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Attorney Daniel R. Lewis has worked and resided in the Central Florida area since 2006, after completing a 9 year term of service in the United States Air Force.  He received his Masters in Arts from the University of Central Florida's History program in 2010, where his thesis work Thomas... More
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  • First Impressions Of GrowLife's (PHOT) 2013 Annual Report 8 comments
    Apr 1, 2014 10:34 AM | about stocks: PHOT

    Highlights

    •Quarter over quarter growth

    •Year over year growth of 235%

    •Future projections for 2014 are of critical importance, as revenue potential in a post-legalization climate offers immense potential (2014 will have full year of CO, partial WA state legalization, and more states implementing medical marijuana at or before November elections).

    Foundation - 2013 revenues comprised of brick and mortar stores (7 stores in California - Los Angeles (Southern) and Santa Rosa (Northern); Colorado - Edwards (Vail Valley) and Boulder; Massachusetts - Peabody (North Shore); New Hampshire - Plaistow; and Maine - Portland and 3 websites (58Hydro.com, Greners.com, Phototron.com)

    Revenue is up Quarter over Quarter
    2013 -
    Quarter #1: $91,809
    Quarter #2: $208,446
    Quarter #3: $475,870
    Quarter #4: $674,620

    2014 -
    Quarter #1: $760,709
    Quarter #2: $872,557
    Quarter #3: $1,313,339
    Quarter #4: $1,912,311

    Also, see page 18 of the filing. Gross profit for 2013 is reported as 853k, up from 2012 gross operating profit of 411k in 2012. (Net loss overall, as described below… but gross operating profit nevertheless for the second straight year)

    Revenue is up year over year

    2011 - $948,406
    2012 - $1,450,745
    2013 - $4,858,976

    Revenue up 235% year to year shows great growth in an emerging sector. This is a positive.

    LOSS and other debt issues in the report

    Net Loss shows a $19.2mil increase year over year, and this is huge. A silver lining is that it appears the majority of losses are non-cash as the company is issuing stock options as payment. So, it's not equipment/business model and the number may be misleading. It certainly provides ammo for any looking to attack this report and/or company. The PR states:

    Moreover, the Company's financial results also include substantial non-cash, one time charges related to warrants that were issued by the company in 2013 and expensed by the company in accordance with GAAP requirements. The reported net loss of the Company for 2013, on a non-GAAP basis, exclusive of non-cash one-time charges, was $2,038,907.

    Sterling Scott, CEO, addressed this issue in the PR today, stating "With the exception of one-time, non-cash charges in 2013, the important metrics of the Company are sound and improving."

    Not counting the stock related expense, GrowLife's operating loss in 2013 was $1,327,380. This total is up $299,369 from 2012. A positive here, IMO, is that share based compensation declined $131,932.

    Impairment of Goodwill and Intangible assets, loss of $279,515

    This is unexpected compensation and changes in the legal climate affecting assets value.

    It is significantly down from $634,128 in 2012. A positive.

    Change in Fair Value of Derivative, loss of $3,598,455 in Q4

    Each financial instrument is evaluated and initially recorded at its fair value; this is re-valued at each reporting date. Here, there was a BIG change in value. See Note 21 on page 57-61. GrowLife had a change in value of its financial instruments (notes) of -$3,701,078, offset by $42,269 in rent from the Boulder store. This is an aggregate total of several notes to various holders.

    This shouldn't be taken lightly, but shouldn't be overly worrisome, either. The company issued notes to several holders to grow the business. The expression 'it takes money to make money' applies. Each note adds up, though, and must be offset by increased revenue and company growth. They obviously feel confident in their ability to generate enough short term revenue to expire the notes and/or exercise them. Acquisitions, debt… will it pay off?

    Dilution a minimum

    Company issued 262,595,733 shares for notes (see above 'derivative liability'). GrowLife also issued 36,981,862 shares for cash at .035 per, for a total of $1,294,365.
    We really only need to focus on the 36M shares sold for cash, as the other shares are for convertible notes and used to grow the company.

    Takeaway: Taking 2013 Q4 revenue as a base, the $1.9M projects to $7.6M over a full year. With legalization upon us in Colorado as of Jan 1, the Portland store operating in a legal MJ environment as well, and overall business booming across the sector this year it is not unreasonable to see $10M revenue or more in this segment of GrowLife's business in 2014. I have talked to employees at several GrowLife stores, who have informed me that inventory is moving very rapidly over the last few months, further confirming a potential spike in 2014. I encourage any investors to make similar phone calls!

    Future growth… an estimation of the GIFT program

    Background: The JV with CANX detailed in the Nov. 30 PR created the entity Organic Growth International (OGI). PHOT owns 45% of OGI, a percentage rising to 51% at the conclusion of the JV. Revenues detailed below are accretive to PHOT at that %.

    GIFT to CMMS (LEAF Aspen)

    1. "Per the terms of the G.I.F.T. agreement, the Company has agreed to finance $280,000 of equipment, to be purchased from the Company, over a term of 5.5 years (66 months), with monthly payments in the amount of $6,878 beginning in month seven and ending in month sixty-six."

