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APDN > SEC Filings for APDN > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for APPLIED DNA SCIENCES INC

Form 10-Q for APPLIED DNA SCIENCES INC


12-May-2014

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", "designed 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 and Form 10-K/A for the fiscal year ended September 30, 2013. 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

Using biotechnology as a forensic foundation, we create unique security solutions addressing the challenges of modern commerce. Whether working in supply chain security, brand protection or law enforcement applications, it is our goal to help establish secure flourishing environments that foster quality, integrity and success. With impenetrable taggants, high-resolution DNA authentication, and comprehensive reporting, our botanical DNA-based technologies are designed to deliver what we believe to be the greatest levels of security, deterrence and legal recourse strength.

SigNature ® DNA . SigNature DNA is our platform ingredient, at the core of all our security solutions. From application to application the vehicle which carries SigNature DNA is custom designed to suit the application. Exhaustive development efforts have yielded a flexible and durable marker with all the accuracy provided by nature. SigNature DNA is based on full, double stranded plant DNA, and provides forensic power and protection for a wide array of applications. Highly secure, robust, durable and, in our belief, cost-effective, SigNature DNA markers are an ingredient that can be used to fortify brand protection efforts; mark, track and convict criminals; and strengthen supply chain security. Custom DNA sequences can be embedded into a wide range of host carriers including ink, varnish, thread, laminates and metal coatings. These items can then be tested for the presence of SigNature DNA Markers through an instant field detection or a forensic level authentication. Hundreds of millions of SigNature DNA marks now exist in the public domain on items ranging from consumer product packaging to microcircuits to guitars. We believe that no marks have ever been copied.

SigNature DNA, SigNature T™ DNA, fiberTyping®, DNANet® and digitalDNA®, our principal anti-counterfeiting and product authentication solutions and our recently introduced Counterfeit Prevention Authentication Program can be used in numerous industries, including microcircuits and other electronics, cash-in-transit (transport and storage of banknotes), homeland security, textiles and apparel, identity cards and other secure documents, law enforcement, pharmaceuticals, wine, and luxury consumer goods.

SigNature T DNA and fiberTyping . There is one common thread that runs through the global textile industry: success breeds counterfeiting and diversion. SigNature T botanical DNA markers are used for brand protection efforts and raw material source compliance programs. In situations where natural fibers like cotton or wool are in play, we can isolate and type inherent DNA, making it possible to verify the presence of specified materials. This fiberTyping process provides DNA verification to help manufacturers, retailers and brand owners ensure quality, safety and compliance of their products.

DNANet. Recognizing that DNA-based evidence is the cornerstone of the modern era of law enforcement, we have created what we believe to be the ultimate crime fighting tool: DNANet, a botanical DNA marker that can be used to definitively link evidence and offenders to specific crime scenes. Whether deployed as a residential asset marker, an offender spray in a retail location or a degradation dye in cash handling boxes, DNA markers facilitate conviction, and establish a heightened level of deterrence. 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. Assets acquired from RedWeb Technologies including Sentry 500 Intruder Spray Systems and Advanced Molecular Taggant Technology and our SmartDNA product line are now included in the DNANet family of products.

digitalDNA. digitalDNA is a new security solution 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 customer interface. digitalDNA begins with a DNA-secured form of the QR ("quick read") code or other two dimensional code. A unique serial code is created for each article, and represented in an easy-to-read QR style barcode. 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. Should there ever be a question about the validity of a digitalDNA code; a laboratory-based analysis can be conducted to determine authenticity.

The unique digitalDNA codes can be used to mark, identify and track virtually any item. Each item's unique digitalDNA code is recorded, at its point of origin, on a secure, cloud-based server, affording easy validation/inquiry/input using an iPhone or mobile computer.

Counterfeit Prevention Authentication Program. We recently announced the launch of a new turnkey program for electronics, military, commercial, and aerospace contractors called the Counterfeit Prevention Authentication Program ("CPA" Program). The program empowers end-users to verify the originality or provenance of parts which have been marked by their suppliers with our SigNature DNA Markers.

