10-Q 1 knowlabs_10q-17430.htm KNOW LABS, INC. 10-Q Untitled Document
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
     QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2018
 
      TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
 
For the transition period from _______ to ________
 
Commission File number               000-30262    
KNOW LABS, INC.

(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 810, Seattle, Washington USA
  98101
 (Address of principal executive offices) 
 (Zip Code)
 
 
206-903-1351
 
 
 (Registrant's telephone number, including area code)
 
 
 
 
 
 
 
 
Visualant, Incorporated
 
 
 (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 check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2
 
Large accelerated filer
Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
 
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 August 9, 2018: 16,570,162 shares
 
 
1
 
 
TABLE OF CONTENTS  
 
 
Page Number
 
 
 
 PART I
FINANCIAL INFORMATION
 3
 
 
 
 ITEM 1
Financial Statements (unaudited except as noted)
 3
 
 
 
 
Consolidated Balance Sheets as of June 30, 2018 and September 30, 2017 (audited)
 3
 
 
 
 
Consolidated Statements of Operations for the three and nine months ended June 30, 2018 and 2017
 4
 
 
 
 
Consolidated Statements of Cash Flows for the nine months ended June 30, 2018 and 2017
 5
 
 
 
 
Notes to the Financial Statements 
 6
 
 
 
 ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operation
 19
 
 
 
 ITEM 3
Quantitative and Qualitative Disclosures About Market Risk
 28
 
 
 
 ITEM 4
Controls and Procedures
 28
 
 
 
 PART II
OTHER INFORMATION
 29
 
 
 
 ITEM 1A.
Risk Factors 
 29
 
 
 
 ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds
 38
 
 
 
 ITEM 3
Defaults upon Senior Securities
 38
 
 
 
 ITEM 4
Mine Safety Disclosures
 38
 
 
 
 ITEM 5
Other Information
 38
 
 
 
 ITEM 6
Exhibits
 38
 
 
 
 
SIGNATURES
 41
 
 
 
 
 
2
 
 
ITEM 1.
FINANCIAL STATEMENTS
 
KNOW LABS, INC. AND SUBSIDIARIES (FORMERLY VISUALANT, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
 
 
 
June 30, 2018
 
 
September 30, 2017
 
ASSETS
 
 
 
 
 (Audited)
 
 
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
 
 
 
Cash and cash equivalents
 $1,304,499 
 $103,181 
Accounts receivable, net of allowance of $60,000 and $60,000, respectively
  430,460 
  693,320 
Prepaid expenses
  9,899 
  27,687 
Inventories, net
  170,734 
  225,909 
Total current assets
  1,915,592 
  1,050,097 
 
    
    
EQUIPMENT, NET
  114,539 
  133,204 
 
    
    
OTHER ASSETS
    
    
Intangible assets
  520,000 
  - 
Other assets
  7,170 
  5,070 
 
    
    
TOTAL ASSETS
 $2,557,301 
 $1,188,371 
 
    
    
LIABILITIES AND STOCKHOLDERS' (DEFICIT)
    
    
 
    
    
CURRENT LIABILITIES:
    
    
Accounts payable - trade
 $1,442,684 
 $2,156,646 
Accounts payable - related parties
  - 
  2,905 
Accrued expenses
  32,688 
  24,000 
Accrued expenses - related parties
  703,226 
  1,166,049 
Deferred revenue
  4,210 
  63,902 
Convertible notes payable
  2,390,065 
  570,000 
Notes payable - current portion of long term debt
  394,670 
  1,165,660 
Total current liabilities
  4,967,543 
  5,149,162 
 
    
    
COMMITMENTS AND CONTINGENCIES
  - 
  - 
 
    
    
STOCKHOLDERS' DEFICIT
    
    
Preferred stock - $0.001 par value, 5,000,000 shares authorized, 0 shares issued and
    
    
outstanding at 6/30/2018 and 9/30/2017, respectively
  - 
  - 
Series A Convertible Preferred stock - $0.001 par value, 23,334 shares authorized, 23,334
    
    
issued and outstanding at 6/30/2018 and 9/30/2017, 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 6/30/2018 and 9/30/2017, respectively
  1,790 
  1,790 
Series D Convertible Preferred stock - $0.001 par value, 1,016,014 shares authorized,
    
    
1,016,004 shares issued and outstanding at 6/30/2018 and 9/30/2017, respectively
  1,015 
  1,015 
Common stock - $0.001 par value, 100,000,000 shares authorized, 15,538,726 and 4,655,486 shares
    
    
issued and outstanding at 6/30/2018 and 9/30/2017, respectively
  15,539 
  4,655 
Additional paid in capital
  31,438,791 
  27,565,453 
Accumulated deficit
  (33,867,400)
  (31,533,727)
Total stockholders' deficit
  (2,410,242)
  (3,960,791)
 
    
    
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
 $2,557,301 
 $1,188,371 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
3
 
 
KNOW LABS, INC. AND SUBSIDIARIES (FORMERLY VISUALANT, INCORPORATED)
STATEMENTS OF OPERATIONS
 
 
 
Three Months Ended,    
 
 
Nine Months Ended,    
 
 
 
June 30, 2018
 
 
June 30, 2017
 
 
June 30, 2018
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
REVENUE
 $1,107,216 
 $1,019,434 
 $3,432,301 
 $3,665,253 
COST OF SALES
  909,957 
  844,739 
  2,760,551 
  2,995,655 
GROSS PROFIT
  197,259 
  174,695 
  671,750 
  669,598 
RESEARCH AND DEVELOPMENT EXPENSES
  125,789 
  (9,240)
  366,809 
  38,243 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
  803,857 
  651,113 
  1,796,319 
  2,469,239 
IMPAIRMENT OF GOODWILL
  - 
  - 
  - 
  983,645 
OPERATING LOSS
  (732,387)
  (467,178)
  (1,491,378)
  (2,821,529)
 
    
    
    
    
OTHER INCOME (EXPENSE):
    
    
    
    
Interest expense
  (8,696)
  (11,237)
  (1,095,880)
  (79,567)
Other income
  436 
  1,634 
  19,192 
  44,774 
Gain (loss) on change - derivative liability
  - 
  1,004,727 
  - 
  (217,828)
Gain on debt settlements
  234,393 
  - 
  234,393 
  - 
Total other income (expense)
  226,133 
  995,124 
  (842,295)
  (252,621)
 
    
    
    
    
(LOSS) INCOME BEFORE INCOME TAXES
  (506,254)
  527,946 
  (2,333,673)
  (3,074,150)
 
    
    
    
    
Income taxes - current provision
  - 
  - 
  - 
  - 
 
    
  . 
    
    
NET (LOSS) INCOME
 $(506,254)
 $527,946 
 $(2,333,673)
 $(3,074,150)
 
    
    
    
    
Basic (loss) income per common share attributable to Visualant,
    
    
    
    
Inc. and subsidiaries common shareholders-
    
    
    
    
Basic (loss) income per share
 $(0.06)
 $0.14 
 $(0.39)
 $(0.85)
 
    
    
    
    
Weighted average shares of common stock outstanding- basic
  8,065,144 
  3,844,840 
  5,947,860 
  3,605,904 
 
    
    
    
    
Diluted (loss) income per common share attributable to Visualant,
    
    
    
    
Inc. and subsidiaries common shareholders-
    
    
    
    
Diluted (loss) income per share
 $(0.06)
 $0.13 
 $(0.39)
 $(0.85)
 
    
    
    
    
Weighted average shares of common stock outstanding- diluted
  8,065,144 
  3,970,322 
  5,947,860 
  3,605,904 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
 
 
 
 
 
 
 
 
4
 
 
KNOW LABS, INC. AND SUBSIDIARIES (FORMERLY VISUALANT, INCORPORATED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
 
Nine Months Ended,  
 
 
 
June 30, 2018
 
 
June 30, 2017
 
 
 
 
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
Net loss
 $(2,333,673)
 $(3,074,150)
Adjustments to reconcile net loss to net cash (used in)
    
    
operating activities
    
    
Depreciation and amortization
  43,984 
  72,041 
Issuance of capital stock for services and expenses
  348,881 
  411,306 
Conversion of interest
  64,233 
  68,043 
Stock based compensation
  7,337 
  32,661 
(Loss) on sale of assets
  - 
  (1,234)
Loss on change - derivative liability
  - 
  213,315 
Amortization of debt discount
  475,174 
  10,500 
Conversion of accrued liabilites- related parties to convertible notes payable
  491,802 
  - 
Provision on loss on accounts receivable
  - 
  135,774 
Issuance of warrant for debt conversion
  232,255 
  - 
Issuance of common stock for conversion of liabilities
  247,950 
  - 
Non cash gain on accounts payable
  (234,393)
  - 
Impairment of goodwill
  - 
  983,645 
Changes in operating assets and liabilities:
    
    
Accounts receivable
  262,860 
  259,662 
Prepaid expenses
  17,788 
  (15,908)
Inventory
  55,175 
  11,357 
Other assets
  (2,100)
  - 
Accounts payable - trade and accrued expenses
  (459,954)
  86,339 
Deferred revenue
  (59,692)
  - 
 NET CASH (USED IN) OPERATING ACTIVITIES
  (842,373)
  (806,649)
 
    
    
CASH FLOWS FROM INVESTING ACTIVITIES:
    
    
Investment in BioMedx, Inc.
  - 
  (260,000)
Proceeds from investment in BioMedx, Inc,
  - 
  260,000 
Investment in equipment
  (25,319)
  - 
Proceeds from sale of equipment
  - 
  1,234 
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES:
  (25,319)
  1,234 
 
    
    
CASH FLOWS FROM FINANCING ACTIVITIES:
    
    
(Repayments) from line of credit
  (170,990)
  (122,127)
Proceeds from convertible notes payable
  530,000 
  330,000 
Repayment of convertible notes
  - 
  (125,000)
Proceeds from issuance of common/preferred stock, net of costs
  1,710,000 
  557,089 
NET CASH PROVIDED BY FINANCING ACTIVITIES
  2,069,010 
  639,962 
 
    
    
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
  1,201,318 
  (165,453)
 
    
    
CASH AND CASH EQUIVALENTS, beginning of period
  103,181 
  188,309 
 
    
    
CASH AND CASH EQUIVALENTS, end of period
 $1,304,499 
 $22,856 
 
    
    
Supplemental disclosures of cash flow information:
    
    
Interest paid
 $8,841 
 $53,000 
Taxes paid
 $- 
 $- 
 
    
    
Non-cash investing and financing activities:
    
    
 Beneficial conversion feature
 $348,096 
 $- 
Conversion of convertible debt
 $- 
 $695,000 
Benificial conversion feaature
 $- 
 $559,130 
Conversion of convertible debt to preferred shares
 $- 
 $220,000 
 Related party accounts converted to notes
 $1,184,066 
 $- 
 Acquisition of patents
 $520,000 
 $- 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
5
 
 
KNOW LABS, INC. AND SUBSIDIARIES (FORMERLY VISUALANT, INCORPORATED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The accompanying unaudited consolidated condensed financial statements have been prepared by Know Labs, Inc, formerly Visualant, Incorporated (“the Company”, “us,” “we,” or “our”) in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting and rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. In the opinion of our management, all adjustments, consisting of only normal recurring accruals, necessary for a fair presentation of the financial position, results of operations, and cash flows for the fiscal periods presented have been included.
 
These financial statements should be read in conjunction with the audited financial statements and related notes included in our Annual Report filed on Form 10-K for the year ended September 30, 2017, filed with the Securities and Exchange Commission (“SEC”) on December 29, 2017. The results of operations for the nine months ended June 30, 2018 are not necessarily indicative of the results expected for the full fiscal year, or for any other fiscal period. 
 
1.
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 $(2,333,673), $(3,901,232) and $(1,746,495) for the nine months ended June 30, 2018 and for the years ended September 30, 2017 and 2016, respectively. Net cash used in operating activities was $(842,373), $(1,264,324) and $(2,746,333) for the nine months ended June 30, 2018 and for the years ended September 30, 2017 and 2016, respectively.
 
The Company anticipates that it will record losses from operations for the foreseeable future. As of June 30, 2018, the Company’s accumulated deficit was $33,867,400.  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, the Company’s Chairman of the Board, 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, 2017 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 September 30, 2018. 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. 
 
2.
ORGANIZATION
 
Know Labs, Inc. (the “Company”) 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. 
 
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 electromagnetic energy to detect the unique digital “signature” of the substance. The Company calls its technology “ChromaID™” and “Bio-RFID.”
 
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™ and Bio-RFID™ technology. To date, the Company has entered into License Agreements with Sumitomo Precision Products Co., Ltd. In addition, it has a technology license agreement with Allied Inventors, formerly Xinova and 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 and Bio-RFID products. The Company is currently not profitable. Even if the Company succeeds in introducing the ChromaID and Bio-RFID technology and related products to its target markets, the Company may not be able to generate sufficient revenue to achieve or sustain profitability.
 
 
 
6
 
 
ChromaID was invented by scientists under contract with the Company. Bio-RFID was invented by individuals working for the Company. The Company actively pursues a robust intellectual property strategy and has been granted twelve patents. The Company also 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 the Company in perpetuity by the Company’s strategic partner, Allied Inventors.
 
Merger with RAAI Lighting, Inc.
 
On April 10, 2018, the Company entered into an Agreement and Plan of Merger with 500 Union Corporation, a Delaware corporation and a wholly owned subsidiary of the Company, and RAAI Lighting, Inc., a Delaware corporation. Pursuant to the Merger Agreement, we have acquired all the outstanding shares of RAAI’s capital stock through a merger of Merger Sub with and into RAAI (the “Merger”), with RAAI surviving the Merger as a wholly owned subsidiary of the Company.
 
Under the terms of the Merger Agreement, each share of RAAI common stock issued and outstanding immediately before the Merger (1,000 shares) were cancelled and converted into the right to receive 2,000 shares of the Company’s common stock. As a result, the Company issued 2,000,000 shares of its common stock to Phillip A. Bosua, formerly the sole stockholder of RAAI. The consideration for the Merger was determined through arms-length bargaining by the Company and RAAI. The Merger was structured to qualify as a tax-free reorganization for U.S. federal income tax purposes. As a result of the Merger, the Company received certain intellectual property, related to RAAI.
 
