UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended December 31, 2006
Commission file number 002-90519
APPLIED DNA SCIENCES, INC.
(Exact name of registrant as specified in its charter)
Nevada 59-2262718
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
25 Health Sciences Drive, Suite 113
Stony Brook, New York 11790
(Address of Principal Executive Offices) (Zip Code)
(631) 444-6861
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the last 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.
Yes _X__ No _____
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes _____ No _X__
The number of shares of Common Stock, $0.001 par value, outstanding on February
15, 2007, was 121,162,385 shares, held by approximately 1,305 shareholders.
Transitional Small Business Disclosure Format (check one):
Yes _____ No _X__
APPLIED DNA SCIENCES, INC
Quarterly Report on Form 10-QSB for the
Quarterly Period Ending December 31, 2006
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheet: December 31, 2006 (Unaudited) 1
Condensed Consolidated Statements of Losses:
Three Months Ended December 31, 2006 and 2005 (Unaudited) and
the Period from September 16, 2002 (Date of Inception)
Through December 31, 2006 (Unaudited) 2
Condensed Consolidated Statement of Stockholder's Equity
(Deficiency): For the Period from September 16, 2002
(Date of Inception) Through December 31, 2006 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows:
Three Months Ended December 31, 2006 and 2005 (Unaudited) and
the Period from September 16, 2002 (Date of Inception)
Through December 31, 2006 (Unaudited) 17
Notes to Unaudited Condensed Consolidated Financial Information:
December 31, 2006 19-42
Item 2. Management Discussion and Analysis 43
Item 3 Controls and Procedures 61
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 63
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 64
Item 3. Defaults Upon Senior Securities 64
Item 4. Submission of Matters to a Vote of Security Holders 64
Item 5. Other Information 64
Item 6. Exhibits 64
Signatures 66
-i-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
APPLIED DNA SCIENCES, INC.
(A Development stage company)
CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)
ASSETS December 31, 2006
-----------------
Current assets:
Cash $ 653,109
Accounts receivable, net of allowance for doubtful accounts of $0 9,631
Advances and other receivables 9,396
Prepaid expenses 66,667
------------
Total current assets 738,803
Property, plant and equipment-net of accumulated depreciation of $36,104 152,258
Other assets:
Deposits 13,822
Capitalized finance costs-net of accumulated amortization of $1,024,788 660,312
Intangible assets:
Patients, net of accumulated amortization of $20,306 (Note B) 13,951
Intellectual property, net of accumulated amortization of $7,430,047 (Note B) 2,000,852
------------
Total Assets $ 3,579,998
============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 6,777,493
Convertible notes payable, net of unamortized discount (Note C) 4,217,171
------------
Total current liabilities 10,994,664
Debt derivative and warrant liability 2,432,324
Commitments and contingencies (Note H)
Deficiency in Stockholders' Equity- (Note D)
Preferred stock, par value $0.001 per share; 10,000,000 shares authorized; 60,000 issued
and outstanding 6
Common stock, par value $0.001 per share; 250,000,000 shares authorized; 121,162,385 issued
and outstanding 121,162
Additional paid in capital 83,037,855
Accumulated deficit (93,006,013)
------------
Total deficiency in stockholders' equity (9,846,990)
Total liabilities and Deficiency in Stockholders' Equity $ 3,579,998
============
See the accompanying notes to the consolidated financial statements
1
APPLIED DNA SCIENCES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF LOSSES
From September 16, 2002
For the Year Ended December 31, (Date of Inception)
2006 2005 Through December 31, 2006
------------- ------------- -------------------------
(RESTATED)
-------------
Sales $ - $ - $ 18,900
Cost of sales - - 15,639
------------- ------------- --------------------
Gross Profit - - 3,261
Operating expenses:
Selling, general and administrative 2,054,455 1,844,477 82,120,414
Research and development 29,306 16,270 1,059,905
Impairment of intangible asset(s) - - 5,655,011
Depreciation and amortization 107,879 342,699 1,837,605
------------- ------------- --------------------
Total operating expenses 2,191,640 2,203,446 90,672,935
------------- ------------- --------------------
NET LOSS FROM OPERATIONS (2,191,640) (2,203,446) (90,669,674)
Net gain in revaluation of debt derivative and warrant
liabilities 2,098,471 6,788,790 35,644,298
Other income 977 13,013 111,807
Interest expense (579,030) (1,778,906) (38,092,444)
------------- ------------- --------------------
Net Income (loss) before provision for income taxes (671,222) 2,819,451 (93,006,013)
Income taxes (benefit) - - -
------------- ------------- --------------------
NET INCOME (LOSS) $ (671,222) $ 2,819,451 $ (93,006,013)
============= ============= ====================
Net income (loss) per share-basic $ (0.01) $ 0.03
============= =============
Net loss per share-assuming fully diluted (Note A) $ (0.02)
==============
Weighted average shares outstanding-
Basic 121,021,515 53,002,278
============= =============
Fully diluted 163,392,948
=============
See the accompanying notes to the consolidated financial statements
2
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Issuance of
common stock
to Founders in
exchange for
services on
September 16,
2002 at $.01
per share -- -- 100,000 $ 10 $ 990 $ -- $ -- $ -- $ 1,000
Net Loss -- -- -- -- -- -- -- (11,612) (11,612)
Balance at
September 30,
2002 -- $ -- 100,000 $ 10 $ 990 $ -- $ -- $ (11,612) $ (10,612)
========= ========= ============ =========== =========== =========== ============ ============ ============
Issuance of
common stock
in connection
with merger
with Prohealth
Medical
Technologies,
Inc on October
1, 2002 -- -- 10,178,352 1,015 -- -- -- -- 1,015
Cancellation of
Common stock in
connection with
merger with
Prohealth
Medical
Technologies,
Inc on October
21, 2002 -- -- (100,000) (10) (1,000) -- -- -- (1,010)
Issuance of
common stock
in exchange for
services in
October 2002 at
$0.65 per share -- -- 602,000 60 39,070 -- -- -- 39,130
Issuance of
common stock
in exchange for
subscription in
November and
December 2002
at $0.065 per
share -- -- 876,000 88 56,852 -- (56,940) -- --
Cancellation of
common stock in
January 2003
previously
issued in
exchange for
consulting
services -- -- (836,000) (84) (54,264) -- 54,340 -- (8)
Issuance of
common stock
in exchange for
licensing
services valued
at $0.065 per
share in
January 2003 -- -- 1,500,000 150 97,350 -- -- -- 97,500
Issuance of
common stock
in exchange for
consulting
services valued
at $0.13 per
share in
January 2003 -- -- 586,250 58 76,155 -- -- -- 76,213
Issuance of
common stock
in exchange for
consulting
services at
$0.065 per
share in
February 2003 -- -- 9,000 1 584 -- -- -- 585
Issuance of
common stock
to Founders in
exchange for
services valued
at $0.0001 per
share in
March 2003 -- -- 10,140,000 1,014 -- -- -- -- 1,014
3
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Issuance of
common stock
in exchange for
consulting
services valued
at $2.50 per
share in March
2003 -- -- 91,060 10 230,624 -- -- -- 230,634
Issuance of
common stock
in exchange for
consulting
services valued
at $0.065 per
share in March
2003 -- -- 6,000 1 389 -- -- -- 390
Common stock
subscribed in
exchange for
cash at $1 per
share in March
2003 -- -- -- -- 18,000 -- -- -- 18,000
Common stock
issued in
exchange for
consulting
services at
$0.065 per
share on April
1, 2003 -- -- 860,000 86 55,814 -- -- -- 55,900
Common stock
issued in
exchange for
cash at $1.00
per share on
April 9, 2003 -- -- 18,000 2 -- -- -- -- 2
Common stock
issued in
exchange for
consulting
services at
$0.065 per
share on April
9, 2003 -- -- 9,000 1 584 -- -- -- 585
Common stock
issued in
exchange for
consulting
services at
$2.50 per
share on April
23, 2003 -- -- 5,000 1 12,499 -- -- -- 12,500
Common stock
issued in
exchange for
consulting
services at
$2.50 per
share, on June
12, 2003 -- -- 10,000 1 24,999 -- -- -- 25,000
Common stock
issued in
exchange for
cash at $1.00
per share on
June 17, 2003 -- -- 50,000 5 49,995 -- -- -- 50,000
Common stock
subscribed in
exchange for
cash at $2.50
per share
pursuant to
private
placement on
June 27, 2003 -- -- -- -- -- 24,000 -- -- 24,000
Common stock
retired in
exchange for
note payable at
$0.0118 per
share, in June
30, 2003 -- -- (7,500,000) (750) 750 -- -- -- --
Common stock
issued in
exchange for
consulting
services at
$0.065 per
share, on June
30, 2003 -- -- 270,000 27 17,523 -- -- -- 17,550
4
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
subscribed in
exchange for
cash at $1.00
per share
pursuant to
private
placement on
June 30, 2003 -- -- -- -- -- 10,000 -- -- 10,000
Common stock
subscribed in
exchange for
cash at $2.50
per share
pursuant to
private
placement on
June 30, 2003 -- -- -- -- -- 24,000 -- -- 24,000
Common stock
issued in
exchange for
consulting
services at
approximately
$2.01 per
share, July
2003 -- -- 213,060 21 428,798 -- -- -- 428,819
Common stock
canceled in
July 2003,
previously
issued for
services
rendered at
$2.50 per share -- -- (24,000) (2) (59,998) -- -- -- (60,000)
Common stock
issued in
exchange for
options
exercised at
$1.00 per
share in July
2003 -- -- 20,000 2 19,998 -- -- -- 20,000
Common stock
issued in
exchange for
exercised of
options
previously
subscribed at
$1.00 per
share in July
2003 -- -- 10,000 1 9,999 (10,000) -- -- --
Common stock
issued in
exchange for
consulting
services at
approximately
$2.38 per
share, August
2003 -- -- 172,500 17 410,915 -- -- -- 410,932
Common stock
issued in
exchange for
options
exercised at
$1.00 per
share in August
2003 -- -- 29,000 3 28,997 -- -- -- 29,000
Common stock
issued in
exchange for
consulting
services at
approximately
$2.42 per
share,
September 2003 -- -- 395,260 40 952,957 -- -- -- 952,997
Common stock
issued in
exchange for
cash at $2.50
per share-
subscription
payable-
September 2003 -- -- 19,200 2 47,998 (48,000) -- -- --
Common stock
issued in
exchange for
cash at $2.50
per share
pursuant
to private
placement
September 2003 -- -- 6,400 1 15,999 -- -- -- 16,000
Common stock
issued in
exchange for
options
exercised at
$1.00 per
share in
September 2003 -- -- 95,000 10 94,991 -- -- -- 95,001
Common stock
subscriptio
receivable
reclassificat
adjustment -- -- -- -- -- -- 2,600 -- 2,600
Common Stock
subscribed to
at $2.50 per
share in
September 2003 -- -- -- -- -- 300,000 -- -- 300,000
5
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Net Loss for
the year ended
September 30,
2003 -- -- -- -- -- -- -- (3,445,164) (3,445,164)
--------- --------- ------------ ----------- ----------- ----------- ------------ ------------ ------------
Balance at
September 30,
2003 -- $ -- 17,811,082 $ 1,781 $ 2,577,568 $ 300,000 $ -- $ (3,456,776) $ (577,427)
========= ========= ============ =========== =========== =========== ============ ============ ============
Preferred
shares issues
in exchange for
services at
$25.00 per
share,
October 2003 15,000 15 -- -- -- -- -- -- 15
Common stock
issued in
exchange for
consulting
services at
approximately
$2.85 per
share, October
2003 -- -- 287,439 29 820,389 -- -- -- 820,418
Common stock
issued in
exchange for
cash at $2.50
per share-
subscription
payable-
October 2003 -- -- 120,000 12 299,988 (300,000) -- -- --
Common stock
canceled in
October 2003,
previously
issued for
services
rendered at
$2.50 per
share -- -- (100,000) (10) (249,990) -- -- -- (250,000)
Common stock
issued in
exchange for
consulting
services at
approximately
$3 per share,
November 2003 -- -- 100,000 10 299,990 -- -- -- 300,000
Common stock
subscribed
in exchange for
cash at $2.50
per share
pursuant
to private
placement,
November, 2003 -- -- 100,000 10 249,990 -- -- -- 250,000
Common stock
subscribed
in exchange for
cash at $2.50
per share
pursuant to
private
placement,
December, 2003 -- -- 6,400 1 15,999 -- -- -- 16,000
Common stock
issued in
exchange for
consulting
services at
approximately
$2.59 per
share, December
2003 -- -- 2,125,500 213 5,504,737 -- -- -- 5,504,950
Common Stock
subscribed
to at $2.50 per
share in
December 2003 -- -- -- -- -- 104,000 -- -- 104,000
Beneficial
conversion
feature
relating to
notes payable -- -- -- -- 1,168,474 -- -- -- 1,168,474
Beneficial
conversion
feature
relating to
warrants -- -- -- -- 206,526 -- -- -- 206,526
Adjust common
stock par value
from $0.0001 to
$0.50 per
share, per
amendment of
articles dated
in December 200 -- -- -- 10,223,166 (10,223,166) -- -- -- --
6
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common Stock
issued pursuant
to subscription
at $2.50 share
in January 2004 -- -- 41,600 20,800 83,200 (104,000) -- -- --
Common stock
issued in
exchange for
consulting
services at
$2.95 per
share, January
2004 -- -- 13,040 6,520 31,948 -- -- -- 38,468
Common stock
issued in
exchange for
consulting
services at
$2.60 per
share, January
2004 -- -- 123,000 61,500 258,300 -- -- -- 319,800
Common stock
issued in
exchange for
consulting
services at
$3.05 per
share, January
2004 -- -- 1,000 500 2,550 -- -- -- 3,050
Common stock
issued in
exchange for
employee
services at
$3.07 per
share, February
2004 -- -- 6,283 3,142 16,147 -- -- -- 19,289
Common stock
issued in
exchange for
consulting
services at
$3.04 per
share, March
2004 -- -- 44,740 22,370 113,640 -- -- -- 136,010
Common Stock
issued for
options
exercised at
$1.00 per share
in March 2004 -- -- 55,000 27,500 27,500 -- -- -- 55,000
Common stock
issued in
exchange for
employee
services at
$3.00 per
share, March
2004 -- -- 5,443 2,722 13,623 -- -- -- 16,345
Common stock
issued in
exchange for
employee
services at
$3.15 per
share, March
2004 -- -- 5,769 2,885 15,292 -- -- -- 18,177
Preferred
shared
converted to
common shares
for consulting
services at
$3.00 per
share, March
2004 (5,000) (5) 125,000 62,500 312,500 -- -- -- 374,995
Common stock
issued in
exchange for
employee
services at
$3.03 per
share, March
2004 -- -- 8,806 4,400 22,238 -- -- -- 26,638
Common Stock
issued pursuant
to subscription
at $2.50 per
share in
March 2004 -- -- 22,500 11,250 (9,000) -- -- -- 2,250
Beneficial
Conversion
Feature
relating to
Notes Payable -- -- 122,362 -- -- -- 122,362
Beneficial
Conversion
Feature
relating to
Warrants -- -- -- -- 177,638 -- -- -- 177,638
Common stock
issued in
exchange for
consulting
services at
$2.58 per
share,
April 2004 -- -- 9,860 4,930 20,511 -- -- -- 25,441
7
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
issued in
exchange for
consulting
services at
$2.35 per
share,
April 2004 -- -- 11,712 5,856 21,667 -- -- -- 27,523
Common stock
issued in
exchange for
consulting
services at
$1.50 per
share,
April 2004 -- -- 367,500 183,750 367,500 -- -- -- 551,250
Common stock
returned to
treasury at
$0.065 per
share,
April 2004 -- -- (50,000) (25,000) 21,750 -- -- -- (3,250)
Preferred
stock converted
to common stock
for consulting
services at
$1.01 per share
in May 2004 (4,000) (4) 100,000 50,000 51,250 -- -- -- 101,246
Common stock
issued per
subscription
May 2004 -- -- 10,000 5,000 (4,000) -- (1,000) -- --
Common stock
issued in
exchange for
consulting
services at
$0.86 per
share in
May 2004 -- -- 137,000 68,500 50,730 -- -- -- 119,230
Common stock
issued in
exchange for
consulting
services at
$1.15 per
share in
May 2004 -- -- 26,380 13,190 17,147 -- -- -- 30,337
Common stock
returned to
treasury at
$0.065 per
share,
June 2004 -- -- (5,000) (2,500) 2,175 -- -- -- (325)
Common stock
issued in
exchange for
consulting
services at
$0.67 per
share in
June 2004 -- -- 270,500 135,250 45,310 -- -- -- 180,560
Common stock
issued in
exchange for
consulting
services at
$0.89 per
share in
June 2004 -- -- 8,000 4,000 3,120 -- -- -- 7,120
Common stock
issued in
exchange for
consulting
services at
$0.65 per
share in
June 2004 -- -- 50,000 25,000 7,250 -- -- -- 32,250
Common stock
issued pursuant
to private
placement at
$1.00 per share
in June 2004 -- -- 250,000 125,000 125,000 -- -- -- 250,000
Common stock
issued in
exchange for
consulting
services at
$0.54 per share
in July 2004 -- -- 100,000 50,000 4,000 -- -- -- 54,000
Common stock
issued in
exchange for
consulting
services at
$0.72 per share
in July 2004 -- -- 5,000 2,500 1,100 -- -- -- 3,600
8
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
issued in
exchange for
consulting
services at
$0.47 per share
in July 2004 -- -- 100,000 50,000 (2,749) -- -- -- 47,251
Common stock
issued in
exchange for
consulting
services at
$0.39 per share
in August 2004 -- -- 100,000 50,000 (11,000) -- -- -- 39,000
Preferred stock
converted to
common stock
for consulting
services at
$0.39 per share
in August 2004 (2,000) (2) 50,000 25,000 (5,500) -- -- -- 19,498
Common stock
issued in
exchange for
consulting
services at
$0.50 per share
in August 2004 -- -- 100,000 50,000 250 -- -- -- 50,250
Common stock
issued in
exchange for
consulting
services at
$0.56 per share
in August 2004 -- -- 200,000 100,000 12,500 -- -- -- 112,500
Common stock
issued in
exchange for
consulting
services at
$0.41 per share
in August 2004 -- -- 92,500 46,250 (8,605) -- -- -- 37,645
Common stock
issued in
exchange for
consulting
services at
$0.52 per share
in September
2004 -- -- 1,000,000 500,000 17,500 -- -- -- 517,500
Common stock
issued in
exchange for
consulting
services at
$0.46 per share
in September
2004 -- -- 5,000 2,500 (212) -- -- -- 2,288
Common stock
issued pursuant
to subscription
at $0.50 per
share in
September 2004 -- -- 40,000 20,000 -- -- -- -- 20,000
Preferred
shares
converted to
common stock
for consulting
services at
$0.41 per share
in September
2004 (4,000) (4) 100,000 50,000 4,000 -- -- -- 53,996
Preferred
shares issued
in exchange for
service at $25
per share in
September 2004 60,000 6 -- -- 1,499,994 -- -- -- 1,500,000
Fair value of
2,841,000
warrants issued
to non
employees and
consultants for
services
rendered at
approximately
$0.71 per
warrant in
