Form 10-K APPLIED DNA SCIENCES For: Sep 30
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2016
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 001-36745
APPLIED DNA SCIENCES, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 59-2262718 | |||
| (State or other jurisdiction of | (I.R.S. Employer | |||
| incorporation or organization) | Identification No.) |
| 50 Health Sciences Drive, | ||||
| Stony Brook, New York | 11790 | (631) 840-8800 | ||
| (Address of principal executive offices) | (Zip Code) | (Registrant’s telephone number, including area code) |
Securities registered under Section 12(b) of the Act:
| Title of Each Class | Name of each Exchange on Which Registered | |
| Common Stock, $0.001 par value | The NASDAQ Capital Market | |
| Warrants to purchase Common Stock | The NASDAQ Capital Market |
Securities registered under Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
¨ Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
The aggregate market value of the Registrant’s voting and non-voting common stock held by non-affiliates of the Registrant, based upon the last sale price of the common stock reported on The Nasdaq Capital Market as of the last business day of the Registrant’s most recently completed second fiscal quarter (March 31, 2016), was approximately $72 million. Shares of the Registrant’s common stock held by each executive officer and director and by each entity or person that, to the Registrant’s knowledge, owned 5% or more of the Registrant’s outstanding common stock as of March 31, 2016 have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
As of November 28, 2016, the Registrant had outstanding 26,351,483 shares of common stock, par value $0.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Shareholders, to be filed within 120 days after the end of the fiscal year ended September 30, 2016 and incorporated by reference in Part III hereof. Except with respect to information specifically incorporated by reference in the Annual Report on Form 10-K, the Proxy Statement is not deemed to be filed as part hereof.
TABLE OF CONTENTS
| I |
Forward-looking Information
This Annual Report on Form 10-K (including but not limited to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are intended to qualify for the “safe harbor” created by those sections. In addition, we may make forward-looking statements in other documents filed with or furnished to the Securities and Exchange Commission ("SEC"), and our management and representatives may make forward-looking statements orally or in writing to analysts, investors, representatives of the media and others. Forward-looking statements can generally be identified by the fact that they do not relate strictly to historical or current facts and include, but are not limited to, statements using terminology such as “can”, “may”, “could”, “should”, “assume”, “forecasts”, “believe”, “designated to”, “will”, “expect”, “plan”, “anticipate”, “estimate”, “potential”, “position”, "predicts”, “strategy”, “guidance”, “intend”, “seek”, “budget”, “project” 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 are based on our current expectations, assumptions, estimates and projections about our business and our industry and are subject to known and unknown risks, uncertainties and other factors. Accordingly, our actual results and the timing of certain events may differ materially from those expressed or implied in such forward-looking statements due to a variety of factors and risks, including, but not limited to, those set forth under Item 1, “Business,” Item 1A, “Risk Factors,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and notes thereto included in this report, those set forth from time to time in our other filings with the SEC, and the following factors and risks:
| · | our short operating history with our current business model and lack of significant revenues; |
| · | our history of net losses, which may continue, and our potential inability to achieve profitability; |
| · | the possibility that we may require additional financing, which may involve the issuance of additional shares of common stock or securities exercisable for common stock and dilute the percentage of ownership held by our current stockholders; |
| · | difficulty in obtaining or inability to obtain, additional financing if such financing becomes necessary; |
| · | volatility in the price and/or trading volume of our common stock; |
| · | future short selling and/or manipulation of the price of our common stock; |
| · | our inability to implement our short and long-term strategies; |
| · | competition from products and services provided by other companies; |
| · | potential difficulties and failures in manufacturing our products; |
| · | loss of strategic relationships; |
| · | dependence on a limited number of key customers; |
| · | lack of acceptance of our products and services by potential customers; |
| · | potential failure to introduce new products and services; |
| · | difficulty or failure in expanding/and or maintaining our sales, marketing and support organizations and our distribution arrangements necessary to enable us to reach our goals with respect to increasing market acceptance of our products and services; |
| · | inability to continue to retain the services of Dr. Hayward, our Chief Executive Officer; |
| 1 |
| · | inability to compete effectively in the industries in which we operate; |
| · | lack of success in our research and development efforts for new products; |
| · | failure to manage our growth in operations and acquisitions of new technologies and businesses; |
| · | inability to protect our intellectual property rights; |
| · | intellectual property litigation against us or other legal actions or proceedings in which we may become involved; |
| · | unauthorized disclosure of sensitive or confidential data (including customer data) and cybersecurity breaches; and |
| · | adverse changes in worldwide or domestic economic, political or business conditions. |
All forward-looking statements and risk factors included in this Annual Report on Form 10-K are made as of the date hereof, based on information available to us as of such date, and we assume no obligations to update any forward-looking statement or risk factor, unless we are required to do so by law. If we do update one or more forward-looking statements, no inference should be drawn that we will make updates with respect to other forward-looking statements or that we will make any further updates to those forward-looking statements at any future time.
Forward-looking statements may include our plans and objectives for future operations, including plans and objectives relating to our products and our future economic performance, projections, business strategy and timing and likelihood of success. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, future business decisions, and the time and money required to successfully complete development and commercialization of our technologies, all of which are difficult or impossible to predict accurately and many of which are beyond our control.
Any of the assumptions underlying the forward-looking statements contained in this Annual Report on Form 10-K could prove inaccurate and, therefore, we cannot assure you that the results contemplated in any of such forward-looking statements will be realized. Based on the significant uncertainties inherent in these forward-looking statements, the inclusion of any such statement should not be regarded as a representation or as a guarantee by us that our objectives or plans will be achieved, and we caution you against relying on any of the forward-looking statements contained herein.
All warrant, option, share and per share information in this report gives retroactive effect to a one-for-60 reverse stock split that was effective on October 29, 2014.
Our trademarks in the United States include SigNature® DNA, SigNature® T DNA, fiberTyping®, DNAnet®, digitalDNA®, SigNify™ and Beacon™. All trademarks, service marks and trade names included or incorporated by reference in this Annual Report on Form 10-K are the property of their respective owners, including, without limitation, SmokeCloak®, a mark owned by MSS Professional A/S and/or its affiliates, and PimaCott®, a mark owned by Divatex Home Fashion, Inc. and/or its affiliates.
| ITEM 1. | BUSINESS. |
Overview
Using biotechnology as a forensic foundation, we create unique security solutions addressing the challenges of modern commerce. Whether for 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 secure taggants, high-resolution DNA authentication, and comprehensive reporting, our plant-based or other DNA technologies are designed to deliver what we believe to be the greatest levels of security, deterrence and legal recourse strength. We are also engaged in the large-scale production of specific DNA sequences using the polymerase chain reaction ("PCR").
SigNature® DNA, the core of our technology platform, is nature’s ultimate means of authentication and supply chain security. Founded on plant-based DNA, our precision-engineered marks have not and, we believe, cannot be broken. The conventional process used to sequence (“decode”) native DNA is not possible with the engineered mark. Additional layers of protection and complexity are added to the mark in a proprietary manner. SigNature DNA can resist wash off, even in aggressive industrial treatment baths. SigNature DNA has proven highly resistant to UV radiation, heat, cold, vibration, abrasion and other extreme environments and conditions. We work closely with our customers to develop a solution that will be optimized to their specifications to deliver maximum impact. Our products and technology are protected by a robust portfolio of patents and trademarks.
| 2 |
Using our products and technology, manufacturers, brands, and other stakeholders can ensure authenticity and protect against diversion throughout a product’s journey from manufacturer to use.
Corporate History
We are a Delaware corporation, which was initially organized in 1983 under the laws of the State of Florida as Datalink Systems, Inc. In 1998, we reincorporated in the State of Nevada, and in 2002, we changed our name to our current name, Applied DNA Sciences, Inc. In December 2008, we reincorporated from Nevada to the State of Delaware.
Our corporate headquarters are at the Long Island High Technology Incubator at Stony Brook University in Stony Brook, New York, where we established laboratories for the manufacture of DNA markers and product prototypes, and DNA authentication. The address of our corporate headquarters is 50 Health Sciences Drive, Stony Brook, New York 11790, and our telephone number is (631) 240-8800. We maintain a website at www.adnas.com where general information about us is available. The information on, or that may be accessed through, our website is not incorporated by reference into and should not be considered a part of this report.
Industry Background
Supply chain security
Supply chains are the systems used by companies to obtain products and services for resale, their own consumption or as a component in a product or service that they then resell. Supply chains often include the sourcing of raw materials, their processing in various stages to create products, and transportation and logistics to move goods both within the supply chain process and to the final consumer. Many different companies may be part of a supply chain, and often the owner of the supply chain has limited ability to oversee and supervise all components of its supply chain. Supply chain security refers to efforts to enhance the security of the supply chain. It combines traditional practices of supply chain management with the security requirements driven by threats such as terrorism, piracy and theft. We focus on one particular part of supply chain security, the substitution of specified inputs with something else, often a cheaper, inferior input. For example, a company might specify that sheets be made of high quality pima cotton but the company that wove the material for the sheets substituted cheaper and inferior upland cotton. We call a supply chain with such security problems a leaky supply chain. Leaky supply chains create significant and growing problems to companies in a wide range of industries as well as governments and individuals worldwide. Large retailers assemble sprawling networks of suppliers in developing countries to produce their goods at cheaper cost, underscoring the difficulties of policing a global supply chain. This is a global problem that only appears to be increasing. Leaky supply chains allow materials to become diluted, diverted or counterfeited, devaluing corporate reputations, potentially causing health and safety concerns, and hindering investment, and may cost hundreds of thousands of people their livelihood every year. In addition, a company with a leaky supply chain has essentially been cheated, since they paid a premium price for an inferior substitution.
As more and more companies begin to address the problem of supply chain security, we expect that different systems will compete to be the leading standards by which products can be tracked across world markets. To insure only genuine products are entering the marketplace requires cutting edge technology. Historically, leaky supply chains and other types of fraud have been combated by embedding various authentication systems and rare and easily distinguishable materials into products, such as radio frequency identification (“RFID”) devices and holograms in packaging, integrated circuit chips and magnetic strips in automatic teller machine cards, banknote threads on currency, elemental taggants in explosives, and radioactivity and rare molecules in crude oil. We believe these techniques are effective but have generally been reverse-engineered and replicated which limit their usefulness as forensic methods for authentication of the sources of products and other items.
Brand Protection
Establishing a strong brand is pivotal to business success, as it is how a company is perceived by the customer. We believe that protecting that brand is as important. Counterfeiting affects brands across the globe and effective brand protection strategy has become imperative for companies. Many customers do not even realize that they have a counterfeit product, attributing the poor quality to the brand thus tarnishing its name. A recent Organisation for Economic Co-operation and Development (OECD) report (April 18, 2016) reiterates a number of trends that have been evident for more than a decade – virtually all brands are being counterfeited, and counterfeit and pirated products are originating from virtually all economies on all continents. Counterfeiters are improving their logistics networks, manipulating transit routes, exploiting governance gaps and taking advantage of the huge growth in online shopping, thereby underlining the need for secure supply chains to protect brands. Consumer safety and satisfaction, brand reputation and revenues can be adversely impacted by counterfeiting. Our SigNature DNA markers can be applied to many products, affording quick and definitive identification of authentic products, and aiding in brand protection efforts.
| 3 |
Law Enforcement Applications
Burglaries, car theft, cash-in-transit robberies… these are worldwide problems begging for a solution. The United States leads the world in the occurrence of home burglaries, with a burglary occurring about every 18 seconds in the U.S. (The SafeWise Report - September 13, 2016). Interpol reported that for the year ending December 31, 2015, they had received 7.4 million records of reported stolen motor vehicles from 126 different countries (Interpol — Database Statistics). According to the FBI, a motor vehicle was stolen in the United States every 46 seconds in 2014 and the value of the stolen motor vehicles was more than $4.5 billion. According to Plastics Today, automotive aftermarket parts are a huge business for counterfeiters, resulting in $9 billion annually in vehicle recalls. (Plastics Today, “Material taggants provide protection from counterfeiting of plastic products” (September 21, 2015)). These crimes have wide-ranging impacts, affecting law enforcement agencies, insurance companies, legislative bodies, and justice departments.
Asset identification, management, protection and authentication solutions that deliver value to the customer are critical components of any successful theft deterrent program. In addition to tagging assets with a unique mark to prevent theft and facilitate return of stolen goods, it is imperative that would-be thieves know that the items are marked and that law enforcement is trained to properly identify recovered property. Forensic marking of home assets uses technology to code valuables at risk of theft to identify burglars, linking them directly with a crime scene. Over the years, authorities have found it difficult to obtain convictions of thieves in possession of suspected stolen property unless the true owner can be identified.
Products and Services
SigNature® DNA, SigNature® T DNA, fiberTyping®, DNAnet®, digitalDNA®, SigNify™ and Beacon™ comprise our principal technology platform. The large-scale production of specific DNA sequences is used in the diagnostics and reagent industries.
Signature DNA Markers
SigNature DNA. SigNature DNA is our patented platform ingredient, at the core of all our security solutions. It provides forensic power and protection for a wide array of applications. Highly secure, robust and durable, SigNature DNA markers are an ingredient that can be used to fortify brand protection efforts; strengthen supply chain security; and mark, track and convict criminals. Custom DNA sequences can be embedded into a wide range of host carriers including ink, varnish, thread, laminates and metal coatings. SigNature DNA markers are resistant to heat, cold, vibration, abrasion, organic solvents, chemicals, UV radiation and other extreme environmental conditions, and so can be identified for numerous years after being embedded directly, or into media applied or attached to the item to be marked. Each individual marker is recorded and stored in a secure database so that we can later detect it using a simple spot test, or the marks can be forensically analyzed to obtain definitive proof of the presence or absence of a specific type of SigNature DNA marker (e.g., one designed to mark a particular product). Our in-lab forensic testing for authenticity results in an expert witness Certificate of DNA Authentication (CODA). Because DNA is one of the most dense information carriers known, only minute quantities of SigNature DNA are necessary for successful analysis and authentication. As a result, SigNature DNA can fold seamlessly into production and logistics workflows.
SigNature DNA has been subjected to rigorous testing by the Idaho National Laboratory, a U.S. National Laboratory, by CALCE (the Center for Advanced Life Cycle Engineering), the largest electronic products and systems research center focused on electronics reliability, and by verified procedures in our laboratories. The forensic marker has passed all tests across a broad spectrum of materials and has met key military stability standards. SigNature DNA has passed a strenuous “red-team” vetting on behalf of the U.S. Defense Logistics Agency.
Hundreds of millions of SigNature DNA markers now exist on items ranging from consumer product packaging to microcircuits; to our knowledge, none has ever been copied.
SigNature T DNA and fiberTyping
SigNature T. SigNature T DNA is a unique patent-pending tagging and authentication system specifically designed for textiles and apparel. Specially engineered to adhere tenaciously to any kind of textile substrate, including natural and synthetic fibers, SigNature T DNA markers are resistant to standard textile production conditions, and cannot be copied. The result: an enduring forensic identity marker that remains present from the fiber stage through to the finished product.
This technology allows for better quality control and assurance at any point in the supply chain. Signature T DNA markers are used for brand protection efforts and raw material, source compliance programs. For example, cotton fibers can be tagged at source, verified as “American grown” and then traced through every step of the supply chain.
Our patented genotyping platform, known as “fiberTyping®”, described below, complements tagging with SigNature T plant-based DNA. fiberTyping is employed to identify the genus and species of the fibers before or after they are tagged with SigNature T DNA. fiberTyping cannot be used to track a specific cotton batch through the supply chain, a function which can only be accomplished by our Signature T DNA system.
| 4 |
fiberTyping. fiberTyping is not a marker, but a test of native cotton fiber, which gives a clear result that determines whether the intended cotton DNA is present in your fiber, yarn or fabric. Samples from the primary material are sent to our forensic labs for DNA analysis and authentication. Cotton classification and the authentication of cotton geographic origin are issues of global significance, important to brand owners and to governments that must regulate the international cotton trade. The use of DNA to identify the cotton fiber content of finished textiles is a significant opportunity for license holders to control their brand and for governments to improve their ability to enforce compliance with trade agreements between nations.
In addition to the global cotton trade, the potential markets for genotyping include biotherapeutics, nutraceuticals, natural foods, wines and fermented alcohols and other natural textiles.
We believe that our DNA extraction protocol and methodologies are more effective than existing forensic systems. We believe that the combination of our SigNatureT DNA and fiberTyping solutions cover the forensic authentication market for textiles and secure systems and protocols developed may be applicable to multiple industry verticals, and can mark and authenticate products at every stage of their life cycle, from beginning to end.
DNAnet
DNAnet. Recognizing that DNA-based evidence is the cornerstone of modern-era law enforcement, we have developed what we believe to be the ultimate crime fighting tools – currently being used in home asset and vehicle marking. DNAnet, a DNA marker can be used to definitively link evidence and offenders to specific crime scenes and help return stolen or lost property to its rightful owner. As the crime is investigated, the fluorescing DNA marker can assist police in linking the offender and stolen items to a specific crime scene, creating a greater ability to identify and convict.
Beacon
Beacon. Beacon® locked optical markers deliver secure real-time inspection capabilities. A unique encrypted mechanism (patent-pending) creates a protected, covert screening tool that can be easily adapted to packaging, security labels and high–value assets through inks, varnishes and coatings. When Beacon locked optical markers are combined with SigNature DNA markers, a strong and flexible end-to-end security solution is created where authenticity and provenance can be determined with confidence.
SigNify
Developing a secure method for real-time, in-field screening of DNA-marked items has long been a priority for us. We believe that standard fluorophores, up-converting phosphors, holograms and other more-traditional screening tools provide little to no defense against counterfeiting. We believe that secure in-field inspection, backed with forensic-level DNA authentication is the key to maintaining a well-defended supply chain or asset management program.
SigNify. The SigNify™ IF portable DNA reader provides definitive real-time authentication of SigNature DNA in the field– DNA becomes a true, front-line solution for supply chain integrity.
Information Technology Systems
digitalDNA. digitalDNA is a software platform that enables customers to manage the security of company-marked goods from point of marking to point of authentication or validation to end of life. The base platform is configurable to customer requirements which differ by vertical market, company business process and IT environment. Basic functions offered include DNA inventory management, program training and communications, a database of marked items information, associated documents and images, chain of custody and location tracking, sample authentication processing and CODA downloads, and other administrative functions. Architected for either cloud or local operation, the system supports mobile data capture using bar codes or other technologies. Of special note is the power of embedding our proprietary DNA into tag ink or substrate as the forensic backstop for tags which can be easily copied. The system is architected as the controller and repository for other validation and authentication devices such as our SigNify DNA Readers, Multi-Mode Reader (prototype), DNA Transfer Systems, and other third party devices and is designed to share data with third party applications through standard interfaces.
DNA Transfer Systems. Our DNA Transfer Systems are developed for DNA marking applications which are high volume with a need for monitoring and control. They are computer-based, fully automated, offer remote internet access for real-time monitoring and can be configured for application-specific alerts and reporting online. They are used to mark cotton at all seven U.S. cotton gins in the 2016 season.
| 5 |
Large-scale production of specific DNA sequences using PCR.
Large-scale production of specific DNA sequences using PCR. Our Triathlon™ PCR systems allow for the large-scale production of specific DNA sequences. The systems are self-contained and modular, can work together in mass production or can be used individually throughout the world, offering the advantage of delivering DNA locally and securely. These DNA sequences are being used by customers as a diagnostic and reagent and provide us the opportunity to cross-sell our DNA-based supply chain security solutions. A new capacity for us will be the ability to manufacture longer DNA sequences valuable in gene therapy, DNA vaccines and diagnostics. These types of DNA are distinct from our DNA security markers and represent a potential new entry into medical markets, where we believe there are opportunities for our broader platform.
Our Strategy
The core technologies of our business allow us to use plant-based, or other DNA sequences to mark objects in a unique manner that we believe cannot be replicated, and then identify these objects by detecting the absence or presence of the DNA. Our disruptive platform offers broad commercial relevance across many industry verticals. Our underlying strategy is to become a solutions provider in supply chains of process industries in which contracts are larger and of longer duration, where the benefits to customers and consumers are more significant, and where our forensic security offers a unique and protected value. Consumers, governments and companies are demanding details about the systems and sources that deliver their goods. They worry about quality, safety, ethics, and the environmental impact. Farsighted organizations are directly addressing new threats and opportunities presented by this question: Where do these goods come from? These are the questions and concerns we are beginning to address for a growing number of companies. We supply key building blocks for creating secure supply chains, which in turn can help ensure integrity in supply, honest claims, and ethical and sustainable sourcing.
Our products and services are offered in the United States, Europe and Asia. At the present time, we are focusing our efforts on textile and apparel, microcircuits and other electronics, cash and valuables-in-transit, consumer asset marking, printing and packaging businesses and diagnostics and reagents. In the future, we plan to expand our focus to include pharmaceuticals, additional consumer products, food and beverage and agrochemicals. To date, the substantial portion of our revenues has been generated from sales of our SigNature DNA and SigNature T DNA, our principal supply chain security and product authentication solutions. We expect to continue to grow revenues from sales of our SigNature DNA, SigNature T DNA, DNAnet, digitalDNA, Beacon, and SigNify offerings, which all have various applications in supply chain security and product authentication, and we expect to continue to work with companies and governments to secure supply chains and restore confidence to products and product labeling throughout the world. In addition, we expect to grow revenues from the large-scale production of specific DNA sequences using our Triathlon™ PCR system which have multiple applications including as a diagnostic and reagent and for gene therapy, DNA vaccines and diagnostics.
Target Potential High-Volume Markets
We will continue to focus our efforts on target vertical markets that are characterized by a high level of vulnerability to leaky supply chains, product diversion and a lack of security. We also intend to expand into additional related high volume markets.
Pursue Strategic Acquisitions and Alliances
We intend to pursue strategic acquisitions of companies and technologies that strengthen and complement our core technologies, improve our competitive positioning, allow us to penetrate new markets, and grow our customer base. We also intend to work in collaboration with potential strategic partners in order to continue to market and sell new product lines derived from, but not limited to, DNA technology.
Present Markets:
Textiles and Apparel
Cotton identity and the authentication of cotton geographic origin are issues of global significance, important to brand owners for quality assurance and compliance, and to governments that must regulate international cotton trade, enforcement of textile labeling, and protect consumers. We believe that our SigNature T DNA, fiberTyping and digitalDNA solutions could have significant potential applications for the enforcement of cotton trade quotas in the U.S. and across the globe, and for legislated quality improvement within the industry. We believe that our products and technology can also be helpful in assuring quality, traceability and economic investment of cotton and other textiles. We believe that similar issues face other natural fibers like wool, cashmere and leather, as well as man-made fiber, recycled polyester, viscose and other synthetic products and we have begun to introduce our textile solutions to these markets as well.
Our Market Response
Our SigNature T DNA supply chain program for DNA tagging and authentication of cotton fibers is currently in use by our customers. We are now tagging product in the United States to assure integrity of textile supply chains. Our SigNature T DNA commercial program involves the creation of unique SigNature T DNA molecular tags that can be used to tag a customer’s cotton fiber at the ginning stage. Installed in October 2016, our fully automated, secure DNA Transfer Systems allow for traceability and monitoring of all DNA-tagged cotton at multiple gins in Arkansas, Texas and California. DNA Transfer Systems allow for expansion of tagging at other gins to support increased demand for tagging in future years.
| 6 |
Once tagged, the cotton fiber, may be authenticated for textile identity from grower to ginner to spinner to manufacturer to distributor to retailer. At each step of the process, its textile identity will be tested to link the original cotton fiber to finished product, preserving the authenticity of the product and the integrity of the supply chain. SigNature T DNA tags are being used to mark premium Pima cotton fiber, known as PimaCott™ and are also beginning to be used to mark Upland cotton, under the HomeGrown® trademark. As the cotton ginning in the U.S. takes place sometime between September and December each year, it is possible that revenues from this business will be seasonal.
In March 2014, we announced that we had entered into a mutual license agreement with Divatex Home Fashion, Inc. (“Divatex” now known as “Himatsingka America”), a leading supplier of home textiles, to commercialize what we believe to be the world’s first supply-chain-DNA-verified cotton product. Divatex is responsible for marketing, while we license our patented SigNature T DNA technology for application to ensure the veracity of the product. See also the information under the caption “—Distribution of our Products and Commercial Agreements—Himatsingka.” In June 2015, we announced that we had signed a memorandum of understanding with LD Commodities Cotton LLC, one of the world’s largest cotton merchandisers, to provide secure logistic supply chain support for the tagging and authentication of cotton fibers with SigNature T DNA derived from botanical genomes. SigNature T DNA concentrate has been shipped to mark over 190 million pounds of cotton to date.
In January 2016, we signed a cooperative research and development agreement (“CRADA”) with USDA (“United States Department of Agriculture”) to collaborate on the development of assays for cultivars from specific geographic regions of the world. It is important to be able to differentiate cotton based on country of origin to help avoid “Conflict Cotton”, cotton grown using child labor or other undesirable practices. We believe this will assist the cotton industry in protecting the quality and traceability of the products and help protect their economic investments.
Microcircuits and other electronics
The vast majority of counterfeits discovered in military equipment are semiconductors, the stamp-sized silicon wafers that act as the “brains” of nearly every type of modern electronic system. According to an article in DefenseOne (Counterfeits Can Kill U.S. Troops. So Why Isn’t Congress and DoD Doing More to Stop it? — August 8, 2013), the U.S. military is an important consumer of these tiny products; a single F-35 Joint Strike Fighter jet is controlled by more than 2,500 semiconductors.
One of the reasons counterfeit microcircuits are a major concern in weapons procurement is because the chips, which control targeting accuracy and other critical parameters, can wreak havoc if they do not perform to specifications. They can also be a means of sabotaging weapon systems if covertly supplied by a hostile government through seemingly legitimate companies.
