DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto, included elsewhere within this report. The Annual Report on Form 10-K contains forward-looking statements including statements using terminology such as "can", "may", "believe", "designated to", "will", "expect", "plan", "anticipate", "estimate", "potential" or "continue", or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. You should read statements that contain these words carefully because they: 21 ? discuss our future expectations; ? contain projections of our future results of operations or of our financial condition; and ? state other "forward-looking" information. We believe it is important to communicate our expectations. However, forward looking statements involve risks and uncertainties and our actual results and the timing of certain events could differ materially from those discussed in forward-looking statements as a result of certain factors, including those set forth under "Risk Factors," "Business" and elsewhere in this report. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to us as of the date thereof, and we assume no obligations to update any forward-looking statement or risk factor, unless we are required to do so by law.
Using biotechnology as a forensic foundation,
Applied DNA Sciencescreates unique security solutions addressing the challenges of modern commerce. Whether working in supply chain security, brand protection or law enforcement applications, it is the goal of Applied DNA Sciencesto help establish secure and flourishing environments that foster quality, integrity and success. With impenetrable taggants, high-resolution DNA authentication, and comprehensive reporting, our botanical DNA-based technologies are designed to deliver what we believe to be the greatest levels of security, deterrence and legal recourse strength. SigNature DNA. SigNature DNA is our platform ingredient, at the core of all Applied DNA Sciencessecurity solutions. From application to application the vehicle which carries SigNature DNA is custom designed to suit the application. Exhaustive development efforts have yielded a flexible and durable marker with all the accuracy provided by nature. SigNature DNA is based on full, double stranded plant DNA, and provides forensic power and protection for a wide array of applications. Highly secure, robust, durable and cost-effective, SigNature DNA markers are an ingredient that can be used to fortify brand protection efforts; mark, track and convict criminals; and strengthen supply chain security. Custom DNA sequences can be embedded into a wide range of host carriers including ink, varnish, thread, laminates and metal coatings. These items can then be tested for the presence of SigNature DNA Markers through an instant field detection or a forensic level authentication. SigNature DNA, SigNature T DNA, DNANet, fiberTyping, digitalDNA, and the Counterfeit Prevention Authentication Program, our principal anti-counterfeiting and product authentication solutions, can be used in numerous industries, including cash-in-transit (transport and storage of banknotes), microcircuits and other electronics, homeland security, textiles and apparel, identity cards and other secure documents, law enforcement, pharmaceuticals, wine, and luxury consumer goods. See Item 1. Business for full descriptions of these products.
To date, the substantial portion of our revenues has been generated from sales of Signature DNA and fiberTyping, our principal anti-counterfeiting and product authentication solutions. We expect to continue to grow revenues from sales of our SigNature DNA platform ingredient, our fibertyping, DNANet, and digitalDNA offerings and theCounterfeit Prevention Authentication Program. We have continued to incur expenses in expanding our laboratory and office facilities and increasing our personnel to meet anticipated future demand. We have limited sources of liquidity. We have developed or are currently attempting to develop business in the following target markets: microcircuits and other electronics, homeland security, cash-in-transit, textile and apparel authentication, secure documents, pharmaceuticals, consumer products, law enforcement, fine wine, art and collectibles, and digital and recording media. Our developments in the semiconductor authentication, cash-in-transit and textile and apparel authentication have contributed to the increase in our revenues. We intend to pursue both domestic and international sales opportunities in each of these vertical markets.
Critical Accounting Policies
Financial Reporting Release No. 60, published by the
SEC, recommends that all companies include a discussion of critical accounting policies used in the preparation of their financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report. 22
The accounting policies identified as critical are as follows:
? Revenue recognition; ? Allowance for uncollectible receivables; and ? Equity based compensation.
