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APDN > SEC Filings for APDN > Form 10-Q on 15-May-2013All Recent SEC Filings

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Form 10-Q for APPLIED DNA SCIENCES INC


15-May-2013

Quarterly Report


Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Unaudited Condensed Consolidated Financial Statements and Notes thereto, included elsewhere within this report. The Quarterly Report contains forward-looking statements , including statements using terminology such as "can", "may", "believe", "designated to", "will", "expect", "plan", "anticipate", "estimate", "potential" or "continue", or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. You should read statements that contain these words carefully because they:

? discuss our future expectations;
? contain projections of our future results of operations or of our financial condition; and
? state other "forward-looking" information.

We believe it is important to communicate our expectations. However, forward looking statements involve risks and uncertainties and our actual results and the timing of certain events could differ materially from those discussed in forward-looking statements as a result of certain factors, including those set forth under "Risk Factors," "Business" and elsewhere in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to us as of the date thereof, and we assume no obligations to update any forward-looking statement or risk factor, unless we are required to do so by law.

Introduction

We are a provider of botanical-DNA based security and authentication solutions that can help protect products, brands and intellectual property of companies, governments and consumers from theft, counterfeiting, fraud and diversion. SigNature® DNA, SmartDNA®, DNANet®, BioMaterial Genotyping™, digitalDNA™, and Cashield® our principal anti-counterfeiting and product authentication solutions, can be used in numerous industries, including cash-in-transit (transport and storage of banknotes), microcircuits and other electronics, homeland security, textiles and apparel, identity cards and other secure documents, law enforcement, pharmaceuticals, wine, and luxury consumer goods.

SigNature DNA. We use the DNA of plants to manufacture highly customized and encrypted botanical DNA markers, or SigNature DNA Markers, which we believe are virtually impossible to replicate. We have embedded SigNature DNA Markers into a range of our customers' products, including various inks, dyes, textile treatments, thermal ribbon, thread, varnishes and adhesives. These items can then be tested for the presence of SigNature DNA Markers through an instant field detection or a forensic level authentication. Our SigNature DNA solution provides a secure, accurate and cost-effective means for users to incorporate our SigNature DNA Markers in, and then quickly and reliably authenticate and identify, a broad range of items, such as recovered banknotes, branded textiles and apparel products, microcircuits and other electronics, pharmaceuticals and cosmetic products, identity cards and other secure documents, digital media, artwork and collectibles and fine wine. Having the ability to reliably authenticate and identify counterfeit versions of such items enables companies and governments to detect, deter, interdict and prosecute counterfeiting enterprises and individuals.

SmartDNA. SmartDNA is a unique and patented security system based on botanical DNA, a new and effective crime protection system for stores, warehouses, banks, pharmacies, ATMs and the protection of valuables. The system contains a water-based, non-toxic spray which may be triggered during a crime, marking the perpetrator and remaining on their person for weeks after the crime. Each SmartDNA product is designed to be unique to each store, warehouse or sting operation allowing the police and prosecutors to link criminals to the crimes.

DNANet. We have recently developed DNANet tactical DNA products for law enforcement, in the form of DNA-marked sprays and liquids. These products, which are being marketed to global police forces, were created to help link criminals to crimes. DNANet is a tactical forensic system providing unique DNA codes for covert operations that require absolute proof of authentication. DNANet is now included in the SmartDNA family of products.

