10-Q/A 1 vsul_10qa-17160.htm VISUALANT, INC. 10-Q/A, AMENDMENT NO. 1 Blueprint
 
  
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q/A
Amendment No. 1
 
     QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended December 31, 2016
 
      TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
 
For the transition period from _______ to ________
 
Commission File number               000-30262
 
 
VISUALANT, INCORPORATED  

(Exact name of registrant as specified in charter)
 
  Nevada
 90-0273142
 (State or other jurisdiction of incorporation or organization)
 (I.R.S. Employer Identification No.)
 
 
  500 Union Street, Suite 420, Seattle, Washington USA
  98101
 (Address of principal executive offices) 
 (Zip Code)
 
 
206-903-1351
 
 
 (Registrant's telephone number, including area code)
 
 
 
 
 
N/A
 
 
 (Former name, address, and fiscal year, if changed since last report)
 
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No
 
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (See the definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act). 
 
Large accelerated filer             Accelerated filer             Non-accelerated filer             Smaller reporting company 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ☐  No
 
The number of shares of common stock, $.001 par value, issued and outstanding as of February 21, 2017: 3,750,962 shares
  
 
1
 
 
EXPLANATORY NOTE
 
This Amendment No. 1 on Form 10-Q/A amends the Company’s Quarterly Report on Form 10-Q/A for the quarter ended December 31, 2016, as filed with the Securities and Exchange Commission (the “SEC”) on February 21, 2017 (the “Original Filing”).
 
The purpose of this Amendment No. 1 on Form 10-Q/A is to respond to certain comments received from the Staff of the SEC. For convenience and ease of reference, the Company is filing this Form 10-Q/A in its entirety with all applicable changes and unless otherwise stated, all information contained in this amendment is as of the filing date of the Original Filing. Except as stated herein, this Form 10-Q/A does not reflect events or transactions occurring after such filing date or modify or update those disclosures in the original Form 10-Q that may have been affected by events or transactions occurring subsequent to such filing date.
 
 
 TABLE OF CONTENTS
 
 
Page Number
 
 
 
 PART I
FINANCIAL INFORMATION
3
 
 
 
 ITEM 1
Financial Statements (unaudited except as noted)
3
 
 
 
 
Consolidated Balance Sheets as of December 31, 2016 and September 30, 2016 (audited)
3
 
 
 
 
Consolidated Statements of Operations for the three months ended December 31, 2016 and 2015
4
 
 
 
 
Consolidated Statements of Cash Flows for the three months ended December 31, 2016 and 2015
5
 
 
 
 
Notes to the Financial Statements 
6
 
 
 
 ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operation
27
 
 
 
 ITEM 3
Quantitative and Qualitative Disclosures About Market Risk
37
 
 
 
 ITEM 4
Controls and Procedures
37
 
 
 
 PART II
OTHER INFORMATION
38
 
 
 
 ITEM 1A.
Risk Factors 
38
 
 
 
 ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds
47
 
 
 
 ITEM 5
Other Information
47
 
 
 
 ITEM 6
Exhibits and Reports on Form 8-K 
47
 
 
 
 
SIGNATURES
49
 
 
 
 
 
 
 
 
 
 
 
 
 
2
 
 
ITEM 1.
FINANCIAL STATEMENTS
 
VISUALANT, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
 
 
 
 
December 31, 2016
 
 
September 30, 2016
 
 
 
 
 
 
(Audited) 
 
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
 
 
 
Cash and cash equivalents
 $180,847 
 $188,309 
Accounts receivable, net of allowance of $175,000 and $55,000, respectively
  635,471 
  808,955 
Prepaid expenses
  17,233 
  20,483 
Inventories, net
  210,717 
  295,218 
Total current assets
  1,044,268 
  1,312,965 
 
    
    
EQUIPMENT, NET
  276,213 
  285,415 
 
    
    
OTHER ASSETS
    
    
Intangible assets, net
  30,625 
  43,750 
Goodwill
     -
  983,645 
Other assets
  5,070 
  5,070 
 
    
    
TOTAL ASSETS
 $1,356,176 
 $2,630,845 
 
    
    
LIABILITIES AND STOCKHOLDERS' (DEFICIT)
    
    
 
    
    
CURRENT LIABILITIES:
    
    
Accounts payable - trade
 $2,098,895 
 $1,984,326 
Accounts payable - related parties
  33,334 
  41,365 
Accrued expenses
  66,706 
  80,481 
Accrued expenses - related parties
  1,082,839 
  1,109,046 
Derivative liability
  562,714 
  145,282 
Convertible notes payable
  555,000 
  909,500 
Notes payable - current portion of long term debt
  1,100,071 
  1,170,339 
Total current liabilities
  5,499,559 
  5,440,339 
 
    
    
COMMITMENTS AND CONTINGENCIES
  - 
  - 
 
    
    
STOCKHOLDERS' DEFICIT
    
    
Preferred stock - $0.001 par value, 5,000,000 shares authorized, 0 shares issued and
    
    
outstanding at 12/31/2016 and 9/30/2016, respectively
  - 
  - 
Series A Convertible Preferred stock - $0.001 par value, 23,334 shares authorized, 23,334
    
    
issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  23 
  23 
Series C Convertible Preferred stock - $0.001 par value, 1,785,715 shares authorized,
    
    
1,785,715 shares issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  1,790 
  1,790 
Series D Convertible Preferred stock - $0.001 par value, 3,906,250 shares authorized,
    
    
375,000 and 0 shares issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  375 
  - 
Common stock - $0.001 par value, 100,000,000 shares authorized, 3,570,010
    
    
and 2,356,152 shares issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  3,570 
  2,356 
Additional paid in capital
  26,090,915 
  24,259,702 
Accumulated deficit
  (30,240,056)
  (27,073,365)
Total stockholders' deficit
  (4,143,383)
  (2,809,494)
 
    
    
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
 $1,356,176 
 $2,630,845 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
3
 
 
VISUALANT, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
 
 
 
 
 
 
 
 
 
Three Months Ended,
 
 
 
December 31, 2016
 
 
December 31, 2015
 
 
 
 
 
 
 
 
REVENUE
 $1,148,800 
 $1,284,800 
COST OF SALES
  958,442 
  1,086,678 
GROSS PROFIT
  190,358 
  198,122 
RESEARCH AND DEVELOPMENT EXPENSES
  40,608 
  91,962 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
  1,307,568
  736,207 
IMPAIRMENT OF GOODWILL
  983,645
  
OPERATING LOSS
  (2,141,463)
  (630,047)
 
    
    
OTHER INCOME (EXPENSE):
    
    
Interest expense
  (52,273)
  (38,639)
Other income
  3,607 
  2,320 
(Loss) on change - derivative liability
  (417,432)
  (1,345,960)
Total other expense
  (466,098)
  (1,382,279)
 
    
    
(LOSS) BEFORE INCOME TAXES
  (2,607,561)
  (2,012,326)
 
    
    
Income taxes - current provision
  - 
  - 
 
    
  . 
NET (LOSS)
 $(2,607,561)
 $(2,012,326)
 
    
    
Basic and diluted loss per common share attributable to Visualant,
    
    
Inc. and subsidiaries common shareholders-
    
    
Basic and diluted loss per share
 $(0.81)
 $(1.73)
 
    
    
Weighted average shares of common stock outstanding- basic and diluted
  3,227,351 
  1,161,366 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
 
 
 
 
 
4
 
 
VISUALANT, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Three Months Ended,    
 
 
 
December 31, 2016
 
 
December 31, 2015
 
 
 
 
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
Net loss
 $(2,607,561)
 $(2,012,326)
Adjustments to reconcile net loss to net cash (used in)
    
    
operating activities
    
    
Depreciation and amortization
  22,327 
  53,722 
Issuance of capital stock for services and expenses
  206,831 
  104,476 
Conversion of interest
  56,454 
  - 
Stock based compensation
  10,887 
  11,837 
Gain on sale of assets
  (1,034)
  - 
Loss on change - derivative liability
  417,432 
  1,346,264 
Amortization of debt discount
  10,000 
  - 
Provision for losses on accounts receivable
  121,041 
  - 
Impairment of goodwill
 983,645 
  - 
 
    
    
Changes in operating assets and liabilities:
    
    
Accounts receivable
  52,443 
  7,768 
Prepaid expenses
  3,250 
  (5,861)
Inventory
  84,501 
  28,888 
Accounts payable - trade and accrued expenses
  66,556 
  (81,196)
Deferred revenue
  - 
  (2,500)
 NET CASH (USED IN) OPERATING ACTIVITIES
  (573,228)
  (548,928)
 
    
    
CASH FLOWS FROM INVESTING ACTIVITIES:
    
    
Investment in BioMedx, Inc., net
  - 
  - 
Proceeds from sale of equipment
  1,034 
  - 
NET CASH PROVIDED BY INVESTING ACTIVITIES:
  1,034 
  - 
 
    
    
CASH FLOWS FROM FINANCING ACTIVITIES:
    
    
(Repayments) proceeds from line of credit
  (35,268)
  221,457 
Proceeds from warrant exercises
  - 
  16,264 
Proceeds from convertible notes payable
  300,000 
  370,000 
Proceeds from issuance of common/preferred stock, net of costs
  300,000 
  - 
NET CASH PROVIDED BY FINANCING ACTIVITIES
  564,732 
  607,721 
 
    
    
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
  (7,462)
  58,793 
 
    
    
CASH AND CASH EQUIVALENTS, beginning of period
  188,309 
  82,266 
 
    
    
CASH AND CASH EQUIVALENTS, end of period
 $180,847 
 $141,059 
 
    
    
Supplemental disclosures of cash flow information:
    
    
Interest paid
 $14,245 
 $15,190 
Taxes paid
 $- 
 $- 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
5
 
VISUALANT, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.
RETATEMENT OF FINANCIAL STATEMENTS
 
The management of the Company has concluded that we should restate our financial statements as of and for the quarter ended December 31, 2016.
 
Subsequent to the filing of 10-Q for the three months ended December 31, 2016, the management of the Company has concluded that its goodwill in Transtech should have been reduced to $0. The assumptions management used to determine goodwill were incorrect and through additional analysis management has determined that a full impairment of goodwill is appropriate.
 
The effect of the restatement on the Consolidates Balance Sheet at December 31, 2016, Consolidated Statement of Operations for the three months ended December 31, 2017, and the Consolidated Statement of Cash Flows for the three months ended December 31,2017 are shown below:
 
 
VISUALANT, INCORPORATED AND SUBSIDIARIES     
 
 
CONSOLIDATED BALANCE SHEETS     
 
 
 
 
 
 
 
 
 
 
 
 
 
Previously Reported
 
 
Adjustment
 
 
As Restated
 
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 180,847 
 - 
 180,847 
Accounts receivable, net of allowance of $175,000 and $40,000, respectively
  635,471 
  - 
  635,471 
Prepaid expenses
  17,233 
  - 
  17,233 
Inventories, net
  210,717 
  - 
  210,717 
Total current assets
  1,044,268 
  - 
  1,044,268 
 
    
    
    
EQUIPMENT, NET
  276,213 
  - 
  276,213 
 
    
    
    
OTHER ASSETS
    
    
    
Intangible assets, net
  30,625 
  - 
  30,625 
Goodwill
  500,000 
  (500,000)
  - 
Other assets
  5,070 
  - 
  5,070 
 
    
    
    
TOTAL ASSETS
 1,856,176 
 (500,000)
 1,356,176 
 
    
    
    
LIABILITIES AND STOCKHOLDERS' (DEFICIT)
    
    
    
 
    
    
    
CURRENT LIABILITIES:
    
    
    
Accounts payable - trade
 2,098,895 
 - 
 2,098,895 
Accounts payable - related parties
  33,334 
  - 
  33,334 
Accrued expenses
  66,706 
  - 
  66,706 
Accrued expenses - related parties
  1,082,839 
  - 
  1,082,839 
Derivative liability
  562,714 
  - 
  562,714 
Convertible notes payable
  555,000 
  - 
  555,000 
Notes payable - current portion of long term debt
  1,100,071 
  - 
  1,100,071 
Total current liabilities
  5,499,559 
  - 
  5,499,559 
 
    
    
    
COMMITMENTS AND CONTINGENCIES
  - 
  - 
  - 
 
    
    
    
STOCKHOLDERS' DEFICIT
    
    
    
Preferred stock - $0.001 par value, 5,000,000 shares authorized, 0 shares issued and
    
    
    
outstanding at 12/31/2016 and 9/30/2016, respectively
  - 
  - 
  - 
Series A Convertible Preferred stock - $0.001 par value, 23,334 shares authorized, 23,334
    
    
    
issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  23 
  - 
  23 
Series C Convertible Preferred stock - $0.001 par value, 1,785,715 shares authorized,
    
    
    
1,785,715 shares issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  1,790 
  - 
  1,790 
Series D Convertible Preferred stock - $0.001 par value, 3,906,250 shares authorized,
    
    
    
375,000 and 0 shares issued and outstanding at 12/31/2016 and 9/30/2016, respectively
  375 
  - 
  375 
Common stock - $0.001 par value, 100,000,000 shares authorized, 3,570,010
    
    
    
and 2,356,152 shares issued and outstanding at 12/31.2016 and 9/30/2016, respectively
  3,570 
  - 
  3,570 
Additional paid in capital
  26,090,915 
  - 
  26,090,915 
Accumulated deficit
  (29,740,056)
  (500,000)
  (30,240,056)
Total stockholders' deficit
  (3,643,383)
  (500,000)
  (4,143,383)
 
    
    
    
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
 1,856,176 
 (500,000)
 1,356,176 
 
 
6
 
 
 
VISUALANT, INCORPORATED AND SUBSIDIARIES           
 
 
CONSOLIDATED STATEMENTS OF OPERATIONS           
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended,
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
Adjusment
 
 
As Restated
 
 
 
 
 
 
 
 
 
 
 
REVENUE
 1,148,800 
 - 
 1,148,800 
COST OF SALES
  958,442 
  - 
  958,442 
GROSS PROFIT
  190,358 
  - 
  190,358 
RESEARCH AND DEVELOPMENT EXPENSES
  40,608 
  - 
  40,608 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
  1,791,213 
  (483,645)
  1,307,568 
IMPAIRMENT OF GOODWILL
    
