(1) Derived from the audited consolidated balance sheet.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated condensed financial statements have been prepared by Know Labs, Inc, (“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, 2021, filed with the Securities and Exchange Commission (“SEC”) on December 21, 2021. The results of operations for the nine months ended June 30, 2022 are not necessarily indicative of the results expected for the full fiscal year, or for any other fiscal period.
1. ORGANIZATION
Know Labs, Inc. was incorporated under the laws of the State of Nevada in 1998. The Company currently has authorized 205,000,000 shares of capital stock, of which 200,000,000 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. At the annual shareholder meeting held on October 15, 2021, our authorized shares of common stock was increased to 200,000,000 shares of voting common stock, par value $0.001 per share.
Know Labs is focused on the development and commercialization of proprietary biosensor technologies which, when paired with our artificial intelligence, or AI, deep learning platform, are capable of uniquely identifying and measuring almost any material or analyte using electromagnetic energy to detect, record, identify and measure the unique “signature” of said materials or analytes. The Company call these our “Bio-RFID™” technology platform when pertaining to radio and microwave spectroscopy; and “ChromaID” technology platform when pertaining to optical spectroscopy. The data obtained with our biosensor technology is analyzed with our trade secret algorithms which are driven by our AI deep learning platform. There are a significant number of analytes in the human body that relate to health and wellness. The Company’s focus is upon those analytes relating to human health, the identification of which provide diagnostic information and require, by their nature, clearance by the United States Food and Drug Administration.
On April 30, 2020, the Company approved and ratified the incorporation of Particle, Inc. Particle is focused on the development and commercialization of our extensive intellectual property relating to electromagnetic energy outside of the medical diagnostic arena which remains the parent company’s singular focus. Since incorporation, Particle has engaged in research and development activities on threaded light bulbs that have a warm white light and can inactivate germs, including bacteria and viruses. It is now looking for partners to take the product to market.
On September 17, 2021, the Company incorporated AI Mind, Inc. AI Mind is focused on monetizing the AI Deep Learning Platform. Since incorporation it initially focused on creating graphical images which were sold as Non Fungible Tokens (“NFTs”). During the nine months ended June 30, 2022, the Company’s artificial intelligence (AI) Deep Learning Platform began generating revenue from digital asset sales of NFT’s and had sales of $4,360,087.
2. LIQUIDITY AND GOING CONCERN
The Company has cash and cash equivalents of $8,351,945 and net working capital of $6,042,208 (exclusive of convertible notes payable) as of June 30, 2022. The Company anticipates that it will record losses from operations for the foreseeable future. The Company believes that it has enough available cash to operate until June 30, 2023. As of June 30, 2022, the Company’s accumulated deficit was $95,827,137. The Company has had limited capital resources and intends to seek additional cash via equity and debt offerings.
On July 29, 2022, the Company filed a Form S-1 registration statement for a proposed new offering of 3 million shares of its common stock with an anticipated offering price of $2.00 per share. Concurrent with, and as a condition to, the offering, Know Labs will apply to uplist its shares to the NYSE American Exchange. The closing of this offering is contingent upon the successful listing of our common stock on NYSE American.
The proceeds of warrants currently outstanding, which could be exercised on a cash basis, may generate potential proceeds of up to $16,383,908.
If the new offering referenced above is not successful or the warrants are not exercised, the cash conditions may 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 consolidated financial statements for the year ended September 30, 2021 did not include an explanatory paragraph expressing the substantial doubt about the Company’s ability to continue as a going concern.
3. SIGNIFICANT ACCOUNTING POLICIES: ADOPTION OF ACCOUNTING STANDARDS
Basis of Presentation – The accompanying 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, its wholly owned subsidiaries, Particle, Inc. and AI Mind, 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.
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 2-5 years, except for leasehold improvements which are depreciated over 5 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.
Intangible Assets – Intangible assets are capitalized and amortized on a straight-line basis over their estimated useful life, if the life is determinable. If the life is not determinable, amortization is not recorded. We regularly perform reviews to determine if facts and circumstances exist which indicate that the useful lives of our intangible assets are shorter than originally estimated or the carrying amount of these assets may not be recoverable. When an indication exists that the carrying amount of intangible assets may not be recoverable, we assess the recoverability of our assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Such impairment test is based on the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Impairment, if any, is based on the excess of the carrying amount over the estimated fair value of those assets.
Revenue Recognition - The Company determines revenue recognition from contracts with customers through the following steps:
| · | identification of the contract, or contracts, with the customer; |
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| · | identification of the performance obligations in the contract; |
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| · | determination of the transaction price; |
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| · | allocation of the transaction price to the performance obligations in the contract; and |
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| · | recognition of the revenue when, or as, the Company satisfies a performance obligation. |
Revenue is recognized when control of the promised goods or services is transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. During the nine months ended June 30, 2022, the Company’s artificial intelligence (AI) Deep Learning Platform began generating revenue from digital asset sales of NFT’s. The Company engineering team, using its research date, AI and proprietary algorithms, produced NFT’s in the form of digital art. The NFT’s produced had no recorded cost basis.