In a January 2013 report on a four-year study conducted between 2005 and 2008, the U.S. Department of Commerce revealed that 39% of 387 companies encountered counterfeit electronic components, microcircuits, or circuit boards. Some industry statistics even suggest that counterfeit parts account for 10% of all electronic equipment sold. In fact, counterfeiters are becoming far more adept at passing off bogus parts by leveraging the same sophisticated technologies that chip manufacturers use to produce authentic ones. (Embedded Intel Solutions — Counterfeit Parts are on the Rise).
The Defense Logistics Agency (DLA) is the nation’s combat support agent for logistics. DLA obtains and supplies almost 100% of the consumable items for America’s Warfighters. The Agency manages over 5.1 million parts, supports more than 2,500 weapon systems, and accounts for nearly 85% of the spare parts for our military forces. DLA’s reach extends far beyond DoD. The Agency supports Foreign Military Sales (FMS) to more than 100 nations. DLA provides significant support to worldwide humanitarian relief, the Federal Emergency Management Agency (FEMA), and other federal, state, and local customers.
The problem is not limited to the defense industry. Consumer and industrial businesses are losing approximately $250 billion each year because of counterfeit components. The automotive industry is also losing $3 billion in sales and the semiconductor business is taking a $75 billion hit due to counterfeit parts (National Technical Systems. “The Global Impact of Counterfeit Electronic Components” (August 2015)).
Our Market Response
On November 15, 2012, DLA began to require that defense contractors provide certain items that have been marked with DNA produced by us or our authorized licensees. This requirement has been in place for items falling within Federal Supply Class (FSC) 5962, Electronic Microcircuits, which have been determined to be at high risk for counterfeiting.
Beginning on December 15, 2014, DLA’s Electronic Product Test Center (“PTC”) in Columbus, Ohio began DNA marking all FSC 5962 microcircuits. This change created a centralized, streamlined DNA marking process within DLA. On November 13, 2014, we were awarded a contract by DLA to provide DLA with SigNature DNA marks and related equipment, services and training and that contract was extended for one year through November 12, 2016. A follow-on one-year contract (plus one exercise year) to ensure there is no lapse in support of the current DNA program at DLA’s PTC was signed on October 14, 2016.
The current program is more streamlined, with scaled-up processes, which has reduced certain costs by providing economies of scale, and benefits of marking technology geared to higher-volume operations. It is governed by a single direct contract with DLA.
In addition, in the third quarter of fiscal 2016, two contracts were completed: one for the Missile Defense Agency - Small Business Innovative Research (“SBIR”) – and one for the Office of the Secretary of Defense – Rapid Innovation Fund (“RIF”). The SBIR allowed for continuation of the effort focused on microcircuits and scale-up of the business model to support volume at the point of manufacture. The RIF expanded upon our DNA authentication program for FSC 5962 to identify authentic products and deter counterfeits from infiltrating DoD supply chains, by establishing a single authentication platform for the following six FSGs (as prioritized by DLA):
| 7 |
FSG 59 – Electrical and Electronic Equipment Components
FSG 31 – Bearings
FSG 25 – Vehicular Equipment Components
FSG 29 – Engine Accessories
FSG 47 – Pipe, Tubing, Hose, and Fittings
FSG 53 – Hardware and Abrasives
Together these contracts have strengthened our core capabilities to offer supply chain risk management solutions across an expanded range of critical components used in defense, industrial and consumer markets.
Cash and Valuables-in-Transit
Cash-in-transit businesses transport and store cash and ATM cassettes. In the U.K. alone, there is an estimated £500 billion being transported each year (approximately $755 billion as of December 2015) or £1.4 billion per day (approximately $2.2 billion) (British Security Industry Association: “Combating Cash Delivery Crime”). The nature of this business makes cash-in-transit an attractive target for criminals and as a result the industry invests in excess of £100 million (approximately $151.1 million) per year in security equipment and devices. Almost 25% of attacks in 2013 in the U.K. resulted in some kind of injury and the proportion of attacks where firearms were used has risen 4% from 2012 to 2013 (Professional Security Magazine Online, “Cash in Transit Attack Stats” (May 15, 2014)) making it more important than ever to be able to link the criminals to the crime. Since 2009, the number of CViT (Cash and Valuables in Transit) convictions attributed to the use of SigNature DNA in cash boxes has risen to 105, with prison sentences of almost 500 years. SigNature DNA forensic markers are helping the UK Police to identify stolen cash and to link the evidence directly to the perpetrators. According to the FBI, in 2015, more than $30 million was stolen and over 50 people were killed or injured in over 4,000 robberies of financial institutions across the nation (Bank Crime Statistics 2015 - FBI).
Our Market Response
We incorporate our SigNature DNA markers in cash degradation inks that are used in the cash-in-transit industry in countries throughout Europe. This solvent-based ink marks bank notes if the cash box is compromised and has the ability to penetrate the bank notes rapidly and permanently. We believe our SigNature DNA markers are more resilient and detectable than other competing technologies.
In August 2015, we signed a five-year exclusivity agreement with Patronus Systems Ltd, a company based in West Sussex, U.K. Under the terms of the agreement, we will supply our SigNature® DNA for use with Patronus Systems’ new bonding agent for the cash handling industry. Patronus Systems will be adding SigNature DNA to every single ATM cassette / cash container to ensure recovered monies can be returned to owners and that law enforcement agencies have the forensic evidence to help them convict criminals.
To date, the use of SigNature DNA in the cash handling industry has allowed our products to facilitate the convictions of more than 100 criminals in the U.K. involved in cash-in-transit crime with aggregate prison sentences of almost 500 years. SigNature DNA has been used since 2008 in Europe within the ink and / or smoke systems of Intelligent Bank Note Neutralisation Systems (“IBNS”), more commonly known as cash boxes and ATM cassettes. Unique, plant-based SigNature DNA markers are incorporated into each IBNS during manufacture.
Consumer Asset Marking
Car crime is a huge and profitable business, costing billions of dollars per year and representing approximately one third of all reported crime. It is estimated that approximately 70 percent of stolen cars are broken up and sold for spare parts, while the rest are given a false identity and sold, with many of those being exported to the Middle and Far East.
Everyone has assets they want to look after - from household goods such as TVs, jewelry and antiques to office equipment including computers and laptops. There are a wide variety of valuable items that need to be uniquely identified and protected from theft. Forensic marking of home assets uses technology to code valuables at risk of theft to mark burglars, linking them directly with a crime scene.
Over the years, authorities have found it difficult to obtain convictions of thieves in possession of suspected stolen property unless the true owner can be identified. If marked items are stolen and later found, police can link them directly with the crime scene, not only allowing the property to be returned to its owner, but also increasing the chance of convicting the thieves.
| 8 |
Our Market Response
We believe that DNAnet enhances law enforcement effectiveness by providing forensic quality evidence. The DNAnet Home Asset Marking program provides a simple and cost-effective way for residents to deter crime and protect their property, a way for law enforcement to identify the rightful owners of lost or stolen property, and a way to tell criminals…stay away because you will get caught! Consumers can purchase a marking kit and apply a DNAnet mark to multiple items of property. In the event of theft, police or personnel with ultraviolet light equipment can reveal the DNAnet mark, which thus permits the stolen property to be returned to the owner and serves as valuable evidence to increase the likelihood that perpetrators will be convicted.
Our DNA marker is being used to protect two European automotive manufacturers against the theft of automotive parts imported into at least one E.U. country. New cars are marked with a unique code applied at point of delivery to the customer and customer details are registered on a secure database. The DNA marker provides absolute identification for the vehicle. The markers are covert and difficult to remove. If found, vehicles and their component parts are traceable back to their owner and location, from anywhere on the globe. If the car is stolen and recovered, police will be able to link the criminal to the crime, and will know exactly where to return the vehicle. Highly visible warning stickers are displayed on the windshield of the car, deterring theft in the first place. Since 85% of stolen cars are taken after theft of car keys, other kinds of crime, such as home burglaries, potentially also would be deterred. To date, over 10,000 high-end German-made cars have been marked with DNAnet.
We are also working with the Swedish National Police and insurers, providing DNAnet property marking kits as part of a major initiative to reduce crime in targeted Swedish neighborhoods.
Since program launch of the DNA Asset Security program in the U.S. in April, 2015, there are over 100 communities in 5 states participating in the DNA Asset Security program. This means that the police departments have been trained and equipped to identify marks on recovered property and have communicated their involvement to their community members. Since the implementation of this program, kit sales have been promoted by both the municipalities, local law enforcement agencies and the company to steadily increase the number of marked valuables in each of these communities. Some of these communities are also participating in signage programs alerting would be criminals that they are now entering DNA protected areas. We estimate that between US and International asset security efforts there have been over 30,000 individual DNAnet asset security kits purchased and distributed and there is now an estimated 1 million pieces of property worldwide marked with DNA from us. Recent property recoveries and associated criminal apprehensions and prosecutions in Sweden provide irrefutable evidence that the system, technology and process is indeed effective.
In addition to private individuals and households and municipalities and law enforcement agencies, we believe that a market opportunity may exist for our home asset marking and similar solutions using DNAnet with respect to small and medium-sized businesses, larger enterprises, home owner associations and insurance groups.
Printing and Packaging
The scourge of counterfeiting in packaging has greatly intensified in recent years. Counterfeiting has spiked, causing detrimental health concerns for consumers, safety concerns for law enforcement agencies, and financial concerns for businesses worldwide. As a result, the global anti-counterfeit packaging market is estimated to reach approximately $128.6 billion by the year 2019, according to MarketsandMarkets.
Billions of dollars per year are at stake for companies as they seek ways to ensure that the products sold with their logos and branding are authorized and authentic. The proliferation of counterfeiting requires brand owners and their converter/printer partners to work together to create a multi-layered protection plan so that their packaging and labels protect their brands and deter those trying to profit at their (and their reputation’s) expense.
Counterfeiters have become so good at their unlawful activity that spotting the difference between legitimate and counterfeit products can be daunting. They have many ways to subvert legitimate brands. They may take an out-of-date — but legitimate — product and sell it in packaging and labels that have been faked. Sometimes, everything — including the packaging, labels and product itself — is counterfeit. Criminals might also use legitimate packaging with knock-off products.
Our Market Response
Our integrated platform of forensic DNA taggants and optical and digital technologies offers a high level of security and flexibility in a cost-effective and easy-to-use format to suit the requirements and budget of most companies. They can be added to the varnish, ink or toner in labels and packaging to act as a trace without impacting the quality of the substrate. Our SigNify™ reader or forensic laboratory process is required to detect DNA and verify that a label is authentic. Proprietary optical and digital technologies complement SigNature DNA with more rapid screening capability.
We certify our print and packaging resellers to assure end-users of quality, reliability and security in the use of our products. Our technology is currently being used on packaging of food products by Nissha. Nissha uses our DNA-based ink with its inkjet printing systems to help secure the fresh fish supply chain for the Ōita Fisheries Co-operative. The Ōita fish label is automatically linked to a central database that enables the food supplier, andretailer as well as the end consumer to verify the original product information at the point of sale. Products from Creative Labels have been used on industrial commodity packaging. A pilot with fruit labels has just been completed demonstrating forensic DNA labeling with optical features screened with our Multi-Mode Reader.
| 9 |
Diagnostics and Reagents
DNA-based diagnostics is an emerging application area in the in-vitro diagnostics industry. DNA–protein adducts are popular across the medical diagnostics industry, where these molecules aid in the determination of the incidence of a suspected disease caused by an organism or pathogen. Based on the amount of target DNA present, probes can be used either directly to detect target DNA, facilitate the performance of targeting proteins or indirectly to target DNA through amplification that creates a number of copies of a specific nucleotide. Increased automation of diagnostic tests, discovery of new diagnostic markets, rising investments in pharmaceutical and pharmacogenomics research, and advancements in DNA array technologies are major growth facilitators for the DNA probes-based diagnostic products market.
The report by Allied Market Research titled, "DNA diagnostics Market (products, applications, techniques, end users and Geography) Global Size, Industry Analysis, Trends, Opportunities, Growth and Forecast, 2013 - 2020," indicates that the global DNA diagnostics market would reach $19 billion by 2020 registering a compound annual growth rate (“CAGR”) of 9.8% from 2014 to 2020. The potential to provide accurate diagnosis and cost effectiveness over alternative diagnostic techniques are factors that supplement the growth of the DNA diagnostics market. Recent figures suggest that globally, approximately 32.5 million people are living with cancer (as of 2012) with 14.5 million people in the US living with cancer (as of 2014) and 36.7 million with HIV/AIDS (as of 2015) (International Agency for Research on Cancer, Cancer Fact Sheets, All Cancers (excluding non-melanoma skin cancer), Estimated Incidence, Mortality and Prevalence Worldwide in 2012; World Health Organization, Global Health Observatory (GHO) Data, Cancer Facts and Figures 2016,amFAR).These numbers, we believe are set to increase consistently; however, advanced automated DNA diagnostics technologies such as next generation sequencing could play a crucial role in diagnosing and curbing these diseases.(Allied Market Research, “DNA Diagnostics Market is Expected to Reach $19 Billion by 2020” (August 28, 2014))
Our Market Response
DNA also plays a role in therapeutics such as gene therapy and DNA-based vaccines. Following our acquisition of substantially all the assets of Vandalia Research, Inc. in September 2015, we are able to produce specific, high-quality DNA sequences with the PCR production system known as Triathlon, which is well suited to meet these pharmaceutic and diagnostic needs. Cell-based DNA production methods are often complicated by impurities. In contrast, our PCR-based production method offers a high degree of purity and efficiency. See also the information set forth under the caption “Acquisitions—Vandalia Asset Purchase.”
Future Markets:
Agrochemicals
The agrochemical industry is faced with an increased prevalence of illegal trade, counterfeiting and brand piracy. From the adulteration and counterfeiting of leading herbicides, pesticides and fertilizers with inferior materials, to the substitution of genetically modified seeds with low yield alternatives, crops are at risk more than ever. These issues threaten company reputations, supply systems, export markets and government tax revenues.
In Europe, Africa and other areas of the world, use of counterfeit and illegally traded pesticides is increasing. Untested and unregulated products may threaten the health of farmers and consumers and pose risks to the natural environment. Counterfeit pesticides threaten the integrity of those industries that depend on the benefits of pesticide use.
Fighting counterfeit pesticides is a complex task. We believe that enforcement of regulations governing pesticide use is inadequate and has led in recent years to an increase in use of illegal, counterfeit pesticides.
European Crop Protection Association statistics show that nearly 10% of the pesticides used in Europe are counterfeit and that their trafficking provides criminal organizations with an annual revenue of up to EUR 6 billion. According to a report by the European police cooperation body Europol, illegal products account for up to one quarter of all the crop protection products used in some Member States.
According to research by International Growth Center (2015), the vast majority of fertilizer samples from the Uganda study were substandard. Additionally, very few of the allegedly improved seeds showed success in producing large crops. In short, the agricultural inputs sold at retail level in Uganda are often ‘fake’ or of very poor quality. In the case of fertilizer, according to estimations by the Vietnam Fertilizer Association (2016), the country’s economy loses US$2 billion every year as a result of fake products. According to local market surveillance bodies, fake fertilizer manufacturers use many different techniques to cheat customers, including the use of formulas that differ from what is printed on the package and imitating established market brands.
| 10 |
Our Market Response
We have previously collaborated with a multinational company to SigNature DNA mark, protect and authenticate an agri-based product, and have completed a pilot program to authenticate the SigNature DNA marker in the product itself, as well as verify the SigNature DNA-marked product after it is applied onto crops in the field. The value to the customer for this application is to ensure the quality and authenticity of the product, to minimize the risk of liability that might occur if the product is not used in compliance with the license agreement that is linked to the product, and ultimately, to ensure that the integrity of the customer’s supply chain is preserved. We have activity with other multinational companies to develop DNA authentication programs for other fertilizers, herbicides, insecticides, fungicides and pesticides, although there can be no assurance that these activities will lead to full commercialization.
Pharmaceuticals
Mitigating supplier risk, compliance in global trade, diversion of medicines and counterfeits are global issues that affect all countries. These illegal activities continue to threaten the health and welfare of the citizens who receive fake or substandard product, as well as threaten the revenues and reputation of pharmaceutical companies.
These activities also undermine the efforts of the government to ensure the availability of affordable drugs to its citizens, thus enabling the proliferation of disease, which can lead to development of drug resistant pathogens.
The pharmaceutical industry also faces major problems relative to counterfeit, diluted, or falsely labeled drugs that make their way through healthcare systems worldwide, posing a health threat to patients and a financial threat to drug makers and distributors. Counterfeit prescription pharmaceuticals are a growing trend, widely recognized as a public health risk and a serious concern to public health officials, private companies, and consumers. The National Association of Boards of Pharmacy estimates that counterfeit drugs account for 1–2% of all drugs sold in the United States. The World Health Organization (WHO) estimates the annual worldwide “take” from counterfeit drugs to be £13 billion (approximately $19.6 billion as of December 2015), a figure that is expected to double by the end of this decade. In some countries, counterfeit prescription drugs comprise as much as 70% of the drug supply and have been responsible for thousands of deaths in some of the world’s most impoverished nations, according to the WHO. The global pharmaceuticals and food anti-counterfeiting market is expected to reach $160 billion by 2020. (Radiant Insights, “Global Pharmaceuticals and Food Anti-Counterfeiting Market Is Expected to Reach USD 160.32 Billion by 2020” (September 28, 2015))
In 2012, the WHO reported that in over 50% of cases, medicines purchased over the Internet from illegal sites that conceal their physical address have been found to be counterfeit (WHO: Medicines: Spurious/falsely-labelled/falsified/counterfeit (SFFC) medicines Fact Sheet June 2012). According to the WHO, counterfeiting can apply to both branded and generic products and counterfeit pharmaceuticals may include products with the correct ingredients but fake packaging, with the wrong ingredients, without active ingredients or with insufficient active ingredients.
Based on this growing threat, many countries have started to address vulnerabilities in the supply chain by enacting legislation which, among other things, requires a comprehensive system, most often referred to as serialization or in the United States as Drug Supply Chain Security.
Nearly 40 percent of the drugs Americans take are made elsewhere, and about 80 percent of manufacturing sites of active pharmaceutical ingredients (APIs) used in drugs manufactured in the United States are located outside our borders—in more than 150 countries, many with less sophisticated manufacturing and regulatory systems than our own. In addition to the sheer volume of imports and foreign facilities, there has been an increase in the variety of sources, shippers, methods of transportation, and supply chain complexity of products. Combined, these factors create great challenges to FDA and industry in ensuring that all drugs and drug components are high quality and travel safely throughout their complex supply chains. These factors also provide opportunities for criminals to adulterate drugs for economic or other malevolent reasons making it more important than ever that supply chains be secured around the world. (U.S. Food and Drug Administration, “Counterfeit Drugs: Fighting Illegal Supply Chains” (February 27, 2014))
Drug supply chain security and serialization requirements affect all aspects of the pharmaceutical supply chain, starting with the manufacturer down through the packager, wholesaler, distributor and final dispensing entity. The laws provide an ‘audit trail’ (or documented evidence) to help to identify and catch counterfeiting and diversion. Serialization requires manufacturers, or in some virtual supply chains third-party packagers, to establish and apply to the smallest saleable unit package or immediate container a “unique identification number.” In some cases, drug makers are spending as much as 8 to 10 percent of a medicine pack’s total production cost on solutions to protect it from duplication and counterfeiting, according to company executives (Business Standard (August 20, 2012)).
Our Market Response
In October 2011, the U.S. Food and Drug Administration (the “FDA”) published a Final Guidance document on the use of so called “Physico-Chemical Identifiers” (PCIDs). Accordingly, we believe that SigNature DNA is able to be used in drugs at levels of approximately 1 part per trillion (1 in 1012); this level of SigNature DNA is less than 1/100,000th the level of DNA considered permissible as a contaminant in oral doses. Any PCID that satisfies the general principals established in the FDA Guidance is highly likely to be acceptable for any FDA regulated product, except for those subject to an FDA-approved New Drug Application. The FDA Guidance stipulates that a PCID should be pharmacologically inactive and present no risk of adverse reaction. The PCID cannot affect the efficacy of the drug. In addition, 11 categories of information about the PCID must be satisfactorily addressed. We believe SigNature DNA fulfilled all of these requirements, and is applicable to food and cosmetics.
| 11 |
Our unique DNA identifier mark-embedded in the ink of a unique serialized barcode can provide a layered security foundation for a customer solution in this market. Strengthening the bar codes to be utilized in the serialization process can be a potent approach to protecting the patient and bringing greater confidence to the brand of the pharmaceutical company.
Personal Care
Never has it been so important to know where cosmetic materials come from. In the fast-moving $197 plus billion global cosmetic industry, sustainable claims for materials has now moved on to origin of materials claims. Brands no longer want just good quality grape juice. They want quality juice from French Champagne grapes. The next trend entering the market will be Proof of Origin as regulators and consumer groups challenge brands asking for evidence.
Personal Care is fashion led and fast to market. The industry prides itself in being an early adopter and adapter of the very latest technologies. For example, skin care brands took Botox, stem cell technology and peptide chemistry, out of medical laboratories and into the market place, by adapting their functions for the industry's own needs. Personal care brands are ravenous for the next high tech idea they can champion.
Sustainability is a strong underlying theme driving personal care (Forum for The Future, 2015). For the past 10 years, multinationals have been embracing corporate social responsibility (CSR), endeavouring to become greener and reduce their negative impact on the planet. L'Oréal, through its brand, The Body Shop, leads the way with Community Trade, where the people harvesting and processing ingredients benefit from sales, in return for their story. L'Oréal has pledged to double the number of community traded materials from 19 to 40 communities by 2020 (Guardian, 2016). The trend of marketing products based on the source of their ingredients has gained greater market weight than the product's efficacy and now, the origin of materials has become the main reason for buying many personal care products. Personal care brands know millennials are twice as likely to purchase from a brand because of its genuine sustainability credentials (Morgan Stanley, 2015).
At the In Cosmetics Formulation Summit on Protection in London in 2016, Jason Matthews (International Regulatory Affairs & Scientific Director at The Body Shop) stressed how important it is for all brands to know, not just the source of materials but every step in their supply chains. He talked about slavery, pointing out that companies found to be using materials involving slavery are breaking the law in the UK and USA. He showed heart wrenching examples of inhumane practice such as the fire in 2012 at Ali Enterprises in India where barred windows and locked fire exits caused the death of 250 workers and the disaster in Bangladesh in 2013 when the poorly constructed Rana Plaza building collapsed killing over 1,137 workers. These workers were making clothing for U.S., Canadian and European clothing labels and retailers. He used these examples to emphasise to personal care brands, how they cannot afford to be associated with such disasters.
Cosmetic brands rely on internal and external ethical auditing, often with certification, to manage their supply chains. The number of certification bodies is growing. It is no longer enough to talk about a company's good practice without supplying proof. Multinationals, their brands and their material suppliers therefore strive for ISO certification and most are also using materials certified by the expanding number of NGO auditing groups. Raw material suppliers and personal care manufacturers boast ISO 9001 quality management standards and many are obtaining ISO 26000, which provides guidance on how businesses and organizations can operate in a socially responsible way. Many brands demand that their products are made with palm oil from responsible sources, i.e. those with Round Table on Sustainable Palm Oil (RSPO) certification and have their sustainable finished products certified by organisations such as Cradle to Cradle™. The personal care industry is not complacent and companies know improvements are needed. They are aware through scandals such as the recent discovery that beef in the UK foods was in fact horse meat, that even the best audited paper trail is vulnerable to abuse (Guardian, 2013).
Also at the In Cosmetics Formulation Summit on Protection in London in 2016, Prof Monique Simmonds, Deputy director of Kew showed evidence of adulteration in botanical materials destined for health supplements and for personal care. Some of the materials they had removed from the supply chain were toxic and could have been lethal. Adulteration and counterfeit cosmetics continues to grow. Counterfeit make-up products containing over 200 times the safe level of lead, arsenic, mercury, copper and cadmium have been seized (Daily Mail, 2015). Because social media can quickly spread bad news to millions of consumers, distancing themselves from dangerous counterfeit products and so protecting brand integrity, has never been more important. Also, the trend in cosmetics is moving away from elitist prestige products and towards masstige and so increasing the opportunities for even more counterfeiting. Personal care brands also cannot afford the financial losses due to counterfeiting, which in the EU is estimated to be $4.7 billion/pa (OECD, 2016).
Our Market Response
We believe that our Signature DNA markers and related technologies are the solution to the need to prove quickly the origin of materials when challenged. Signature DNA markers allow the whole supply chain to be followed as never before.
Signature DNA is the next cutting-edge technology for the cosmetic industry to digest, adopt and adapt. SigNature DNA markers are safe, approved for cosmetic use and so can be included today in cosmetic grade raw materials and in finished personal care products, for traceability. Our laboratories at Stony Brook, NY have shown that prestige skin care products already contain far greater background DNA than we need for tracing. (Routinely, SigNature DNA is included at parts per trillion (0.001µg/mg) and in the case of one skin care product, the background DNA content was 6µg/mg of product). Because SigNature DNA markers are botanically derived and have no connection with genetically modified organisms (GMO) in any way, we believe they are perfect for personal care, even for natural brands. The latest advances in forensic science technology enable the presence of SigNature DNA markers in a material, to demonstrate in just tens of minutes even out in the field, making it an effective practical solution for large numbers of supply chain issues.
| 12 |
Our technology enables brands hungry for the next big trend, to now move on from sustainability to authenticity.
Personal care companies using our technologies in their supply chains will become the auditors and certifiers friend. Their paper trails of signatures supporting origin claims will now be supported by forensic proof. SigNature DNA markers from the raw materials will be present in the finished products, giving brands the weapon they need to respond to social media and to defend themselves from many of the consequences of counterfeiters.