  983,645 
  983,645 
OPERATING LOSS
  (1,641,463)
  (500,000)
  (2,141,463)
 
    
    
    
OTHER INCOME (EXPENSE):
    
    
    
Interest expense
  (52,273)
  - 
  (52,273)
Other (expense) income
  3,607 
  - 
  3,607 
(Loss) on change - derivative liability
  (417,432)
  - 
  (417,432)
Total other expense
  (466,098)
  - 
  (466,098)
 
    
    
    
(LOSS) BEFORE INCOME TAXES
  (2,107,561)
  (500,000)
  (2,607,561)
 
    
    
    
Income taxes - current provision
  - 
    
  - 
 
    
  . 
  . 
NET (LOSS)
 (2,107,561)
 (500,000)
 (2,607,561)
 
    
    
    
Basic and diluted loss per common share attributable to Visualant,
    
    
    
Inc. and subsidiaries common shareholders-
    
    
    
Basic and diluted loss per share
 (0.65)
 (0.15)
 (0.80)
 
    
    
    
Weighted average shares of common stock outstanding- basic and diluted
  3,227,351 
  3,227,351 
  3,227,351 
 
 
 
 
 
 
 
 
7
 
 
 
VISUALANT, INCORPORATED AND SUBSIDIARIES           
 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS           
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended,
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
Adjusment
 
 
As Restated
 
 
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
 
 
 
Net loss
 (2,107,561)
 (500,000)
 (2,607,561)
Adjustments to reconcile net loss to net cash (used in)
    
    
  - 
operating activities
    
    
  - 
Depreciation and amortization
  22,327 
  - 
  22,327 
Issuance of capital stock for services and expenses
  206,831 
  - 
  206,831 
Conversion of interest
  56,454 
    
    
Stock based compensation
  10,887 
  - 
  10,887 
Loss (gain) on sale of assets
  (1,034)
  - 
  (1,034)
(Gain) loss on change - derivative liability
  417,432 
  - 
  417,432 
Amortization of debt discount
  10,000 
    
    
Provision for losses on accounts receivable
  121,041 
  - 
  121,041 
Impairment of goodwill
  483,645 
  500,000 
  983,645 
 
    
    
    
 
    
    
  - 
Changes in operating assets and liabilities:
    
    
  - 
Accounts receivable
  52,443 
  - 
  52,443 
Prepaid expenses
  3,250 
  - 
  3,250 
Inventory
  84,501 
  - 
  84,501 
Accounts payable - trade and accrued expenses
  66,556 
  - 
  66,556 
Deferred revenue
  - 
  - 
  - 
NET CASH (USED IN) OPERATING ACTIVITIES
  (573,228)
  - 
  (573,228)
 
    
    
  0 
CASH FLOWS FROM INVESTING ACTIVITIES:
    
    
  - 
Capital expenditures
  - 
  - 
  - 
Proceeds from sale of equipment
  1,034 
  - 
  1,034 
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES:
  1,034 
  - 
  1,034 
 
    
    
  - 
CASH FLOWS FROM FINANCING ACTIVITIES:
    
    
  - 
Proceeds (repayments) from line of credit
  (35,268)
  - 
  (35,268)
Proceeds from sale of common and preferred stock, net
  300,000 
  - 
  300,000 
Proceeds from warrant exercises
  - 
  - 
  - 
Proceeds from convertible notes payable
  300,000 
  - 
  300,000 
NET CASH PROVIDED BY FINANCING ACTIVITIES
  564,732 
  - 
  564,732 
 
    
    
  - 
NET INCREASE IN CASH AND CASH EQUIVALENTS
  (7,462)
  - 
  (7,462)
 
    
    
  - 
CASH AND CASH EQUIVALENTS, beginning of period
  188,309 
  - 
  188,309 
 
    
    
  - 
CASH AND CASH EQUIVALENTS, end of period
 180,847 
 - 
 180,847 
 
    
    
  - 
Supplemental disclosures of cash flow information:
    
    
  - 
Interest paid
 14,245 
 - 
 14,245 
Taxes paid
 - 
 - 
 - 
 
 
 
8
 
 
2.
GOING CONCERN
 
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred net losses of $2,107,561, $1,746,495 and $2,631,037 for the three months ended December 31, 2016 and the years ended September 30, 2016 and 2015, respectively. Net cash used in operating activities was $(573,228), $(3,373,734) and $(239,877) for the three months ended December 31, 2017 and the years ended September 30, 2016 and 2015, respectively.
 
The Company anticipates that it will record losses from operations for the foreseeable future. As of December 31, 2016, the Company’s accumulated deficit was $30,240,056.  The Company has limited capital resources, and operations to date have been funded with the proceeds from private equity and debt financings and loans from Ronald P. Erickson, our Chief Executive Officer, or entities with which he is affiliated. These conditions raise substantial doubt about our ability to continue as a going concern. The audit report prepared by the Company’s independent registered public accounting firm relating to our financial statements for the year ended September 30, 2016 includes an explanatory paragraph expressing the substantial doubt about the Company’s ability to continue as a going concern.
 
We believe that our cash on hand will be sufficient to fund our operations until February 28, 2017. We need additional financing to implement our business plan and to service our ongoing operations and pay our current debts. There can be no assurance that we will be able to secure any needed funding, or that if such funding is available, the terms or conditions would be acceptable to us. If we are unable to obtain additional financing when it is needed, we will need to restructure our operations, and divest all or a portion of our business. We may seek additional capital through a combination of private and public equity offerings, debt financings and strategic collaborations. Debt financing, if obtained, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, and could increase our expenses and require that our assets secure such debt. Equity financing, if obtained, could result in dilution to our then-existing stockholders and/or require such stockholders to waive certain rights and preferences. If such financing is not available on satisfactory terms, or is not available at all, we may be required to delay, scale back, eliminate the development of business opportunities or file for bankruptcy and our operations and financial condition may be materially adversely affected.
 
3.
ORGANIZATION
 
Visualant, Incorporated (the “Company,” “Visualant, Inc.” or “Visualant”) was incorporated under the laws of the State of Nevada in 1998. The Company has authorized 105,000,000 shares of capital stock, of which 100,000,000 are shares of voting common stock, par value $0.001 per share, and 5,000,000 are shares preferred stock, par value $0.001 per share.
 
On July 21, 2015, the Company filed with the Nevada Secretary of State an Amended and Restated Certificate of Designations, Preferences and Rights for its Series A Convertible Preferred Stock. Among other things, the Amended and Restated Certificate changed the conversion price and the stated value from $0.10 (pre-reverse stock split) to $30.00 (post-reverse stock split), and added a provision adjusting the conversion price upon the occurrence of certain events. As a result of the foregoing, the Company currently has 23,334 Series A Preferred Stock issued and outstanding, with a conversion price of $0.70 per share.
 
On August 11, 2016, the Company applied with the State of Nevada for the approval of the Certificate of Designations, Preferences, and Rights of Series C Convertible Preferred Stock. The Certificate designated 1,250,000 shares as Series C Convertible Preferred Stock with a par value of $.001 per share. The Series C Convertible Preferred Stock is convertible into common stock at $0.70 per share, with certain adjustments as set forth in the Certificate. On August 31, 2016, the Company filed with the State of Nevada a Certificate of Correction to the Certificate of Designations of Preferences, Powers, Rights and Limitations for the Series C Convertible Preferred Stock to correct the number of authorized shares. The Certificate authorized 1,785,715 shares of Series C Preferred Stock with a par value of $.001 per share. The Series C Convertible Preferred Stock is convertible into common stock at $0.70 per share, with certain adjustments as set forth in the Certificate. As a result of the foregoing, the Company currently has 1,785,715 shares of Series C Preferred Stock issued and outstanding, with a conversion price of $0.70 per share.
 
On November 8, 2016, the Company applied with the State of Nevada for the approval of the Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock. The Certificate designated up to 3,906,250 shares with a par value of $.001 per share. The Series D Convertible Preferred Stock is convertible into common stock at $0.80 per share, with certain adjustments as set forth in the Certificate. The Company has issued 375,000 shares of Series D Convertible Preferred Stock through February 21, 2017, and intends to issue up to 3,125,000 Series D Shares (and an equal number of warrants) for gross proceeds of $2,500,000 pursuant on a “best efforts” basis.
 
Since 2007 the Company has been focused primarily on the development of a proprietary technology which is capable of uniquely identifying and authenticating almost any substance using light at the “photon” level to detect the unique digital “signature” of the substance. The Company calls this its “ChromaID™” technology.
 
 
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In 2010, the Company acquired TransTech Systems, Inc. as an adjunct to its business. TransTech is a distributor of products for employee and personnel identification. TransTech currently provides substantially all of the Company’s revenues.
The Company is in the process of commercializing its ChromaID™ technology. To date, the Company has entered into License Agreements with Sumitomo Precision Products Co., Ltd. and Intellicheck, Inc. In addition, it has a strategic relationship with Xinova., formerly Invention Development Management Company, a subsidiary of Intellectual Ventures.
The Company believes that its commercialization success is dependent upon its ability to significantly increase the number of customers that are purchasing and using its products. To date the Company has generated minimal revenue from sales of its ChromaID products. The Company is currently not profitable. Even if the Company succeeds in introducing the ChromaID technology and related products to its target markets, the Company may not be able to generate sufficient revenue to achieve or sustain profitability.
ChromaID was invented by scientists from the University of Washington under contract with Visualant. The Company has pursued an intellectual property strategy and have been granted ten patents. The Company also has 20 patents pending. The Company possess all right, title and interest to the issued patents. Ten of the pending patents are licensed exclusively to the Company in perpetuity by the Company’s strategic partner, Xinova
 
In June 2015, the Company effected a 1-for-150 reverse stock split of our common stock. All warrant, option, share and per share information in this Form 10-Q gives retroactive effect to the 1-for-150 reverse split with all numbers rounded up to the nearest whole share.
 
4.  
SIGNIFICANT ACCOUNTING POLICIES: ADOPTION OF ACCOUNTING STANDARDS
 
Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of the Company. Intercompany accounts and transactions have been eliminated. The preparation of these unaudited condensed consolidated financial statements were prepared in conformity with U.S. generally accepted accounting principles (“GAAP”).
 
Principles of Consolidation – The consolidated financial statements include the accounts of the Company and its wholly owned and majority-owned subsidiaries, TransTech Systems, Inc. Inter-Company items and transactions have been eliminated in consolidation.
 
Cash and Cash Equivalents – The Company classifies highly liquid temporary investments with an original maturity of three months or less when purchased as cash equivalents. The Company maintains cash balances at various financial institutions. Balances at US banks are insured by the Federal Deposit Insurance Corporation up to $250,000. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risk for cash on deposit.  
 
Accounts Receivable and Allowance for Doubtful Accounts – Accounts receivable consist primarily of amounts due to the Company from normal business activities. The Company maintains an allowance for doubtful accounts to reflect the expected non-collection of accounts receivable based on past collection history and specific risks identified within the portfolio. If the financial condition of the customers were to deteriorate resulting in an impairment of their ability to make payments, or if payments from customers are significantly delayed, additional allowances might be required.
 
Inventories – Inventories consist primarily of printers and consumable supplies, including ribbons and cards, badge accessories, capture devices, and access control components held for resale and are stated at the lower of cost or market on the first-in, first-out (“FIFO”) method.  Inventories are considered available for resale when drop shipped and invoiced directly to a customer from a vendor, or when physically received by TransTech at a warehouse location.  The Company records a provision for excess and obsolete inventory whenever an impairment has been identified. There is a $25,000 reserve for impaired inventory as of December 31, 2016 and September 30, 2016, respectively.
 
Equipment – Equipment consists of machinery, leasehold improvements, furniture and fixtures and software, which are stated at cost less accumulated depreciation and amortization. Depreciation is computed by the straight-line method over the estimated useful lives or lease period of the relevant asset, generally 2-10 years, except for leasehold improvements which are depreciated over 5-20 years. 
 
Intangible Assets/ Intellectual Property – The Company amortizes the intangible assets and intellectual property acquired in connection with the acquisition of TransTech, over sixty months on a straight - line basis, which was the time frame that the management of the Company was able to project forward for future revenue, either under agreement or through expected continued business activities.  Intangible assets and intellectual property acquired from RATLab LLC and Javelin are recorded likewise. The Company performs annual assessments and has determined that no impairment is necessary. On June 7, 2011, the Company closed the acquisition of all Visualant related assets of the RATLab LLC, namely the rights to the medical field of use of the Chroma ID technology. On July 31, 2012, the Company closed the acquisition of all rights to the ChromaID technology in the environmental field of use from Javelin LLC.
 
 
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Goodwill – Goodwill is the excess of cost of an acquired entity over the fair value of amounts assigned to assets acquired and liabilities assumed in a business combination. With the adoption of ASC 350, goodwill is not amortized, rather it is tested for impairment annually, and will be tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testing for goodwill is done at a reporting unit level. Reporting units are one level below the business segment level, but are combined when reporting units within the same segment have similar economic characteristics. Under the criteria set forth by ASC 350, the Company has one reporting unit based on the current structure.  An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit.  The Company determined that its goodwill related to the 2010 acquisition of TransTech Systems was impaired and recorded an impairment of $983,645 as selling, general and administrative expenses during the three months ended December 31, 2016.
 
Long-Lived Assets – The Company reviews its long-lived assets for impairment annually or when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets under certain circumstances are reported at the lower of carrying amount or fair value. Assets to be disposed of and assets not expected to provide any future service potential to the Company are recorded at the lower of carrying amount or fair value (less the projected cost associated with selling the asset). To the extent carrying values exceed fair values, an impairment loss is recognized in operating results.
 
Fair Value Measurements and Financial Instruments  ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value.  The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs).  The hierarchy consists of three levels:
 
Level 1 – Quoted prices in active markets for identical assets and liabilities;
 
Level 2 – Inputs other than level one inputs that are either directly or indirectly observable; and.
 
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
 
The recorded value of other financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, other current assets, and accounts payable and accrued expenses approximate the fair value of the respective assets and liabilities at December 31, 2016 and 2015 based upon the short-term nature of the assets and liabilities. 
 