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, service has been performed, or no refund will be required. At
September 30, 2013and 2012, the Company recorded deferred revenue of $148,503and $0, respectively. Revenue arrangements with multiple components are divided into separate units of accounting if certain criteria are met, including whether the delivered component has stand-alone value to the customer. Consideration received is allocated among the separate units of accounting based on their respective selling prices. The selling price for each unit is based on vendor-specific objective evidence, or VSOE, if available, third party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third party is available. The applicable revenue recognition criteria are then applied to each of the units. Revenue for a Government contract award, which supports our development efforts on specific projects is recognized as milestones are achieved as per the contract. The Company recognized revenue of $100,000from this contract during the year ended September 30, 2013.
Allowance for Uncollectible Receivables
We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company's estimate is based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company's estimate of the allowance for doubtful accounts will change. At
September 30, 2013and September 30, 2012, the Company had an allowance for doubtful accounts of $62,415and $0, respectively. The Company writes-off receivables that are deemed uncollectible. The Company wrote off $15,000and $0of accounts receivable that were not previously reserved for during the years ended September 30, 2013and 2012, respectively.
Equity Based Compensation
The Company follows ASC 718, Compensation ("ASC 718") which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in
the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates. 23
Comparison of the Year Ended
Revenues For the years ended
September 30, 2013and 2012, we generated $2,036,222and $1,854,694in revenues from operations, respectively. The increase in revenues of $181,528or 9.8% for the twelve months ended September 30, 2013was primarily caused by sales to suppliers of the United States Defense Logistics Agency("DLA"). In late January 2013, the DLA announced that it would subsidize marking costs for its trusted suppliers, and in March 2013, after this and other mechanisms were in place, we were able to begin shipments for this market. The sales to these third party suppliers during the year ended September 30, 2013was offset by a decrease in sales due to the completion of our prior pilot contract with the Logistics Management Institute("LMI"). Revenue during the twelve months ended September 30, 2013included $100,000recognized from a development contract from the Missile Defense Agency.
Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the twelve months ended
September 30, 2013increased by $3,582,771or 47% to $11,198,505from $7,615,734in the same period in 2012. The increase is primarily attributable to higher professional fees, specifically for legal and consulting, and additional salary expenses due to building an infrastructure for finance, production and information technology, to meet the anticipated future demand for sales. The increase is also attributable to increased rent expense due to the move into our new corporate headquarters. Bad debt expense increased to $77,415for the year ended September 30, 2013as compared to $0for the year ended September 30, 2012.
Research and Development
Research and development expenses increased by
$259,811or 60.0% for the year ended September 30, 2013compared to the same period in 2012 to $692,480from $432,669. This increase is primarily due to the increased laboratory space with our new corporate headquarters as well as an increase in research and development to support expansion of the Company's business and markets.
Depreciation and Amortization
In the twelve months ended
September 30, 2013, depreciation and amortization increased by $7,134or 2.3% compared to the same period in 2012 from $313,940for the year ended September 30, 2012to $321,074for the year ended September 30, 2013. The increase in depreciation expense for the year ended September 30, 2013was attributable to the impairment of certain intellectual property purchased as part of the purchase of certain assets of RedWeb Technologies of approximately $115,000. The increase is also due to depreciation and amortization expense for the leasehold improvements and lab equipment purchased during the year ended September 30, 2013related to the relocation of our corporate offices. These increases were offset by the completion of the amortization of our intangible property, which we incurred approximately $270,000of amortization expense during the year ended September 30, 2012as compared to $19,470for the year ended September 30, 2013. The amortization during the year ended September 30, 2013related to the intellectual property acquired from RedWeb Technologies.
Total Operating Expenses
Total operating expenses increased to
$12,212,059for the twelve months ended September 30, 2013from $8,362,343in the same period of 2012, or an increase of $3,849,716or 46.0%, primarily attributable to an increase in professional fees, salaries and in R&D expenditures, as more fully described above.
Interest (Expenses) Income
Interest (expenses) income for the twelve months ended
September 30, 2013, decreased to income of $1,272from expense of ( $643,063) in the same period of 2012. The decrease in interest (expense) income was due to no outstanding notes payable as of September 30, 2013.