Digital Asset Sales - Revenue includes sale of NFT’s in the form of digital art generated from the Company’s artificial intelligence Deep Learning Platform. The Company uses the NFT exchange, OpenSea, to facilitate the transaction with the customer. The Company, through OpenSea, has custody and control of the NFT prior to the delivery to the customer and records revenue at the point in time when the NFT is delivered to the customer and the customer pays. The Company has no obligations for returns, refunds or warranty after the NFT sale. The customer pays in the form of transferring the crypto currency digital asset, Ethereum. The value of the sale is determined based on the value of the Ethereum crypto currency received as consideration. Payment is required before the NFT is delivered. Each NFT that is generated produces a unique identifying code. The Company also earns a royalty of up to 10%, when an NFT is resold by its owner in a secondary market transaction. The Company recognizes this royalty as revenue when the transaction is consummated, and they receive compensation.
After the sale of the NFT, the Ethereum is converted to US dollars as soon as practically possible. The Company records the total value of the gross NFT sale in revenue. Costs incurred in connection with the NFT transaction are recorded in the statement of operations as Selling and Transactional Cost of Digital Assets and include costs to outside consultants, estimated employee and CEO special bonus compensation, digital asset conversion losses and estimated sales and use tax. The amount totaled $164,093 and $3,436,955 for the three and nine months ended June 30, 2022, respectively.
Research and Development Expenses – Research and development expenses consist of the cost of employees, consultants and contractors who design, engineer and develop new products and processes as well as materials, supplies and facilities used in producing prototypes.
The Company’s current research and development efforts are primarily focused on improving our Bio-RFID technology, extending its capacity and developing new and unique applications for this technology. As part of this effort, the Company conducts on-going laboratory testing to ensure that application methods are compatible with the end-user and regulatory requirements, and that they can be implemented in a cost-effective manner. The Company also is actively involved in identifying new applications. The Company’s current internal team along with outside consultants has considerable experience working with the application of the Company’s technologies and their applications. The Company engages third party experts as required to supplement our internal team. The Company believes that continued development of new and enhanced technologies is essential to our future success. The Company incurred expenses of $3,406,996, $3,969,972 and $2,033,726 for the nine months ended June 30, 2022 and the years ended September 30, 2021 and 2020, respectively, on development activities.
Advertising – Advertising costs are charged to selling, general and administrative expenses as incurred. Advertising and marketing costs for the nine months ended June 30, 2022 and 2021 were $514,401 and $240,000, respectively.
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, 2022 and September 30, 2021 are based upon the short-term nature of the assets and liabilities.
The Company has a money market account which is considered a level 1 asset. The balance as of June 30, 2022 and September 30, 2021 was $6,041,016 and $12,217,714, respectively.
Derivative Financial Instruments –Pursuant to ASC 815 “Derivatives and Hedging”, the Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. The Company then determines if embedded derivative must be bifurcated and separately accounted for. 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.
The Company determined that the conversion features for purposes of bifurcation within convertible notes payable were immaterial and there was no derivative liability to be recorded as of June 30, 2022 and September 30, 2021.
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 and warrants to purchase shares of Company common stock at the fair market value at the time of grant. Stock-based compensation cost to employees is measured by the Company at the grant date, based on the fair value of the award, over the requisite service period under ASC 718. For options issued to employees, the Company recognizes stock compensation costs utilizing the fair value methodology over the related period of benefit.
Convertible Securities – Based upon ASC 815-15, the Company has adopted a sequencing approach regarding the application of ASC 815-40 to convertible securities. The Company 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 the Company’s 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. As of June 30, 2022, the Company had 43,802,147 shares of common stock issued and outstanding. As of June 30, 2022, there were options outstanding for the purchase of 20,927,370 common shares (including unearned stock option grants totaling 11,550,745 shares related to performance targets), warrants for the purchase of 21,651,513 common shares, and 8,108,356 shares of our common stock issuable upon the conversion of Series C and Series D Convertible Preferred Stock. In addition, the Company currently has 9,020,264 common shares at the current price of $0.25 per share reserved and are issuable upon conversion of convertible debentures of $2,255,066. All of which could potentially dilute future earnings per share but are excluded from the June 30, 2022, calculation of net loss per share because their impact is antidilutive.
As of June 30, 2021, the Company had 33,719,669 shares of common stock issued and outstanding. As of June 30, 2021, there were options outstanding for the purchase of 14,650,120 common shares (including unearned stock option grants totaling 11,775,745 shares related to performance targets), warrants for the purchase of 23,169,587 common shares, and 8,108,356 shares of the Company’s common stock issuable upon the conversion of Series C and Series D Convertible Preferred Stock. In addition, the Company currently has 16,124,764 common shares (9,020,264 common shares at the current price of $0.25 per share and 7,104,500 common shares at the current price of $2.00 per share) reserved and are issuable upon conversion of convertible debentures of $16,464,066. All of which could potentially dilute future earnings per share but are excluded from the June 30, 2021 calculation of net loss per share because their impact is antidilutive.