Food and Beverage
Each year, millions of people are deceived into buying counterfeited food and beverages, posing significant health and safety risks. Thousands of tons of fake and sub-standard food and drink were seized in 57 countries around the world as part of an INTERPOL-Europol coordinated operation. Operation Opson V, conducted from November 2015 through February 2016, resulted in the seizure of more than 11,000 tons of counterfeit and illicit food (Fortune “Largest Ever Bust of Counterfeit Foods Finds Gruesome Stuff Including Monkey Meat” April 8, 2016).The initiative, in its fifth year, brought in a record haul, seizing “foods” like monkey meat, locusts and caterpillars, as well as fake alcohol.
Counterfeit food threats are becoming more common as supply chains become more global and as imaging and manufacturing technology become more accessible. The distribution and selling of counterfeit foods is officially known as economically motivated adulteration (EMA), a subcategory of food fraud. EMA can be anything from altering the weight of the product by adding a lower quality ingredient to tampering with the product’s label. Diluting fruit juice with water, adding chemicals to boost the protein content of a food, and changing the expiration dates on meat labels are all good examples. These acts are illegal, of course, and potential health concerns, but the issue is widespread and hard for the government to control. In fact, according to the U.S. Pharmacopeial Convention (USP), an estimated 7% of products in grocery stores nationwide contain fraudulent ingredients. There are numerous alarming examples of counterfeit foods that have been reported. For instance, long-grain rice is being labeled and sold as basmati rice, Spanish olive oil is being bottled and sold as Italian olive oil, and mixtures of industrial solvents and alcohol are being sold as vodka. In addition, herbal teas have been found to contain no herbs or tea and juices have been found to contain vegetable oil, which is used as a flame retardant, and labeled tuna turns out to be an unidentifiable concoction of random meats. The National Center for Food Protection and Defense (“NCFPD”) has estimated the annual impact to the food industry from fraud to be $10 billion to $15 billion annually— often due to product disguising the country of origin, substitution, dilution and false labeling (NCFPD, Amy Kircher, Economically Motivated Adulteration and FIDES (2012)). Globally, the anti-counterfeit packaging market accounted for $57.4 billion in 2013, which is forecast to generate revenue of $142.7 billion by 2020 at 13.9% CAGR from 2013-2020. (Allied Market Research, “Anti-Counterfeit Food Packaging Market is Expected to Reach $62.5 Billion, Globally by 2020” (May 28, 2015)).
Our Market Response
We believe our SigNature DNA markers and authentication program can help in the battle against counterfeit foods and beverages. We operate under ISO 9001:2008 certification and provide botanical-DNA based security and authentication solutions that help protect brands and their supply-chains. Our SigNature DNA markers and authentication solutions ensure transparent identification and tracking of branded products, helping to maintain supply chain integrity and security and detect and prevent counterfeiting.
Sales and Marketing
We have 12 employees engaged in sales and marketing, of which six are directly involved with sales. We expect to hire additional sales directors and/or consultants and increase our use of channel and strategic partners to assist us with sales and marketing efforts with respect to our target vertical markets.
Research and Development
Our research and development efforts are primarily focused on incorporating DNA into carriers (such as ink or textile treatments), and authenticating DNA from the marked substrates or the endogenous DNA both in our laboratories and with the development of infield DNA readers. As part of this effort, we typically conduct feasibility and pilot testing to ensure that DNA application methods are compatible with the customer’s manufacturing and logistic processes, and that they can be implemented in a cost effective manner. In some cases, the DNA application methods may undergo wash-out and/or adherence tests to ensure that DNA can be authenticated even if it is subjected to aggressive removal techniques. We are also actively involved in identifying new formulation development, and new application methods that provide even better adhesion of DNA to substrates, and more homogeneous distribution of the DNA onto the surface. In short, we have considerable experience working with a wide range of carriers and substrates, and authenticating them even years after they have been applied onto the surface. We believe that our continued development of new and enhanced technologies relating to our core business is essential to our future success. We incurred approximately $3.7 million and $2.6 million on research and development activities for the fiscal years ended September 30, 2016 and 2015, respectively.
| 13 |
Raw Materials and Suppliers
Our sources of raw materials include sources of DNA that are readily available in nature, which we are able to replicate to use in our product offerings.
Manufacturing
We have the capability to manufacture SigNature DNA markers and all of our products at our laboratories in Stony Brook. We also have in-house capabilities to complete all authentications. We are also engaged in the large-scale production of specific DNA sequences using PCR.
Distribution of our Products and Commercial Agreements
Our products are distributed in the following ways:
| • | directly to the customer; |
| • | through channel partners; and |
| • | through licensed distributors. |
We have entered into the following agreements and arrangements for the distribution of our products, among others:
DLA. On November 13, 2014, we were awarded a contract by DLA to provide DLA with SigNature DNA markers and related equipment, services and training. Beginning on December 15, 2014, DLA’s Electronic Test Laboratory in Columbus, Ohio began DNA marking all FSC 5962 microcircuits. This created a centralized, streamlined DNA marking process within DLA. This contract was extended through November 12, 2016.A follow-on one-year contract (plus one exercise year) to ensure there is no lapse in support of the current DNA program at DLA’s PTC was signed on October 14, 2016.
Office of the Secretary of Defense. On August 28, 2014, we were awarded a two-year development contract by the Office of the Secretary of Defense on behalf of the DLA in the amount of $2.97 million. The Rapid Innovation Fund project will develop a single authentication platform — our Signature DNA and complementary technologies — to identify authentic products and deter counterfeits from infiltrating six DoD Federal Supply Groups (“FSGs”).
Those FSGs are, in order of risk to DLA:
| 1. | FSG 59 (Electrical and Electronic Equipment Components) |
| 2. | FSG 31 (Bearings) |
| 3. | FSG 25 (Vehicular Equipment Components) |
| 4. | FSG 29 (Engine Accessories) |
| 5. | FSG 47 (Pipe, Tubing, Hose and Fittings) |
| 6. | FSG 53 (Hardware and Abrasives) |
Our DNA marking solution currently protects items in DoD Federal Supply Class (FSC) 5962, Microcircuits. This project will demonstrate our authentication solutions for the other high-risk commodities above. We performed services such as development, test and evaluation, field trials, and transition to government operations. This contract expired during August 2016.
U.S. Missile Defense Agency. On July 14, 2014, we were awarded a Phase II SBIR contract by the U.S. Missile Defense Agency to perform research and development for avoidance of counterfeit parts by expanding the scope and scale of our existing SigNature DNA® technology platform established in its Phase I SBIR contract for Federal Supply Class 5962 electronic components, and by developing an optical reader. The contract provided for monthly payments to us totaling approximately $975,000 over a two-year period. This contract expired during July 2016.
Defense Contractor. On October 4, 2013, we, as seller, entered into a master option agreement with one of the four largest American defense contractors, as buyer (“Buyer”), and committed to supply one (1) unique SigNature DNA provenance mark for Buyer and SigNature DNA ink for marking up to 25,000 electronic components/year, upon Buyer’s request through the issuance of a purchase order. For the Buyer, the agreement is an enterprise-wide option to purchase. The term of the agreement commenced on October 3, 2013 and expires October 3, 2023. Buyer has engaged a third-party marker, which third-party marker is and must remain approved by us, to provide certain services to incorporate our ink onto certain electronic components of Buyer. Either party may terminate the agreement in the event of a material breach that is uncured for 30 days. We have received from Buyer two purchase orders governed by these terms in the amount of an aggregate of $111,000 thus far. The agreement severely restricts publicity on behalf of both parties.
Dreyfus. On May 30, 2015, we entered into a Memorandum of Understanding (“MOU”) with LD Commodities Cotton LLC (“Dreyfus”) which operates under the trade name of Allenberg Cotton Co. The MOU provides for a two year exclusive worldwide license from us to Allenberg to manage the use of SigNature T DNA for the purpose of tagging cotton fiber and to ensure chain of custody of the baled DNA-tagged fiber. In consideration of the MOU, we agreed to only use Allenberg and its designated gins for the tagging of cotton fiber and Allenberg agreed not to use any other tagging technology for marking or authenticating cotton. Allenberg will collect a tagging fee on our behalf for each pound of SigNature T DNA-tagged cotton conditional upon its sale to its customers.
| 14 |
Himatsingka. On March 25, 2015, we entered into a mutual license agreement with Divatex Home Fashions, Inc., (currently operating as Himatsingka America, Inc.) (“Himatsingka”), a supplier of home textiles, to commercialize a supply-chain-DNA–verified cotton product. Himatsingka is responsible for marketing and we are responsible for licensing our SigNature T DNA technology for application to cotton at the ginning sites. Finished product made from this tagged fiber will be offered for sale under the PimaCott™ content-branded label. The initial term of the license agreement is two (2) years. The term of the license agreement will automatically renew for additional one (1) year periods, unless the agreement is earlier terminated in accordance with its terms. We also have the right to terminate the license agreement if Himatsingka does not complete the cumulative sale of 45 million pounds of product by the second anniversary of the license agreement.
We and Himatsingka have reached a confidential agreement on the amount of the licensing and related costs, which we bear, and the marketing and related costs, which Himatsingka bears, and an initial allocation of revenues (the “Revenue Sharing Model”). We collect the tagging fee from merchants and pay to Himatsingka its share of the tagging fee on a quarterly basis, based on when payments are received by us. Each party is entitled to be reimbursed for its respective agreed costs. The balance of the tagging fees received are to be divided equally between the parties, except for fees relating to the first 100 million pounds of cotton tagged, which will be distributed as set forth in the Revenue Sharing Model. On June 29, 2016, Himatsingka waived its portion of the tagging fee for up to $250,000.
Customer Concentration
Our revenues earned from the sale of products and services for the fiscal year ended September 30, 2016 included an aggregate of 75% of our total revenues from three customers. These three customers accounted for approximately 20% of our total accounts receivable at September 30, 2016. Our revenues earned from sale of products and services for the fiscal year ended September 30, 2015 included an aggregate of 79% from two customers of our total revenues. These two customers accounted for approximately 90% of our total accounts receivable at September 30, 2015. At September 30, 2016, one customer accounted for an aggregate of 78% of our total accounts receivable. Generally, our customers do not have an obligation to make purchases from us and may stop ordering our products and services or may terminate existing orders or contracts at any time with little or no financial penalty. The loss of any of our significant customers, any substantial decline in sales to these customers, or any significant change in the timing or volume of purchases by our customers, could result in lower revenues and could harm our business, financial condition or results of operations.
Acquisitions
Vandalia Asset Purchase
On September 11, 2015, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”), with Vandalia Research, Inc. a West Virginia corporation ("Vandalia"), and Derek A. Gregg, Vandalia’s Chief Executive Officer and a director of Vandalia, providing for the purchase of substantially all the assets (“Assets”) of Vandalia. The Company completed the acquisition of such Assets on the same date (“Vandalia Asset Acquisition”). The purchase price for the Assets was $1,500,000, which amount was determined through arms-length negotiation. Of this amount, $500,000 was placed in an escrow account for a period of nine months following the closing to satisfy Vandalia’s indemnification obligations of which $350,000 was released to Vandalia after sixty days. On June 30, 2016, the Company received $50,000 of the remaining funds in escrow to satisfy indemnification obligations and the balance of $100,000 was released to Vandalia.
The Vandalia Assets relate to the business of producing specific, high-quality DNA sequences with the PCR production system known as Triathlon™, including machinery, equipment, inventory, registered and other intellectual property, including patents, trademarks, trade secrets, domain names, copyrights and rights to software, and customer contracts. The Assets also include Vandalia’s rights under a patent license agreement between Marshall University Research Corporation (“Marshall”) and Vandalia pursuant to which we will pay to Marshall a royalty of one percent (1%) of the net revenues received by us from the sale of the licensed product. Vandalia and Derek Gregg agreed not to compete with us and not to solicit our employees or customers for a period of five (5) years following the closing. Derek Gregg also entered into a consulting agreement with us for a term of twelve (12) months subject to earlier termination by either party upon thirty (30) days’ notice. Prior to the Vandalia Asset Acquisition, we were a customer of Vandalia, paying approximately $230,300 during fiscal 2014. The consulting agreement with Derek Gregg terminated on September 30, 2016.
Competition
The principal markets for our offerings are intensely competitive. We compete with many existing suppliers and new competitors continue to enter the market. Many of our competitors, both in the United States and elsewhere, are major pharmaceutical, chemical and biotechnology companies, or have strategic alliances with such companies, and many of them have substantially greater capital resources, marketing experience, research and development staff, and facilities than we do. Any of these companies could succeed in developing products that are more effective than the products that we have or may develop and may be more successful than us in producing and marketing their existing products. Some of our competitors that operate in the anti-counterfeiting and fraud prevention markets include: 3DTL Inc., Alp Vision Sa, Authentix Inc., Brandwatch Technologies, Chromologic LLC, Collectors Universe Inc., Collotype Labels International, Data Dot Technology, De La Rue Plc., Digimarc Corp., DNA Technologies, Inc., DuPont Authentication Systems, FractureCode Corporation, Haelixa, ICA Bremen GmbH, ID Global Solutions Corporation, IEHCorporationInformium AG,, Eastman Kodak Company, L-1 Identity Solutions Inc., opSec Security Group plc., MicroTagTemed Ltd., Nanotech Security Corp., Nokomis, Inc., ProoftagSAS, SafeTraces Inc., Selectamark Security Systems plc, Spectra Systems Corp., SmartWater Technology, Inc., Sun Chemical Corp, TraceTag International, TruTag Technologies Inc., and YottaMark Inc..
| 15 |
Some examples of competing security products include:
| • | fingerprint scanner (a system that scans fingerprints before granting access to secure information or facilities); |
| • | voice recognition software (software that authenticates users based on individual vocal patterns); |
| • | cornea scanner (a scanner that scans the iris of a user’s eye to compare with data in a computer database); |
| • | face scanner (a scanning system that uses complex algorithms to distinguish one face from another); |
| • | integrated circuit chip and magnetic strips (integrated circuit chips that receive and, if authentic, send a correct electric signal back to the reader, and magnetic strips that contain information, both of which are common components of debit and credit cards); |
| • | optically variable microstructures (these include holograms, which display images in three dimensions and are generally difficult to reproduce using advanced color photocopiers and printing techniques, along with other devices with similar features); |
| • | elemental taggants and fluorescence (elemental taggants are various unique substances that can be used to mark products and other items, are revealed by techniques such as x-ray fluorescence); and |
| • | radioactivity and rare molecules (radioactive substances or rare molecules which are uncommon and readily detected). |
We expect competition with our products and services to continue and intensify in the future. We believe competition in our principal markets is primarily driven by:
| • | product performance, features and liability; |
| • | price; |
| • | timing of product introductions; |
| • | ability to develop, maintain and protect proprietary products and technologies; |
| • | sales and distribution capabilities; |
| • | technical support and service; |
| • | brand loyalty; |
| • | applications support; and |
| • | breadth of product line. |
If a competitor develops superior technology or cost-effective alternatives to our products, our business, financial condition and results of operations could be significantly harmed.
Proprietary Rights
We believe that our 41 patents, 83 patent applications, 37 registered trademarks, and 8 trademark applications, and our trade secrets, copyrights and other intellectual property rights are important assets for us. Our patents will expire at various times between 2021 and 2032. The duration of our trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained.
On May 31, 2016, 3SI granted a non-exclusive license to us to exploit, including the rights to have manufactured and have assembled and offer for sale, sell, market, advertise and distribute nucleic acid tags suitable for use in any product or system covered by one or more valid claims in any unexpired patents worldwide. On September 11, 2015, as part of the Vandalia Asset Acquisition, Marshall University Research Corporation consented to the assignment and transfer of Vandalia's exclusive worldwide right and license under Patents to manufacture, use, produce, sell and have sold, market and develop Licensed Products or derivatives therefrom to us.
However, there are events that are outside of our control that pose a threat to our intellectual property rights as well as to our products and services. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed. The efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. Protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. There is always the possibility that the scope of the protection gained from one of our issued patents will be insufficient or deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. This secrecy could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from these trade secrets.
| 16 |
Litigation regarding patents and other intellectual property rights is extensive in the biotechnology industry. In the event of an intellectual property dispute, we may be forced to litigate. This litigation could involve proceedings instituted by the U.S. Patent and Trademark Office or the International Trade Commission, as well as proceedings brought directly by affected third parties. Intellectual property litigation can be extremely expensive, and these expenses, as well as the consequences should we not prevail, could seriously harm our business. If a third party claims an intellectual property right to technology we use, we might need to discontinue an important product or product line, alter our products and processes, pay license fees or cease our affected business activities. Although we might under these circumstances attempt to obtain a license to this intellectual property, we may not be able to do so on favorable terms, or at all.
Government Approvals
We do not require any material governmental approvals to conduct our business as we currently do.
Impact of Government Regulation
We and our products are subject to regulation by various U.S. federal regulatory agencies such as the Federal Trade Commission and are subject to regulation by the Occupational Safety and Health Administration (“OSHA”) concerning employee safety and health matters. Such regulations principally relate to the ingredients, labeling, packaging, advertising and marketing of our products. There are no significant capital expenditures for government regulation matters either planned in the current year or expected in the near future.
Compliance with Environmental Law
We believe that we are in compliance with all applicable environmental law.
Employees
As of September 30, 2016 we had a total of 60 employees, consisting of 55 full-time and 5 part-time employees, including 4 in management, 9 in research and development, 1 in life sciences, 4 in forensics, 7 in quality assurance and compliance, 4 in finance and accounting, 10 in operations, 12 in sales and marketing, 1 in human resources, 2 in shared services, 4 in information services, 1 in investor relations, and 1 in product development. We expect to increase staffing dedicated to sales, research and development, manufacturing, and production. Expenses related to travel, marketing, salaries, and general overhead will be increased as necessary to support our growth in revenue. 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 human capital is dependent upon our ability to generate revenues and obtain sources of funding. As we continue to expand, we will incur additional costs for human capital. Since June 2012, we have been working with Insperity Inc. to assist in managing many of our back-end administrative human resources, benefits, and payroll responsibilities. We are an at-will employer and generally do not enter into employment agreements requiring our employees to continue in our employment for any period of time, with the exception of our Chief Executive Officer, Dr. James A. Hayward. The initial term of Dr. Hayward’s current employment agreement is July 1, 2016 through June 30, 2017, and this employment agreement automatically renews for one-year periods subject to ninety days’ prior notice of non-renewal by Dr. Hayward or us any in accordance with the terms of the employment agreement.
Available Information
We are subject to the informational requirements of the Exchange Act, which requires us to file our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to such reports and other information with the SEC. This information is available at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Because we file documents electronically with the SEC, you may also obtain this information by visiting the SEC’s website at: www.sec.gov. Our website is located at: www.adnas.com. The information on, or that may be accessed through, our website is not incorporated by reference into and should not be considered a part of this report.
Because of the following factors, as well as other variables affecting our operating results and financial condition, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. In addition to the factors discussed elsewhere in this report and our other reports and documents filed with the SEC, the following are important factors that could cause actual results or events to differ materially from those contained in any forward-looking statements made by us or on our behalf. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we may currently deem immaterial also may impair our business, financial condition, operating results and/or stock price. If any of the following risks or such other risks actually occurs, our business, financial condition, operating results and/or stock price could be harmed. In the following factors, “volatility in our share price”, “adverse impact on the price (or value) of our shares”, “decline in the price of our common stock” and similar terms also refer to our warrants and shares to be received upon exercise of our warrants.
| 17 |
Risks Relating to Our Business:
We have a short operating history with our current business model, and have not produced significant revenues. This makes it difficult to evaluate our future prospects and increases the risk that we will not be successful.
We have a short operating history with our current business model, which involves the development, marketing, sale and distribution of supply chain security and product authentication solutions as well as the large scale production of specific DNA sequences using the polymerase chain reaction. Our operations since inception have produced limited revenues, and may not produce significant revenues in the near term, or at all, which may harm our ability to obtain additional financing and may require us to reduce or discontinue our operations. If we create significant revenues in the future, we expect to derive most of such revenues from the sale of supply chain security and product authentication solutions. You must consider our business and prospects in light of the risks and difficulties we will encounter as a company operating in a rapidly evolving industry. We may not be able to successfully address these risks and difficulties, which could significantly harm our business, operating results, and financial condition.
We have a history of net losses which may continue, and which may harm our ability to obtain financing and continue our operations.
We incurred net losses of $12.2 million and $11.9 million for the fiscal years ended September 30, 2016, and 2015, respectively. These net losses have principally been the result of the various costs associated with our selling, general and administrative and research and development expenses as we expanded operations, acquired, developed and validated technologies, expanded marketing activities, incurred interest expense on notes we issued to obtain financing and issued warrants with “reset” provisions. Our operations are subject to the risks and competition inherent in a company that moved from the development stage to an operating company. We may not generate sufficient revenues from operations to achieve or sustain profitability on a quarterly, annual or any other basis in the future. Our revenues and profits, if any, will depend upon various factors, including whether our existing products and services or any new products and services we develop will achieve market acceptance. If we continue to incur losses, then our accumulated deficit will continue to increase which may significantly impair our ability to obtain additional financing. As a result, our business, results of operations and financial condition would be significantly harmed, and we may be required to reduce or terminate our operations.
If we are unable to obtain additional financing our business operations may be harmed or discontinued.
Our continuation as a going concern is dependent upon our future revenues and our ability to commercialize more products, obtain additional capital and attain profitable operations. We may require additional funds to complete the continued development and commercialization of our products, product manufacturing, and to fund expected additional losses from operations, until revenues are sufficient to cover our operating expenses. If we are unsuccessful in obtaining any necessary additional financing, we will most likely be forced to reduce or terminate our operations.
Our operating results could be adversely affected by a reduction in business with our significant customers.
Our revenue earned from the sale of products and services for the fiscal year ended September 30, 2016 included an aggregate of 75% of our total revenues from three customers. These three customers accounted for approximately 20% of our total accounts receivable at September 30, 2016. At September 30, 2016, one customer accounted for an aggregate of 78% of our total accounts receivable. Our revenues earned from sale of products and services for the fiscal year ended September 30, 2015 included an aggregate of 79% from two customers of our total revenues. These two customers accounted for approximately 90% of our total accounts receivable at September 30, 2015. Generally, our customers do not have an obligation to make purchases from us and may stop ordering our products and services or may terminate existing orders or contracts at any time with little or no financial penalty. The loss of any of our significant customers, any substantial decline in sales to these customers, or any significant change in the timing or volume of purchases by our customers, could result in lower revenues and could harm our business, financial condition or results of operations.
If our existing products and services are not accepted by potential customers or if we fail to introduce new products and services, our business, results of operations and financial condition will be harmed.
There has been limited market acceptance of our botanical DNA based technology, encapsulation, embedment and authentication products and services to date. Some of the factors that will affect whether we achieve market acceptance of our solutions include:
| ● | availability, quality and price relative to competitive solutions; |
| ● | customers’ opinions of the solutions’ utility; |
| ● | ease of use; |
| ● | consistency with prior practices; |
| 18 |
| ● | scientists’ opinions of the solutions’ usefulness; and |
| ● | general trends in anti-counterfeit and security solutions’ research. |
Dependence on channel partners.
Our future growth will depend to a material extent on the successful advocacy of our technology by channel partners to their members and customers, and implementation of our technology in solutions propagated by channel partners and provided by third parties. Our business has relied on the success of business partners. Our continuing success is largely dependent on a new generation of business partners involved in our tagging technology.
If our channel partners are not successful in advocating and deploying our technology, we may not be able to achieve and sustain profitable operations. If other business partners who include our technology in their products or otherwise license our intellectual property for use in their products cease to do so, or we fail to obtain other partners who will incorporate, embed, integrate or bundle our technology, or these partners are unsuccessful in their efforts, expanding deployment of our technology and increasing revenues will be adversely affected. Consequently, our ability to increase revenue could be adversely affected and we may suffer other adverse effects to our business. In addition, if our technology does not perform according to market expectations, our future sales would suffer as customers seek and employ alternative technologies.
Many of our business endeavors can be impeded or frustrated by larger, more influential companies or by standard-setting bodies or institutions downplaying, minimizing or rejecting the value or use of our technology. A negative position by such companies, bodies or institutions, could result in obstacles for us that we would be incapable of overcoming and may block or impede the adoption of our technology. In addition, potential customers may delay or reject initiatives that relate to deployment of our technology. Such a development would make the achievement of our business objectives in this market difficult or impossible.
The expenses or losses associated with lack of widespread market acceptance of our solutions may harm our business, operating results and financial condition.
Rapid technological changes and frequent new product introductions are typical in the markets we serve. Our future success may depend in part on continuous, timely development and introduction of new products that address evolving market requirements. We believe successful new product introductions may provide a significant competitive advantage because customers invest their time in selecting and learning to use new products, and once invested in the new technology, are often reluctant to switch products. To the extent we fail to introduce new and innovative products, we may lose any market share we then have to our competitors, which will be difficult or impossible to regain. Any inability, for technological or other reasons, to successfully develop and introduce new products could reduce our growth rate or damage our business. We may experience delays in the development and introduction of products. We may not keep pace with the rapid rate of change in anti-counterfeiting and security products’ research, and any new products acquired or developed by us may not meet the requirements of the marketplace or achieve market acceptance.
We need to expand our sales, marketing and support organizations and our distribution arrangements to increase market acceptance of our products and services.
We currently have a limited number of sales, marketing, customer service and support personnel and will need to increase our staff to generate a greater volume of sales and to support any new customers or the expanding needs of existing customers. The employment market for sales, marketing, customer service and support personnel in our industry is very competitive, and we may not be able to hire the kind and number of sales, marketing, customer service and support personnel we are targeting. Our inability to hire qualified sales, marketing, customer service and support personnel may harm our business, operating results and financial condition. While we have entered into a limited number of agreements with distributors, we may not be able to sufficiently build out a distribution network or enter into arrangements with qualified distributors on acceptable terms or at all. If we are not able to develop greater distribution capacity, we may not be able to generate sufficient revenue to support our operations.
If we are unable to continue to retain the services of Dr. Hayward, we may not be able to continue our operations.