Appointment of Director
 
On April 10, 2018, the Board increased the size of the Board from three to four members and Phillip A. Bosua was appointed as a member of the Board. Mr. Bosua’s term of office expire at the next annual meeting of our stockholders. On May 24, 2018, the Board of Directors increased the size of the Board from four to five members and appointed (Ret.) Admiral William Owens as a member of the Board. Admiral Owen’s term of office expires at the next annual meeting of our stockholders.
 
Appointment of Officer.  
 
On April 10, 2018, the Company appointed Mr. Bosua as Chief Executive Officer of the Company, replacing Ronald P. Erickson, who remains Chairman of the Company. Previously, Mr. Bosua served as the Company’s Chief Product Officer since August 2017. The Company entered into a Consulting Agreement with Mr. Bosua’s company, Blaze Clinical on July 7, 2017.
 
On April 10, 2018, the Company entered into an Employment Agreement with Mr. Bosua reflecting Mr. Bosua’s appointment as Chief Executive Officer. The Employment Agreement is for an initial term of 12 months (subject to earlier termination) and will be automatically extended for additional 12-month terms unless either party notifies the other party of its intention to terminate the Employment Agreement. Mr. Bosua will be paid a base salary of $225,000 per year, received 500,000 shares of common stock valued at $0.33 per share and may be entitled to bonuses and equity awards at the discretion of the Board or a committee of the Board. The Employment Agreement provides for severance pay equal to 12 months of base salary if Mr. Bosua is terminated without “cause” or voluntarily terminates his employment for “good reason.”
 
On April 10, 2018, the Company entered into an Amended Employment Agreement for Ronald P. Erickson which amends the Employment Agreement dated July 1, 2017. The Agreement expires March 21, 2019.
 
Merger with Know Labs, Inc.
 
On May 1, 2018, Know Labs, Inc., a Nevada corporation incorporated on April 3, 2018, and our wholly-owned subsidiary, merged with and into the Company pursuant to an Agreement and Plan of Merger dated May 1, 2018. In connection with the merger, our Articles of Incorporation were effectively amended to change our name to Know Labs, Inc. by and through the filing of Articles of Merger. This parent-subsidiary merger was approved by us, the parent, in accordance with Nevada Revised Statutes Section 92A.180. Stockholder approval was not required. This amendment was filed with the Nevada Secretary of State and became effective on May 1, 2018.
 
Corporate Name Change and Symbol Change
 
On May 24, 2018, the Financial Industry Regulatory Authority (“FINRA”) announced the effectiveness of a change in our name from Visualant Incorporated to Know Labs, Inc. and a change in our ticker symbol from VSUL to the new trading symbol KNWN which became effective on the opening of trading as of May 25, 2018. In addition, in connection with the name change and symbol change, we were assigned the CUSIP number of 499238103.
 
Closing of Financing on June 25, 2018
 
On June 25, 2018, the Company closed a private placement and received gross proceeds of $1,750,000 in exchange for issuing 7,000,000 shares of common stock and warrants to purchase 3,500,000 shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements.
 
 
7
 
 
The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and the warrants expire five years after their issuance.
 
The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.  
 
3.
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 and RAAI Lighting, 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 $35,000 reserve for impaired inventory as of June 30, 2018 and September 30, 2017, 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 2-3 years. 
 
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 as of June 30, 2018 and September 30, 2017 are based upon the short-term nature of the assets and liabilities. 
 
 
8
 
 
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 – Know Lab 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. 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.
 
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 June 30, 2018, there were options outstanding for the purchase of 534,736 common shares, warrants for the purchase of 15,586,424 common shares, 4,914,405 shares of the Company’s common stock issuable upon the conversion of Series A, Series C and Series D Convertible Preferred Stock. In addition, the Company has an unknown number of shares issuable upon conversion of convertible debentures of $2,390,066. All of which could potentially dilute future earnings per share.
 
As of June 30, 2017, there were options outstanding for the purchase of 50,908 common shares, warrants for the purchase of 5,127,416 common shares, 2,825,053 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, all of which could potentially dilute future earnings per share.  Total outstanding common stock equivalents at June 30, 2017 were 6,527,268.
 
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.
 
 
 
9
 
 
4.  ACCOUNTS RECEIVABLE/CUSTOMER CONCENTRATION
 
Accounts receivable were $430,460 and $693,320, net of allowance, as of June 30, 2018 and September 30, 2017, respectively. The Company had one customer in excess of 10% (30.2%) of the Company’s consolidated revenues for the nine months ended June 30, 2018. The Company had two customers (41.7% and 13.2%) with accounts receivable in excess of 10% as of June 30, 2018. The Company has a total allowance for bad debt in the amount of $60,000 as of June 30, 2018. 
 
5.  INVENTORIES
 
Inventories were $170,734 and $225,909 as of June 30, 2018 and September 30, 2017, 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 was a $35,000 reserve for impaired inventory as of June 30, 2018 and September 30, 2017, respectively.
  
6.  FIXED ASSETS
 
Fixed assets, net of accumulated depreciation, was $114,539 and $133,204 as of June 30, 2018 and September 30, 2017, respectively. Accumulated depreciation was $654,257 and $662,855 as of June 30, 2018 and September 30, 2017, respectively. Total depreciation expense was $43,982 and $28,788 for the nine months ended June 30, 2018 and 2017, 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 June 30, 2018 was comprised of the following: 
 
 
Estimated
 
June 30, 2018    
 
 
Useful Lives
 
Purchased
 
 
Capital Leases
 
 
Total
 
Machinery and equipment
2-10 years
 $260,094 
 $42,681 
 $302,775 
Leasehold improvements
2-3 years
  276,112 
  - 
  276,112 
Furniture and fixtures
2-3 years
  59,059 
  95,020 
  154,079 
Software and websites
3- 7 years
  35,830 
  - 
  35,830 
Less: accumulated depreciation
 
  (516,556)
  (137,701)
  (654,257)
 
 $114,539 
 $- 
 $114,539 
 
7.  INTANGIBLE ASSETS
 
Intangible assets as of June 30, 2018 and September 30, 2017 consisted of the following: 
 
 
Estimated
 
June 30,
 
 
September 30,
 
 
Useful Lives
 
2018
 
 
2017
 
 
 
 
 
 
 
 
 
Technology
5 years
 $520,000 
 $- 
Less: accumulated amortization
 
  - 
  - 
    Intangible assets, net
 
 $520,000 
 $- 
 
Total amortization expense was $0 and for the period ended June 30, 2018 and the year ended September 30, 2017, respectively.
 
Merger with RAAI Lighting, Inc.
 
On April 10, 2018, the Company entered into an Agreement and Plan of Merger with 500 Union Corporation, a Delaware corporation and a wholly owned subsidiary of the Company, and RAAI Lighting, Inc., a Delaware corporation. Pursuant to the Merger Agreement, we have acquired all the outstanding shares of RAAI’s capital stock through a merger of Merger Sub with and into RAAI (the “Merger”), with RAAI surviving the Merger as a wholly owned subsidiary of the Company.
 
Under the terms of the Merger Agreement, each share of RAAI common stock issued and outstanding immediately before the Merger (1,000 shares) were cancelled and converted into the right to receive 2,000 shares of the Company’s common stock. As a result, the Company issued 2,000,000 shares of its common stock to Phillip A. Bosua, formerly the sole stockholder of RAAI. The consideration for the Merger was determined through arms-length bargaining by the Company and RAAI. The Merger was structured to qualify as a tax-free reorganization for U.S. federal income tax purposes. As a result of the Merger, the Company received certain intellectual property, related to RAAI.
 
 
10
 
Merger with Know Labs, Inc.
 
On May 1, 2018, Know Labs, Inc., a Nevada corporation incorporated on April 3, 2018, and our wholly-owned subsidiary, merged with and into the Company pursuant to an Agreement and Plan of Merger dated May 1, 2018. In connection with the merger, our Articles of Incorporation were effectively amended to change our name to Know Labs, Inc. by and through the filing of Articles of Merger. This parent-subsidiary merger was approved by us, the parent, in accordance with Nevada Revised Statutes Section 92A.180. Stockholder approval was not required. This amendment was filed with the Nevada Secretary of State and became effective on May 1, 2018.
 
RAAI had no outstanding indebtedness or assets at the closing of the Merger. The 2,000,000 shares of the Company’s common stock issued for RAAI’s shares were recorded at the fair value at the date of the merger at $520,000 and the value assigned to the patent acquired with RAAI.
 
The fair value of the intellectual property associated with the assets acquired was $520,000 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.
 
8.  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.
 
There was no derivative liability as of June 30, 2018 and September 30, 2017. For the year ended September 30, 2017, the Company recorded non-cash loss of $217,828 related to the “change in fair value of derivative” expense related to its derivative instruments. The Company early adopted ASU 2017-11 and has reclassified its financial instrument with down round features to equity in the amount of $410,524 at September 30, 2017.
 
9. CONVERTIBLE NOTES PAYABLE
 
Convertible notes payable as of June 30, 2018 and September 30, 2017 consisted of the following:
 
Convertible Promissory Note dated September 30, 2016
 
On September 30, 2016, the Company entered into a $210,000 Convertible Promissory Note with Clayton A. Struve, an accredited investor 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 year ended September 30, 2017, the Company recorded interest of $21,000 related to the convertible note. This note was extended in the Securities Purchase Agreement, General Security Agreement and Subordination Agreement dated August 14, 2017 with a maturity date of August 13, 2018. The Company recorded accrued interest of $36,707 as of June 30, 2018.
 
Securities Purchase Agreement dated August 14, 2017
 
On August 14, 2017, the Company issued a senior convertible exchangeable debenture with a principal amount of $360,000 and a common stock purchase warrant to purchase 1,440,000 shares of common stock in a private placement to Clayton Struve for gross proceeds of $300,000 pursuantto a Securities Purchase Agreement dated August 14, 2017. The debenture accrues interest at 20% per annum and matures August 13, 2018. The convertible debenture contains a beneficial conversion valued at $110,629. The warrants were valued at $111,429. Because the note is immediately convertible, the warrants and beneficial conversion were expensed as interest.
 
On the same date, the Company entered into a General Security Agreement with the investor, pursuant to which the Company has agreed to grant a security interest to the investor in substantially all the Company’s assets, effective upon the filing of a UCC-3 termination statement to terminate the security interest held by Capital Source Business Finance Group in the assets of the Company. In addition, an entity affiliated with Ronald P. Erickson, the Company’s Chief Executive Officer, entered into a Subordination Agreement with the investor pursuant to which all debt owed by the Company to such entity is subordinated to amounts owed by the Company to the investor under the Debenture (including amounts that become owing under any Debentures issued to the investor in the future).
 
 
11
 
 
The initial conversion price of the Debenture is $0.25 per share, subject to certain adjustments. The initial exercise price of the Warrant is $0.25 per share, also subject to certain adjustments.
 
As part of the Purchase Agreement, the Company granted the investor “piggyback” registration rights to register the shares of common stock issuable upon the conversion of the Debenture and the exercise of the Warrant with the Securities and Exchange Commission for resale or other disposition.
 
The Debenture and the Warrant were issued in a transaction that was not registered under the Securities Act of 1933, as amended in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and Rule 506 of SEC Regulation D under the Act.  
 
In connection with the private placement, the placement agent for the Debenture and the Warrant received a cash fee of $30,000 and the Company expects to issue warrants to purchase shares of the Company’s common stock to the placement agent based on 10% of proceeds.
 
Under the terms of the Purchase Agreement, the investor may purchase up to an aggregate of $1,000,000 principal amount of Debentures (before a 20% original issue discount) (and Warrants to purchase up to an aggregate of 250,000 shares of common stock). These securities are being offered on a “best efforts” basis by the placement agent.
 
During the year ended September 30, 2017, $156,941 was recorded as interest expense related to debt discounts, beneficial conversions and warrants associated with Convertible Promissory Notes.
 
On December 12, 2017, the Company closed an additional $250,000 and issued a senior convertible exchangeable debenture with a principal amount of $300,000 and a common stock purchase warrant to purchase 1,200,000 shares of common stock in a private placement dated December 12, 2017 to an accredited investor pursuant to a Securities Purchase Agreement dated August 14, 2017. The convertible debenture contains a beneficial conversion valued at $93,174. The warrants were valued at $123,600. Because the note is immediately convertible, the warrants and beneficial conversion were expensed as interest.
 
On March 2, 2018, the Company received gross proceeds of $280,000 in exchange for issuing a senior convertible redeemable debenture with a principal amount of $336,000 and a warrant to purchase 1,344,000 shares of common stock in a private placement dated February 28, 2018 to an accredited investor pursuant to a Securities Purchase Agreement dated August 14, 2017. The convertible debenture contains a beneficial conversion valued at $252,932. The warrants were valued at $348,096. Because the note is immediately convertible, the warrants and beneficial conversion were expensed as interest.
 
In connection with the February 28, 2018 private placement, the placement agent for the debenture and the warrant received a cash fee of $28,000 and the Company issued warrants to purchase shares of the Company’s common stock to the placement agent or its affiliates based on 10% of proceeds.
 
Convertible Redeemable Promissory Notes with Ronald P. Erickson and J3E2A2Z
 
The Company entered into a Note and Account Payable Conversion Agreement pursuant to which (a) all $664,233 currently owing under the J3E2A2Z Notes was converted to a Convertible Redeemable Promissory Note in the principal amount of $664,233, and (b) all $519,833 of the J3E2A2Z Account Payable was converted into a Convertible Redeemable Promissory Note in the principal amount of $519,833 together with a warrant to purchase up to 1,039,666 shares of common stock of the Company for a period of five years. The initial exercise price of the warrants described above is $0.50 per share, also subject to certain adjustments. See Note 10 and 11 for additional details. The warrants were valued at $110,545. Because the note is immediately convertible, the warrants and beneficial conversion were expensed as interest. The Company recorded accrued interest of $14,988 as of June 30, 2018.
  