Derivative financial instruments -The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations. For stock-based derivative financial instruments, the Company uses a Black-Scholes-Merton option pricing model to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
 
Revenue Recognition – Visualant and TransTech revenue are derived from products and services. Revenue is considered realized when the products or services have been provided to the customer, the work has been accepted by the customer and collectability is reasonably assured. Furthermore, if an actual measurement of revenue cannot be determined, the Company defers all revenue recognition until such time that an actual measurement can be determined. If during the course of a contract management determines that losses are expected to be incurred, such costs are charged to operations in the period such losses are determined. Revenues are deferred when cash has been received from the customer but the revenue has not been earned.
 
Stock Based Compensation – The Company has share-based compensation plans under which employees, consultants, suppliers and directors may be granted restricted stock, as well as options to purchase shares of Company common stock at the fair market value at the time of grant. Stock-based compensation cost is measured by the Company at the grant date, based on the fair value of the award, over the requisite service period. For options issued to employees, the Company recognizes stock compensation costs utilizing the fair value methodology over the related period of benefit.  Grants of stock options and stock to non-employees and other parties are accounted for in accordance with the ASC 505.
 
Convertible Securities Based upon ASC 815-15, we have adopted a sequencing approach regarding the application of ASC 815-40 to convertible securities issued subsequent to September 30, 2015. We will evaluate our contracts based upon the earliest issuance date. In the event partial reclassification of contracts subject to ASC 815-40-25 is necessary, due to our inability to demonstrate we have sufficient shares authorized and unissued, shares will be allocated on the basis of issuance date, with the earliest issuance date receiving first allocation of shares. If a reclassification of an instrument were required, it would result in the instrument issued latest being reclassified first.
 
 
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Net Loss per Share – Under the provisions of ASC 260, “Earnings Per Share,” basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding for the periods presented. Diluted net loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the income of the Company, subject to anti-dilution limitations. The common stock equivalents have not been included as they are anti-dilutive. As of December 31, 2016, there were options outstanding for the purchase of 50,908 common shares, warrants for the purchase of 4,494,080 common shares, 2,184,048 shares of our common stock issuable upon the conversion of Series A, Series C and Series D Convertible Preferred Stock and up to 332,940 shares of our common stock issuable upon the exercise of placement agent warrants. As of December 31, 2015, there were options outstanding for the purchase of 56,641 common shares, warrants for the purchase of 893,244 common shares, 11,667 shares of our common stock issuable upon the conversion of Series A Convertible Preferred Stock, up to 34,031 shares of our common stock issuable upon the exercise of placement agent warrants and an unknown number of shares related to the conversion of $479,000 in convertible promissory notes which could potentially dilute future earnings per share.
 
Dividend Policy – The Company has never paid any cash dividends and intends, for the foreseeable future, to retain any future earnings for the development of our business. Our future dividend policy will be determined by the board of directors on the basis of various factors, including our results of operations, financial condition, capital requirements and investment opportunities.
 
Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Recent Accounting Pronouncements
 
A variety of proposed or otherwise potential accounting standards are currently under study by standard setting organizations and various regulatory agencies. Due to the tentative and preliminary nature of those proposed standards, management has not determined whether implementation of such proposed standards would be material to the Company’s consolidated financial statements.
 
5.
DEVELOPMENT OF OUR CHROMAID™ TECHNOLOGY
 
The Company is focused primarily on the development of a proprietary technology which is capable of uniquely identifying and authenticating almost any substance using light to create, record and detect the unique digital “signature” of the substance. The Company calls this its “ChromaID™” technology.
 
The Company’s ChromaID™ Technology
 
The Company has developed a proprietary technology to uniquely identify and authenticate almost any substance. This patented technology utilizes light at the photon (elementary particle of light) level through a series of emitters and detectors to generate a unique signature or “fingerprint” from a scan of almost any solid, liquid or gaseous material. This signature of reflected or transmitted light is digitized, creating a unique ChromaID signature. Each ChromaID signature is comprised of from hundreds or thousands of specific data points.
 
The ChromaID technology looks beyond visible light frequencies to areas of near infra-red and ultraviolet light that are outside the humanly visible light spectrum. The data obtained allows the Company to create a very specific and unique ChromaID signature of the substance for a myriad of authentication and verification applications.
 
Traditional light-based identification technology, called spectrophotometry, has relied upon a complex system of prisms, mirrors and visible light. Spectrophotometers typically have a higher cost and utilize a form factor more suited to a laboratory setting and require trained laboratory personnel to interpret the information. The ChromaID technology uses lower cost LEDs and photodiodes and specific frequencies of light resulting in a more accurate, portable and easy-to-use solution for a wide variety of applications. The ChromaID technology not only has significant cost advantages as compared to spectrophotometry, it is also completely flexible is size, shape and configuration. The ChromaID scan head can range in size from endoscopic to a scale that could be the size of a large ceiling-mounted florescent light fixture.
 
In normal operation, a ChromaID master or reference scan is generated and stored in a database. The Visualant scan head can then scan similar materials to identify, authenticate or diagnose them by comparing the new ChromaID digital signature scan to that of the original or reference ChromaID signature or scan result.
The following summarizes the Company’s plans for its Company’s proprietary ChromaID technology. Based on the Company’s anticipated expenditures on this technology, the expected efforts of its management and its relationship with Xinova and the Company’s other strategic partner, Sumitomo Precision Products, Ltd., the Company expects its ChromaID technology to provide an increasing portion of its revenues in future years from product sales, licenses, royalties and other revenue streams., as discussed further below.
 
 
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ChromaID: A Foundational Platform Technology
 
The Company’s ChromaID technology provides a platform upon which a myriad of applications can be developed. As a platform technology, it is analogous to a smartphone, upon which an enormous number of previously unforeseen applications have been developed. The ChromaID technology is an enabling technology that brings the science of light and photonics to low cost, real world commercialization opportunities across multiple industries. The technology is foundational and as such, the basis upon which the Company believes a significant business can be built.
 
As with other foundational technologies, a single application may reach across multiple industries. The ChromaID technology can, for example effectively differentiate and identify different brands of clear vodkas that appear identical to the human eye. By extension this same technology can identify pure water from water with contaminants present. It can provide real time detection of liquid medicines such as morphine that have been adulterated or compromised. It can detect if jet fuel has water contamination present. It could determine when it is time to change oil in a deep fat fryer. These are but a few of the potential applications of the ChromaID technology based upon extensions of its ability to identify different clear liquids.
 
The cornerstone of a company with a foundational platform technology is its intellectual property. ChromaID was invented by scientists from the University of Washington under contract with Visualant. The Company has pursued an intellectual property strategy and has been granted nine patents. The Company currently has 20 patents pending. The Company possesses all right, title and interest to the issued patents. Ten of the pending patents are licensed exclusively to us in perpetuity by our strategic partner, Xinova.
 
Xinova Relationship
 
In November 2013, the Company entered into a strategic relationship with Xinova, formerly Invention Development Management Company, a subsidiary of Intellectual Ventures, a private intellectual property fund. Xinova has worked to expand the reach and the potential application of the ChromaID technology and has filed ten patents base on the ChromaID technology, which it has licensed to us.
 
Products
 
The Company first delivered product, the ChromaID Lab Kit, scans and identifies solid surfaces. The Company is marketing this product to customers who are considering licensing the technology. Target markets include, but are not limited to, commercial paint manufacturers, pharmaceutical equipment manufacturers, process control companies, currency paper and ink manufacturers, security cards, cosmetic companies, scanner manufactures and food processing companies.
 
The Company’s second product, the ChromaID Liquid Lab Kit, scans and identifies liquids. This product is currently in prototype form. Similar to the Company’s first product, it will be marketed to customers who are considering licensing the technology. Rather than use an LED emitter to reflect light off of a surface that is captured by a photodiode to generate a ChromaID signature the liquid analysis product shines light through the liquid (transmissive) with the LEDs positioned on one side of the liquid sample and the photo detectors on the opposite side. This device is in a functional state in our laboratory and the Company anticipates having a Liquid ChromaID Lab Kit available for customers by the Company during the fall of 2015. Target markets include, but are not limited to, water companies, petrochemical companies, pharmaceutical companies, and numerous consumer applications.
 
The ChromaID Lab Kits allows potential licensors of our technology to work with our technology and develop solutions for their particular application. Our contractual arrangements with Xinova are described in greater detail below.
 
The Company’s next planned product should be an exemplar product is a prototype that will be produced to address several markets. The primary purpose of this prototype will be to demonstrate the technology to prospective business partners, and will consist of a small, hand held, battery powered, Bluetooth enabled scanning device. The scanner should wirelessly connect to a smart phone or tablet to transfer the scanned data. The smart phone application will include two or three industry specific but generic applications that allow for the demonstration of the scanning and matching of the ChromaID signatures. The applications will focus on drug identification, food safety and liquid detection. The prototype device will lend itself to consumer applications and can be a consumer product as well.
 
Research and Development
 
The Company’s research and development efforts are primarily focused improving the core foundational ChromaID technology and developing new and unique applications for the technology. As part of this effort, the Company typically conduct testing to ensure that ChromaID application methods are compatible with the customer’s requirements, and that they can be implemented in a cost effective manner. The Company is also actively involved in identifying new application methods. Visualant’s team has considerable experience working with the application of light-based technologies and their application to various industries. The Company believes that its continued development of new and enhanced technologies relating to our core business is essential to its future success. The Company spent $325,803 and $362,661 during the years ended September 30, 2016 and 2015, respectively, on research and development activities.
 
 
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The Company’s Patents
 
The Company believes that it’s ten patents, 20 patent applications, and two registered trademarks, and our trade secrets, copyrights and other intellectual property rights are important assets. The Company’s patents will expire at various times between 2027 and 2033. The duration of the Company’s trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained.
 
The patents that have been granted to Visualant include:
 
On August 9, 2011, the Company was issued US Patent No. 7,996,173 B2 entitled “Method, Apparatus and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy,” by the United States Office of Patents and Trademarks. The patent expires August 24, 2029.
 
On December 13, 2011, the Company was issued US Patent No. 8,076,630 B2 entitled “System and Method of Evaluating an Object Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires November 7, 2028.
 
On December 20, 2011, the Company was issued US Patent No. 8,081,304 B2 entitled “Method, Apparatus and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 28, 2030.
 
On October 9, 2012, the Company was issued US Patent No. 8,285,510 B2 entitled “Method, Apparatus, and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On February 5, 2013, the Company was issued US Patent No. 8,368,878 B2 entitled “Method, Apparatus and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On November 12, 2013, the Company was issued US Patent No. 8,583,394 B2 entitled “Method, Apparatus and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On November 21, 2014, the Company was issued US Patent No. 8,888,207 B2 entitled “Systems, Methods, and Articles Related to Machine-Readable Indicia and Symbols” by the United States Office of Patents and Trademarks. The patent expires February 7, 2033.
 
On March 23, 2015, the Company was issued US Patent No. 8,988,666 B2 entitled “Method, Apparatus, and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On May 26, 2015, the Company was issued patent US Patent No. 9,041,920 B2 entitled “Device for Evaluation of Fluids using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires March 12, 2033.
 
On April 19, 2016, the Company was issued patent US Patent No. 9,316,581 B2 entitled “Method, Apparatus, and Article to Facilitate Evaluation of Substances Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires March 12, 2033.
 
The Company pursues a patent strategy to expand its unique intellectual property in the United States and other countries.
 
Services and License Agreement with Xinova
 
In November 2013, the Company entered into a strategic relationship with Xinova, formerly Invention Development Management Company, a subsidiary of Intellectual Ventures, a private intellectual property fund. Xinova has worked to expand the reach and the potential application of the ChromaID technology and has filed ten patents base on the ChromaID technology, which it has licensed to us.
 
The agreement requires Xinova to identify and engage inventors to develop new applications of Visualant’s ChromaID™ technology, present the developments to us for approval, and file at least 10 patent applications to protect the developments. Xinova is responsible for the development and patent costs. The Company provided the Chroma ID Lab Kits to Xinova at no cost and are providing ongoing technical support. In addition, to provide time for this accelerated expansion of its intellectual property the Company delayed the selling of the ChromaID Lab Kits for 140 days except for certain select accounts. The Company continued its business development efforts during this period and have worked with Xinova and their global business development resources to secure potential customers and licensees for the ChromaID technology. The Company shipped 20 ChromaID Lab Kits to inventors in the Xinova network during December 2013 and January 2014.
 
 
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The Company has received a worldwide, nontransferable, exclusive license to the intellectual property developed under the Xinova agreement during the term of the agreement, and solely within the identification, authentication and diagnostics field of use, to (a) make, have made, use, import, sell and offer for sale products and services; (b) make improvements; and (c) grant sublicenses of any and all of the foregoing rights (including the right to grant further sublicenses).
 
The Company received a nonexclusive and nontransferable option to acquire a worldwide, nontransferable, nonexclusive license to the useful intellectual property held by Xinova within the identification, authentication and diagnostics field of use to (a) make, have made, use, import, sell and offer to sell products and services and (b) grant sublicenses to any and all of the foregoing rights. The option to acquire this license may be exercised for up to two years from the effective date of the Agreement.
 
Xinova is providing global business development services to us for geographies not being pursued by Visualant. Also, Xinova has introduced the Company to potential customers, licensees and distributors for the purpose of identifying and pursuing a license, sale or distribution arrangement or other monetization event.
 
The Company granted to Xinova a nonexclusive, worldwide, fully paid, nontransferable, sublicenseable, perpetual license to our intellectual property solely outside the identification, authentication and diagnostics field of use to (a) make, have made, use, import, sell and offer for sale products and services and (b) grant sublicenses of any and all of the foregoing rights (including the right to grant further sublicenses).
 
The Company granted to Xinova a nonexclusive, worldwide, fully paid up, royalty-free, nontransferable, non-sublicenseable, perpetual license to access and use the Company’s technology solely for the purpose of marketing the aforementioned sublicenses of our intellectual property to third parties outside the designated fields of use.
 
In connection with the original license agreement, the Company issued a warrant to purchase 97,169 shares of common stock to Xinova as consideration for the exclusive intellectual property license and application development services. The warrant has a current exercise price of $0.70 per share and expires November 10, 2018. The per share price is subject to adjustment based on any issuances below $0.70 per share except as described in the warrant.
 