Our success depends to a significant extent upon the continued service of Dr. James A. Hayward, our Chairman, Chief Executive Officer and President. On July 28, 2016, we entered into a new employment agreement with Dr. Hayward. The initial term is from July 1, 2016 through June 30, 2017, with automatic one-year renewal periods. Loss of the services of Dr. Hayward could significantly harm our business, results of operations and financial condition. We do not maintain key-person insurance on the life of Dr. Hayward.
| 19 |
The markets for our supply chain security and product authentication solutions are very competitive, and we may be unable to continue to compete effectively in these industries in the future.
The principal markets for our supply chain security and product authentication solutions are intensely competitive. Many of our competitors, both in the United States and elsewhere, are major pharmaceutical, chemical and biotechnology companies, or have strategic alliances with such companies, and many of them have substantially greater capital resources, marketing experience, research and development staff, and facilities than we do. Any of these companies could succeed in developing products that are more effective than the products that we have or may develop and may be more successful than us in producing and marketing their existing products. Some of our competitors that operate in the supply chain security and fraud prevention markets include: 3DTL Inc., Alp Vision Sa, Authentix Inc., Brandwatch Technologies, Chromologic LLC, Collectors Universe Inc., Collotype Labels International, Data Dot Technology, De La Rue Plc., Digimarc Corp., DNA Technologies, Inc., DuPont Authentication Systems, FractureCode Corporation, Haelixa, ICA Bremen GmbH, ID Global Solutions Corporation, IEHCorporationInformium AG,, Eastman Kodak Company, L-1 Identity Solutions Inc., opSec Security Group plc., MicroTagTemed Ltd., Nanotech Security Corp., Nokomis, Inc., ProoftagSAS, SafeTraces Inc., Selectamark Security Systems plc, Spectra Systems Corp., SmartWater Technology, Inc., Sun Chemical Corp, TraceTag International, TruTag Technologies Inc., and YottaMark Inc.
We expect this competition to continue and intensify in the future. Competition in our markets is primarily driven by:
| ● | product performance, features and liability; |
| ● | price; |
| ● | timing of product introductions; |
| ● | ability to develop, maintain and protect proprietary products and technologies; |
| ● | sales and distribution capabilities; |
| ● | technical support and service; |
| ● | brand loyalty; |
| ● | applications support; and |
| ● | breadth of product line. |
If a competitor develops superior technology or cost-effective alternatives to our products, our business, financial condition and results of operations could be significantly harmed.
Revenues from our customer contracts with respect to cotton will be seasonal and may also be subject to weather conditions and other factors beyond our control, which may cause our operating results to fluctuate significantly quarterly and annually.
A significant and growing proportion of our revenues is expected to derive from customer contracts for tagging, authentications and other services related to cotton. The cotton ginning season in the United States takes place between September and December each year. Therefore, revenues from our customer contracts relating to cotton will be seasonal, which may cause our operating results to fluctuate significantly quarterly and annually. Additionally, weather and climatic conditions, natural disasters and other factors beyond our control also affect the production and sale of cotton and other agricultural commodities to which our customer contracts may relate, as well as our customers’ or prospective customers’ decisions regarding purchases of our products and services, and may cause our operating results to fluctuate significantly quarterly and annually. The seasonal fluctuations in operating results described above may cause a decline in the price of our common stock . In addition, , the nature of some of our cotton contracts include extended payment terms that will result in a longer collection period and slower cash inflows.
Fluctuations in quarterly results.
Our revenues and profitability are difficult to predict due to the nature of the markets in which we compete, fluctuating user demand, the uncertainty of current and future global economic conditions, and for many other reasons, including that our operating results are highly dependent on the volume and timing of orders received during a quarter, which are difficult to forecast. Customers generally order on an as-needed basis and we typically do not obtain firm, long-term purchase commitments from our customers.
| 20 |
Our research and development efforts for new products may be unsuccessful.
We incur research and development expenses to develop new products and technologies in an effort to maintain our competitive position in a market characterized by rapid rates of technological advancement. Our research and development efforts are subject to unanticipated delays, expenses and technical problems. There can be no assurance that any of these products or technologies will be successfully developed or that, if developed, will be commercially successful. In the event that we are unable to develop commercialized products from our research and development efforts or we are unable or unwilling to allocate amounts beyond our currently anticipated research and development investment, we could lose our entire investment in these new products and technologies. Any failure to translate research and development expenditures into successful new product introduction could have an adverse effect on our business.
Failure to license new technologies could impair sales of our existing products or any new product development we undertake in the future.
To generate broad product lines, it is advantageous to sometimes license technologies from third parties rather than depend exclusively on the development efforts of our own employees. As a result, we believe our ability to license new technologies from third parties may be important to our ability to offer new products. In addition, from time to time we are notified of, or become aware of patents held by third parties that are related to technologies we are selling or may sell in the future. After a review of these patents, we may decide to seek a license for these technologies from these third parties. There can be no assurance that we will be able to successfully identify new technologies developed by others. Even if we are able to identify new technologies of interest, we may not be able to negotiate a license on favorable terms, or at all.
Our failure to manage our growth in operations and acquisitions of new product lines and new businesses could harm our business.
The recent growth in our operations could place a significant strain on our current management resources. To manage such growth, we may need to improve our:
| ● | operations and financial systems; |
| ● | procedures and controls; and |
| ● | training and management of our employees. |
Our future growth, if any, may be attributable to acquisitions of new product lines and new businesses. For example, during the fiscal year ended September 30, 2015, we completed the purchase of substantially all the assets and technology of Vandalia relating to large-scale production of specific DNA sequences using the polymerase chain reaction, while in the fiscal year ended September 30, 2013, we completed the purchase of certain assets and technology from RedWeb Technologies Limited relating to its forensic tagging security system. Future acquisitions, if successfully consummated, would likely create increased working capital requirements, which would likely precede by several months any material contribution of an acquisition to our net income. Our failure to manage growth or future acquisitions successfully could seriously harm our operating results. Also, acquisition costs could cause our operating results to vary significantly from quarter to quarter. Furthermore, our stockholders would be diluted if we financed the acquisitions by incurring convertible debt or issuing securities.
A percentage of our sales occur outside of the U.S. As a result, we are subject to the economic, political, regulatory and other risks of international operations.
For fiscal 2016 and 2015, 24% and 14%, respectively, of our revenue was from customers located outside of the U.S. We believe that the revenue from the sale of our products outside the U.S. will continue to grow in the near future. We intend to expand our international operations to the extent that suitable opportunities become available. Our foreign operations and sales could be adversely affected as a result of:
| ● | nationalization of private enterprises and assets; |
| ● | political or economic instability in certain countries and regions; |
| ● | differences in foreign laws, including increased difficulties in protecting intellectual property and uncertainty in enforcement of contract rights; |
| ● | the possibility that foreign governments may adopt regulations or take other actions that could directly or indirectly harm our business and growth strategy; |
| ● | credit risks; |
| ● | currency fluctuations; |
| 21 |
| ● | tariff and tax increases; |
| ● | export and import restrictions and restrictive regulations of foreign governments; |
| ● | shipping products during times of crisis or wars; and |
| ● | other risks inherent in foreign operations. |
We are subject to numerous regulatory, legal, operational, and other risks as a result of our international operations which could adversely impact our businesses in many ways.
As a U.S. company, we are required to comply with the economic sanctions and embargo programs administered by Office of Foreign Assets Control and similar multi-national bodies and governmental agencies worldwide, and the Foreign Corrupt Practices Act (“FCPA”). A violation of a sanction or embargo program or of the FCPA or similar laws prohibiting certain payments to governmental officials, such as the U.K. Bribery Act, could subject us, and individual employees, to a regulatory enforcement action as well as significant civil and criminal penalties which could adversely impact our business and operations.
Failure to attract and retain qualified scientific, production and managerial personnel could harm our business.
Recruiting and retaining qualified scientific and production personnel to perform and manage prototype, sample, and product manufacturing and business development personnel to conduct business development are critical to our success. In addition, our desired growth and expansion into areas and activities requiring additional expertise, such as clinical testing, government approvals, production, sales and marketing will require the addition of new management personnel and the development of additional expertise by existing management personnel. Because our industry is very competitive, we face significant challenges in attracting and retaining a qualified personnel base. Although we believe we have been, and will continue to be, able to attract and retain these personnel, we cannot assure you that we will continue to be able to successfully attract qualified personnel in the future. The failure to attract and retain these personnel or, alternatively, to develop this expertise internally would harm our business since our ability to conduct business development and manufacturing would be reduced or eliminated, resulting in lower revenues. We generally do not enter into employment agreements requiring our employees to continue in our employment for any period of time, with the exception of our Chief Executive Officer. See “—If we are unable to continue to retain the services of Dr. Hayward, we may not be able to continue our operations. “in this Item 1A and the information set forth under the caption “Employment Agreement with Dr. James A. Hayward” in Item 11, “Executive Compensation.”
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.
Our patents, trademarks, trade secrets, copyrights and all of our other intellectual property rights are important assets for us. There are events that are outside of our control that pose a threat to our intellectual property rights as well as to our products and services. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed. The efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. Protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. There is always the possibility that the scope of the protection gained from one of our issued patents will be insufficient or deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from these trade secrets.
Intellectual property litigation could harm our business, financial condition and results of operations.
Litigation regarding patents and other intellectual property rights is extensive in the biotechnology industry. In the event of an intellectual property dispute, we may be forced to litigate. This litigation could involve proceedings instituted by the U.S. Patent and Trademark Office or the International Trade Commission, as well as proceedings brought directly by affected third parties. Intellectual property litigation can be extremely expensive, and these expenses, as well as the consequences should we not prevail, could seriously harm our business.
| 22 |
If a third party claims an intellectual property right to technology we use, we might need to discontinue an important product or product line, alter our products and processes, pay license fees or cease our affected business activities. Although we might under these circumstances attempt to obtain a license to this intellectual property, we may not be able to do so on favorable terms, or at all. Furthermore, a third party may claim that we are using inventions covered by the third party’s patent rights and may go to court to stop us from engaging in our normal operations and activities, including making or selling our products. These lawsuits are costly and could affect our results of operations and divert the attention of managerial and technical personnel. A court may decide that we are infringing the third party’s patents and would order us to stop the activities covered by the patents. In addition, a court may order us to pay the other party damages for having violated the other party’s patents. The biotechnology industry has produced a proliferation of patents, and it is not always clear to industry participants, including us, which patents cover various types of products or methods of use. The coverage of patents is subject to interpretation by the courts, and the interpretation is not always uniform. If we are sued for patent infringement, we would need to demonstrate that our products or methods of use either do not infringe the patent claims of the relevant patent and/or that the patent claims are invalid, and we may not be able to do this. Proving invalidity, in particular, is difficult since it requires a showing of clear and convincing evidence to overcome the presumption of validity enjoyed by issued patents.
Because some patent applications in the United States may be maintained in secrecy until the patents are issued, because patent applications in the United States and many foreign jurisdictions are typically not published until eighteen months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our or our licensor’s issued patents or pending applications or that we or our licensors were the first to invent the technology. During the ordinary course of our business, we do not conduct “prior art” searches before filing a patent application. Our competitors may have filed, and may in the future file, patent applications covering technology similar to ours. Any such patent application may have priority over our or our licensors’ patent applications and could further require us to obtain rights to issued patents covering such technologies. If another party has filed a United States patent application on inventions similar to ours, we may have to participate in an interference proceeding declared by the United States Patent and Trademark Office to determine priority of invention in the United States. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful, resulting in a loss of our United States patent position with respect to such inventions.
Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.
Accidents related to hazardous materials could adversely affect our business.
Some of our operations require the controlled use of hazardous materials for chemical reactions and synthesis. These materials are common to molecular/biological/chemical laboratories and require no special handling or regulation. Although we believe our safety procedures comply with the standards prescribed by federal, state, local and foreign regulations, the risk of accidental contamination of property or injury to individuals from these materials cannot be completely eliminated. In the event of an accident, we could be liable for any damages that result, which could seriously damage our business and results of operations.
Potential product liability claims could affect our earnings and financial condition.
We face a potential risk of liability claims based on our products and services. Though we have product liability insurance coverage which we believe is adequate, we may not be able to maintain this insurance at reasonable cost and on reasonable terms. We also cannot assure that this insurance, if obtained, will be adequate to protect us against a product liability claim, should one arise. In the event that a product liability claim is successfully brought against us, it could result in a significant decrease in our liquidity or assets, which could result in the reduction or termination of our business.
Litigation generally could affect our financial condition and results of operations.
We generally may be subject to claims made by and required to respond to litigation brought by customers, former employees, former officers and directors, former distributors and sales representatives, former consultants and vendors and service providers. We have faced such claims and litigation in the past and we cannot assure you that we will not be subject to claims in the future. In the event that a claim is successfully brought against us, considering our lack of material revenue and the losses our business has incurred for the period from our inception to September 30, 2016, this could result in a significant decrease in our liquidity or assets, which could result in the reduction or termination of our business.
Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.
Our operations could be subject to earthquakes, power shortages, telecommunications failures, cyber-attacks or other vulnerabilities in our computer systems, terrorism, water shortages, tsunamis, floods, hurricanes, typhoons, fires, extreme weather conditions, medical epidemics, political or economic instability, and other natural or manmade disasters or business interruptions. The occurrence of any of these business disruptions could seriously harm our revenue and financial condition and increase our costs and expenses.
General economic conditions may adversely affect our business, operating results and financial condition.
A general weakening or decline in the global economy or a period of economic slowdown may have serious negative consequences for our business and operating results. Since our customers incorporate our products into a variety of consumer goods, the demand for our products is subject to worldwide economic conditions and their impact on levels of consumer spending. Some of the factors affecting consumer spending include general economic conditions, unemployment, consumer debt, reductions in net worth, residential real estate and mortgage markets, taxation, energy prices, interest rates, consumer confidence and other macroeconomic factors. During periods of economic weakness or uncertainty, demand for consumer goods incorporating our products may weaken, and current or potential customers may defer purchases of our products.
| 23 |
A cybersecurity incident and other technology disruptions could negatively affect our business and our relationships with customers.
We use technology in substantially all aspects of our business operations. The widespread use of technology, including mobile devices, cloud computing, and the internet, give rise to cybersecurity risks, including security breach, espionage, system disruption, theft and inadvertent release of information. Our business involves the storage and transmission of numerous classes of sensitive and/or confidential information and intellectual property, including information relating to customers and suppliers, private information about employees, and financial and strategic information about us and our business partners. If we fail to effectively assess and identify cybersecurity risks associated with the use of technology in our business operations, we may become increasingly vulnerable to such risks. Additionally, while we have implemented measures to prevent security breaches and cyber incidents, our preventative measures and incident response efforts may not be entirely effective. The theft, destruction, loss, misappropriation, or release of sensitive and/or confidential information or intellectual property, or interference with our information technology systems or the technology systems of third parties on which we rely, could result in business disruption, negative publicity, brand damage, violation of privacy laws, loss of customers, potential liability and competitive disadvantage.
Risks Relating to Our Common Stock and Other Securities:
There are a large number of shares of common stock underlying our outstanding options and warrants and the sale of these shares may depress the market price of our common stock and cause immediate and substantial dilution to our existing stockholders.
As of November 28, 2016, we had 26,351,483 shares of common stock issued and outstanding, outstanding options to purchase 4,415,734 shares of common stock and outstanding warrants to purchase 9,548,969 shares of common stock. The issuance of shares upon exercise of our outstanding options and warrants will cause immediate and substantial dilution to our stockholders. In addition, under our publicly traded warrants (including additional warrants sold privately that have registration rights), in the event of a “Fundamental Transaction” (as defined in the related warrant agreement, which generally includes any merger with another entity, the sale, transfer or other disposition of all or substantially all of our assets to another entity, or the acquisition by a person of more than 50% of our common stock), each warrant holder will have the right at any time prior to the consummation of the Fundamental Transaction to require us to repurchase the warrant for a purchase price in cash equal to the Black Scholes value (as calculated under the warrant agreement) of the then remaining unexercised portion of such warrant on the date of such Fundamental Transaction, which may materially adversely affect our financial condition and/or results of operations.
We may require additional financing which may in turn require the issuance of additional shares of common stock, preferred stock or other debt or equity securities (including convertible securities) and which would dilute the ownership held by our stockholders.
We may need to raise funds through either debt or the sale of our shares of our common stock in order to achieve our business goals. Any additional shares issued would further dilute the percentage ownership held by the stockholders. Furthermore, if we raise funds in equity transactions through the issuance of convertible securities which are convertible at the time of conversion at a discount to the prevailing market price, substantial dilution is likely to occur resulting in a material decline in the price of your shares. Our public offerings completed in November 2014 and April 2015, our registered direct public offering (the “Registered Direct Offering”) and concurrent private placement, during November 2015 and our private placement completed in November 2016 resulted in dilution to investors and future offerings of securities could result in further dilution to investors.
We may require additional financing in the future, which may not be available or, if available, may be on terms that cause a decline in the value of the shares of our common stock held by stockholders.
If we raise capital in the future by issuing additional securities, our stockholders may experience a decline in the value of the shares of our common stock they currently hold or may acquire prior to any such financing. In addition, such securities may have rights senior to the rights of holders of our shares of common stock.
If we fail to comply with the continuing listing standards of The NASDAQ Capital Market, our securities could be delisted.
Our common stock and publicly traded warrants are listed on The NASDAQ Capital Market under the symbols “APDN” and “APDNW,” respectively. For our common stock and publicly traded warrants to continue to be listed on The NASDAQ Capital Market, we must meet the current continued listing requirements. If we were unable to meet these requirements, our common stock and warrants could be delisted from The NASDAQ Capital Market. If our securities were to be delisted from The NASDAQ Capital Market, our securities could begin to trade on the Over-The-Counter Bulletin Board or on one of the markets operated by OTC Markets Group, including OTC Pink (formerly known as the “pink sheets”), as the case may be. In such event, our securities could once again be subject to the “penny stock” rules which among other things require brokers or dealers to approve investors’ accounts, receive written agreements and determine investor suitability for transactions and disclose risks relating to investing in the penny stock market. Any such delisting of our securities could have an adverse effect on the market price of, and the efficiency of the trading market for our securities, not only in terms of the number of shares that can be bought and sold at a given price, but also through delays in the timing of transactions and less coverage of us by securities analysts, if any. Also, if in the future we were to determine that we need to seek additional equity capital, it could have an adverse effect on our ability to raise capital in the public or private equity markets.
| 24 |
Any material weaknesses in our internal control over financing reporting in the future could adversely affect investor confidence, impair the value of our common stock and increase our cost of raising capital.
Any failure to remedy deficiencies in our internal control over financial reporting that may be discovered or our failure to implement new or improved controls, or difficulties encountered in the implementation of such controls, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Any such failure could, in turn, affect the future ability of our management to certify that internal control over our financial reporting is effective. Inferior internal control over financial reporting could also subject us to the scrutiny of the SEC and other regulatory bodies which could cause investors to lose confidence in our reported financial information and could subject us to civil or criminal penalties or stockholder litigation, which could have an adverse effect on our results of operations and the market price of our common stock.
In addition, if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our share price. Furthermore, deficiencies could result in future non-compliance with Section 404 of the Sarbanes-Oxley Act of 2002. Such non-compliance could subject us to a variety of administrative sanctions, including review by the SEC or other regulatory authorities.
Short sellers of our stock may be manipulative and may drive down the market price of our common stock.
Short selling is the practice of selling securities that the seller does not own but rather has borrowed or intends to borrow from a third party with the intention of buying identical securities at a later date to return to the lender. A short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is therefore in the short seller’s interest for the price of the stock to decline, some short sellers publish, or arrange for the publication of, opinions or characterizations regarding the relevant issuer, its business prospects and similar matters calculated to or which may create negative market momentum, which may permit them to obtain profits for themselves as a result of selling the stock short. Issuers whose securities have historically had limited trading volumes and/or have been susceptible to relatively high volatility levels can be particularly vulnerable to such short seller attacks. The publication of any such commentary regarding us in the future may bring about a temporary, or possibly long term, decline in the market price of our common stock. In the past, the publication of commentary regarding us by a disclosed short seller has been associated with the selling of shares of our common stock in the market on a large scale, resulting in a precipitous decline in the market price per share of our common stock. No assurances can be made that similar declines in the market price of our common stock will not occur in the future, in connection with such commentary by short sellers or otherwise. We have identified two persons of interest believed to be involved in publication of such commentary regarding us that occurred in connection with disclosed short-selling in October 2015. The identities of the suspects have been reported to certain federal and state authorities. We are not aware of any actions taken by authorities to date.
The price of our common stock may be volatile or may decline, and the trading volume of our common stock may fluctuate, which may make it more difficult to realize a profit on your investment in our shares of common stock.
Our common stock is listed on The NASDAQ Capital Market. The trading price of our common stock has been and may continue to be volatile. In addition, the trading volume of our common stock may fluctuate and cause significant price variations to occur. Volatility in the market price of our common stock may prevent you from being able to sell your shares of common stock at or above the price you paid for your shares of common stock, which may make it more difficult to realize a profit on your investment. A number of factors may affect the market price of our common stock, including, but not limited to, the following:
| • | our operating and financial performance and prospects; |
| • | our quarterly or annual earnings or those of other companies in our industry or that investors deem comparable to us; |
| • | conditions that impact demand for our products and services; |
| • | public reactions to our press releases, other public announcements and filings with the SEC; |
| • | market and industry perception of our success, or lack thereof, in pursuing our growth strategy; |
| • | strategic actions by us or our competitors, such as acquisitions or restructurings; |
| • | changes in accounting standards, policies, guidance, interpretations or principles; |
| • | arrival and departure of key personnel, including management personnel; |
| 25 |
| • | changes in our capital structure; |
| • | changes in the price of our warrants or other securities we may issue from time to time; |
| • | sales of common stock by us, our directors, officers or large stockholders; |
| • | the expiration of any applicable contractual lock-up agreements; |
| • | changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events; |
| • | announcements of new products or innovations by us or our competitors and announcements concerning our competitors or our industry in general; |
| • | difficulties in commercialization and distribution of our products or lower than expected sales volume or revenues; |
| • | changes in our relationships with manufacturers, suppliers or collaborators, or our inability to supply enough product to meet demand; |
| • | our ability to obtain additional funding; |
| • | changes or developments in applicable laws or regulations; |
| • | any intellectual property infringement actions or other litigation or legal proceeding in which we may become involved; |
| • | changes in financial estimates or recommendations by securities analysts, or their ceasing to publish research or reports about our business; |
| • | the trading volume of our common stock; and |
| • | the appeal and current level of investor interest in the biotechnology/biopharmaceutical capital market sector and in companies in general with business, research strategies and product development pipelines which are similar to us. |
In addition, The NASDAQ Capital Market and other securities markets have, from time to time, experienced extreme price and trading volume fluctuations. The market prices of securities of biotechnology and other life sciences companies in a comparable stage to ours historically have been particularly volatile, and trading volume in such securities and our common stock has often been relatively low. Moreover, the securities and financial markets in general have experienced substantial volatility that has often been unrelated or disproportionate to the operating results of any individual company. During certain periods, specific industry sectors, such as the biotechnology segment, may experience greater volatility than other sectors or the securities markets as a whole. These broad market fluctuations, during which our industry and companies at our stage may experience a stronger degree of market sensitivity, will adversely affect the market price of our common stock.
In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our reputation and materially adversely affect our business, financial condition and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
Our corporate headquarters is located at the Long Island High Technology Incubator (“LIHTI”), which is located on the campus of Stony Brook University at 50 Health Sciences Drive, Stony Brook, NY 11790. The lease is for a 30,000 square foot building. The term of the lease commenced on June 15, 2013 and expired on May 31, 2016, with the option to extend the lease for two additional three-year periods. We have exercised our option to extend the lease for one additional three-year period, ending May 31, 2019. The base rent during the additional three-year period is $458,908 per annum. In addition to the office space, we also have 1,500 square feet of laboratory space. The term of the lease commenced on November 1, 2015 and expired on October 31, 2016, and was renewed through October 31, 2017. We also have an operating lease for a laboratory in Calverton, New York that expires on October 31, 2017. As discussed in Note C to the accompanying consolidated financial statements, pursuant to the Asset Purchase Agreement, we entered into a month to month sublease with Vandalia of approximately 5,000 square feet at Vandalia’s office facility in West Virginia which we terminated during December 2015.
| 26 |
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
| 27 |
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock was quoted on The Over The Counter Market Group (“OTCQB”) maintained by the National Association of Securities Dealers under the symbol “APDN” through November 14, 2014 and was listed on The NASDAQ Capital Market under the symbol “APDN” on November 17, 2014. Our warrants were listed on The NASDAQ Capital Market under the symbol “APDNW” on November 17, 2014. There is no certainty that the common stock and warrants will continue to be listed or that any liquidity exists for our stockholders, or warrantholders.
The following table sets forth the quarterly quotes of high and low prices for our common stock and warrants on The NASDAQ Capital Market or the OTCQB, as applicable during the fiscal years ended September 30, 2016 and 2015. The following high and low sales prices of our common stock have been adjusted retroactively to reflect a one-for-60 reverse stock split that was effective on October 29, 2014:
| Fiscal 2016 | Fiscal 2015 | |||||||||||||||
| Common Stock: | High | Low | High | Low | ||||||||||||
| First Quarter | $ | 9.70 | $ | 2.74 | $ | 7.70 | $ | 2.02 | ||||||||
| Second Quarter | $ | 3.74 | $ | 2.46 | $ | 4.44 | $ | 2.54 | ||||||||
| Third Quarter | $ | 3.50 | $ | 2.35 | $ | 3.72 | $ | 2.27 | ||||||||
| Fourth Quarter | $ | 3.61 | $ | 2.70 | $ | 6.60 | $ | 2.50 | ||||||||
| Fiscal 2016 | Fiscal 2015 | |||||||||||||||
| Warrants: | High | Low | High | Low | ||||||||||||
| First Quarter | $ | 6.35 | $ | 0.91 | $ | 1.29 | $ | 0.50 | ||||||||
| Second Quarter | $ | 2.35 | $ | 1.00 | $ | 1.80 | $ | 0.80 | ||||||||
| Third Quarter | $ | 2.06 | $ | 0.94 | $ | 1.81 | $ | 0.85 | ||||||||
| Fourth Quarter | $ | 1.29 | $ | 0.85 | $ | 3.80 | $ | 0.95 | ||||||||
Holders
As of November 28, 2016, we had approximately 601 holders of record of our common stock and 5 holders of record of our publicly traded warrants. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of our common stock and warrants is American Stock Transfer & Trust Company, 6201 15th Avenue, Brooklyn, New York 11219.