10.
NOTES PAYABLE, CAPITALIZED LEASES AND LONG TERM DEBT
 
Notes payable, capitalized leases and long-term debt as of June 30, 2018 and September 30, 2017 consisted of the following: 
 
 
12
 
 
 
 
June 30,
 
 
September 30,
 
 
 
2018
 
 
2017
 
 
 
 
 
 
 
 
Capital Source Business Finance Group
 $194,735 
 $365,725 
Note payable to Umpqua Bank
  199,935 
  199,935 
Secured note payable to J3E2A2Z LP - related party
  - 
  600,000 
Total debt
  394,670 
  1,165,660 
Less current portion of long term debt
  (394,670)
  (1,165,660)
Long term debt
 $- 
 $- 
 
Capital Source Business Finance Group
 
Know Labs, Inc. (the “Company”) finances its TransTech operations from operations and a Secured Credit Facility with Capital Source Business Finance Group. On June 15, 2018, TransTech entered into a Fifth Modification to the Loan and Security Agreement related to the $500,000 secured credit facility with Capital Source to fund its operations. The Modification extended the maturity to December 12, 2018. The secured credit facility provides for a prime rate interest floor for prime interest of 4.5% plus 2.5%. The eligible borrowing is based on 80% of eligible trade accounts receivable, not to exceed $500,000. The secured credit facility is collateralized by the assets of TransTech, with a guarantee by Know Labs, including a security interest in all assets of Know Labs. The remaining balance on the accounts receivable must be repaid by the time the secured credit facility expires on December 12, 2018, unless the Company renews by automatic extension for the next successive term. The Company has $47,000 available as of June 30, 2018.
 
Note Payable to Umpqua Bank
 
On July 9, 2018, the Company repaid a $199,935 Business Loan Agreement with Umpqua Bank from funds previously provided by an entity affiliated with Ronald P. Erickson, our Chairman of the Board. The Company paid $27,041 and issued 800,000 shares of common stock in exchange for the conversion of this debt. Mr. Erickson is an accredited investor. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
Note Payables to Ronald P. Erickson or J3E2A2Z LP
 
On January 25, 2018, the Company entered into amendments to two demand promissory notes, totaling $600,000 with Mr. Erickson, the Company’s Chief Executive Officer and/or entities in which Mr. Erickson has a beneficial interest. On March 16, 2018, the demand promissory notes and accrued interest were converted into convertible notes payable. See Note 9 for additional details.
 
11.
 
EQUITY
 
Authorized Capital Stock
 
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. 
 
Voting Preferred Stock
 
Series D Preferred Stock and Warrants
 
On May 1, 2018, the Company issued 357,143 shares of Series D Convertible Preferred Stock and a warrant to purchase 357,143 shares of common stock in a private placement to an accredited investor for gross proceeds of $250,000 pursuant to a Series D Preferred Stock and Warrant Purchase Agreement dated May 1, 2016.
 
The initial conversion price of the Series D Shares is $0.70 per share, subject to certain adjustments. The initial exercise price of the warrant is $0.70 per share, also subject to certain adjustments. The Company also amended and restated the Certificate of Designations, resulting in an adjustment to the conversion price of all currently outstanding Series D Shares to $0.70 per share.
 
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.
 
 
13
 
 
The following equity issuances occurred during the nine months ended June 30, 2018:
 
The Company issued 708,240 shares of common stock to Names Executive Officers, directors, employees and consultants and for services during 2018. The Company expensed $183,881.
 
On April 10, 2018, the Company issued 2,000,000 shares of our common stock to Phillip A. Bosua under the terms of the Merger Agreement with RAAI common stock. The shares were valued at the fair market value of $520,000 or $0.26 per share.
 
On June 25, 2018, the Company closed a private placement and received gross proceeds of $1,750,000 ($1,710,000 as of June 30, 2018) in exchange for issuing 7,000,000 (6,840,000 as of June 30, 2018) shares of common stock and warrants to purchase 3,500,000 (3,420,000 as of June 30, 2018) shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements. The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and they expired five years after their issuance. The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.  
 
On June 25, 2018, the Company issued 500,000 shares of our common stock to Phillip A. Bosua under the terms of an Employment agreement dated April 10, 2018. The shares were valued at the fair market value of $165,000 or $0.33 per share.
 
The Company closed debt conversions and issued 835,000 shares of common stock in exchange for the conversion of $247,950 in preexisting debt owed by the Company to certain service providers, all of whom are accredited investors. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
Warrants to Purchase Common Stock
 
The following warrants were issued during the nine months ended June 30, 2018:
 
On December 15, 2017, the Company received $250,000 and issued a senior convertible exchangeable debenture with a principal amount of $300,000 and a five year common stock purchase warrant to purchase 1,200,000 shares of common stock in a private placement dated December 12, 2017 to an accredited investor pursuant to a Securities Purchase Agreement dated August 14, 2017. See Note 9 for additional details. The initial exercise price of the warrants described above is $0.25 per share, also subject to certain adjustments.
 
On March 2, 2018, the Company received gross proceeds of $280,000 in exchange for issuing a senior convertible redeemable debenture with a principal amount of $336,000 and a five year warrant to purchase 1,344,000 shares of common stock in a private placement dated February 28, 2018 to an accredited investor pursuant to a Securities Purchase Agreement dated August 14, 2017 See Note 9 for additional details. The initial exercise price of the warrants described above is $0.25 per share, also subject to certain adjustments.
 
The Company entered into a Note and Account Payable Conversion Agreement pursuant to which (a) all $664,233 currently owing under the J3E2A2Z Notes was converted to a Convertible Redeemable Promissory Note in the principal amount of $664,233, and (b) all $519,833 of the J3E2A2Z Account Payable was converted into a Convertible Redeemable Promissory Note in the principal amount of $519,833 together with a warrant to purchase up to 1,039,666 shares of common stock of the Company for a period of five years. The initial exercise price of the warrants described above is $0.50 per share, also subject to certain adjustments. See Note 9 for additional details.
 
In addition, effective as of January 31, 2018, Erickson was issued a warrant to purchase up to 855,000 shares of common stock of the Company for a period of five years. The initial exercise price of the warrants described above is $0.50 per share, also subject to certain adjustments. See Note 9 for additional details.
 
During the nine months ended June 30, 2018, The Company issued placement agent warrants related to the issuance of senior convertible redeemable debentures and Series D Preferred Stock to purchase up to 498,400 shares of common stock for a period of five years. The initial exercise price of the warrants described above is $0.25 per share, also subject to certain adjustments. The estimated fair value was $??
 
On June 25, 2018, the Company closed a private placement and received gross proceeds of $1,750,000 ($1,710,000 as of June 30, 2018) in exchange for issuing 7,000,000 (6,840,000 as of June 30, 2018) shares of common stock and warrants to purchase 3,500,000 (3,420,000 as of June 30, 2018) shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements. The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and they expired five years after their issuance. The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.  
 
 
14
 
 
The Company issued warrants to purchase 874,000 shares of common stock to Named Executive Officers, directors, employees and consultants and for services during 2018. The Company expensed $232,255.
 
A summary of the warrants outstanding as of June 30, 2018 were as follows:
 
 
 
June 30, 2018  
 
 
 
 
 
 
Weighted
 
 
 
 
 
 
Average
 
 
 
 
 
 
Exercise
 
 
 
Shares
 
 
Price
 
Outstanding at beginning of period
  6,900,356 
 $0.428 
Issued
  9,231,066 
  0.250 
Exercised
  - 
  - 
Forfeited
  - 
  - 
Expired
  (544,998)
  (0.250)
Outstanding at end of period
  15,586,424 
 $0.328 
Exerciseable at end of period
  15,586,424 
    
 
A summary of the status of the warrants outstanding as of June 30, 2018 is presented below:
 
 
 
 
 
June 30, 2018      
 
 
 
 
 
Weighted
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Average
 
 
Average
 
 
 
 
 
Average
 
 
Number of
 
 
Remaining
 
 
Exercise
 
 
Shares
 
 
Exercise
 
 
Warrants
 
 
Life ( In Years)
 
 
Price
 
 
Exerciseable
 
 
Price
 
  13,929,123 
  4.27 
 $0.250 
  13,929,123 
 $0.250 
  714,286 
  3.08 
  0.700 
  714,286 
  0.700 
  936,348 
  3.37 
  1.000 
  936,348 
  1.000 
  6,667 
  0.50 
  30.000 
  6,667 
  30.000 
  15,586,424 
  3.84 
 $0.328 
  15,586,424 
 $0.328 
 
The significant weighted average assumptions relating to the valuation of the Company’s warrants for the nine months ended June 30, 2018 were as follows:
 
Dividend yield
0%
Expected life
1-2 years
Expected volatility
125%-145%
Risk free interest rate
2.0%-2.14%
 
There were vested warrants of 14,643,409 as of June 30, 2018 with an aggregate intrinsic value of $9,489,655.
  
12.
STOCK OPTIONS
 
Description of Stock Option 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. On April 10, 2018, the Board approved an amendment to its 2011 Stock Incentive Plan increasing the number of shares of common stock reserved under the Incentive Plan from 93,333 to 1,200,000.
 
 
15
 
 
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 the following stock option transactions during the nine months ended June 30, 2018.
 
A former employee forfeited stock option grants for 10,668 shares of common stock at $14.719 per share. 
 
On April 10, 2018, an employee was granted an option to purchase 300,000 shares of common stock at an exercise price of $0.250 per share. The stock option grant vests quarterly over four years (none during the first six months) and is exercisable for 5 years. The stock option grant was valued at $27,000.
 
On June 15, 2018, an employee was granted an option to purchase 230,000 shares of common stock at an exercise price of $0.250 per share. The stock option grant vests quarterly over four years (none during the first six months) and is exercisable for 5 years. The stock option grant was valued at $37,950
 
There are currently 534,736 options to purchase common stock at an average exercise price of $0.377 per share outstanding as of June 30, 2018 under the 2011 Stock Incentive Plan. The Company recorded $7,334 and $32,661 of compensation expense, net of related tax effects, relative to stock options for the nine months ended June 30, 2018 and 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 June 30, 2018, there is approximately $64,949 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 4.83 years. 
 
Stock option activity for the nine months ended June 30, 2018 and for the years ended September 30, 2017 and 2016 was as follows:
 
 
 
  Weighted Average
 
 
 
  Options
 
 
Exercise Price  
 
 
 
Outstanding as of September 30, 2015
  57,407 
 $18.425 
 $1,057,725 
Granted
  - 
  - 
  - 
Exercised
  - 
  - 
  - 
Forfeitures
  (6,499)
  (21.403)
  (139,098)
Outstanding as of September 30, 2016
  50,908 
  18.045 
  918,627 
Granted
  - 
  - 
  - 
Exercised
  - 
  - 
  - 
Forfeitures
  (35,504)
  (19.507)
  (692,568)
Outstanding as of September 30, 2017
  15,404 
  14.675 
  226,059 
Granted
  530,000 
  0.250 
  132,500 
Exercised
  - 
  - 
  - 
Forfeitures
  (10,668)
  14.719 
  (157,020)
Outstanding as of June 30, 2018
  534,736 
 $0.377 
 $201,539 
 
The following table summarizes information about stock options outstanding and exercisable as of June 30, 2018:
 
 
16
 
 
 
 
 
 
 
 
 
Weighted
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
 
 
 
Average
 
 
Average
 
 
 
 
 
Average
 
 
Range of
 
 
Number
 
 
Remaining Life
 
 
Exercise Price
 
 
Number
 
 
Exercise Price
 
 
Exercise Prices
 
 
Outstanding
 
 
In Years
 
 
Exerciseable
 
 
Exerciseable
 
 
Exerciseable
 
  0.25 
  530,000 
  4.86 
 $0.250 
  - 
 $- 
  13.500 
  1,334 
  0.50 
  13.50 
  1,334 
  13.50 
  15.000 
  3,402 
  0.79 
  15.00 
  2,068 
  15.00 
    
  534,736 
  4.83 
 $0.377 
  3,402 
 $14.41 
 
There were stock option grants of 530,000 shares as of June 30, 2018 with an aggregate intrinsic value of $355,100.
 
13.
OTHER SIGNIFICANT TRANSACTIONS WITH RELATED PARTIES
 
Transactions with Clayton Struve
 
See Note 9 and 11 for Convertible Notes Payable and Series C and D Preferred Stock and Warrants with Clayton Struve:
 
Related Party Transactions with Ronald P. Erickson
 
See Note 9 and 10 for Convertible Notes Payable and Notes Payable with Ronald P. Erickson, our Chairman and/or entities in which Mr. Erickson has a beneficial interest.
 
Mr. Erickson and/or entities with which he is affiliated also have accrued compensation and interest of approximately $567,785. The Company owes Mr. Erickson, or entities with which he is affiliated, $1,792,766 as of June 30, 2018.
 
On July 9, 2018, the Company repaid a $199,935 Business Loan Agreement with Umpqua Bank from funds previously provided by an entity affiliated with Ronald P. Erickson, our Chairman of the Board. The Company paid $27,041 and issued 800,000 shares of common stock in exchange for the conversion of this debt. Mr. Erickson is an accredited investor. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
Stock Issuances to Named Executive Officers and Directors
 
During January to May 2018, the Company issued 300,000 shares of restricted common stock to two Named Executive Officers employees and two directors for services during 2018. The shares were issued in accordance with the 2011 Stock Incentive Plan and were valued at $0.233 per share, the market price of our common stock.
 
Related Party Transaction with Phillip A. Bosua
 
On February 7, 2018, the Company issued 50,000 shares of our common stock to Phillip A. Bosua under the terms of a consulting agreement dated July 6, 2017.
 
On April 10, 2018, the Company issued 2,000,000 shares of our common stock to Phillip A. Bosua under the terms of the Merger Agreement with RAAI common stock.
 
On June 25, 2018, the Company issued 500,000 shares of our common stock to Phillip A. Bosua under the terms of an Employment agreement dated April 10, 2018.
 