BioMaterial GenoTyping. Our BioMaterial GenoTyping solution refers to the development of genetic assays to distinguish between varieties or strains of biomaterials, such as cotton, wool, tobacco, fermented beverages, natural drugs and foods, that contain their own source DNA. We have developed two proprietary genetic tests (FiberTyping™ and PimaTyping™) to track American Pima cotton from the field to finished garments. These genetic assays provide the cotton industry with what we believe to be the first authentication tools that can be applied throughout the U.S. and global cotton industry from cotton growers, mills, wholesalers, distributors, manufacturers and retailers through trade groups and government agencies.


digitalDNA. digitalDNA is a DNA-secured form of the QR ("quick read") code. digitalDNA is a new security tool that utilizes the flexibility of mobile communications, the instant accessibility of secure, cloud-based data, and the absolute certainty of DNA to make item tracking and authentication fast, easy and definitive, while providing the opportunity to create a new and exciting customer interface. The product uses forensic authentication of a botanical DNA marker, sequence-encrypted within a secure QR code, and physically included within the ink used to digitally print the code. The resulting pattern or "rune" can be scanned via an Apple-approved app with an iPhone to assure originality. These mobile scans can be performed anywhere along the supply chain without limit. Tracking information is fed into "tunable algorithms" that use pattern recognition to automatically identify supply-chain risks, for counterfeits or product diversion. Rapid-reading reporters, associated with the DNA marker, are also embedded in the ink, and prevent the secure code from being digitally copied.

The digitalDNA platform is designed to meet compliance specifications defined by the PCI (Payment Card Industry) Security Standards Council, the new and strict standards developed for handling credit card transactions, and HIPAA (Health Insurance Portability and Accountability Act), the stringent requirements for protecting personal health information.

Cashield. Cashield is a family of cash degradation inks that permanently stain banknotes stolen from cash-handling or ATM systems. Cashield extends our offering beyond our prior singular product, AzSure®, to a family of security inks that include Red, Violet, Green, Teal, Indigo, and the original AzSure® Blue. Current degradation dyes suffer from a critical technical weakness, as the dyes may be removed by the use of solvents. We initiated the development of Cashield in response to demand for a more effective carrier for our SigNature DNA markers. Cashield has been certified for use in the European Union by the Laboratoire National de Métrologie et d'Essais (LNE) and passed all 47 individual dye penetration and wash-out-resistance tests. Additionally, a CViT study presented by the University of Leeds cited Cashield AzSure Blue ink as having improved performance versus staining inks from other suppliers. In this study, the AzSure Blue ink was tested across a range of currencies, including British pounds, Euros, and U.S. dollars. The evaluation involved exposure to numerous industrial solvents. Final analysis of the results concluded that the AzSure Blue ink was bound strongly in five seconds or less to a variety of banknotes, and could not be removed with any solvent.

Plan of Operations

General

To date, the substantial portion of our revenues has been generated from sales of our SigNature DNA and BioMaterial Genotyping, our principal anti-counterfeiting and product authentication solutions ("authentication services"). We have continued to incur expenses in expanding our laboratory and office facilities and increasing our personnel to meet anticipated future demand. We expect to generate revenues from sales of our SigNature Program, Cashield, DNANet, SmartDNA, digitalDNA and BioMaterial Genotyping offerings. We have developed or are currently attempting to develop business in the following target markets: homeland security, cash-in-transit, textile and apparel authentication, secure documents, pharmaceuticals, consumer products, law enforcement, fine wine, art and collectibles, and digital and recording media. Our developments in the cash-in-transit, semiconductor authentication and textile and apparel authentication markets have contributed to our revenues. We intend to pursue both domestic and international sales opportunities in each of these vertical markets.

Critical Accounting Policies

Financial Reporting Release No. 60, published by the SEC, recommends that all companies include a discussion of critical accounting policies used in the preparation of their financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates.

We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.

The accounting policies identified as critical are as follows:

? Revenue recognition;
? Allowance for doubtful accounts; and


? Equity based compensation.

Revenue Recognition

Revenues are derived from research, development, qualification and production testing for certain commercial products.