September 200 -- -- -- -- 2,019,862 -- -- -- 2,019,862
Net Loss -- -- -- -- -- -- -- (19,358,258) (19,358,258)
--------- --------- ------------ ----------- ----------- ----------- ------------ ------------ ------------
Balance at
September 30,
2004 60,000 $ 6 23,981,054 $11,990,527 $ 6,118,993 $ -- $ (1,000) $(22,815,034) $ (4,706,508)
========= ========= ============ =========== =========== =========== ============ ============ ============
9
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
issued in
exchange for
consulting
services at
$0.68 per share
in October 2004 -- -- 200,000 100,000 36,000 -- -- -- 136,000
Common stock
returned to
treasury at
$0.60 per share
in October 2004 -- -- (1,069,600) (534,800) (107,297) -- -- -- (642,097)
Common stock
issued in
exchange for
consulting
services at
$0.60 per share
in October 2004 -- -- 82,500 41,250 8,250 -- -- -- 49,500
Common Stock
issued pursuant
to subscription
at $0.60 per
share in
October 2004 -- -- 500,000 250,000 50,000 (300,000) -- -- --
Common stock
issued in
exchange for
consulting
services at
$0.50 per share
in October 2004 -- -- 532,500 266,250 -- -- -- -- 266,250
Common Stock
issued in
exchange for
debt at $0.50
per share in
October 2004 -- -- 500,000 250,000 -- -- -- -- 250,000
Common Stock
issued pursuant
to subscription
at $0.45 per
share in
October 2004 -- -- 1,000,000 500,000 (50,000) (450,000) -- -- --
Common stock
issued in
exchange for
consulting
services at
$0.45 per share
in October 2004 -- -- 315,000 157,500 (15,750) -- -- -- 141,750
Common Stock
issued in
exchange for
consulting
services at
$0.47 per share
in November
2004 -- -- 100,000 50,000 (3,000) -- -- -- 47,000
Common Stock
issued in
exchange for
consulting
services at
$0.80 per share
in November
2004 -- -- 300,000 150,000 90,000 -- -- -- 240,000
Common Stock
issued in
exchange for
consulting
services at
$1.44 per share
in November 200 -- -- 115,000 57,500 108,100 -- -- -- 165,600
Common Stock
issued in
exchange for
employee
services at
$1.44 per share
in November
2004 -- -- 5,000 2,500 4,700 -- -- -- 7,200
Warrants
exercised at
$0.60 per share
in November
2004 -- -- 60,000 30,000 6,000 (4,000) -- -- 32,000
Beneficial
Conversion
discount
relating to
Notes Payable -- -- -- -- 1,465,000 -- -- -- 1,465,000
10
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
issued at
$0.016 per
share in
exchange for
note payable in
December 2004 -- -- 5,500,000 2,750,000 (2,661,500) -- -- -- 88,500
Common stock
issued in
settlement of
debt at $0.50
per share in
December 2004 -- -- 2,930,000 1,465,000 -- (125,000) -- -- 1,340,000
Fair value of
6,063,500
warrants issued
to non employee
and consultants
for services
rendered at
$0.52 per
warrant in
October and
December 2004 -- -- -- -- 3,169,052 -- -- -- 3,169,052
Warrants
exercised at
$0.10 per share
in January 2005 -- -- 25,000 12,500 (10,000) -- -- -- 2,500
Common Stock
issued in
settlement of
debt at $0.33
per share in
January 2005 -- -- 1,628,789 814,395 (276,895) -- -- -- 537,500
Warrants
exercised at
$0.10 per share
in January 2005 -- -- 17,500 8,750 (7,000) -- -- -- 1,750
Common Stock
issued in
settlement of
debt at $0.33
per share in
January 2005 -- -- 2,399,012 1,199,504 (407,830) -- -- -- 791,674
Common Stock
issued in
exchange fo
consulting
services at
$1.30 per share
in January 2005 -- -- 315,636 157,818 252,508 -- -- -- 410,326
Fair value of
warrant
liability
reclassed due
to registration
rights granted
in February
2005 -- -- -- -- (3,108,851) -- -- -- (3,108,851)
Common Stock
issued in
exchange for
consulting
services at
$1.44 per share
in February 200 -- -- 5,796,785 2,898,393 5,418,814 -- -- -- 8,317,207
Fair value of
55,000 warrants
issued to
consultants for
services at
$1.31 per
warrant in
February 2005 -- -- -- -- 72,017 -- -- -- 72,017
Common Stock
issued in
settlement of
debt at $0.33
per share in
February 2005 -- -- 75,757 37,879 (12,879) -- -- -- 25,000
Warrants
exercised at
$0.10 per share
in February
2005 -- -- 20,000 10,000 (8,000) -- -- -- 2,000
Common Stock
issued in
settlement of
debt at $0.33
per share in
February 2005 -- -- 606,060 303,030 (103,030) -- -- -- 200,000
Warrants
exercised at
$0.10 per share
in February
2005 -- -- 45,000 22,500 (18,000) -- -- -- 4,500
11
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common Stock
issued in
exchange for
related party
debt at $1.31
per share in
February 2005 -- -- 1,500,000 750,000 1,215,000 -- -- -- 1,965,000
Common Stock
issued in
settlement of
debt at $0.33
per share in
February 2005 -- -- 278,433 139,217 (47,334) -- -- -- 91,883
Common Stock
issued in
exchange for
consulting
services at
$1.17 per share
in February 200 -- -- 17,236 8,618 11,548 -- -- -- 20,166
Common stock
issued in
exchange for
debt at $0.50
per share in
February 2005 -- -- 300,000 150,000 -- -- -- -- 150,000
Common Stock
issued in
exchange for
consulting
services at
$0.95 per share
in February
2005 -- -- 716,500 358,250 322,425 -- -- -- 680,675
Common Stock
issued in
exchange for
consulting
services at
$0.95 per share
in February
2005 -- -- 10,500 5,250 4,725 -- -- -- 9,975
Common stock
issued in
exchange for
debt at $0.50
per share in
March 2005 -- -- 13,202,000 6,601,000 -- -- -- -- 6,601,000
Common Stock
issued in
exchange for
consulting
services at
$1.19 per share
in March 2005 -- -- 185,000 92,500 127,650 -- -- -- 220,150
Options
exercised at
$0.60 per share
in March 2005 -- -- 100,000 50,000 10,000 -- -- -- 60,000
Common Stock
issued in
exchange for
consulting
services at
$0.98 per share
in March 2005 -- -- 1,675,272 837,636 804,131 -- -- -- 1,641,767
Common Stock
issued in
exchange for
consulting
services at
$0.92 per share
in March 2005 -- -- 24,333 12,167 10,219 -- -- -- 22,386
Common Stock
issued in
exchange for
consulting
services at
$0.99 per share
in March 2005 -- -- 15,000 7,500 7,350 -- -- -- 14,850
Common stock
issued in
exchange for
debt at $0.50
per share in
March 2005 -- -- 1,240,000 620,000 -- -- -- -- 620,000
12
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common stock
canceled for
shares issued
in exchange of
debt in
March 2005 -- -- (500,000) (250,000) -- -- -- -- (250,000)
Common stock
subscribed
Canceled in
March 2005 -- -- -- -- -- 750,000 -- -- 750,000
Common Stock
issued in
exchange for
consulting
services at
$0.89 per share
in March 2005 -- -- 10,000 5,000 3,900 -- -- -- 8,900
Adjust common
stock par value
from $0.50 to
$0.001 per
share, per
amendment of
articles
dated March-05 -- -- -- (32,312,879) 32,312,879 -- -- -- --
Beneficial
Conversion
discount
relating to
Notes Payable
in March 2005 -- -- -- -- 7,371,000 -- -- -- 7,371,000
Stock options
granted to
employees in
exchange for
services
rendered, at
exercise price
below fair
value of common
stock in March
2005 -- -- -- -- 180,000 -- -- -- 180,000
Common Stock
issued in
exchange for
consulting
services at
$0.80 per
share in April
2005 -- -- 160,000 160 127,840 -- -- -- 128,000
Common Stock
issued in
exchange for
consulting
services at
$0.80 per
share in April
2005 -- -- 40,000 40 31,960 -- -- -- 32,000
Common Stock
issued in
exchange for
consulting
services at
$0.75 per share
in April 2005 -- -- 850,000 850 636,650 -- -- -- 637,500
Common Stock
issued in
exchange for
consulting
services at
$0.33 per share
in April 2005 -- -- 500,000 500 164,500 -- -- -- 165,000
Common Stock
canceled during
April 2005,
previously
issued for
services
rendered at
$3.42 per share -- -- (10,000) (10) (34,190) -- -- -- (34,200)
Common Stock
issued in
settlement of
debt at $0.33
per share in
April 2005 -- -- 75,758 77 24,923 (25,000) -- -- --
Common Stock
issued in
exchange for
consulting
services at
$0.68 per share
in April 2005 -- -- 50,000 50 33,950 -- -- -- 34,000
Proceeds
received
against
subscription
Payable in June
2005 -- -- -- -- -- 118,000 -- -- 118,000
13
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Common Stock
canceled in
June 2005,
previously
issued for
services
rendered at
$0.50 per share -- -- (10,000) (10) (4,990) -- -- -- (5,000)
Cancellation of
previously
granted stock
options granted
to employees
for services
rendered, at
exercise
price below
fair value
of common stock -- -- -- -- (180,000) -- -- -- (180,000)
Common Stock
issued in
exchange for
consulting
services at
$0.60 per share
in July 2005 -- -- 157,000 157 94,043 -- -- -- 94,200
Common Stock
issued in
exchange for
intellectua
property at
$0.67 per share
in July 2005 -- -- 36,000,000 36,000 24,084,000 -- -- -- 24,120,000
Common Stock
issued in
exchange for
consulting
services at
$0.60 per share
in July 2005 -- -- 640,000 640 383,360 -- -- -- 384,000
Common Stock
issued in
exchange for
employee
services at
$0.48 per share
in July 2005 -- -- 8,000,000 8,000 3,832,000 -- -- -- 3,840,000
Common Stock
issued in
exchange for
consulting
services at
$0.94 per share
in July 2005 -- -- 121,985 121 168,217 -- -- -- 168,338
Common Stock
issued in
exchange for
consulting
services at
$0.48 per share
in August 2005 -- -- 250,000 250 119,750 -- -- -- 120,000
Common Stock
penalty shares
issued pursuant
to pending SB-2
registration at
$0.62 per share
in September
2005 -- -- 814,158 814 501,858 -- -- -- 502,672
Common Stock
penalty shares
issued pursuant
to pending SB-2
registration at
$0.70 per share
in September
2005 -- -- 391,224 391 273,466 -- -- -- 273,857
Common Stock
issued in
exchange for
consulting
services at
$0.94 per share
in September
2005 -- -- 185,000 185 173,715 -- -- -- 173,900
Common Stock
returned in
September 2005,
previously
issued for
services
rendered at
$0.40 per share -- -- (740,000) (740) (453,232) 56,000 1,000 -- (396,972)
14
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Net Loss -- -- -- -- -- -- -- (67,109,519) (67,109,519)
--------- --------- ------------ ----------- ----------- ----------- ------------ ------------ ------------
Balance as of
September
30, 2005 60,000 $ 6 112,230,392 $ 112,230 $82,320,715 $ 20,000 $ -- $(89,924,553) $ (7,471,602)
========= ========= ============ =========== =========== =========== ============ ============ ============
Common stock
issued in
exchange for
services at
$0.50 per share
in October 2005 -- -- 400,000 400 199,600 -- -- -- 200,000
Common Stock
issued in
exchange for
consulting
services at
$0.75 per share
in October 2005 -- -- 100,000 100 74,900 -- -- -- 75,000
Common Stock
returned in
October 2005,
previously
issued for
services
rendered at
$0.60 per share -- -- (350,000) (350) (209,650) -- -- -- (210,000)
Common stock
issued pursuant
to subscription
at $0.50 per
share in
December 2005 -- -- 40,000 40 19,960 (20,000) -- -- --
Common Stock to
investors
pursuant to
registration
rights
agreement at
$0.51 per
share in
December 2005 -- -- 505,854 506 257,480 -- -- -- 257,986
Common Stock
returned in
January 2006,
previously
issued for
services
rendered at
$0.60 per share -- -- (250,000) (250) (149,750) -- -- -- (150,000)
Common Stock
issued to
investors
pursuant to
registration
rights
agreement at
$0.32 per share
in January 2006 -- -- 806,212 806 257,182 -- -- -- 257,988
Common Stock
issued to
investors
pursuant to
registration
rights
agreement at
$0.20 per share
in January 2006 -- -- 1,289,927 1,290 256,695 -- -- -- 257,985
Fair value of
200,000
warrants issued
to consultants
for services
at $0.22 per
warrant in
January 2006 -- -- -- -- 43,098 -- -- -- 43,098
Common Stock
issued in
exchange for
consulting
services at
$0.17 per share
in February
2006 -- -- 160,000 160 27,040 -- -- -- 27,200
Common Stock
issued in
exchange for
consulting
services at
$0.16 per share
in February
2006 -- -- 3,800,000 3,800 604,200 -- -- -- 608,000
Common Stock
returned in
March 2006,
previously
issued for
services
rendered at
$0.80 per share -- -- (150,000) (150) (119,850) -- -- -- (120,000)
15
APPLIED DNA SCIENCES, INC
(A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2006
(unaudited)
Deficit
Additional Accumulated
Preferred Common Paid in Common Stock During
Preferred Shares Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- --------- ------------ ----------- ----------- ---------- ------------ ------------ ------------
Previously
issued
warrants
reclassed to
warrant
liability -- -- -- -- (1,584,614) -- -- -- (1,584,614)
Common Stock
issued in
exchange for
consulting
services at
$0.20 per share
in July 2006 -- -- 2,400,000 2,400 477,600 -- -- -- 480,000
Fair value of
stock options
granted to
employees in
exchange for
services
rendered in
September 2006 -- -- -- -- 153,000 -- -- -- 153,000
Net loss -- -- -- -- -- -- -- (2,410,237) (2,410,237)
--------- --------- ------------ ----------- ----------- ----------- ------------ ------------ ------------
Balance as of
September
30, 2006 60,000 $ 6 $120,982,385 $ 120,982 $82,627,606 $ -- $ -- $(92,334,791) $ (9,586,197)
========= ========= ============ =========== =========== =========== ============ ============ ============
Common stock
issued in
Dec 2006
in settlement
of related
party debt
at $2.28 per
share -- -- 180,000 180 410,249 -- -- -- 410,429
Net loss -- -- -- -- -- -- -- (671,222) (671,222)
--------- --------- ------------ ----------- ----------- ----------- ------------ ------------ ------------
Balance as of
December
31, 2006 60,000 $ 6 121,162,385 $ 121,162 $83,037,855 $ -- $ -- $(93,006,013) $ (9,846,990)
========= ========= ============ =========== =========== =========== ============ ============ ============
See accompanying notes to consolidated financial statements
16
APPLIED DNA SCIENCES, INC
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
For the Period
September 16, 2002
(Date of Inception)
For the three months ended December 31, through
2006 2005 December 31, 2006
------------ ------------ ------------
Cash flows from operating activities: RESTATED
Net income (loss) $ (671,222) $ 2,819,451 $(93,006,013)
Adjustments to reconcile net loss to net used in operating activities:
Depreciation and amortization 107,879 336,942 1,837,605
Organization expenses -- -- 88,500
Impairment of intangible assets -- -- 5,655,011
Preferred shares issued in exchange for services -- -- 1,500,000
Options and warrants issued in exchange for services rendered -- -- 11,001,255
Income attributable to repricing of warrants and debt derivatives (2,098,471) (6,788,790) (35,644,299)
Financing costs attributable to issuance of warrants -- 1,758,900 25,419,214
Amortization of beneficial conversion feature-convertible notes -- -- 10,461,000
Amortization of capitalized financing costs 388,775 -- 1,024,788
Amortization of debt discount attributable to convertible debentures 455,400 -- 1,186,890
Debt in exchange for common stock at fair market price -- -- 1,365,000
Common stock issued in exchange for services rendered -- 75,000 31,964,573
Common stock exchanged for intellectual property in connection with
costs of acquiring intangible assets -- -- 14,689,100
Common stock issued in connection with penalties pursuant to
registration -- 257,986 1,550,487
Common stock canceled-previously issued for services rendered -- (210,000) (1,343,845)
Change in assets and liabilities:
Increase in accounts receivable (977) -- (19,027)
Decrease (increase) in prepaid expenses and deposits 40,000 -- (80,489)
Decrease (increase) in other assets -- (4,975)
Increase in due related parties -- 53,805 --
Increase (decrease) in accounts payable and accrued liabilities 1,217,460 1,288,311 6,747,621
------------ ------------ ------------
Net cash used in operating activities (561,156) (413,370) (15,602,629)
Cash flows from investing activities:
Payments for patent filing -- 6,103 (25,698)
Acquisition (disposal) of property and equipment, net (11,039) (9,397) (188,360)
------------ ------------ ------------
Net cash provided by (used in) investing activities (11,039) (3,294) (214,058)
Cash flows from financing activities:
Proceeds from sale of common stock, net of cost -- -- 432,000
Proceeds from issuance of convertible notes -- -- 12,968,900
Proceeds from sale of options -- -- 343,750
Repayment of debt -- -- (24,854)
Proceeds from loans -- 550,000 2,750,000
------------ ------------ ------------
Net cash provided by financing activities -- 550,000 16,469,796
17
APPLIED DNA SCIENCES, INC
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
For the Period
September 16, 2002
(Date of Inception)
For the three months ended December 31, through
2006 2005 December 31, 2006
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (572,195) 133,336 653,109
Cash and cash equivalents at beginning of period 1,225,304 31,190 --
------------ ------------ ------------
Cash and cash equivalents at end of period $ 653,109 $ 164,526 $ 653,109
============ ============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during period for interest -- -- --
Cash paid during period for taxes -- -- --
Non-cash transactions:
Common stock issued for services -- 75,000 31,964,573
Common stock issued in exchange for intellectual
property -- --
Common stock issued in exchange for previously
incurred debt 410,429 -- 2,707,729
Common stock canceled-previously issued for services
rendered -- (210,000) (1,343,845)
Common stock issued for ESOP shares -- --
Common stock penalty shares issued pursuant to Pending
SB-2 registration -- 257,986
Amortization of beneficial conversion feature -- -- 10,461,000
Preferred shares in exchange for service at $25 per
share in September 2004 -- -- 1,500,000
Warrants issued in exchange for financing costs -- 1,758,900 24,907,115
Fair value of options and warrants issued to
consultants for services -- -- 11,001,255
Acquisition:
Common stock retained -- -- 1,015
Assets acquired -- -- (135)
------------ ------------ ------------
Total consideration paid -- -- 880
------------ ------------ ------------
Organizational expenses-note issued in exchange for
shares retired 88,500
Common stock issued in exchange for note payable 88,500
See the accompanying notes to the consolidated financial statements
18
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
General
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-QSB, and therefore,
do not include all the information necessary for a fair presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles.