On June 25, 2018, the Company closed a debt conversion with an entity controlled by Phillip A. Bosua and issued 255,000 shares of common stock in exchange for the conversion of $63,750 in preexisting debt owed by the Company to this entity. 
 
14.
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 proceeding that is not ordinary routine litigation incidental to our business.
 
Properties and Operating Leases
 
The Company is obligated under the following non-cancelable operating leases for its various facilities and certain equipment.
 
 
17
 
 
Years Ended June 30,
 
Total
 
2019
 $86,190 
2020
  90,379 
2021
  32,456 
2022
  - 
2023
  - 
Beyond
  - 
Total
 $209,025 
 
Corporate Offices
 
On April 13, 2017, the Company leased our executive office located at 500 Union Street, Suite 810, Seattle, Washington, USA, 98101. The Company leases 943 square feet and the net monthly payment is $2,672. The monthly payment increases approximately 3% each year and the lease expires on May 31, 2022.
 
Lab Facilities and Executive Offices
 
On May 1, 2018, the Company leased its lab facilities and executive offices located at 304 Alaskan Way South, Suite 102, Seattle, Washington, USA, 98101. The Company leases 2,800 square feet and the net monthly payment is $4,000. The lease expires on April 30, 2019.
 
TransTech Facilities
 
TransTech is located at 12142 NE Sky Lane, Suite 130, Aurora, OR 97002. TransTech leases a total of approximately 6,340 square feet of office and warehouse space for its administrative offices, product inventory and shipping operations. Effective December 1, 2017, TransTech leases this office from December 1, 2017 at $4,465 per month. The monthly payment increases approximately 3% each year and the lease expires on January 31, 2020. Until December 1, 2017, TransTech leased this office on a month to month basis at $6,942 per month.
 
Consulting Agreement with Phillip A. Bosua
 
On July 7, 2017, the Company entered into a Consulting Agreement with Phillip A. Bosua whereby Mr. Bosua can earn up to 200,000 shares of the Company’s company stock based on achieving certain product development and funding milestones.
 
On March 1, 2018, the Company entered into a Consulting and Services Agreement with Blaze, Inc. and Mr. Bosua. The Consulting Agreement supersedes the Consulting Relationship Letter dated July 6, 2017 between the Company and Mr. Bosua. Under the terms of the Consulting Agreement, Blaze and Mr. Bosua are performing certain development work on behalf of the Company related to potential products for the consumer marketplace. The Consulting Agreement is deemed to be effective as of the date of the July 7, 2017 Consulting Relationship Letter and is effective until the completion of services or earlier termination in accordance with the terms of the Agreement.
 
On April 10, 2018, the Company terminated the Consulting and Services Agreement with Blaze, Inc. and Mr. Bosua.
 
Entry into Employment Agreement with Phillip A. Bosua, Chief Executive Officer
 
Phillip A. Bosua was appointed the Company’s CEO on April 10, 2018.  On April 10, 2018, the Company entered into an Employment Agreement with Mr. Bosua reflecting his appointment as Chief Executive Officer. The Employment Agreement is for an initial term of 12 months (subject to earlier termination) and will be automatically extended for additional 12-month terms unless either party notifies the other party of its intention to terminate the Employment Agreement. Mr. Bosua will be paid a base salary of $225,000 per year and may be entitled to bonuses and equity awards at the discretion of the Board or a committee of the Board. The Employment Agreement provides for severance pay equal to 12 months of base salary if Mr. Bosua is terminated without “cause” or voluntarily terminates his employment for “good reason.”  
 
Entry into Employment and Amended Employment Agreements with Ronald P. Erickson
 
On August 4, 2017, the Board of Directors approved an Employment Agreement with Ronald P. Erickson pursuant to which the Company engaged Mr. Erickson as the Company’s Chief Executive Officer through December 31, 2018.
 
 
 
18
 
Mr. Erickson’s annual compensation is $180,000. Mr. Erickson is also entitled to receive an annual bonus and equity awards compensation as approved by the Board. The bonus should be paid no later than 30 days following earning of the bonus.
 
Mr. Erickson will be entitled to participate in all group employment benefits that are offered by the Company to the Company’s senior executives and management employees from time to time, subject to the terms and conditions of such benefit plans, including any eligibility requirements.
 
If the Company terminates Mr. Erickson’s employment at any time prior to the expiration of the Term without Cause, as defined in the Employment Agreement, or if Mr. Erickson terminates his employment at any time for “Good Reason” or due to a “Disability”, Mr. Erickson will be entitled to receive (i) his Base Salary amount for one year; and (ii) medical benefits for eighteen months.  
 
On April 10, 2018, the Company appointed Mr. Bosua as Chief Executive Officer of the Company, replacing Ronald P. Erickson, who remains Chairman of the Company. On April 10, 2018, the Company entered into an Amended Employment Agreement for Ronald P. Erickson which amends the Employment Agreement dated July 1, 2017. The Agreement expires March 21, 2019.
 
15.   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 June 30, 2018, there were the following material transactions that require disclosure:
 
On July 9, 2018, the Company repaid a $199,935 Business Loan Agreement with Umpqua Bank from funds previously provided by an entity affiliated with Ronald P. Erickson, our Chairman of the Board. The Company paid $27,041 and issued 800,000 shares of common stock in exchange for the conversion of this debt. Mr. Erickson is an accredited investor. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
On July 17, 2018, the Company filed with the State of Nevada a second Amended and Restated Certificate of Designation of Preferences, Powers, and Rights of the Series D Convertible Preferred Stock. The Amended Certificate restates the prior Certificate of Designation filed on May 8, 2017 to decrease the number of authorized Series D shares from 3,906,250 shares to 1,016,014 shares. No other amendments were made to the preferences and rights of the Series D Convertible Preferred Stock. The filing of the Amended Certificate was unanimously approved by the Board of Directors and the shareholders of Series D Convertible Preferred Stock.
 
On July 30, 2018, two employees were granted an option to purchase 1,150,000 shares of common stock at an exercise price of $1.28 per share. The stock option grant vests quarterly over four years and are exercisable for 5 years.
 
On August 1, 2018, the Company filed with the State of Nevada a Certificate of Designation establishing the Designations, Preferences, Limitations and Relative Rights of Series F Preferred Stock (the “Designation”). The Designation authorized 500 shares of Series F Preferred Stock. The Series F Preferred Stock shall only be issued to the current Board of Directors on the date of the Designation’s filing and is not convertible into common stock. As set forth in the Designation, the Series F Preferred Stock has no rights to dividends or liquidation preference and carries rights to vote 100,000 shares of common stock per share of Series F upon a Trigger Event, as defined in the Designation. A Trigger Event includes certain unsolicited bids, tender offers, proxy contests, and significant share purchases, all as described in the Designation. Unless and until a Trigger Event, the Series F shall have no right to vote. The Series F Preferred Stock shall remain issued and outstanding until the date which is 731 days after the issuance of Series F Preferred Stock (“Explosion Date”), unless a Trigger Event occurs, in which case the Explosion Date shall be extended by 183 days.
 
On August 1, 2018, the Board approved an amendment to its 2011 Stock Incentive Plan increasing the number of shares of common stock reserved under the Incentive Plan 1,200,000 to 2,000,000.
 
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.
 
 
19
 
 
BACKGROUND AND CAPITAL STRUCTURE
 
Know Labs, Inc., formerly Visualant, Incorporated, was incorporated under the laws of the State of Nevada in 1998. Since 2007, we have been focused primarily on research and development of proprietary technologies which can be used to authenticate and diagnose a wide variety of organic and non-organic substances and materials. Our Common Stock trades on the OTCQB Exchange under the symbol “KNWN.”
 
BUSINESS
 
We are focused on the development, marketing and sales of a proprietary technologies which are capable of uniquely authenticating or diagnosing almost any substance or material using electromagnetic energy to create, record and detect the unique “signature” of the substance. We call these our “ChromaID™” and “Bio-RFID™” technologies.
 
Overview
 
For the past several years we have focused on the development of our proprietary ChromaID™ technology. Using light from low-cost LEDs (light emitting diodes) we map the color of substances, fluids and materials and with our proprietary processes we can authenticate, identify and diagnose based upon the color that is present. The color is both visible to us as humans but also outside of the humanly visible color spectrum in the near infra-red and near ultra-violet and beyond. Our ChromaID scanner sees what we like to call “Nature’s Color Fingerprint.” Everything in nature has a unique color identifier and with ChromaID we can see it, and identify, authenticate and diagnose based upon the color that is present. Our ChromaID scanner is capable of uniquely identifying and authenticating almost any substance or liquid using light to create, record and detect its unique color signature. We will continue to develop and enhance our ChromaID technology and extend its capacity. More recently, we have focused upon extensions and new inventions derived from our ChromaID technology which we call Bio-RFID. The rapid advances made with Bio-RFID technology in our laboratory have caused us to move quickly in to the commercialization phase of our Company as we work to create revenue generating products for the marketplace. We will also, as time permits, pursue licensing opportunities with third parties who have ready applications for our technology.
 
In 2010, we acquired TransTech Systems, Inc. as an adjunct to our business. TransTech is a distributor of products for employee and personnel identification and authentication. TransTech has historically provided substantially all of the Company’s revenues.
 
Our ChromaID™ Technology
 
We have developed a proprietary technology to uniquely authenticate or diagnose almost any material and 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 and beyond 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, verification and diagnostic 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 (shape and size) 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 electromagnetic frequencies 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. We call this the ChromaID Reference Library. The 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. Over time, we believe the ChromaID Reference Libraries can become a significant asset of the Company, providing valuable information in numerous fields of use.
 
Our Bio-RFID™ Technology
 
Working in our lab over the past year, we have developed extensions and new inventions derived from our ChromaID technology which we refer to as Bio-RFID technology. While we are in the early stages of the development of this technology, we have recently announced that we have successfully been able to non-invasively ascertain blood glucose levels. We are building the internal and external development team necessary to commercialize this newly discovered technology as well as make additional patent filings covering the intellectual property created with these new inventions.
 
 
20
 
 
ChromaID and Bio-RFID: Foundational Platform Technologies
 
Our ChromaID and Bio-RFID technologies provide a platform upon which a myriad of applications can be developed. As platform technologies, they are analogous to a smartphone, upon which an enormous number of previously unforeseen applications have been developed. ChromaID and Bio-RFID technologies are “enabling” technologies that bring the science of electromagnetic energy to low-cost, real-world commercialization opportunities across multiple industries. The technologies are 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.
 
Similarly, the Bio-RFID technology non-invasively identity the presence and quantity of glucose in the human blood stream. By extension, there may be other molecular structures which this same technology can identity in the blood stream which, over time, the Company will focus upon.
 
The cornerstone of a company with a foundational platform technology is its intellectual property. We have pursued an active intellectual property strategy and have been granted 12 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, Allied Inventors.
 
Our Patents
 
We believe that our 12 patents, 20 patent applications, three registered trademarks, and our trade secrets, copyrights and other intellectual property rights are important assets. 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 issued patents cover the fundamental aspects of the Know Labs ChromaID technology and a growing number of unique applications ranging, to date, from invisible bar codes to tissue and liquid analysis. We are filing patents on Bio-RFID technology and will continue to expand the Company’s patent portfolio over time through internal development efforts as well as through licensing opportunities with third parties.
 
The patents that have been issued to Know Labs and their dates of issuance are:
 
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.
 
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. This patent describes using ChromaID to see what we call invisible bar codes and other identifiers.
 
 
21
 
 
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 issued 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. This patent describes a ChromaID fluid sampling devices.
 
On April 19, 2016, we were issued 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. This patent describes an enhancement to the foundational ChromaID technology.
 
On April 18, 2017, we were issued US Patent No. 9,625,371 B2 entitled “Method, Apparatus, and Article to Facilitate Evaluation of Substances Using Electromagnetic Energy.” The patent expires July 2027. This patent pertains to the use of ChromaID technology for the identification and analysis of biological tissue. It has many potential applications in medical, industrial and consumer markets.
 
On April 4, 2018, we were issued US Patent No. 9,869,636 B2, entitled “Device for Evaluation of Fluids Using Electromagnetic Energy.” The patent expires approximately April 2033. This patent pertains to the use of ChromaID technology for evaluating and analyzing fluids such as those following through an IV drip in a hospital or water, for example.
 
We continue to pursue a patent strategy to expand its unique intellectual property in the United States and other countries.
 
Joint Development Agreements and Product Strategy
 
We are currently undertaking internal development work on potential products for the consumer marketplace. This development work was being performed through our Consulting Agreement with Blaze Clinical, and Phillip A. Bosua, who served as our Chief Product Officer. As these products begin to take form over the coming months, we will make appropriate product announcements.
 
We also will continue to engage with partners through licensing our technology in various fields of use, entering in to joint venture agreements to develop specific applications, and it certain specific instances developing its own products for the marketplace.
 
We have deployed our ChromaID development kit to a number of potential joint venture partners and customers around the world. There are strong indications of interest in deploying our technology in a wide variety of applications involving identification, authentication and diagnostics. We are focusing our current efforts on productizing our technology as it moves out of the research laboratory and in to the marketplace.
 
Research and Development
 
Our research and development efforts are primarily focused improving our core foundational ChromaID and Bio-RFID technology, extending its capacity and developing new and unique applications for the technology. As part of this effort, we typically conduct testing to ensure that 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 current team has considerable experience working with the application of light and radio frequency 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 incurred expenses of $366,809, $79,405 and $325,803 for the nine months ended June 30, 2018 and for the years ended September 30, 2017 and 2016, respectively, on development activities. On July 6, 2017, we entered into a Consulting Agreement with Phillip A. Bosua, our Chief Product Officer.
 
RECENT DEVELOPMENTS
 
We have the following recent developments:
 
Merger with RAAI Lighting, Inc.
 
On April 10, 2018, we entered into an Agreement and Plan of Merger with 500 Union Corporation, a Delaware corporation and a wholly owned subsidiary of the Company, and RAAI Lighting, Inc., a Delaware corporation. Pursuant to the Merger Agreement, we have acquired all the outstanding shares of RAAI’s capital stock through a merger of Merger Sub with and into RAAI (the “Merger”), with RAAI surviving the Merger as a wholly owned subsidiary of the Company.
 
