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GrowLife 2018 Discussion

THE COMPANY AND OUR BUSINESS

Note from CEO:

As a part of our on-going communications, we strive to keep our investors, customers, and the general public informed on happenings within GrowLife. I am taking our 2018 10k filing and this blog to do just that.

On March 8th, we filed our annual report for 2018. Highlights can be found here in our issued press release. The annual report is an oppotunity for us to convey as much information on operational and financial highlights from the previous year. We always encourage shareholders to review this filing in detail as it outlines a very clear picture of where the company has been and where it is headed.

That being said, it is a robust filing and may be overwhelming for some investors. I wanted to take this opportunity to highlight some aspects of it and share the excitement we are feeling as a management team about GrowLife’s last year of success and where we are headed in the future.

Marco Hegyi, CEO — GrowLife, Inc.

Management Discussion

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.

GrowLife’s goal is to become the nation’s largest cultivation facility service provider for the production of organics, herbs and greens and plant-based medicines.

Over the last year we have been discussing how we can meet our goal and help our customers significantly lower their production costs. We have continued to distribute thousands of third-party products to growers through retail, e-commerce and direct sales channels, sold to both commercial and consumer cultivators, and began developing our own products in our Innovations division. As we pursued our goal of “measuring our success by our customer’s success” we discovered that we needed to add an industry leading technology for cloning of plants, to be able to service customers from “clone to harvest.”

As we illustrated in last quarter’s Management Discussion section, the bell curve we mapped out from our “Commercial Vertical Grow System” proof of concept tests showed that the Commercial Cultivation Stage is where most of the money is spent for production. However, the Cloning Stage is where the greatest yield to impact occurs. (dashed line) While we could have simply partnered with EZ-Clone, the 20-year leader in cloning, to use their products to help increase the yield of our system, there were far greater strategic and economic benefits to both companies if GrowLife pursued an acquisition.

In October GrowLife acquired 51% of EZ-Clone and intends to acquire the remaining 49% this year. The addition of EZ-Clone was the missing piece for many reasons. Like a jigsaw puzzle, the pattern became apparent of how we needed to proceed, or pivot the GrowLife business model for growth.

The Company will continue to provide the best products that drive down our customer’s production cost while increasing our gross margin. Initially we can purchase and resell third-party products as we have done in the past; however, over time we will develop our own technologies and, in some cases, acquire them to accelerate bringing them to market. Acquiring companies is not difficult but integrating talent and the best of their culture can be challenging. As a result, we have organized to integrate such acquisitions.

At the end of 2018, GrowLife decided to shift its operating organization from divisions to a functional structure with a deep leadership team to provide greater coverage for further geographical and acquisition expansion. Each leader has extensive experience in their roles. With a functional organization we maintain clear lines of daily communication across the company and deep into our operations. A newly acquired company can be quickly integrated into our three groups while maintaining continuity of leadership and knowledge transfer. EZ-Clone integrated into GrowLife in six months, less than half the time of our commercial flooring business FreeFit. Such best practices are conveyed with Standard Operating Procedures and absorbed with a receptive culture.

Where we once saw divisions to serve different market segments, we elected to align our resources behind three functional groups serving commercial customers at different stages. Where we were racing to the bottom by distributing other people’s commodity products that are seen as too expensive for our customers and generating only 8–10% gross margins, we now focus on our own GrowLife/EZ-Clone products that generate 40–55% gross margins at reasonable prices to our customers. And our retail stores in Canada, LA and Maine serve as regional fulfillment and e-Commerce is about e-Logistic for our commercial customers. This is just the start. Given the 87% year-over-year revenue growth, GrowLife will continue to provide essential and hard-to-find goods including growing media, industry-leading hydroponics equipment, organic plant nutrients, and thousands more products on demand to our customers across the United States and Canada. That being said, as our revenue mix transitions to offering proprietary products — we expect to see our gross margins grow by upwards of 300%.

Vision

Our vision continues to revolve around the key words in our mission statement: value and trust,with our employees, our customers and our shareholders. Value is more than economic benefit; it must not mean compromise or that the relationship ends with the transaction; Quite the opposite. We have been exploring revenue models that may work the way our commercial customers need help such as dealing with the IRS 280e challenge. Employees and shareholders also expect value but benefits and dilution are challenging so we look to ways that solve problems. For competitive reasons we do not go into details but will share updaters as we launch such programs. Thus, we seek value. Trust is earned through consistency of practice. Our operations have demonstrated such practice. We are cautiously transparent where we do not promise what we may not deliver on — therefore we do not give revenue guidance and, for competitive reasons, avoid to many details, but we share as much as we can to keep our customers and shareholders always informed.