Revenue from fixed price testing contracts is generally recorded upon completion of the contracts, which are generally short-term, or upon completion of identifiable contractual tasks. At the time we enter into a contract that includes multiple tasks, we estimate the amount of actual labor and other costs that will be required to complete each task based on historical experience. Revenues are recognized which provide for a profit margin relative to the testing performed. Revenue relative to each task and from contracts which are time and materials based is recorded as effort is expended. Billings in excess of amounts earned are deferred. Any anticipated losses on contracts are charged to income when identified. To the extent management does not accurately forecast the level of effort required to complete a contract, or individual tasks within a contract, and we are unable to negotiate additional billings with a customer for cost over-runs, we may incur losses on individual contracts.

For revenue from product sales, we recognize revenue in accordance with Accounting Standards Codification subtopic 605-10, Revenue Recognition ("ASC 605-10"). ASC 605-10 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. We defer any revenue for which the product has not been delivered or is subject to refund until such time that we and the customer jointly determine that the product has been delivered or no refund will be required.

ASC 605-10 incorporates Accounting Standards Codification subtopic 605-25, Multiple-Element Arraignments ("ASC 605-25"). ASC 605-25 addresses accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The effect of implementing ASC05-25 on our financial position and results of operations are not significant.

Allowance for Uncollectible Receivables

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. We use a combination of write-off history, aging analysis and any specific known troubled accounts in determining the allowance. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. The Company writes-off receivables that are deemed uncollectible.

Equity Based Compensation

The Company follows Accounting Standards Codification subtopic 718-10, Compensation ("ASC 718-10") which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates.

Comparison of Results of Operations for the Three Months Ended March 31, 2013 and 2012

Revenues

For the three months ended March 31, 2013, we generated $344,605 in revenues from operations principally from the sales of authentication services. For the three months ended March 31, 2012, we generated $518,402 in revenues from operations. The decrease in sales for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 was primarily caused by the completion of our prior pilot contract with the Logistics Management Institute ("LMI"), and a slower than anticipated replacement of that revenue by DNA marking contracts with commercial electronics manufacturers. In late January 2013, the United States Defense Logistics Agency ("DLA") announced that it would subsidize SigNature DNA marking costs for its trusted suppliers, and in March 2013, after this and other mechanisms were in place, we were able to begin SigNature DNA shipments for this market segment.


Costs and Expenses

Selling, General and Administrative

Selling, general and administrative expenses increased from $1,824,646 for the three months ended March 31, 2012 to $2,754,407 for the three months ended March 31, 2013. The increase of $929,761, or 51%, is primarily attributable to higher professional, salary and service fees incurred.

Research and Development

Research and development expenses increased from $96,097 for the three months ended March 31, 2012 to $176,485 for the three months ended March 31, 2013. The increase of $80,388 is attributable to additional research and development activity needed with current operations.

Depreciation and Amortization

In the three months ended March 31, 2013, depreciation and amortization decreased by $76,878 from $98,708 for the three months ended March 31, 2012 to $21,830 for the three months ended March 31, 2013. The decrease is attributable to completion of the amortization of our intangible property.

Total Operating Expenses

Total operating expenses increased to $2,952,722 for the three months ended March 31, 2013 from $2,019,451 for the three months ended March 31, 2012, or an increase of $933,271 primarily attributable to an increase in professional fees paid and in R&D expenditures, which was offset by a decrease in depreciation and amortization expense.

Interest, net

Interest, net for the three months ended March 31, 2013 was income of $405 from a net interest expense of $42,833 for the three months ended March 31, 2012. The decrease in interest expense was due to no outstanding notes payable as of March 31, 2013.

Loss from Change in Fair Value of Warrant Liability

In November 2012, we issued warrants containing certain reset provisions which require us to classify as a liability mark to market to fair value each reporting period as a non-cash adjustment to our current period operations. This resulted in a $519,919 charge to current period operations as compared to $-0- for the same period last year.

Net Income (Loss)

Net loss for the three months ended March 31, 2013 increased to $3,127,631 from a net loss of $1,543,882 for the three months ended March 31, 2012, which is primarily attributable to factors described above.