Loss from Change in Fair Value of Warrant Liability
November 2012and July 2013, we issued warrants containing certain reset provisions which require us to classify them as a liability and mark the warrants to market and record the change in fair value each reporting period as a non-cash adjustment to our current period operations. This resulted in a $7,508,146charge to operations during the twelve months ended September 30, 2013as compared to $-0- for the same period last year.
Net loss for the twelve months ended
September 30, 2013was $17,686,472compared to $7,150,712in the same period of 2012, a net change of $10,535,760or 147.3% increase primarily a result of the loss on change in fair value of warrant liability as well as the combination of factors described above. 24
Liquidity and Capital Resources
Our liquidity needs consist of our working capital requirements and research and development expenditure funding. As of
September 30, 2013, we had working capital of $6,091,555. For the year ended September 30, 2013, we generated a net cash flow deficit from operating activities of $7,870,353consisting primarily of our net loss of $17,686,472, net with non-cash adjustments of $321,074in depreciation, amortization and impairment charges, $77,415in bad debt expense, $1,954,385for equity based compensation and $7,508,146change in fair value of warrant liability. Additionally, we had a net increase in operating assets of $562,101and a net increase in operating liabilities of $517,200. Cash used in investing activities was $1,220,628consisting primarily of $584,080of assets acquired under the RedWeb asset purchase agreement and $636,548for the purchase of equipment and leasehold improvement primarily related to the relocation of our corporate office. Cash provided by financing activities for the year ended September 30, 2013totaled $14,726,500consisting primarily of proceeds from the two financings with Crede in November 2012and July 2013of $14,635,000, net of fees. Cash flows from financing activities also included $151,500from the exercise of warrants and options, net with $60,000paid to re-acquire previously issued warrants. Management believes that our positive cash balance and working capital as of September 30, 2013along with our current customer base, projected cash flow and the minimum projected revenues for the next fiscal year will allow us to continue to improve our working capital and to have sufficient capital resources to meet projected cash flow requirements for the next twelve months from the filing date of this report. However, if we do not meet our minimum revenue projections for the next fiscal year, we may be required to seek additional capital. We have no commitments for any future funding, and may not be able to obtain additional financing or grants on terms acceptable to us, if at all, in the future. If we are unable to obtain additional capital this could restrict our ability to grow. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. In accordance with our financing agreements with Crede (described below), the Company has agreed not to issue additional Common Stock or securities convertible into Common Stock at a price below the per share price issued to Crede under the Second Purchase Agreement, $0.187, or the market price of the Common Stock on the day before the registration statement was declared effective ( $0.167), for a period of 180 days from the effective date of the registration statement, which was declared effective on July 31, 2013. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock.
We expect capital expenditures to be less than approximately
Substantially all of the real property used in our business is leased under operating lease agreements.
Recent Debt and Equity Financing Transactions
Fiscal 2013 -Securities Purchase Agreements
During the year ended
September 30, 2013, we entered into two securities purchase agreements on November 28, 2012and July 19, 2013, respectively, with an institutional investor ("Crede") to sell an aggregate of $15.0 million( $7.5 millionper agreement) of our securities. The total net proceeds received under these two transactions were $14.6 million( $15 milliongross proceeds, less investment fees of $365,000). The table below summarizes the securities issued as part of these securities purchase agreements. Securities Issued Initial Purchase Agreement Second Purchase Agreement Price per Price per Shares issued share Shares issued share Common Stock 10,752,688 $ 0.186010,695,187 $ 0.1870Series A Warrants 10,752,688 $ 0.223210,695,187 $ 0.2431Series B Warrants 29,569,862 $ 0.223229,411,764 $ 0.2431Series C Warrants 26,881,720 $ 0.223226,737,967 $ 0.2431Series A Preferred Stock 5,500 $ 1,000- $ - Series B Preferred Stock - $ - 5,500 $ 1,000The Series A and Series B Preferred contained weighted average anti-dilution protection. The Series A and Series B Preferred did not accrue dividends except to