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three month period ended December 31, 2006
are not necessarily indicative of the results that may be expected for the
fiscal year ending September 30, 2007. The unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated
September 30, 2006 financial statements and footnotes thereto included in the
Company's SEC Form 10-KSB, as amended.
Business and Basis of Presentation
On September 16, 2002, Applied DNA Sciences, Inc. (the "Company") was
incorporated under the laws of the State of Nevada. The Company is in the
development stage, as defined by Statement of Financial Accounting Standards No.
7 ("SFAS No. 7") and its efforts have been principally devoted to developing DNA
embedded biotechnology security solutions in the United States. To date, the
Company has generated nominal sales revenues, has incurred expenses and has
sustained losses. Consequently, its operations are subject to all the risks
inherent in the establishment of a new business enterprise. For the period from
inception through December 31, 2006, the Company has accumulated losses of
$93,006,013.
The consolidated financial statements include the accounts of the Company,
and its wholly-owned subsidiary ProHealth Medical Technologies, Inc. Significant
inter-company transactions have been eliminated in consolidation.
Reclassification
Certain prior period amounts have been reclassified for comparative
purposes.
Property and Equipment
Property and equipment are stated at cost and depreciated over their
estimated useful lives of 3 to 5 years using the straight line method. At
December 31, 2006 property and equipment consist of:
Computer equipment $ 27,404
Lab equipment 54,973
Furniture 105,985
Accumulated depreciation (36,104)
--------
Net $ 152,258
Stock Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based
19
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
employee compensation and the effect of the method used on reported results. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in APB Opinion No. 25 and related
interpretations. Accordingly, compensation expense for stock options is measured
as the excess, if any, of the fair market value of the Company's stock at the
date of the grant over the exercise price of the related option. The Company has
adopted the annual disclosure provisions of SFAS No. 148 in its financial
reports for the year ended September 30, 2006 and for the subsequent periods.
The Company did not issue employee options as stock-based compensation during
the three months ended December 31, 2006 and therefore has no unrecognized stock
compensation related liabilities ended December 31, 2006.
On January 1, 2006, the Company adopted the fair value recognition
provisions of Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock Based
Compensation, to account for compensation costs under our stock option plans. We
previously utilized the intrinsic value method under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (as amended) ("APB
25"). Under the intrinsic value method prescribed by APB 25, no compensation
costs were recognized for our employee stock options because the option exercise
price equaled the market price on the date of the grant. Prior to January 1,
2006 we only disclosed the pro forma effects on net income and earnings per
share as if the fair value recognition provisions of SFAS 123(R) had been
utilized.
In adopting SFAS No. 123(R), we elected to use the modified prospective
method to account for the transition from the intrinsic value method to the fair
value recognition method. Under modified prospective method, compensation cost
is recognized from the adoption date forward for all new stock options granted
and for any outstanding unvested awards as if the fair value method had been
applied to those awards as of the date of the grant. In the three months ended
December 31, 2006; the Company did not grant any employee stock options.
The following table shows the effect on net earnings and earnings per share
had compensation cost been recognized based upon the estimated fair value on the
grant date of stock options for three months ended December 31, 2005, in
accordance with SFAS 123, as amended by SFAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure":
For the Period
September 16, 2002
For the Three For the Three (Date of Inception)
Months ended Months ended through
December 31, 2006 December 31, 2005 December 31, 2006
----------------- ----------------- -----------------
Net income (loss) - as reported $ (671,222) $ 2,819,451 $ (93,006,013)
Add: Total stock based employee
compensation expense as reported
under intrinsic value method (APB
No. 25) - - -
Deduct: Total stock based employee
compensation expense as reported
under fair value method (FASB No.
123) - - (1,406,350)
---------- ----------- --------------
Net Income (loss) - Pro Forma $(671,222) $ 2,819,451 $ (94,412,363)
========== =========== ==============
Net Income (loss) attributable to
common stockholders - Pro Forma $(671,222) $ 2,819,451 $ (94,412,363)
========== =========== ==============
Basic income (loss) per share - as
reported $ (0.01) $ 0.03 $ (1.62)
========== =========== ==============
Basic income (loss) per share -Pro
forma $ (0.01) $ 0.03 $ (1.65)
========== =========== ======= ======
Fully diluted income per share - as
reported N/A $ 0.02 N/A
=== ====== ==== ===
Fully diluted income per share -Pro
forma N/A $ 0.02 N/A
=== =========== ===
20
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Revenue Recognition
Revenues are recognized in the period that services are provided. For
revenue from product sales, the Company recognizes revenue in accordance with
Staff Accounting Bulletin No. 104, REVENUE RECOGNITION ("SAB104"), which
superseded Staff Accounting Bulletin No. 101, REVENUE RECOGNITION IN FINANCIAL
STATEMENTS ("SAB101"). SAB 101 requires that four basic criteria must be met
before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and
determinable; and (4) collectibility is reasonably assured. Determination of
criteria (3) and (4) are based on management's judgments regarding the fixed
nature of the selling prices of the products delivered and the collectibility of
those amounts. Provisions for discounts and rebates to customers, estimated
returns and allowances, and other adjustments are provided for in the same
period the related sales are recorded. The Company defers any revenue for which
the product has not been delivered or is subject to refund until such time that
the Company and the customer jointly determine that the product has been
delivered or no refund will be required. At December 31, 2006 the Company did
not have any deferred revenue.
SAB 104 incorporates Emerging Issues Task Force 00-21 ("EITF 00-21"),
MULTIPLE DELIVERABLE REVENUE ARRANGEMENTS. EITF 00-21 addresses accounting for
arrangements that may involve the delivery or performance of multiple products,
services and/or rights to use assets. The effect of implementing EITF 00-21 on
the Company's financial position and results of operations was not significant.
Concentrations of Credit Risk
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 credit quality institutions. At times, such investments
may be in excess of the FDIC insurance limit. The Company periodically reviews
its trade receivables in determining its allowance for doubtful accounts. At
December 31, 2006, allowance for doubtful receivable was $0.
21
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Net income (loss) per share
The following reconciliation of net income and share amounts used in the
computation of income (loss) per share for the three months ended December 31,
2005:
Three Months Ended
December 31, 2005
------------------
Net income used in computing basic net income per share $ 2,629,918
Impact of assumed assumptions:
Fair value of warrants relating to convertible debt
charged to interest expense 1,758,900
Impact of equity classified as liability:
Gain on warrant liability marked to fair value (6,788,790)
------------
Net loss in computing diluted net loss per share: $(2,399,972)
============
The weighted average shares outstanding used in the basic net income per
share computations for the three months ended December 31, 2005 was 53,002,278.
In determining the number of shares used in computing diluted loss per share,
the Company added approximately 110,390,670 potentially dilutive securities for
the three months ended December 31, 2006. The potentially dilutive securities
added were mostly attributable to the warrants, options and convertible
debentures outstanding. As a result, the diluted loss per share for the three
months ended December 31, 2006 was $0.02.
Derivative Financial Instruments
The Company's derivative financial instruments consist of embedded
derivatives related to the 10% Secured Convertible Promissory Notes (the "Serial
Notes") entered into in 2006 (see Note D). These embedded derivatives include
certain conversion features, variable interest features, call options and
default provisions. The accounting treatment of derivative financial instruments
requires that the Company recorded the derivatives and related warrants at their
fair values as of the inception date of the Note Agreement (estimated at
$2,419,719) and at fair value as of each subsequent balance sheet date. In
addition, under the provisions of EITF Issue No. 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock," as a result of entering into the Notes, the Company is
required to classify all other non-employee stock options and warrants as
derivative liabilities and mark them to market at each reporting date. The fair
value of such options and warrants that were reclassified as liabilities from
additional paid-in capital in the three months ended December 31, 2006 totaled
$1,584,614. Any change in fair value will be recorded as non-operating, non-cash
income or expense at each reporting date. If the fair value of the derivatives
is higher at the subsequent balance sheet date, the Company will record a
non-operating, non-cash charge. If the fair value of the derivatives is lower at
the subsequent balance sheet date, the Company will record non-operating,
non-cash income. Conversion-related derivatives were valued using the Binomial
Option Pricing Model with the following assumptions: dividend yield of 0%;
annual volatility of 111 to 112%; and risk free interest rate of 4.96 to 5.15%
as well as probability analysis related to trading volume restrictions. The
remaining derivatives were valued using discounted cash flows and probability
analysis. The derivatives are classified as long-term liabilities (see Note F).
22
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
New Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155. "Accounting for certain
Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140,"
or SFAS No. 155. SFAS No. 155 permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of Statement No. 133, establishes a
requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on a
qualifying special purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. SFAS 155 is effective for all financial instruments acquired or
issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006. We do not expect the adoption of SFAS 155 to have a material
impact on our consolidated financial position, results of operations or cash
flows.
In March 2006, the FASB issued FASB Statement No. 156, Accounting for
Servicing of Financial Assets - an amendment to FASB Statement No. 140.
Statement 156 requires that an entity recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset by
entering into a service contract under certain situations. The new standard is
effective for fiscal years beginning after September 15, 2006. The adoption of
SFAS No.156 did not have a material impact on the Company's financial position
and results of operations.
In July 2006, the FASB issued Interpretation No. 48 (FIN 48). "Accounting
for uncertainty in Income Taxes". FIN 48 clarifies the accounting for Income
Taxes by prescribing the minimum recognition threshold a tax position is
required to meet before being recognized in the financial statements. It also
provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition and clearly
scopes income taxes out of SFAS 5, "Accounting for Contingencies". FIN 48 is
effective for fiscal years beginning after December 15, 2006. We have not yet
evaluated the impact of adopting FIN 48 on our consolidated financial position,
results of operations and cash flows.
In September 2006 the Financial Account Standards Board (the "FASB") issued
its Statement of Financial Accounting Standards 157, Fair Value Measurements.
This Statement defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. This Statement applies under other
accounting pronouncements that require or permit fair value measurements, the
Board having previously concluded in those accounting pronouncements that fair
value is the relevant measurement attribute. Accordingly, this Statement does
not require any new fair value measurements. However, for some entities, the
application of this Statement will change current practice. FAS 157 effective
date is for fiscal years beginning after November 15, 2007. The Company does not
expect adoption of this standard will have a material impact on its financial
position, operations or cash flows.
In September 2006 the FASB issued its Statement of Financial Accounting
Standards 158 "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans". This Statement improves financial reporting by requiring
an employer to recognize the overfunded or underfunded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset or
liability in its statement of financial position and to recognize changes in
that funded status in the year in which the changes occur through comprehensive
income of a business entity or changes in unrestricted net assets of a
not-for-profit organization. This Statement also improves financial reporting by
requiring an employer to measure the funded status of a plan as of the date of
its year-end statement of financial position, with limited exceptions. The
effective date for an employer with publicly traded equity securities is as of
the end of the fiscal year ending after December 15, 2006. The Company does not
expect adoption of this standard will have a material impact on its financial
position, operations or cash flows.
23
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
NOTE B - INTANGIBLE ASSETS AND AMORTIZATION
The Company has adopted SFAS No. 142, Goodwill and Other Intangible Assets,
whereby the Company periodically tests its intangible assets for impairment. On
an annual basis, and when there is reason to suspect that their values have been
diminished or impaired, these assets are tested for impairment, and write-downs
will be included in results from operations.
Biowell Technology, Inc.
On July 12, 2005, the Company acquired certain intellectual properties from
Biowell Technology, Inc. ("Biowell") through an Asset Purchase Agreement
("Agreement") in exchange for 36 million shares of the Company's restricted
common stock having an aggregate fair value at the date of issuance of
$24,120,000. The intangible assets acquired consist of proprietary DNA
anti-counterfeit trade secrets created by Biowell that are intended to protect
intellectual property from counterfeiting, fraud, piracy, product diversion and
unauthorized intrusion.
The purchase price has been allocated as follows:
Amortizable intangible assets acquired are comprised of:
Developed core technologies $ 2,260,900
Developed product technologies 7,170,000
-----------
Total amortizable intangible assets 9,430,900
Transaction costs 14,869,100
-----------
Total purchase price $24,120,000
===========
In Process Research & Development
The Company concluded as of the date of acquisition, the acquired
intangible assets, consisting of developed core and product technologies had
reached full development and that it was not the intention of the Company's
management to utilize the asset in specific research and development activities
as defined in SFAS No. 2 Accounting for Research & Development Costs, As a
result, the Company determined there was no in-process research and development
("IPR& D") projects in place related to the technology acquired, nor any future
research and development activities planned. Accordingly, there is no charge to
operations during the year ended September 30, 2005 for IPR&D in connection with
the acquisition of the assets.
Transaction costs
The amount of the purchase price that could not be allocated to acquired
identifiable intangible assets or IPR & D was $14,689,100 and was charged to
operations as a cost of the transaction during the year ended September 30,
2005.
The identifiable intangible assets acquired and their carrying value at
December 31, 2006 are:
Trade secrets and developed technologies $9,430,900
(Weighted average life of 7 years)
Patents (Weighted average life of 5 years) 34,257
-----------
Total Amortized identifiable intangible $9,465,157
assets-Gross carrying value:
Less:
Accumulated Amortization (1,795,343)
Impairment (5,655,011)
-----------
Net: $ 2,014,803
Residual value: $ 0
24
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Total amortization expense charged to operations for the three months ended
December 31, 2006 and 2005 was $92,661 and $338,545, respectively.
