoni's shares have been issued to the Ciabattoni Living Trust, of which Mr. Ciabattoni is the Trustee.

On December 31, 2013, the Company issued 72,222 shares of its common stock to Jeff Giarraputo, an independent member of the Company's Board of Directors, as consideration for his service as a Board member from December 19, 2013 through December 31, 2013. The shares were valued at $1,444 in the aggregate.

Commencing in August 2012, outside board members were awarded 2,000,000 shares per year which vest quarterly.

Note that in each case, the price per share is $0.02. How was that value established?

In the 10-K's Subsequent Events section on page 71, under the heading, "Shares Issued to Board Members", there is the following statement about the outside directors' first-quarter compensation:

On March 31, 2014, the Company issued 500,000 shares, 2,000,000 shares in the aggregate, to each of its four (4) independent Board members as compensation for their Board service for the January 1, 2014 through March 31, 2014 period. The shares were valued at $0.02 per share and $40,000 in the aggregate and were issued in accordance with an August 2012 Board grant. The four independent Board members are Eric Shevin, Alan Hammer, Tony Ciabatonni, and Jeff Giarraputo.

The statement mentions the "August 2012 Board grant". At that time, PHOT shares were selling for approximately $0.02, and it appears that the pay plan established that the independent directors would be paid $40,000 per year ($10K/quarter), assuming the stock price never changed.

Most companies, however, declare a cash amount of director compensation, but many allow the director the choice of taking cash, or the equivalent value in shares. In these cases, a $10,000 quarterly compensation might translate, for a stock valued at $10 on the day of the payout, to 1000 shares of stock.

Growlife's arrangement was completely different: No matter the price of the stock on the final day of the quarter, 500 thousand shares would be awarded to the director (assuming he was a director for the complete quarter), and the company would record a $0.02 per share expense, for a total of $10,000.

Why might this bother the SEC?

According to the SEC, one of the conditions under which it might suspend trading in a stock is:

Questions about the accuracy of publicly available information, including in company press releases and reports, about the company's current operational status, financial condition, or business transactions;

For brevity, let's just look at the three December 31, 2013 payments to the three newest directors, Hammer, Ciabattoni and Giarraputo. They were awarded a total of 227,777 shares, which the company valued at $4,555 for expense purposes. Yet, at the December 31 closing price of $0.151, those shares should have resulted in a charge of $34,394. For these three directors alone, it appears that PHOT is understating its expenses by nearly $30 thousand.

Looking at the Subsequent Event "future charges" shown above, the understatement would be even more astounding, due to the increase in PHOT's stock price during the quarter (assuming this is not corrected in the 10-Q for 1Q/14). On March 31, 2014, PHOT closed at $0.5795. Therefore, the 500 thousand share payments to each of the four directors, while being listed by Growlife as $40 thousand expense (at $0.02), should be recorded as a $1.159 million charge. That's a difference of $1.1M!

Of course, this is also quite a deal for the director who, instead of receiving $10 thousand compensation per quarter, is given 500,000 shares worth a total of $289,750. Imagine that, nearly $300K for attending a board meeting or two during a quarter, at a company that had 2013 revenues of less than $5 million.

Sign me up!

Based on this one example, I can see why the SEC might think that there are problems with the accuracy of PHOT's reports.

There may be other issues that the SEC is looking at, as it appears that PHOT did not issue some Form 4 filings at the time various options and stock grants were made in 2013, and so issued a series of Form 5 filings in late 1Q/14, in an effort to put these items into the record. Here is an example, covering two stock grants and a stock option (for 12 million shares), that was filed to cover the lack of timely Form 4s.

In addition, from April 3-April 7, 2014, Robert Hunt, a director at PHOT and the president of Growlife Hydroponics, Inc., sold nearly two million shares of PHOT stock, approximately 13% of his holdings. Here are the Form 4s showing amounts held at start (15.7M) and end (13.8M) of his selling. While the selling began on April 3, the first filing reporting the sale wasn't filed until April 8, which missed the two-day filing deadline.

Growlife may be able to repair its relationship with the SEC and trade again on the OTCQB, but until then, it will be a reminder to investors to read and understand the filings, as well as to learn the types of "red flags" that could trigger action from the SEC.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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