Comprehensive loss – Comprehensive loss is defined as the change in equity of a business during a period from non-owner sources. There were no differences between net loss for the nine months ended June 30, 2022 and 2021 and comprehensive loss for those periods.
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 In August 2020, the FASB issued Accounting Standards Update (“ASU”) No. 2020-06, Debt -- debt with Conversion and Other Options (Subtopic470-20) and Derivatives and Hedging --Contracts in Entity’ Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’ Own Equity (“ASU 2020-06”), which simplifies accounting for convertible instruments by removing major separation models required under current GAAP. The ASU also removes certain settlement conditions that are required for equity-linked contracts to qualify for the derivative scope exception, and it simplifies the diluted earnings per share calculation in certain areas. The new standard is effective for the Company on October 1, 2021. Adoption of the ASU did not have an impact to the Company’s financial position, results of operations or cashflows.
Based on the Company’s review of accounting standard updates issued since the filing of the June 30, 2022 Form 10-Q, there have been no other newly issued or newly applicable accounting pronouncements that have had, or are expected to have, a significant impact on the Company’s consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
4. Artificial Intelligence (AI) Deep Learning Platform
AI Revenue
During the nine months ended June 30, 2022, the Company’s artificial intelligence (AI) Deep Learning Platform began generating revenue from digital asset sales of NFT’s and had sales of $4,360,087. The Company’s sales of NFT’s are generated using the NFT digital exchange, OpenSea. Customers purchasing the NFT’s must make payments in the crypto currency, Ethereum. The Ethereum is received into a digital wallet and then moved to an account at Coinbase where the Ethereum is converted to U.S. dollars. During the three months ended December 31, 2021, the Company was not able to establish a digital wallet and corporate account at Coinbase in order to receive the Ethereum. The Company used the digital wallet and Coinbase account of the Company’s CEO. The Company and the CEO executed an assignment of his account to the Company while the Company establishes its own Coinbase account. All proceeds received from the sale of NFT were deposited in the CEO’s personal digital accounts. As of December 31, 2021 the Company had recorded an accounts receivable-related party of $3,124,581 for the cash it expected to receive from the CEO’s personal digital account.
The Company has established a digital wallet and corporate account at Circle in order to receive the Ethereum and then convert it to cash. During 2022, the Company received $2,908,551 of Ethereum which was converted to cash and recorded a reduction in value of $169,884 related to the decline in value of the Ethereum. The accounts receivable-related party was $46,146 as of June 30, 2022. As of June 30, 2022, accrued expenses include $436,378 of expenses, primarily sales and use tax and other expenses. As of June 30, 2022 accrued expenses-related party include $799,353 of unpaid compensation that was due and payable to the CEO for the NFT revenue. This unpaid compensation was paid in July 2022. During 2021, approximately $1.3 million of the selling and transactional costs for the digital assets was paid through the CEO’s personal digital asset account including approximately $1.075 million which was paid to a consultant via the transfer of Ethereum.
5. PROPERTY AND EQUIPMENT
Property and equipment as of June 30, 2022 and September 30, 2021 was comprised of the following:
| | Estimated | | June 30, | | | September 30, | |
| | Useful Lives | | 2022 | | | 2021 | |
| Machinery and equipment | | 2-3 years | | $ | 1,498,355 | | | $ | 654,798 | |
| Leasehold improvements | | 5 years | | | 3,612 | | | | 3,612 | |
| Furniture and fixtures | | 5 years | | | 26,855 | | | | 26,855 | |
| Less: accumulated depreciation | | | | | (575,444 | ) | | | (356,761 | ) |
| | | | $ | 953,378 | | | $ | 328,504 | |
Total depreciation expense was $218,683 and $64,980 for the nine months ended June 20, 2022 and 2021, respectively. $207,440 and $10,918 of depreciation was recorded for research and development and selling, general and administrative purposes, respectively, for the nine months ended June 30, 2022. $0 and $64,980 of depreciation was recorded for research and development and selling, general and administrative purposes, respectively, for the nine months ended June 30, 2021.
6. LEASES
The Company has entered into operating leases for office and development facilities. These leases have terms which range from two to three years and include options to renew. These operating leases are listed as separate line items on the Company's June 30, 2022 and September 30, 2021 Consolidated Balance Sheets and represent the Company’s right to use the underlying asset for the lease term. The Company’s obligation to make lease payments are also listed as separate line items on the Company's June 30, 2022 and September 30, 2021 Consolidated Balance Sheets. Based on the present value of the lease payments for the remaining lease term of the Company's existing leases, the Company recognized right-of-use assets and lease liabilities for operating leases of approximately $262,242 as of June 30, 2022. Operating lease right-of-use assets and liabilities commencing after October 1, 2018 are recognized at commencement date based on the present value of lease payments over the lease term. During years ended June 30, 2022 and September 30, 2021, the Company amended two leases and recognized the rent payments as an expense in the current period. As of June 30, 2022 and September 30, 2021, total operating lease liabilities for remaining long term lease was approximately $243,076 and $290,000, respectively. In the nine months ended June 30, 2022 and 2021, the Company recognized approximately $130,767 and $102,741, respectively in total lease costs for the leases.