the extent dividends were paid on the Common Stock. The Company's Common Stock was junior in rank to the Series A and Series B Preferred with respect to preferences as to dividends, distributions and payments upon the liquidation, dissolution and winding up of the Company. The Series A and Series B Preferred generally had no voting rights except as required by law. The Series A and Series B Preferred were converted into Common Stock as set forth below. Crede may exercise Series A and Series B Warrants by paying in cash or on a cashless basis by exchanging such Warrants for Common Stock using the Black-Scholes value. In the event that the Common Stock trades at a price 25% or more above the exercise price of the Series A and Series B Warrants for a period of 20 consecutive days (with average daily dollar volume of Common Stock on the OTC Bulletin Board at least equal to $300,000), the Company may obligate Crede to exercise such Warrants for cash. 25 Pursuant to registration rights agreements between the Company and Crede, the Company filed registration statements within 30 days of the Initial Closing of both purchase agreements. The registration statements covered the resale of all shares of Common Stock issuable pursuant to the Purchase Agreements, including the shares of Common Stock underlying the Series A and Series B Preferred and Series A, B and C Warrants. The Company has agreed to prepare and file amendments and supplements to the registration statements to the extent necessary to keep the registration statements effective for the period of time required under the Purchase Agreements. The Series A and Series B Preferred and the Series A, B and C Warrants each contain a 9.9% "blocker" so that in no event shall the Series A and Series B Preferred or any of the Series A, B and C Warrants be convertible or exercisable (including through the cashless exercise exchange provision) into or for Common Stock to the extent that such conversion or exercise would result in Crede having "beneficial ownership" (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended) of more than 9.9% of the Common Stock. Crede would, however, have the right from time to time to convert, exercise or exchange for shares of Common Stock, which over time would aggregate to greater than 9.9% beneficial ownership if all such shares of Common Stock so acquired had been held at one time by Crede. Crede has the right to participate in other equity or equity-linked financings completed by the Company for a period of 180 days from the date the registration statement went effective on July 30, 2013. In addition, the Company has agreed not to issue additional Common Stock or securities convertible into Common Stock at a price below the per share price issued to Crede under the Second Purchase Agreement, $0.187, or the market price of the Common Stock on the day before the registration statement was declared effective ( $0.167), for a period of 180 days from the effective date of the registration statement, except for issuances (i) pursuant to acquisitions, joint ventures, license arrangements, leasing arrangements and other similar arrangements, (ii) to employees, consultants, directors and officers approved by the Board or pursuant to a plan approved by the Board, (iii) pursuant to one or more contracts entered into by the Company with third parties which would result in revenues to the Company during a three-month period equal to an annual run rate of $15 Millionin revenues and (iv) pursuant to a contract entered into by the Company with a third party which would reasonably be expected to result in more than $3 Millionin annual receivables. Until one year after the Second Closing, which occurred on July 31, 2013, the Company is prohibited from entering into any transaction to (i) sell any convertible securities at a conversion rate or other price that is generally based on and/or varies with the trading prices of the Company's Common Stock at any time after the initial issuance of such convertible securities or (ii) sell securities at a future determined price, including, without limitation, an "equity line of credit" or an "at the market offering." On January 8, 2013, we exercised our option and converted the Series A Preferred into 25,462,963 shares or our Common Stock at a conversion price of $0.216per share and on April 25, 2013, Crede effected the cashless exercise of the Series A and Series B Warrants related to the Initial Purchase Agreement. Also, on August 14, 2013, we exercised our option and converted the Series B Preferred into 42,307,692 shares of our Common Stock at a conversion price of $0.13per share. On January 22, 2013, we exercised our option to repurchase the Series C warrants related to the Initial Purchase Agreement and on August 14, 2013, we exercised our option to repurchase the Series C Warrants related to the Second Purchase Agreement for $50,000and $10,000, respectively.