Plan of Operations

General

To date, the substantial portion of our revenues has been generated from sales of Signature DNA and fiberTyping, our principal anti-counterfeiting and product authentication solutions. We expect to continue to grow revenues from sales of our SigNature DNA platform ingredient, our fibertyping, DNANet, and digitalDNA offerings and the Counterfeit Prevention Authentication Program. We have continued to incur expenses in expanding our laboratory and office facilities and increasing our personnel to meet current and anticipated future demand. We have limited sources of liquidity. We have developed or are currently attempting to develop business in the following target markets: microcircuits and other electronics, 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 semiconductor authentication, cash-in-transit and textile and apparel authentication have contributed to the increase in 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 condensed 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

The Company recognizes revenue in accordance with Accounting Standards Codification ("ASC") 605, Revenue Recognition ("ASC 605"). ASC 605 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and/or service has been performed; (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 or services provided and the collectability of those amounts. Provisions for allowances and other adjustments are provided for in the same period the related sales are recorded. The Company defers any revenue for which the product has not been delivered, service hasn't been provided, or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered, service has been performed, or no refund will be required. At March 31, 2014 and September 30, 2013, the Company recorded deferred revenue of $415,989 and $148,503, respectively.

Revenue arrangements with multiple components are divided into separate units of accounting if certain criteria are met, including whether the delivered component has stand-alone value to the customer. Consideration received is allocated among the separate units of accounting based on their respective selling prices. The selling price for each unit is based on vendor-specific objective evidence, or VSOE, if available, third party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third party is available. The applicable revenue recognition criteria are then applied to each of the units.

Revenue for a government contract award, which supports our development efforts on specific projects, is recognized as milestones under the contract are achieved as per the contract. The Company recognized revenue of approximately $25,000 and $50,000 from this contract during the three and six month periods ended March 31, 2014, respectively.

Allowance for Uncollectible Receivables

We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company's estimate is based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company's estimate of the allowance for doubtful accounts will change. At March 31, 2014 and September 30, 2013 the Company had an allowance for doubtful accounts of $36,757 and $62,415, respectively. The Company writes off receivables that are deemed uncollectible. During the three and six month periods ended March 31, 2014, the Company wrote-off $16,801 and $41,801, respectively, of accounts receivable that was previously reserved.

Equity Based Compensation

The Company follows Accounting Standards Codification subtopic 718, Compensation ("ASC 718") 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.

Remediation of Weakness in Internal Controls

We concluded that our disclosure controls and procedures were not effective as of March 31, 2014 as the result of a material weakness in our internal control over financial reporting as of September 30, 2014, that was not yet remediated as of March 31, 2014. The material weakness, which arose primarily due to the need for more enhanced and formalized documentation and procedures regarding the financial statement closing and review process, is further described in Item 4 of this Quarterly Report on Form 10-Q. We are taking the following steps to remediate this material weakness and to improve our disclosure controls and procedures:

· Our CEO has appointed a Sarbanes-Oxley project leadership team, consisting of our CFO and our Controller, that will oversee the project;

· Together with a consultant that we have engaged, we have enhanced our review procedures and the documentation thereof; and

· We have implemented these enhanced procedures as we prepared our Form 10-Q for the period ended March 31, 2014.

Comparison of Results of Operations for the Three Months Ended March 31, 2014 and 2013

Revenues

For the three months ended March 31, 2014 and 2013, we generated $637,146 and $344,605, respectively, in revenues from operations. The increase in revenues of $292,541 or 85% was primarily from revenue related to a term sheet entered into with a provider of polyolefins where the Company has agreed to cooperate in the development and supply of markers and related additives for polyolefin products, as well as an increase in sales to suppliers of the United States Defense Logistics Agency ("DLA") and to the textile industry.

Costs and Expenses

Selling, General and Administrative

Selling, general and administrative expenses for the three months ended March 31, 2014 increased by $543,332 or 20% from $2,754,407 for the three months ended March 31, 2013 to $3,297,739 for the three months ended March 31, 2014. The increase is primarily attributable to higher salary expense of approximately $200,000 due to an increase in headcount from 38 as of March 31, 2013 to 52 as of March 31, 2014. The increase in the number of employees compared to the same period in the prior year was due to an increase for production, sales, information technology and finance, to meet the anticipated future demand for sales. In addition, the increase in salary expense is also attributable to commissions for the three month period ended March 31, 2014 of approximately $30,000. The increase is also due to an increase in stock based compensation of approximately $150,000. Rent and related utilities expense increased by approximately $90,000 as a result of the larger office space and the Company now paying its utilities as compared to them being included as part of the rent during the three month period ended March 31, 2013. Legal fees also increased by approximately $70,000.