Because the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments.
Information related to the Company's operating right-of-use assets and related lease liabilities as of and for the year ended June 30, 2022 was as follows:
Cash paid for ROU operating lease liability $159,112
Weighted-average remaining lease term 20 months
Weighted-average discount rate 7%
The minimum future lease payments as of June 30, 2022 are as follows:
Years Ended June 30, | | $ | |
2023 | | $ | 156,253 | |
2024 | | | 118,602 | |
Total remaining payments | | | 274,855 | |
Less Imputed Interest | | | (12,629 | ) |
Total lease liability | | $ | 262,226 | |
7. CONVERTIBLE NOTES PAYABLE AND NOTE PAYABLE
Convertible notes payable as of June 30, 2022 and September 30, 2021 consisted of the following:
Convertible Promissory Notes with Clayton A. Struve
The Company owes Clayton A. Struve $1,071,000 under convertible promissory or OID notes. The Company recorded accrued interest of $84,671 and $79,062 as of June 30, 2022 and September 30, 2021, respectively. On May 3, 2022, the Company signed Amendments to the convertible promissory or OID notes, extending the due dates to September 30, 2022.
Convertible Redeemable Promissory Notes with Ronald P. Erickson and J3E2A2Z
On March 16, 2018, 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. 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 $269,383 and $216,246 as of June 30, 2022 and September 30, 2021, respectively. On April 4, 2022, the Company approved Amendments to the convertible redeemable promissory notes with Ronald P. Erickson and J3E2A2Z, extending the due dates to September 30, 2022.
Convertible Debt Offering
Beginning in 2019, the Company entered into series of debt offerings with similar and consistent terms. The Company issued Subordinated Convertible Notes and Warrants in a private placement to accredited investors, pursuant to a series of substantially identical Securities Purchase Agreements, Common Stock Warrants, and related documents. The notes are convertible into one share of common stock for each dollar invested in a Convertible Note Payable and automatically convert to common stock after one year. The convertible notes contain terms and conditions which are deemed to be a Beneficial Conversion Feature (BCF). Warrants are issued to purchase common stock with exercise prices of $1.20 and $2.40 per share and the number of warrants are equal to 50% of the convertible note balance. The Company compensates the placement agent with a cash fee and warrants. Through June 30, 2022, the Company has raised approximately $24 million through these offerings, of which $14,209,000 and $5,639,500 were raised in the years ended September 30, 2021 and 2020, respectively.
During the year ended September 30, 2021, the Company issued 6,091,960 shares of common stock related to the automatic conversion of Convertible Notes and interest from a private placement to accredited investors in 2020. The Convertible Notes and interested were automatically converted to Common Stock at $1.00 per share on the one year anniversary starting on October 17, 2020.
The Convertible Notes issued during the year ended September 30, 2021 are initially convertible into 7,104,500 shares of Common Stock, subject to certain adjustments, and the Warrants are initially exercisable for 3,552,250 shares of Common Stoc. As of June 30, 2022 all convertible notes and accrued interest had been converted to common stock.
The fair value of the Warrants issued to debt holders during the year ended September 30, 2021 was $4,439,317 on the date of issuance and was amortized over the one-year term of the Convertible Notes. The fair value of the warrants was recorded as debt discount (with an offset to APIC) and was amortized over the one-year term of the Convertible Notes.
In connection with the debt offering during the year ended September 30, 2021, the placement agent for the Convertible Notes and the Warrants received a cash fee of $727,117 and warrants to purchase 492,090 shares of the Company’s common stock, all based on 2-8% of gross proceeds to the Company. The warrants issued for these services had a fair value of $1,667,281 at the date of issuance. The fair value of the warrants was recorded as debt discount (with an offset to APIC) and will be amortized over the one-year term of the Convertible Notes. The $727,117 cash fee was recorded as issuance costs and was amortized over the one-year term of the related Convertible Notes.
During the year ended September 30, 2021, the Company recorded a debt discount of $9,769,683 associated with a beneficial conversion feature on the debt, which was accreted to interest expense using the effective interest method over the one-year term of the Convertible Notes.
During the nine months ended June 30, 2022, amortization related to the debt offerings of $7,272,911 and $4,184,657 of the beneficial conversion feature, warrants issued to debt holders and placement agent was recognized as interest expense in the consolidated statements of operations.