NOTE C - PRIVATE PLACEMENT OF CONVERTIBLE NOTES
Convertible notes payable as of December 31, 2006 are as follows:
10% Secured Convertible Notes Payable dated March 8, 2006,
net of unamortized debt discount of $393,910 (see below) $ 1,106,090
10% Secured Convertible Notes Payable dated May 2, 2006,
net of unamortized debt discount of $212,758 (see below) 787,242
10% Secured Convertible Notes Payable dated June 15, 2006,
net of unamortized debt discount of $626,161 (see below) 2,323,839
--=---------
4,217,171
Less: current portion (4,217,171)
------------
$ -
10% Secured Convertible Promissory Notes dated March 8, 2006
On March 8, 2006, in connection with a private placement, the Company
issued 10% Secured Convertible Promissory Notes in the aggregate principal
amount of $1,500,000 (the "Serial Notes") and warrants to purchase 3,000,000
shares of the Company's common stock to accredited investors. The Serial Notes
bear interest at 10%, mature on September 7, 2007 and are convertible into the
Company's common stock, at the holder's option, at fifty cents ($0.50) per share
during the period from the date of issuance (March 8, 2006) through March 7,
2007. Should the holder of the Serial Note elect not to convert to the Company's
common stock on or before March 7, 2007, the outstanding principal, along with
accrued and unpaid interest automatically converts to the Company's common stock
at an amount equal to 80% of the average bid price of the Company's common stock
on the Over-The-Counter Bulletin Board for a period equal to ten (10) days prior
to conversion on the maturity date of September 7, 2007. At any time prior to
conversion, the Company will have the right to prepay the promissory notes and
accrued but unpaid interest thereon in cash upon 3 days notice, allowing the
holders to convert the promissory notes during such notice period. The full
principal amount of the Serial Notes is due upon a default under the terms of
the Note Agreement. In addition, the Company granted the Investors a security
interest in all of its assets (see Note B). The Company agreed to file a
registration statement with the SEC to effect the registration of the shares of
its common stock underlying the Serial Notes and the warrants within 30 days of
the effective date of the Company's pending Registration Statement (SEC File 333
- 122848) being declared effective. The Company also agreed to use its
reasonable best efforts to cause the registration statement to be declared
effective no later than 180 days after its filing. If the Registration Statement
is not filed and declared effective as described above, the Company will be
required to pay liquidated damages in the form of cash to the holders of the
Serial Notes, in an amount equal to 2% of the unpaid principal balance per month
if the above deadlines are not met. In the event of a default on the Serial
Notes, the Serial Notes will bear interest at twelve percent (12%) per annum
until paid.
25
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
The warrants are exercisable for five years from March 8, 2006 until March
7, 2011 at a price of $0.50 per share. The Company has the right, but not the
obligation, to call these warrants for $1.25 per share at the earlier of (i) one
year from issuance or (ii) the date that shares of common stock issuable upon
conversion of the Serial Notes and exercise of the warrants are registered for
resale and the Company's common stock trades at or above $1.25 per share for
twenty (20) consecutive trading days. The Notes include certain features that
are considered embedded derivative financial instruments, such as a variety of
conversion options, a variable interest rate feature, events of default and a
variable liquidated damages clause.
The initial relative fair value assigned to the embedded derivatives was
$346,500.
In conjunction with the Notes, the Company issued warrants to purchase
3,000,000 shares of common stock. The accounting treatment of the derivatives
and warrants requires that the Company record the warrants at their fair values
as of the inception date of the debt issuance, which totaled $512,100.
The Company recorded the fair value of the derivatives ($346,500) and
warrants ($512,100) to debt discount, aggregating $858,600, which will be
amortized to interest expense over the term of the Notes. Amortization of
$143,100 was recorded for the three months ended December 31, 2006.
The market price of the Company's common stock significantly impacts the
extent to which the Company may be required or may be permitted to convert the
Serial Notes into shares of the Company's common stock. The lower the market
price of the Company's common stock at the due date of September 7, 2007, the
more shares the Company will need to issue to convert the principal and interest
payments then due on the Notes.
10% Secured Convertible Promissory Notes dated May 2, 2006
On May 2, 2006, in connection with a private placement, the Company issued
10% Secured Convertible Promissory Notes in the aggregate principal amount of
$1,000,000 (the "Serial Notes") and warrants to purchase 2,000,000 shares of the
Company's common stock to accredited investors. The Serial Notes bear interest
at 10%, mature on August 2, 2007 and are convertible into the Company's common
stock, at the holder's option, at fifty cents ($0.50) per share during the
period from the date of issuance (May 2, 2006) through May 2, 2007. Should the
holder of the Serial Note elect not to convert to the Company's common stock on
or before May 2, 2007, the outstanding principal, along with accrued and unpaid
interest automatically converts to the Company's common stock at an amount equal
to 80% of the average bid price of the Company's common stock on the
Over-The-Counter Bulletin Board during the 12 months prior to such conversion.
At any time prior to conversion, the Company will have the right to prepay the
promissory notes and accrued but unpaid interest thereon in cash upon 3 days
notice, allowing the holders to convert the promissory notes during such notice
period. The full principal amount of the Serial Notes is due upon a default
under the terms of the Note Agreement. In addition, the Company granted the
Investors a security interest in all of its assets (see Note B). The Company
agreed to file a registration statement with the SEC to effect the registration
of the shares of its common stock underlying the Serial Notes and the warrants
within 30 days of the effective date of the Company's pending Registration
Statement (SEC File 333 - 122848) being declared effective. The Company also
agreed to use its reasonable best efforts to cause the registration statement to
be declared effective no later than 180 days after its filing. In the event of a
default on the Serial Notes, the Serial Notes will bear interest at twelve
percent (12%) per annum until paid.
The warrants are exercisable for four years from May 2, 2007 until May 2,
2011 at a price of $0.50 per share. The Company has the right, but not the
obligation, to call these warrants for $0.001 per share at the earlier of (i)
one year from issuance and (ii) the date that shares of common stock issuable
upon conversion of the Serial Notes and exercise of the warrants are registered
for resale and the
26
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Company's common stock trades at and above $1.00 per share for twenty (20)
consecutive trading days. The Notes include certain features that are considered
embedded derivative financial instruments, such as a variety of conversion
options, a variable interest rate feature, events of default and a variable
liquidated damages clause.
The initial relative fair value assigned to the embedded derivatives was
$82,358.
In conjunction with the Notes, the Company issued warrants to purchase
2,000,000 shares of common stock. The accounting treatment of the derivatives
and warrants requires that the Company record the warrants at their fair values
as of the inception date of the debt issuance, which totaled $373,600.
The Company recorded the fair value of the derivatives ($82,358) and
warrants ($373,600) to debt discount, aggregating $455,958, which will be
amortized to interest expense over the term of the Notes. Amortization of
$91,200 was recorded for the three months ended December 31, 2006.
The market price of the Company's common stock significantly impacts the
extent to which the Company may be required or may be permitted to convert the
Serial Notes into shares of the Company's common stock. The lower the market
price of the Company's common stock at the due date of September 7, 2007, the
more shares the Company will need to issue to convert the principal and interest
payments then due on the Notes.
10% Secured Convertible Promissory Notes dated June 15, 2006
On June 15, 2006, in connection with a private placement, the Company
issued 10% Secured Convertible Promissory Notes in the aggregate principal
amount of $2,950,000 (the "Serial Notes") and warrants to purchase 5,900,000
shares of the Company's common stock to accredited investors. The Serial Notes
bear interest at 10%, mature on August 2, 2007 and are convertible into the
Company's common stock, at the holder's option, at fifty cents ($0.50) per share
during the period from the one years from the date of issuance (June 15, 2006)
through June 15, 2007. Should the holder of the Serial Note elect not to convert
to the Company's common stock on or before June 15, 2007, the outstanding
principal, along with accrued and unpaid interest automatically converts to the
Company's common stock at an amount equal to 80% of the average bid price of the
Company's common stock on the Over-The-Counter Bulletin Board during the 12
months prior to such conversion. At any time prior to conversion, the Company
will have the right to prepay the promissory notes and accrued but unpaid
interest thereon in cash upon 3 days notice, allowing the holders to convert the
promissory notes during such notice period. The full principal amount of the
Serial Notes is due upon a default under the terms of the Note Agreement. In
addition, the Company granted the Investors a security interest in all of its
assets (see Note B). The Company agreed to file a registration statement with
the SEC to effect the registration of the shares of its common stock underlying
the Serial Notes and the warrants within 30 days of the effective date of the
Company's pending Registration Statement (SEC File 333 - 122848) being declared
effective. The Company also agreed to use its reasonable best efforts to cause
the registration statement to be declared effective no later than 180 days after
its filing. In the event of a default on the Serial Notes, the Serial Notes will
bear interest at twelve percent (12%) per annum until paid.
The warrants are exercisable for four years from June 15, 2007 until June
15, 2011 at a price of $0.50 per share. The Company has the right, but not the
obligation, to call these warrants for $0.001 per share at the earlier of (i)
one year from issuance and (ii) the date that shares of common stock issuable
upon conversion of the Serial Notes and exercise of the warrants are registered
for resale and the Company's common stock trades at and above $1.00 per share
for twenty (20) consecutive trading days. The Notes include certain features
that are considered embedded derivative financial instruments, such as a variety
of conversion options, a variable interest rate feature, events of default and a
variable liquidated damages clause.
27
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
The initial relative fair value assigned to the embedded derivatives was
$175,321.
In conjunction with the Notes, the Company issued warrants to purchase
5,900,000 shares of common stock. The accounting treatment of the derivatives
and warrants requires that the Company record the warrants at their fair values
as of the inception date of the debt issuance, which totaled $929,840.
The Company recorded the fair value of the derivatives ($175,321) and
warrants ($929,840) to debt discount, aggregating $1,105,161, which will be
amortized to interest expense over the term of the Notes. Amortization of
$221,100 was recorded for the three months ended December 31, 2006.
The market price of the Company's common stock significantly impacts the
extent to which the Company may be required or may be permitted to convert the
Serial Notes into shares of the Company's common stock. The lower the market
price of the Company's common stock at the due date of September 7, 2007, the
more shares the Company will need to issue to convert the principal and interest
payments then due on the Notes.
$1,675,000 Convertible Notes
Convertible notes payable ("Bridge Unit Offering") in quarterly
installments of interest only at 10% per annum, secured by all assets of the
Company and due on the earlier of the 9 month anniversary date of the initial
closing of the offering or the completion of any equity financing of $3,000,000
or more; the Company, at its sole discretion may prepay principal at any time
without penalty. The Bridge Unit Offering Notes unpaid principal along with
accrued and unpaid interest were converted to an aggregate of 4,988,051 shares
of the Company's common shares at a price equal to approximately $0.33 per share
during the quarter ended March 31, 2005.
$1,465,000 Convertible Notes
Beginning in December, 2004, the Company sold a 10% convertible debenture
in the aggregate amount of $1,465,000 in a private placement and exempt
offerings to sophisticated investors, net of costs and fees.
The Convertible Note's terms called for the debt to automatically convert
at $0.50 per share upon the filing a of a registration statement with the
Securities and Exchange Commission.
The Company filed the registration statement on February 15, 2005 and the
Convertible Notes were converted to an aggregate of 2,930,000 shares of the
Company's common stock in February 2005.
As additional consideration for the purchase of the Convertible Notes, the
Company granted to the holders warrants entitling it to purchase 2,930,000
common shares of the Company's common stock at the price of $0.75 per share.
These warrants were issued in February, 2005 and lapse if unexercised by
February, 2010. A registration rights agreement was executed in December 2004
and consummated in February, 2005 requiring the Company to register the shares
of its common stock underlying the Convertible Notes and warrants so as to
permit the public resale thereof. The registration rights agreement provided for
the payment of liquidated damages of 3.5% of the aggregate Convertible Note
financing per month if the stipulated registration deadlines were not met. The
liquidated damages, which approximate $51,275 per month, may be paid, at the
Company's option, in cash or unregistered shares of the Company's common stock.
In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Convertible
28
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Notes. The Company allocated a portion of the proceeds equal to the intrinsic
value of that feature to additional paid-in capital. The Company recognized and
measured an aggregate of $1,465,000 of the proceeds, which is equal to the
intrinsic value of the imbedded beneficial conversion feature, to additional
paid-in capital and a discount against the Convertible Notes. Since the
Convertible Notes were converted to the Company's common stock in February 2005,
the debt discount attributed to the beneficial conversion feature of $1,465,000
was charged to interest expense in its entirety during the six months ended
March 31, 2005.
In conjunction with raising capital through the issuance of Convertible
Notes, the Company has issued a warrant in February, 2005 that has registration
rights for the underlying shares. As the contract must be settled by the
delivery of registered shares and the delivery of the registered shares is not
controlled by the Company, pursuant to EITF 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock", the net value of the warrants at the date of issuance was recorded as a
warrant liability on the balance sheet $3,845,039 and charged to operations as
interest expense. Upon the registration statement being declared effective, the
fair value of the warrant on that date will be reclassified to equity. The
Company initially valued the warrants using the Black-Scholes pricing model with
the following assumptions: (1) dividend yield of 0%; (2) expected volatility of
148.66%, (3) risk-free interest rate of 3.21%, and (4) expected life of 3 years.
In connection with the placement of the $1,465,000 of convertible notes as
described above, the Company agreed to registered shares of the Company's common
stock underlying certain previously issued and outstanding warrants that were
not subject to a registration rights agreement at the time the warrants were
issued. These warrants consist of following:
o 105,464 warrants entitling the holder to purchase 105,464 shares of
the Company's common stock at the price of $0.10 per share. These
warrants were issued in July, 2004 and lapse if unexercised by July,
2009.
o 1,602,500 warrants entitling the holder to purchase 1,602,500 shares
of the Company's common stock at the price of $0.60 per share. These
warrants were issued in October, 2003 and lapse if unexercised by
October, 2008.
As a result, the Company is required to classify the warrants as derivative
liabilities and mark then to market at each reporting date. The fair value of
the warrants that were subject to registration reclassified as liabilities from
additional paid in capital at February 2005 totaled $3,108,851. Upon the
registration statement being declared effective, the fair value of the warrants
on that date will be reclassified to equity. The Company initially valued the
warrants using the Black-Scholes pricing model with the following assumptions:
(1) dividend yield of 0%; (2) expected volatility of 148.66%, (3) risk-free
interest rate of 3.21%, and (4) expected life of 3 years.
$7,371,000 Convertible Notes
In January and February, 2005, the Company sold a 10% convertible debenture
in the aggregate amount of $7,371,000 in a private placement and exempt
offerings to sophisticated investors, net of costs and fees.
The Convertible Note's terms called for the debt to automatically convert
at $0.50 per share upon the filing of a registration statement with the
Securities and Exchange Commission.
The Company filed the registration statement on February 15, 2005 and the
Convertible Notes were converted to an aggregate of 14,742,000 shares of the
Company's common stock.
29
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
As additional consideration for the purchase of the Convertible Notes, the
Company granted to the holders warrants entitling it to purchase 14,742,000
common shares of the Company's common stock at the price of $0.75 per share.
These warrants lapse if unexercised by February, 2010. A registration rights
agreement was executed and consummated in January, 2005 requiring the Company to
register the shares of its common stock underlying the Convertible Notes and
warrants so as to permit the public resale thereof. The registration rights
agreement provided for the payment of liquidated damages of 3.5% of the
aggregate Convertible Note financing per month if the stipulated registration
deadlines were not met. The liquidated damages, which approximate $257,985 per
month, may be paid, at the Company's option, in cash or unregistered shares of
the Company's common stock.
In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Convertible Notes. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid-in capital. The Company recognized and measured an aggregate
of $7,731,000 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid-in capital and a
discount against the Convertible Notes. Since the Convertible Notes were
converted to the Company's common stock in February 2005, the debt discount
attributed to the beneficial conversion feature of $7,371,000 was charged to
interest expense in its entirety during the six months ended March 31, 2005.
In conjunction with raising capital through the issuance of Convertible
Notes, the Company has issued warrants that have registration rights for the
underlying shares. As the contract must be settled by the delivery of registered
shares and the delivery of the registered shares is not controlled by the
Company, pursuant to EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", the
net value of the warrants at the date of issuance was recorded as a warrant
liability on the balance sheet $19,303,175 and charged to operations as interest
expense. Upon the registration statement being declared effective, the fair
value of the warrant on that date will be reclassified to equity. The Company
initially valued the warrants using the Black-Scholes pricing model with the
following assumptions: (1) dividend yield of 0%; (2) expected volatility of
152.59%, (3) risk-free interest rate of 3.67%, and (4) expected life of 5 years.
NOTE D - CAPITAL STOCK
The Company is authorized to issue 10,000,000 shares of preferred stock
with a $0.001 par value per share. The Company is authorized to issue
250,000,000 shares of common stock, with a $0.001 par value per share as the
result of a shareholder meeting conducted on February 14, 2005. Prior to the
February 14, 2005 share increase and par value change, the Company had
100,000,000 authorized shares with a par value of $0.50. In February 2005, the
Company passed a resolution authorizing change in the par value per common
shares from $0.50 per share to $0.001 per share.
During the period September 16, 2002 through September 30, 2003, the
Company issued 100,000 shares of common stock in exchange for reimbursement of
services provided by the founders of the Company. The Company valued the shares
issued at approximately $1,000, which represents the fair value of the services
received which did not differ materially from the value of the stock issued.
In October, 2002, the Company issued 10,178,352 shares of common stock in
exchange for the previously issued 100,000 shares to the Company's founders in
connection with the merger with Prohealth Medical Technologies, Inc.
In October, 2002 the Company canceled 100,000 shares of common stock issued
to the Company's founders.