We will continue to provide our customers the over 15,000 products that they demand; however, those third-party manufacturers are not rushing to lower their prices to help our customers lower their production costs. It is understandable because they make more in the short term without concern of the macro-market impact. GrowLife is a nationwide company and is concerned about the macro-economics and the progression of the industries we service.

One of the many things that attracted me to EZ-Clone was Billy Blackburn. Billy was working on the EZ-Clone Pro project that I saw in 2017. A cloning system for almost 500 clones at one time; a system that could easily cannibalize his smaller core cloning business. We discussed the trade-offs and he told me “that’s where the market is going and what customer’s need. EZ-Clone needs to adjust, not our customers.” I am so glad that he is on our team and heading up R&D and manufacturing.

We see outdoor farming as a wasteful, destructive practice and an inefficient use of precious resources. Current water, land and harvest cycles are limited and, if left unchecked, will fail to support the world’s population growth. Indoor cultivation on the other hand allows our customers to replicate nature in a controllable manner that uses a fraction of water and land while providing 2–5 times the crop cycles of outdoor. The challenge is in getting the economics right. Even many large-scale indoor grow operations with large capital investments have had a difficult time staying in business because their poorly designed economic models fail to deliver a profit. Fruits and vegetables have limited revenue benefit due to their low prices and saturated supply from international and domestic growers.

In contrast, Cannabis currently has an attractive revenue model and valuation multiple but modest demand of about 5% of the population due to shadows cast by interstate commerce restrictions, banking issues and threatening federal laws. Cannabis laws and regulations are not the only factors that are expected to change. We must prepare for significantly lower prices if Cannabis is to become a mainstream alternative to beer, wine and other alcohol in the future. Expecting a $12 Cannabis cigarette to drop to $1 over the next couple of years is not unreasonable.

Therefore, GrowLife’s vision of indoor cultivation is that it is inevitable; not another gardening alternative. In order for Cannabis growers, as well as other plant cultivators of fruits and vegetables, to serve their markets and customers they must significant increase operations at scale, remove inefficiencies and lower their production costs with local, safer, healthier and affordable crops. We see lowering the cost of production as the most important area for GrowLife to focus on and our path to lead our industry. This means increasing efficiencies, scaling up production volumes and driving down indoor operating costs. Given this vision of the future, lowering our customer’s production costs serves as our compass to mergers, acquisitions and partnerships.

GrowLife’s commercial customers are at different stages of commercial operations across all States and Provenances. Along with our business-to-business focus we have looked at the business-to-consumer sought to offer the GrowLife Consumer Cube products. We recognize demand is increasing from small, aspiring cultivation consumers across North America who seek to learn and use a complete indoor growing solution. At our current size, we have recognized that we cannot serve both the consumer and commercial markets efficiently and thus have decided to concentrate our efforts on commercial customers.

To grow our commercial programs GrowLife is investing in two areas, Sales with Marketing support and Research and Development or innovation. The funding for these efforts started with $1 million in equity financing in February 2018 from Chicago Venture Partners and then with $2.5 million from shareholders with a Rights Offering. These funds allowed us to begin our expansion and innovation projects, thus our greater than normal G&A expenses and EZ-Clone acquisition.

Demand: Market Size and Growth

GrowLife Inc. is engaged in the business of offering both commodity-based and proprietary general hydroponic growing equipment for the indoor plant cultivation and cannabis industries.

Additionally, through two recent asset acquisitions, GrowLife has begun selling company manufactured products including:

- Luxury Vinyl Tile for residential, commercial, and temporary surface consumers of the Floor Covering industry.

- Plant cloning and propagation equipment which service the plant

Hydroponic Growing Equipment (US)

Key Industry Statistics:

- In 2018, the Hydroponic Growing Equipment Stores industry generated $842 million in gross revenue in the United States. (source).

- The industry grew 4.6% from 2013 to 2018 and is expected to continuing growing at a rate of 1.4% through 2019. (source|source)

- As of 2019, there are approximately 2,546 businesses engaged in the industry who employ around 9,982. (source|source)

- No companies have been identified as “major players”.