Convertible notes payable as of June 30, 2022 and September 30, 2021 are summarized below:
| | June 30, 2022 | | | September 30, 2021 | |
| Convertible note- Clayton A. Struve | | $ | 1,071,000 | | | $ | 1,071,000 | |
| Convertible note- Ronald P. Erickson and affiliates | | | 1,184,066 | | | | 1,184,066 | |
| 2020 Convertible notes | | | - | | | | 5,639,500 | |
| 2021 Convertible notes | | | 14,209,000 | | | | 14,209,000 | |
| Boustead fee refund (originally booked as contra debt) | | | - | | | | 50,000 | |
| Less conversions of notes | | | (14,209,000 | ) | | | (5,639,500 | ) |
| Less debt discount - BCF | | | - | | | | (4,308,337 | ) |
| Less debt discount - warrants | | | - | | | | (1,957,590 | ) |
| Less debt discount - warrants issued for services | | | - | | | | (1,056,984 | ) |
| | $ | 2,255,066 | | | $ | 9,191,155 | |
Note Payable-PPP Loans
On April 30, 2020, the Company received $226,170 under the Paycheck Protection Program of the U.S. Small Business Administration’s 7(a) Loan Program pursuant to the Coronavirus, Aid, Relief and Economic Security Act (CARES Act), Pub. Law 116-136, 134 Stat. 281 (2020). As of March 31, 2022 and September 30, 2021, the Company recorded interest expense of $4,350 and $3,222, respectively. On April 27, 2022, the Company was notified by the SBA that the Company is required to repay principal of $98,106 and interest of $1,997. The remaining loan and accrued interest balances were forgiven. .
On February 1, 2021, the Company received $205,633 under the Paycheck Protection Program of the U.S. Small Business Administration’s 7(a) Loan Program pursuant to the Coronavirus, Aid, Relief and Economic Security Act (CARES Act), Pub. Law 116-136, 134 Stat. 281 (2020). As of June 30, 2022 and September 30, 2021, the Company recorded interest expense of $2,721 and $1,268, respectively. On June 11, 2022, the Company was notified by the SBA that the Company is required to repay principal of $78,843 and interest of $1,057. The remaining loan and accrued interest balances were forgiven.
As a result of a portion of these loans being forgiven, the Company recognized a gain on loan forgiveness of approximately $253,000 which is included in other income.
EQUITY
Authorized Capital Stock
The Company was incorporated under the laws of the State of Nevada in 1998. The Company has authorized 205,000,000 shares of capital stock, of which 200,000,000 are shares of voting common stock, par value $0.001 per share, and 5,000,000 are “blank check” preferred stock, par value $0.001 per share. As of June 30, 2022, the Company had 43,826,781 shares of common stock and 2,801,719 shares of preferred stock issued and outstanding.
As of June 30, 2022, there were options outstanding for the purchase of 20,927,370 common shares (including unearned stock option grants totaling 11,550,745 shares related to performance targets), warrants for the purchase of 21,651,513 common shares, and 8,108,356 shares of our common stock issuable upon the conversion of Series C and Series D Convertible Preferred Stock. In addition, the Company currently has 9,020,264 common shares at the current price of $0.25 per share reserved and are issuable upon conversion of convertible debentures of $2,255,066. All of which could potentially dilute future earnings per share but are excluded from the June 30, 2022, calculation of net loss per share because their impact is antidilutive.
Annual Shareholder Meeting
On October 15, 2021, the Company held its annual shareholder meeting. The Company’s shareholders approved and adopted various motions as detailed in the Company’s Form 8-K that was filed with the SEC on October 19, 2021.
Second Amended and Restated Bylaws
On October 15, 2021, the shareholders of the Company approving the Second Amended and Restated Bylaws effective October 15, 2021.
Certificate of Amendment to Articles of Incorporation
On December 6, 2021, the Company received approval from the State of Nevada for a Certificate of Amendment to the Articles of Incorporation related to the increase in the number of authorized common shares.
Series C and D Preferred Stock and Warrants
On August 5, 2016, the Company closed a Series C Preferred Stock and Warrant Purchase Agreement with Clayton A. Struve, an accredited investor for the purchase of $1,250,000 of preferred stock with a conversion price of $0.70 per share. The preferred stock has a yield of 8% and an ownership blocker of 4.99%. In addition, Mr. Struve received a five-year warrant to acquire 1,785,714 shares of common stock at $0.70 per share. On August 14, 2017, the price of the Series C Stock were adjusted to $0.25 per share pursuant to the documents governing such instruments. On June 30, 2022 and September 30, 2021 there are 1,785,715 Series C Preferred shares outstanding. On May 3, 2022, the Company approved the Extension of Warrant Agreement with Clayton Struve, extending the exercise dates to August 4, 2024.
