Business context and reporting period
The supplied filing is Visualant, Incorporated’s unaudited Form 10-Q for the quarter and six months ended March 31, 2014; it does not identify USBC, Inc. as the registrant. Visualant combines TransTech’s security and identification-products distribution business with development and commercialization of its ChromaID optical identification technology. TransTech generated most current revenue; ChromaID was in early commercialization.
Financial results and liquidity
| Metric | Three months ended March 31, 2014 | Six months ended March 31, 2014 |
|---|---|---|
| Revenue | $2.025 million, down 8.7% year over year | $3.902 million, down 8.7% |
| Gross profit and margin | $340,275; 16.8% (prior year 25.9%) | $646,343; 16.6% (prior year 25.9%) |
| Operating loss | $505,133, versus $1.133 million | $1.355 million, versus $1.816 million |
| Net loss attributable to common shareholders | $1.720 million, versus $2.347 million | $2.581 million, versus $3.055 million |
| Operating cash flow | Not stated separately | Cash used of $836,696 in the cash-flow statement |
| Cash | Not stated separately | $65,938 at March 31, 2014, versus $747,129 at September 30, 2013 |
At March 31, 2014, current assets were $1.497 million and current liabilities $8.761 million. Management reported a working-capital deficit of approximately $1.901 million excluding the $5.363 million warrant derivative liability. Total assets were $3.489 million, total debt was $908,928 (almost all current), and stockholders’ deficit was $5.343 million. The six-month net loss included a $1.179 million noncash loss from revaluing warrant liabilities.
Material changes versus the prior comparable period
- Revenue declined mainly because Sumitomo license revenue had been fully recognized by May 2013: the company reported a $250,000 year-over-year reduction for the quarter and $500,000 for the six-month period. Higher TransTech sales partly offset this decline; initial ChromaID shipments contributed only modest revenue.
- Gross margin contracted as the higher-margin Sumitomo license revenue fell away. TransTech’s reported gross margin improved modestly, but did not offset that effect.
- Operating losses narrowed, primarily because selling, general and administrative expenses fell: by $742,000 for the quarter and $949,000 for the six months. The filing cites lower business-development, stock-compensation, legal, and TransTech expenses. Research and development increased for the six-month period.
- Net losses improved year over year, but included substantial noncash warrant-related expense in 2014; the comparable 2013 period included a large loss on purchasing warrants and additional investment rights.
Outlook, risks, contingencies, and unusual items
- Management expects continuing losses while commercializing ChromaID and says additional financing will be required. The filing’s going-concern disclosure states that limited capital, accumulated losses, and dependence on financing raise substantial doubt about the company’s ability to continue as a going concern.
- Management expects ChromaID to provide most net revenue in future years, but TransTech currently provides most revenue. The filing gives no quantified revenue, earnings, or cash-flow guidance.
- The Sumitomo joint development agreement expired December 31, 2013; the parties were still defining their future commercial relationship. Under the IDMC agreement, Visualant shipped 20 ChromaID kits, provided ongoing support, issued a warrant for 14,575,286 shares, and agreed to delay most kit sales for 140 days. IDMC is to pursue applications and at least ten patent filings.
- The BFI receivables facility was scheduled to expire June 11, 2014, unless renewed; the filing describes a $394,988 balance due at expiry and a separate $105,000 secured note due June 12, 2014. The company also relied on CEO-related financing. The filing contains differing descriptions of the March 31 CEO note amount and borrowing, which investors should reconcile.
- Warrants with down-round provisions create fair-value volatility and potential dilution. At March 31, 126.5 million warrants and 12.7 million options were outstanding; common shares outstanding were 165.3 million.
- Disclosure controls were reported ineffective due to a material weakness: the audit committee lacked a financial expert. Management said it expected to appoint an independent audit committee financial expert. The filing reports no pending legal proceedings expected to have a material adverse effect; Visualant continued to pursue a damages claim after receiving shares in its Ascendiant dispute.
- Other stated risks include dependence on major TransTech vendors, ChromaID’s unproven commercial potential, possible regulatory approval for medical applications, financing and dilution risks, and dependence on key personnel.
Important facts for investors to verify
- Confirm the intended issuer: the provided filing names Visualant, Incorporated, not USBC, Inc.
- Reconcile the cash-flow discussion: the cash-flow statement reports $836,696 used in operations, while MD&A cites approximately $857,000.
- Check the CEO-related note disclosures and amounts: the notes describe a $300,000 note with $205,000 borrowed, while the risk discussion describes a $350,000 note.
- Review the near-term BFI facility renewal or repayment, the June 2014 debt maturities, and the company’s ability to obtain further funding.
- Assess the warrant liability, down-round provisions, potential share dilution, and the assumptions behind the reported $1.179 million revaluation loss.
- Track ChromaID commercialization and IDMC deliverables, the post-expiry relationship with Sumitomo, and any new licensing or royalty revenue.
- Verify remediation of the disclosed internal-control weakness and the filing’s inconsistent accumulated-deficit disclosures: the balance sheet reports $23.119 million, while a risk-factor passage reports $21.9 million.