The Company agreed to pay Xinova a percentage of license revenue for the global development business services and a percentage of revenue received from any company introduced to us by Xinova. The Company also have also agreed to pay Xinova a royalty when the Company receives royalty product revenue from an Xinova-introduced company. Xinova has agreed to pay the Company a license fee for the nonexclusive license of the Company’s intellectual property.
 
The term of both the exclusive intellectual property license and the nonexclusive intellectual property license commences on the effective date of November 11, 2013, and terminates when all claims of the patents expire or are held in valid or unenforceable by a court of competent jurisdiction from which no appeal can be taken.
 
The term of the Agreement commences on the effective date until either party terminates the Agreement at any time following the fifth anniversary of the effective date by providing at least ninety days’ prior written notice to the other party.
 
6.             
AGREEMENTS WITH SUMITOMO PRECISION PRODUCTS CO., LTD.
 
In May 2012, the Company entered into a Joint Research and Product Development Agreement (the “Joint Development Agreement”) with Sumitomo Precision Products Co., Ltd., a publicly-traded Japanese corporation, for the commercialization of our ChromaID technology. In March 2013, the Company entered into an amendment to this agreement, which extended the Joint Development Agreement from March 31, 2013 to December 31, 2013. The extension provided for continuing work between Sumitomo and Visualant focused on advancing the ChromaID technology and market research aimed at identifying the most significant markets for the ChromaID technology. This agreement expired December 31, 2013. This collaborative work supported the development of the ChromaID Lab Kit. The current version of the technology was introduced to the marketplace as a part of our ChromaID Lab Kit during the fourth quarter of 2013.
 
The Company also entered into a License Agreement with Sumitomo in May 2012 which provides for an exclusive license for the then-extant ChromaID technology. The territories covered by this license include Japan, China, Taiwan, Korea and the entirety of Southeast Asia (Burma, Indonesia, Thailand, Cambodia, Laos, Vietnam, Singapore and the Philippines). On May 21, 2015, the Company entered into an amendment to the License Agreement, which, effective as of June 18, 2014, which eliminated the Sumitomo exclusivity and provides that if the Company sells products in certain territories – Japan, China, Taiwan, Korea and the entirety of Southeast Asia (Burma, Indonesia, Thailand, Cambodia, Laos, Vietnam, Singapore and the Philippines) – the Company will pay Sumitomo a royalty rate of 2% of net sales (excluding non-recurring engineering revenues) over the remaining term of the five-year License Agreement (through May 2017).
 
 
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7.             
ACCOUNTS RECEIVABLE/CUSTOMER CONCENTRATION
 
Accounts receivable were $635,471 and $808,955, net of allowance, as of December 31, 2016 and September 30, 2016, respectively. The Company had no customers in excess of 10% of the Company’s consolidated revenues for the three months ended December 31, 2016. The Company had one customer (31.9%) with accounts receivable in excess of 10% as of December 31, 2016. The customer has not made a payment on the account since December 31, 2016 and the Company reserved $120,000 during the three months ended December 31, 2016 as selling, general and administrative expenses. The Company intends to aggressively pursue collection of the balance.
 
8.             
INVENTORIES
 
Inventories were $210,717 and $295,218 as of December 31, 2016 and September 30, 2016, respectively. Inventories consist primarily of printers and consumable supplies, including ribbons and cards, badge accessories, capture devices, and access control components held for resale. There is a $25,000 reserve for impaired inventory as of December 31, 2016 and September 30, 2016, respectively.
 
9.             
NOTES RECEIVABLE
 
On November 1, 2016, the Company purchased an Original Issue Discount Convertible Promissory Note from BioMedx, Inc. The Company paid $260,000 for the Note with a principal amount of $286,000. The Note matures one year from issuance and bears interest at 5%. The principal and interest can be converted to Biologic common stock at the option of the Company. The Company received 150,000 shares of Pulse Biologics common stock as partial consideration for purchasing the Note. In addition, if BioMedx does not repay the Promissory Note, the Company will have the right to convert the Promissory Note into 51% of the ownership of BioMedx.
 
In addition, the Company and Pulse Biologics agreed to negotiate in good faith to enter into a joint development agreement and subsequent merger transaction prior to December 31, 2017.
 
BioMedx is an early stage company that owns a royalty bearing license, for medical applications, to certain technology developed by Pulse Evolution. The Company’s management concluded BioMedx’s ability to repay Promissory Note is contingent on BioMedx obtaining additional financing. In addition, BioMedx will require additional financing to commercialize the licensed technology. Due to the inherent uncertainty involved in these activities, the Company’s management has determined the value of the Promissory Note and BioMedx common stock is zero at December 31, 2016 and recorded a reserve for the full value.
 
10.             
FIXED ASSETS
 
Fixed assets, net of accumulated depreciation, was $276,213 and $285,415 as of December 31, 2016 and September 30, 2016, respectively. Accumulated depreciation was $805,251 and $796,481 as of December 31, 2016 and September 30, 2016, respectively. Total depreciation expense, was $9,700 and $18,097 for the three months ended December 31, 2016 and 2015, respectively. All equipment is used for selling, general and administrative purposes and accordingly all depreciation is classified in selling, general and administrative expenses.
 
Property and equipment as of December 31, 2016 was comprised of the following: 
 
 
Estimated
 
December 31, 2016    
 
 
Useful Lives
 
Purchased
 
 
Capital Leases
 
 
Total
 
Machinery and equipment
2-10 years
 $252,204 
 $69,581 
 $321,785 
Leasehold improvements
5-20 years
  548,612 
  - 
  548,612 
Furniture and fixtures
3-10 years
  73,977 
  101,260 
  175,237 
Software and websites
3- 7 years
  35,830 
  - 
  35,830 
Less: accumulated depreciation
 
  (634,410)
  (170,841)
  (805,251)
 
 $276,213 
 $- 
 $276,213 
 
11.             
INTANGIBLE ASSETS
 
Intangible assets as of December 31, 2016 and September 30, 2016 consisted of the following: 
 
 
16
 
 
 
Estimated
 
December 31,
 
 
September 30,
 
 
Useful Lives
 
2016
 
 
2016
 
 
 
 
 
 
 
 
 
Customer contracts
5 years
 $983,645 
 $983,645 
Technology
5 years
  712,500 
  712,500 
Less: accumulated amortization
 
  (1,665,520)
  (1,652,395)
    Intangible assets, net
 
 $30,625 
 $43,750 
 
Total amortization expense was $13,125 and $35,625 for the three months ended December 31, 2016 and 2015, respectively.
 
The fair value of the TransTech intellectual property acquired was $983,645, estimated by using a discounted cash flow approach based on future economic benefits associated with agreements with customers, or through expected continued business activities with its customers. In summary, the estimate was based on a projected income approach and related discounted cash flows over five years, with applicable risk factors assigned to assumptions in the forecasted results. The TransTech intellectual property was fully amortized as of December 31, 2016.
 
The fair value of the RATLab intellectual property associated with the assets acquired was $450,000 estimated by using a discounted cash flow approach based on future economic benefits. In summary, the estimate was based on a projected income approach and related discounted cash flows over five years, with applicable risk factors assigned to assumptions in the forecasted results. The RATLab intellectual property was fully amortized as of December 31, 2016.
 
The fair value of the Javelin intellectual property acquired was $262,500 estimated by using a discounted cash flow approach based on future economic benefits associated with the assets acquired. In summary, the estimate was based on a projected income approach and related discounted cash flows over five years, with applicable risk factors assigned to assumptions in the forecasted results.
 
12.             
GOODWILL
 
The Company’s TransTech business is very capital intensive. The Company reviewed TransTech’s operations based on its overall financial constraints and determined the value has been impaired. The Company recorded an impairment of goodwill associated with TransTech of $983,645 during the three months December 31, 2016. (See further discussion at Note 1)
 
13.             
ACCOUNTS PAYABLE
 
Accounts payable were $2,098,895 and $1,984,326 as of December 31, 2016 and 2015, respectively. Such liabilities consisted of amounts due to vendors for inventory purchases and technology development, external audit, legal and other expenses incurred by the Company. The Company had one vendor (11.1%) with accounts payable in excess of 10% of its accounts payable as of December 31, 2016. The Company does expect to have vendors with accounts payable balances of 10% of total accounts payable in the foreseeable future.
 
14.            
DERIVATIVE INSTRUMENTS
 
In April 2008, the FASB issued a pronouncement that provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives. This pronouncement was effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of these requirements can affect the accounting for warrants and many convertible instruments with provisions that protect holders from a decline in the stock price (or “down-round” provisions). For example, warrants or conversion features with such provisions are no longer recorded in equity. Down-round provisions reduce the exercise price of a warrant or convertible instrument if a company either issues equity shares for a price that is lower than the exercise price of those instruments or issues new warrants or convertible instruments that have a lower exercise price.
 
Derivative liability as of December 31, 2016 is as follows:
 
 
17
 
 
 
 
 
 
 
 
 
 
 
 
 
Carrying
 
 
 
Fair Value Measurements Using Inputs  
 
 
Amount at
 
Financial Instruments
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Instruments
 $- 
 $562,714 
 $- 
 $562,714 
 
    
    
    
    
Total
 $- 
 $562,714 
 $- 
 $562,714 
 
Derivative liability as of September 30, 2016 is as follows:
 
 
 
 
 
 
 
 
 
 
 
Carrying
 
 
 
Fair Value Measurements Using Inputs  
 
 
Amount at
 
Financial Instruments
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Instruments
 $- 
 $145,282 
 $- 
 $145,282 
 
    
    
    
    
Total
 $- 
 $145,282 
 $- 
 $145,282 
 
The risk-free rate of return reflects the interest rate for the United States Treasury Note with similar time-to-maturity to that of the warrants, historical volatility was 130% and the stock price was $0.70 at December 31, 2016.
 
Derivative Instruments – Warrants with the June 2013 Private Placement
 
The Company issued warrants to purchase 697,370 shares of common stock in connection with our June 2013 private placement of 348,685 shares of common stock.  The per share price is subject to adjustment. In August 2016 the exercise price was reset to $0.70 per share. These warrants were not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign operation.  These warrants were issued with a down-round provision whereby the exercise price would be adjusted downward in the event that additional shares of our common stock or securities exercisable, convertible or exchangeable for the Company’s common stock were issued at a price less than the exercise price.  Therefore, the fair value of these warrants were recorded as a liability in the consolidated balance sheet and are marked to market each reporting period until they are exercised or expire or otherwise extinguished.
 
The proceeds from the private placement were allocated between the shares of common stock and the warrants issued in connection with the private placement based upon their estimated fair values as of the closing date at June 14, 2013, resulting in the aggregate amount of $2,494,710 allocated to stockholders’ equity and $2,735,290 allocated to the warrant derivative.  The Company recognized $1,448,710 of other expense resulting from the increase in the fair value of the warrant liability at September 30, 2013. During the year ended September 30, 2014, the Company recognized $2,092,000 of other income resulting from the decrease in the fair value of the warrant liability at September 30, 2014. During the year ended September 30, 2015, the Company recognized $104,716 of other expense resulting from the decrease in the fair value of the warrant liability at September 30, 2015. During the year ended September 30, 2016, the Company recognized $2,085,536 of other income resulting from the decrease in the fair value of the warrant liability at September 30, 2016. During the three months December 31, 2016, the Company recognized $67,170 of other expense resulting from the increase in the fair value of the warrant liability at December 31, 2016.
 
Derivative Instruments – Warrant with the November 2013 Xinova Services and License Agreement
 
The Company issued a warrant to purchase 97,169 shares of common stock in connection with the November 2013 Xinova Services and License Agreement. The warrant price of $30.00 per share expires November 10, 2018 and the per share price is subject to adjustment. In August 2016 the exercise price was reset to $0.70 per share. This warrant was not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign operation.  This warrant was issued with a down-round provision whereby the exercise price would be adjusted downward in the event that additional shares of our common stock or securities exercisable, convertible or exchangeable for our common stock were issued at a price less than the exercise price.  Therefore, the fair value of these warrants was recorded as a liability in the consolidated balance sheet and are marked to market each reporting period until they are exercised or expire or otherwise extinguished. During the year ended September 30, 2014, the Company recognized $320,657 of other expense related to the Xinova warrant. During the year ended September 30, 2015, the Company recognized $14,574 of other income related to the Xinova warrant. During the year ended September 30, 2016, the Company recognized $286,260 of other income from the increase in the fair value of the warrant liability at September 30, 2016. During the quarter ended December 31, 2016, the Company recognized $13,118 of other expense resulting from the increase in the fair value of the warrant liability at December 31, 2016.
 
 
18
 
 
Derivative Instrument – Series A Convertible Preferred Stock
 
The Company issued 11,667 shares of Series A Convertible Preferred Stock with attached warrants during the year ended September 30, 2015. The Company allocated $233,322 to stockholder’s equity and $116,678 to the derivative warrant liability. The warrants were issued with a down round provision. The warrants have a term of five years, 23,334 are exercisable at $30 per common share and 23,334 are exercisable at $45 per common share. On August 4, 2016 the exercise price was adjusted to $0.70 per share. During the year ended September 30, 2015, the Company recognized $30,338 of other expense related to the warrant liability. During the year ended September 30, 2016, the Company recognized $132,724 of other income resulting from the increase in the fair value of the warrant liability at September 30, 2016. During the three months December 31, 2016, the Company recognized $9,520 of other expense resulting from the increase in the fair value of the warrant liability at December 31, 2016.
  
15.
CONVERTIBLE NOTES PAYABLE
 
Convertible notes payable as of December 31, 2016 and September 30, 2016 consisted of the following:
 
The Company entered into Convertible Promissory Notes totaling $710,000 with accredited investors during September 2015 to February 2016 to fund short-term working capital. The Notes accrue interest at a rate of 8% per annum and become due September 2016 to February 2017 and are convertible into common stock at the same price of our next financing. On November 31, 2016 holders of $695,000 of the Convertible Promissory Notes converted to 944,948 shares of common stock and five year warrants to purchase common stock at a price of $1.00 per share. The Company recorded accrued interest of $14,687 during the three months ended December 31, 2016.
 