As of June 30, 2022 and September 30, 2021, the Company has $750,000 of Series D Preferred Stock outstanding with Clayton A. Struve, an accredited investor. On August 14, 2017, the price of the Series D Stock were adjusted to $0.25 per share pursuant to the documents governing such instruments. The Series D Preferred Stock is convertible into shares of common stock at a price of $0.25 per share or by multiplying the number of Series D Preferred Stock shares by the stated value and dividing by the conversion price then in effect, subject to certain diluted events, and has the right to vote the number of shares of common stock the Series D Preferred Stock would be issuable on conversion, subject to a 4.99% blocker. The Preferred Series D has an annual yield of 8% The Series D Preferred Stock is convertible into shares of common stock at a price of $0.25 per share or by multiplying the number of Series D Preferred Stock shares by the stated value and dividing by the conversion price then in effect, subject to certain diluted events, and has the right to vote the number of shares of common stock the Series D Preferred Stock would be issuable on conversion, subject to a 4.99% blocker. The Preferred Series D has an annual yield of 8% if and when dividends are declared.
Series F Preferred Stock
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 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. As of June 30, 2022 and September 30, 2021, there are no Series F shares outstanding.
Securities Subject to Price Adjustments
If in the future, if the Company sells its common stock at a price below $0.25 per share, the conversion price of 8,108,356 outstanding shares of Series C and D Preferred Stock would adjust below $0.25 per share pursuant to the documents governing such instruments. In addition, the conversion price of Convertible Notes Payable in the principal amount of $2,255,066, that convert into 9,020,264 shares of our common stock at $0.25 per share and the exercise price of certain outstanding warrants to purchase 10,284,381 shares of common stock would adjust below $0.25 per share pursuant to the documents governing such instruments. Warrants totaling 4,487,207 would adjust below $1.20 per share and warrants totaling 3,954,625 would adjust below $2.40 per share, in each case pursuant to the documents governing such instruments.
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.
Nine Months Ended June 30, 2022
During the nine months ended June 30, 2022, the Company issued 863,986 shares of common stock related to warrant exercises and received $793,986.
During the nine months ended June 30, 2022, the Company issued 8,750 shares related to the exercise of stock option grants and received $13,688.
The Company issued 7,672,860 shares of common stock related to the automatic conversion of Convertible Notes and interest from a private placement to accredited investors in 2021. The Convertible Notes and interested were automatically converted to Common Stock at $2.00 per share on the one year anniversary in March 2022.
On January 5, 2022, the Company issued 30,000 shares each to three directors shares at an exercise price of $1.70 per share.
Warrants to Purchase Common Stock
Nine Months Ended June 30, 2022
On January 5, 2022, the Company issued 20,000 warrants to purchase common stock each to three directors shares at $1.70 per share. The warrants expire on January 5, 2027.
During the nine months ended June 30, 2022, warrants to purchase 108,756 shares of common stock at $1.00 per share expired.
Extension of Warrant Agreement with Clayton A. Struve
On May 3, 2022, the Company approved the Extension of Warrant Agreement with Clayton Struve, extending the exercise dates as follows:
Warrant No./Class | | Issue Date | | No. Warrant Shares | | | Exercise Price | | | Original Expiration Date | | Amended Expiration Date | |
Clayton A. Struve Warrant | | 08-14-2017 | | | 1,440,000 | | | $ | 0.25 | | | 08-13-2023 | | 08-13-2024 | |
Clayton A. Struve Warrant | | 12-12-2017 | | | 1,200,000 | | | $ | 0.25 | | | 12-11-2023 | | 12-11-2024 | |
Clayton A. Struve Warrant | | 08-04-2016 | | | 1,785,715 | | | $ | 0.25 | | | 08-04-2023 | | 08-04-2024 | |
Clayton A. Struve Warrant | | 02-28-2018 | | | 1,344,000 | | | $ | 0.25 | | | 02-28-2023 | | 02-28-2024 | |
The Company recorded interest expense of $244,260 during the nine months ended June 30, 2022 related to the extension of the warrants.
| | June 30, 2022 | |
| | | | | Weighted | |
| | | | | Average | |
| | | | | Exercise | |
| | Shares | | | Price | |
Outstanding at beginning of period | | | 22,564,255 | | | $ | 0.998 | |
Issued | | | 60,000 | | | | - | |
Exercised | | | (863,986 | ) | | | (0.919 | ) |
Forfeited | | | - | | | | - | |
Expired | | | (108,756 | ) | | | (1.000 | ) |
Outstanding at end of period | | | 21,651,513 | | | $ | 1.003 | |
Exerciseable at end of period | | | 21,651,513 | | | | | |
The following table summarizes information about warrants outstanding and exercisable as of June 30, 2022:
| | | June 30, 2022 | |
| | | Weighted | | | Weighted | | | | | | Weighted | |
| | | Average | | | Average | | | | | | Average | |
Number of | | | Remaining | | | Exercise | | | Shares | | | Exercise | |
Warrants | | | Life ( In Years) | | | Price | | | Exerciseable | | | Price | |
| 10,729,381 | | | | 4.79 | | | $ | 0.250 | | | | 10,729,381 | | | $ | 0.250 | |
| | | | | | | | | | | | | | | | | | |
| 6,547,207 | | | | 2.59 | | | 1.20-1.85 | | | | 6,547,207 | | | 1.20-1.85 | |
| 4,364,925 | | | | 3.77 | | | 2.00-2.40 | | | | 4,364,925 | | | 2.00-2.40 | |
| 10,000 | | | | 1.00 | | | | 4.080 | | | | 10,000 | | | | 4.080 | |
| 21,651,513 | | | | 3.43 | | | $ | 1.003 | | | | 21,651,513 | | | $ | 1.003 | |
There were vested warrants of 21,651,513 with an aggregate intrinsic value of $31,557,563.