Under the terms of the Merger Agreement, each share of RAAI common stock issued and outstanding immediately before the Merger (1,000 shares) were cancelled and converted into the right to receive 2,000 shares of the Company’s common stock. As a result, we issued 2,000,000 shares of its common stock to Phillip A. Bosua, formerly the sole stockholder of RAAI. The consideration for the Merger was determined through arms-length bargaining by the Company and RAAI. The Merger was structured to qualify as a tax-free reorganization for U.S. federal income tax purposes. As a result of the Merger, the Company received certain intellectual property, related to RAAI.
 
 
22
 
 
Appointment of Director
 
On April 10, 2018, the Board increased the size of the Board from three to four members and Phillip A. Bosua was appointed as a member of the Board. Mr. Bosua’s term of office expire at the next annual meeting of our stockholders. On May 24, 2018, the Board of Directors increased the size of the Board from four to five members and appointed (Ret.) Admiral William Owens as a member of the Board. Admiral Owen’s term of office expires at the next annual meeting of our stockholders.
 
Appointment of Officer.  
 
On April 10, 2018, we appointed Mr. Bosua as Chief Executive Officer of the Company, replacing Ronald P. Erickson, who remains Chairman of the Company. Mr. Erickson has been a director and officer of Know Labs since April 2003. He was appointed as our CEO and President in November 2009 and as Chairman of the Board in February 2015. Previously, Mr. Erickson was our President and Chief Executive Officer from September 2003 through August 2003 and was Chairman of the Board from August 2004 until May 2011.
 
Phillip A. Bosua was appointed the Company’s CEO on April 10, 2018. Previously, Mr. Bosua served as our Chief Product Officer since August 2017. We entered into a Consulting Agreement with Mr. Bosua’s company, Blaze Clinical on July 7, 2017. From September 2012 to February 2015, Mr. Bosua was the founder and Chief Executive Officer of LIFX Inc. (where he developed and marketed an innovative “smart” light bulb) and from August 2015 until February 2016 was Vice President Consumer Products at Soraa (which markets specialty LED light bulbs). From February 2016 to July 2017, Mr. Bosua was the founder and CEO of RAAI, Inc. (where he continued the development of his smart lighting technology). From May 2008 to February 2013 he was the Founder and CEO of LimeMouse Apps, a leading developer of applications for the Apple App Store.
 
On April 10, 2018, we entered into an Employment Agreement with Mr. Bosua reflecting his appointment as Chief Executive Officer. The Employment Agreement is for an initial term of 12 months (subject to earlier termination) and will be automatically extended for additional 12-month terms unless either party notifies the other party of its intention to terminate the Employment Agreement. Mr. Bosua will be paid a base salary of $225,000 per year, received 500,000 shares of common stock valued at $0.33 per share and may be entitled to bonuses and equity awards at the discretion of the Board or a committee of the Board. The Employment Agreement provides for severance pay equal to 12 months of base salary if Mr. Bosua is terminated without “cause” or voluntarily terminates his employment for “good reason.”
 
On April 10, 2018, we entered into an Amended Employment Agreement for Ronald P. Erickson which amends the Employment Agreement dated July 1, 2017. The Agreement expires March 21, 2019.
 
Amendment of Equity Incentive Plan
 
On April 10, 2018, the Board approved an amendment to its 2011 Stock Incentive Plan increasing the number of shares of common stock reserved under the Incentive Plan from 93,333 to 1,200,000. On August 1, 2018, the Board approved an amendment to its 2011 Stock Incentive Plan increasing the number of shares of common stock reserved under the Incentive Plan 1,200,000 to 2,000,000.
 
Merger with Know Labs, Inc.
 
On May 1, 2018, Know Labs, Inc., a Nevada corporation incorporated on April 3, 2018, and our wholly-owned subsidiary, merged with and into the Company pursuant to an Agreement and Plan of Merger dated May 1, 2018. In connection with the merger, our Articles of Incorporation were effectively amended to change our name to Know Labs, Inc. by and through the filing of Articles of Merger. This parent-subsidiary merger was approved by us, the parent, in accordance with Nevada Revised Statutes Section 92A.180. Stockholder approval was not required. This amendment was filed with the Nevada Secretary of State and became effective on May 1, 2018.
 
Corporate Name Change and Symbol Change
 
On May 24, 2018, the Financial Industry Regulatory Authority (“FINRA”) announced the effectiveness of a change in our name from Visualant Incorporated to Know Labs, Inc. and a change in our ticker symbol from VSUL to the new trading symbol KNWN which became effective on the opening of trading as of May 25, 2018. In addition, in connection with the name change and symbol change, we were assigned the CUSIP number of 499238103.
 
Closing of Financing on June 25, 2018
 
On June 25, 2018, we closed a private placement and received gross proceeds of $1,750,000 in exchange for issuing 7,000,000 shares of common stock and warrants to purchase 3,500,000 shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements.
 
The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and they expired five years after their issuance.
 
 
23
 
 
The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act. 
 
Conversion of Certain Debt to Equity
 
On June 25, 2018, we closed debt conversions and issued 605,000 shares of common stock in exchange for the conversion of $151,250 in preexisting debt owed by the Company to certain service providers, all of whom are accredited investors. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
On July 9, 2018, we repaid a $199,935 Business Loan Agreement with Umpqua Bank from funds previously provided by an entity affiliated with Ronald P. Erickson, our Chairman of the Board. The Company paid $27,041 and issued 800,000 shares of common stock in exchange for the conversion of this debt. Mr. Erickson is an accredited investor. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
THE COMPANY’S COMMON STOCK
 
Our common stock trades on the OTCQB Exchange under the symbol “KNWN.” On May 1, 2018, we filed a corporate action with FINRA to effectively change the Company’s OTC trading symbol and change our name to “Know Labs, Inc.” Our name change from Visualant, Incorporated to Know Labs, Inc. and symbol change from VSUL to KNWN was announced by FINRA declared effective on the opening of trading as of May 25, 2018. 
 
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) 
 
 
 
Three Months Ended June 30,    
 
 
 
2018
 
 
2017
 
 
$ Variance
 
 
% Variance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 $1,107 
 $1,019 
 $88 
  8.6%
Cost of sales
  910 
  844 
  66 
  -7.8%
Gross profit
  197 
  175 
  22 
  12.6%
Research and development expenses
  126 
  (9)
  135 
  -1500.0%
Selling, general and administrative expenses
  803 
  651 
  152 
  -23.3%
Operating loss
  (732)
  (467)
  (265)
  -56.7%
Other (expense) income:
    
    
    
    
Interest expense
  (9)
  (11)
  2 
  18.2%
Other income
  - 
  2 
  (2)
  -100.0%
Gain on change- derivative liability warrants
  - 
  1,004 
  (1,004)
  -100.0%
Gain on debt settlements
  235 
  - 
  235 
  100.0%
Total other income
  226 
  995 
  (769)
  -77.3%
(Loss) income before income taxes
  (506)
  528 
  (1,034)
  -195.8%
Income taxes - current (benefit)
  - 
  - 
  - 
  0.0%
Net (loss) income
 $(506)
 $528 
 $(1,034)
  -195.8%
 
THREE ENDED JUNE 30, 2018 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2017
 
Sales
 
Net revenue for the three months ended June 30, 2018 increased $88,000 to $1,107,000 as compared to $1,019,000 for the three months ended June 30, 2017. The increase was due to a sale by TransTech to an aerospace customer in the three months ended June 30, 2018 that was not repeated in the three months ended June 30, 2017.
 
 
 
24
 
 
Cost of Sales
 
Cost of sales for the three months ended June 30, 2018 increased $66,000 to $910,000 as compared to $844,000 for the three months ended June 30, 2017. The increase was due to a sale by TransTech to an aerospace customer in the three months ended June 30, 2018 that was not repeated in the three months ended June 30, 2017.
 
Gross profit was $197,000 for the three months ended June 30, 2018 as compared to $175,000 for the three months ended June 30, 2017. Gross profit was 20.1% for the three months ended June 30, 2018 as compared to 17.2% for the three months ended June 30, 2017. We have focused TransTech on maximizing profits at the current sales level.
 
Research and Development Expenses
 
Research and development expenses for the three months ended June 30, 2018 increased $135,000 to $126,000 as compared to a credit of $9,000 for the three months ended June 30, 2017. The increase was due to expenditures related to the Consulting and Services Agreement with Phillip A. Bosua, our Chief Product Officer for product development, including the development of our Bio-RFID™ technology.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses for the three months ended June 30, 2018 increased $152,000 to $803,000 as compared to $651,000 for the three months ended June 30, 2017. 
 
The increase primarily was due to (i) decreased payroll expenses of $67,000; (ii) decreased amortization expense of $31,000; and (iii) decreased corporate development expense of $42,000; (iv) decreased TransTech expenses of $66,000; and (v) decreased other expenses of $48,000;offset by (vi) increased legal expenses of $42,000;(vii) increased stock based compensation of $340,000;and (viii) increased consulting expenses of $24,000. As part of the selling, general and administrative expenses for the three months ended June 30, 2018, we recorded $26,000 of investor relation expenses and business development expenses.
 
Other Income (Expense)
 
Other income for the three months ended June 30, 2018 was $226,000 as compared to other income of $995,000 for the three months ended June 30, 2017. The other expense for the three months ended June 30, 2018 included (i) interest expense of $9,000;offset by gain on debt settlements of $235,000. The gain on debt settlements related to the reversal of old accounts payable.
 
The other income for the three months ended June 30, 2017 included (i) change in the value of derivatives of $1,004,000; (ii) by other income of $2,000; offset by (iii) interest expense of $11,000. The decrease is a result of the decline of the derivative liability as our underlying stock price has declined.
 
Net (Loss) Profit
 
Net loss for the three months ended June 30, 2018 was $506,000 as compared to a net profit of $528,000 for the three months ended June 30, 2017. The net loss for the three months ended June 30, 2018, included non-cash expenses of $406,000. The non-cash items include (i) depreciation and amortization of $14,000; (ii) issuance of common stock for conversion of liabilities of $248,000; (iii) issuance of capital stock for services and expenses of $278,000;(iv) provision for loss on accounts receivable o $21,000;and (v) issuance of warrants for debt conversion of $121,000; and (vi) offset by non cash gain on accounts payable of $234,000. TransTech’s net income from operations was $21,000 for the three months ended June 30, 2018 as compared to a net loss from operations of ($135,000) for the three months ended June 30, 2017.
 
We expect losses to continue as we commercialize our ChromaID™ and Bio-RFID™technology.
 
(dollars in thousands) 
 
 
25
 
 
 
 
Nine Months Ended June 30,    
 
 
 
2018
 
 
2017
 
 
$ Variance
 
 
% Variance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 $3,432 
 $3,665 
 $(233)
  -6.4%
Cost of sales
  2,760 
  2,995 
  (235)
  7.8%
Gross profit
  672 
  670 
  2 
  0.3%
Research and development expenses
  367 
  38 
  329 
  -865.8%
Selling, general and administrative expenses
  1,796 
  2,469 
  (673)
  27.3%
Impairment of goodwill
  - 
  984 
  (984)
  100.0%
Operating loss
  (1,491)
  (2,821)
  1,330 
  47.1%
Other (expense) income:
    
    
    
    
Interest expense
  (1,096)
  (80)
  (1,016)
  -1270.0%
Other income
  19 
  45 
  (26)
  -57.8%
(Loss) on change- derivative liability warrants
  - 
  (218)
  218 
  100.0%
Gain on debt settlements
  234 
  - 
  234 
  100.0%
Total other (expense)
  (843)
  (253)
  (590)
  -233.2%
(Loss) before income taxes
  (2,334)
  (3,074)
  740 
  24.1%
Income taxes - current (benefit)
  - 
  - 
  - 
  0.0%
Net (loss)
 $(2,334)
 $(3,074)
 $740 
  24.1%
 
NINE MONTHS ENDED JUNE 30, 2018 COMPARED TO THE NINE MONTHS ENDED JUNE 30, 2017
 
Sales
 
Net revenue for the nine months ended June 30, 2018 decreased $223,000 to $3,432,000 as compared to $3,665,000 for the nine months ended June 30, 2017. The decrease was due to lower sales by TransTech.
 
Cost of Sales
 
Cost of sales for the nine months ended June 30, 2018 decreased $235,000 to $2,760,000 as compared to $2,995,000 for the nine months ended June 30, 2017. The decrease was due to lower sales by TransTech.
 
Gross profit was $672,000 for the nine months ended June 30, 2018 as compared to $670,000 for the nine months ended June 30, 2017. Gross profit was 19.6% for the nine months ended June 30, 2018 as compared to 18.3% for the nine months ended June 30, 2017. We have focused TransTech on maximizing profits at the current sales level.
 
Research and Development Expenses
 
Research and development expenses for the nine months ended June 30, 2018 increased $329,000 to $367,000 as compared to $38,000 for the nine months ended June 30, 2017. The increase was due to expenditures related to the Consulting and Services Agreement with Phillip A. Bosua, our Chief Product Officer for product development, including the development of our Bio-RFID™ technology.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses for nine months ended June 30, 2018 decreased $673,000 to $1,796,000 as compared to $2,469,000 for the nine months ended June 30, 2017. 
 
The decrease primarily was due to (i) decreased payroll expenses of $124,000; (ii) decreased amortization expense of $44,000; (iii) decreased corporate development expense of $425,000; (iv) decreased TransTech expenses of $405,000; (v) decreased other expenses of $48,000;(vi) decreased marketing of $44,000; (vii) decreased audit expenses of $30,000; and (viii) decreased other expenses of $21,000;offset by (ix) increased legal expenses of $24,000;and (x) increased stock based compensation of $444,000;As part of the selling, general and administrative expenses for the three months ended June 30, 2018, we recorded $86,000 of investor relation expenses and business development expenses.
 