Comparison of Results of Operations for the Six Months Ended March 31, 2013 and 2012

Revenues

For the six months ended March 31, 2013, we generated $662,275 in revenues from operations principally from the sales of authentication services. For the six months ended March 31, 2012, we generated $1,035,306 in revenues from operations. The decrease in sales for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 was primarily caused by the completion of our prior pilot contract with LMI, and a slower than anticipated replacement of that revenue by DNA marking contracts with commercial electronics manufacturers. In late January 2013, DLA announced that it would subsidize SigNature DNA marking costs for its trusted suppliers, and in March 2013, after this and other mechanisms were in place, we were able to begin SigNature DNA shipments for this market segment.


Costs and Expenses

Selling, General and Administrative

Selling, general and administrative expenses increased from $3,977,074 for the six months ended March 31, 2012 to $5,275,574 for the six months ended March 31, 2013. The increase of $1,298,500, or 33%, is primarily attributable to the higher professional, salary and service fees incurred.

Research and Development

Research and development expenses increased from $174,570 for the six months ended March 31, 2012 to $324,151 for the six months ended March 31, 2013. The increase of $149,581 is attributable to additional research and development activity needed with current operations.

Depreciation and Amortization

In the six months ended March 31, 2013, depreciation and amortization decreased by $154,256 from $197,081 for the six months ended March 31, 2012 to $42,825 for the three months ended March 31, 2013. The decrease is attributable to completion of the amortization of our intangible property.

Total Operating Expenses

Total operating expenses increased to $5,642,550 for the six months ended March 31, 2013 from $4,348,725 for the six months ended March 31, 2012, or an increase of $1,293,825 primarily attributable to an increase in professional fees paid and in R&D expenditures which was offset by a decrease in depreciation and amortization expense.

Interest, net

Interest, net for the six months ended March 31, 2013 was income of $405 from a net interest expense of $640,368 for the six months ended March 31, 2012. The decrease in interest expense was due to no outstanding notes payable as of March 31, 2013.

Loss from Change in Fair Value of Warrant Liability

In November 2012, we issued warrants containing certain reset provisions which require us classify as a liability mark to market to fair value each reporting period as a non-cash adjustment to our current period operations. This resulted in a $6,852,518 charge to current period operations as compared to $-0- for the same period last year.

Net Income (Loss)

Net loss for the six months ended March 31, 2013 increased to $11,832,388 from a net loss of $3,953,787 for the six months ended March 31, 2012, which is primarily attributable to factors described above.

Liquidity and Capital Resources

Our liquidity needs consist of our working capital requirements and research and development expenditure funding. As of March 31, 2013, we had working capital of $4,028,959. For the six months ended March 31, 2013, we generated a net cash flow deficit from operating activities of $3,889,111 consisting primarily of our loss of $11,832,388, net with non-cash adjustments of $42,825 in depreciation and amortization charges, $886,261 for equity based compensation and $6,852,518 change in fair value of warrant liability. Additionally, we had a net increase in operating assets of $56,041 and a net increase in operating liabilities of $217,714. Cash used in investing activities was $30,061 primarily from the purchase of equipment. Cash provided by financing activities for the six months ended March 31, 2013 totaled $7,600,000 consisting of proceeds of $5,500,000 from the sale of our Series A Preferred, $2,000,000 from the sale of our common stock, $150,000 from the exercise of warrants, net with $50,000 paid to re-acquire previously issued warrants.


On January 7, 2013, we completed the second closing ("Second Closing") of our transaction with Crede CG II, Ltd. ("Crede") and sold to Crede 5,500 shares of our Series A Preferred at a price of $1,000 per share, resulting in gross proceeds to us of $5,500,000. On January 8, 2013, we exercised our option and converted the Series A Preferred held by Crede into 25,462,963 shares of our Common Stock at a conversion price of $0.216 per share.