30
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
During the fiscal year ended September 30, 2003, the Company issued
2,369,130 shares of common stock, net of cancellation of 860,000 shares in
exchange for consulting services. The Company valued the shares issued at
$2,191,227, net of cancellation of $60,008, which represents the fair value of
the services received which did not differ materially from the value of the
stock issued.
In November 2003, the Company issued 876,000 shares of common stock in
exchange for subscription at approximately $0.065 per share.
In January 2003, the Company issued 1,500,000 shares of common stock in
exchange for a licensing agreement. The Company valued the shares issued at
approximately $0.065 per share, which represents the fair value of the license
received which did not differ materially from the value of the stock issued. The
Company charged the cost of the license to operations.
In March 2003, the Company issued 10,140,000 shares of common stock to
Company's founders in exchange for services. In accordance with EITF 96-18 the
measurement date to determine fair value was in September 2002. This was the
date at which a commitment for performance by the counter party to earn the
equity instrument was reached. The Company valued the shares issued at
approximately $0.0001 per share, which presents the fair value of the services
received which did not differ materially from the value of the stock issued.
In connection with the Company's acquisition of ProHealth, the controlling
owner of ProHealth granted the Company an option to acquire up to 8,500,000
shares of the Company's common stock in exchange for $100,000. The option
expired on December 10, 2004. On June 30, 2003, the Company exercised its option
and acquired 7,500,000 common shares under this agreement in exchange for an
$88,500 convertible promissory note payable to the former controlling owner. The
Company had an option through December 10, 2004 to acquire the remaining
1,000,000 shares from the former controlling owner in exchange for $11,500. On
June 30, 2003, the Company retired the 7,500,000 shares common acquired pursuant
to the option agreement.
In September 2003, the Company issued 19,200 shares of common stock for
cash previously subscribed at $2.50 per share.
During the fiscal year ended September 30, 2003, the Company issued 154,000
shares of common stock in exchange for previously issued options to purchase the
Company's common stock at $1.00 per share.
During the fiscal year ended September 30, 2003, the Company issued 74,400
shares of common stock in exchange for cash at approximately $0.89 per share.
In October 2003, the Company issued 15,000 shares of convertible preferred
stock in exchange for services. The Company valued the shares issued at the $15
par value and recorded the value for services when the shares were converted
into common shares as identified below.
During the fiscal year ended September 30, 2004, the Company issued
5,149,472 shares of common stock, net of cancellation of 155,000 shares, in
exchange for consulting services. The Company valued the shares issued at
$8,787,315, net of cancellation of $408,575, which represents the fair value of
the services received which did not differ materially from the value of the
stock issued
During the fiscal year ended September 30, 2004, the Company issued 340,500
shares of common stock for shares previously subscribed at approximately $2.04
per share.
In March 2004, the Company issued 55,000 of common stock for options
exercised at $1.00 per share.
31
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
During the fiscal year ended September 30 2004, the Company converted
15,000 preferred shares into 375,000 shares of common stock at $1.47 per share
in exchange for employee services valued at $549,750.
In June 2004, the Company sold 250,000 shares of common stock at $1.00 per
share for total proceeds of $250,000 pursuant to private placement.
In September 2004, the Company issued 60,000 convertible preferred shares
at $25.00, in exchange for consulting services valued at $1,500,000.
During the fiscal year ended September 30, 2005, the Company issued
11,040,647 shares of common stock, net of cancellation of 2,329,600 shares, in
exchange for consulting and employee services. The Company valued the shares
issued at $13,008,371, net of cancellation of $1,328,269, which represents the
fair value of the services received which did not differ materially from the
value of the stock issued
During the fiscal year ended September 30, 2005, the Company issued
1,500,000 shares of common stock for shares previously subscribed at
approximately $0.54 per share.
During the fiscal year ended September 30, 2005, the Company issued 267,500
shares of common stock for warrants and options exercised at approximately $0.39
per share
In October 2004, the Company issued 500,000 shares of common stock in
exchange for debt at $0.50 per share.
In December 2004, the Company issued net 5,500,000 shares of common stock
for default as per terms of notes payable for $88,500. Out of total, 3,500,000
shares were retained in escrow on behalf of another party for future deferred
compensation.
In February 2005, the Company in exchange for a related party note in the
outstanding principal amount of $600,000 and as settlement for certain claims
related thereto issued 1,500,000 shares of common stock using a price of $1.31
per share. (See note G)
In March, 2005, the Company granted an aggregate of 300,000 stock options
to employees that vested immediately. The exercise prices of the stock options
granted were below the fair value of the Company's common stock at the grant
date. Compensation expense of $180,000 and $0 was charged to operations during
the period ended March 31, 2005 and 2004, respectively.
In June 2005, the Company cancelled 300,000 stock options previously
granted valued at $180,000. In accordance with EITF 96-18 the measurement date
to determine fair value was the date at which a commitment for performance by
the counter party to earn the equity instrument was reached. The Company valued
the shares issued for consulting services at the rate which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In July 2005, the Company issued 36 million shares in exchange for
intellectual property at approximately $0.67 per share for a total of
$24,120,000. The value of the acquired intangible assets was established at
$9,430,900, with the balance of the purchase price, or $14,689,100, charged to
operations as a cost of the transaction. (See Note B)
In 2005, the Company issued 8,550,000 shares of its common stock without
restriction to employees in exchange for services rendered. The Company valued
the shares issued at market value and charged to operations in the period the
shares were issued. The Company is investigating the circumstances surrounding
the issuance of the shares and the possible subsequent resale of certain of the
shares on the open market and the possibility of violations of securities laws
(see Note H).
32
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Until the Company successfully completes its pending registration statement
on SEC Form SB-2, the Company is subject to liquidated damages (see Note D). In
connection with the $1,465,000 and $7,371,000 million convertible debt
financing, the Company was obligated to deliver registered shares underlying the
convertible notes and warrants by July 2005. Since the registration was not
effective by July 2005, the Company has been accruing and charging to operations
the stipulated liquidated damages in shares of the Company's common stock
accruing at a rate of 3.5% per month on the face value of the previously issued
convertible notes. During the year ended September 30, 2005, the Company has
paid and charged to operations penalties of $776,529 in the form of 605,382
unregistered shares of its common stock to the former note holders.
In October, 2005, the Company issued 400,000 shares of common stock
subscribed for cash at $0.50 per share for a total of $200,000 pursuant to the
terms of a subscription payable. This issuance is considered exempt under
Regulation D of the Securities Act of 1933 and Rule 506 promulgated thereunder.
In October 2005, the Company issued 100,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.75 per share for a total of $75,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In October 2005, the Company cancelled 350,000 shares previously issued for
services valued at $210,000.
In December, 2005, the Company issued 40,000 shares of common stock
subscribed for cash at $0.50 per share for a total of $20,000 pursuant to the
terms of a subscription payable. This issuance is considered exempt under
Regulation D of the Securities Act of 1933 and Rule 506 promulgated thereunder.
For the fiscal year ended September 30, 2005, the Company issued a total of
2,096,139 penalty shares pursuant to a registration rights agreement. In
connection with the 7,371,000 million convertible debt financing in the quarter
ended March 31, 2005, the Company was obligated to complete a stock registration
by July 2005. Since the registration statement was not effective by July 2005,
the Company paid the required $773,959 of liquidated damages in shares of
Company stock accruing at the rate of 3.5% per month on the face value of the
Notes for the month of September 2005. The Company valued the shares issued at
approximately $0.30 per share for a total of $773,959. The Company continues to
accrue the penalties relating to the pending registration statement.
In January, 2006, the Company cancelled 250,000 shares previously issued
for services valued at $150,000.
In January 2006, the Company issued 2,096,139 penalty shares pursuant to a
registration rights agreement. In connection with the 7,371,000 million
convertible debt financing in the quarter ended March 31, 2005, the Company was
obligated to complete a stock registration by July 2005. Since the registration
statement was not effective by July 2005, the Company paid the required $257,985
of liquidated damages in shares of Company stock accruing at the rate of 3.5%
per month on the face value of the Notes for the month of November and December
2005. The Company valued the shares issued at approximately $0.25 per share for
a total of $515,973. The Company continues to accrue the penalties relating to
the pending registration statement.
In February 2006, the Company issued 160,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.17 per share for a total of $27,200, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued
33
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
In February 2006, the Company issued 3,800,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.16 per share for a total of $608,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued
In March 2006, the Company cancelled 150,000 shares previously issued for
services valued at $120,000.
In December 2006, the Company issued 180,000 shares of common stock in
settlement of a previously incurred debt of $410,429 held by a related party
(see Note G).
NOTE E - STOCK OPTIONS AND WARRANTS
Warrants
The following table summarizes the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company. These warrants were granted in lieu of cash
compensation for services performed or financing expenses in connection with the
sale of the Company's common stock.
Warrants Exercisable
Outstanding Weighted Weighted
Remaining Average Weighted Average
Exercise Number Contractual Exercise Average Exercise
Prices Outstanding Life(Years) Price Exercisable Price
---------------- ---------------- ------------------------ --------------- ---------------- ---------------
$0.09 18,900,000 4.67 $0.09 18,900,000 $0.09
$0.10 105,464 2.51 $0.10 105,464 $0.10
$0.20 5,000 2.14 $0.20 5,000 $0.20
$0.50 16,450,000 3.52 $0.50 8,550,000 $0.50
$0.55 9,000,000 2.22 $0.55 9,000,000 $0.55
$0.60 8,847,000 3.13 $0.60 8,847,000 $0.60
$0.70 950,000 1.34 $0.70 950,000 $0.70
$0.75 17,727,000 3.50 $0.75 17,727,000 $0.75
---------- ----------
71,984,464 64,084,464
========== ==========
Transactions involving warrants are summarized as follows:
Weighted
Average
Number of Price Per
Shares Share
----------- ----------
Balance, September 30, 2004 4,870,253 $0.63
Granted 32,873,000 0.71
Exercised (142,500) 0.34
Canceled or expired (731,289) 0.65
----------- -----
Balance, September 30, 2005 36,869,464 0.67
Granted 35,500,000 0.29
Exercised - -
Canceled or expired - -
----------- -----
Outstanding at September 30, 2006 72,369,464 0.48
Granted - -
Exercised - -
Canceled or expired (385,000) (0.71)
----------- -----
Balance, December 31, 2006 71,984,464 $0.48
=========== =====
34
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
Employee Stock Options
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 a non-qualified employee stock option plan.
Options Outstanding Options Exercisable
-------------------------------------------- ----------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (Years) Price Exercisable Price
-------------- ------------- ------------ -------------- ------------ --------------
$ 0.68 3,660,000 4.75 $ 0.68 2,745,000 $ 0.68
0.09 2,000,000 4.91 0.09 500,000 0.09
--------- ---------
5,660,000 3,245,000 0.47
Transactions involving stock options issued to employees are summarized as
follows:
Number of Weighted Average Exercise
Shares Price Per Share
---------- -------------------------
Outstanding at October 1, 2005 3,660,000 $0.68
Granted 2,000,000 0.09
Exercised - -
Cancelled or expired - -
- -
Outstanding at September 30, 2006 5,660,000 $0.47
--------- -----
Granted - -
Exercised - -
Canceled or expired - -
- -
--------- -----
Outstanding at December 31, 2006 5,660,000 $0.47
The Company did not grant any employee options during the three months
ended December 31, 2006.
Effective January, 2006, the Company adopted SFAS 123R and recognized
compensation expense in its financial statements in fiscal 2006. Prior to the
adoption of SFAS 123R, the Company
35
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
accounted for its stock option plans according to Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no
compensation costs were recognized upon issuance or exercise of stock options
for fiscal 2005.
SFAS No. 123, "Accounting for Stock-Based Compensation," required the
disclosure of the estimated fair value of employee option grants and their
impact on net income using option pricing models that are designed to estimate
the value of options that, unlike employee stock options, can be traded at any
time and are transferable. In addition to restrictions on trading, employee
stock options may include other restrictions such as vesting periods. Further,
such models require the input of highly subjective assumptions, including the
expected volatility of the stock price.
NOTE F - DEBT DERIVATIVE AND WARRANT LIABILITY
In accordance with SFAS 133 "Accounting for Derivative Instruments and
Hedging Activities and EITF 00-19 "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", the
Company accounted for identified embedded derivatives and warrants to purchase
its common stock that provide for the payment of liquidated damages if the
stipulated registration deadlines were not met as liabilities.
As of the date of this filing, the registration statement has not yet been
declared effective by the SEC. The Company determined the fair value of the
embedded derivatives and valued the warrants using the Black-Scholes option
pricing model. Assumptions regarding the life were one to five years, expected
dividend yield of 0%, a risk free rate of 4.74 to 5.00%, and a volatility of
83.69%. The determined value of both the warrants and the underlying embedded
derivatives as of December 31, 2006 was $2,432,324. The net change in the fair
value of the derivative and warrant liability values from September 30, 2006 has
been recorded as a gain from change in debt derivative and warrant liabilities
in the consolidated condensed statement of operations.
NOTE G- RELATED PARTY TRANSACTIONS
On December 12, 2006, the Company issued 180,000 shares of its common stock
as settlement of the outstanding related party note payable of $410,429 and
related accrued interest of $8,884 (see Note D).
The Company's officers have advanced funds to the Company for travel
related and working capital purposes. No formal repayment terms or arrangements
exist. There were no advances due at December 31, 2006.
On July 15, 2005, the Company entered into a consulting agreement with
Timpix International Limited ("Timpix") for the consulting services of three
former Biowell employees, Drs. Jun-Jei Sheu, Ben Liang and Johnson Chen. The
consulting agreement is for the shorter of two years, or until all of the
consultants have obtained a visa to work in the United States and execute
employment agreements with the Company. The consulting agreement shall
automatically renew for one year periods until terminated. Pursuant to the
consulting agreement, the Company is obligated to pay $47,000 per month, which
is apportioned at $20,000 per month for Mr. Sheu, $15,000 per month for Mr.
Liang and $12,000 per month for Mr. Chen. In the event that either of Messrs.
Sheu, Liang or Chen becomes employed by us, the monthly consulting fee shall be
reduced accordingly. We have negotiated an agreement in principle to restructure
the Consulting Agreement, whereby, fees owed to Timpix from July 2005 through
December 2005 will be waived, and salaries for each of the three consultants
will be reduced starting January 1, 2006.
36
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
On November 13, 2006, The Company restructured its consulting agreement
with Timpix for consulting services of three former Biowell employees. Drs
Jun-Jei Sheu, Ben Liang and Johnson Chen. The restructured consulting agreement
expires on July 15, 2007 or until all of the consultants have obtained a visa to
work in the United States and execute employment agreements with the Company.
The revised consulting agreement shall automatically renew for one year periods
until terminated. Pursuant to the agreement, the Company is obligated to pay
$120,000, $100,000 and $80,000 per year pro-rated for each week, or part
thereof, of time spent within the United States providing full time services for
Drs Jun-Jei Sheu, Ben Lang and Johnson Chen, respectively. The Company is
obligated to provide a corporate house for the Consultants while working in the
United States. All previous fees incurred through November 13, 2006 have been
waived.
In July 2005, the Company entered into a license agreement with Biowell,
whereby the Company granted Biowell an exclusive license to sell, market, and
sub-license the Company's products in selected Asian countries. The exclusive
license for such selected territories is for an initial period of until December
31, 2010, and if Biowell meets its performance goals, the license agreement will
extend for an additional five year term. The license agreement gives Biowell the
initial rights to future anti-fraud biotechnologies developed by the Company and
also new applications for the existing technology that may be developed for the
marketplace as long as the license agreement remains in effect. In the event
that Biowell shall sub-license the products within its territories, Biowell
shall pay the Company 50% of all fees, payments or consideration or any kind
received in connection with the grant of the sublicense. Biowell is required to
pay a royalty of 10% on all net sales made and is required to meet certain
minimum annual net sales in its various territories. Cumulative royalties earned
from the period July 2005 through December 31, 2006 totaled $34,698. Net amounts
owed to the Company by Biowell in connection with the royalty agreement as of
September 30, 2006 are $9,396.
NOTE H - COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
The Company leases office space under operating lease in Stony Brook, New
York for its corporate use from an entity controlled by significant former
shareholder, expiring in November 2007. In November 2005, the Company vacated
the Los Angeles facility to relocate to the new Stony Brook New York address.
Total lease rental expenses for the three months ended December 31, 2006 was
$12,500.
Employment and Consulting Agreements
The Company has consulting agreements with outside contractors, certain of
whom are also Company stockholders. The Agreements are generally month to month.
On July 15, 2005, we entered into a consulting agreement with Timpix for
the consulting services of three former Biowell employees, Drs. Jun-Jei Sheu,
Ben Liang and Johnson Chen. The consulting agreement is for the shorter of two
years, or until all of the consultants have obtained a visa to work in the
United States and execute employment agreements with us. Such consulting
agreement shall automatically renew for one year periods until terminated.
Pursuant to the consulting agreement, we shall pay $47,000 per month, which is
apportioned at $20,000 per month for Mr. Sheu, $15,000 per month for Mr. Liang
and $12,000 per month for Mr. Chen. In the event that either of Messrs. Sheu,
Liang or Chen becomes employed by us, the monthly consulting fee shall be
reduced accordingly. The Company has negotiated an agreement to restructure the
Consulting Agreement, whereby, fees owed to Timpix from July 2005 through
September 2006 will be waived.