 
 
 
 
 
 
 

 

 
 
 
 
 
 
19
 
 
On September 30, 2016, the Company entered into a $175,000 Convertible Promissory Note with Clayton A. Struve, an accredited investor and affiliate of the Company, to fund short-term working capital. The Convertible Promissory Note accrues interest at a rate of 10% per annum and becomes due on March 30, 2017. The Note holder can convert to common stock at $0.70 per share. During the three months ended December 31, 2016 the Company recorded interest of $5,367 related to the convertible note.
 
The Company entered into two Convertible Promissory Notes totaling $330,000 with accredited investors during on November 1, 2016. The Notes accrue interest at a rate of 10% per annum and become due May 1,2017 and are convertible into Preferred stock at a conversion price of $0.80 per share and a five-year warrant to purchase a share of common stock at $1.00 per share. The company first allocated the value received the warrants based on the Black Scholes value assuming a 1 year life, 130% volatility and .7% risk free interest rate. The remaining value was below the fair market value on the date of issuance and as a result the company recorded and beneficial conversion dividend of $326,687 at the time issuance. The Company recorded accrued interest of $5,683 as of December 31, 2016.
 
16.
NOTES PAYABLE, CAPITALIZED LEASES AND LONG TERM DEBT
 
Notes payable, capitalized leases and long term debt as of December 31, 2016 and September 30, 2016 consisted of the following:
 
 
 
December 31,
 
 
September 30,
 
 
 
2016
 
 
2016
 
 
 
 
 
 
 
 
Capital Source Business Finance Group
 $300,136 
 $370,404 
Note payable to Umpqua Bank
  199,935 
  199,935 
Secured note payable to J3E2A2Z LP - related party
  600,000 
  600,000 
Total debt
  1,100,071 
  1,170,339 
Less current portion of long term debt
  (1,100,071)
  (1,170,339)
Long term debt
 $- 
 $- 
 
Capital Source Business Finance Group
 
The Company finances its TransTech operations from operations and a Secured Credit Facility with Capital Source Business Finance Group. On December 9, 2008, TransTech entered into a $1,000,000 secured credit facility with Capital Source to fund its operations.   On December 12, 2016, the secured credit facility was renewed for an additional six months, with a floor for prime interest of 4.5% (currently 4.5%) plus 2.5%. The eligible borrowing is based on 80% of eligible trade accounts receivable, not to exceed $1,000,000. The secured credit facility is collateralized by the assets of TransTech, with a guarantee by Visualant, including a security interest in all assets of Visualant. Availability under this Secured Credit ranges from $0 to $175,000 ($10,000 as of September 30, 2016) on a daily basis. The remaining balance on the accounts receivable line of $300,136 as of September 30, 2016 must be repaid by the time the secured credit facility expires on June 12, 2017, or we renew by automatic extension for the next successive six-month term.
 
Note Payable to Umpqua Bank
 
The Company has a $199,935 Business Loan Agreement with Umpqua Bank (the “Umpqua Loan”), which matures on December 31, 2017 and provides for interest at 3.25% per year. Related to this Umpqua Loan, the Company entered into a demand promissory note for $200,000 on January 10, 2014 with an entity affiliated with Ronald P. Erickson, our Chief Executive Officer. This demand promissory note will be effective in case of a default by the Company under the Umpqua Loan. The Company recorded accrued interest of $17,852 as of December 31, 2016.
 
Note Payables to Ronald P. Erickson or J3E2A2Z LP
 
The Company also has two other demand promissory notes payable to entities affiliated with Mr. Erickson, totaling $600,000. Each of these notes were issued between January and July 2014, provide for interest of 3% per year and now mature on March 31, 2017. The notes payable also provide for a second lien on our assets if not repaid by March 31, 2017 or converted into convertible debentures or equity on terms acceptable to the Mr. Erickson. The Company recorded accrued interest of $44,704 as of December 31, 2016.
 
17.
EQUITY
 
Authorized Capital Stock
 
 
20
 
 
The Company has authorized 105,000,000 shares of capital stock, of which 100,000,000 are shares of voting common stock, par value $0.001 per share, and 5,000,000 are shares of voting preferred stock, par value $0.001 per share.
 
Voting Preferred Stock
 
The Company is authorized to issue up to 5,000,000 shares of preferred stock with a par value of $0.001. 
 
Series A Convertible Preferred Stock
 
On July 21, 2015, the Company filed with the Nevada Secretary of State an Amended and Restated Certificate of Designations, Preferences and Rights for its Series A Convertible Preferred Stock. Among other things, the Amended and Restated Certificate changed the conversion price and the stated value from $0.10 (pre-reverse stock split) to $30.00 (post-reverse stock split), and added a provision adjusting the conversion price upon the occurrence of certain events. As a result of the foregoing, the Company currently have 23,334 Series A Preferred Stock issued and outstanding, with a conversion price of $0.70 per share.
 
Under the Amended and Restated Certificate, the Company has 23,334 shares of Series A Preferred authorized, all of which are outstanding. Each holder of outstanding shares of Series A Preferred is entitled to the number of votes equal to the number of whole shares of common stock into which the shares of Series A Preferred held by such holder are then convertible as of the applicable record date. The Company cannot amend, alter or repeal any preferences, rights, or other terms of the Series A Preferred so as to adversely affect the Series A Preferred, without the written consent or affirmative vote of the holders of at least 66% of the then outstanding shares of Series A Preferred, voting as a separate voting group. 
 
During the year ended September 30, 2015, the Company sold 11,667 Series A Preferred Stock to two investors for total consideration of $350,000. These shares are were convertible into 11,667 shares of common stock at $30.00 per share, subject to adjustment, for a period of five years.   The Series A Preferred Stock has voting rights and may not be redeemed without the consent of the holder.
 
The Company also issued to these investors (i) a Series C five-year Warrant for 23,334 shares of common stock at an exercise price of $30.00 per share, which is callable at $60.00 per share; and (ii) a Series D five-year Warrant for 23,334 shares of common stock at an exercise price of $45.00 per share, which is callable at $90.00 per share. The Series A Preferred Stock and Series C and D Warrants had registration rights.
 
On July 20, 2015, the two investors entered into an Amendment to Series A Preferred Stock Terms whereby they agreed to the terms of the Amended and Restated Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock and waived all registration rights.
 
On August 4, 2016, the conversion price of the Series A Preferred Stock was adjusted to $0.70 per share due to the Company’s issuance of common stock at that price.
 
On March 8, 2016, the Company received approval from the State of Nevada for a Correction to the Company’s Amended and Restated Certificate of Designations, Preferences and Rights of its Series A Convertible Preferred Stock. The Amended and Restated Certificate filed July 21, 2015 changed the conversion price and the stated value from $0.10 (pre-reverse stock split) to $30.00 (post-reverse stock split), and added a provision adjusting the conversion price upon the occurrence of certain events. On February 19, 2016, the holders of Series A Convertible Preferred Stock entered into Amendment 2 of Series A Preferred Stock Terms and increased the number of Preferred Stock Shares to properly account for the reverse stock split. As a result of the foregoing, we currently have 23,334 Series A Preferred Stock issued and outstanding, with a conversion price of $0.70 per share.
 
Series C Convertible Preferred Stock
 
On August 5, 2016, the Company closed a Series C Preferred Stock and Warrant Purchase Agreement with an accredited investor for the purchase of $1,250,000 of preferred stock with a conversion price of $0.70 per share. The Series C Convertible Preferred Stock has a yield of 8% and an ownership blocker of 4.99%. In addition, the investor received 100% warrant coverage with five-year warrants with an exercise price of $0.70. Shares issuable upon the conversion of the Series C Convertible Preferred Stock and the shares issuable upon exercise of the warrants were included in a registration statement filed by the Company.
 
On August 11, 2016, the Company applied with the State of Nevada for the approval of the Certificate of Designations, Preferences, and Rights of Series C Convertible Preferred Stock. The Certificate designated 1,785,715 shares as Series C Convertible Preferred Stock with a par value of $.001 per share. The Series C Convertible Preferred Stock is convertible into common stock at $0.70 per share, with certain adjustments as set forth in the Certificate. On August 31, 2016, the Company filed with the State of Nevada a Certificate of Correction to the Certificate of Designations of Preferences, Powers, Rights and Limitations for the Series C Convertible Preferred Stock to correct the number of authorized shares. The Certificate authorized 1,785,715 shares of Series C Preferred Stock with a par value of $.001 per share. The Series C Convertible Preferred Stock is convertible into common stock at $0.70 per share, with certain adjustments as set forth in the Certificate. As a result of the foregoing, the Company currently has 1,785,715 shares of Series C Preferred Stock issued and outstanding, with a conversion price of $0.70 per share.
 
 
21
 
 
To determine the effective conversion price, a portion of the proceeds received by the Company upon issuance of the Series C Preferred Stock was first allocated to the freestanding warrants issued as part of this transaction. Given that the warrants will not subsequently be measured at fair value, the Company determined that the warrants should receive an allocation of the proceeds based on their relative fair value. This is based on the understanding that the FASB staff and the SEC staff believe that a freestanding instrument issued in a basket transaction should be initially measured at fair value if it is required to be subsequently measured at fair value pursuant to US generally accepted accounting principles (“GAAP”), with the residual proceeds from the transaction allocated to any remaining instruments based on their relative fair values. As such, the warrants were allocated a fair value of approximately $514,706 upon issuance, with the remaining $735,294 of proceeds allocated to the Series C Preferred Stock.
 
Proportionately, this allocation resulted in approximately 59% of the face amount of the Series C Preferred Stock issuance remaining, which applied to the stated conversion price of $0.70 resulted in an effective conversion price of approximately $0.41.
 
Having determined the effective conversion price, the Company then compared this to the fair value of the underlying Common Stock as of the commitment date, which was approximately $1.06 per share, and concluded that the conversion feature did have an intrinsic value of $0.65 per share. As such, the Company concluded that the Series C Preferred Stock did contain a beneficial conversion feature and an accounting entry and additional financial statement disclosure was required.
 
Because the Company’s preferred stock is perpetual, with no stated maturity date, and the conversions may occur any time from inception, the dividend is recognized immediately when a beneficial conversion exists at issuance. During the year ending September 30, 2016, the Company recognized preferred stock dividends of $1.16 million on Series C preferred stock related to the beneficial conversion feature arising from a common stock effective conversion rate of $0.41 versus a current market price of $1.06 per common share.
 
Series D Convertible Preferred Stock
 
On November 14, 2016, the Company issued 187,500 shares of Series D Convertible Preferred Stock and a warrant to purchase 187,500 shares of common stock in a private placement to certain accredited investors for gross proceeds of $150,000 pursuant to a Series D Preferred Stock and Warrant Purchase Agreement dated November 10, 2016.
 
On December 19, 2016, the Company issued 187,500 shares of Series D Convertible Preferred Stock and a warrant to purchase 187,500 shares of common stock in a private placement to an accredited investor for gross proceeds of $150,000 pursuant to a Series D Preferred Stock and Warrant Purchase Agreement dated December 14, 2016.
 
The initial conversion price of the Series D Shares is $0.80 per share, subject to certain adjustments. The initial exercise price of the warrant is $1.00 per share, also subject to certain adjustments.
 
As part of the Purchase Agreement, the Company has agreed to register the shares of common stock sold in the private placement and the shares of common stock issuable upon exercise of the warrant for resale or other disposition.
 
On November 8, 2016, the Company applied with the State of Nevada for the approval of the Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock. The Certificate designated up to 3,906,250 shares with a par value of $.001 per share. The Series D Convertible Preferred Stock is convertible into common stock at $0.80 per share, with certain adjustments as set forth in the Certificate. The Company has issued 375,000 shares of Series D Convertible Preferred Stock through February 21, 2017, and intends to issue up to 3,125,000 Series D Shares (and an equal number of warrants) for gross proceeds of $2,500,000 pursuant on a “best efforts” basis.
 
To determine the effective conversion price, a portion of the proceeds received by the Company upon issuance of the Series D Preferred Stock was first allocated to the freestanding warrants issued as part of this transaction. Given that the warrants are subject to repricing in the event of a future financing below $0.80 per share, the Company determined that the warrants should receive an allocation of the proceeds based on their relative fair value.
 
As such, the warrants associated with the November 14, 2016 issuance were allocated a fair value of approximately $56,539 upon issuance, with the remaining $63,539 of net proceeds allocated to the Series D Preferred Stock. Proportionately, this allocation resulted in approximately 53% of the amount of the Series D Preferred Stock issuance remaining, which applied to the stated conversion price of $0.80 resulted in an effective conversion price of approximately $0.34. Having determined the effective conversion price, the Company then compared this to the fair value of the underlying Common Stock as of the commitment date, which was approximately $1.14 per share, and concluded that the conversion feature did have an intrinsic value of $0.80 per share. As such, the Company concluded that the Series D Preferred Stock did contain a beneficial conversion feature of $150,211 which was recorded as a beneficial conversion in stockholders’ equity.
 
 
22
 
 
The warrants associated with the December 19, 2016 issuance were allocated a fair value of approximately $60,357 upon issuance, with the remaining $69,643 of net proceeds allocated to the Series D Preferred Stock. Proportionately, this allocation resulted in approximately 54% of the amount of the Series D Preferred Stock issuance remaining, which applied to the stated conversion price of $0.80 resulted in an effective conversion price of approximately $0.37. Having determined the effective conversion price, the Company then compared this to the fair value of the underlying Common Stock as of the commitment date, which was approximately $0.81 per share, and concluded that the conversion feature did have an intrinsic value of $0.44 per share. As such, the Company concluded that the Series C Preferred Stock did contain a beneficial conversion feature of 82,232 which was recorded as a beneficial conversion in stockholders’ equity.
 
Common Stock
 
All of the offerings and sales described below were deemed to be exempt under Rule 506 of Regulation D and/or Section 4(a)(2) of the Securities Act. No advertising or general solicitation was employed in offering the securities, the offerings and sales were made to a limited number of persons, all of whom were accredited investors and transfer was restricted by the company in accordance with the requirements of Regulation D and the Securities Act. All issuances to accredited and non-accredited investors were structured to comply with the requirements of the safe harbor afforded by Rule 506 of Regulation D, including limiting the number of non-accredited investors to no more than 35 investors who have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of an investment in our securities.
 