We had entered into a Securities Purchase Agreement ("Purchase Agreement") with Crede dated November 28, 2012 pursuant to which Crede agreed to purchase the Series A Preferred on the first business day following the date a registration statement covering the resale of all shares of Common Stock issuable pursuant to the Purchase Agreement, including those underlying the Series A Preferred and Series A, B and C Warrants, is declared effective by the SEC. The Company's registration statement on Form S-3 was declared effective by the SEC on January 4, 2013.

Pursuant to the Purchase Agreement, Crede purchased at the initial closing held on November 29, 2012 ("Initial Closing") 10,752,688 shares of our Common Stock at a price of $0.186 per share, resulting in gross proceeds to us of $2,000,000. In addition, at the Initial Closing, Crede was issued (i) five year Series A Warrants allowing it to initially purchase 10,752,688 shares of Common Stock at a price of $0.2232 per share, (ii) five year Series B Warrants allowing it to initially purchase 29,569,892 shares of Common Stock at a price of $0.2232 which became exercisable at the Second Closing and (iii) Series C Warrants allowing it to initially purchase 26,881,720 shares of Common Stock which became exercisable for six months after the eleventh trading day following the Second Closing. Crede may also exchange the Warrants for Common Stock pursuant to a Black-Scholes formula. The Series A, B and C Warrants each contain a 9.9% "blocker" so that in no event shall any of the Warrants be exercisable or exchangeable into or for Common Stock to the extent that such exercise or exchange would result in Crede having "beneficial ownership" (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended) of more than 9.9% of the Company's Common Stock.

On January 22, 2013, the Company exercised its option to repurchase the Series C Warrants issued to Crede for $50,000.

Crede has the right to participate in other equity or equity -linked financings completed by the Company for a period of 180 days from January 4, 2013. In addition, the Company has agreed not to issue additional Common Stock or securities convertible into Common Stock at a price below $0.186 per share or the market price of the Common Stock on the date the registration statement was is declared effective, for a period of 180 days from the effective date of the registration statement, except for issuances (i) pursuant to acquisitions, joint ventures, license arrangements, leasing arrangements and other similar arrangements, (ii) to employees, consultants, directors and officers approved by the Board or pursuant to a plan approved by the Board, (iii) pursuant to one or more contracts entered into by us with third parties which would result in revenues to us during a three-month period equal to an annual run rate of $15 Million in revenues and (iv) pursuant to a contract entered into by us with a third party which would reasonably be expected to result in more than $3 Million in annual receivables.

Until one year after the Second Closing, we are prohibited from entering into any transaction to (i) sell any convertible securities at a conversion rate or other price that is generally based on and/or varies with the trading prices of the our Common Stock at any time after the initial issuance of such convertible securities or (ii) sell securities at a future determined price, including, without limitation, an "equity line of credit" or an "at the market offering."

Management believes that our positive cash balance and working capital as of March 31, 2013 along with our current customer base, projected cash flow and the minimum guaranteed revenues for the next fiscal year will allow us to continue to improve our working capital and to have sufficient capital resources to meet projected cash flow requirements.

We expect capital expenditures to be less than $1,000,000 in fiscal 2013. Our primary investments will be in laboratory equipment to support prototyping, manufacturing and our authentication services.

We may be required to seek additional capital should our current positive working capital fall short. We have no commitments for any future funding, and may not be able to obtain additional financing or grants on terms acceptable to us, if at all, in the future. If we are unable to obtain additional capital this could restrict our ability to grow. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock.

Substantially all of the real property used in our business is leased.


Subsequent Events

On April 25, 2013, Crede effected the cashless exercise of 10,752,688 Series A Warrants and 29,569,862 Series B Warrants, and the Company thereupon issued to Crede an aggregate of 31,257,045 shares of its Common Stock.

On May 10, 2013, the Company entered into an Asset Purchase Agreement (the "Asset Purchase Agreement") with RedWeb Technologies Limited ("RedWeb"), a . . .

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