Research and Development

Research and development expenses increased to $359,782 for the three months ended March 31, 2014 from $176,485 for the three months ended March 31, 2013. The increase of $183,297 or 104% is attributable to the increased laboratory space with our new corporate headquarters as well as an increase in research and development to support the expansion of the Company's business and markets. In particular, we have multiple workstreams in progress toward a launch of new products for field detection and reading of optical marks which use the SigNature DNA ingredient.

Depreciation and Amortization

In the three months ended March 31, 2014, depreciation and amortization increased by $84,980 from $21,830 for the three months ended March 31, 2013 to $106,810 for the three months ended March 31, 2014. The increase is attributable to depreciation and amortization expense for the leasehold improvements and lab equipment purchased during the second half of the fiscal year ended September 30, 2013 related to the relocation of our corporate offices. The increase also relates to amortization for the intellectual property purchased from RedWeb Technologies during May 2013.

Total Operating Expenses

Total operating expenses increased to $3,764,331 for the three months ended March 31, 2014 from $2,952,722 for the three months ended March 31, 2013, or an increase of $811,609 or 27% primarily attributable to an increase in payroll, stock based compensation expense and in R&D expenditures, as described above.

Gain (Loss) from Change in Fair Value of Warrant Liability

Gain (Loss) from change in fair value of warrant liability during the three months ended March 31, 2014 and 2013 was a gain of $455,899 and a loss of ($519,919), respectively. These changes in fair value relate to warrants containing certain reset provisions which required us to classify them as liabilities and mark the warrants to market and record the change in fair value at each reporting period as a non cash adjustment to our current period operations.

Net Loss

Net loss for the three months ended March 31, 2014 decreased to $2,750,436 from a net loss of $3,127,631 for the three months ended March 31, 2013 primarily attributable to factors described above.

Comparison of Results of Operations for the Six Months Ended March 31, 2014 and 2013

Revenues

For the six months ended March 31, 2014 and 2013, we generated $1,234,500 and $662,275, respectively, in revenues from operations. The increase in revenues of $572,225 or 86% was primarily from an increase in sales to suppliers of the United States Defense Logistics Agency ("DLA") of approximately $390,000 as well as revenues related to a term sheet entered into with a provider of polyolefins where the Company has agreed to cooperate in the development and supply of markers and related additives for polyolefin products. To a lesser extent, the increase relates to a higher level of sales in the textile industry.

Costs and Expenses

Selling, General and Administrative

Selling, general and administrative expenses for the six months ended March 31, 2014 increased by $1,867,743 or 35% from $5,275,574 for the six months ended March 31, 2013 to $7,143,317 for the six months ended March 31, 2014. The increase is primarily attributable to an increase in payroll of approximately $515,000 due to an increase in headcount from 38 as of March 31, 2013 to 52 as of March 31, 2014. The increase in the number of employees compared to the same period in the prior year was due to an increase for production, sales, information technology and finance, to meet the anticipated future demand for sales. In addition, the increase in salary expense is also attributable to the options granted during December 2013 and February 2014, which vested immediately for a total expense of approximately $480,000. The increase is also due to shares of Common Stock issued to a consultant for settlement of their fees during the three months ended December 31, 2013 for $337,500. Rent and related utilities expense increased by approximately $170,000 as a result of the larger office space and the Company now paying its utilities as compared to them being included as part of the rent during the six month period ended March 31, 2013. Legal fees also increased by approximately $130,000.

Research and Development

Research and development expenses increased to $819,086 for the six months ended March 31, 2014 from $324,151 for the six months ended March 31, 2013. The increase of $494,935 or 153% is attributable to the increased laboratory space with our new corporate headquarters as well as an increase in research and development to support the expansion of the Company's business and markets. In particular, we have multiple workstreams in progress toward a launch of new products for field detection and reading of optical marks which use the SigNature DNA ingredient.

Depreciation and Amortization

In the six months ended March 31, 2014, depreciation and amortization increased by $169,200 from $42,825 for the six months ended March 31, 2013 to $212,025 for the six months ended March 31, 2014. The increase is attributable to depreciation and amortization expense for the leasehold improvements and lab equipment purchased during the second half of the fiscal year ended September 30, 2013 related to the relocation of our corporate offices. The increase also relates to amortization for the intellectual property purchased from RedWeb Technologies during May 2013.