The following equity issuances occurred during the three months ended December 31, 2016:
 
On October 21, 2015, the Company entered into a Public Relations Agreement with Financial Genetics LLC for public relation services. On October 18, 2016, the Company entered into an Amendment to Public Relations Agreement with Financial Genetics LLC. Under the Agreements, Financial Genetics was issued 168,910 shares of our common stock during the three months ended December 31, 2016. The Company expensed $136,833 during the three months ended December 31, 2016.
 
On October 6, 2016, the Company entered into a Services Agreement with Redwood Investment Group LLC for financial services. Under the Agreement, Redwood was issued 100,000 shares of our common stock. The Company expensed $70,000 during the three months ended December 31, 2016.
 
The Company entered into Convertible Promissory Notes totaling $710,000 with accredited investors during September 2015 to February 2016 to fund short-term working capital. The Notes accrued interest at a rate of 8% per annum and became due September 2016 to February 2017 and were convertible into common stock as part of our next financing. On November 30, 2016, the Company converted $695,000 of the /Convertible Promissory Notes and interest of $54,078 into 936,348 shares of comment stock at $0.80 per share. The Company also issued warrants to purchase 936,348 shares of the Company’s common stock. The five year warrants are exercisable at $1.00 per share, subject to adjustment.
 
On December 22, 2016, a supplier converted accounts payable totaling $6,880 into 8,600 shares of common stock valued at $0.80 per share.
 
On May 6, 2015, the Company’s stockholders approved a reverse split of our common stock, in a ratio to be determined by the Company’s Board of Directors, of not less than 1-for-50 or more than 1-for-150. On June 9, 2015, the Company’s Board of Directors determined that the ratio of the reverse split would be 1-for-150. All warrant, option, share and per share information in this Form 10-Q gives retroactive effect for a 1-for-150 split with all numbers rounded up to the nearest whole share.
 
Warrants to Purchase Common Stock
 
The following warrants were issued during the three months ended December 31, 2016:
 
The Company entered into Convertible Promissory Notes totaling $710,000 with accredited investors during September 2015 to February 2016 to fund short-term working capital. The Notes accrued interest at a rate of 8% per annum and became due September 2016 to February 2017 and were convertible into common stock as part of our next financing. On November 30, 2016, the Company converted $695,000 of the /Convertible Promissory Notes and interest of $54,078 into 936,348 shares of comment stock at $0.80 per share. The Company also issued warrants to purchase 936,348 shares of the Company’s common stock. The five year warrants are exercisable at $1.00 per share, subject to adjustment.
 
On November 14, 2016, the Company issued 187,500 shares of Series D Convertible Preferred Stock and a warrant to purchase 187,500 shares of common stock in a private placement to certain accredited investors for gross proceeds of $150,000 pursuant to a Series D Preferred Stock and Warrant Purchase Agreement dated November 10, 2016.
 
On December 19, 2016, the Company issued 187,500 shares of Series D Convertible Preferred Stock and a warrant to purchase 187,500 shares of common stock in a private placement to an accredited investor for gross proceeds of $150,000 pursuant to a Series D Preferred Stock and Warrant Purchase Agreement dated December 14, 2016.
 
 
23
 
 
The initial conversion price of the Series D Shares is $0.80 per share, subject to certain adjustments. The initial exercise price of the warrant is $1.00 per share, also subject to certain adjustments.
 
During the three months ended December 31, 2016, the Company revised five year placement agent warrants to purchase 312,500 shares of common stock. The price was reduced from $1.00 to $0.70 per share and the exercise price is now subject to adjustment. The Company recorded 250,000 shares during the year ended September 30, 2016 the fair value of these warrants is $104,125 at December 31, 2016.
 
A summary of the warrants outstanding as of December 31, 2016 were as follows:
 
 
 
December 31, 2016  
 
 
 
 
 
 
Weighted
 
 
 
 
 
 
Average
 
 
 
 
 
 
Exercise
 
 
 
Shares
 
 
Price
 
Outstanding at beginning of period
  3,453,171 
 $0.84 
Issued
  1,373,849 
  0.93 
Exercised
  - 
  - 
Forfeited
  - 
  - 
Expired
  - 
  - 
Outstanding at end of period
  4,827,020 
 $0.87 
Exercisable at end of period
  4,827,020 
    
 
A summary of the status of the warrants outstanding as of December 31, 2016 is presented below:
 
 
 
 
 
December 31, 2016      
 
 
 
 
 
Weighted
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Average
 
 
Average
 
 
 
 
 
Average
 
 
Number of
 
 
Remaining
 
 
Exercise
 
 
Shares
 
 
Exercise
 
 
Warrants
 
 
Life ( In Years)
 
 
Price
 
 
Exercisable
 
 
Price
 
  3,501,336 
  3.94 
 $0.70 
  3,501,336 
 $0.70 
  1,311,348 
  4.92 
  1.00 
  1,311,348 
  1.00 
  14,336 
  1.12 
  30.00 
  14,336 
  30.00 
  4,827,020 
  3.96 
 $0.87 
  4,827,020 
 $0.87 
 
The significant weighted average assumptions relating to the valuation of the Company’s warrants for the period ended December 31, 2016 were as follows:
 
Dividend yield
0%
Expected life
.25-3
Expected volatility
130%
Risk free interest rate
.01-.07%
 
There were vested warrants of 4,827,020 as of December 31, 2016 with an aggregate intrinsic value of $0.
 
18.
STOCK OPTIONS
 
Description of Stock Option Plan
 
On April 29, 2011, the Company’s 2011 Stock Incentive Plan was approved at the Annual Stockholder Meeting. The Company was authorized to issue options for, and has reserved for issuance, up to 46,667 shares of common stock under the 2011 Stock Incentive Plan. On March 21, 2013, an amendment to the Stock Option Plan was approved by the stockholders of the Company, increasing the number of shares reserved for issuance under the Plan to 93,333 shares.
 
 
24
 
 
Determining Fair Value under ASC 505
 
The Company records compensation expense associated with stock options and other equity-based compensation using the Black-Scholes-Merton option valuation model for estimating fair value of stock options granted under our plan. The Company amortizes the fair value of stock options on a ratable basis over the requisite service periods, which are generally the vesting periods. The expected life of awards granted represents the period of time that they are expected to be outstanding.  The Company estimates the volatility of our common stock based on the historical volatility of its own common stock over the most recent period corresponding with the estimated expected life of the award. The Company bases the risk-free interest rate used in the Black Scholes-Merton option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. The Company has not paid any cash dividends on our common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes-Merton option valuation model and adjusts share-based compensation for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate is recognized in the period the forfeiture estimate is changed.
 
Stock Option Activity
 
The Company had no stock option transactions during the three months ended December 31, 2016:
 
There are currently 50,908 options to purchase common stock at an average exercise price of $18.05 per share outstanding as of December 31, 2016 under the 2011 Stock Incentive Plan. The Company recorded $10,887 and $11,837 of compensation expense, net of related tax effects, relative to stock options for the three months ended December 31, 2016 and 2015 in accordance with ASC 505. Net loss per share (basic and diluted) associated with this expense was approximately ($0.00) and ($0.01) per share, respectively. As of December 31, 2016, there is approximately $102,276 of total unrecognized costs related to employee granted stock options that are not vested. These costs are expected to be recognized over a period of approximately 2.78 years. 
 
Stock option activity for the three months ended December 31, 2016 and the years ended September 30, 2016 and 2015 was as follows:
 
 
 
  Weighted Average    
 

 
  Options
 
 
Exercise Price  
 
 
 
Outstanding as of September 30, 2014
  87,333 
  18.80 
  1,642,200 
Granted
  11,335 
  15.00 
  170,025 
Exercised
  - 
  - 
  - 
Forfeitures
  (41,261)
  (18.29)
  (754,500)
Outstanding as of September 30, 2015
  57,407 
  18.43 
  1,057,725 
Granted
  - 
  - 
  - 
Exercised
  - 
  - 
  - 
Forfeitures
  (6,499)
  (21.40)
  (139,098)
Outstanding as of September 30, 2016
  50,908 
  18.04 
  918,627 
Granted
  - 
  - 
  - 
Exercised
  - 
  - 
  - 
Forfeitures
  - 
  - 
  - 
Outstanding as of December 31, 2016
  50,908 
 $18.045 
 $918,627 
 
The following table summarizes information about stock options outstanding and exercisable as of December 31, 2016:
 

 
 
 
 
 
 
 
Weighted
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
 
 
 
Average
 
 
Average
 
 
 
 
 
Average
 
 
Range of
 
 
Number
 
 
Remaining Life
 
 
Exercise Price
 
 
Number
 
 
Exercise Price
 
 
Exercise Prices
 
 
Outstanding
 
 
In Years
 
 
Exercisable
 
 
Exercisable
 
 
Exercisable
 
    13.500 
  3,334 
  1.75 
 $13.50 
  3,334 
 $13.50 
    15.000 
  20,906 
  2.58 
  15.00 
  9,514 
  15.00 
    19.500 
  13,334 
  2.67 
  19.50 
  13,334 
  19.50 
    22.500 
  13,334 
  3.38 
  22.50 
  13,334 
  22.50 
    
  50,908 
  2.87 
 $18.04 
  39,516 
 $18.92 
 
There were exercisable options of 50,908 as of December 31, 2016 with an aggregate intrinsic value of $0.
 
 
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19.
OTHER SIGNIFICANT TRANSACTIONS WITH RELATED PARTIES
 
Related Party Transactions with Ronald P. Erickson
 
See Note 13 for Notes Payable to Ronald P. Erickson, our Chief Executive Officer Chief and/or entities in which Mr. Erickson has a beneficial interest.
 
Note Payable to Umpqua Bank
 
The Company has a $199,935 Business Loan Agreement with Umpqua Bank (the “Umpqua Loan”), which matures on December 31, 2017 and provides for interest at 3.25% per year. Related to this Umpqua Loan, the Company entered into a demand promissory note for $200,000 on January 10, 2014 with an entity affiliated with Ronald P. Erickson, our Chief Executive Officer. This demand promissory note will be effective in case of a default by the Company under the Umpqua Loan. The Company recorded accrued interest of $17,852 as of December 31, 2016.
 
Note Payables to Ronald P. Erickson or J3E2A2Z LP
 
The Company also has two other demand promissory notes payable to entities affiliated with Mr. Erickson, totaling $600,000. Each of these notes was issued between January and July 2014, provides for interest of 3% per year and now matures on March 31, 2017. The notes payable also provide for a second lien on our assets if not repaid by March 31, 2017 or converted into convertible debentures or equity on terms acceptable to the Mr. Erickson. The Company recorded accrued interest of $44,704 as of December 31, 2016.
 
Other Amounts Due to Mr. Erickson
 
Mr. Erickson and/or entities with which he is affiliated also have advanced $529,833 and have unreimbursed expenses and compensation of approximately $430,056. The Company owes Mr. Erickson, or entities with which he is affiliated, $1,559,889 as of December 31, 2016.
 
20.
COMMITMENTS, CONTINGENCIES AND LEGAL PROCEEDINGS
 
Legal Proceedings
 
The Company may from time to time become a party to various legal proceedings arising in the ordinary course of our business. The Company is currently not a party to any pending legal preceding that is not ordinary routine litigation incidental to our business.
 
Properties and Operating Leases
 
The Company is obligated under various non-cancelable operating leases for its various facilities and certain equipment.
 
Corporate Offices
 
The Company’s executive office is located at 500 Union Street, Suite 420, Seattle, Washington, USA, 98101. The Company leases 1,014 square feet and its net monthly payment is $2,535. The Company leases this office on a month to month basis.
 
TransTech Facilities
 
TransTech is located at 12142 NE Sky Lane, Suite 130, Aurora, OR 97002. TransTech leases a total of approximately 9,750 square feet of office and warehouse space for its administrative offices, product inventory and shipping operations. The Company leases this office on a month to month basis at $6,942 per month.
 
The aggregate future minimum lease payments under operating leases as of December 31, 2016 were $10,030.
 
21.            
SUBSEQUENT EVENTS
 
The Company evaluates subsequent events, for the purpose of adjustment or disclosure, up through the date the financial statements are available. Subsequent to December 31, 2016, there were the following material transactions that require disclosure:
 
Extension of Related Party Notes
 
On January 9, 2017, the Company entered into amendments to two demand promissory notes, totaling $600,000, and a note payable for $200,000 related to the Umpqua Bank Business Loan Agreement with Mr. Erickson, our Chief Executive Officer and/or entities in which Mr. Erickson has a beneficial interest. The amendments extend the due date from December 31, 2016 to March 31, 2017 and continue to provide for interest of 3% per annum and a second lien on company assets if not repaid by March 31, 2017 or converted into convertible debentures or equity on terms acceptable to the Holder.
 
 
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Issuance of Equity
 
On October 21, 2015, the Company entered into a Public Relations Agreement with Financial Genetics LLC for public relation services. On October 18, 2016, the Company entered into an Amendment to Public Relations Agreement with Financial Genetics LLC. Under the Agreements, Financial Genetics was issued 80,952 shares of our common stock and expensed $66,666 subsequent to the three months ended December 31, 2016.
 
On October 6, 2015, the Company entered into a Services Agreement with Redwood Investment Group LLC for financial services. Under the Agreement, Redwood was issued 100,000 shares of our common stock and expensed $70,000 subsequent to the three months ended December 31, 2016.
 
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-looking statements in this report reflect the good-faith judgment of our management and the statements are based on facts and factors as we currently know them. Forward-looking statements are subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, but are not limited to, those discussed below as well as those discussed elsewhere in this report (including in Part II, Item 1A (Risk Factors)). Readers are urged not to place undue reliance on these forward-looking statements because they speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report.
 
BACKGROUND AND CAPITAL STRUCTURE
 
Visualant, Incorporated (the “Company,” “Visualant, Inc.” or “Visualant”) was incorporated under the laws of the State of Nevada in 1998. We have authorized 105,000,000 shares of capital stock, of which 100,000,000 are shares of voting common stock, par value $0.001 per share, and 5,000,000 are shares preferred stock, par value $0.001 per share.
 
