Know Labs, Inc. — Form 10-Q Summary
Entity and period: The supplied filing is for Know Labs, Inc. (formerly Visualant, Incorporated), not USBC, Inc. It reports the fiscal third quarter and nine months ended June 30, 2018; the company’s fiscal year ends September 30. The filing was signed August 9, 2018.
Business context
Know Labs is developing ChromaID and Bio-RFID technologies for identifying or diagnosing substances using electromagnetic energy. Its TransTech Systems subsidiary, a distributor of personnel-identification products, generated substantially all reported revenue; the new technologies had generated minimal revenue. The company acquired RAAI Lighting in April 2018 for 2 million Know Labs common shares and recorded $520,000 of acquired intellectual property. In May, it changed its name and ticker from Visualant/VSUL to Know Labs/KNWN.
Financial results and liquidity
| Metric | Three months ended June 30, 2018 | Nine months ended June 30, 2018 |
|---|---|---|
| Revenue | $1.107 million, up 8.6% year over year | $3.432 million, down 6.4% |
| Gross profit | $197,259 | $671,750 |
| Operating loss | $732,387 | $1.491 million |
| Net loss | $506,254, versus net income of $527,946 | $2.334 million, versus a $3.074 million loss |
| Net cash used in operating activities | Not separately presented for the quarter | $842,373 |
- Quarterly revenue growth reflected a TransTech aerospace sale not repeated in the prior-year quarter. Nine-month revenue declined due to lower TransTech sales. Nine-month gross margin was 19.6%, compared with 18.3% in 2017. The MD&A states quarterly gross margin was 20.1%, but the reported quarterly revenue and gross profit imply approximately 17.8%; the filing does not reconcile this difference.
- Nine-month R&D expense rose to $366,809 from $38,243, largely attributed to product development, including Bio-RFID. SG&A fell to $1.796 million from $2.469 million; the prior-year period included a $983,645 goodwill impairment. Interest expense rose sharply to $1.096 million from $79,567, principally due to convertible-debt discounts and related features. The current period also included a $234,393 gain from debt settlements, described as reversal of old accounts payable.
- Cash was $1.304 million at June 30, up from $103,181 at September 30, 2017. Financing provided $2.069 million in the nine-month period, including $1.710 million net equity proceeds and $530,000 of convertible-note proceeds; operating activities used $842,373 and investing activities used $25,319.
- Total current assets were $1.916 million and current liabilities $4.968 million, a current-liability excess of approximately $3.052 million. Current liabilities included $2.390 million of convertible notes and $394,670 of current debt. The company separately describes approximately $267,000 of net working capital “net of convertible notes payable and notes payable”; this is not its balance-sheet working-capital position.
- The $500,000 Capital Source secured facility was modified, with maturity extended to December 12, 2018; $47,000 was available at quarter-end. It is secured by TransTech assets and includes a Know Labs guarantee and security interest in company assets. Contractual obligations included $2.390 million of convertible notes and $394,670 of notes payable shown due within one year.
Material changes and capital structure
- A June 25 private placement raised $1.75 million gross in exchange for 7 million common shares and warrants for 3.5 million shares, generally exercisable at $0.25 per share for five years. The balance sheet reports 15,538,726 common shares outstanding at June 30; 16,570,162 were outstanding as of August 9.
- Convertible notes payable increased from $570,000 at September 30, 2017 to $2.390 million at June 30, 2018. The company reported 15.586 million warrants outstanding and potential common shares from preferred stock and convertible debt, creating substantial potential dilution.
- On April 10, Phillip Bosua became CEO, replacing Ronald Erickson, who remained Chairman. Bosua’s employment agreement provides a $225,000 annual base salary, 500,000 shares, potential discretionary awards and 12 months’ severance in specified circumstances.
Outlook, risks and unusual items
- Management expects operating losses to continue while it commercializes ChromaID and Bio-RFID. It provides no quantified revenue or earnings guidance. The filing says cash was expected to fund operations through September 30, 2018 in the going-concern note, but through December 31, 2018 in MD&A and risk disclosures; these runway statements conflict.
- The filing identifies substantial doubt about the company’s ability to continue as a going concern, citing recurring losses, operating cash outflows, limited capital and the need for additional financing. It warns that unavailable financing could require restructuring, asset divestitures, scaling back development or bankruptcy.
- Disclosure controls were deemed ineffective because of material weaknesses, including no full-time CFO and no audit committee financial expert. Management warned of risk of reporting misstatement. The filing reports no material pending legal proceedings and no material off-balance-sheet arrangements.
- Key risks include dependence on financing and related-party funding, debt maturities and secured-creditor remedies, dilution, limited commercialization and customer adoption, concentrated TransTech vendors and customers, reliance on external development resources, intellectual-property protection, possible regulatory approval for medical uses, and volatile OTC trading.
Important facts for investors to verify
- Confirm the issuer identity: the document is Know Labs, Inc., not USBC, Inc., and confirm the intended reporting period.
- Reconcile the stated quarterly gross margin with the revenue and gross-profit figures, and clarify the conflicting cash-runway estimates.
- Review the terms, maturity dates, security and conversion provisions of the $2.390 million convertible notes, other debt, and Capital Source facility, including the subsequent Umpqua Bank repayment and share issuance.
- Assess funding needs and dilution from outstanding warrants, preferred shares, convertible debt and subsequent issuances; verify the status of the June placement proceeds and issued shares.
- Evaluate whether TransTech can sustain revenue and whether the company’s technology can progress from development to commercial sales, licensing or meaningful royalties.
- Check remediation of the disclosed internal-control weaknesses and whether an audit committee financial expert and appropriate finance leadership were appointed.