9. STOCK INCENTIVE PLANS
2021 Equity Incentive Plan
The Company initially had 20,000,000 shares of its common stock authorized as the maximum number of shares of the Company’s common stock that may be delivered to participants under the 2021 Plan, subject to adjustment for certain corporate changes affecting the shares, such as stock splits. This number was increased to 22,000,000 shares of common stock as of January 1, 2022 as a result of the automatic share reserve increase. Shares subject to an award under the 2021 Plan for which the award is canceled, forfeited or expires again become available for grants under the 2021 Plan. Shares subject to an award that is settled in cash will not again be made available for grants under the 2021 Plan. As of the date of this report on Form 10-Q, 15,722,750 shares of our common stock remain available for issuance under the 2021 Plan. The 2021 Plan also authorizes for issuance the sum of (A) any shares of our common stock that, as of the date of stockholder approval of the 2021 Plan, have been reserved but not issued pursuant to any awards granted under our 2011 Stock Incentive Plan, as amended, or the 2011 Plan, and (B) any shares of our common stock subject to stock options or similar awards granted under the 2011 Plan that, after the date of stockholder approval of the 2021 Plan, expire or otherwise terminate without having been exercised in full and shares of our common stock issued pursuant to awards granted under the 2011 Plan that are forfeited to or repurchased by us, with the maximum number of shares of our common stock to be added to the 2021 Plan pursuant to clause (ii) equal to 14,650,120.
Nine Months Ended June 30, 2022
On December 16, 2021, the Company issued a stock option grant to Ronald P. Erickson for 1,000,000 shares at an exercise price of $2.09 per share. The stock option grant expires in five years. The stock option grant vests quarterly over four years.
On December 16, 2021, the Company issued a stock option grant to Phillip A. Bosua for 1,300,000 shares at an exercise price of $2.09 per share. The stock option grant expires in five years. The stock option grant vests quarterly over four years.
On May 20, 2022, the Company issued a stock option grant to Peter Conley for 1,000,000 shares at an exercise price of $1.48 per share. The stock option grant expires in five years. The stock option grant vests quarterly over four years after two quarters.
During the nine months ended June 30, 2022, the Compensation committee also issued stock option grants to eighteen employees and consultants for 3,146,000 shares at an average exercise price of $1.699 per share. The stock option grants expire in five years. The stock option grant primarily vest quarterly over four years.
During the nine months ended June 30, 2022, the Company issued 8,750 shares related to the exercise of stock option grants and received $13,688.
During the nine months ended June 30, 2022, five employees and consultants forfeited stock option grants for 825,000 shares at an average $1.838 per share.
There are currently 20,927,370 (including unearned stock option grants totaling 11,550,745 shares related to performance milestones) options to purchase common stock at an average exercise price of $1.628 per share outstanding as of June 30, 2022 under the 2021 Stock Incentive Plan. The Company recorded $1,555,875 and $570,514 of compensation expense, net of related tax effects, relative to stock options for the nine months ended June 30, 2022 and 2021, respectively in accordance with ASC 718. As of June 30, 2022, there is $7,065,596, net of forfeitures, 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 4.15 years.