As of December 31, 2016, we had 3,570,010 shares of common stock issued and outstanding, held by 54 stockholders of record. The number of stockholders, including beneficial owners holding shares through nominee names, is approximately 2,300. Each share of common stock entitles its holder to one vote on each matter submitted to the stockholders for a vote, and no cumulative voting for directors is permitted.  Stockholders do not have any preemptive rights to acquire additional securities issued by us.  As of December 31, 2016, there were options outstanding for the purchase of 50,908 common shares, warrants for the purchase of 4,494,080 common shares, 2,184,048 shares of our common stock issuable upon the conversion of Series A, Series C and Series D Convertible Preferred Stock and up to 332,940 shares of our common stock issuable upon the exercise of placement agent warrants.
 
In June 2015, we effected a 1-for-150 reverse stock split of our common stock. All warrant, option, share and per share information in this Form 10-Q gives retroactive effect to the 1-for-150 reverse split with all numbers rounded up to the nearest whole share.
 
BUSINESS
 
We are focused primarily on the development of a proprietary technology which is capable of uniquely identifying and authenticating almost any substance using light to create, record and detect the unique digital “signature” of the substance. We call this our “ChromaID™” technology.
 
Our ChromaID™ Technology
 
We have developed a proprietary technology to uniquely identify and authenticate almost any substance. This patented technology utilizes light at the photon (elementary particle of light) level through a series of emitters and detectors to generate a unique signature or “fingerprint” from a scan of almost any solid, liquid or gaseous material. This signature of reflected or transmitted light is digitized, creating a unique ChromaID signature. Each ChromaID signature is comprised of from hundreds to thousands of specific data points.
 
The ChromaID technology looks beyond visible light frequencies to areas of near infra-red and ultraviolet light that are outside the humanly visible light spectrum. The data obtained allows us to create a very specific and unique ChromaID signature of the substance for a myriad of authentication and verification applications.
 
 
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Traditional light-based identification technology, called spectrophotometry, has relied upon a complex system of prisms, mirrors and visible light. Spectrophotometers typically have a higher cost and utilize a form factor more suited to a laboratory setting and require trained laboratory personnel to interpret the information. The ChromaID technology uses lower cost LEDs and photodiodes and specific frequencies of light resulting in a more accurate, portable and easy-to-use solution for a wide variety of applications. The ChromaID technology not only has significant cost advantages as compared to spectrophotometry, it is also completely flexible is size, shape and configuration. The ChromaID scan head can range in size from endoscopic to a scale that could be the size of a large ceiling-mounted florescent light fixture.
 
In normal operation, a ChromaID master or reference scan is generated and stored in a database. The Visualant scan head can then scan similar materials to identify, authenticate or diagnose them by comparing the new ChromaID digital signature scan to that of the original or reference ChromaID signature or scan result.
ChromaID was invented by scientists from the University of Washington under contract with Visualant. We have pursued an intellectual property strategy and have been granted ten patents. We also have 20 patents pending. We possess all right, title and interest to the issued patents. Ten of the pending patents are licensed exclusively to us in perpetuity by Xinova.
 
In 2010, we acquired TransTech Systems, Inc. (“TransTech”) as an adjunct to our business. TransTech is a distributor of products for employee and personnel identification. TransTech currently provides substantially all of our revenues. We intend, however, to further develop and market our ChromaID technology.
 
The following summarizes our plans for our proprietary ChromaID technology. Based on our anticipated expenditures on this technology, the expected efforts of our management and our relationship with Xinova, and our other strategic partner, Sumitomo Precision Products, Ltd., we expect our ChromaID technology to provide an increasing portion of our revenues in future years from product sales, licenses, royalties and other revenue streams., as discussed further below.
 
ChromaID: A Foundational Platform Technology
 
Our ChromaID technology provides a platform upon which a myriad of applications can be developed. As a platform technology, it is analogous to a smartphone, upon which an enormous number of previously unforeseen applications have been developed. The ChromaID technology is an enabling technology that brings the science of light and photonics to low cost, real world commercialization opportunities across multiple industries. The technology is foundational and as such, the basis upon which we believe a significant business can be built.
 
As with other foundational technologies, a single application may reach across multiple industries. The ChromaID technology can, for example effectively differentiate and identify different brands of clear vodkas that appear identical to the human eye. By extension this same technology can identify pure water from water with contaminants present. It can provide real time detection of liquid medicines such as morphine that have been adulterated or compromised. It can detect if jet fuel has water contamination present. It could determine when it is time to change oil in a deep fat fryer. These are but a few of the potential applications of the ChromaID technology based upon extensions of its ability to identify different clear liquids.
 
The cornerstone of a company with a foundational platform technology is its intellectual property. ChromaID was invented by scientists from the University of Washington under contract with Visualant. We have pursued an intellectual property strategy and have been granted ten patents. We currently have 20 patents pending. We possess all right, title and interest to the issued patents. Ten of the pending patents are licensed exclusively to us in perpetuity by our strategic partner Xinova.
 
At the Photonics West trade show held in San Francisco in February 2013, we were honored to receive a PRISM award from the Society of Photo-Optical Instrumentation Engineers International, better known as SPIE. The PRISM awards recognize photonic products that break with conventional ideas, solve problems, and improve life through the application of light-based technologies.
 
Xinova Relationship
 
In November 2013, we entered into a strategic relationship with Xinova, formerly Invention Development Management Company, a subsidiary of Intellectual Ventures, a private intellectual property fund with over $5 billion under management. Xinova owns over 40,000 IP assets and has broad global relationships for the invention of technology, the filing of patents and the licensing of intellectual property. Xinova has worked to expand the reach and the potential application of the ChromaID technology and has filed ten patents base on the ChromaID technology, which it has licensed to us.
 
Initial testing in our laboratories and the work of the Xinova inventors has shown that the ChromaID technology has a number of broad and useful applications a few of which include:
 
Milk identification for quality, protein and fat content and impurities
Identification of liquids for counterfeits or contaminants
Detecting adulterants in food and food products compromising its quality
Color grading of diamonds
Identifying real cosmetics versus counterfeit cosmetics
Identifying counterfeit medications versus real medications
Identifying regular flour versus gluten free flour
Authenticating secure identification cards
 
 
28
 
 
Products
 
Our first delivered product, the ChromaID Lab Kit, scans and identifies solid surfaces. We are marketing this product to customers who are considering licensing the technology. Target markets include, but are not limited to, commercial paint manufacturers, pharmaceutical equipment manufacturers, process control companies, currency paper and ink manufacturers, security cards, cosmetic companies, scanner manufactures and food processing companies.
 
Our second product, the ChromaID Liquid Lab Kit, scans and identifies liquids. This product is currently in prototype form. Similar to our first product, it will be marketed to customers who are considering licensing the technology. Rather than use an LED emitter to reflect light off of a surface that is captured by a photodiode to generate a ChromaID signature the liquid analysis product shines light through the liquid (transmissive) with the LEDs positioned on one side of the liquid sample and the photo detectors on the opposite side. This device is in a functional state in our laboratory and we anticipate having a Liquid ChromaID Lab Kit available for customers by the Company during the fall of 2015. Target markets include, but are not limited to, water companies, petrochemical companies, pharmaceutical companies, and numerous consumer applications.
 
The ChromaID Lab Kits allows potential licensors of our technology to work with our technology and develop solutions for their particular application. Our contractual arrangements with Xinova are described in greater detail below.
 
Our next planned product should be an exemplar product is a prototype that will be produced to address several markets. The primary purpose of this prototype will be to demonstrate the technology to prospective business partners, and will consist of a small, hand held, battery powered, Bluetooth enabled scanning device. The scanner should wirelessly connect to a smart phone or tablet to transfer the scanned data. The smart phone application will include two or three industry specific but generic applications that allow for the demonstration of the scanning and matching of the ChromaID signatures. The applications will focus on drug identification, food safety and liquid detection. The prototype device will lend itself to consumer applications and can be a consumer product as well.
 
Our Commercialization Plans for the ChromaID Technology
 
We shipped our first ChromaID product, the ChromaID Lab Kits, to our strategic partner Xinova during the last calendar quarter of 2013 and first calendar quarter of 2014, after we completed final assembly and testing. Some ChromaID Lab Kits are provided free of charge to potential customers. Others are sold for a modest price. To date, we have achieved limited revenue from the sale of our ChromaID Lab Kits.
 
The Lab Kit includes the following:
 
ChromaID Scanner. A small device made with electronic and optical components and firmware which pulses light onto a flat material and records and digitizes the light that is reflected back from that material. The device is the size of a typical flashlight (5.5” long and 1.25” diameter). However, the technology can be incorporated into almost any size, shape and configuration.
 
ChromaID Lab Software. A software application that runs on a Windows PC. The software allows for configuration of the scanner, controls the behavior of the ChromaID Scanner, displays a graph of the captured ChromaID signature profile, stores the ChromaID signature in a database and uses algorithms to compare the accuracy of the match of the unknown scan to the known ChromaID signature profile. This software is intended for lab and experimental use only and is not required for commercialized product applications.
 
 Software Development Toolkit. A collection of software applications, API (an abbreviation of application program interface – a set of routines, protocols, and tools for building software applications) definitions and file descriptions that allow a customer to extract the raw data from the ChromaID signatures and run their own software routines against that raw data.
 
The ChromaID Lab Kit allows customers to experiment with and evaluate the ChromaID technology and determine if it is appropriate for their specific applications. The primary electronic and optical parts of the ChromaID scanner, called the “scan head,” could be supplied to customers to integrate into their own products. A set of ChromaID Developer Tools are also available. These allow customers to develop their own applications and products based on the ChromaID technology.
 
ChromaID signatures must be stored, managed, and readily accessible for comparison, matching and authentication purposes. The database can be owned and operated by the end customer, but in the case of thousands of ChromaID signatures, database management may be outsourced to us or a third party provider. These database services could be made available on a per-access transaction basis or on a monthly or annual subscription basis. The actual storage location of the database can be cloud-based, on a stand-alone scanning device or on a mobile device via a Bluetooth connection depending on the requirements of access, size of the database and security as defined by the customer. As a result, large databases can be accessed by cell phone or other mobile technologies using either local storage or cloud based storage.
 
 
29
 
 
Based on the commercialization plans outlined above, our business model anticipates deriving revenue from several sources:
 
Sales of the ChromaID Lab Kit and ChromaID Liquid Lab Kit
Non Recurring Engineering (NRE) fees to assist customers with scan integration into their products
Licensing of the ChromaID technology
Royalties per unit generated from the sales of scan heads
Multi-unit sales of the above referenced exemplar product for as yet to be determined consumer product applications
Per click transaction revenue from accessing the unique ChromaID signatures
Developing custom product applications for customers
ChromaID database administration and management services
 
Our Acceleration of Business Development in the United States and Around the World
 
We are coordinating our internal business development, sales and marketing efforts with those of our strategic partners Xinova, and Sumitomo Precision Products to leverage market data and information in order to focus on specific target vertical markets which have the greatest potential for early adoption. The ChromaID Lab Kit provides a means for us to demonstrate the technology to customers in these markets. It also allows customers to experiment with developing unique applications for their particular use. Our Business Development team is pursuing license opportunities with customers in our target markets. As an example, in March 2016 we entered into a Collaboration Agreement and License with Intellicheck Mobilisa. The agreement provides Intellicheck with exclusive rights to our ChromaID technology in the areas of homeland security, law enforcement and crime prevention.   
There is no requirement for FDA or other government approval for the current applications of our ChromaID technology. Over time, as we explore the application of our ChromaID technology for medical diagnostics and other applications, we expect that there will be requirements for FDA and other government approvals before applications using the technology in medical and other regulated fields can enter the marketplace.
 
Research and Development
 
Our research and development efforts are primarily focused improving the core foundational ChromaID technology and developing new and unique applications for the technology. As part of this effort, we typically conduct testing to ensure that ChromaID application methods are compatible with the customer’s requirements, and that they can be implemented in a cost effective manner. We are also actively involved in identifying new application methods. Our team has considerable experience working with the application of light-based technologies and their application to various industries. We believe that its continued development of new and enhanced technologies relating to our core business is essential to our future success. We spent $325,803 and $362,661 during the years ended September 30, 2016 and 2015, respectively, on development activities.
 
Our Patents
 
We believe that our ten patents, 20 patent applications, and two registered trademarks, and our trade secrets, copyrights and other intellectual property rights are important assets for us. Our patents will expire at various times between 2027 and 2033. The duration of our trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained.
 
The patents that have been granted to Visualant include:
 
On August 9, 2011, we were issued US Patent No. 7,996,173 B2 entitled “Method, Apparatus and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy,” by the United States Office of Patents and Trademarks. The patent expires August 24, 2029.
 
On December 13, 2011, we were issued US Patent No. 8,076,630 B2 entitled “System and Method of Evaluating an Object Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires November 7, 2028.
 
On December 20, 2011, we were issued US Patent No. 8,081,304 B2 entitled “Method, Apparatus and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 28, 2030.
 
On October 9, 2012, we were issued US Patent No. 8,285,510 B2 entitled “Method, Apparatus, and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On February 5, 2013, we were issued US Patent No. 8,368,878 B2 entitled “Method, Apparatus and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
 
30
 
 
On November 12, 2013, we were issued US Patent No. 8,583,394 B2 entitled “Method, Apparatus and Article to Facilitate Distributed Evaluation of Objects Using Electromagnetic Energy by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On November 21, 2014, we were issued US Patent No. 8,888,207 B2 entitled “Systems, Methods, and Articles Related to Machine-Readable Indicia and Symbols” by the United States Office of Patents and Trademarks. The patent expires February 7, 2033.
 
On March 23, 2015, we were issued US Patent No. 8,988,666 B2 entitled “Method, Apparatus, and Article to Facilitate Evaluation of Objects Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires July 31, 2027.
 
On May 26, 2015, we were patent US Patent No. 9,041,920 B2 entitled “Device for Evaluation of Fluids using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires March 12, 2033.
 
On April 19, 2016, we were issued patent US Patent No. 9,316,581 B2 entitled “Method, Apparatus, and Article to Facilitate Evaluation of Substances Using Electromagnetic Energy” by the United States Office of Patents and Trademarks. The patent expires March 12, 2033.
 
We pursue a patent strategy to expand our unique intellectual property in the United States and other countries.
 
Services and License Agreement Invention Development Management Company, L.L.C.
 
In November 2013, we entered into a strategic relationship with Xinova, formerly Invention Development Management Company, a subsidiary of Intellectual Ventures, a private intellectual property fund with over $5 billion under management. Xinova owns over 40,000 IP assets and has broad global relationships for the invention of technology, the filing of patents and the licensing of intellectual property. Xinova has worked to expand the reach and the potential application of the ChromaID technology and has filed ten patents base on the ChromaID technology, which it has licensed to us.
 