- According to the market research report by Transparency Market Research, the global hydroponics market is anticipated to reach a value of US$12.1 bn from US$6.9 bn by the end of 2025. The market is likely to register a promising 6.50% CAGR between 2017 and 2025. (source)

Key Industry Drivers:

- Much of the industry’s sudden popularity is the result of heightened consumer interest in locally grown and organic produce; many producers of hydroponic fruits and vegetables strive to use sustainable business practices and natural nutrients and pesticides, in addition to the increasing size of the legalized cannabis market.

- The increasing awareness among consumers regarding the consumption of greens is predicted to encourage the growth of the global hydroponics market in the coming years. (source)

- Vertical cultivation to act as a major opportunity for the market players, which is likely to accelerate market growth in the near future. (source)

- Consumer interest in organic foods and hydroponic growing has also increased as disposable income continues to rise.

- According to the World Bank, there is a deduction of 3% land in the past 54 years which may lead to more urbanization and adoption of hydroponics in the years to come. (source)

- Impact of the Cannabis Industry

o The legalized cannabis industry is growing exponentially. Hydroponics is the preferred method of cultivation of cannabis products, which will in turn increase demand for hydroponics equipment.

o In certain states and throughout Canada, individuals above 21 years of age and patients with medical marijuana cards are also allowed to grow limited quantities of marijuana for personal use. This has encouraged patients to purchase hydroponic growing equipment and pursue small-scale marijuana cultivation.

Competitive advantages:

Most hydroponic growing equipment stores are small business operations that serve their immediate geographic areas. GrowLife serves all of North America

Growth Outlook of Hydroponics Industry:

“The industry is growing faster than overall GDP”

Factors:

- Increasing consumer focus on healthy eating habits will likely spur demand as more consumers seek out organic and pesticide-free produce and opt to grow their own or purchase locally produced organic foods made with hydroponic growing equipment.

- Medical and recreational cannabis has been legalized in multiple states and the country of Canada and is expected to be approved in a number of US states over the next five years, which will lead more patients and cultivators to buy cannabis products and hydroponic growing equipment to fulfill demand for this growing market.

- This hydroponics industry will also continue to benefit from risk-averse local farmers wishing to break their reliance on weather conditions that may be increasingly volatile.

- IBIS World estimates that per capita disposable income will rise at an annualized rate of 2.7% over the five years to 2022.

- The US Department of Agriculture reported in 2016 that the number of certified organic food operators increased nearly 12.0% from 2015, and this growth is expected to remain high over the next five years.

Medical and Recreational Marijuana Growing Industry

Key Industry Statistics:

- In 2018, the Medical and Recreational Marijuana Growing industry in the United States generated $6 billion and is expected to grow to $8.2 billion in 2019. (source)

- According to data released by Forbes, In 2017 the worldwide legal marijuana trade grew by 37% and was worth $9.5 billion. At $8.5 billion, the U.S. accounted for 90% of it. At $0.6 billion Canada’s 2017 share was 6%. The rest of the world combined made up the remaining 4%. (source)

- Nine states and the District of Columbia have legalized the drug for recreational purposes, according to the National Conference of State Legislatures. More than half the states (31) — plus the District of Columbia, Guam and Puerto Rico — have legalized it for medical purposes. (source)

- As of 2018, there are approximately 223,123 businesses engaged in the industry, employing roughly 763,189 people.

- No companies have been identified as “major players”.

- Over the past five years, the number of growers has grown by 14.6% and the number of employees has grown by 16.5%.

- Medical Marijuana patients with severe pain comprise the largest market segment for the industry, accounting for 64.6% of the market in 2016, with recreational consumers accounting for 14.1% of the market. The remaining market share is shared by consumers purchasing products for treatment of other various medical conditions.

Key Industry Drivers:

- Medical marijuana growers continue to benefit from the steadily aging population. Chronic illnesses have become more prevalent as the population continues to age, driving demand for medical marijuana.

- An estimated 2.6 million people use marijuana for medicinal purposes, and this segment of the US population is anticipated to increase drastically over the next five years.

- More than two-thirds of Americans now live in jurisdictions that have legalized either the medical or adult use of marijuana.