On November 13, 2006, The Company restructured its consulting agreement
with Timpix International Limited ("Timpix") for consulting services of three
former Biowell employees. Drs Jun-Jei Sheu, Ben Liang and Johnson Chen. The
restructured consulting agreement expires on July 15, 2007 or
37
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
until all of the consultants have obtained a visa to work in the United States
and execute employment agreements with the Company. The revised consulting
agreement shall automatically renew for one year periods until terminated.
Pursuant to the agreement, the Company is obligated to pay $120,000, $100,000
and $80,000 per year pro-rated for each week, or part thereof, of time spent
within the United States providing full time services for Drs Jun-Jei Sheu, Ben
Lang and Johnson Chen, respectively. The Company is obligated to provide a
corporate house for the Consultants while working in the United States. All
previous fees incurred through November 13, 2006 have been waived.
Litigation
On or about November 24, 2004, Oceanic Consulting, S.A. filed a complaint
against the Company in the Superior Court of the State of New York. The
Complaint alleges a breach of contract. The Company and the Plaintiff settled
the dispute and the Company recorded the settlement amount as of September 30,
2006.
On or about January 10, 2005, Stern & Co. filed a complaint against the
Company in the United States District Court for the Southern District of New
York. The Complaint alleges a breach of contract. Subsequent to the date of the
financial statements, the Company and the Plaintiff settled the dispute and the
Company recorded the settlement amount as of September 30, 2006.
On April 29, 2005, Crystal Research Associates, LLC obtained a default
judgment against us for $13,000 in the Superior Court of New Jersey, Middlesex
County. The Company settled this matter in May 2006.
On or about January 12, 2006, James Paul Brown, a former consultant to the
Company filed a complaint against the Company in the Superior Court of the State
of California. The Complaint alleges a breach of contract. Subsequent to the
date of the financial statements, the Company and the Plaintiff settled the
dispute and the Company recorded the settlement amount as of September 30, 2006.
In January 2006, a former employee of the Company filed a complaint
alleging wrongful termination against the Company. The former employee is
seeking $230,000 in damages. The Company believes that it has meritorious
defenses to the plaintiff's claims and intends to vigorously defend itself
against the Plaintiff's claims. Management believes the ultimate outcome of this
matter will not have a material adverse effect on the Company's consolidated
financial position or results of operations.
On or about April 4, 2006, the Company filed a complaint against Paul Reep,
Adrian Butash, John Barnett, Chanty Cheang, Jaime Cardona (former Company
employees and officers), and Angela Wiggins ( a former consultant to the
Company) in the United States District Court for the Central District of
California. The Company has asked the court to make a judicial determination
that an agreement, which the Company did not authorize and which is the basis of
previously disclosed litigation against the Company by Paul Reep, a former
employee of the Company, and a new action filed by former employees of the
Company as set forth in the subsequent paragraph, is invalid and unenforceable.
This matter is in its early stages.
On or about April 17, 2006, former employees of the Company filed a
complaint against the Company and certain of its current officers and Directors
in Los Angeles County Superior Court. The Complaint alleges a breach of
contract, violations of California Labor Code and wrongful termination and is
seeking $950,000 in specified damages, plus fees and costs. The complaint
alleges a breach of contract. The Company believes that it has meritorious
defenses to the plaintiff's claims and intends to vigorously defend itself
against the Plaintiff's claims. Management believes the ultimate outcome of this
matter will not have a material adverse effect on the Company's consolidated
financial position or results of operations.
38
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
The Company is subject to other legal proceedings and claims, which arise
in the ordinary course of its business. Although occasional adverse decisions or
settlements may occur, the Company believes that the final disposition of such
matters should not have a material adverse effect on its financial position,
results of operations or liquidity.
Registration of Company's Shares of Common Stock
Until the Company successfully completes its pending registration statement
on SEC Form SB-2, the Company is subject to liquidated damages (see Notes D and
H). In connection with the $1,465,000 and $7,371,000 million convertible debt
financing during the quarters ended December 31, 2004 and March 31, 2005,
respectively, the Company was obligated to deliver registered shares underlying
the convertible notes and warrants by July 2005 (see Note C). Since the
registration was not effective by July 2005, the Company has been accruing and
charging to operations the stipulated liquidated damages in shares of Company
stock accruing at the rate of 3.5% per month on the face value of the previously
issued convertible notes. During the year ended September 30, 2006, the Company
has paid and charged to operations penalties of $773,958 in the form of
unregistered shares of its common stock to the former note holders, and has
accrued and charged to operations an additional $5,129,011 representing unpaid
penalties through December 31, 2006.
Matters Voluntarily Reported to the SEC and Securities Act Violations
We previously disclosed that we were investigating the circumstances
surrounding certain issuances of 8,550,000 shares to employees and consultants
in July 2005 (see Note G), and have engaged our new outside counsel to conduct
this investigation. We have voluntarily reported our current findings from the
investigation to the SEC, and we have agreed to provide the SEC with further
information arising from the investigation. We believe that the issuance of
8,000,000 shares to employees in July 2005 was effectuated by both our former
President and our former Chief Financial Officer/Chief Operating Officer without
approval of the Board of Directors. These former officers received a total of
3,000,000 of these shares. In addition, it appears that the 8,000,000 shares
issued in July 2005, as well as an additional 550,000 shares issued to employees
and consultants in March, May and August 2005, were improperly issued without a
restrictive legend stating that the shares could not be resold legally except in
compliance with the Securities Act of 1933, as amended. The members of our
management who effectuated the stock issuances that are being examined in the
investigation no longer work for us. We believe that we may incur significant
costs and expenses in continuing this investigation. In the event that any of
the exemptions from registration with respect to the issuance of the Company's
common stock under federal and applicable state securities laws were not
available, the Company may be subject to claims by federal and state regulators
for any such violations. In addition, if any purchaser of the Company's common
stock were to prevail in a suit resulting from a violation of federal or
applicable state securities laws, the Company could be liable to return the
amount paid for such securities with interest thereon, less the amount of any
income received thereon, upon tender of such securities, or for damages if the
purchaser no longer owns the securities. As of the date of these financial
statements, the Company is not aware of any alleged specific violation or the
likelihood of any claim. There can be no assurance that litigation asserting
such claims will not be initiated, or that the Company would prevail in any such
litigation.
The Company is unable to predict the extent of its ultimate liability with
respect to any and all future securities matters. The costs and other effects of
any future litigation, government investigations, legal and administrative cases
and proceedings, settlements, judgments and investigations, claims and changes
in this matter could have a material adverse effect on the Company's financial
condition and operating results.
39
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
NOTE I - RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements as of December
31, 2005 and the three months ended December 31, 2005 have been restated to
correct the following errors in its previously issued financial statements.
o In connection with our review of our outstanding warrants and options
to acquire our Company's stock during the year ended September 30,
2005, the Company determined it erroneously classified as equity
warrants that should have been classified as derivative liabilities.
The Company determined the warrants have registration rights for the
underlying common shares and the contract must be settled by the
delivery of registered shares. Since the delivery of the registered
shares is not controlled by the Company, pursuant to EITF 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock", the warrants are to be
recorded as a derivative liability and valued at fair market value
until the Company meets the criteria under EITF 00-19 for permanent
equity. The net value of the warrants at the date of issuance was
recorded as a warrant liability on the balance sheet and the change in
fair value from the date of issuance to December 31, 2005 of
$6,788,790 has been included in other income in the accompanying
restated financial statements.
o In connection with our review of our outstanding warrants and options
to acquire our Company's stock, the Company determined $329,700 of
liquidated damages payable to investors pursuant to the terms of the
Registration Rights Agreement had not been accounted for and recorded
as a selling, general and administrative expense.
o In connection with our review of our outstanding warrants and options
to acquire our Company's stock, the Company determined the issuance of
5,500,000 warrants to acquire the Company's common stock in connection
with the issuance of debt was erroneously valued at $563,750 and was
erroneously charged to selling, general and administrative expense;
the fair value of the warrants was $1,758,900 and has been charged to
interest expense.
The impact of these restatement adjustments is to decrease the reported net
loss by $5,263,940 from a loss of $2,444,489 to net income of $2,819,451 for the
three months ended December 31, 2005. There was no effect on total cash flows
provided by (used in) operations, investing or financing activities.
The following are reconciliations of the Company's condensed consolidated
statements of income for the three months ended December 31, 2005 and the
condensed consolidated statement of cash flows for the three months ended
December 31, 2005:
(1) Under Selling, general and administrative:
a. Recording three month liquidation damages relating to December
2004 Convertible note discussed in Note C above of $153,825
b. Recording three month liquidation damages relating to 2003 bridge
Convertible note discussed in Note C above of $175,875.
c. The Company originally recorded under Selling, general and
administrative an estimate of the fair value of warrants issued
in conjunction with the November 2005 convertible notes of
$563,950
The net effect to selling, general and administrative is a reduction of
$234,250, net of items a, b and c above.
40
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
(2) Under Net gain/loss on reevaluation of debt derivative and warrant
liability:
Recording of the change in warrant valuation from September 30, 2005
(previous reporting period) to December 31, 2005 of $6,788,790
(3) Under Interest Income (expense):
In conjunction with raising capital through the issuance of
Convertible Notes, the Company has issued warrants that have
registration rights for the underlying shares. As the contract must be
settled by the delivery of registered shares and the delivery of the
registered shares is not controlled by the Company, pursuant to EITF
00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock", the net value of
the warrants at the date of issuance was recorded as a warrant
liability on the balance sheet $1,758,900 and charged to operations as
interest expense. Upon the registration statement being declared
effective, the fair value of the warrant on that date will be
reclassified to equity. The Company initially valued the warrants
using the Black-Scholes pricing model with the following assumptions:
(1) dividend yield of 0%; (2) expected volatility of 156%, (3)
risk-free interest rate of 4.55%, and (4) expected life of 5 years.
41
APPLIED DNA SCIENCES, INC
(a development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(Unaudited)
NOTE I - RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
Condensed Consolidated Statement of Income (Losses)
For the Three Months Ended December 31, 2005
As previously
Reported Adjustment Reference As Restated
------------- ------------ -------- -------------
Selling, general & administrative $ 2,078,727 $ (234,250) 1 $ 1,844,477
Research and development $ 342,699 $ 342,699
Depreciation $ 16,270 $ $ 16,270
Total operating expenses $ 2,437,696 $ (234,250) 1 $ 2,203,446
Net loss from operations $ (2,437,696) $ (234,250) 1 $ (2,203,446)
Net gain (loss) in fair value of debt derivative and
warrant liability $ - $ 6,788,790 2 $ 6,788,790
Other income (expense) $ 13,013 $ $ 13,013
Interest income (expense) $ (19,806) $ (1,758,900) 3 $ (1,778,906)
Net income (loss) $ (2,444,489) $ 5,263,940 1,2,3 $ 2,819,451
Net income (loss) per share-basic $ (0.02) 0.05 $ 0.03
Net income (loss) per share-fully diluted NA 0.02 $ 0.02
Condensed Consolidated Statement of Cash Flows
For the Three Months Ended December 31, 2005
Cash flows from operating activities
Net income (loss) $ (2,444,489) $ 5,263,940 1,2,3 $ 2,819,451
Adjustments to reconcile to net used in operating
activities
Depreciation and amortization $ 336,942 $ $ 336,942
Warrants issued to consultants $ 563,750 $ (563,750) 1 $ -
Income attributable to repricing of warrants and debt
derivatives $ - $ (6,788,790) 2 $ (6,788,790)
Financing costs attributable to issuance of warrants $ - $ 1,758,900 3 $ 1,758,900
Common stock issued in exchange for services $ 75,000 $ $ 75,000
Common stock issued as penalty in connection with
financing $ 257,986 $ $ 257,986
Common stock canceled-previously issued for services
rendered $ (210,000) $ $ (210,000)
Increase in other assets $ (4,975) $ $ (4,975)
Increase in due related parties $ 53,805 $ $ 53,805
Increase (decrease) in accounts payable and accrued
liabilities $ 958,611 $ 329,700 1 $ 1,288,311
Net cash used in operating activities $ (413,370) $ $ (413,370)
Cash flows from investing activities:
Payments for patent filing $ 6,103 6,103
Capital expenditures $ (9,397) $ $ (9,397)
Net cash used in investing activities $ (3,294) $ $ (3,294)
Cash flows from financing activities
Proceeds from loans $ 550,000 $ $ 550,000
Net cash provided by financing activities $ 550,000 $ $ 550,000
Net increase in cash and cash equivalents $ 133,336 $ $ 133,336
Cash and cash equivalents at beginning of period $ 31,190 $ $ 31,190
Cash and cash equivalents at end of period $ 164,526 $ $ 164,526
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with our
Consolidated Financial Statements and Notes thereto, included elsewhere within
this report. The quarterly report contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
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:
o discuss our future expectations;
o contain projections of our future results of operations or of
our financial condition; and
o 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.
Introduction
We provide botanical DNA encryption, embedment and authentication
solutions that can help protect companies, governments and consumers from
counterfeiting, fraud, piracy, product diversion, identity theft, and
unauthorized intrusion into physical locations and databases. Our SigNature
Program provides a secure, accurate and cost-effective means for customers to
incorporate our SigNature DNA Markers in, and then quickly and reliably
authenticate and identify, a broad range of items such as artwork and
collectibles, fine wine, consumer products, digital media, financial
instruments, identity cards and other official documents. Having the ability to
reliably authenticate and identify counterfeit versions of such items enables
companies and governments to detect, deter, interdict and prosecute
counterfeiting enterprises and individuals.
Our SigNature Program enables our potential clients to
cost-effectively:
o assure manufacturers, suppliers, distributors, retailers and
end-users that their products are authentic and can be
forensically authenticated;
o integrate our SigNature DNA Markers with existing security
solutions such as barcodes, radio frequency identification
(RFID) tags, holograms, microchips and other securities
measures; and
o add value to the "bottom-line" by helping to diminish product
diversion and counterfeiting.
Counterfeit and diverted products continue to pose a significant and
growing problem with consumer packaged goods, especially for prestige and
established brands worldwide. Piracy, identity theft and forged documents and
items are also highly prevalent in vertical markets such as digital media, fine
art, luxury goods, and alcoholic beverages. Key aspects of our strategy include:
o continuing to improve and customize our solution to meet our
potential customers' needs;
o continuing to develop and enhance our existing DNA marker
authentication technologies;
43
o expanding our customer base both domestically and abroad by
targeting high volume markets; and
o augmenting our competitive position through strategic
acquisitions and alliances.
Plan of Operations
General
We expect to generate revenues principally from sales of our SigNature
Program. We are currently attempting to develop business in six target markets:
art and collectibles, fine wine, consumer products, digital recording media,
pharmaceuticals, and homeland security driven programs. We intend to pursue both
domestic and international sales opportunities in each of these vertical
markets.
We believe that our existing capital resources will enable us to fund
our operations until approximately April 2007. We believe we will be required to
seek additional capital to sustain or expand our prototype and sample
manufacturing, and sales and marketing activities, and to otherwise continue our
business operations beyond that date. 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 would restrict our ability to grow and may require us to
curtail or discontinue our business operations. Additionally, while a reduction
in our business operations may prolong our ability to operate, that reduction
would harm our ability to implement our business strategy. If we can obtain any
equity financing, it may involve substantial dilution to our then existing
shareholders.
Product Research and Development
We anticipate spending approximately $200,000 for product research and
development activities during the next twelve (12) months. This projected
expenditure for product research and development activities is dependent upon
our ability to obtain sources of financing or generate revenues . There is no
guarantee that we will be successful in raising the funds required or generating
revenues sufficient to fund the projected research and product development costs
during the next twelve (12) months.
Acquisition of Plant and Equipment and Other Assets
We do not anticipate the sale of any material property, plant or
equipment during the next 12 months. We do anticipate spending approximately
$200,000 on the acquisition of leasehold improvements during the next 12 months.
This projected expenditure for leasehold improvements is dependent upon our
ability to obtain sources of financing or generate revenues. There is no
guarantee that we will be successful in raising the funds required or generating
revenues sufficient to fund the projected costs of the leasehold improvements
during the next 12 months.
Number of Employees
We currently have seven employees and two part-time 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.
Specifically, the company expects to increase its staffing dedicated to sales,
product prototyping, manufacturing of DNA Markers and forensic authentication
services. In order for us to attract and retain quality personnel, we anticipate
we will have to offer competitive salaries. Any such increase in personnel is
dependent upon our ability to generate sufficient revenues or obtain sources of
financing. There is no guarantee that we will be successful in raising the funds
required or generating revenues sufficient to fund an increase in the number of
our employees. If we expand by hiring additional employees, we will incur
additional costs for such personnel.
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.
44
While all these significant accounting policies impact our financial condition
and results of operations, we view certain of these policies as critical.
Policies determined to be critical are those policies that have the most
significant impact on our consolidated financial statements and require
management to use a greater degree of judgment and estimates. Actual results may
differ from those estimates.
We believe that given current facts and circumstances, it is unlikely
that applying any other reasonable judgments or estimate methodologies would
cause a material effect on our consolidated results of operations, financial
position or liquidity for the periods presented in this report.