    60 months of payments, $6878 per month = $412,680. Profit of $132,680 to OGI, giving PHOT $59,706 profit from their 45% cut.

    I'm underwhelmed. This is just under $12,000 per year in profit on $37,141.20 in annual revenue.

    Perhaps volume would remedy the meager bottom line. OGI has been given up to $40M to utilize for GIFT, and this was only $280k, or 0.7%.

    If PHOT can string together enough GIFTs, accretion of this revenue may prove productive.

    Sterling Scott, CEO, intimates on MoneyTV there are currently 10-20 potential GIFT customers currently under consideration.

    The projections here are estimations with a huge assumption, because mot all GIFTs are created equal. Each potential grow operation will be of different size. For the sake of discussion and operation, we can use the LEAF deal and extrapolate.

    $12,000 per year in profit on $37,141.20 in annual revenue from LEAF, times 10, equates to $120,000 profit from the equipment on just over $371k in revenue.

    Still not loving the numbers.

    Mitigating this is the fact that PHOT will sell all nutrients, bulbs, and supplies to each GIFT under an exclusive equipment provision. This revenue and profit cannot be ignored. Information on this revenue total would be welcome from management.

    Takeaway: This is the big move GrowLife made in the sector, asking shareholders to approve an increase in Authorized Shares and trust the company to use these shares combined with the Joint Venture money received from CANX to grow the company revenue and footprint. Early revenue and profit projections don't move the needle as anticipated, IMO.

    Other factors

    Lawsuit with RXNB - This looms large with closing rescheduled to take place Friday. RXNB wants the shares NOW. GrowLife doesn't think they have shown them the books to there satisfaction. This is a huge issue looming for Friday, IMO. See page 15 for details.

    Much has been made about [b]insider stock compensation[/b], as the slew of Form 5's were filed Friday. On the top of page 17 this is summarized. During 2013, 44,150,110 shares valued at $1,428,636 as wages. Non issue JMO. Actually, a plus as it incentivized performance in the company growth.

    The chart on page 83 lists each member's compensation. By way of example, CEO Sterling Scott made $615,933 in cash and stock.

    Expectations
    Quarter 3 earnings saw an immediate drop post-earnings, much related to CEO Sterling's comments intimating better revenue numbers. Not the case this quarter.

    After the drop, the PPS ook an immediate turn in PPS 3 days later, as GrowLife released news of the CANX JV (announcing the GIFT) immediately following the Q3 earnings release, moving the PPS from $.07 and reaching $.17 within a very short time. If earnings are again met with disappointment, don't rule out the possibility of more GIFT news immediately. It happened before, just 4 months ago.

    Brick and mortar stores and websites, potentially $10M in 2014 ( see above).

    GIFT needs to be implemented in volume to be revenue accretive to the point it makes the company very profitable, as hoped.

    I don't make PPS predictions. Especially in the OTC. I will say that there's good and bad here. That being said, I'm holding my position and watching closely. If there is a dip, even a severe one, I expect it to be recovered within the month of April. On the other hand, revenue is up, debt is understandable when growing this business at the rate they are growing it. Damned if you report, because people will poke holes. If you believe in the business model, and I do, then it's a hold.

    Overall I give the 10k a C+/B-. I'm underwhelmed by GIFT details and don't like the derivative debt they are banking on paying off. I also don't like the recurring losses of $24,400,704 and stockholder deficit of $5,843,964.

    As stated, I do understand that the money has to be spent to grow and make the money GrowLife projects to make in 2014 and beyond. These details underscore for me how 'all in' this company went to capitalize in this industry immediately.

    Sorry so long, I like to be thorough. This is a first read… surely a deeper understanding awaits over the next few days.

    TM

    Disclosure: I am long PHOT.

    Stocks: PHOT
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Comments (8)
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  • scooby123
    , contributor
    Comments (182) | Send Message
     
    Great read, thanks for all the great info. A lot to digest here. I look forward to more info.
    1 Apr 2014, 05:22 PM Reply Like
  • bluesit1969
    , contributor
    Comments (242) | Send Message
     
    Very thorough, loved the way you broke it down. Any more info on the lawsuit would be appreciated.
    1 Apr 2014, 06:37 PM Reply Like
  • D.R.Lewis
    , contributor
    Comments (14) | Send Message
     
    Author’s reply » From pg 15 of the annual:

     

    ITEM 3. LEGAL PROCEEDINGS.

     

    The Company discloses the following pending legal actions to which we are a party or of which our property is the subject that may have a material adverse affect on our business and operations:

     

    On March 20, 2014, Wise Phoenix, LLC (“WP”) and AJOA Holdings, LLC (“AJOA”), collectively referred to as the “Sellers,” and R.X.N.B., Inc., a Nevada Corporation (“RXNB”) initiated a lawsuit against the Company and OGI, the Company’s Joint Venture, in Clark County, Nevada in its Business Court division in regards to a Sellers Interest Purchase Agreement (“RXNB Agreement”) with the Company and OGI. The Sellers and RXNB claim that the Company must effect registration of Company shares issuable to Seller in connection with the RXNB Agreement since it had complied with the provisions set forth in the RXNB Agreement and delivered documents and instruments to the Company. The Company contends that the Sellers and RXNB have not met the requirements established by the RXNB Agreement and therefore the Company is not obligated to register or issue the shares.