Dividends
We have never declared or paid any cash dividends on our common stock. We do not anticipate paying any cash dividends to stockholders in the foreseeable future. In addition, any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements, and such other factors as the Board of Directors deem relevant.
ITEM 6. Selected Financial Data.
Information requested by this Item is not applicable as we are electing scaled disclosure requirements available to Smaller Reporting Companies with respect to this Item.
| 28 |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis includes certain forward-looking statements that involve risks, uncertainties and assumptions. You should review the Risk Factors section of this Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by such forward-looking statements. See “Forward-Looking Information” at the beginning of this Form 10-K.
All warrant, option, share and per share information in this report gives retroactive effect to a one-for-60 reverse stock split that was effective on October 29, 2014.
Introduction
Using biotechnology as a forensic foundation, we create unique security solutions addressing the challenges of modern commerce. Whether for 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 secure taggants, high-resolution DNA authentication, and comprehensive reporting, our plant-based DNA technologies are designed to deliver what we believe to be the greatest levels of security, deterrence and legal recourse strength. We are also engaged in the large-scale production of specific DNA sequences using the polymerase chain reaction ("PCR").
General
To date, the substantial portion of our revenues has been generated from sales of our SigNature DNA and SigNature T DNA, our principal supply chain security and product authentication solutions. We expect to continue to grow revenues from sales of our SigNature DNA, SigNature T DNA, DNAnet, digitalDNA, Beacon, and SigNify offerings as well as from the large-scale production of specific DNA sequences using PCR as we work with companies and governments to secure supply chains and restore confidence to products and product labeling throughout the world. We have continued to incur expenses in expanding our business and increasing our personnel to meet current and anticipated future demand. We have limited sources of liquidity. Our products and services are offered in the United States, Europe and Asia. At the present time, we are focusing our efforts on textile and apparel, microcircuits and other electronics, cash-in-transit, consumer asset marking, printing and packaging businesses and diagnostics and reagents. In the future, we plan to expand our focus to include pharmaceuticals, consumer products, food and beverage, industrial materials, and agrochemicals.
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; |
| ● | Equity based compensation; and |
| ● | Fair value of financial instruments. |
Revenue Recognition
We recognize 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. We defer any revenue for which the product has not been delivered, service has not been provided, or is subject to refund until such time that we and the customer jointly determine that the product has been delivered, the service has been provided, or no refund will be required. At September 30, 2016 and 2015, we recorded total deferred revenue of $2,737,588 and $282,050, respectively.
| 29 |
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 government contract awards, which supports our development efforts on specific projects, is recognized as milestones are achieved as per the contract. We recognized revenue of approximately $1,064,105 and $2,792,555, from these contract awards during the fiscal years ended September 30, 2016 and 2015, respectively.
We recognize the revenue under our MOU with Dreyfus, when the product has been shipped, as there is no right of return under this arrangement and there is a commitment from their customer to purchase the marked cotton. We have has evaluated the other indicators of gross and net revenue recognition, including whether or not we are the primary obligor and if we have general inventory risk. We do not have any general inventory risk and are not the primary obligor as it relates to the marketing portion of the cotton tagging fee. With respect to our mutual license agreement with Himatsingka America Inc. (formerly known as Divatex Home Fashion, Inc.) (“Himatsingka”), we have carefully evaluated all of the key gross and net revenue recognition indicators and has concluded that the circumstances as they relate to Himatsingka’s portion of the tagging fee are more consistent with those key indicators that support net revenue reporting. On June 29, 2016, Himatsingka waived its portion of the tagging fee for up to $250,000. In addition, the nature of some of our cotton contracts includes extended payment terms that will result in a longer collection period and slower cash inflows. Under our MOU with Dreyfus, as of September 30, 2016 and September 30, 2015 there was $4,621,345 and $2,893,400 included in short term accounts receivable, respectively. As of September 30, 2016 and September 30, 2015 there was $1,535,000 and $1,500,000 included in long-term accounts receivable, respectively. Also, as of September 30, 2016 $2,305,000 was included in deferred revenue for shipments during fiscal 2016. The cotton ginning season in the United States takes place between September and December each year, therefore, revenues from these customer contracts may be seasonal.
Equity Based Compensation
We account for stock-based compensation for employees and directors in accordance with ASC 718, Compensation (“ASC 718”). ASC 718 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. Under the provisions of ASC 718, stock-based compensation costs are measured at the grant date, based on the fair value of the award, and are recognized as expense over the employee’s requisite service period (generally the vesting period of the equity grant). The fair value of our common stock options is estimated using the Black Scholes option-pricing model with the following assumptions: expected volatility, dividend rate, risk free interest rate and the expected life. We expense stock-based compensation by using the straight-line method. In accordance with ASC 718, excess tax benefits realized from the exercise of stock-based awards are classified in cash flows from financing activities. The future realization of the reserved deferred tax assets related to these tax benefits associated with the exercise of stock options will result in a credit to additional paid in capital if the related tax deduction reduces taxes payable. We have elected the “with and without approach” regarding ordering of windfall tax benefits to determine whether the windfall tax benefit did reduce taxes payable in the current year. Under this approach, the windfall tax benefit would be recognized in additional paid-in-capital only if an incremental tax benefit is realized after considering all other benefits presently available.
The fair value for options granted was calculated using the following weighted average assumptions:
| 2016 | 2015 | |||||||
| Stock price | $ | 3.05 | $ | 2.85 | ||||
| Exercise price | $ | 2.93 | $ | 2.85 | ||||
| Expected term | 7.89 | 5.12 | ||||||
| Dividend yield | - | - | ||||||
| Volatility | 135 | % | 133 | % | ||||
| Risk free rate | 1.8 | % | 1.7 | % | ||||
We account for stock based compensation awards issued to non-employees for services, as prescribed by ASC 718-10, at either the fair value of the services rendered or the instruments issued in exchange for such services, whichever is more readily determinable, using the measurement date guidelines enumerated in ASC 505-50.
| 30 |
Fair Value of Financial Instruments
The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related asset or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities.
We utilize observable market inputs (quoted market prices) when measuring fair value whenever possible.
Level 3 Measurements:
Warrant Liability: Estimated using the Binomial Lattice option valuation model. Significant observable and unobservable inputs include stock price, exercise price, annual risk free rate, term, and expected volatility. An increase or decrease in these inputs could significantly increase or decrease the fair value of the warrant. See Notes H and K to the accompanying consolidated financial statements.
For fair value measurements categorized within Level 3 of the fair value hierarchy, our accounting and finance department, who report to the Chief Financial Officer, determine its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of our accounting and finance department and are approved by the Chief Financial Officer.
Use of Estimates
The preparation of the financial statements in conformity with Accounting Principles Generally Accepted in the United States ("GAAP”) requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. The most complex and subjective estimates include recoverability of long-lived assets, including the values assigned to goodwill, intangible assets and property, plant and equipment, fair value calculations for stock based compensation, contingencies, anticipated collection period of accounts receivable and allowance for doubtful accounts. Management reviews its estimates on a regular basis and the effects of any material revisions are reflected in the consolidated financial statements in the period they are deemed necessary. Accordingly, actual results could differ from those estimates.
Comparison of the Fiscal Year Ended September 30, 2016 to the Fiscal Year Ended September 30, 2015
Revenues
Product revenues
For the fiscal years ended September 30, 2016 and 2015, we generated $2,538,202 and $5,435,776 in revenues from product sales, respectively. The decrease in product revenues of $2,897,574 or 53% for the fiscal year ended September 30, 2016 is attributable to a decrease in revenue of approximately $2,700,000 in the textile industry for protecting cotton supply chains as well as approximately $249,000 from military contracts due to the consolidation of our contracts with multiple individual suppliers of the DLA to one contract directly with the DLA, as well as other decreases in revenue from another military customer and CVIT of $175,000. These decreases were offset by increases in DNA production of $76,000 and consumer asset marking of $171,000.
Service revenues
For the fiscal years ended September 30, 2016 and 2015, we generated $1,648,225 and $3,572,723 in revenues from sales of services, respectively. The decrease in service revenues of $1,924,498 or 54% for the fiscal year ended September 30, 2016 is attributable to a decrease in the two government contract awards of approximately $1,800,000, of which one expired on July 14, 2016 and the other one in August 2016, as well as a decrease in industrial materials of $108,000 relating to pilots completed during the fiscal year ended September 30, 2015.
| 31 |
Costs and Expenses
Cost of Revenues
Cost of revenues for the fiscal years ended September 30, 2016 and 2015 were $746,582 and $384,269, respectively. The increase in cost of revenues of $362,313, or 94% is attributable to the deployment of cotton DNA transfer devices into the field and increased DNAnet kit sales during fiscal 2016 as compared to fiscal 2015.
Selling, General and Administrative
Selling, general and administrative expenses for the fiscal year ended September 30, 2016 decreased by $2,170,859 or 16% to $11,239,397 from $13,410,256 in the same period in 2015. The decrease is primarily attributable to a decrease in stock based compensation expense of $2,068,127, associated to grants to employees that vested immediately during fiscal 2015 whereas the grants to employees during fiscal 2016 have a four year vesting period, as well as stock based compensation expense associated with stock option modifications resulting from the extension of certain stock options, and to a lesser extent, the acceleration of vesting terms.
Research and Development
Research and development expenses increased by $1,116,503 or 43% for the fiscal year ended September 30, 2016 compared to the same period in 2015 to $3,693,810 from $2,577,307. The increase is primarily attributable to development costs incurred in relation to the two government development contract awards, as well as costs related to the cooperative research and development agreement with the USDA for enhanced cotton genotyping.
Depreciation and Amortization
Depreciation and amortization increased by $215,855 or 44% compared to the same period in 2015 from $490,641 for the fiscal year ended September 30, 2015 to $706,496 for the fiscal year ended September 30, 2016.The increase is attributable to depreciation and amortization expense for the lab equipment purchased during the fiscal year ended September 30, 2016 and a full year of amortization on the customer relationships and technology purchased from Vandalia during September 2015.
Interest Income (Expenses)
Interest income (expense) for the fiscal year ended September 30, 2016, increased to income of $11,004 from expense of $23,468 in the same period of 2015. The increase in interest income was due to the return of escrow funds associated with the Vandalia Asset Purchase Agreement.
Loss from Change in Fair Value of Warrant Liability
Loss from change in fair value of warrant liability during the fiscal year ended September 30, 2015 was $2,994,540. This change in fair value related to warrants containing certain reset provisions which required us to classify them as liabilities, mark the warrants to market and record the change in fair value at each reporting period, and upon exercise as a non-cash adjustment to our current period operations. As discussed in Note H of the accompanying consolidated financial statements, on November 21, 2014, we repurchased the remaining outstanding Series B Warrants.
Net Loss
Net loss increased $294,842, or 2% to $12,175,979 for the fiscal year ended September 30, 2016 compared to $11,881,137 for the fiscal year ended September 30, 2015 due to the factors noted above.
Recent Accounting Pronouncements
See Note B, "Recent Accounting Principles," to the accompanying consolidated financial statements for a description of accounting standards which may impact our consolidated financial statements in future reporting periods.
Liquidity and Capital Resources
Our liquidity needs consist of our working capital requirements and research and development expenditure funding. As of September 30, 2016, we had working capital of $7,267,005. For the fiscal year ended September 30, 2016, we used cash of $9,896,727 consisting primarily of our loss of $12,175,979, net with non-cash adjustments of $706,496 in depreciation and amortization charges, $2,038,830 for stock-based compensation, $5,520 loss on sale of property plant and equipment, $78,130 in common stock issued for consulting services and $116,825 of bad debt expense. Additionally, we had a net increase in operating assets of $2,878,753 and a net increase in operating liabilities of $2,202,204. Cash used in investing activities was $779,762, consisting of $112,403 for the purchase of intangibles assets and $672,859 for the purchase of property, plant and equipment. Cash provided by financing activities was $7,843,579, which included $7,853,155 in net proceeds from the sale of common stock and warrants related to one public offering with concurrent private placement, $4,410 of proceeds from the exercise of warrants, offset by $13,986 of deferred offering costs.
| 32 |
At September 30, 2016, there was approximately $1.5 million included in the long-term accounts receivable relating to a customer from the cotton industry that purchased SigNature T DNA to mark the cotton supply chain. The nature of this contract includes extended payment terms that will result in a longer collection period and slower cash inflows, which will affect our liquidity and capital resources.
We have recurring net losses, which have resulted in an accumulated deficit of $223,817,388 as of September 30, 2016. We have incurred a net loss of $12,175,979 for the fiscal year ended September 30, 2016. At September 30, 2016 we had cash and cash equivalents of $4,479,274. Our current capital resources include cash and cash equivalents, accounts receivable and inventories. Historically, we have financed our operations principally from the sale of equity securities. As discussed in Note J, to the accompanying consolidated financial statements, during the fiscal year ended September 30, 2016, we closed on a registered direct public offering and concurrent private placement of common stock and warrants for gross proceeds of approximately $8.75 million before deducting underwriting discounts and offering expenses.
In addition, on November 7, 2016, we closed a private placement of common stock and warrants to purchase common stock, for aggregate gross proceeds of approximately $5 million, before deducting placement agent fees and offering expenses.
We expect to finance operations primarily through cash received from the November 2016 private placement as well as collection of our current accounts receivables. We estimate that we will have sufficient cash and cash equivalents to fund operations for the next twelve months from the balance sheet date.
We may require additional funds to complete the continued development of our products, product manufacturing, and to fund expected additional losses from operations, until revenues are sufficient to cover our operating expenses. If revenues are not sufficient to cover our operating expenses, and if we are not successful in obtaining the necessary additional financing, we will most likely be forced to reduce operations.
We expect capital expenditures to be less than $300,000 in fiscal 2017. 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.
Recent Debt and Equity Financing Transactions
Fiscal 2016
On November 23, 2015, we entered into a securities purchase agreement with certain institutional investors providing for the purchase and sale of 2,500,000 shares of our common stock at a price of $3.49 per share in the Registered Direct Offering. In the concurrent Private Placement, we sold to each investor that purchased shares in the Registered Direct Offering warrants to purchase our common stock, each exercisable for 0.5 shares of common stock, in the amount of one warrant for each share of common stock purchased by such investor in the Registered Direct Offering, aggregating to 1,250,000 shares of our common stock issuable upon exercise of such warrants. Such warrants were sold at a price of $0.01 per warrant, with an exercise price of $4.30 per share of common stock issuable upon exercise of such warrants, subject to adjustment as provided therein. The warrants will be exercisable beginning six months following the closing date of the Registered Direct Offering and the Private Placement and will expire upon the close of business on the date that is five years from the date on which they become exercisable. The aggregate gross proceeds to us from the Registered Direct Offering and concurrent private placement before deducting the placement agent fees and offering expenses, were $8.75 million (excluding proceeds from any future exercises of such warrants).
In connection with our entry into the securities purchase agreement with certain institutional investors as part of the Registered Direct Offering and the Private Placement, we agreed not to enter into any agreement to issue or announce the issuance or proposed issuance of any common stock or common stock equivalents for a period of 90 days following the closing of the offerings.
In connection with the closing of the Registered Direct Offering and the Private Placement, as partial compensation, on November 25, 2015, we granted warrants to purchase 50,000 shares of common stock to our placement agent. These warrants have an exercise price of $4.03 (115% of the public offering price), subject to adjustment as set forth therein, are exercisable beginning six months following the closing date of the Private Placement and expire at 5:00 PM (Eastern Standard Time) on November 25, 2020.
Fiscal 2015
On November 20, 2014, we closed our underwritten public offering of 2,800,000 shares of common stock and warrants to purchase up to an aggregate of 2,800,000 shares of common stock for gross proceeds of $9.1 million before deducting underwriting discounts and offering expenses. We utilized $4,091,000 of the gross proceeds to repurchase the remaining Series B Warrants from Crede, as discussed in Note H to the accompanying consolidated financial statements. The combined price for each share of common stock and warrant was $3.25. The warrants may be exercised for a period of five years and have an exercise price of $3.50 per share. In connection with the offering, we granted to the underwriters a 45-day option to purchase up to 420,000 additional shares of common stock at $3.24 per share and/or up to 420,000 additional warrants at $0.01 per share to cover over-allotments, if any. Our Chief Executive Officer and an affiliated company of a member of our board of directors participated in this underwritten public offering. On December 19, 2014, we closed on the underwriters’ exercise of its over-allotment option of 416,850 warrants for gross proceeds of $4,169 and on December 30, 2014, we closed on the underwriters’ additional exercise of its over-allotment option of 52,000 shares of common stock for gross proceeds of $168,400. The total number of common stock and warrants issued under this offering, including the exercise of the over-allotment option was 2,852,000 and 3,216,850, respectively. The gross proceeds to us were $9.3 million and net proceeds after deducting underwriting discounts, offering expenses and the repurchase of the remaining Series B Warrants from Crede was approximately $3.69 million.
| 33 |
In connection with the closing of this underwritten public offering, on November 20, 2014, we granted 128,800 warrants to purchase common stock to our underwriters as partial compensation. These warrants have an exercise price of $3.73 (115% of the public offering price) and expire on November 14, 2019.
On April 1, 2015, we closed our underwritten public offering of 4,011,000 shares of common stock and warrants to purchase up to an aggregate of 1,604,400 shares of common stock, at $3.00 ($2.99 for one share of common stock and $0.01 for one warrant) (“combined offering price”), including 191,000 shares and 76,400 warrants sold pursuant to the partial exercise of the underwriters’ over-allotment option. The warrants have a per share exercise price of $3.50, are exercisable immediately, and expire on November 20, 2019. The gross proceeds to us from this offering, including the partial exercise of the over-allotment option but before deducting the underwriting discount and offering expenses, is $12.0 million. In connection with the offering, we granted to the underwriters a 45-day option to purchase up to 573,000 additional shares of common stock and up to 229,200 additional warrants to cover over-allotments, if any. On April 30, 2015, we closed on the underwriters’ exercise of its over-allotment option of 87,000 shares of common stock and 152,800 warrants for gross proceeds of $263,950.
In connection with the closing of this underwritten public offering, as partial compensation, on April 1, 2015, we granted up to 163,720 warrants to purchase common stock to its underwriters. These warrants have an exercise price of $3.44 (115% of the public offering price) and expire on March 27, 2020.
Subsequent Events
On November 2, 2016, we entered into a securities purchase agreement (“Securities Purchase Agreement”) with funds managed by Sabby Management, LLC (collectively, the “Investors”). Pursuant to the Securities Purchase Agreement, the Investors agreed to purchase, in a private placement (the “Private Placement”), 2,272,727 shares (the “Shares”) of our common stock, $.001 par value (“Common Stock”), and warrants to purchase 2,272,727 shares of Common Stock (“Warrants”). The aggregate gross proceeds of the Private Placement were approximately $5.0 million before deducting the placement agents’ fee and other placement expenses.
Each Warrant will be exercisable for one share of our Common Stock and will have the same terms as our existing publicly traded warrants that are currently listed on The NASDAQ Capital Market under the symbol “APDNW”, with an exercise price of $3.50 and an expiration date of November 20, 2019. The combined price per share for the Common Stock and the Warrant will be $2.20. The Private Placement closed on November 7, 2016 (the “Closing Date”).
Pursuant to a Placement Agency Agreement with us, the placement agents for the Private Placement were Maxim Group LLC, as Lead Placement Agent, and Imperial Capital, LLC, as Co-Placement Agent, (collectively, “Placement Agents”) who received a cash fee of 7.0% of the gross proceeds of the Private Placement, and who were also granted warrants to purchase that number of shares of Common Stock equal to 3.0% of the Shares sold in the Private Placement (“Placement Agent Warrants”). The Placement Agent Warrants are non-exercisable for 180 days from the Closing Date, have an exercise price equal to 115% of the offering price of the Shares and terminate on the five year anniversary of the Closing Date. In addition, we agreed to reimburse the Placement Agents for out-of-pocket expenses actually incurred in an amount not to exceed $50,000, $15,000 of which will be paid to reimburse the Investors for legal and due diligence fees and expenses.
We intend to use the aggregate net proceeds from the Private Placement for general corporate purposes, including working capital, capital expenditures, business development and research and development.
Pursuant to a registration rights agreement between us and the Investors, we agreed to file a registration statement by December 7, 2016 and to use our best efforts to cause such registration statement to be declared effective by the Securities and Exchange Commission (“SEC”) by January 6, 2017 (or by February 6, 2017 in the event of a “full review” by the SEC). In the event the registration statement fails to be filed or to be declared effective within the applicable time periods, we will be subject to monthly damages equal to 2% of the purchase price of the securities not covered by an effective registration statement. We plan to file a registration statement for the securities sold in the Private Placement on Form S-3 by December 7, 2016. Upon effectiveness of the registration statement, it is expected that the Common Stock and Warrants issued in the Private Placement will be freely tradeable on The NASDAQ Capital Market under the symbols “APDN” and “APDNW”, respectively. Any offering of the securities pursuant to the resale registration statement will only be by means of a prospectus.
The Securities Purchase Agreement contains customary representations, warranties and agreements by us and customary conditions to closing. Under the Securities Purchase Agreement, we agreed not to issue additional Common Stock or securities convertible into Common Stock for a period of one hundred twenty (120) days after the Effective Date, as defined in the Securities Purchase Agreement (the “Restricted Period”), except for, among other customary exclusions, issuances pursuant to our stock or option plan (provided that issuances to consultants will not exceed 50,000 shares in the aggregate during the Restricted Period). Further, we agreed not to effect any issuance of Common Stock or securities convertible into Common Stock involving a Variable Rate Transaction, as defined in the Securities Purchase Agreement, while the Investor holds any Warrants. In addition, pursuant to the Securities Purchase Agreement, upon any Subsequent Financing, as defined in the Securities Purchase Agreement, during the period ending on the nine (9) month anniversary of the Effective Date, the Investors shall have the right to participate in up to an amount equal to 25% of the Subsequent Financing; provided that no Investor shall have such participation right to the extent that after giving effect to such participation, such Investor (together with such Investor’s affiliates, and any persons acting as a group together with such Investor or its affiliates) would beneficially own in excess of 9.99% of the Common Stock outstanding immediately after giving effect to the Subsequent Financing.
| 34 |
In connection with the Private Placement, we and each of our executive officers, directors and certain stockholders have entered into lock-up agreements with the Lead Placement Agent (the “Lock-Up Agreements”) and have agreed, subject to certain exceptions set forth in the Lock-Up Agreements, not to offer, sell, agree to offer or sell, solicit offers to purchase, grant any call option or purchase any put option with respect to, pledge, borrow, or otherwise dispose of any Common Stock of, warrant to purchase Common Stock or other security convertible into, or exercisable or exchangeable for Common Stock, or equity securities, or establish or increase any “put equivalent position” or liquidate or decrease any “call equivalent position” with respect to any relevant security or otherwise enter into any swap, derivative or other transaction or arrangement that transfers to another, in whole or in part, any economic consequence of ownership of a relevant security for 180 days from the date of the final prospectus filed with the SEC without the prior written consent of the Lead Placement Agent. Notwithstanding the foregoing, if (a) we issue an earnings release or other press release of material information, or a material event relating to us occurs, during the last 17 days of the lock-up period, or (b) prior to the expiration of the lock-up period, we announce that we will release earnings results during the 16-day period beginning on the last day of the lock-up period, the restrictions described above shall continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings releases or other press release or the occurrence of the material event, unless the Lead Placement Agent waives that extension.
| 35 |
Product Research and Development
We anticipate spending approximately $2,500,000 for product research and development activities during the next twelve months.
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 during the fiscal years ended September 30, 2016 and 2015.
| 36 |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Information requested by this Item is not applicable as we are electing scaled disclosure requirements available to Smaller Reporting Companies with respect to this Item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See pages F-1 through F-25 following the Exhibit Index.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
Management Report on Internal Control over Financial Reporting
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including, our Chief Executive Officer, along with the Chief Financial Officer, on September 30, 2016, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) under the Exchange Act, as of September 30, 2016. Disclosure controls and procedures are those controls and procedures designed to provide reasonable assurance that the information required to be disclosed in our Exchange Act filings is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2016, our disclosure controls and procedures were effective.
Management Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published consolidated financial statements. Internal control over financial reporting is promulgated under the Exchange Act as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting, no matter how well designed, has inherent limitations and may not prevent or detect misstatements. Therefore, even effective internal control over financial reporting can only provide reasonable assurance with respect to the financial statement preparation and presentation.
Our management has conducted, with the participation of our CEO and CFO, an assessment, including testing of the effectiveness, of our internal control over financial reporting as of September 30, 2016. Management’s assessment of internal control over financial reporting was based on assessment criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on such evaluation, management concluded that our internal control over financial reporting was effective as of September 30, 2016.