The accounting policies identified as critical are as follows:
o Equity issued with registration rights
o Warrant liability
o Fair value of intangible assets
Equity Issued with Registration Rights
In connection with the placements of our convertible notes and warrants
to certain investors during the fiscal quarters ended December 31, 2003,
December 31, 2004, March 31, 2005, March 31, 2006 and June 30, 2006, we granted
certain registration rights that provide for liquidated damages in the event of
failure to timely perform under the agreements. Although these notes and
warrants do not provide for net-cash settlement, the existence of liquidated
damages provides for a defacto net-cash settlement option. Therefore, the common
stock underlying the notes and warrants subject to such liquidated damages does
not meet the tests required for shareholders' equity classification, and
accordingly has been reflected between liabilities and equity in the
accompanying consolidated balance sheet until such time as the conditions are
eliminated.
Warrant Liability
In connection with the placement of certain debt instruments, as
described above, we issued freestanding warrants. Although the terms of the
warrants do not provide for net-cash settlement, in certain circumstances,
physical or net-share settlement is deemed to not be within our control and,
accordingly, we are required to account for these freestanding warrants as a
derivative financial instrument liability, rather than as shareholders' equity.
The warrant liability is initially measured and recorded at its fair
value, and is then re-valued at each reporting date, with changes in the fair
value reported as non-cash charges or credits to earnings. For warrant-based
derivative financial instruments, the Black-Scholes option pricing model is used
to value the warrant liability.
The classification of derivative instruments, including whether such
instruments should be recorded as liabilities or as equity, is re-assessed at
the end of each reporting period. Derivative instrument liabilities are
classified in the balance sheet as current or non-current based on whether or
not net-cash settlement of the derivative instrument could be required within 12
months of the balance sheet date.
We do not use derivative instruments to hedge exposures to cash flow,
market, or foreign currency risks.
Fair Value of Intangible Assets
We have adopted SFAS No. 142, Goodwill and Other Intangible Assets,
whereby we periodically test our intangible assets for impairment. On an annual
basis, and when there is reason to suspect that their values have been
diminished or impaired, these assets are tested for impairment, and write-downs
will be included in results from operations. On July 12, 2005, we acquired
certain intellectual properties from Biowell through an Asset Purchase Agreement
in exchange for 36 million shares of our restricted
45
common stock having an aggregate fair value at the date of issuance of $24.12
million. The value of the acquired intangible assets was $9,430,900, with the
balance of the purchase price, or $14,689,100, charged to operations as a cost
of the transaction.
During the year ended September 30, 2006, the Company management
preformed an evaluation of its intangible assets (intellectual property) for
purposes of determining the implied fair value of the assets at September 30,
2006. The test indicated that the recorded remaining book value of its
intellectual property exceeded its fair value, as determined by discounted cash
flows. As a result, upon completion of the assessment, management recorded a
non-cash impairment charge of $5,655,011, net of tax, or $0.05 per share during
the year ended September 30, 2006 to reduce the carrying value of the patents to
$2,091,800. Considerable management judgment is necessary to estimate the fair
value. Accordingly, actual results could vary significantly from management's
estimates.
The identifiable intangible assets acquired and their carrying values
at December 31, 2006 are:
Weighted
Average
Gross Accumulated Amortization
Carrying Amortization and Residual Period
Amount Impairment Charge Net Value (Years)
Amortizable
Intangible
Assets:
Intellectual
Property $9,430,900 $7,339,100 $2,091,800 -- 7
Patents 34,237 18,574 15,663 -- 5
Total
Amortized
Identifiable
Intangible $9,465,137 $7,357,674 $2,107,463 -- 6.99
Total amortization expense charged to operations for the three months
ended December 31, 2006 and 2005 were $92,661 and $338,545.
Estimated amortization expense as of December 31, 2006 is as follows:
2007 $ 370,643
2008 370,643
2009 365,753
2010 363,792
2011 and after 636,632
Total $ 2,107,463
Use of Estimates
In preparing financial statements in conformity with accounting
principles generally accepted in
46
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. The most
significant estimates relate to the estimation of percentage of completion on
uncompleted contracts, valuation of inventory, allowance for doubtful accounts
and estimated life of customer lists. Actual results could differ from those
estimates.
Restatement of Consolidated Financial Statements
The Company has restated its consolidated financial statements as of
and for the year ended September 30, 2005 and the quarterly unaudited data for
the first three quarters of 2006 and all of 2005.
These restatements and resulting revisions relate to the accounting
treatment for and disclosure regarding the issuance by the Company of options
and warrants to acquire the Company's common stock. In addition the Company
corrected certain errors in accounting for the exchange of its common stock for
previously incurred debt with a Company director. These errors were discovered
in connection with comments raised by the SEC in their review and comment on the
Company's Registration Statement on Form SB-2, as amended.
In this regard, you should rely on the restated financial results for
the fiscal year ended September 30, 2005 and for each of the quarters in the
year 2005 and the first, second and third quarters of 2006. As the Company
previously reported in its Current Report on Form 8-K, dated May 16, 2006, you
should not rely on the Company's previously issued consolidated financial
statements and other financial information for these reporting periods.
The consolidated financial statements for the three months ended
December 31, 2005 have been restated from the amounts previously reported to
correct the accounting for financial derivatives. While the effect of the
corrections to the financial statements is fully described in accompanying notes
to the restated consolidated financial statements, the following is a summary of
the net effect of the errors on these consolidated financial statements:
o the Company's net loss for the three months ended December 31,
2005 decreased by $5,263,940 from a net loss of $2,444,489 to
a net income of $2,819,451.
Comparison of Results of Operations for the Three Months Ended December 31, 2006
and 2005 Revenues
From our inception on September 16, 2002, we have not generated
significant revenues from operations.
Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the three months ended
December 31, 2006 compared to the same period in 2005 increased from $1.844
million to $2.054 million in the same period last year. This increase of $0.21
million, or 11.4%, is primarily attributable to costs incurred in connection
with professional services.
47
Research and Development
Research and development expenses increased by $13,036 from $16,270 to
$29,306 for the three months ended December 31, 2006 compared to the same period
in 2005 primarily due to increased independent testing costs.
Depreciation and Amortization
In the three months ended December 31, 2006, depreciation and
amortization decreased by $234,820 from $342,699 to $107,879 for the period
compared to the same period in 2005. The decrease is attributable to the reduced
amortization of our intellectual property due to our impairment recorded in
September 30, 2006.
Total Operating Expenses
Total operating expenses decreased to $2.19 million from $2.2 million,
or a decrease of $0.01 million as a result of the combination of factors listed
above.
Other Income/Loss
Gain on reevaluation of debt derivative and warrant liability decreased
by $4.7 million from $6.8 million to $2.1 million for the three months ended
December 31, 2006 as compared to the same period in 2005.
Interest Expenses
Interest expense for the three months ended December 31, 2006 decreased
by $1.2 million to $0.58 million from $1.78 million in the same period of 2005.
In the three months ended December 31, 2005, we incurred non-cash interest
expense relating to the fair value of warrants issued in conjunction with our
November 2005 financing of $1.79 million.
Net Income (loss)
Net loss for the three months ended December 31, 2006 increased to a
loss of $0.67 million from a net income of $2.82 million in the prior period as
a result of the combination of factors described above.
Liquidity and Capital Resources
Our liquidity needs consist of our working capital requirements,
indebtedness payments and research and development expenditure funding.
Historically, we have financed our operations through the sale of equity and
convertible debt as well as borrowings from various credit sources.
In fiscal 2005, we completed two private placements of convertible debt
and associated warrants. In November and December, 2004 we issued and sold
$1.465 million in aggregate principal amount of promissory notes, convertible at
$0.50 per share, and associated warrants to purchase up to 2,930,000 shares of
our common stock, exercisable at $0.75 per share for three years from their date
of issuance, to 13 investors (the "December 2004 Placement"). Each promissory
note was automatically convertible into shares of our common stock at a price of
$0.50 per share upon the closing of a subsequent private placement by us for at
least $1 million. In January and February of 2005, we issued and sold $7.371
million in aggregate principal amount of 10% Secured Convertible Promissory
Notes, convertible at $0.50 per share, and associated warrants to purchase up to
14,742,000 shares of our common stock, exercisable at $0.75 per share until five
years from their date of issuance, to 61 investors (the "January and February
2005 Placement"). Upon the closing of the January and February 2005 Offering,
the notes issued in the December 2004 Placement automatically converted into an
aggregate of 2,930,000 shares of our common stock, and upon the filing of this
registration statement on February 15, 2005, the notes issued in the January and
February 2005 Placement automatically converted into an aggregate of 14,742,000
shares of our common stock. Additional private placements in fiscal 2005 raised
$243,000. We also received proceeds of $60,000 from the exercise of a warrant to
purchase 100,000 shares of our
48
common stock in fiscal 2005. The $9.135 million in gross proceeds from these
private placements and warrant exercises were used to fund commissions, fees and
expenses associated with the placements, consultants and public reporting costs,
salaries and wages, royalties, research and development, facility costs as well
as general working capital needs. Since the conversion price of the notes issued
in the November and December 2003, December 2004, December 2005 and the January
and February 2005 placements were less than the market price of our common stock
at the time these notes were issued, we recognized a charge relating to the
beneficial conversion feature of these notes during the quarter in which they
are issued.
In fiscal 2006, we completed three additional private placements of
convertible debt and associated warrants. On November 3, 2005, we issued and
sold a promissory note in the principal amount of $550,000 to Allied
International Fund, Inc. ("Allied"). Allied in turn financed a portion of the
making of this loan by borrowing $450,000 from certain persons, including
$100,000 from James A. Hayward, a director and our Chief Executive Officer. The
terms of the promissory note provided that we issue upon the funding of the note
warrants to purchase 5,000,000 shares of our common stock at an exercise price
of $0.50 per share to certain persons designated by Allied. On November 9, 2005,
we issued nine warrants to Allied and eight other persons to purchase an
aggregate of 5,500,000 shares of our common stock at an exercise price of $0.50
per share. These warrants included a warrant to purchase 1,100,000 shares that
was issued to James A. Hayward, a director and our Chief Executive Officer. We
paid $55,000 in cash to VC Arjent, Ltd. for its services as the placement agent
with respect to this placement. All principal and accrued but unpaid interest
under the promissory note was paid in full shortly after the closing of and from
the proceeds of a private placement we completed on March 8, 2006. On March 8,
2006, we issued and sold an aggregate of 30 units consisting of (i) a $50,000
principal amount secured convertible promissory note bearing interest at 10% per
annum and convertible at $0.50 per share, and (ii) a warrant to purchase 100,000
shares of our common stock at an exercise price of $0.50 per share, for
aggregate gross proceeds of $1.5 million. The units were sold pursuant to
subscription agreements by and between each of the purchasers and Applied DNA
Operations Management, Inc., a Nevada corporation and our wholly owned
subsidiary (our "Subsidiary"). The $2.050 million in gross proceeds from these
first two offerings were held by our Subsidiary for our benefit and used to fund
commissions, fees and expenses associated with the placements, to repay the
outstanding promissory note described above plus accrued interest thereunder, to
fund financing fees, consultants and public reporting costs, salaries and wages,
research and development, facility costs as well as and general working capital
needs. On March 24, 2006, we commenced an offering (the "Offshore Offering") of
up to 140 units, at a price of $50,000 per unit, for a maximum offering of $7
million for sale to "accredited investors" who are not "U.S. persons." The units
being sold as part of the Offshore Offering consist of (i) a $50,000 principal
amount secured convertible promissory note, and (ii) a warrant to purchase
100,000 shares of our common stock at a price of $0.50 per share. On May 2,
2006, we closed on the first tranche of the Offshore Offering in which we sold
20 units for aggregate gross proceeds of $1,000,000. We paid Arjent Limited
$375,000 in commissions, fees and expenses from these gross proceeds. On June
15, 2006, we completed the second tranche of the Offshore Offering in which we
sold 59 units for aggregate gross proceeds of $2,950,000. We paid Arjent Limited
$442,500 in commissions, fees and expenses from these gross proceeds.
Additionally, on July 10, 2006 we issued 2.4 million shares of our common stock
to Arjent Limited at $0.001 per share as partial consideration for its services
in connection with the Offshore Offering.
On March 29, 2006 and April 13, 2006, we borrowed $200,000 in the
aggregate, at a rate of 7.5% per annum, from BioCogent whose President and Chief
Executive Officer and sole stockholder is James A. Hayward, one of our directors
and our Chief Executive Officer. These loans were due and payable upon the
earlier to occur of (1) the close of business on June 30, 2006, or (2) the
closing of the issuance and sale of our securities for gross proceeds of at
least $250,000. The proceeds from the loans were used for general corporate
purposes. The note issued on March 29, 2006 was repaid with interest in May,
2006. The note issued on April 13, 2006 was repaid with interest in June, 2006.
49
As of December 31, 2006, we had $4,217,171 in outstanding notes
payables. Please see "Management's Discussion and Analysis -- Liquidity and
Capital Resources" and Note C to the financial statements in this quarterly
report for a full description of the terms of the outstanding promissory notes.
Substantially all of the real property used in our business is leased
under operating lease agreements.
As of December 31, 2006, we had a working capital deficit of
approximately $10.26 million. For the three months ended December 31, 2006, we
generated a net cash flow deficit from operating activities of $561,156
consisting primarily of year to date losses of $671,222. Non-cash adjustments
included $952,054 in depreciation and amortization charges net with a non-cash
reduction of $2,098,471 attributable to the repricing of the debt derivative and
warrant liability. Additionally, we had a net decrease in current assets of
$39,023 and a net increase in current liabilities of $1,217,460. Cash used in
investing activities totaled $11,039, which was utilized for acquisition of
property and equipment. We did not have any cash provided by financing
activities for the three months ended December 31, 2006.
From our inception on September 16, 2002 through December 31, 2006, we
generated a cash flow deficit of $15,602,629 from operating activities. Cash
flows used in investing activities was $214,058 during this period. We met our
cash requirements during this period through the private placement of $432,000
of common stock, $12,968,900 from the issuance of convertible notes, $2,725,146
from the issuance of notes payable (net of repayments and costs) and $343,750
from the proceeds from the exercise of options to acquire our common stock.
We expect capital expenditures to be less than $200,000 in fiscal 2007.
Our primary investments will be in laboratory equipment to support prototyping
and our authentication services.
We have raised capital to meet our working capital needs in the past,
and will likely require additional financing within the next two (2) to three
(3) months in order to meet our current and projected cash flow deficits from
operations and development. We presently do not have any available credit, bank
financing or other readily available external sources of liquidity. Financing
transactions may include the issuance of equity or debt securities, obtaining
credit facilities, or other financing mechanisms. However, the trading price of
our common stock, a downturn in the U.S. or global stock and debt markets and
other reasons could make it more difficult to obtain financing through the
issuance of equity securities or borrowing. Further, if we issue additional
equity or convertible 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. If additional financing
is not available or is not available on acceptable terms, this could have a
material adverse effect on our business, results of operations liquidity and
financial condition.
Our registered independent certified public accountants have stated in
their report dated January 5, 2007, that we have incurred operating losses in
the last two years, and that we are dependent upon management's ability to
develop profitable operations. These factors among others may raise substantial
doubt about our ability to continue as a going concern.
Pursuant to the terms of a registration rights agreement with respect
to common stock underlying convertible notes and warrants we issued in private
placements in November and December 2003, December 2004, and January and
February, 2005, if we did not have a registration statement registering the
shares underlying these convertible notes and warrants declared effective on or
before June 15, 2005, we are obligated to pay liquidated damages in the amount
of 3.5% per month of the face amount of the notes, which equals $367,885, until
the registration statement is declared effective. At our option, these
liquidated damages can be paid in cash or restricted shares of our common stock.
To date we have decided to pay certain of these liquidated damages in common
stock, although any future payments of liquidated damages may, at our option, be
made in cash. If we decide to pay such liquidated damages in cash, we would be
required to use our limited working capital and potentially raise additional
funds. If
50
we decide to pay the liquidated damages in shares of common stock, the number of
shares issued would depend on our stock price at the time that payment is due.
Based on the closing market prices of $0.66, $0.58, $0.70, $0.49, $0.32 and
$0.20 for our common stock on July 15, 2005, August 15, 2005, September 15,
2005, October 17, 2005, November 15, 2005 and December 15, 2005, respectively,
we issued a total of 3,807,375 shares of common stock in liquidated damages from
August, 2005 to January, 2006 to persons who invested in the January and
February, 2005 private placements. The issuance of shares upon any payment by us
of further liquidated damages will have the effect of further diluting the
proportionate equity interest and voting power of holders of our common stock,
including investors in this offering.
We paid liquidated damages in the form of common stock only for the
period from June 15, 2005 to December 15, 2005, and only to persons who invested
in the January and February, 2005 private placements. We believe that we have no
enforceable obligation to pay liquidated damages to holders of any shares we
agreed to register under the registration rights agreement for periods after the
first anniversary of the date of issuance of such shares, since they were
eligible for resale under Rule 144 of the Securities Act during such periods,
and such liquidated damages are grossly inconsistent with actual damages to such
persons. Nonetheless, as of December 31, 2006 we have accrued approximately $5.1
million in penalties representing further liquidated damages associated with our
failure to have the registration statement declared effective by the deadline,
and have included this amount in accounts payable and accrued expenses.