- The industry has been significantly restricted by an increasing amount of proposed regulations. In particular, medical marijuana remains a Schedule I controlled substance under federal law, despite state-level legalization. Following legalization in many states during the 2016 election cycle, and expected legalization in the upcoming 2018 cycle, beneficial regulation is expected to create an opportunity for the industry. (source)

Growth Outlook of the Medical and Recreational Marijuana Growing Industry:

“The industry is growing at a faster rate than the US economy”

- The industry has experienced an annual growth rate of 28.3% from 2013–2018 and is expected to grow 27.4% in 2019 over the previous year. (source)

- Forbes expects that by 2022, legal cannabis revenue in the U.S. market is projected to hit $23.4 billion (73% of the world market market). During the same period, Canada is projected to reach $5.5 billion (17%) and at $3.1 billion, the rest of the world will represent almost 10% of the legal cannabis market (source)

Factors:

- Continued legalization on the state level will increase accessibility to medical and recreational marijuana, increasing nationwide demand.

- Growing acceptance of the marijuana products will increase demand. According to a poll conducted by the Pew Research Center, 62% of Americans say the use of marijuana should be legalized in 2018, compared with just 31% in 2000.

- The level of household income determines consumers’ ability to purchase medical marijuana products. While prescription products can be essential for health and therefore less susceptible to changes in consumer expenditure, the unconventional nature of the industry’s products make it subject to changes in disposable income. As a result, an increase in disposable income will boost demand for medical marijuana growers.

Competitive advantages:

- GrowLife has branded itself among cannabis cultivators as experts in the space. The company is associated with cannabis growing and is known as one of the first companies in the space

- GrowLife offers consultancy services on commercial cultivation set ups.

- GrowLife offers educational resources on proper growing procedures for home growing consumers.

Floor Covering Industry: Segment Luxury Vinyl Tile (LVT) (US)

Key Industry Statistics:

- In 2016, the U.S. flooring market grew an estimated 5.1%, according to Market Insights, with total revenues of $21.174 billion.

- North America flooring market will witness gains over 5% up to 2024 according to Global Market Insights.

- Luxury Vinyl Tile (“LVT”)

- LVT now accounts for 16.5% of the total flooring market in dollars and 18.8% in volume after a 6.5% rise in units to 3.537 billion square feet. In 2015, resilient held a 13.3% market share in terms of dollars, which was up from 12.2% in 2014, 11.9% in 2013 and 11.2% in 2012 respectively.

- Sales have gone from nearly $750 million in 2012 to $948 million in 2013, $1.142 billion in 2014, $1.651 billion in 2015 and $2.161 in 2016. That represents respective gains of 26.4%, 20.5%, 27.1% and 30.9% respectively.

- LVT sales have more than doubled in three years.

- LVT increased significantly in both residential and commercial markets — dollars and square feet — in 2016. Residential LVT saw a 68.3% increase in square footage from 760 million in 2015 to 1.04 billion (including WPC), making up 76.1% of the LVT market. This number was 71% a year ago and 55% two years ago.

- The commercial market rose from 297.2 million square feet to 326.3 million square feet, a 9.8% increase. While residential brought in more dollars — $1.512 billion — last year, commercial LVT still performed well, posting a 12.5% increase, rising from $576.4 million in 2015 to $648.6 million in 2016.

Competitive advantages:

- GrowLife’s LVT product FreeFit® features significant competitive advantages including:

- 20k+ HD imaging, “Real Touch” texture technology, fully customizable platform, “Seriously Easy to Install” design, made in the US, waterproof, lifespan 3x longer than traditional vinyl, 4mmm thickness and 22mil wear layer and wear and stain resistance.

- Direct to consumer sales model that major competitors cannot execute on due to resale agreements.

Growth Outlook:

The global vinyl flooring market is expected to reach an estimated $16.2 billion by 2023, and it is forecast to grow at a CAGR of 4.4% from 2018 to 2023.

Company Info

Employees

As of December 31, 2018, we had 32 full-time and part-time employees. Marco Hegyi, our Chief Executive Officer, is based in Kirkland, Washington. Mark E. Scott, our Chief Financial Officer, is based primarily in Seattle, Washington. In addition, we have approximately 25 full and part time employees located throughout the United States and Canada who operate our businesses. We employ 7 full-time and part-time employees at EZ-Clone in Sacramento, CA. None of our employees are 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.