Changes in Internal Control over Financial Reporting
There were no changes, in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Not applicable.
| 37 |
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by Items 10, 11, 12, 13 and 14 will be included in our definitive proxy statement for the 2017
Annual Meeting of Stockholders, which will be filed with the SEC within 120 days after September 30, 2016. The relevant portions
of such definitive proxy statement are incorporated herein by reference.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
| (a) | We have filed the following documents as part of this Form 10-K: |
| 1. | Consolidated Financial Statements |
Our consolidated financial statements at September 30, 2016 and 2015 and for the years ended September 30, 2016 and 2015, and the notes thereto, together with the report of our independent registered public accounting firm on those consolidated financial statements, are hereby filed as part of this report beginning on page F-1.
| 2. | Financial Statement Schedules |
All financial statement schedules have been omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto.
| 3. | Exhibits |
The information required by this item is set forth on the exhibit index that follows the signature page of this report.
| 38 |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| APPLIED DNA SCIENCES, INC. | ||
| Date: December 6, 2016 | /s/ James A. Hayward | |
| James A. Hayward | ||
| President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Name | Position | Date | ||
| /s/ JAMES A. HAYWARD | Chief Executive Officer (Principal Executive Officer), | December 6, 2016 | ||
| James A. Hayward | President, Chairman of the Board of Directors and Director | |||
| /s/ BETH M. JANTZEN | Chief Financial Officer (Principal Financial Officer and | December 6, 2016 | ||
| Beth M. Jantzen | Principal Accounting Officer) | |||
/s/ JOHN BITZER, III |
Director | December 6, 2016 | ||
| John Bitzer, III | ||||
| /s/ ROBERT CATELL | Director | December 6, 2016 | ||
| Robert Catell | ||||
/s/ JOSEPH D. CECCOLI |
Director | December 6, 2016 | ||
| Joseph D. Ceccoli | ||||
/s/ CHARLES S. RYAN |
Director | December 6, 2016 | ||
| Charles S. Ryan | ||||
/s/ YACOV A. SHAMASH |
Director | December 6, 2016 | ||
| Yacov A. Shamash | ||||
/s/ SANFORD R. SIMON |
Director | December 6, 2016 | ||
| Sanford R. Simon |
| 39 |
EXHIBIT INDEX
The following exhibits are included as part of this Form 10-K. References to “the Company” in this Exhibit List mean Applied DNA Sciences, Inc., a Delaware corporation.
| Incorporated by Reference | Filed
or Furnished Herewith | |||||||||||
| Exhibit Number |
Description | Form | Exhibit | File No. | Date Filed | |||||||
| 3.1 | Certificate of Incorporation | 8-K | 3.1 | 002-90539 | 1/16/2009 | |||||||
| 3.2 | Certificate of Amendment of Certificate of Incorporation | 8-K | 3.1 | 002-90539 | 6/30/2010 | |||||||
| 3.3 | Second Certificate of Amendment of Certificate of Incorporation | 8-K | 3.1 | 002-90539 | 1/30/2012 | |||||||
| 3.4 | Third Certificate of Amendment of Certificate of Incorporation | 8-K | 3.1 | 002-90539 | 10/29/2014 | |||||||
| 3.5 | Form of Certificate of Designations of the Series A Convertible Preferred Stock | 8-K | 3.1 | 002-90539 | 11/29/2012 | |||||||
| 3.6 | Form of Certificate of Designations of the Series B Convertible Preferred Stock | 8-K | 3.1 | 002-90539 | 7/22/2013 | |||||||
| 3.7 | By-Laws | 8-K | 3.2 | 002-90539 | 1/16/2009 | |||||||
| 4.1 | Form of Underwriter’s Warrant to be issued to Maxim Group LLC | S-1/A | 10.26 | 333-199121 | 10/30/2014 | |||||||
| 4.2 | Form of Senior Indenture, to be entered into between Applied DNA Sciences, Inc. and the Trustee designated therein | S-3 | 4.1 | 333-202432 | 3/2/2015 | |||||||
| 4.3 | Form of Subordinated Indenture, to be entered into between Applied DNA Sciences, Inc. and the Trustee designated therein | S-3 | 4.3 | 333-202432 | 3/2/2015 | |||||||
| 4.4 | Form of Underwriter’s Warrant | 8-K | 4.1 | 001-36745 | 3/27/2015 | |||||||
| 4.5 | Form of Purchase Warrant | 8-K | 4.1 | 001-36745 | 11/23/2015 | |||||||
| 4.6 | Form of Placement Agent Warrant issued to Maxim Group LLC | 8-K | 4.2 | 001-36745 | 11/23/2015 | |||||||
| 4.7 | Form of Placement Agent Warrant issued to Maxim Group LLC and Imperial Capital, LLC | 8-K | 4.1 | 001-36745 | 11/2/2016 | |||||||
| 10.1† | Applied DNA Sciences, Inc. 2005 Incentive Stock Plan and form of employee stock option agreement thereunder, as amended and restated as of January 21, 2015 | 10-K | 10.1 | 001-36745 | 12/14/2015 | |||||||
| 10.2* | Joint Development and Marketing Agreement, dated April 18, 2007 by and between Applied DNA Sciences and International Imaging Materials, Inc. | 8-K | 10.1 | 002-90539 | 4/24/2007 | |||||||
| 10.3 | Form of Subscription Agreement, dated July 15, 2011, by and among Applied DNA Sciences, Inc. and the investors named on the signature pages thereto | 10-K | 10.28 | 002-90539 | 12/9/2011 | |||||||
| 10.4 | Form of Warrant, dated July 15, 2011, issued to the investors named on the signature pages | 10-K | 10.29 | 002-90539 | 12/9/2011 | |||||||
| 10.5† | Employment Agreement, dated July 1, 2016, between James A. Hayward and Applied DNA Sciences, Inc. | 8-K | 5.02 | 001-36745 | 8/2/2016 | |||||||
| 10.6* | Exclusive Sales Agreement dated November 1, 2011 by and between Applied DNA Sciences, Inc. and Nissha Printing Co., Ltd. | 10-Q | 10.1 | 002-90539 | 2/14/2012 | |||||||
| 10.7 | Software Distribution Agreement, dated as of January 25, 2012, by and between Applied DNA Sciences, Inc. and DivineRune, Inc. | 10-Q | 10.1 | 002-90539 | 5/15/2012 | |||||||
| 10.8 | Form of Subscription Agreement dated June 21, 2012, by and among Applied DNA Sciences, Inc. and the investor named on the signature page thereto | 10-K | 10.37 | 002-90539 | 12/20/2013 | |||||||
| 10.9† | Form of Indemnification Agreement dated as of September 7, 2012, by and between Applied DNA Sciences, Inc. and each of its directors and executive officers | 8-K | 10.1 | 002-90539 | 9/13/2012 | |||||||
| 40 |
| Incorporated by Reference | Filed
or Furnished Herewith | |||||||||||
| Exhibit
Number |
Description | Form | Exhibit | File No. | Date Filed | |||||||
| 10.10 | Asset Purchase Agreement dated May 10, 2013, between Applied DNA Sciences, Inc. and RedWeb Technologies Limited | 10-Q | 10.1 | 002-90539 | 8/13/2013 | |||||||
| 10.11 | Agreement of Lease dated June 14, 2013, between Applied DNA Sciences, Inc. and Long Island High Technology Incubator, Inc. | 10-Q | 10.2 | 002-90539 | 8/13/2013 | |||||||
| 10.12* | Term sheet for Mutual Cooperation with Borealis AG dated March 31, 2014 | 8-K/A | 10.1 | 002-90539 | 7/22/2014 | |||||||
| 10.13 | Form of Subscription Agreement dated June 3, 2014 | 8-K | 10.1 | 002-90539 | 6/6/2014 | |||||||
| 10.14 | Form of Warrant dated June 3, 2014 | 8-K | 10.2 | 002-90539 | 6/6/2014 | |||||||
| 10.15 | Form of Award/Contract issued by U.S. Missile Defense Agency dated July 14, 2014 | 8-K | 10.1 | 002-90539 | 7/18/2014 | |||||||
| 10.16 | Form of Promissory Note | 8-K | 10.1 | 002-90539 | 9/17/2014 | |||||||
| 10.17 | Form of Award/Contract awarded by Office of Secretary of Defense on behalf of Defense Logistics Agency dated August 28, 2014 | 8-K/A | 10.1 | 002-90539 | 9/8/2014 | |||||||
| 10.18 | Warrant Repurchase Option Agreement dated October 28, 2014 between Applied DNA Sciences, Inc. and Crede CG III, Ltd. | S-1/A | 10.28 | 333-199121 | 10/30/2014 | |||||||
| 10.19 | Letter Agreement dated November 11, 2014 between Applied DNA Sciences, Inc. and James A. Hayward regarding Exchange of 12.5% Promissory Note | S-1/A | 10.29 | 333-199121 | 11/12/2014 | |||||||
| 10.20 | Underwriting agreement between Applied DNA Sciences, Inc. and Maxim Group LLC dated November 17, 2014 | S-1/A | 1.1 | 333-199121 | 11/12/2014 | |||||||
| 10.21 | Form of Warrant Agreement between Applied DNA Sciences, Inc. and American Stock Transfer & Trust Company, LLC, as warrant agent | S-1/A | 10.25 | 002-90539 | 11/12/14 | |||||||
| 10.22 | First Amendment to Warrant Agreement dated April 1, 2015 between Applied DNA Sciences, Inc. and American Stock Transfer & Trust Company, LLC as warrant agent | 8-K | 4.1 | 001-36745 | 4/1/2015 | |||||||
| 10.23* | Mutual License Agreement dated March 25, 2015 between Applied DNA Sciences, Inc. and Divatex Home Fashion, Inc. | 10-Q | 10.1 | 001-36745 | 5/11/2015 | |||||||
| 10.24 | Underwriting Agreement dated March 27, 2015, between Applied DNA Sciences, Inc. and Maxim Group LLC, as representative of the underwriters named on Schedule A thereto. | 8-K | 1.1 | 001-36745 | 3/27/2015 | |||||||
| 10.25** | Asset Purchase Agreement dated September 11, 2015 between Applied DNA Sciences, Inc. and Vandalia Research, Inc. | 8-K | 2.1 | 001-36745 | 9/17/2015 | |||||||
| 10.26 | Placement Agency Agreement by and between Applied DNA Sciences, Inc. and Maxim Group LLC, dated November 23, 2015 | 8-K/A | 10.1 | 001-36745 | 11/23/2015 | |||||||
| 10.27 | Form of Securities Purchase Agreement | 8-K/A | 10.2 | 001-36745 | 11/23/2015 | |||||||
| 10.28 | Placement Agency Agreement between Maxim Group LLC, Imperial Capital, LLC and Applied DNA Sciences, Inc. dated November 2, 2016 | 8-K | 10.1 | 001-36745 | 11/2/2016 | |||||||
| 10.29 | Securities Purchase Agreement dated November 2, 2016 | 8-K | 10.2 | 001-36745 | 11/2/2016 | |||||||
| 10.30 | Registration Rights Agreement dated November 2, 2016 | 8-K | 10.3 | 001-36745 | 11/2/2016 | |||||||
| 10.31 | Second Amendment to Warrant Agreement dated November 2, 2016 | 8-K | 10.3 | 001-36745 | 11/2/2016 | |||||||
| 21.1 | Subsidiaries of Applied DNA Sciences, Inc. | S-1/A | 21.1 | 333-199121 | 10/30/2014 | |||||||
| 23.1 | Consent of Marcum LLP | Filed | ||||||||||
| 101 INS | XBRL Instance Document | Filed | ||||||||||
| 101 SCH | XBRL Taxonomy Extension Schema Document | Filed | ||||||||||
| 101 CAL | XBRL Taxonomy Extension Calculation Linkbase Document | Filed | ||||||||||
| 101 DEF | XBRL Taxonomy Extension Definitions Linkbase Document | Filed | ||||||||||
| 101 LAB | XBRL Taxonomy Extension Labels Linkbase Document | Filed | ||||||||||
| 101 PRE | XBRL Taxonomy Extension Presentation Linkbase Document | Filed | ||||||||||
† Indicates a management contract or any compensatory plan, contract or arrangement.
* A request for confidentiality has been granted for certain portions of the indicated document. Confidential portions have been omitted and filed separately with the SEC as required by Rule 24b-2 promulgated under the Exchange Act.
** Schedules (or similar attachments) have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Applied DNA Sciences, Inc. agrees to furnish supplementally a copy of any such omitted schedule or attachment to the U.S. Securities and Exchange Commission upon request; provided, however, that Applied DNA Sciences, Inc. may request confidential treatment pursuant to Rule 24b-2 under the Exchange Act for any schedule or attachment so furnished.
| 41 |
APPLIED DNA SCIENCES, INC.
INDEX TO FINANCIAL STATEMENTS
| F-1 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of the Board of Directors and Shareholders of
Applied DNA Sciences, Inc.
We have audited the accompanying consolidated balance sheets of Applied DNA Sciences, Inc. (the “Company”) as of September 30, 2016 and 2015, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied DNA Sciences, Inc., as of September 30, 2016 and 2015, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Marcum llp
Marcum llp
Melville, NY
December 6, 2016
| F-2 |
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2016 AND 2015
| September 30, | ||||||||
| 2016 | 2015 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 4,479,274 | $ | 7,312,184 | ||||
| Accounts receivable, net of allowance of $32,965 and $7,140 at September 30, 2016 and 2015, respectively | 6,374,895 | 3,929,517 | ||||||
| Inventories | 297,759 | - | ||||||
| Prepaid expenses and other current assets | 200,006 | 293,351 | ||||||
| Total current assets | 11,351,934 | 11,535,052 | ||||||
| Property, plant and equipment, net of accumulated depreciation of $1,263,200 and $852,867 at September 30, 2016 and 2015, respectively | 792,499 | 572,107 | ||||||
| Other assets: | ||||||||
| Long term accounts receivables | 1,535,000 | 1,500,000 | ||||||
| Deposits | 61,126 | 62,988 | ||||||
| Deferred offering costs | 13,986 | - | ||||||
| Goodwill | 285,386 | 285,386 | ||||||
| Intangible assets, net of accumulated amortization of $423,649 and $238,368, as of September 30, 2016 and 2015, respectively | 1,525,900 | 1,598,779 | ||||||
| Total Assets | $ | 15,565,831 | $ | 15,554,312 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable and accrued liabilities | $ | 2,247,341 | $ | 2,385,006 | ||||
| Deferred revenue | 1,837,588 | 282,050 | ||||||
| Total current liabilities | 4,084,929 | 2,667,056 | ||||||
| Long term accounts payable | 215,500 | 320,400 | ||||||
| Long term deferred revenue | 900,000 | - | ||||||
| Total liabilities | 5,200,429 | 2,987,456 | ||||||
| Commitments and contingencies | ||||||||
| Stockholders’ Equity | ||||||||
| Preferred stock, par value $0.001 per share; 10,000,000 shares authorized; -0- shares issued and outstanding as of September 30, 2016 and 2015 | - | - | ||||||
| Series A Preferred stock, par value $0.001 per share; 10,000,000 shares authorized; -0- issued and outstanding as of September 30, 2016 and 2015 | - | - | ||||||
| Series B Preferred stock, par value $0.001 per share; 10,000,000 shares authorized; -0- issued and outstanding as of September 30, 2016 and 2015 | - | - | ||||||
| Common stock, par value $0.001 per share; 500,000,000 shares authorized; 24,078,756 and 21,504,578 shares issued and outstanding as of September 30, 2016 and 2015, respectively | 24,079 | 21,505 | ||||||
| Additional paid in capital | 234,158,711 | 224,186,760 | ||||||
| Accumulated deficit | (223,817,388 | ) | (211,641,409 | ) | ||||
| Total stockholders’ equity | 10,365,402 | 12,566,856 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 15,565,831 | $ | 15,554,312 | ||||
See the accompanying notes to the consolidated financial statements
| F-3 |
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 2016 AND 2015
| 2016 | 2015 | |||||||
| Revenues: | ||||||||
| Product revenues | $ | 2,538,202 | $ | 5,435,776 | ||||
| Service revenues | 1,648,225 | 3,572,723 | ||||||
| Total revenues | 4,186,427 | 9,008,499 | ||||||
| Cost of revenues | 746,582 | 384,269 | ||||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 11,239,397 | 13,410,256 | ||||||
| Research and development | 3,693,810 | 2,577,307 | ||||||
| Depreciation and amortization | 706,496 | 490,641 | ||||||
| Total operating expenses | 15,639,703 | 16,478,204 | ||||||
| LOSS FROM OPERATIONS | (12,199,858 | ) | (7,853,974 | ) | ||||
| Other (expense) income: | ||||||||
| Interest income (expense), net (including related party interest of $31,875 for the year ended September 30, 2015) | 11,004 | (23,468 | ) | |||||
| Other income (expense), net | 12,875 | (28,313 | ) | |||||
| Loss on conversion of Promissory notes | - | (980,842 | ) | |||||
| Loss on change in fair value of warrant liability | - | (2,994,540 | ) | |||||
| Loss before provision for income taxes | (12,175,979 | ) | (11,881,137 | ) | ||||
| Provision for income taxes | - | - | ||||||
| NET LOSS | $ | (12,175,979 | ) | $ | (11,881,137 | ) | ||
| Net loss per share-basic and diluted | $ | (0.51 | ) | $ | (0.63 | ) | ||
| Weighted average shares outstanding-basic and diluted | 23,693,096 | 18,938,283 | ||||||
See the accompanying notes to the consolidated financial statements
| F-4 |
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY
YEARS ENDED SEPTEMBER 30, 2016 and 2015
Common | Common | Additional | Accumulated | Total | ||||||||||||||||
| Balance, October 1, 2014 | 13,935,954 | $ | 13,937 | $ | 198,277,859 | $ | (199,760,272 | ) | $ | (1,468,476 | ) | |||||||||
| Other | 6,440 | 6 | (6 | ) | — | — | ||||||||||||||
| Exercise of warrants and options cashlessly | 4,376 | 4 | (4 | ) | — | — | ||||||||||||||
| Common stock issued for consulting services | 40,500 | 41 | 136,240 | — | 136,281 | |||||||||||||||
| Shares issued in underwritten public offerings, net of offering costs | 6,950,000 | 6,950 | 18,926,364 | — | 18,933,314 | |||||||||||||||
| Shares and warrants issued upon conversion of promissory notes and accrued interest | 567,308 | 567 | 2,824,024 | — | 2,824,591 | |||||||||||||||
| Stock based compensation expense | — | 4,022,283 | — | 4,022,283 | ||||||||||||||||
| Net loss | — | — | — | (11,881,137 | ) | (11,881,137 | ) | |||||||||||||
| Balance, September 30, 2015 | 21,504,578 | $ | 21,505 | $ | 224,186,760 | $ | (211,641,409 | ) | $ | 12,566,856 | ||||||||||
| Exercise of warrants and options cashlessly | 48,918 | 49 | (49 | ) | — | — | ||||||||||||||
| Common stock issued for consulting services | 24,000 | 24 | 78,106 | — | 78,130 | |||||||||||||||
| Shares issued in underwritten public offerings, net of offering costs | 2,500,000 | 2,500 | 7,850,655 | — | 7,853,155 | |||||||||||||||
| Exercise of warrants for cash | 1,260 | 1 | 4,409 | — | 4,410 | |||||||||||||||
| Stock based compensation expense | — | — | 2,038,830 | — | 2,038,830 | |||||||||||||||
| Net loss | — | — | — | (12,175,979 | ) | (12,175,979 | ) | |||||||||||||
| Balance, September 30, 2016 | 24,078,756 | $ | 24,079 | $ | 234,158,711 | $ | (223,817,388 | ) | $ | 10,365,402 | ||||||||||
See the accompanying notes to the consolidated financial statements
| F-5 |
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2016 AND 2015
| 2016 | 2015 | |||||||
| Cash flows from operating activities: | ||||||||
| Net loss | $ | (12,175,979 | ) | $ | (11,881,137 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation and amortization | 706,496 | 490,641 | ||||||
| Stock based compensation expense | 2,038,830 | 4,022,283 | ||||||
| Change in fair value of warrant liability | - | 2,994,540 | ||||||
| Loss on sale of property, plant and equipment | 5,520 | - | ||||||
| Loss on conversion of promissory notes | - | 980,842 | ||||||
| Common stock issued for consulting services | 78,130 | 136,281 | ||||||
| Security deposit write-off | 10,000 | - | ||||||
| Provision for bad debts | 116,825 | 34,996 | ||||||
| Change in operating assets and liabilities: | ||||||||
| Accounts receivable | (2,597,203 | ) | (4,635,445 | ) | ||||
| Prepaid expenses, other current assets and deposits | 16,209 | (78,587 | ) | |||||
| Inventories | (297,759 | ) | 30,000 | |||||
| Accounts payable and accrued liabilities | (253,333 | ) | 1,241,052 | |||||
| Deferred revenue | 2,455,537 | (301,312 | ) | |||||
| Net cash used in operating activities | (9,896,727 | ) | (6,965,846 | ) | ||||
| Cash flows used in investing activities: | ||||||||
| Proceeds from sale of property, plant and equipment | 5,500 | - | ||||||
| Purchase of assets under asset purchase agreement | - | (1,500,000 | ) | |||||
| Purchase of intangible assets | (112,403 | ) | (286,953 | ) | ||||
| Purchase of property, plant and equipment | (672,859 | ) | (351,615 | ) | ||||
| Net cash used in investing activities | (779,762 | ) | (2,138,568 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Net proceeds from sale of common stock and warrants | 7,853,155 | 19,114,418 | ||||||
| Proceeds from exercise of warrants | 4,410 | - | ||||||
| Deferred offering costs | (13,986 | ) | - | |||||
| Purchase and cancellation of previously issued warrants | - | (4,090,952 | ) | |||||
| Net cash provided by financing activities | 7,843,579 | 15,023,466 | ||||||
| Net (decrease) increase in cash and cash equivalents | (2,832,910 | ) | 5,919,052 | |||||
| Cash and cash equivalents at beginning of year | 7,312,184 | 1,393,132 | ||||||
| Cash and cash equivalents at end of year | $ | 4,479,274 | $ | 7,312,184 | ||||
| Supplemental Disclosures of Cash Flow Information: | ||||||||
| Cash paid during year for interest | $ | - | $ | - | ||||
| Cash paid during year for income taxes | $ | - | $ | - | ||||
| Non-cash investing and financing transactions: | ||||||||
| Common stock and warrants issued upon conversion of promissory notes payable and accrued interest | $ | - | $ | 1,843,750 | ||||
| Property, plant and equipment acquired, and included in accounts payable | $ | 10,767 | $ | 1,500 | ||||
| Intangible assets acquired, and included in accounts payable | $ | - | $ | 11,845 | ||||
| Common stock issued for cashless exercise of options | $ | 49 | $ | 4 | ||||
| Reclassification of deferred offering costs to additional paid in capital | $ | - | $ | 181,104 | ||||
See the accompanying notes to the consolidated financial statements
| F-6 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE A – LIQUIDITY AND MANAGEMENT’S PLAN
The Company has recurring net losses, which have resulted in an accumulated deficit of $223,817,388 as of September 30, 2016. The Company incurred a net loss of $12,175,979 and generated negative operating cash flow of $9,896,727 for the fiscal year ended September 30, 2016. At September 30, 2016 the Company had cash and cash equivalents of $4,479,274 and working capital of $7,267,005. The Company’s current capital resources include cash and cash equivalents, accounts receivable and inventories. Historically, the Company has financed its operations principally from the sale of equity securities. As discussed in Note J, during the fiscal year ended September 30, 2016, the Company closed on a registered direct public offering and concurrent private placement of common stock and warrants for gross proceeds of approximately $8.75 million before deducting underwriting discounts and offering expenses.
In addition, on November 7, 2016, the Company closed a private placement of common stock and warrants to purchase common stock, for aggregate gross proceeds of approximately $5 million, before deducting placement agent fees and offering expenses (See Note J).
The Company expects to finance operations primarily through cash received from the November 2016 private placement as well as collection of its current accounts receivables. The Company estimates that it will have sufficient cash and cash equivalents to fund operations for the next twelve months from the Balance Sheet date.
The Company may 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 revenues are not sufficient to cover the Company's operating expenses, and if the Company is not successful in obtaining the necessary additional financing, it will most likely be forced to reduce operations.
NOTE B – SUMMARY OF ACCOUNTING POLICIES
Business and Basis of Presentation
On September 16, 2002, the Company was incorporated under the laws of the State of Nevada. Effective December 17, 2008, the Company reincorporated from the State of Nevada to the State of Delaware. The Company is principally devoted to developing and marketing plant-based or other DNA technology solutions in the United States, Europe and Asia. To date, the Company has had a limited operating history with its current business model, and as a result, its operations have produced limited recurring revenues from its services and products; it has incurred expenses and has sustained losses. Consequently, its operations are subject to all the risks inherent in the establishment of a biotechnology company.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, APDN (B.V.I.) Inc. and Applied DNA Sciences Europe Limited, which currently have no operations. Significant inter-company transactions and balances have been eliminated in consolidation. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation.
On October 24, 2014, the Company filed a Third Certificate of Amendment of its Certificate of Incorporation with the Secretary of State of the State of Delaware that effected a one-for-60 (1:60) reverse stock split of its common stock, par value $.001 per share, and a decrease in its authorized common stock, from 1,350,000,000 to 500,000,000 shares, effective October 29, 2014. All warrant, option, share, and per share information in the consolidated financial statements gives retroactive effect to a one-for-60 reverse stock split that was effected on October 29, 2014.
| F-7 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Use of Estimates
The preparation of the financial statements in conformity with Accounting Principles Generally Accepted in the U.S. ("GAAP") requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. The most complex and subjective estimates include recoverability of long-lived assets, including the values assigned to goodwill, intangible assets and property, plant and equipment, fair value calculations for warrants and stock based compensation, contingencies, anticipated collection periods for accounts receivables and allowance for doubtful accounts. Management reviews its estimates on a regular basis and the effects of any material revisions are reflected in the consolidated financial statements in the period they are deemed necessary. Accordingly, actual results could differ from those estimates.
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 has not been provided, or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered, the service has been provided, or no refund will be required. At September 30, 2016 and 2015, the Company recorded total deferred revenue of $2,737,588 and $282,050, 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 government contract awards, which supports the Company’s development efforts on specific projects, is recognized as milestones are achieved as per the contract. The Company recognized revenue of approximately $1,064,105 and $2,792,555 from these contract awards during the fiscal years ended September 30, 2016 and 2015, respectively.