The agreement requires Xinova to identify and engage inventors to develop new applications of our ChromaID™ technology, present the developments to us for approval, and file at least 10 patent applications to protect the developments. Xinova is responsible for the development and patent costs. We provided the Chroma ID Lab Kits to Xinova at no cost and are providing ongoing technical support. In addition, to provide time for this accelerated expansion of its intellectual property we delayed the selling of the ChromaID Lab Kits for 140 days except for certain select accounts. We have continued our business development efforts during this period and have worked with Xinova and their global business development resources to secure potential customers and licensees for the ChromaID technology. We shipped 20 ChromaID Lab Kits to inventors in the Xinova network during December 2013 and January 2014. As part of our agreement with Xinova, we curtailed our ChromaID marketing efforts through the fourth calendar quarter of 2014 while Xinova worked to expand our intellectual property portfolio. Thereafter, we began to actively market the ChromaID Lab Kits to interested and qualified customers.
 
We have received a worldwide, nontransferable, exclusive license to the intellectual property developed under the Xinova agreement during the term of the agreement, and solely within the identification, authentication and diagnostics field of use, to (a) make, have made, use, import, sell and offer for sale products and services; (b) make improvements; and (c) grant sublicenses of any and all of the foregoing rights (including the right to grant further sublicenses).
 
We received a nonexclusive and nontransferable option to acquire a worldwide, nontransferable, nonexclusive license to the useful intellectual property held by Xinova within the identification, authentication and diagnostics field of use to (a) make, have made, use, import, sell and offer to sell products and services and (b) grant sublicenses to any and all of the foregoing rights. The option to acquire this license may be exercised for up to two years from the effective date of the Agreement.
 
Xinova is providing global business development services to us for geographies not being pursued by Visualant. Also, Xinova has introduced us to potential customers, licensees and distributors for the purpose of identifying and pursuing a license, sale or distribution arrangement or other monetization event.
 
We granted to Xinova a nonexclusive, worldwide, fully paid, nontransferable, sublicenseable, perpetual license to our intellectual property solely outside the identification, authentication and diagnostics field of use to (a) make, have made, use, import, sell and offer for sale products and services and (b) grant sublicenses of any and all of the foregoing rights (including the right to grant further sublicenses).
 
We granted to Xinova a nonexclusive, worldwide, fully paid up, royalty-free, nontransferable, non-sublicenseable, perpetual license to access and use our technology solely for the purpose of marketing the aforementioned sublicenses of our intellectual property to third parties outside the designated fields of use.
 
 
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In connection with the original license agreement, we issued a warrant to purchase 97,169 shares of common stock to Xinova as consideration for the exclusive intellectual property license and application development services. The warrant has a current exercise price of $0.70 per share and expires November 10, 2018. The per share price is subject to adjustment based on any issuances below $0.70 per share except as described in the warrant.
 
We agreed to pay Xinova a percentage of license revenue for the global development business services and a percentage of revenue received from any company introduce to us by Xinova. We also have also agreed to pay Xinova a royalty when we receive royalty product revenue from an Xinova-introduced company. Xinova has agreed to pay us a license fee for the nonexclusive license of our intellectual property.
 
The term of both the exclusive intellectual property license and the nonexclusive intellectual property license commences on the effective date of November 11, 2013, and terminates when all claims of the patents expire or are held in valid or unenforceable by a court of competent jurisdiction from which no appeal can be taken.
 
The term of the Agreement commences on the effective date until either party terminates the Agreement at any time following the fifth anniversary of the effective date by providing at least ninety days’ prior written notice to the other party.
 
TransTech Systems, Inc.
 
Our wholly owned subsidiary, TransTech Systems, Inc., is a distributor of products, including systems solutions, components and consumables, for employee and personnel identification in government and the private sector, document authentication, access control, and radio frequency identification. TransTech provides these products and services, along with marketing and business development assistance to value-added resellers and system integrators throughout North America.
 
We expect our ownership of TransTech to accelerate our market entry and penetration through well-operated and positioned dealers of security and authentication systems, thus creating a natural distribution channel for products featuring our proprietary ChromaID technology. TransTech currently provides substantially all of our revenues. Its management team functions independently from Visualant’s and its operations require a minimal commitment of our management time and other resources. Our acquisition of TransTech in June 2010 and its operations are described in greater detail below.
 
Agreements with Sumitomo Precision Products Co., Ltd.
 
In May 2012, we entered into a Joint Research and Product Development Agreement with Sumitomo Precision Products Co., Ltd., a publicly-traded Japanese corporation, for the commercialization of our ChromaID technology. In March 2013, we entered into an amendment to this agreement, which extended the Joint Development Agreement from March 31, 2013 to December 31, 2013. The extension provided for continuing work between Sumitomo and Visualant focused upon advancing the ChromaID technology and market research aimed at identifying the most significant markets for the ChromaID technology. This collaborative work supported the development of the ChromaID Lab Kit. This agreement expired December 31, 2013. The current version of the technology was introduced to the marketplace as a part of our ChromaID Lab Kit during the fourth quarter of 2013. Sumitomo invested $2,250,000 in exchange for 115,385 shares of restricted shares of common stock priced at $19.50 per share that was funded on June 21, 2012.  
 
We also entered into a License Agreement with Sumitomo in May 2012, under which Sumitomo paid the Company an initial payment of $1 million. The License Agreement granted Sumitomo an exclusive license for the then extant ChromaID technology. The territories covered by this license include Japan, China, Taiwan, Korea and the entirety of Southeast Asia (Burma, Indonesia, Thailand, Cambodia, Laos, Vietnam, Singapore and the Philippines). The Sumitomo License fee was recorded as revenue over the life the Joint Research and Product Development Agreement and was fully recorded as of May 31, 2013. On May 21, 2015, we entered into an amendment to the License Agreement, which, effective as of June 18, 2014, eliminated the Sumitomo exclusivity and provides that if we sell products in certain territories – Japan, China, Taiwan, Korea and the entirety of Southeast Asia (Burma, Indonesia, Thailand, Cambodia, Laos, Vietnam, Singapore and the Philippines) – the Company will pay Sumitomo a royalty rate of 2% of net sales (excluding non-recurring engineering revenues) over the remaining term of the five-year License Agreement (through May 2017).
 
Potential Markets and Customers
 
Our plan is to develop markets and customers who have a need to authenticate, detect, identify, verify or diagnose materials or substances which may include, but are not limited to, commercial paint manufacturers, pharmaceutical equipment manufacturers, process control companies, water purification and quality companies, currency paper and ink manufacturers, security card manufacturers, cosmetic companies and food processing companies.
 
Market opportunities include identification, detection, or diagnosis of:
 
 
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Pharmaceuticals – pill counting and verification
Food safety – testing for contaminants and quality
Gemstones – diamond color grading
Liquid analysis – water purity
Law enforcement - illicit drug identification for law enforcement applications
Paint – color matching
ID badges – counterfeit ID detection
Secure packaging - Container seals and packaging materials with invisible markings
Cosmetics – matching skin tones to correct products
Documents and Currency– detect counterfeit paper and inks
Medical - Noninvasive skin analysis for discovery of diseases or medical conditions
 
Our Strategy
 
To date, the substantial portion of our non-TransTech revenue has been generated from the development license with Sumitomo Precision Products and sales of our ChromaID Lab Kits. We expect to continue to grow revenues from sales of our Lab Kits, non-recurring engineering fees, licenses, per unit royalties and subscriptions, as well as “per click” revenues. Key aspects of our strategy include:
 
Customize and Refine our Solutions to Meet Potential Customers’ Needs
 
We are continuously improving and expanding our potential product offerings by testing the incorporation of our technologies into different media, such as the new ChromaID Liquid Lab Kit that is in the prototype stage. Each vertical market has specific requirements for their potential product application that will involve determining the range of LEDs and photodiodes that will provide optimum performance and the associated form factor required for their product. Our goal is to develop a cost-effective scanning system for each potential industry and customer that can be incorporated into that potential customer’s products that they will then take to market.
 
Continue to Expand Applications for ChromaID Technology
 
While we have basic proof of concepts for applications in several large markets to date, we plan to continue our ongoing effort to expand proof-of-concept testing in other vertical markets that have yet to be tested. We have also identified and are further examining opportunities to collaborate with companies and universities to develop new applications for the ChromaID technology. We believe the strength of our solutions is based on the unique and proprietary ChromaID signature that is created from every scan.
 
Target Potential High-Volume Markets
 
We will continue to focus our efforts on target vertical markets that are characterized by a high level of vulnerability to counterfeiting, product tampering, piracy, fraud, identity theft, contamination and adulteration. We believe the ChromaID technology can be a lower cost, real time, flexible form factor solution in the following areas: access control, quality and process control, food safety, water quality, law enforcement support, standardization and medical diagnostics. Our current target markets include pharmaceuticals, food quality and safety, gemstone grading, water purity, law enforcement, paint color matching, identity cards, chemical identification, cosmetics, currency, process control and healthcare. If and when we have significantly penetrated these markets, we intend to expand into additional related high volume markets.
 
Pursue Strategic Acquisitions and Alliances
 
We intend to pursue strategic acquisitions of companies and technologies that strengthen and complement our core technologies, improve our competitive positioning, allow us to penetrate new markets, and grow our customer base. We also intend to work in collaboration with potential strategic partners in order to continue to market and sell new product lines derived from, but not limited to, ChromaID technology.
 
Target Additional Markets
 
In fourth fiscal quarter of 2014, we began introducing our technology and services in Europe, the United States and Asia. Several potential customers are currently analyzing our technology. At the present time, we are focusing our efforts on the pharmaceutical industry, the food safety industry, law enforcement and homeland security. In the future, we plan to expand our focus to include identification cards and other secure documents, industrial materials, agrochemicals, pharmaceuticals, consumer products, cosmetics, currency and medical diagnostics.
 
Industry Background
 
 
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Visualant’s ChromaID is a part of the broad industry built upon photonics or light-based technology. Photonics science includes the generation, emission, transmission, modulation, signal processing, switching, amplification, and detection/sensing of light. Though covering all light's technical applications over the whole spectrum, most photonic applications are in the range of visible and near-infrared light. The term photonics developed as an outgrowth of the first practical semiconductor light emitters invented in the early 1960s and optical fibers developed in the 1970s.
 
Photonics came into common use in the 1980s as fiber-optic data transmission was adopted by telecommunications network operators. At that time, the term was used widely at Bell Laboratories. Its use was confirmed when the IEEE Lasers and Electro-Optics Society established an archival journal named Photonics Technology Letters at the end of the 1980s.
 
Photonics covers a huge range of science and technology applications, including laser manufacturing, biological and chemical sensing, medical diagnostics and therapy, display technology, and optical computing.
 
Applications of photonics includes all areas from everyday life to the most advanced science, e.g. light detection, telecommunications, information processing, lighting, metrology, spectroscopy, holography, medicine (surgery, vision correction, endoscopy, health monitoring), military technology, laser material processing, visual art, biophotonics, agriculture and robotics.
 
The world photonics market, according to the World Photonics Report of 2013 was a $350 billion market and will grow to a $650 billion market by 2020.
 
Our business model is focused on the use of structured light - a disruptive conceptual breakthrough in photonics. Light-emitting diodes (LEDs) shine a single wavelength of pulsed light in increasing steps of intensity onto a subject. Photodiodes capture the light that is returned via reflection or re emission of that light. The photodiode produces an analog signal that is then converted into a 24 bit digital data point for each pulse of light. A typical scan is comprised of hundreds of pulses of light across a number of specific frequency LED’s creating a unique ChromaID signature for the subject being scanned. In a typical application, a “reference” or “master” ChromaID signature is captured and stored in a database for that specific subject. When an unknown substance is scanned to produce its own ChromaID signature, (the “discovery scan”), the unknown substance’s ChromaID signature is compared to that of the known (or “reference”) ChromaID signature. Algorithms are used to compare the two sets of data and determine if the “discovery” signature is the same as the “reference” ChromaID signature. This accuracy threshold can be adjusted from 51 % to 99.995 % accuracy based on the requirements for each specific application of the ChromaID technology. Historically, a number of the applications for ChromaID technology were performed by spectrophotometers. The sales of spectrophotometers by companies such as Ocean Optics, Perkin Elmer, Fisher Thermo Scientific and Agilent are multibillion dollar businesses. Spectrophotometers combine broad-spectrum light; a diffraction grating to split it; and a linear array for graphical presentation in software. They tend to be bulky, fragile, and expensive; scanning and analysis are complex. We believe our ChromaID technology uses lower cost components, provides more accurate data, has a very flexible form factor and the information it provides can be easily understood. The use of structured light by our ChromaID technology provides a platform for the development of a myriad of applications in the categories of identification, authentication and diagnostics.
 
We believe that the ChromaID technology is analogous to a smartphone, upon which an enormous number of previously unforeseen applications have been developed. The ChromaID technology may be considered an enabling technology that brings the science of light and photonics to low cost, real world commercialization opportunities across multiple industries. ChromaID is a sensor technology which, with its low cost, small form factor, and ease of connectivity can be an enabling technology for the broad Internet of Things and integrated into many aspects of everyday life providing useful information relating health, life and safety. The technology is foundational and as such, the basis upon which we believe a significant business can be built.
 
THE COMPANY’S COMMON STOCK
 
Our common stock trades on the OTCQB Exchange under the symbol “VSUL.”
 
PRIMARY RISKS AND UNCERTAINTIES
 
We are exposed to various risks related to our need for additional financing, the sale of significant numbers of our shares and a volatile market price for our common stock. These risks and uncertainties are discussed in more detail below in Part II, Item 1A. 
 
RESULTS OF OPERATIONS
 
The following table presents certain consolidated statement of operations information and presentation of that data as a percentage of change from period-to-period.
 
(dollars in thousands)
 
 
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Three Months Ended December 31,
 
 
 
2016
 
 
2015
 
 
$ Variance
 
 
% Variance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 $1,149 
 $1,285 
 $(136)
  -10.6%
Cost of sales
  959 
  1,087 
  (128)
  11.8%
Gross profit