June 21, 2012, we closed a private placement of our Common Stock, pursuant to an exemption from registration provided by Section 4(2) of the Securities Act and by Rule 506 of Regulation D promulgated thereunder. We issued and sold 35,576,568 shares of common stock at a purchase price of $0.04336per share (which is equal to a 20% discount to the average volume, weighted average price of the Common Stock for the ten trading days prior to the closing) to an "accredited investor," as defined in regulations promulgated under the Securities Act, for gross proceeds of $1,542,600. On August 10, 2012, we closed a private placement of our Common Stock, pursuant to an exemption from registration provided by Section 4(2) of the Securities Act and by Rule 506 of Regulation D promulgated thereunder. We issued and sold 8,265,683 shares of our Common Stock at a purchase price of $0.04336per share to "accredited investors," as defined in regulations promulgated under the Securities Act, for gross proceeds of $358,400. On September 27, 2012, we closed a private placement of our Common Stock, pursuant to an exemption from registration provided by Section 4(2) of the Securities Act and by Rule 506 of Regulation D promulgated thereunder. We issued and sold 1,121,265 shares of our Common Stock at a purchase price of $0.17837per share to "accredited investors," as defined in regulations promulgated under the Securities Act, for gross proceeds of $200,000. 26 Subsequent Events On October 14, 2013, Karol Graycommenced employment with the Company as the Chief Financial Officer. Pursuant to an offer letter, Ms. Gray will be an at-will employee and will be paid an annual starting salary of $336,000. In addition, after six months employment, she will be granted a five year option pursuant to the Company's 2005 Incentive Stock Plan to purchase up to 2,000,000 shares of the Company's Common Stock at the fair market value on the date of grant, vesting in four equal annual increments beginning on the first anniversary of the date of grant. On December 16, 2013, Crede effected the cashless exercise of 10,695,187 Series A Warrants and 7,000,000 Series B Warrants, and the Company thereupon issued to Crede an aggregate of 18,823,073 shares of its Common Stock.
Subsequent Option Grants
October 14, 2013, the Company granted an aggregate of 7,928,000 options to purchase the Company's Common Stock at an exercise price of $0.0886per share for five years to employees, 5,928,000 of these options vest at 25% each anniversary for the next four years and 2,000,000 of these options vest immediately. On October 17, 2013, the Company granted, Dr. James A. Hayward, Chairman, CEO and President and Mr. Ming-Hwa Liang, Chief Technology Officer and Secretary of the Company options to purchase 50,000,000 and 3,000,000 shares of the Company's Common Stock, respectively, at an exercise price of $0.097per share for five years to employees with vesting at 25% each anniversary for the next four years. Also on October 17, 2013, the Company granted an aggregate of 3,777,780 options to purchase the Company's Common Stock at an exercise price of $0.0886per share for five years to nonemployee directors with immediate vesting.
December 10, 2013, the Company granted an aggregate of 2,126,000 options to purchase the Company's Common Stock at an exercise price of $0.1360per share for five years to employees, with immediate vesting.
We anticipate spending approximately
Acquisition of Plant and Equipment and Other Assets
We do not anticipate the sale of any material property, plant or equipment during the next 12 months.
Number of Employees
We currently have 47 full-time employees and two part-time employees, including five in management, seven in Research and Development, four in forensics, six in Quality Assurance, four in finance and accounting, twelve in operations, nine in sales and marketing, one in human resources and one in investor relations. We expect to increase our staffing dedicated to sales, manufacturing and production, and forensic authentication services. Expenses related to travel, marketing, salaries, and general overhead will be increased as necessary to support our growth in revenue. In order for us to attract and retain quality personnel, we anticipate we will have to offer competitive salaries and benefits to future employees. We anticipate that it may become desirable to add additional full and or part time employees to discharge certain critical functions during the next 12 months. This projected increase in personnel is dependent upon our ability to generate revenues and obtain sources of financing. There is no guarantee that we will be successful in raising the funds required or generating revenues sufficient to fund the projected increase in the number of employees. As we continue to expand, we will incur additional costs for personnel. In
June 2012we began working with Insperity Inc. to help us manage many of our back-end administrative human resources and payroll responsibilities.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
The effect of inflation on our revenue and operating results was not significant.