The Company recognizes the revenue under its memorandum of understanding (“MOU”) with LD Commodities Cotton LLC (“Dreyfus”), when the product has been shipped, as there is no right of return under this arrangement and there is a commitment from their customer to purchase the marked cotton. The Company has evaluated the other indicators of gross and net revenue recognition, including whether or not the Company is the primary obligor and if it has general inventory risk. The Company does not have any general inventory risk and is not the primary obligor as it relates to the marketing portion of the cotton tagging fee. With respect to the Company’s mutual license agreement with Himatsingka America Inc. (formerly known as Divatex Home Fashion, Inc.) (“Himatsingka”), the Company has carefully evaluated all of the key gross and net revenue recognition indicators and has concluded that the circumstances as they relate to Himatsingka’s portion of the tagging fee are more consistent with those key indicators that support net revenue reporting. On June 29, 2016, Himatsingka waived its portion of the tagging fee for up to $250,000. In addition, the nature of some of the Company’s cotton contracts includes extended payment terms that will result in a longer collection period and slower cash inflows. Under the Company’s MOU with Louis Dreyfus commodities, as of September 30, 2016 and 2015 there was $4,621,345 and $2,893,400, included in short term accounts receivable, respectively. As of September 30, 2016 and 2015 there was $1,535,000 and $1,500,000 included in long-term accounts receivable, respectively. Also, as of September 30, 2016 $2,305,000 was included in deferred revenue for shipments during fiscal 2016. The cotton ginning season in the United States takes place between September and December each year, therefore, revenues from these customer contracts may be seasonal.
| F-8 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Cash Equivalents
For the purpose of the accompanying consolidated financial statements, all highly liquid investments with a maturity of three months or less are considered to be cash equivalents.
Accounts Receivable
The Company provides 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.
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. As the Company increases sales to its cotton customers, which have longer payment terms on certain contracts, its collection cycle may increase in future periods. The Company classifies receivable amounts as current or long-term based on expected payment and records long-term accounts receivable when the collection period is expected to be greater than one year.
At September 30, 2016 and 2015, the Company has an allowance for doubtful accounts of $32,965 and $7,140, respectively. The Company writes-off receivables that are deemed uncollectible.
Inventories
Inventories, which consist primarily of raw materials and finished goods, are stated at the lower of cost or market, which cost determined by using the first-in, first-out (FIFO) method.
Deferred offering costs
Deferred offering costs consist of fees paid in relation to legal, accounting, regulatory and printing work completed in preparation of equity offerings. Deferred offering costs will be charged against the proceeds from equity offerings. At September 30, 2016 deferred offering costs were $13,986 and were reclassified to equity upon the closing of the November 7, 2016 private placement (see Note J).
Income Taxes
The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740-10”) which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes include, but not limited to, accounting for intangibles, warrants, equity based compensation and depreciation and amortization. The Company evaluates the recoverability of deferred tax assets and establishes a valuation allowance when it is more likely than not that some portion or all of the deferred tax asset will not be realized. During the fiscal years ended September 30, 2016 and 2015, the Company incurred losses from operations. Based upon these results and the trends in the Company’s performance projected for fiscal year 2017, it is more likely than not that the Company will not realize any benefit from the deferred tax assets recorded by the Company in previous periods. Management makes judgments as to the interpretation of tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In management’s opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary. The Company has identified its federal tax return and its state tax return in New York as “major” tax jurisdictions. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated financial statements.
The Company believes that its income tax positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. It is the Company’s policy to accrue interest and penalties on unrecognized tax benefits as components of income tax provision. The Company did not have any accrued interest or penalties as of September 30, 2016 and 2015. Tax years 2012 through 2015 remain subject to future examination by the applicable taxing authorities.
F-9
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Property, Plant and Equipment
Property, plant and equipment are stated at cost and depreciated using the straight line method over their estimated useful lives. The estimated useful life for computer equipment, lab equipment and furniture is 3 to 5 years and leasehold improvements are amortized over the shorter of their useful life or the lease terms. Property plant and equipment consist of:
| September 30, | ||||||||
| 2016 | 2015 | |||||||
| Computer equipment | $ | 70,134 | $ | 43,718 | ||||
| Lab equipment | 1,651,400 | 1,069,541 | ||||||
| Furniture | 44,592 | 44,592 | ||||||
| Leasehold improvements | 289,573 | 267,123 | ||||||
| Total | 2,055,699 | 1,424,974 | ||||||
| Accumulated depreciation | 1,263,200 | 852,867 | ||||||
| Property, plant and equipment, net | $ | 792,499 | $ | 572,107 | ||||
Depreciation expense for the fiscal years ended September 30, 2016 and 2015 were $452,212 and $393,750, respectively.
Impairment of Long-Lived Assets
The Company evaluates its long lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses, or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of long-lived assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. As of September 30, 2016 and 2015, the Company concluded that its long-lived assets were not required to be tested for recoverability.
Net Loss per Share
The Company presents loss per share utilizing a dual presentation of basic and diluted loss per share. Basic loss per share includes no dilution and has been calculated based upon the weighted average number of common shares outstanding during the period. Dilutive common stock equivalents consist of shares issuable upon the exercise of the Company’s stock options and warrants.
| F-10 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Net Loss per Share, continued
For the years ended September 30, 2016 and 2015, common stock equivalent shares are excluded from the computation of the diluted loss per share as their effect would be anti-dilutive.
Securities that could potentially dilute basic net income per share in the future that were not included in the computation of diluted net loss per share because to do so would have been antidilutive for the fiscal years ended September 30, 2016 and 2015 are as follows:
| 2016 | 2015 | |||||||
| Warrants | 7,208,060 | 6,027,654 | ||||||
| Employee options | 4,403,234 | 3,458,905 | ||||||
| 11,611,294 | 9,486,559 | |||||||
Stock Based Compensation
The Company accounts for stock-based compensation for employees and directors in accordance with ASC 718, Compensation (“ASC 718”). ASC 718 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. Under the provisions of ASC 718, stock-based compensation costs are measured at the grant date, based on the fair value of the award, and are recognized as expense over the employee’s requisite service period (generally the vesting period of the equity grant). The fair value of the Company’s common stock options is estimated using the Black Scholes option-pricing model with the following assumptions: expected volatility, dividend rate, risk free interest rate and the expected life. The Company expenses stock-based compensation by using the straight-line method. In accordance with ASC 718, excess tax benefits realized from the exercise of stock-based awards are classified in cash flows from financing activities. The future realization of the reserved deferred tax assets related to these tax benefits associated with the exercise of stock options will result in a credit to additional paid in capital if the related tax deduction reduces taxes payable. The Company has elected the “with and without approach” regarding ordering of windfall tax benefits to determine whether the windfall tax benefit did reduce taxes payable in the current year. Under this approach, the windfall tax benefit would be recognized in additional paid-in-capital only if an incremental tax benefit is realized after considering all other benefits presently available.
The Company accounts for stock based compensation awards issued to non-employees for services, as prescribed by ASC 718-10, at either the fair value of the services rendered or the instruments issued in exchange for such services, whichever is more readily determinable, using the measurement date guidelines enumerated in ASC 505-50.
Concentrations
Financial instruments and related items, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and trade receivables. The Company places its cash and temporary cash investments with high credit quality institutions. At times, such investments may be in excess of the FDIC insurance limit.
The Company’s revenues earned from sale of products and services for the fiscal years ended September 30, 2016 included an aggregate of 75% from three customers of the Company’s total revenues. These three customers accounted for approximately 20% of the Company’s total accounts receivable at September 30, 2016. At September 30, 2016, one customer accounted for an aggregate of 78% of the Company’s total accounts receivable.
The Company’s revenues earned from sale of products and services for the fiscal year ended September 30, 2015 included an aggregate of 79% from two customers of the Company’s total revenues. These two customers accounted for approximately 90% of the Company’s total accounts receivable at September 30, 2015.
Research and Development
The Company accounts for research and development costs in accordance with the ASC 730, Research and Development (“ASC 730”). Under ASC 730, all research and development costs must be charged to expense as incurred. Accordingly, internal research and development costs are expensed as incurred. Third-party research and development costs are expensed when the contracted work has been performed or as milestone results have been achieved. Company-sponsored research and development costs related to both present and future products are expensed in the period incurred. During the fiscal years ended September 30, 2016 and 2015, the Company incurred research and development expenses of $3,693,810 and $2,577,307, respectively.
| F-11 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Advertising
The Company follows the policy of charging the costs of advertising to expense as incurred. The Company charged to operations $245,281 and $158,373, as advertising costs for the fiscal years ended September 30, 2016 and 2015, respectively.
Goodwill and Other Intangible Assets
The Company amortizes its intangible assets using the straight-line method over their estimated period of benefit. All of the Company’s intangible assets, except for goodwill are subject to amortization.
Goodwill and other intangible assets arise as a result of business acquisitions. Goodwill consists of the excess of the cost of the acquisitions over the tangible and intangible assets acquired and liabilities.
The Company evaluates goodwill for impairment at least annually. The Company also reviews its goodwill and other intangible assets for impairment whenever events or changes in circumstances indicate that it is more likely than not their carrying amount may exceed their implied fair value. The Company quantitatively determines whether, more likely than not, the fair value exceeds the carrying amount of a reporting unit. There are numerous assumptions and estimates underlying the quantitative assessments including future earnings, long-term strategies, and the Company's annual planning and forecasts. If these planned initiatives do not accomplish the targeted objectives, the assumptions and estimates underlying the quantitative assessments could be adversely affected and have a material effect upon the Company's financial condition and results of operations. As of September 30, 2016 and 2015 goodwill and other intangible impairment assessments indicated that there was no impairment.
Internally Developed Software
Internally developed software products, consist of capitalized costs associated with the development of computer software to be sold, leased or otherwise marketed. Software development costs associated with new products are expensed as incurred until technological feasibility, as defined in FASB ASC Topic 985-20, has been established. Costs incurred thereafter are capitalized until the product is made generally available. The stage during the Company's development process for a new product or new release at which technological feasibility requirements are established affects the amount of costs capitalized. Annual amortization of internally developed software products is the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or the straight-line method over the remaining estimated economic life of the software product, generally estimated to be 5 years from the date the product became available for general release to customers. The Company generally recognizes amortization expense for capitalized software costs using the straight-line method. Internally developed software products are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Fair Value of Financial Instruments
The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related asset or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities.
The Company utilizes observable market inputs (quoted market prices) when measuring fair value whenever possible.
| F-12 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Fair Value of Financial Instruments, continued
Level 3 Measurements:
Warrant Liability: Estimated using the Binomial Lattice option valuation model. Significant observable and unobservable inputs include stock price, exercise price, annual risk free rate, term, and expected volatility. An increase or decrease in these inputs could significantly increase or decrease the fair value of the warrant. See Notes H and K.
For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s accounting and finance department, who report to the Chief Financial Officer, determine its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s accounting and finance department and are approved by the Chief Financial Officer.
Recently Accounting Principles
In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-09, "Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." The objective of this update is to simplify several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods and is to be applied utilizing a modified retrospective approach. The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, "Balance Sheet Classification of Deferred Taxes" ("ASU 2015-17"). This update requires an entity to classify deferred tax liabilities and assets as noncurrent within a classified statement of financial position. ASU 2015-17 is effective for annual and interim reporting periods beginning after December 15, 2016. This update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Early application is permitted as of the beginning of the interim or annual reporting period. The Company expects the impact of the adoption of this pronouncement on its consolidated balance sheet to be a reclassification only, and does not expect the pronouncement to have a significant impact.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments (“ASU 2015-16”). The FASB issued ASU 2015-16 to simplify US GAAP to require that the acquirer record, in the same period’s financial statements, the effect of changes to provisional, measurement period amounts calculated as if the accounting had been completed at the acquisition date and disclose the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This guidance was effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The Company does not believe that this pronouncement will have a material impact on its consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory (Topic 330) ("ASU 2015-11"). ASU 2015-11 simplifies the accounting for the valuation of all inventory not accounted for using the last-in, first-out ("LIFO") method by prescribing that inventory be valued at the lower of cost and net realizable value. ASU 2015-11 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 on a prospective basis. The Company does not expect the adoption of ASU 2015-11 to have a material effect on its consolidated financial statements.
In August 2014, FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in ASU 2014-15 are effective for annual reporting periods ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company will adopt the methodologies prescribed by ASU 2014-15 by the date required, and does not anticipate that the adoption of ASU 2014-15 will have a material effect on its consolidated financial position or results of operations.
| F-13 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE B – SUMMARY OF ACCOUNTING POLICIES, continued
Recently Accounting Principles, continued
In June 2014, the FASB issued ASU 2014-12, “Accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period” (“ASU 2014-12”) which requires performance-based awards with a performance target that affects vesting and that could be achieved after an employee completes the requisite service period to be accounted for as a performance condition. If performance targets are clearly defined and it is probable that the performance condition will be achieved, stock-based expense should be recognized over the remaining requisite service period. This guidance is effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-12 to have a material impact on the Company’s consolidated financial position or results of operations.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”) which provides updated, comprehensive revenue recognition guidance for contracts with customers, including a new principles-based five step framework that eliminates much of the industry-specific guidance in current accounting literature. Under ASU 2014-09, revenue recognition is based on a core principle that companies recognize revenue in an amount consistent with the consideration they expect to be entitled to in exchange for the transfer of goods or services. The standards update also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of recognized revenue. This guidance will be effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2017. The Company is in the process of evaluating the provisions of ASU 2014-09 and assessing the potential effect on the Company’s consolidated financial position or results of operations.
NOTE C - ASSET PURCHASE AGREEMENT
On September 11, 2015, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”), with Vandalia Research, Inc. a West Virginia corporation (“Vandalia”), and Derek A. Gregg, Vandalia’s Chief Executive Officer and a director of Vandalia, providing for the purchase of substantially all the assets (“Assets”) of Vandalia. The Company completed the acquisition of such Assets on the same date (“Vandalia Asset Acquisition”). The Vandalia Assets relate to the business of producing specific, DNA sequences with the polymerase chain reaction production system known as Triathlon™, including machinery, equipment, inventory, registered and other intellectual property, including patents, trademarks, trade secrets, domain names, copyrights and rights to software, and customer contracts. The Assets also include Vandalia’s rights under a patent license agreement between Marshall University Research Corporation (“Marshall”) and Vandalia pursuant to which the Company will pay to Marshall a royalty of one percent (1%) of the net revenues received by it from the sale of the licensed product. The purchase price for the Assets was $1,500,000, which amount was determined through arms-length negotiation. Of this amount, $500,000 was placed in an escrow account for a period of nine months following the closing to satisfy Vandalia’s indemnification obligations of which $350,000 was released to Vandalia after sixty days. On June 30, 2016, the Company received $50,000 of the remaining funds in escrow to satisfy indeminification obligations and the balance of $100,000 was released to Vandalia. Vandalia and Derek Gregg agreed not to compete with the Company and not to solicit the Company’s employees or customers for a period of five years following the closing. Derek Gregg also entered into a consulting agreement with the Company for a term of twelve months subject to earlier termination by either party upon thirty days’ notice. Pursuant to the Asset Purchase Agreement, the Company entered into a month to month sublease with Vandalia of approximately 5,000 square feet at Vandalia’s office facility at an aggregate monthly rent of $5,416, which the Company terminated during December 2015. Purchase orders of $237,000 were assigned by Vandalia to the Company. Prior to the Vandalia Asset Acquisition, the Company was a customer of Vandalia, paying approximately $230,300 during the fiscal year ended September 30, 2014. The Company entered into this Asset Purchase Agreement in order to be able to increase its capacity for producing DNA, as well as to expand its business and product offerings.
The asset purchase agreement was accounted for using the acquisition method under ASC 805, Business Combinations, which requires the acquired assets to be recorded at fair values as of the acquisition date of September 11, 2015. The following table summarizes the purchase price and the values of assets acquired:
| Allocation of Purchase Price: | September 11, 2015 | |||
| Inventory | $ | 30,000 | ||
| Fixed assets | 36,614 | |||
| Security deposit | 10,000 | |||
| Identifiable intangible assets: | ||||
| Contract in place | 69,000 | |||
| Intellectual property | 448,000 | |||
| Customer relationships | 621,000 | |||
| Goodwill | 285,386 | |||
| Fair value of assets acquired | $ | 1,500,000 | ||
The goodwill acquired is the result of expected synergies as well as intangible assets that did not qualify for separation. During the fiscal year ended September 30, 2015, the Company expensed $184,319 of acquisition-related legal costs. The costs are included in the line item Selling, General & Administrative costs in the accompanying consolidated statements of operations for the fiscal year ended September 30, 2015 . The amounts of revenue and net income of Vandalia included in the Company’s consolidated statements of operations for the fiscal year ended September 30, 2015 was $175,000 and $102,398, respectively. The goodwill of $285,386 is fully deductible for tax purposes.
| F-14 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE D – INVENTORIES
Inventories consist of the following:
| September 30, | ||||
| 2016 | ||||
| Raw materials | $ | 100,420 | ||
| Finished goods | 197,339 | |||
| $ | 297,759 | |||
| Total | ||||
NOTE E – INTANGIBLE ASSETS
Intangible assets at September 30, 2016 and 2015 are as follows:
| 2016 | 2015 | |||||||
| Internally developed software (5-year useful life) | $ | 411,199 | $ | 298,797 | ||||
| Customer relationships (10-year useful life) | 621,000 | 621,000 | ||||||
| Intellectual property (5-15 years) | 917,350 | 917,350 | ||||||
| 1,949,549 | 1,837,147 | |||||||
| Less: | ||||||||
| Accumulated amortization | 423,649 | 238,368 | ||||||
| Intangible assets, net | $ | 1,525,900 | $ | 1,598,779 | ||||
Total amortization expense charged to operations for the fiscal years ended September 30, 2016 and 2015 were $254,284 and $96,891, respectively.
The following table presents the estimated amortization expense of the intangible assets for each of the five succeeding years as of September 30, 2016:
| Amount | ||||
| 2017 | $ | 243,177 | ||
| 2018 | 197,031 | |||
| 2019 | 149,357 | |||
| 2020 | 174,207 | |||
| 2021 | 174,207 | |||
| Thereafter | 587,921 | |||
| Total | $ | 1,525,900 | ||
| F-15 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE F – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities at September 30, 2016 and 2015 are as follows:
| 2016 | 2015 | |||||||
| Accounts payable | $ | 1,530,258 | $ | 1,237,973 | ||||
| Accrued salaries payable | 678,982 | 1,002,743 | ||||||
| Other accrued expenses | 38,101 | 144,290 | ||||||
| Total | $ | 2,247,341 | $ | 2,385,006 | ||||
NOTE G – PROMISSORY NOTES PAYABLE
On September 11, 2014, the Company issued and sold promissory notes (the “Notes”) in the aggregate principal amount of $1,800,000 and bearing interest at a rate of 12.5% per annum to Dr. James A. Hayward, the Company’s President, Chairman and Chief Executive Officer, in the amount of $1,000,000, and to another individual, in the amount of $800,000, both of whom are “accredited investors” as defined in regulations promulgated under the Securities Act of 1933, as amended (the “Securities Act”).
The Notes had a ten-month maturity. Interest was payable in cash or in shares of common stock at the option of the holders of the Notes. Interest to be paid in shares was to be paid in shares of common stock equal to (i) the amount of interest payable, divided by (ii) the average of the closing prices for the five consecutive trading days immediately preceding the applicable interest date. The Notes were permitted to be prepaid in whole or in part, at any time, subject to certain prepayment penalties. Upon an event of default, the Notes and all accrued interest thereon were to automatically convert into common stock at the closing price of the common stock on the date of issuance of the Notes. In the event of a consolidation or merger with another corporation in which the Company does not survive, the Notes were to be paid in full. On November 11, 2014, Dr. Hayward and the other individual agreed to exchange for cancellation their respective Notes (including principal and accrued interest thereon) for 315,171 shares of common stock and warrants to purchase 315,171 shares of common stock, in the case of Dr. Hayward, and 252,137 shares of common stock and warrants to purchase 252,137 shares of common stock, in the case of the other individual, at $3.25 ($3.24 for one share of common stock and $0.01 for one warrant) (“combined price”) , the aggregate public offering per share price of common stock and warrants issued in the Company’s underwritten public offering, which closed on November 20, 2014. The conversion of the Notes resulted in a loss on conversion of approximately $981,000, which was recorded on the consolidated statement of operations for the fiscal year ended September 30, 2015. The loss was calculated as the difference between the carrying amount of the promissory note and accrued interest on the conversion date compared to the fair value of the common stock and warrants issued as settlement of the Notes.
Interest expense for these Notes was $31,875 for the fiscal year ended September 30, 2015.
NOTE H– WARRANT LIABILITY
On December 16, 2013, Crede CG III, Ltd (“Crede”) effected the cashless exercise of 178,253 Series A Warrants and 116,667 Series B Warrants. At December 16, 2013 (date of exercise), the Company determined the fair value of the Warrants to be $2,455,042 using the Binomial Lattice model with the following assumptions: fair value of the Company’s common stock $10.80 per share; dividend yield 0%; expected term: 4.55 years; risk free interest rate: 1.55%; expected volatility of: 118.89%; and an exercise price of $14.59.
The Series A and Series B Warrants were classified as liabilities on the issuance date due to certain provisions contained in the warrant agreements, which may cause an adjustment to the conversion rate or the number of warrants outstanding.
On October 28, 2014, the Company entered into a warrant repurchase option agreement with Crede, pursuant to which it had the option to purchase between 50% and 100% of Crede’s Series B Warrant (then exercisable for 387,621 shares of common stock) at a purchase price of $10.55 per share underlying such Series B Warrant (up to an aggregate purchase price of $4,091,000 for all of the Series B Warrant). On November 21, 2014, the Company exercised its option and repurchased 100% of Crede’s Series B Warrant for an aggregate purchase price of approximately $4,091,000. The change in fair value of the warrant liability on the day of repurchase amounted to a loss of $2,994,540 and was included in other income (expense) for the fiscal year ended September 30, 2015.
| F-16 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE I– RELATED PARTY TRANSACTIONS
As discussed in Note G, on September 11, 2014, the Company issued and sold a promissory note in the aggregate principal amount of $1,000,000 and bearing interest at a rate of 12.5% per annum to Dr. James A. Hayward, the Company’s President, Chairman and Chief Executive Officer. On November 11, 2014, Dr. Hayward agreed to exchange for cancellation of his Note (including principal and accrued interest thereon) for 315,171 shares of common stock and warrants to purchase 315,171 shares of common stock, at a combined price of $3.25, the aggregate public offering price of common stock and warrants issued in the Company’s underwritten public offering which closed on November 20, 2014.
As discussed in Note J, the Company’s Chief Executive Officer and an affiliated company of a member of the Company’s board of directors participated in the Company’s November 20, 2014 underwritten public offering.
NOTE J – CAPITAL STOCK
Common Stock Transactions during and subsequent to the Fiscal Year Ended September 30, 2016:
On November 2, 2016, the Company entered into a securities purchase agreement with an institutional investor providing for the purchase of $5 million of common stock and warrants at a combined price of $2.20 per share of common stock and warrant (the “Private Placement”). In the Private Placement, the Company sold 2,272,727 shares of its common stock and warrants to purchase 2,272,727 shares of its common stock. The warrants have the same terms as the Company's existing publicly traded warrants (APDNW) with an exercise price of $3.50 per share and an expiration date of November 20, 2019. The offering closed on November 7, 2016.
The Company has agreed to file a registration statement providing for the resale of these securities on Form S-3 by December 7, 2016. Upon effectiveness of the registration statement, it is expected that the common stock and warrants issued in the Private Placement will be freely tradeable on The NASDAQ Capital Market under the symbols "APDN" and "APDNW", respectively.
The aggregate gross proceeds to the Company from the Private Placement were $5 million before deducting the placement agents' fee and other offering expenses.
In connection with the closing of this Private Placement, as partial compensation, on November 7, 2016, the Company granted warrants to purchase an aggregate of 68,182 shares of its common stock to the Company's placement agents, Maxim Group LLC and Imperial Capital LLC (the “Placement Agent Warrants”) at an exercise price of $2.53 (115% of the public offering price), subject to adjustment as set forth therein (including for stock dividends and splits and certain other distributions and “Fundamental Transactions,” as defined therein). The Placement Agent Warrants will be exercisable beginning six months following the closing date of the Private Placement and terminate at 5:00 P.M. (Eastern Standard Time) on November 7, 2021. In addition, the Placement Agent Warrants provide for cashless exercise, which the Placement Agents may elect if there is no effective registration statement registering the resale of the shares issuable upon exercise of the Placement Agent Warrants. The number of shares of common stock that may be acquired by the Placement Agents upon any exercise of the Placement Agent Warrants (or otherwise in respect hereof) shall be limited to the extent necessary to insure that, following such exercise, the total number of shares of common stock then beneficially owned by the Placement Agent and its Affiliates (as defined therein) and any other Persons whose beneficial ownership of common stock would be aggregated with the Placement Agent pursuant to the Exchange Act, does not exceed 9.99% of the total number of issued and outstanding shares of common stock.
On November 23, 2015, the Company entered into a securities purchase agreement with certain institutional investors providing for the purchase and sale of 2,500,000 shares of common stock at a price of $3.49 per share in a registered direct public offering. In a concurrent private placement, the Company sold warrants to purchase 1,250,000 shares of its common stock at a price of $0.01 per warrant, with an exercise price of $4.30 per share. The warrants were exercisable beginning six months following the closing date of the private placement and will expire five years from the date on which they become exercisable. The gross proceeds to the Company from this registered direct offering and private placement before deducting the placement agent fees and offering expenses, is $8.75 million.
In connection with the closing of the registered direct offering and the concurrent private placement, as partial compensation, on November 25, 2015, the Company granted warrants to purchase 50,000 shares of common stock to its placement agent. These warrants have an exercise price of $4.03 (115% of the public offering price), subject to adjustment as set forth therein, will be exercisable beginning six months following the closing date of the Private Placement and expire at 5:00 PM (Eastern Standard Time) on November 25, 2020.