     

    On March 24, 2014, Sellers, RXNB, OGI and the Company agreed to extend the closing date of the RXNB Agreement to April 4, 2014.* Additionally, Sellers and RXNB agreed to withdraw their lawsuit against the Company and OGI without prejudice.

     

    *Today it was announced that the deadline has been pushed back to April 30.
    1 Apr 2014, 08:27 PM Reply Like
  • bluesit1969
    , contributor
    Comments (242) | Send Message
     
    D.R.Lewis- Thanks for the update, and I like the fact that both parties appear to be working together to solve the issue.
    1 Apr 2014, 09:41 PM Reply Like
  • Econ Student
    , contributor
    Comments (248) | Send Message
     
    Good analysis. I think this is a solid stock there is a lot of different things to consider. It's a good stock I think there are more undervalued companies though (OTCQB:TRTC).
    2 Apr 2014, 02:32 AM Reply Like
  • MR-Tampa
    , contributor
    Comments (56) | Send Message
     
    "I do understand that the money has to be spent to grow and make the money GrowLife projects to make in 2014 and beyond" ... if only the money was being spent on future income generating opportunities, the reality is that too much is going in excessive operating costs ... look at the total remuneration for the Directors in 2013, $3.4m (when revenues are $4.8m only), and at the "investor relations/public relations expense of $565,049" (12% of revenues !) ...

     

    As you mention yourself there has been a huge issuance of new shares related to the acquisitions which are behind the growth in revenues generated in 2013, as I am sure you are aware it has been demonstrated that most M&A deals are value destroying for the acquiring company shareholders...

     

    The GIFT scheme has impressed some, but looks unlikely to be what leads the company to grow in its current $500m market value...

     

    Finally, I do think that it is a mistake to analyze any company without taking stock related compensation into consideration... As Warren Buffett famously said: "When a company gives something of value to its employees in return for their services, it is clearly a compensation expense. And if expenses don't belong in the earnings statement, where in the world do they belong?"

     

    I look forward to reading if after further analysis of the 10K your view of the company's actual performance changes.
    3 Apr 2014, 04:02 PM Reply Like
  • D.R.Lewis
    , contributor
    Comments (14) | Send Message
     
    Author’s reply » Very fair comments, Mr. Tampa. As stated, I gave PHOT a C+/B- evaluation after reading and dissecting the 8k.

     

    I do think it is hard to construct executive compensation as a % of 2013 revenue. Let me explain... for the year PHOT had $4.8M, but revenues have risen every quarter now for 8 straight quarters, climaxing in the 2013 Q4 $1.9M revenue figure.

     

    Just for easy math, we say that $2M from Q4 is replicated, we have an $8M revenue figure for 2014. I think it's fair to assess the company as in growth stages and those figure will come more into line with an acceptable value in 2014 and 2015.

     

    And, I wouldn't call them overcompensated at this point. As the article by Alan Brochstein published today on this site points out eloquently, the leadership here is high class, experienced and a huge asset to the company. CEO Sterling Scott was paid $615K this year and $41K in 2012. I don't think that's too much.

     

    The chart on page 83 gives the figures for all executive compensation in cash and shares for 2013. The only one who might be 'overpaid' is Marco Hegyi, who made $1.7M - half of the total executive compensation. Of course, he comes from Fortune 100 firms Yahoo and Microsoft, and carried a heftier price tag.

     

    This is not to diminish many of your points, especially regarding the GIFT program. As stated, the GIFT bottom line from the LEAF Aspen deal underwhelmed me, and was a big part of the reason for my lower grade here.

     

    Hope this explains more detail for you.
    3 Apr 2014, 04:43 PM Reply Like
  • MR-Tampa
    , contributor
    Comments (56) | Send Message
     
    So a CEO who earns $615K in 2013 which if I follow your argument I should link to a normalized revenue base of $8m, that is 7.7% of your normalized revenues ... That is going to make a lot of hedge fund managers feel quite jealous, and you feel it is not too much !

     

    This plus the suspiciously high amount paid for investor relations should raise alarm bells ...

     

    What do you make of the gross margin falling from 33% in Q1 of 2013 to 8% in Q4 of 2013 ? The economics of the businesses being acquired appear to be rather unimpressive... And the management warns clearly in its 10K that: "All of GrowLife’s brands and its retail and online distribution channels compete for customers and sales with many different companies and products that are competitive today and likely to be even more competitive in the future."

     

    You refer to another SA article about the management:"high class, experienced and a huge asset" = cheerleader language, which reminds me that "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact" (Warren Buffett).

     

    When as a financial analyst I look at the business model of the company, its likely organic growth, its gross margin potential I still fail to see how it can grow into its current $450m (but now falling) market value...

     

    Would you care to share what your gross margin assumption is for the company going forward ?
    4 Apr 2014, 10:53 AM Reply Like
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