Impairment of Goodwill
 
Our TransTech business is very capital intensive. We reviewed TransTech’s operations based on its overall financial constraints and determined the value has been impaired. We recorded an impairment of goodwill associated with TransTech of $984,000 during the nine months ended June 30, 2017.
  
 
26
 
 
Other Income (Expense)
 
Other expense for the nine months ended June 30, 2018 was $843,000 as compared to other expense of $253,000 for the nine months ended June 30, 2017. The other expense for the nine months ended June 30, 2018 included (i) interest expense of $1,096,000; offset by (ii) other income of $19,999 and (iii) gain on debt settlements of $234,000. The interest expense related a senior convertible exchangeable debenture issued on December 12, 2017 and February 28, 2018 in conjunction with a Securities Purchase Agreement dated August 14, 2017. The gain on debt settlements related to the reversal of old accounts payable.
 
The other expense for the nine months ended June 30, 2017 included (i) change in the value of derivatives of $218,000; (ii) interest expenses of $80,000; offset by(iii) other income of $45,000. The decrease is a result of the decline of the derivative liability as our underlying stock price has declined.
 
Net (Loss)
 
Net loss for the nine months ended June 30, 2018 was $2,334,000 as compared to $3,074,000 for the nine months ended June 30, 2017. The net loss for the nine months ended June 30, 2018, included non-cash expenses of $1,677,000. The non-cash items include (i) depreciation and amortization of $44,000; (ii) stock based compensation of $7,000; (iii) conversion of interest and amortization of debt discount of $539,000; (iv) conversion of accrued liabilities of $492,000; (v) issuanceof common stock for conversion of liabilities of $248,000; (vi) issuance of capital stock for services and expenses of $349,000; and (vii) issuance of warrants for debt conversion of $232,000; and (viii) offset by non cash gain on accounts payable of $234,000. TransTech’s net income from operations was $64,000 for the nine months ended June 30, 2018 as compared to a net loss from operations of ($237,000) for the nine months ended June 30, 2017.
 
We expect losses to continue as we commercialize our ChromaID™ and Bio-RFID™technology.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. Significant factors in the management of liquidity are funds generated by operations, levels of accounts receivable and accounts payable and capital expenditures.
 
On June 25, 2018, we closed a private placement and received gross proceeds of $1,750,000 ($1,710,000 as of June 30, 2018) in exchange for issuing 7,000,000 (6,840,000 as of June 30, 2018) shares of common stock and warrants to purchase 3,500,000 (3,420,000 as of June 30, 2018) shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements. The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and they expired five years after their issuance. The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.  
 
We had cash of approximately $1,304,000 and net working capital of approximately $267,000 (net of convertible notes payable and notes payable) as of June 30, 2018.  We have experienced net losses since inception and we expect losses to continue as we commercialize our ChromaID™ technology. As of June 30, 2018, we had an accumulated deficit of $33,867,000 and net losses in the amount of $2,334,000, $3,901,000 and $1,746,000 for the nine months ended June 30, 2018 and years ended September 30, 2017 and 2016, respectively. We believe that our cash on hand will be sufficient to fund our operations through December 31, 2018.
 
The opinion of our independent registered public accounting firm on our audited financial statements as of and for the year ended September 30, 2017 contains an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon raising capital from financing transactions.
 
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.
 
We have financed our corporate operations and our technology development through the issuance of convertible debentures, the issuance of preferred stock, the sale common stock, issuance of common stock in conjunction with an equity line of credit, loans by our Chairman and the exercise of warrants.
 
 
27
 
 
We finance our TransTech operations from operations and a Secured Credit Facility with Capital Source Business Finance Group. On June 15, 2018, TransTech entered into a Fifth Modification to the Loan and Security Agreement related to the $500,000 secured credit facility with Capital Source to fund its operations. The Modification extended the maturity to December 12, 2018. The secured credit facility provides for a prime rate interest floor for prime interest of 4.5% plus 2.5%. The eligible borrowing is based on 80% of eligible trade accounts receivable, not to exceed $500,000. The secured credit facility is collateralized by the assets of TransTech, with a guarantee by Know Labs, including a security interest in all assets of Know Labs. The remaining balance on the accounts receivable must be repaid by the time the secured credit facility expires on December 12, 2018, unless we renew by automatic extension for the next successive term. We have $47,000 available as of June 30, 2018.
 
Operating Activities
 
Net cash used in operating activities for the nine months ended June 30, 2018 was $842,000. This amount was primarily related to (i) a net loss of $2,334,000;(ii) a decrease in deferred revenue of $60,000;and (iii) a decrease in accounts payable and accrued expenses of $460,000;offset by (iv) a decrease in accounts receivable of $263,000; (v) other of $72,000;and (vi) non-cash expenses of $1,677,000. The non-cash items include (vii) depreciation and amortization of $44,000;(viii) stock based compensation of $7,000; (ix) conversion of interest and amortization of debt discount of $539,000; (x) conversion of accrued liabilities of $492,000; (xi) issuance of common stock for conversion of liabilities of $248,000;(xii) issuance of capital stock for services and expenses of $349,000; and (xiii) issuance of warrants for debt conversion of $232,000; and (xiv) offset by non cash gain on accounts payable of $234,000.
 
Investing Activities
 
Net cash provided used in investing activities for the nine months ended June 30, 2018 was $25,000. This amount was primarily related to the investment in equipment for the lab.
 
Financing Activities
 
Net cash provided by financing activities for the nine months ended June 30, 2018 was $2,069.000. This amount was primarily related to (i) proceeds from the issuance of common stock of $1,710,000 (ii) proceeds from convertible notes of $530,000; offset by (iii) repayment of line of credit of $170,990.
 
Our contractual cash obligations as of June 30, 2018 are summarized in the table below:
 
 
 
 
 
 
Less Than
 
 
 
 
 
 
 
 
Greater Than
 
Contractual Cash Obligations
 
Total
 
 
1 Year
 
 
1-3 Years
 
 
3-5 Years
 
 
5 Years
 
Operating leases
 $209,025 
 $86,190 
 $90,379 
 $32,456 
 $- 
Convertible notes payable
  2,390,065 
  2,390,065 
  - 
  - 
  - 
Notes payable
  394,670 
  394,670 
  - 
  - 
  - 
Capital expenditures
  100,000 
  20,000 
  40,000 
  40,000 
  - 
 
 $3,093,760 
 $2,890,925 
 $130,379 
 $72,456 
 $- 
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
This item is not applicable. 
 
ITEM 4.
CONTROLS AND PROCEDURES
 
a) Evaluation of Disclosure Controls and Procedures
 
We conducted an evaluation, under the supervision and with the participation of our management, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (“Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controlsand procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive and principal financial officers concluded as of June 30, 2018 that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses in our internal controls over financial reporting discussed immediately below.
 
 
28
 
 
Identified Material Weakness
 
A material weakness in our internal control over financial reporting is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
 
Management identified the following material weakness during its assessment of internal controls over financial reporting:
 
Personnel: We do not employ a full time Chief Financial Officer. Our Chairman serves as interim Chief Financial Officer. We utilize a consultant to assist with our financial reporting.
 
Audit Committee: While we have an audit committee, we lack a financial expert. During 2018, the Board expects to appoint an additional independent Director to serve as Audit Committee Chairman who is an “audit committee financial expert” as defined by the Securities and Exchange Commission (“SEC”) and as adopted under the Sarbanes-Oxley Act of 2002.
 
b) Changes in Internal Control over Financial Reporting
 
During the three months ended June 30, 2018, there were no changes in our internal controls over financial reporting during this fiscal quarter that materially affected, or is reasonably likely to have a materially affect, on our internal control over financial reporting.
 
PART II.     OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 
From time to time, the Company may become subject to various legal proceedings that are incidental to the ordinary conduct of its business. Although the Company cannot accurately predict the amount of any liability that may ultimately arise with respect to any of these matters, it makes provision for potential liabilities when it deems them probable and reasonably estimable. These provisions are based on current information and legal advice and may be adjusted from time to time according to developments.
 
We are currently not a party to any pending legal proceeding that is not ordinary routine litigation incidental to our business. We know of no material, existing or pending legal proceedings against our Company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any director, officer or any affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.
 
ITEM 1A. 
RISK FACTORS
 
There are certain inherent risks which will have an effect on the Company’s development in the future and the most significant risks and uncertainties known and identified by our management are described below.
 
RISK FACTORS
 
An investment in our securities is speculative in nature, involves a high degree of risk, and should not be made by an investor who cannot bear the economic risk this investment for an indefinite period of time and who cannot afford the potential loss of his or her investment. Each prospective investor should carefully consider the following risk factors associated with the Offering, as well as other information contained elsewhere in this Memorandum before making an investment.
 
Risks Relating to the Company Generally
 
We need additional financing to support our technology development and ongoing operations, pay our debts and maintain ownership of our intellectual properties.
 
We are currently operating at a loss. We believe that our cash on hand will be sufficient to fund our operations through December 31, 2018. We need additional financing to implement our business plan and to service our ongoing operations, pay our current debts (described below) and maintain ownership of our intellectual property. 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/or 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 securesuch 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.  There can there can be no assurance that we will be able to sell that number of shares, if any. 
 
 
29
 
 
We need to continue as a going concern if our business is to succeed.
 
Because of our recurring losses and negative cash flows from operations, the audit report of our independent registered public accountants on our consolidated financial statements for the year ended September 30, 2017 contains an explanatory paragraph stating that there is substantial doubt about our ability to continue as a going concern.  Factors identified in the report include our historical net losses, negative working capital, and the need for additional financing to implement our business plan and service our debt repayments. If we are not able to attain profitability in the near future our financial condition could deteriorate further, which would have a material adverse impact on our business and prospects and result in a significant or complete loss of your investment. Further, we may be unable to pay our debt obligations as they become due, which include obligations to secured creditors. If we are unable to continue as a going concern, we might have to liquidate our assets and the values we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our financial statements.  Additionally, we are subject to customary operational covenants, including limitations on our ability to incur liens or additional debt, pay dividends, redeem stock, make specified investments and engage in merger, consolidation or asset sale transactions, among other restrictions. In addition, the inclusion of an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern and our lack of cash resources may materially adversely affect our share price and our ability to raise new capital or to enter into critical contractual relations with third parties.
 
As of June 30, 2018, we owe approximately $3,353,000 and if we do not satisfy these obligations, the lenders may have the right to demand payment in full or exercise other remedies.
 
On March 16, 2018, we closed a Note and Account Payable Conversion Agreement with J3E2A2Z, a Washington limited partnership, Ronald P. Erickson, our Executive Chairman of the Board and a member of the Board of Directors pursuant to which (a) all $664,233 currently owing under the J3E2A2Z Notes was converted to a Convertible Redeemable Promissory Note in the principal amount of $664,233, and (b) all $519,833 of the J3E2A2Z Account Payable was converted into a Convertible Redeemable Promissory Note in the principal amount of $519,833.
 
Mr. Erickson and/or entities with which he is affiliated also have accrued compensation and interest of approximately $567,785. The Company owes Mr. Erickson, or entities with which he is affiliated, $1,792,766 as of June 30, 2018.
 
On July 9, 2018, the Company repaid a $199,935 Business Loan Agreement with Umpqua Bank from funds previously provided by an entity affiliated with Ronald P. Erickson, our Chairman of the Board. The Company paid $27,041 and issued 800,000 shares of common stock in exchange for the conversion of this debt. Mr. Erickson is an accredited investor. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
Including Mr. Erickson, we owe $2,390,066 under various convertible promissory notes as of June 30 ,2018.
 
We require additional financing, to service and/or repay these debt obligations. If we raise additional capital through borrowing or other debt financing, we may incur substantial interest expense. If and when we raise more equity capital in the future, it will result in substantial dilution to our current stockholders.
 
We have a history of operating losses and there can be no assurance that we can achieve or maintain profitability.
 
We have experienced net losses since inception. As of June 30, 2018, we had an accumulated deficit of $33,867,000 and net losses in the amount of $2,334,000, $3,901,000 and $1,746,000 for the nine months ended June 30, 2018 and for the years ended September 30, 2017 and 2016, respectively. There can be no assurance that we will achieve or maintain profitability. If we achieve profitability in the future, we may not be able to sustain profitability in subsequent periods. Failure to become and remain profitable would impair our ability to sustain operations and adversely affect the price of our common stock and our ability to raise capital. Our operating expenses may increase as we spend resources on growing our business, and if our revenue does not correspondingly increase, our operating results and financial condition will suffer. Our ChromaID business has produced minimal revenues, and may not produce significant revenues in the near term, or at all, which would harm our ability to continue our operations or obtain additional financing and require us to reduce or discontinue our operations. You must consider our business and prospects in light of the risks and difficulties we will encounter as business with an early-stage technology in a new and rapidly evolving industry. We may not be able to successfully address these risks and difficulties, which could significantly harm our business, operating results and financial condition.
 
If the company were to dissolve or wind-up operations, holders of our common stock would not receive a liquidation preference.
 
If we were to wind-up or dissolve our company and liquidate and distribute our assets, our common stockholders would share in our assets only after we satisfy any amounts we owe to our creditors and preferred equity holders.  If our liquidation or dissolution were attributable to our inability to profitably operate our business, then it is likely that we would have material liabilities at the time of liquidation or dissolution.  Accordingly, it is very unlikely that sufficient assets will remain available after the payment of our creditors and preferred equity holders to enable common stockholders to receive any liquidation distribution with respect to any common stock.
 
 
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We may not be able to generate sufficient revenue from the commercialization of our ChromaID and Bio-RFID technology and related products to achieve or sustain profitability.
 
We are in the early stages of commercializing our ChromaID and Bio-RFID technology.  To date, we have entered into a License Agreement with Sumitomo Precision Products Co., Ltd. and have a strategic relationship with Allied Inventors. None of these relationships have generated any significant revenue. Failure to develop and sell products based upon our ChromaID and Bio-RFID technology, grant additional licenses and obtain royalties or develop other revenue streams will have a material adverse effect on our business, financial condition and results of operations. 
 