Stock option activity for the nine months ended June 30, 2022 and the years ended September 30, 2021 and 2020 was as follows:
| | Weighted Average | |
| | Options | | | Exercise Price | | | Proceed $ | |
Outstanding as of October 1, 2019 | | | 4,532,668 | | | $ | 2.025 | | | $ | 9,180,369 | |
Granted | | | 3,085,000 | | | | 1.142 | | | | 3,522,400 | |
Exercised | | | (73,191 | ) | | | (0.250 | ) | | | (18,298 | ) |
Forfeitures | | | (2,739,477 | ) | | | (2.593 | ) | | | (7,103,921 | ) |
Outstanding as of September 30, 2020 | | | 4,805,000 | | | | 1.161 | | | | 5,580,550 | |
Granted | | | 10,650,745 | | | | 1.766 | | | | 18,807,990 | |
Exercised | | | (20,625 | ) | | | (1.359 | ) | | | (28,031 | ) |
Forfeitures | | | (120,000 | ) | | | (3.300 | ) | | | (396,000 | ) |
Outstanding as of September 30, 2021 | | | 15,315,120 | | | | 1.565 | | | | 23,964,509 | |
Granted | | | 6,446,000 | | | | 1.805 | | | | 11,632,130 | |
Exercised | | | (8,750 | ) | | | (1.564 | ) | | | (13,688 | ) |
Forfeitures | | | (825,000 | ) | | | (1.838 | ) | | | (1,516,150 | ) |
Outstanding as of June 30, 2022 | | | 20,927,370 | | | $ | 1.628 | | | $ | 34,066,802 | |
The following table summarizes information about stock options outstanding and exercisable as of June 30, 2022:
| | | | | | Weighted | | | Weighted | | | | | | Weighted | |
| | | | | | Average | | | Average | | | | | | Average | |
Range of | | | Number | | | Remaining Life | | | Exercise Price | | | Number | | | Exercise Price | |
Exercise Prices | | | Outstanding | | | In Years | | | Outstanding | | | Exerciseable | | | Exerciseable | |
| $ | 0.25 | | | | 230,000 | | | | 0.96 | | | $ | 0.250 | | | | 201,250 | | | $ | 0.250 | |
1.10-1.25 | | | | 2,930,625 | | | | 2.35 | | | | 1.101 | | | | 548,307 | | | | 1.105 | |
1.28-1.67 | | | | 12,330,745 | | | | 2.46 | | | | 1.503 | | | | 1,175,521 | | | | 1.303 | |
1.79-3.67 | | | | 5,436,000 | | | | 4.25 | | | | 1.195 | | | | 665,063 | | | | 1.917 | |
| | | | | 20,927,370 | | | | 4.15 | | | | 1.628 | | | | 2,590,141 | | | $ | 1.241 | |
There are stock option grants of 20,927,370 shares as of June 30, 2022 with an aggregate intrinsic value of $22,540,075.
As of September 30, 2021, the 2020 Particle Stock Incentive Plan, was terminated and all stock option grants were cancelled by the participants. The Company recorded $197,553 and $833,771 of compensation expense, net of related tax effects, relative to Particle stock options for the years ended September 30, 2021 and 2020 and in accordance with ASC 718.
10. SIGNIFICANT AND OTHER TRANSACTIONS WITH RELATED PARTIES
Transactions with Clayton Struve
See Notes 7 and 8 for related party transactions with Clayton A. Struve.
The Company owes Clayton A. Struve $1,071,000 under convertible promissory or OID notes. The Company recorded accrued interest of $84,671 and $79,062 as of June 30, 2022 and September 30, 2021, respectively. On May 3, 2022, the Company signed Amendments to the convertible promissory or OID notes, extending the due dates to September 30, 2022.
Related Party Transactions with Ronald P. Erickson
See Notes 7, 9, and 11 for related party transactions with Ronald P. Erickson.
On December 16, 2021, the Company issued a stock option grant to Ronald P. Erickson for 1,000,000 shares at an exercise price of $2.09 per share. The stock option grant expires in five years. The stock option grant vests quarterly over four years.
Mr. Erickson and/or entities with which he is affiliated also have accrued compensation, travel and interest of approximately $274,640 and $421,599 as of June 30, 2022 and September 30, 2021, respectively.
During the nine months ended June 30, 2022, the Company paid $120,000 of salaries to Mr. Erickson that were previously accrued and reported but were deferred.
Related Party Transaction with Phillip A. Bosua
See Notes 9 and 11 for related party transactions with Phillip A. Bosua.
On December 16, 2021, the Company issued a stock option grant to Phillip A. Bosua for 1,300,000 shares at an exercise price of $2.09 per share. The stock option grant expires in five years. The stock option grant vests quarterly over four years.
As of December 31, 2021 the Company had recorded an accounts receivable-related party of $3,124,581 for the cash it expected to receive from the CEO’s personal digital account.
The Company has established a digital wallet and corporate account at Circle in order to receive the Ethereum and then convert it to cash. The Company received $2,908,551 of Ethereum and recorded a reduction in value of $169,884 related to the decline in value of the Ethereum. The accounts receivable-related party was $46,146 as of June 30, 2022. As of June 30, 2022, accrued expenses include approximately $436,378 of expenses, primarily sales and use tax and other expenses. As of June 30, 2022 accrued expenses-related party include $799,353 of unpaid compensation that was due and payable to the CEO for the NFT revenue. This unpaid compensation was paid in July 2022 During 2021, approximately $1.3 million of the selling and transactional costs for the digital assets was paid through the CEO’s personal digital asset account including approximately $1.075 million which was paid to a consultant via the transfer of Ethereum.
Related Party Transactions with Directors
On January 5, 2022, the Company issued 30,000 shares each to three directors shares at an exercise price of $1.70 per share.
On January 5, 2022, the Company issued 20,000 warrants to purchase common stock each to three directors shares at $1.70 per share. The warrants expire on January 5, 2027.
