8-K: Know Labs Converts $1.18 Million Debt Held by CEO-Affiliated Entity into New Series H Preferred Stock

Know Labs, Inc. has converted approximately $1.18 million in principal debt owed to an entity affiliated with its CEO into 16,916 shares of a newly created Series H Convertible Preferred Stock, aiming to strengthen its balance sheet.

Summary

• Know Labs, Inc. (KNW) entered into a Promissory Note Conversion Agreement with J3E2A2Z LP, an entity affiliated with and controlled by CEO Ronald P. Erickson.
• The agreement converts $1,184,066 in aggregate principal owed under two outstanding Convertible Redeemable Promissory Notes, each dated January 31, 2018.
• In exchange, J3E2A2Z LP received 16,916 shares of a newly designated Series H Convertible Preferred Stock.
• The conversion rate was one share of Series H Preferred Stock for every $70.00 in principal converted.
• Upon consummation, the principal debt amount is no longer outstanding, but any accrued and unpaid interest on the original notes remains due and payable.
• The Series H Convertible Preferred Stock is convertible into common stock at an initial conversion price of $0.335 per share, subject to adjustment.
• Holders of Series H Preferred Stock are entitled to cumulative dividends at 8.0% per annum of the stated value ($70.00), payable upon conversion or when declared, either in cash or additional Series H Preferred Stock (PIK Dividend Shares).
• The Series H Preferred Stock ranks junior to Series C and D Convertible Preferred Stock but senior to common stock and any future preferred stock regarding dividend and liquidation rights.
• The issuance was made in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act, with J3E2A2Z LP representing itself as an accredited investor.

Sentiment

Score: 6

Explanation: The conversion of debt to equity is generally positive for a company's balance sheet, reducing immediate cash obligations. However, the transaction involves a related party (CEO-affiliated entity) and introduces new preferred shares with cumulative dividends and potential future dilution, which temper the overall positive sentiment. It's a necessary financial restructuring rather than a sign of strong operational performance.

Positives

• The conversion of $1.18 million in principal debt reduces the company's outstanding liabilities, potentially improving its balance sheet and reducing immediate cash outflows for debt servicing.
• The transaction was approved by the Board of Directors upon recommendation of the Nominating and Governance Committee, suggesting adherence to corporate governance procedures.
• The Series H Preferred Stock includes anti-dilution rights (price-based, full-ratchet, and proportional) protecting holders from future dilutive issuances below $0.50 per share.

Negatives

• The conversion involves a related party (CEO-affiliated entity), which can raise questions about potential conflicts of interest, although the Board committee approved it.
• Accrued and unpaid interest on the converted notes remains outstanding, meaning not all debt obligations were eliminated.
• The Series H Preferred Stock accrues cumulative dividends at 8.0% per annum, which will be an ongoing obligation for the company, potentially payable in cash or additional preferred shares, which could lead to further dilution if paid in shares.
• The company needs to amend its Articles of Incorporation to increase authorized common stock to permit full conversion of the Series H Preferred Stock, indicating a potential future administrative hurdle and potential for significant common stock dilution.
• The 19.99% beneficial ownership limitation on conversion requires stockholder approval for conversions exceeding this threshold, which could complicate future conversions for the holder.

Risks

• Dilution Risk: The Series H Convertible Preferred Stock is convertible into common stock at $0.335 per share, and dividends can be paid in additional preferred shares, leading to potential future dilution for existing common stockholders.
• Related Party Transaction Risk: The transaction involves an entity affiliated with the CEO, which, despite board approval, inherently carries a risk of perceived or actual conflicts of interest.
• Ongoing Dividend Obligation: The 8.0% cumulative dividend rate on the Series H Preferred Stock represents an ongoing financial obligation that could strain cash flow or lead to further share issuance if paid in kind.
• Shareholder Approval Risk: The 19.99% beneficial ownership limitation on conversion requires future stockholder approval for conversions beyond this threshold, which may not be obtained, potentially limiting the liquidity or conversion flexibility for the preferred shareholder.
• Liquidation Preference Risk: While senior to common stock, the Series H Preferred Stock is junior to Series C and D Convertible Preferred Stock in liquidation, meaning it would receive less in a liquidation event than those senior classes.
• Regulatory/Compliance Risk: The company must ensure it takes all necessary actions, including amending its Articles of Incorporation, to have sufficient authorized common stock for conversion, and any failure could lead to compliance issues.

Future Outlook

The company anticipates needing to amend its Articles of Incorporation to increase the authorized number of common shares to facilitate the full conversion of the newly issued Series H Preferred Stock, indicating a future administrative action required for the preferred stock's full convertibility.

Management Comments

• "The Company's Board of Directors, upon recommendation of the Nominating and Governance Committee of the Board of Directors, approved entry into the Conversion Agreement and authorized from its blank check preferred stock a new Series H Convertible Preferred Stock."
• "The issuance of the Series H Convertible Preferred Stock was made in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act."

Industry Context

This debt-to-equity conversion is a common strategy for companies, particularly those in growth or development phases, to reduce immediate cash outflows related to debt servicing and improve balance sheet liquidity. It can be a sign of a company managing its capital structure in a challenging market or preparing for future growth without incurring new cash debt.

Comparison to Industry Standards

• N/A The document does not provide sufficient information or context to compare the specific terms of this debt conversion or the Series H Preferred Stock to global industry benchmarks or specific comparable companies/projects. The terms are highly specific to Know Labs' capital structure and relationship with its CEO-affiliated entity.

Corporate Governance

Related Party Transactions

• Know Labs, Inc. entered into a Promissory Note Conversion Agreement with J3E2A2Z LP, an entity affiliated with and controlled by Ronald P. Erickson, the company's Chief Executive Officer.
• The agreement converted approximately $1.18 million in principal debt owed to J3E2A2Z LP into 16,916 shares of Series H Convertible Preferred Stock.

Stakeholder Impact

• Shareholders (Common Stock): Potential for future dilution if Series H Preferred Stock is converted into common stock or if dividends are paid in PIK Dividend Shares. The 19.99% beneficial ownership limitation requires their approval for larger conversions.
• Creditors: The conversion of $1.18 million in principal debt reduces the company's outstanding liabilities, which could be viewed positively by remaining creditors as it strengthens the balance sheet. However, accrued interest on the converted notes remains outstanding.
• Management (Ronald P. Erickson/J3E2A2Z LP): J3E2A2Z LP, affiliated with the CEO, becomes a significant preferred shareholder, gaining specific rights, including cumulative dividends, conversion options, and protective voting rights over certain corporate actions.

Next Steps

• Know Labs needs to amend its Articles of Incorporation to increase the authorized number of common shares to allow for the full conversion of the Series H Preferred Stock.
• The Series H Preferred Stock holders gain the option to convert their shares into common stock after September 30, 2025.
• The company will continue to accrue and pay any unpaid interest on the original converted notes.

Key Dates

Recommendation

Keywords

Know Labs, KNW, SEC Filing, 8-K, Debt Conversion, Preferred Stock, Series H Convertible Preferred Stock, Related Party Transaction, Ronald P. Erickson, Corporate Governance, Financial Restructuring, Equity Issuance, Dilution, Convertible Notes, Accredited Investor, NYSE American