To date, we have generated minimal revenue from sales of our products. We believe that our commercialization success is dependent upon our ability to significantly increase the number of customers that are using our products In addition, demand for our products may not materialize, or increase as quickly as planned, and we may therefore be unable to increase our revenue levels as expected. We are currently not profitableEven if we succeed in introducing our technology and related products to our target markets, we may not be able to generate sufficient revenue to achieve or sustain profitability.
 
We currently rely upon external resources for engineering and product development services. If we are unable to secure an engineering or product development partner or establish satisfactory engineering and product development capabilities, we may not be able to successfully commercialize our ChromaID and Bio-RFID technology.
 
Our success depends upon our ability to develop products that are accurate and provide solutions for our customers. Achieving the desired results for our customers requires solving engineering issues in concert with them. Any failure of our ChromaID and Bio-RFID technology or related products to meet customer expectations could result in customers choosing to retain their existing methods or to adopt systems other than ours.
 
We have not historically had internal resources which can work on engineering and product development matters. We have used third parties in the past and will continue to do so. These resources are not always readily available and the absence of their availability could inhibit our research and development efforts and our responsiveness to our customers. Our inability to secure those resources could impact our ability to provide engineering and product development services and could have an impact on our customers’ willingness to use our technology.
 
We are in the early stages of commercialization and our ChromaID and Bio-RFID technology and related products may never achieve significant commercial market acceptance.
 
Our success depends on our ability to develop and market products that are recognized as accurate and cost-effective. Many of our potential customers may be reluctant to use our new technology. Market acceptance will depend on many factors, including our ability to convince potential customers that our ChromaID and Bio-RFID technology and related products are an attractive alternative to existing light-based technologies. We will need to demonstrate that our products provide accurate and cost-effective alternatives to existing light-based authentication technologies. Compared to most competing technologies, our technology is relatively new, and most potential customers have limited knowledge of, or experience with, our products. Prior to implementing our technology and related products, potential customers are required to devote significant time and effort to testing and validating our products. In addition, during the implementation phase, customers may be required to devote significant time and effort to training their personnel on appropriate practices to ensure accurate results from our technology and products. Any failure of our technology or related products to meet customer expectations could result in customers choosing to retain their existing testing methods or to adopt systems other than ours.
 
Many factors influence the perception of a system including its use by leaders in the industry. If we are unable to induce industry leaders in our target markets to implement and use our technology and related products, acceptance and adoption of our products could be slowed. In addition, if our products fail to gain significant acceptance in the marketplace and we are unable to expand our customer base, we may never generate sufficient revenue to achieve or sustain profitability.
 
Our management has concluded that we have material weaknesses in our internal controls over financial reporting and that our disclosure controls and procedures are not effective.
 
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company's annual or interim financial statements will not be prevented or detected on a timely basis. During the audit of our financial statements for the year ended September 30, 2017, our management identified material weaknesses in our internal control over financial reporting. If these weaknesses continue, investors could lose confidence in the accuracy and completeness of our financial reports and other disclosures.  
 
In addition, our management has concluded that our disclosure controls and procedures were not effective due to the lack of an audit committee “financial expert.” These material weaknesses, if not remediated, create an increased risk of misstatement of the Company’s financial results, which, if material, may require future restatement thereof. A failure to implement improved internal controls, or difficulties encountered in their implementation or execution, could cause future delays in our reporting obligations and could have a negative effect on us and the trading price of our common stock.
 
 
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Our services and license agreement with Allied Inventors is important to our business strategy and operations.
 
In November 2013, we entered into a five-year strategic relationship with Allied Inventors, formerly Xinova and Invention Development Management Company, a former subsidiary of Intellectual Ventures, a private intellectual property fund with over $5 billion under management. Allied Inventors 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. Allied Inventors 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 amended agreement with Allied Inventors covers a number of areas that are important to our operations, including the following:
 
● The agreement requires Allied Inventors to identify and engage inventors to develop new applications of our ChromaID technology, present the developments to us for approval, and file at least ten patent applications to protect the developments;
● We received a worldwide, nontransferable, exclusive license to the licensed intellectual property developed under this agreement within the identification, authentication and diagnostics field of use;
● We received a nonexclusive and nontransferable option to acquire a worldwide, nontransferable, nonexclusive license to intellectual property held by Allied Inventors within that same field of use; and
● We granted to Allied Inventors certain licenses to our intellectual property outside the identification, authentication and diagnostics field of use.
 
Failure to operate in accordance with the Allied Inventors agreement, or an early termination or cancellation of this agreement for any reason, would have a material adverse effect on ability to execute our business strategy and on our results of operations and business.
 
If components used in our finished products become unavailable, or third-party manufacturers otherwise experience delays, we may incur delays in shipment to our customers, which would damage our business.
 
We depend on third-party suppliers for substantially all of our components and products. We purchase these products and components from third-party suppliers that serve the advanced lighting systems market and we believe that alternative sources of supply are readily available for most products and components. However, consolidation could result in one or more current suppliers being acquired by a competitor, rendering us unable to continue purchasing necessary amounts of key components at competitive prices. In addition, for certain of our customized components, arrangements for additional or replacement suppliers will take time and result in delays. We purchase products and components pursuant to purchase orders placed from time to time in the ordinary course of business. This means we are vulnerable to unanticipated price increases and product shortages. Any interruption or delay in the supply of components and products, or our inability to obtain components and products from alternate sources at acceptable prices in a timely manner, could harm our business, financial condition and results of operations.
 
While we believe alternative manufacturers for these products are available, we have selected these particular manufacturers based on their ability to consistently produce these products per our specifications ensuring the best quality product at the most cost-effective price. We depend on our third-party manufacturers to satisfy performance and quality specifications and to dedicate sufficient production capacity within scheduled delivery times. Accordingly, the loss of all or one of these manufacturers or delays in obtaining shipments could have a material adverse effect on our operations until such time as an alternative manufacturer could be found.
 
We are dependent on key personnel.
 
Our success depends to a significant degree upon the continued contributions of key management and other personnel, some of whom could be difficult to replace, including Ronald P. Erickson, our Chairman and Phil Bosua, our Chief Executive Officer. We do not maintain key person life insurance covering any of our officers. Our success will depend on the performance of our officers, our ability to retain and motivate our officers, our ability to integrate new officers into our operations, and the ability of all personnel to work together effectively as a team.  Our officers do not currently have employment agreements.  Our failure to retain and recruit officers and other key personnel could have a material adverse effect on our business, financial condition and results of operations.  Our success also depends on our continued ability to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, manufacturing, administrative and sales and marketing personnel. Competition for these individuals is intense, and we may not be able to successfully recruit, assimilate or retain sufficiently qualified personnel. In particular, we may encounter difficulties in recruiting and retaining a sufficient number of qualified technical personnel, which could harm our ability to develop new products and adversely impact our relationships with existing and future customers. The inability to attract and retain necessary technical, managerial, manufacturing, administrative and sales and marketing personnel could harm our ability to obtain new customers and develop new products and could adversely affect our business and operating results.
 
We have limited insurance which may not cover claims by third parties against us or our officers and directors.
 
We have limited directors’ and officers’ liability insurance and commercial liability insurance policies. Claims by third parties against us may exceed policy amounts and we may not have amounts to cover these claims. Any significant claims would have a material adverse effect on our business, financial condition and results of operations.  In addition, our limited directors’ and officers’ liability insurance may affect our ability to attract and retain directors and officers.
 
 
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Our inability to effectively protect our intellectual property would adversely affect our ability to compete effectively, our revenue, our financial condition and our results of operations.
 
We rely on a combination of patent, trademark, and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. Obtaining and maintaining a strong patent position is important to our business. Patent law relating to the scope of claims in the technology fields in which we operate is complex and uncertain, so we cannot be assured that we will be able to obtain or maintain patent rights, or that the patent rights we may obtain will be valuable, provide an effective barrier to competitors or otherwise provide competitive advantages. Others have filed, and in the future are likely to file, patent applications that are similar or identical to ours or those of our licensors. To determine the priority of inventions, or demonstrate that we did not derive our invention from another, we may have to participate in interference or derivation proceedings in the USPTO or in court that couldresult in substantial costs in legal fees and could substantially affect the scope of our patent protection. We cannot be assured our patent applications will prevail over those filed by others. Also, our intellectual property rights may be subject to other challenges by third parties. Patents we obtain could be challenged in litigation or in administrative proceedings such as ex parte reexam, inter parties review, or post grant review in the United States or opposition proceedings in Europe or other jurisdictions.
 
There can be no assurance that:
 
any of our existing patents will continue to be held valid, if challenged;
patents will be issued for any of our pending applications;
any claims allowed from existing or pending patents will have sufficient scope or strength to protect us;
our patents will be issued in the primary countries where our products are sold in order to protect our rights and potential commercial advantage; or
any of our products or technologies will not infringe on the patents of other companies.
 
If we are enjoined from selling our products, or if we are required to develop new technologies or pay significant monetary damages or are required to make substantial royalty payments, our business and results of operations would be harmed.
 
Obtaining and maintaining a patent portfolio entails significant expense and resources. Part of the expense includes periodic maintenance fees, renewal fees, annuity fees, various other governmental fees on patents and/or applications due in several stages over the lifetime of patents and/or applications, as well as the cost associated with complying with numerous procedural provisions during the patent application process. We may or may not choose to pursue or maintain protection for particular inventions. In addition, there are situations in which failure to make certain payments or noncompliance with certain requirements in the patent process can result in abandonment or lapse of a patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. If we choose to forgo patent protection or allow a patent application or patent to lapse purposefully or inadvertently, our competitive position could suffer.
 
Legal actions to enforce our patent rights can be expensive and may involve the diversion of significant management time. In addition, these legal actions could be unsuccessful and could also result in the invalidation of our patents or a finding that they are unenforceable. We may or may not choose to pursue litigation or interferences against those that have infringed on our patents, or used them without authorization, due to the associated expense and time commitment of monitoring these activities. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could have a material adverse effect on our results of operations and business.
 
Claims by others that our products infringe their patents or other intellectual property rights could prevent us from manufacturing and selling some of our products or require us to pay royalties or incur substantial costs from litigation or development of non-infringing technology.
 
In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We may receive notices that claim we have infringed upon the intellectual property of others. Even if these claims are not valid, they could subject us to significant costs. Any such claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert our attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all. We have engaged in litigation and litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. A successful claim of intellectual property infringement against us and our failure or inability to license the infringed technology or develop or license technology with comparable functionality could have a material adverse effect on our business, financial condition and operating results.
 
Our TransTech vendor base is concentrated.
 
Evolis, Fargo, Ultra Electronics - Magicard Division and NiSCA, are major vendors of TransTech whose products account for approximately 61% of TransTech’s revenue. TransTech buys, packages and distributes products from these vendors after issuing purchase orders. Any loss of any of these vendors would have a material adverse effect on our business, financial condition and results of operations. 
 
 
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We currently have a very small sales and marketing organization at our TransTech Systems subsidiary. If we are unable to secure a sales and marketing partner or establish satisfactory sales and marketing capabilities at the Know Labs parent Company level we may not be able to successfully commercialize our ChromaID and Bio-RFID technology.
 
Our subsidiary, TransTech Systems, has six sales and marketing employees on staff to support the ongoing sales efforts of that business. In order to commercialize products that are approved for commercial sales, we sell directly to our customers, collaborate with third parties that have such commercial infrastructure and work withour strategic business partners to generate sales. If we are not successful entering into appropriate collaboration arrangements, or recruiting sales and marketing personnel or in building a sales and marketing infrastructure, we will have difficulty successfully commercializing our ChromaID and Bio-RFID technology, which would adversely affect our business, operating results and financial condition.
 
We may not be able to enter into collaboration agreements on terms acceptable to us or at all. In addition, even if we enter into such relationships, we may have limited or no control over the sales, marketing and distribution activities of these third parties. Our future revenues may depend heavily on the success of the efforts of these third parties. If we elect to establish a sales and marketing infrastructure we may not realize a positive return on this investment. In addition, we must compete with established and well-funded pharmaceutical and biotechnology companies to recruit, hire, train and retain sales and marketing personnel. Factors that may inhibit our efforts to commercialize ChromaID and Bio-RFID without strategic partners or licensees include:
 
our inability to recruit and retain adequate numbers of effective sales and marketing personnel;
 
the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and
 
unforeseen costs and expenses associated with creating an independent sales and marketing organization.
 
Government regulatory approval may be necessary before some of our products can be sold and there is no assurance such approval will be granted.
 
Our ChromaID and Bio-RFID technology may have a number of potential applications in fields of use which will require prior governmental regulatory approval before the technology can be introduced to the marketplace. For example, we are exploring the use of our ChromaID and Bio-RFID technology for certain medical diagnostic applications.  There is no assurance that we will be successful in developing medical applications for our technology.  If we were to be successful in developing medical applications of our technology, prior approval by the FDA and other governmental regulatory bodies may be required before the technology could be introduced into the marketplace.  There is no assurance that such regulatory approval would be obtained for a medical diagnostic or other applications requiring such approval.
 
We may engage in acquisitions, mergers, strategic alliances, joint ventures and divestures that could result in final results that are different than expected.
 
In the normal course of business, we engage in discussions relating to possible acquisitions, equity investments, mergers, strategic alliances, joint ventures and divestitures. Such transactions are accompanied by a number of risks, including the use of significant amounts of cash, potentially dilutive issuances of equity securities, incurrence of debt on potentially unfavorable terms as well as impairment expenses related to goodwill and amortization expenses related to other intangible assets, the possibility that we may pay too much cash or issue too many of our shares as the purchase price for an acquisition relative to the economic benefits that we ultimately derive from such acquisition, and various potential difficulties involved in integrating acquired businesses into our operations.
 
From time to time, we have also engaged in discussions with candidates regarding the potential acquisitions of our product lines, technologies and businesses. If a divestiture such as this does occur, we cannot be certain that our business, operating results and financial condition will not be materially and adversely affected. A successful divestiture depends on various factors, including our ability to effectively transfer liabilities, contracts, facilities and employees to any purchaser; identify and separate the intellectual property to be divested from the intellectual property that we wish to retain; reduce fixed costs previously associated with the divested assets or business; and collect the proceeds from any divestitures.
 