Total Operating Expenses

Total operating expenses increased to $8,174,428 for the six months ended March 31, 2014 from $5,642,550 for the six months ended March 31, 2013, or an increase of $2,531,878 or 45% primarily attributable to an increase in payroll expense and in R&D expenditures, as described above.

Loss from Change in Fair Value of Warrant Liability

Loss from change in fair value of warrant liability during the six months ended March 31, 2014 and 2013 was $2,178,859 and $6,852,518, respectively. These losses relate to warrants containing certain reset provisions which required us classify them as liabilities and mark the warrants to market and record the change in fair value at each reporting period as a non cash adjustment to our current period operations.

Net Loss

Net loss for the six months ended March 31, 2014 decreased to $9,042,086 from a net loss of $11,832,388 for the six months ended March 31, 2013 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, 2014, we had working capital of $967,081. For the six months ended March 31, 2014, we generated a net cash flow deficit from operating activities of $4,262,536 consisting primarily of our loss of $9,042,086, net with non-cash adjustments of $212,025 in depreciation and amortization charges, $1,313,331 for equity based compensation, $2,178,859 change in fair value of warrant liability, $337,500 in common stock issued for consulting services and $16,144 of bad debt expense. Additionally, we had a net decrease in operating assets of $109,633 and a net increase in operating liabilities of $612,058. Cash used in investing activities was $109,581 for the purchase of property, plant and equipment. There were no financing activities during the six months ended March 31, 2014.

The Company has recurring net losses, which have resulted in an accumulated deficit of $195,735,697 as of March 31, 2014. The Company incurred a net loss of $9,042,086 and generated negative operating cash flow of $4,262,536 for the six month period ended March 31, 2014. However, the Company has attained positive working capital of $967,081 as of March 31, 2014. At March 31, 2014, the Company had cash and cash equivalents of $1,988,184. The Company's current capital resources include cash and cash equivalents and other working capital resources, and cash generated through operations. Historically, the Company has financed its operations principally from the sale of equity securities.

Continuation of the Company as a going concern is dependent upon future revenues, obtaining additional capital and ultimately, upon the Company attaining profitable operations. The Company will require additional funds to complete the continued development of its products, product manufacturing, and to fund expected additional losses from operations, until revenues are sufficient to cover the Company's operating expenses. If the Company is unsuccessful in obtaining the necessary additional financing, it will most likely be forced to reduce operations.

Management believes that it will be able to raise additional funds and the Company is currently in discussions with investment bankers and potential investors regarding possible financing. However, the Company has no formal commitments for any future funding, and may not be able to obtain additional financing on terms acceptable to it, if at all, in the future.

The ability of the Company to continue as a going concern is dependent on its ability to successfully accomplish the plan described in the preceding paragraphs. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result from the outcome of this uncertainty.

We expect capital expenditures to be less than $750,000 in fiscal 2014. Our primary investments will be in laboratory equipment to support prototyping, manufacturing, our authentication services and outside services for our detector and reader development.

Substantially all of the real property used in our business is leased under operating lease agreements.

Subsequent Events

None.

Product Research and Development

We anticipate spending approximately $1,200,000 for product research and development activities during the next twelve months.

Acquisition of Plant and Equipment and Other Assets

We do not anticipate the sale of any material property, plant or equipment during the next 12 months.

Number of Employees

We currently have forty-eight full-time employees and four part-time employees, including five in management, eight in research and development, four in forensics, six in quality assurance, five in finance and accounting, eight in operations, nine in sales and marketing, one in human resources, two administrative, two in information services and two in investor relations and communications. We expect to increase our staffing dedicated to sales, manufacturing and production, and forensic authentication services. Expenses related to travel, marketing, salaries, and general overhead will be increased as necessary to support our growth in revenue. In order for us to attract and retain quality personnel, we anticipate we will have to offer competitive salaries and benefits to future employees. We anticipate that it may become desirable to add additional full and or part time employees to discharge certain critical functions during the next 12 months. This projected increase in personnel is dependent upon our ability to generate revenues and obtain sources of financing. There is no guarantee that we will be successful in raising the funds required or generating revenues sufficient to fund the projected increase in the number of employees. As we continue to expand, we will incur additional costs for personnel. In June 2012 we began working with Insperity Inc. to help us manage many of our back-end administrative human resources and payroll responsibilities.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Inflation

The effect of inflation on our revenue and operating results was not significant.

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