During the fiscal year ended September 30, 2016, the Company granted 24,000 shares of common stock to consultants for a total expense of approximately $78,130 pursuant to the Company's 2005 Incentive Stock Plan.
| F-17 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE J – CAPITAL STOCK, continued
Common Stock Transactions during the Fiscal Year Ended September 30, 2015:
On October 24, 2014, the Company filed a Third Certificate of Amendment of its Certificate of Incorporation with the Secretary of State of the State of Delaware that effected a one-for-60 (1:60) reverse stock split of its common stock, par value $.001 per share, and a decrease in its authorized common stock, from 1,350,000,000 to 500,000,000 shares, effective October 29, 2014. All warrant, option, share, and per share information in the consolidated financial statements gives retroactive effect to the one-for-60 reverse stock split that was effected on October 29, 2014. In addition, the Company is authorized to issue 10,000,000 shares of preferred stock with a $0.001 par value per share.
On November 20, 2014, the Company closed its underwritten public offering of 2,800,000 shares of common stock and warrants to purchase up to an aggregate of 2,800,000 shares of common stock for gross proceeds of $9.1 million before deducting underwriting discounts and offering expenses. The Company utilized $4,091,000 of the gross proceeds to repurchase the remaining Series B Warrants from Crede, as discussed in Note H. The combined price for each share of common stock and one warrant was $3.25. The warrants may be exercised for a period of five years and have an exercise price of $3.50 per share. In connection with the offering, the Company granted to the underwriters a 45-day option to purchase up to 420,000 additional shares of common stock at $3.24 per share and/or up to 420,000 additional warrants at $0.01 per share to cover over-allotments, if any. The Company’s Chief Executive Officer and an affiliated company of a member of the Company’s board of directors participated in this underwritten public offering. The Company’s common stock and warrants are listed on the Nasdaq Capital Market under the symbols “APDN” and “APDNW”, respectively. On December 19, 2014, the Company closed on the underwriters’ exercise of its over-allotment option of 416,850 warrants for gross proceeds of $4,169 and on December 30, 2014, the Company closed on the underwriters’ additional exercise of its over-allotment option of 52,000 shares of common stock for gross proceeds of $168,480. The total number of common stock and warrants issued under this offering, including the exercise of the over-allotment option was 2,852,000 and 3,216,850, respectively. The gross proceeds to the Company was $9.3 million and net proceeds after deducting underwriting discounts, offering expenses and the repurchase of the remaining Series B Warrants from Crede was approximately $3.69 million.
In connection with the closing of this underwritten public offering, on November 20, 2014, the Company granted 128,800 warrants to purchase common stock to its underwriters as partial compensation. These warrants have an exercise price of $3.73 (115% of the public offering price) and expire on November 14, 2019.
See Note G for the common stock and warrants issued in connection with the conversion of the promissory notes.
During the fiscal year ended September 30, 2015, the Company granted 40,500 shares of common stock to consultants for a total expense of approximately $136,281 pursuant to the Company's 2005 Incentive Stock Plan.
On April 1, 2015, the Company closed its underwritten public offering of 4,011,000 shares of common stock and warrants to purchase up to an aggregate of 1,604,400 shares of common stock, at $3.00 ($2.99 for one share of common stock and $0.01 for one warrant) (“combined offering price”), including 191,000 shares and 76,400 warrants sold pursuant to the partial exercise of the underwriters’ over-allotment option. The warrants have a per share exercise price of $3.50, are exercisable immediately, and expire on November 20, 2019. The gross proceeds to the Company from this offering, including the partial exercise of the over-allotment option but before deducting the underwriting discount and offering expenses, were $12.0 million. In connection with the offering, the Company granted to the underwriters a 45-day option to purchase up to 573,000 additional shares of common stock and up to 229,200 additional warrants to cover over-allotments, if any. On April 30, 2015, the Company closed on the underwriters’ exercise of its over-allotment option of 87,000 shares of common stock and 152,800 warrants for gross proceeds of $263,950.
In connection with the closing of this underwritten public offering, as partial compensation, on April 1, 2015, the Company granted up to 163,720 warrants to purchase common stock to its underwriters. These warrants have an exercise price of $3.44 (115% of the public offering price) and expire on March 27, 2020.
| F-18 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE K– STOCK OPTIONS AND WARRANTS
Warrants
The following table summarizes the changes in warrants outstanding. These warrants were granted in lieu of cash compensation for services performed or financing expenses in connection with the sales of the Company’s common stock.
Transactions involving warrants (see Note J) are summarized as follows:
| Number of Shares | Weighted Average Exercise Price Per Share | |||||||
| Balance at October 1, 2015 | 6,027,654 | $ | 3.54 | |||||
| Granted | 1,300,000 | 4.29 | ||||||
| Exercised | (1,260 | ) | (3.50 | ) | ||||
| Cancelled or expired | (118,334 | ) | (5.58 | ) | ||||
| Balance, September 30, 2016 | 7,208,060 | $ | 3.64 | |||||
Employee Stock Options
In 2005, the Board of Directors and the holders of a majority of the outstanding shares of common stock approved the 2005 Incentive Stock Plan (the “Incentive Plan”). In 2007, 2008, 2012 and 2015, the Board of Directors and holders of a majority of the outstanding shares of common stock approved various increases in the number of shares of common stock that can be issued as stock awards and stock options thereunder to an aggregate of 8,333,333 shares and the number of shares of common stock that can be covered by awards made to any participant in any calendar year to 833,334 shares. The Incentive Plan’s expiration date is January 25, 2025.
The Incentive Plan is designed to retain directors, executives, and selected employees and consultants by rewarding them for making contributions to our success with an award of options to purchase shares of common stock. As of September 30, 2016, a total of 275,752 shares have been issued and options to purchase 4,925,357 shares have been granted under the Incentive Plan.
| F-19 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE K– STOCK OPTIONS AND WARRANTS, continued
Employee Stock Options, continued
The following table summarizes the changes in options outstanding and the related prices for the shares of the Company’s common stock issued to employees of the Company under the 2005 Incentive Stock Plan as of September 30, 2016:
| Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Exercisable Weighted Average Exercise Price | |||||||||||||||||
| $ | 2.59 | 41,667 | 3.50 | $ | 2.59 | 41,667 | $ | 2.59 | ||||||||||||||
| $ | 2.66 | 4,584 | 3.58 | $ | 2.66 | 1,146 | $ | 2.66 | ||||||||||||||
| $ | 2.69 | 83,334 | 3.14 | $ | 2.69 | 83,334 | $ | 2.69 | ||||||||||||||
| $ | 2.78 | 8,750 | 9.37 | $ | 2.78 | 3,125 | $ | 2.78 | ||||||||||||||
| $ | 2.81 | 500,000 | 9.60 | $ | 2.81 | - | $ | - | ||||||||||||||
| $ | 2.85 | 1,667 | 3.31 | $ | 2.85 | 417 | $ | 2.85 | ||||||||||||||
| $ | 2.86 | 690,008 | 7.64 | $ | 2.86 | 690,008 | $ | 2.86 | ||||||||||||||
| $ | 2.96 | 50,000 | 9.60 | $ | 2.96 | - | $ | - | ||||||||||||||
| $ | 2.99 | 489,523 | 9.23 | $ | 2.99 | - | $ | - | ||||||||||||||
| $ | 3.00 | 1,000 | 9.90 | $ | 3.00 | - | $ | - | ||||||||||||||
| $ | 3.06 | 5,000 | 9.77 | $ | 3.06 | - | $ | - | ||||||||||||||
| $ | 3.18 | 2,000 | 9.81 | $ | 3.18 | - | $ | - | ||||||||||||||
| $ | 3.20 | 17,668 | 9.92 | $ | 3.20 | 16,668 | $ | 3.20 | ||||||||||||||
| $ | 3.24 | 5,000 | 9.25 | $ | 3.24 | - | $ | - | ||||||||||||||
| $ | 3.45 | 30,000 | 8.38 | $ | 3.45 | 7,500 | $ | 3.45 | ||||||||||||||
| $ | 3.48 | 2,500 | 8.95 | $ | 3.48 | 625 | $ | 3.48 | ||||||||||||||
| $ | 3.51 | 666,667 | 1.78 | $ | 3.51 | 666,667 | $ | 3.51 | ||||||||||||||
| $ | 3.60 | 333,334 | 3.75 | $ | 3.60 | 333,334 | $ | 3.60 | ||||||||||||||
| $ | 3.90 | 10,581 | 0.18 | $ | 3.90 | 10,581 | $ | 3.90 | ||||||||||||||
| $ | 3.92 | 3,000 | 9.12 | $ | 3.92 | - | $ | - | ||||||||||||||
| $ | 4.08 | 79,500 | 0.81 | $ | 4.08 | 79,500 | $ | 4.08 | ||||||||||||||
| $ | 4.20 | 20,834 | 1.98 | $ | 4.20 | 20,834 | $ | 4.20 | ||||||||||||||
| $ | 4.91 | 10,000 | 9.01 | $ | 4.91 | 10,000 | $ | 4.91 | ||||||||||||||
| $ | 5.31 | 116,561 | 1.54 | $ | 5.31 | 74,948 | $ | 5.31 | ||||||||||||||
| $ | 5.82 | 946,300 | 2.06 | $ | 5.82 | 504,633 | $ | 5.82 | ||||||||||||||
| $ | 6.00 | 8,334 | 2.97 | $ | 6.00 | 8,334 | $ | 6.00 | ||||||||||||||
| $ | 6.60 | 123,338 | 2.16 | $ | 6.60 | 123,338 | $ | 6.60 | ||||||||||||||
| $ | 6.89 | 4,167 | 2.58 | $ | 6.89 | 2,084 | $ | 6.89 | ||||||||||||||
| $ | 6.96 | 4,167 | 2.16 | $ | 6.96 | 2,084 | $ | 6.96 | ||||||||||||||
| $ | 7.02 | 33,334 | 2.17 | $ | 7.02 | 16,666 | $ | 7.02 | ||||||||||||||
| $ | 8.16 | 32,091 | 2.50 | $ | 8.16 | 32,091 | $ | 8.16 | ||||||||||||||
| $ | 9.60 | 41,667 | 2.35 | $ | 9.60 | 41,667 | $ | 9.60 | ||||||||||||||
| $ | 10.79 | 34,991 | 1.55 | $ | 10.79 | 34,991 | $ | 10.79 | ||||||||||||||
| $ | 12.00 | 1,667 | 1.61 | $ | 12.00 | 1,250 | $ | 12.00 | ||||||||||||||
| 4,403,234 | 4.90 | $ | 4.08 | 2,807,492 | $ | 4.22 | ||||||||||||||||
| F-20 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE K– STOCK OPTIONS AND WARRANTS, continued
Employee Stock Options, continued
Transactions involving stock options issued to employees are summarized as follows:
Number of |
Weighted Average |
Aggregate |
Weighted Average Contractual Life (years) |
||||||||||||
| Outstanding at October 1, 2015 | 3,458,905 | $ | 4.42 | ||||||||||||
| Granted | 1,115,941 | 2.93 | |||||||||||||
| Exercised | (80,334 | ) | 2.86 | ||||||||||||
| Cancelled or expired | (91,278 | ) | 4.04 | ||||||||||||
| Outstanding at September 30, 2016 | 4,403,234 | $ | 4. 08 | ||||||||||||
| Vested at September 30, 2016 | 2,807,492 | 4.22 | $ | 540,606 | 3.52 | ||||||||||
| Non-vested at September 30, 2016 | 1,595,742 | $ | 615,810 | 7.06 | |||||||||||
The aggregate intrinsic value for options exercised during the fiscal years ended September 30, 2016 and 2015 was $50,110 and $308, respectively.
For the fiscal year ended September 30, 2016, the Company issued an aggregate of 1,115,941 options to employees, non-employee board of director members, members of the strategic advisory board and consultants. Included in these grants was 160,000 options granted to executives and 500,000 performance based options granted to an employee during May 2016. The performance based options vest in tranches as certain performance conditions are met by the employee. None of these performance based options were vested as of September 30, 2016.
For the fiscal year ended September 30, 2015, the Company issued 952,594 options to employees, consultants and non-employee board of director members. Included in these grants was 450,000 options granted to executives.
The fair value of options granted during the fiscal years ended September 30, 2016 and 2015 was determined using the Black Scholes Option Pricing Model. For the purposes of the valuation model, the Company used the simplified method for determining the granted options expected lives. The simplified method is used since the Company does not have adequate historical data to utilize in calculating the expected term of options. The fair value for options granted was calculated using the following weighted average assumptions:
| 2016 | 2015 | |||||||
| Stock price | $ | 3.05 | $ | 2.85 | ||||
| Exercise price | $ | 2.93 | $ | 2.85 | ||||
| Expected term | 7.89 | 5.12 | ||||||
| Dividend yield | - | - | ||||||
| Volatility | 135 | % | 133 | % | ||||
| Risk free rate | 1.8 | % | 1.7 | % | ||||
The Company recorded $2,038,830 and $4,022,283 as stock compensation expense for fiscal years ended September 30, 2016 and 2015, respectively. Included in this amount is $37,342 and $676,175 for the fiscal years ended September 30, 2016 and 2015, respectively for employee stock option modifications. These modifications extended the term of the option for an employee in fiscal 2016 and extended the terms of the options for three former employees and two executive officers in fiscal 2015. As of September 30, 2016, unrecorded compensation cost related to non-vested awards was $3,565,086, which is expected to be recognized over a weighted average period of approximately 4.97 years. The weighted average grant date fair value per share for options granted during the fiscal years ended September 30, 2016 and 2015 was $2.84 and $2.49, respectively.
| F-21 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE L– INCOME TAXES
The income tax provision (benefit) for the fiscal years ended September 30, 2016 and 2015 consists of the following:
| 2016 | 2015 | |||||||
| Federal: | ||||||||
| Current | $ | - | - | |||||
| Deferred | (3,780,000 | ) | 13,924,000 | |||||
(3,780,000 | ) | 13,924,000 | ||||||
| State and local: | ||||||||
| Current | - | - | ||||||
| Deferred | (1,302,000 | ) | (70,000 | ) | ||||
| (1,302,000 | ) | (70,000 | ) | |||||
| Change in valuation allowance | 5,082,000 | (13,854,000 | ) | |||||
| Income tax provision (benefit) | $ | - | - | |||||
The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S statutory rate to losses before income tax expense for the years ended September 30, 2016 and 2015 as follows:
| 2016 | 2015 | |||||||
| Statutory federal income tax rate | 34.00 | % | 34.00 | % | ||||
| Statutory state and local income tax rate (1%, as of September 30, 2016 and 2015), net of federal benefit | 7.72 | % | 0.59 | % | ||||
| Stock based compensation | (2.33 | %) | (8.34 | %) | ||||
| Other permanent differences | 0.72 | % | (4.94 | %) | ||||
| Effect of change in deferred tax rate | 2.01 | % | 4.15 | % | ||||
| Warrant liability | - | (33.78 | %) | |||||
| Adjustment to state tax credits | 0.41 | % | - | |||||
| Adjustment to depreciation and amortization | 1.09 | % | (16.28 | %) | ||||
| Adjustment to stock based compensation | (2.43 | %) | (30,73 | %) | ||||
| Adjustment of prior years’ NOLs | 0.55 | % | (61.28 | %) | ||||
| Change in valuation allowance | (41.74 | %) | 116.61 | % | ||||
| Effective tax rate | 0.00 | % | 0.00 | % | ||||
| F-22 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE L– INCOME TAXES, continued
Deferred income taxes result from temporary differences in the recognition of income and expenses for financial reporting purposes and for tax purposes. The tax effect of these temporary differences representing deferred tax asset and liabilities result principally from the following:
| September 30, | ||||||||
| 2016 | 2015 | |||||||
| Deferred tax assets (liabilities): | ||||||||
| Stock based compensation | $ | 2,025,000 | $ | 1,961,000 | ||||
| Depreciation and amortization | 351,000 | 35,000 | ||||||
| Amortization of debt discount | 16,269,000 | 16,055,000 | ||||||
| Net operating loss carry forward | 12,713,000 | 8,199,000 | ||||||
| Tax credits | 221,000 | 86,000 | ||||||
| Other | 105,000 | 266,000 | ||||||
| Less: valuation allowance | (31,684,000 | ) | (26,602,000 | ) | ||||
| Net deferred tax asset | $ | - | $ | - | ||||
As of September 30, 2016, the Company has approximately $33,920,000 of Federal and $45,229,000 of State net operating loss “NOL” carryforwards available which begin to expire after 2022. Pursuant to Internal Revenue Code Section 382, the Company’s ability to utilize the NOLs is subject to certain limitations due to changes in stock ownership in prior years. The annual limitation ranges between $786,000 and $1,103,000 and any unused amounts can be carried forward to subsequent years.
The Company has provided a full valuation allowance against all of the net deferred tax assets based on management’s determination that it is more likely than not that the net deferred tax assets will not be realized in the future. The valuation allowance increased by $5,082,000.
Based on a study of Section 382 of the Internal Revenue Code conducted by the Company at September 30, 2015, deferred tax asset related to net operating loss carryforward is decreased by $21,118,000 and the state NOL is decreased by $20,796,000 at September 30, 2015. A similar study was performed at September 30, 2016, which resulted in no change.
The Company has Federal research and development credits of approximately $172,000 that will expire after 2034. The Company also has state investment tax credits of $49,000 that will expire after 2029.
| F-23 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE M – COMMITMENTS AND CONTINGENCIES
Operating leases
The Company leases office space under an operating lease in Stony Brook, New York for its corporate headquarters. The lease is for a 30,000 square foot building. The term of the lease commenced on June 15, 2013 and expired on May 31, 2016, with the option to extend the lease for two additional three-year periods. The Company has exercised its option to extend the lease for one additional three-year period, ended May 31, 2019. The base rent during the additional three-year period is $458,098 per annum. In addition to the office space, the Company also has 1,500 square feet of laboratory space. The term of the lease commenced on November 1, 2015 and expires on October 31, 2017. The Company also has an operating lease for a laboratory Huddersfield, England, which is currently inactive and in Calverton, New York. The Calverton lease was from February 1, 2014 through October 31, 2014, with the option to renew for additional one year periods and now expires on October 31, 2017. As discussed in Note C, pursuant to the Asset Purchase Agreement, the Company entered into a month to month sublease with Vandalia of approximately 5,000 square feet at Vandalia’s office facility at an aggregate monthly rent of $5,416. The Vandalia sublease was terminated during December 2015. Total rent expense for the years ended September 30, 2016 and 2015 were $490,745 and $490,915, respectively.
Future minimum rental payments (excluding real estate tax and maintenance costs) as of September 30, 2016 are as follows:
For the year ending September 30,
| 2017 | $ | 513,277 | ||
| 2018 | 462,717 | |||
| 2019 | 305,399 | |||
| Total | $ | 1,281,393 |
Employment and Consulting Agreements
Employment agreements
On July 11, 2011, the Company’s Board of Directors approved the terms of employment for Dr. James A. Hayward, the Company’s Chief Executive Officer (“CEO”).
Dr. Hayward’s employment agreement provides that Dr. Hayward will be the Company’s CEO, and will continue to serve on the Company’s Board of Directors. The initial term of his employment was from July 1, 2011 through June 30, 2014, which automatically renews for one-year periods subject to ninety days’ prior notice of non-renewal by either party. On July 28, 2016, a new employment agreement was entered into with the Chief Executive Officer effective July 1, 2016. The initial term is from July 1, 2016 through June 30, 2017, with automatic one-year renewal periods. The terms of the agreement are substantially the same as his original agreement, except a cash incentive bonus was modified. Under the new agreement, Dr. Hayward will be eligible for a special cash incentive bonus of up to $800,000, $300,000 of which is payable if and when annual revenue reaches $8 million and $100,000 of which would be payable for each $2 million of annual revenue in excess of $8 million. Pursuant to the contract, Dr. Hayward’s annual salary is $400,000. The Board of Directors, acting in its discretion, may grant annual bonuses to Dr. Hayward. Dr. Hayward will be entitled to certain benefits and perquisites and will be eligible to participate in retirement, welfare and incentive plans available to the Company’s other employees.
The agreement with Dr. Hayward also provides that if he is terminated before the end of the initial or a renewal term by us without cause or if Dr. Hayward terminates his employment for good reason, then, in addition to previously earned and unpaid salary, bonus and benefits, and subject to the delivery of a general release and continuing compliance with restrictive covenants, Dr. Hayward will be entitled to receive a pro rata portion of the greater of either (X) the annual bonus he would have received if employment had continued through the end of the year of termination or (Y) the prior year’s bonus; salary continuation payments for two years following termination equal to the greater of (i) three times base salary or (ii) two times base salary plus bonus; company-paid COBRA continuation coverage for 18 months post-termination; continuing life insurance benefits (if any) for two years; and extended exercisability of outstanding vested options (for three years from termination date or, if earlier, the expiration of the fixed option term). If termination of employment as described above occurs within six months before or two years after a change in control of the Company, then, in addition to the above payments and benefits, all of Dr. Hayward’s outstanding options and other equity incentive awards will become fully vested and Dr. Hayward will receive a lump sum payment of the amounts that would otherwise be paid as salary continuation. In general, a change in control will include a 30% or more change in ownership of the Company.
| F-24 |
APPLIED DNA SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE M– COMMITMENTS AND CONTINGENCIES, continued
Employment agreements, continued
Upon termination due to death or disability, Dr. Hayward will generally be entitled to receive the same payments and benefits he would have received if his employment had been terminated by the Company without cause (as described in the preceding paragraph), other than salary continuation payments.
Effective May 7, 2016, the Chief Executive Officer's annual salary was voluntarily reduced by $100,000. Accordingly, his current annual base salary as of September 30, 2016 is $300,000.
Litigation
From time to time, the Company may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. When the Company is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, the Company will record a liability for the loss. In addition to the estimated loss, the recorded liability includes probable and estimable legal costs associated with the claim or potential claim. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm the Company’s business. There is no pending litigation involving the Company at this time.
NOTE N– FAIR VALUE
The carrying value of cash, accounts receivable, accounts payable and accrued expenses approximate estimated fair values because of their short maturities.
The carrying value of the warrant liability is determined using the Binomial Lattice model option pricing model as described in Note H. Certain assumptions used in the calculation of the warrants liability represent level-3 unobservable inputs. The Company did not have any assets or liabilities categorized as Level 1 or 2 as of September 30, 2016.
The following table summarizes the activity of Level 3 inputs measured on a recurring basis:
Fair Value Measurements of Common Stock Warrants Using Significant Unobservable Inputs (Level 3)
Fair Value Measurements of Derivative Warrant Liability Using Significant Unobservable Inputs (Level 3)
| Year Ended September 30, | ||||||
| 2015 | ||||||
| Balance at October 1, 2014 | $ | 1,096,412 | ||||
| Adjustment resulting from change in value recognized in earnings (a) | 2,994,540 | |||||
| Reclassification of warrant upon repurchase | (4,090,952 | ) | ||||
| Reclassification to equity upon exercise | - | |||||
| Balance at September 30, 2015 | $ | - | ||||
(a) Adjustment resulting from change in fair value is the amount of total gains or losses for the period attributable to the change in unrealized gains or losses relating to liabilities held at the reporting date and realized gains or losses at the date of exercise. The gain or loss is recorded in change in fair value of warrant liability in the accompanying consolidated statements of operations.
NOTE O– GEOGRAPHIC AREA INFORMATION
Net revenues by geographic location of customers are as follows:
| Year Ended September 30, | |||||||
| 2016 | 2015 | ||||||
| United States | $ | 3,177,792 | $ | 7,817,037 | |||
| Europe | 876,790 | 920,267 | |||||
| Asia and other | 131,845 | 271,195 | |||||
| Total | $ | 4,186,427 | $ | 9,008,499 | |||
| F-25 |
Exhibit 23.1
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM’S CONSENT
We consent to the incorporation by reference in the Registration Statements of Applied DNA Sciences, Inc. on Form S-3 (File No. 333-202432) and Form S-8 (File No. 333-182350 and 333-205123) of our report dated December 6, 2016 with respect to our audits of the consolidated financial statements of Applied DNA Sciences, Inc. as of September 30, 2016 and 2015, and for the years then ended, which report is included in this Annual Report on Form 10-K of Applied DNA Sciences, Inc. for the year ended September 30, 2016.
| /s/ Marcum LLP | |
| Marcum LLP | |
| Melville, New York | |
| December 6, 2016 |
Exhibit 31.1
CERTIFICATION
I, James A. Hayward, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Applied DNA Sciences, Inc.; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financing reporting; and |
| 5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| Date: | December 6, 2016 |
| /s/ James A. Hayward | ||
| James A. Hayward | ||
| President, Chief Executive Officer and Chairman | ||
Exhibit 31.2
CERTIFICATION
I, Beth Jantzen, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Applied DNA Sciences, Inc.; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financing reporting; and |
| 5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| Date: | December 6, 2016 |
| /s/ Beth Jantzen | ||
| Beth Jantzen, CPA | ||
| Chief Financial Officer | ||
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Applied DNA Sciences, Inc. (the “Company”) for the fiscal year ended September 30, 2016, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James A. Hayward, President, Chief Executive Officer and Chairman of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
| (1) | The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| /s/ James A. Hayward | ||
| James A. Hayward | ||
| President, Chief Executive Officer and Chairman | ||
| Date: December 6, 2016 | ||
| * | A signed original of this written statement required by Section 906 has been provided to Applied DNA Sciences, Inc. and will be retained by Applied DNA Sciences, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. |
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Applied DNA Sciences, Inc. (the “Company”) for the fiscal year ended September 30, 2016, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Beth Jantzen, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
| (1) | The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| /s/ Beth Jantzen | ||
| Beth Jantzen, CPA | ||
| Chief Financial Officer | ||
| Date: December 6, 2016 |
| * | A signed original of this written statement required by Section 906 has been provided to Applied DNA Sciences, Inc. and will be retained by Applied DNA Sciences, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. |