If we do not realize the expected benefits of any acquisition or divestiture transaction, our financial position, results of operations, cash flows and stock price could be negatively impacted.
 
Our growth strategy depends in part on our ability to execute successful strategic acquisitions. We have made strategic acquisitions in the past and may do so in the future, and if the acquired companies do not perform as expected, this could adversely affect our operating results, financial condition and existing business.
 
We may continue to expand our business through strategic acquisitions. The success of any acquisition will depend on, among other things:
 
 
the availability of suitable candidates;
 
 
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higher than anticipated acquisition costs and expenses;
 
 
competition from other companies for the purchase of available candidates;
 
 
our ability to value those candidates accurately and negotiate favorable terms for those acquisitions;
 
 
the availability of funds to finance acquisitions and obtaining any consents necessary under our credit facility;
 
 
the ability to establish new informational, operational and financial systems to meet the needs of our business;
 
 
the ability to achieve anticipated synergies, including with respect to complementary products or services; and
 
 
the availability of management resources to oversee the integration and operation of the acquired businesses.
 
We may not be successful in effectively integrating acquired businesses and completing acquisitions in the future. We also may incur substantial expenses and devote significant management time and resources in seeking to complete acquisitions. Acquired businesses may fail to meet our performance expectations. If we do not achieve the anticipated benefits of an acquisition as rapidly as expected, or at all, investors or analysts may not perceive the same benefits of the acquisition as we do. If these risks materialize, our stock price could be materially adversely affected.
 
We are subject to corporate governance and internal control requirements, and our costs related to compliance with, or our failure to comply with existing and future requirements could adversely affect our business.
 
We must comply with corporate governance requirements under the Sarbanes-Oxley Act of 2002 and the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, as well as additional rules and regulations currently in place and that may be subsequently adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules, and regulations continue to evolve and may become increasingly stringent in the future. The financial cost of compliance with these laws, rules, and regulations is expected to remain substantial.
 
Our management has concluded that our disclosure controls and procedures were not effective due to the lack of an audit committee “financial expert.” We expect to appoint an additional independent director to serve as Audit Committee Chairman. This director will be an “audit committee financial expert” as defined by the SEC. However, we cannot assure you that we will be able to fully comply with these laws, rules, and regulations that address corporate governance, internal control reporting, and similar matters in the future. Failure to comply with these laws, rules and regulations could materially adversely affect our reputation, financial condition, and the value of our securities. 
 
The Capital Source credit facility contains covenants that may limit our flexibility in operating our business and failure to comply with any of these covenants could have a material adverse effect on our business.
 
In December 8, 2009, we entered into the Capital Source credit facility. On June 15, 2018, TransTech entered into the Fifth Modification to the Loan and Security Agreement.
 
This Capital Source credit facility contains covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:
 
 
sell, transfer, lease or dispose of certain assets;
 
 
engage in certain mergers and consolidations;
 
 
incur debt or encumber or permit liens on certain assets, except in the limited circumstances permitted under the loan and security agreements;
 
 
make certain restricted payments, including paying dividends on, or repurchasing or making distributions with respect to, our common stock; and
 
 
enter into certain transactions with affiliates.
 
A breach of any of the covenants under the Capital Source credit facility could result in a default under the Capital Source credit facility. Upon the occurrence of an event of default under the Capital Source credit facility, the lenders could elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. If we are unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure such indebtedness.
 
The exercise prices of certain warrants, convertible notes payable and the Series A, C, and D Preferred Shares may require further adjustment.
 
 
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In the future, if we sell our common stock at a price below $0.25 per share, the exercise price of 23,334 outstanding shares of Series A Preferred Stock, 1,785,715 outstanding shares of Series C Preferred Stock, 3,108,356 outstanding shares Series D Preferred Stock and a warrant for Allied Inventors to purchase 97,169 shares of common stock would adjust below $0.25 per share pursuant to the documents governing such instruments. In addition, the conversion price of a Convertible Note Payable of $2,390,066 and the exercise price of additional outstanding warrants to purchase 13,021,053 shares of common stock would adjust below $0.25 per share pursuant to the documents governing such instruments.  
 
Risks Relating to Our Stock
 
The price of our common stock is volatile, which may cause investment losses for our stockholders.
 
The market price of our common stock has been and is likely in the future to be volatile. Our common stock price may fluctuate in response to factors such as:
 
 
Announcements by us regarding liquidity, significant acquisitions, equity investments and divestitures, strategic relationships, addition or loss of significant customers and contracts, capital expenditure commitments and litigation;
 
Issuance of convertible or equity securities and related warrants for general or merger and acquisition purposes;
 
Issuance or repayment of debt, accounts payable or convertible debt for general or merger and acquisition purposes;
 
Sale of a significant number of shares of our common stock by stockholders;
 
General market and economic conditions;
 
Quarterly variations in our operating results;
 
Investor and public relation activities;
 
Announcements of technological innovations;
 
New product introductions by us or our competitors;
 
Competitive activities; and
 
Additions or departures of key personnel.
 
These broad market and industry factors may have a material adverse effect on the market price of our common stock, regardless of our actual operating performance. These factors could have a material adverse effect on our business, financial condition and results of operations.
 
Transfers of our securities may be restricted by virtue of state securities “blue sky” laws, which prohibit trading absent compliance with individual state laws. These restrictions may make it difficult or impossible to sell shares in those states.
 
Transfers of our common stock may be restricted under the securities or securities regulations laws promulgated by various states and foreign jurisdictions, commonly referred to as "blue sky" laws. Absent compliance with such individual state laws, our common stock may not be traded in such jurisdictions. Because the securities held by many of our stockholders have not been registered for resale under the blue sky laws of any state, the holders of such shares and persons who desire to purchase them should be aware that there may be significant state blue sky law restrictions upon the ability of investors to sell the securities and of purchasers to purchase the securities. These restrictions may prohibit the secondary trading of our common stock. Investors should consider the secondary market for our securities to be a limited one.
 
Three individual investors could have significant influence over matters submitted to stockholders for approval.
 
As of August 9, 2018, four individuals in the aggregate, assuming the exercise of all warrants to purchase common stock, hold shares representing approximately 63% of our common stock on a fully-converted basis and could be considered a control group for purposes of SEC rules. However, the agreement with one of these individuals limits his ownership to 4.99% individually. Beneficial ownership includes shares over which an individual or entity has investment or voting power and includes shares that could be issued upon the exercise of options and warrants within 60 days after the date of determination. If these persons were to choose to act together, they would be able to significantly influence all matters submitted to our stockholders for approval, as well as our officers, directors, management and affairs. For example, these persons, if they choose to act together, could significantly influence the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of us on terms that other stockholders may desire.
  
The sale of a significant number of our shares of common stock could depress the price of our common stock.
 
Sales or issuances of a large number of shares of common stock in the public market or the perception that sales may occur could cause the market price of our common stock to decline. As of August 9, 2018, we had 16,570,162 shares of common stock issued and outstanding, held by 68 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 August 9, 2018, there were options outstanding for the purchase of 1,684,736 common shares, warrants for the purchase of 15,586,424 common shares, and 4,917,405 shares of our common stock issuable upon the conversion of Series A, Series C and Series D Convertible Preferred Stock. In addition, we have an unknown number of shares are issuable upon conversion of convertible debentures of $2,390,065. All of which could potentially dilute future earnings per share.   
 
 
 
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Significant shares of common stock are held by our principal stockholders, other company insiders and other large stockholders. As “affiliates” of Visualant, as defined under Securities and Exchange Commission Rule 144 under the Securities Act of 1933, our principal stockholders, other of our insiders and other large stockholders may only sell their shares of common stock in the public market pursuant to an effective registration statement or in compliance with Rule 144.
 
These options, warrants, convertible notes payable and convertible preferred stock could result in further dilution to common stock holders and may affect the market price of the common stock.
 
Future issuance of additional shares of common stock and/or preferred stock could dilute existing stockholders. We have and may issue preferred stock that could have rights that are preferential to the rights of common stock that could discourage potentially beneficially transactions to our common stockholders.
 
Pursuant to our certificate of incorporation, we currently have authorized 100,000,000 shares of common stock and 5,000,000 shares of preferred stock. To the extent that common shares are available for issuance, subject to compliance with applicable stock exchange listing rules, our board of directors has the ability to issue additional shares of common stock in the future for such consideration as the board of directors may consider sufficient.The issuance of any additional securities could, among other things, result in substantial dilution of the percentage ownership of our stockholders at the time of issuance, result in substantial dilution of our earnings per share and adversely affect the prevailing market price for our common stock.
 
An issuance of additional shares of preferred stock could result in a class of outstanding securities that would have preferences with respect to voting rights and dividends and in liquidation over our common stock and could, upon conversion or otherwise, have all of the rights of our common stock.  Our Board of Directors' authority to issue preferred stock could discourage potential takeover attempts or could delay or prevent a change in control through merger, tender offer, proxy contest or otherwise by making these attempts more difficult or costly to achieve.  The issuance of preferred stock could impair the voting, dividend and liquidation rights of common stockholders without their approval.
 
Future capital raises may dilute our existing stockholders’ ownership and/or have other adverse effects on our operations.
 
If we raise additional capital by issuing equity securities, our existing stockholders’ percentage ownership will be reduced and these stockholders may experience substantial dilution. We may also issue equity securities that provide for rights, preferences and privileges senior to those of our common stock. If we raise additional funds by issuing debt securities, these debt securities would have rights senior to those of our common stock and the terms of the debt securities issued could impose significant restrictions on our operations, including liens on our assets. If we raise additional funds through collaborations and licensing arrangements, we may be required to relinquish some rights to our technologies or candidate products, or to grant licenses on terms that are not favorable to us.
 
We do not anticipate paying any cash dividends on our capital stock in the foreseeable future.
 
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business, and we do not anticipate paying any cash dividends on our capital stock in the foreseeable future. In addition, the terms of any future debt agreements may preclude us from paying dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.
 
Anti-takeover provisions may limit the ability of another party to acquire our company, which could cause our stock price to decline.
 
Our certificate of incorporation, as amended, our bylaws and Nevada law contain provisions that could discourage, delay or prevent a third party from acquiring our company, even if doing so may be beneficial to our stockholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock.
 
Our articles of incorporation allow for our board to create new series of preferred stock without further approval by our stockholders, which could adversely affect the rights of the holders of our common stock; our Series A Preferred Stock contains provisions that restrict our ability to take certain actions without the consent of at least 66% of the Series A Preferred Stock then outstanding.
 
Our Board of Directors has the authority to fix and determine the relative rights and preferences of preferred stock. Our Board of Directors also has the authority to issue preferred stock without further stockholder approval. As a result, our Board of Directors could authorize the issuance of a series of preferred stock that would grant to holders the preferred right to our assets upon liquidation, the right to receive dividend payments before dividends are distributed to the holders of common stock and the right to the redemption of the shares, together with a premium, prior to the redemption of our common stock. In addition, our Board of Directors could authorize the issuance of a series of preferred stock that has greater voting power than our common stock or that is convertible into our common stock, which could decrease the relative voting power of our common stock or result in dilution to our existing stockholders.
 
In addition, our articles of incorporation restrict our ability to take certain actions without the approval of at least 66% of the Series A Preferred Stock then outstanding. These actions include, among other things;
 
 
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● authorizing, creating, designating, establishing or issuing an increased number of shares of Series A Preferred Stock or any other class or series of capital stock ranking senior to or on a parity with the Series A Preferred Stock;
 
● adopting a plan for the liquidation, dissolution or winding up the affairs of our company or any recapitalization plan (whether by merger, consolidation or otherwise);
 
● amending, altering or repealing, whether by merger, consolidation or otherwise, our articles of incorporation or bylaws in a manner that would adversely affect any right, preference, privilege or voting power of the Series A Preferred Stock; and
 
● declaring or paying any dividend (with certain exceptions) or directly or indirectly purchase, redeem, repurchase or otherwise acquire any shares of our capital stock, stock options or convertible securities (with certain exceptions).
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 
 
During the three months ended June 30, 2018, we had the following unregistered sales of equity securities:
 
We issued 379,000 shares of common stock to Names Executive Officers, directors, employees and consultants and for services during 2018. We expensed $110,990.
 
On April 10, 2018, we issued 2,000,000 shares of our common stock to Phillip A. Bosua under the terms of the Merger Agreement with RAAI common stock.
 
On June 25, 2018, we closed a private placement and received gross proceeds of $1,750,000 ($1,710,000 as of June 30, 2018) in exchange for issuing 7,000,000 (6,840,000 as of June 30, 2018) shares of common stock and warrants to purchase 3,500,000 (3,420,000 as of June 30, 2018) shares of common stock in a private placement to accredited investors pursuant to a series of substantially identical subscription agreements. The initial exercise price of the warrants described above is $0.25 per share, subject to certain adjustments, and they expired five years after their issuance. The shares and the warrants described above were issued in transactions that were not registered under the Securities Act of 1933, as amended (the “Act”) in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.  
 
On June 25, 2018, we issued 500,000 shares of our common stock to Phillip A. Bosua under the terms of an Employment agreement dated April 10, 2018.
 
We closed debt conversions and issued 605,000 shares of common stock in exchange for the conversion of $199,650 in preexisting debt owed by the Company to certain service providers, all of whom are accredited investors. These shares were issued in transactions that were not registered under the Act in reliance upon applicable exemptions from registration under Section 4(a)(2) of the Act and/or Rule 506 of SEC Regulation D under the Act.
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
There have been no events which are required to be reported under this item. 
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
N/A.
 
ITEM 5.
OTHER INFORMATION 
 
This item is not applicable.
 
ITEM 6.
EXHIBITS
 
The exhibits required to be filed herewith by Item 601 of Regulation S-K, as described in the following index of exhibits, are attached hereto unless otherwise indicated as being incorporated by reference, as follows:
 
(a)             Exhibits
 
Exhibit No.
 
Description
   
 
 
 
 
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