Matters Voluntarily Reported to the SEC and Securities Act Violations
During the months of March, May, July and August 2005, we issued a
total of 8,550,000 shares of our common stock to certain employees and
consultants pursuant to the 2005 Incentive Stock Plan. We engaged our outside
counsel to conduct an investigation of the circumstances surrounding the
issuance of these shares. On April 26, 2006, we voluntarily reported the
findings from this investigation to the SEC, and agreed to provide the SEC with
further information arising from the investigation. We believe that the issuance
of 8,000,000 shares to employees in July 2005 was effectuated by both our former
President and our former Chief Financial Officer/Chief Operating Officer without
approval of our board of directors. These former officers received a total of
3,000,000 of these shares. In addition, it appears that the 8,000,000 shares
issued in July 2005, as well as an additional 550,000 shares issued to employees
and consultants in March, May and August 2005, were improperly issued without a
restrictive legend stating that the shares could not be resold legally except in
compliance with the Securities Act of 1933, as amended. The members of the
Company's management who effectuated the stock issuances no longer work for the
Company. These shares were not registered under the Securities Act of 1933, or
the securities laws of any state, and we believe that certain of these shares
may have been sold on the open market, though we have been unable to determine
the magnitude of such sales. If violations of securities laws occurred in
connection with the resale of certain of these shares, the employees and
consultants or persons who purchased shares from them may have rights to have
their purchase rescinded or other claims against us for violation of securities
laws, which could harm our business, results of operations, and financial
condition.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Inflation
The impact of inflation on the costs of the Company is dependent upon
market conditions. The Company is not aware of any inflationary pressures that
have had any significant impact on the Company's operations over the past
quarter, and the Company does not anticipate that inflationary factors will have
a significant impact on future operations.
51
Going Concern
The financial statements included in this filing have been prepared in
conformity with generally accepted accounting principles that contemplate our
continuance as a going concern. Our auditors, in their report dated January 5,
2007, have expressed substantial doubt about our ability to continue as going
concern. Our cash position may be inadequate to pay all of the costs associated
with the testing, production and marketing of our products. Management intends
to use borrowings and the sale of equity or convertible debt to mitigate the
effects of its cash position, however no assurance can be given that debt or
equity financing, if and when required will be available. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded assets and classification of liabilities that might
be necessary should we be unable to continue existence.
RISK FACTORS
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.
Risks Relating to Our Business:
If We Are Unable to Obtain Additional Financing Our Business Operations Will be
Harmed or Discontinued, and If We Do Obtain Additional Financing Our
Shareholders May Suffer Substantial Dilution.
We believe that our existing capital resources will enable us to fund
our operations until approximately April, 2007. We believe we will be required
to seek additional capital to sustain or expand our prototype and sample
manufacturing, and sales and marketing activities, and to otherwise continue our
business operations beyond that date. 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 would restrict our ability to grow and may require us to
curtail or discontinue our business operations. Additionally, while a reduction
in our business operations may prolong our ability to operate, that reduction
would harm our ability to implement our business strategy. If we can obtain any
equity financing, it may involve substantial dilution to our then existing
shareholders.
We Have a History Of Losses Which May Continue, and Which May Harm Our Ability
to Obtain Financing and Continue Our Operations.
We incurred net losses of $2.4 million for the year ended September 30,
2006. For the three months ended December 31, 2006, we incurred a net loss of
$671,222. These net losses have principally been the result of the various costs
associated with our selling, general and administrative expenses as we commenced
operations, acquired, developed and validated technologies, began marketing
activities, and our interest expense on notes and warrants we issued to obtain
financing. Our operations are subject to the risks and competition inherent in a
company moving from the development stage to a new growth enterprise. 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 any level of market acceptance. If we continue to incur losses, our
accumulated deficit will continue to increase, which might 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.
Our Independent Auditors Have Expressed Substantial Doubt About Our Ability to
Continue As a Going Concern, Which May Hinder Our Ability to Obtain Future
Financing.
In their report dated January 5, 2007, our independent auditors stated
that our financial statements
52
for the year ended September 30, 2006 were prepared assuming that we would
continue as a going concern, and that they have substantial doubt about our
ability to continue as a going concern. Our auditors' doubts are based on our
incurring net losses of $93 million during the period from September 16, 2002
(date of inception) to September 30, 2006. We continue to experience net
operating losses. Our ability to continue as a going concern is subject to our
ability to generate a profit and/or obtain necessary funding from outside
sources, including by the sale of our securities, obtaining loans from financial
institutions, or obtaining grants from various organizations or governments,
where possible. Our continued net operating losses and our auditors' doubts
increase the difficulty of our meeting such goals and our efforts to continue as
a going concern may not prove successful.
We have a Short Operating History, a Relatively New 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 marketing, sale and distribution of botanical DNA encryption,
embedment and authentication products and services, which are based on
technologies that we acquired in July 12, 2005 from, and some of which are
manufactured for us by, Biowell Technology, Inc. ("Biowell"). We first derived
revenue from this model in the second calendar quarter of 2006, which was
insignificant. Prior to the July 12, 2005 acquisition, our operations consisted
principally of providing marketing and business development services to Biowell.
As a result, we have a very limited operating history for you to evaluate in
assessing our future prospects. We are in the process of transitioning from a
developmental stage to an early-stage growth enterprise. Our operations since
inception have not produced significant 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 revenues in the future, prior to our introduction of
any new products, we will derive all such revenues from the sale of botanical
DNA encryption, encapsulation, embedment and authentication products and
services, which is an immature industry. You must consider our business and
prospects in light of the risks and difficulties we will encounter as an
early-stage company in a new and 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 Are Obligated to Pay Liquidated Damages As a Result of Our Failure to Have
the Registration Statement on Form SB-2 Declared Effective Prior to June 15,
2005, and any Payment of Liquidated Damages Will Either Result in Depletion of
Our Limited Working Capital or Issuance of Shares of Common Stock Which Would
Cause Dilution to Our Existing Shareholders.
Pursuant to the terms of a registration rights agreement with respect
to common stock underlying convertible notes and warrants we issued in private
placements in November and December, 2003, December, 2004, and January and
February, 2005, if we did not have a registration statement registering the
shares underlying these convertible notes and warrants declared effective on or
before June 15, 2005, we are obligated to pay liquidated damages in the amount
of 3.5% per month of the face amount of the notes, which equals $367,885, until
the registration statement is declared effective. At our option, these
liquidated damages can be paid in cash or restricted shares of our common stock.
To date we have decided to pay certain of these liquidated damages in common
stock, although any future payments of liquidated damages may, at our option, be
made in cash. If we decide to pay such liquidated damages in cash, we would be
required to use our limited working capital and potentially raise additional
funds. If we decide to pay the liquidated damages in shares of common stock, the
number of shares issued would depend on our stock price at the time that payment
is due. Based on the closing market prices of $0.66, $0.58, $0.70, $0.49, $0.32
and $0.20 for our common stock on July 15, 2005, August 15, 2005, September 15,
2005, October 17, 2005, November 15, 2005 and December 15, 2005, respectively,
we issued a total of 3,807,375 shares of common stock in liquidated damages from
August, 2005 to January, 2006 to persons who invested in the January and
February, 2005 private placements. The issuance of
53
shares upon any payment by us of further liquidated damages will have the effect
of further diluting the proportionate equity interest and voting power of
holders of our common stock, including investors in this offering.
We paid liquidated damages in the form of common stock only for the
period from June 15, 2005 to December 15, 2005, and only to persons who invested
in the January and February, 2005 private placements. We believe that we have no
enforceable obligation to pay liquidated damages to holders of any shares we
agreed to register under the registration rights agreement for periods after the
first anniversary of the date of issuance of such shares, since they were
eligible for resale under Rule 144 of the Securities Act during such periods,
and such liquidated damages are grossly inconsistent with actual damages to such
persons. Nonetheless, as of December 31, 2006 we have accrued approximately $5.1
million in penalties representing further liquidated damages associated with our
failure to have the registration statement declared effective by the deadline,
and have included this amount in accounts payable and accrued expenses.
If Our Existing Products and Services are Not Accepted by Potential Customers or
We Fail to Introduce New Products and Services, Our Business, Results of
Operations and Financial Condition Will be Harmed.
There has been limited or no market acceptance of our botanical DNA
encryption, 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:
o availability, quality and price relative to competitive
solutions;
o customers' opinions of the solutions' utility;
o ease of use;
o consistency with prior practices;
o scientists' opinions of the solutions' usefulness;
o citation of the solutions in published research; and
o general trends in anti-counterfeit and security solutions'
research.
The expenses or losses associated with the continued lack of market
acceptance of our solutions will harm our business, operating results and
financial condition.
Rapid technological changes and frequent new product introductions are
typical for 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 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.
If We Are Unable to Retain the Services of Drs. Hayward or Liang We May Not Be
Able to Continue Our Operations.
Our success depends to a significant extent upon the continued service
Dr. James A. Hayward, our Chief Executive Officer; and Dr. Benjamin Liang, our
Secretary and Strategic Technology
54
Development Officer. We do not have employment agreements with Drs. Hayward or
Liang. Loss of the services of Drs. Hayward or Liang could significantly harm
our business, results of operations and financial condition. We do not maintain
key-man insurance on the lives of Drs. Hayward or Liang.
The Markets for our SigNature Program are Very Competitive, and We May be Unable
to Continue to Compete Effectively in this Industry in the Future.
The principal markets for our SigNature Program 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: Applied Optical
Technologies, Authentix, ChemTAG, Collectors Universe Inc., Collotype, Data Dot
Technology, Digimarc Corp., DNA Technologies, Inc., Informium AG, Inksure
Technologies, L-1 Identity Solutions, Manakoa, SmartWater Technology, SureTrace,
Tracetag and Warnex.
We expect this competition to continue and intensify in the future.
Competition in our markets is primarily driven by:
o product performance, features and liability;
o price;
o timing of product introductions;
o ability to develop, maintain and protect proprietary products
and technologies;
o sales and distribution capabilities;
o technical support and service;
o brand loyalty;
o applications support; and
o 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.
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 few 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. We do not currently have any arrangements with any
distributors and we may not be able to 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.
A Manufacturer's Inability or Willingness to Produce Our Goods on Time and to
Our Specifications Could Result in Lost Revenue and Net Losses.
55
Though we manufacture prototypes, samples and some of our own products,
we currently do not own or operate any significant manufacturing facilities and
depend upon independent third parties, and particularly Biowell, for the
manufacture of some of our products to our specifications. The inability of a
manufacturer to ship orders of such products in a timely manner or to meet our
quality standards could cause us to miss the delivery date requirements of our
customers for those items, which could result in cancellation of orders, refusal
to accept deliveries or a reduction in purchase prices, any of which could harm
our business by resulting in decreased revenues or net losses upon sales of
products, if any sales could be made.
If We Need to Replace Manufacturers, Our Expenses Could Increase, Resulting in
Smaller Profit Margins.
We compete with other companies for the production capacity of our
manufacturers and import quota capacity. Some of these competitors have greater
financial and other resources than we have, and thus may have an advantage in
the competition for production and import quota capacity. If we experience a
significant increase in demand, or if our existing manufacturers must be
replaced, we will need to establish new relationships with another or multiple
manufacturers. We cannot assure you that this additional third party
manufacturing capacity will be available when required on terms that are
acceptable to us or terms similar to those we have with our existing
manufacturers, either from a production standpoint or a financial standpoint. We
do not have long-term contracts with our manufacturers, and our manufacturers do
not produce our products exclusively. Should we be forced to replace our
manufacturers, we may experience an adverse financial impact, or an adverse
operational impact, such as being forced to pay increased costs for such
replacement manufacturing or delays upon distribution and delivery of our
products to our customers, which could cause us to lose customers or lose
revenues because of late shipments.
If a Manufacturer Fails to Use Acceptable Labor Practices, We Might Have Delays
in Shipments or Face Joint Liability for Violations, Resulting in Decreased
Revenue and Increased Expenses.
While we require our independent manufacturers to operate in compliance
with applicable laws and regulations, we have no control over their ultimate
actions. While our internal and vendor operating guidelines promote ethical
business practices and our staff and buying agents periodically visit and
monitor the operations of our independent manufacturers, we do not control these
manufacturers or their labor practices. The violation of labor or other laws by
our independent manufacturers, or by one of our licensing partners, or the
divergence of an independent manufacturer's or licensing partner's labor
practices from those generally accepted as ethical in the United States, could
interrupt, or otherwise disrupt the shipment of finished products to us or
damage our reputation. Any of these, in turn, could have a material adverse
effect on our financial condition and results of operations, such as the loss of
potential revenue and incurring additional expenses.
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 is and will continue to be important
to our ability to offer new products. In addition, from time to time we are
notified 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. If we lose the rights to patented technology, we may need to
discontinue selling certain products or redesign our products, and we may lose a
competitive advantage. Potential competitors could license technologies that we
fail to license and potentially erode our market
56
share for certain products. Intellectual property licenses would typically
subject us to various commercialization, sublicensing, minimum payment, and
other obligations. If we fail to comply with these requirements, we could lose
important rights under a license. In addition, certain rights granted under the
license could be lost for reasons beyond our control, and we may not receive
significant indemnification from a licensor against third party claims of
intellectual property infringement.
Our Failure To Manage Our Growth In Operations and Acquisitions of New Product
Lines and New Businesses Could Harm our Business.
Any growth in our operations, if any, will place a significant strain
on our current management resources. To manage such growth, we would need to
improve our:
o operations and financial systems;
o procedures and controls; and
o training and management of our employees.
Our future growth, if any, may be attributable to acquisitions of new
product lines and new businesses. 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 quarterly operating results to vary
significantly. Furthermore, our stockholders would be diluted if we financed the
acquisitions by incurring convertible debt or issuing securities.
Although we currently only have operations within the United States, if
we were to acquire an international operation; we would face additional risks,
including:
o difficulties in staffing, managing and integrating
international operations due to language, cultural or other
differences;
o different or conflicting regulatory or legal requirements;
o foreign currency fluctuations; and
o diversion of significant time and attention of our management.
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, and marketing will require the addition of new management personnel
and the development of additional expertise by existing management personnel.
Because the industry in which we compete is very competitive, we face
significant challenges attracting and retaining a qualified personnel base.
Although we believe we have been and will be able to attract and retain these
personnel, we may not be able to continue to successfully attract qualified
personnel. 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 will 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.
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
57
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.
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. 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 product candidates. 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. 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
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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. 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, and we have faced such claims in the past. 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, and vendors and
service providers. We have faced such claims and litigation in the past and we
cannot assure 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 revenue
and the losses our business has incurred for the period from our inception to
June 30, 2006, this could result in a significant decrease in our liquidity or
assets, which could result in the reduction or termination of our business.
Matter Voluntarily Reported to the Securities and Exchange Commission
During the months of March, May, July and August 2005, we issued a
total of 8,550,000 shares of our common stock to certain employees and
consultants pursuant to the 2005 Incentive Stock Plan. We engaged our outside
counsel to conduct an investigation of the circumstances surrounding the
issuance of these shares. On April 26, 2006, we voluntarily reported the
findings from this investigation to the SEC, and agreed to provide the SEC with
further information arising from the investigation. We believe that the issuance
of 8,000,000 shares to employees in July 2005 was effectuated by both our former
President and our former Chief Financial Officer/Chief Operating Officer without
approval of our board of directors. These former officers received a total of
3,000,000 of these shares. In addition, it appears that the 8,000,000 shares
issued in July 2005, as well as an additional 550,000 shares issued to employees
and consultants in March, May and August 2005, were improperly issued without a
restrictive legend stating that the shares could not be resold legally except in
compliance with the Securities Act of 1933, as amended. The members of the
Company's management who effectuated the stock issuances no longer work for the
Company. These shares were not registered under the Securities Act of 1933, or
the securities laws of any state, and we believe that certain of these shares
may have been sold on the open market, though we have been unable to determine
the magnitude of such sales. If violations of securities laws occurred in
connection with the resale of certain of these shares, the employees and
consultants or persons who purchased shares from them may have rights to have
their purchase rescinded or other claims
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against us for violation of securities laws, which could harm our business,
results of operations, and financial condition.
Risks Relating to Our Common Stock:
There Are a Large Number of Shares Underlying Our Options and Warrants That May
be Available for Future Sale and the Sale of These Shares May Depress the Market
Price of Our Common Stock and Will Cause Immediate and Substantial Dilution to
Our Existing Stockholders.
As of February 15, 2007, we had 121,162,385 shares of common stock
issued and outstanding and outstanding options and warrants to purchase
77,644,464 shares of common stock. All of the shares issuable upon exercise of
our options and warrants may be sold without restriction. The sale of these
shares may adversely affect the market price of our common stock. The issuance
of shares upon exercise of options and warrants will cause immediate and
substantial dilution to the interests of other stockholders since the selling
stockholders may convert and sell the full amount issuable on exercise.
If We Fail to Remain Current on Our Reporting Requirements, We Could be Removed
From the OTC Bulletin Board Which Would Limit the Ability of Broker-Dealers to
Sell Our Securities and the Ability of Stockholders to Sell Their Securities in
the Secondary Market.
Companies trading on The Over The Counter Bulletin Board (the "OTC
Bulletin Board"), such as us, must be reporting issuers under Section 12 or
Section 15(d) of the Securities Exchange Act of 1934, as amended, and must be
current in their reports under Section 13, in order to maintain price quotation
privileges on the OTC Bulletin Board. If we fail to remain current on our
reporting requirements, we could be removed from the OTC Bulletin Board. As a
result, the market liquidity for our securities could be severely adversely
affected by limiting the ability of broker-dealers to sell our securities and
the ability of stockholders to sell their securities in the secondary market.
Prior to May 2001, we were delinquent in our reporting requirements, having
failed to file our quarterly and annual reports for the years ended 1998 - 2000
(except the quarterly reports for the first two quarters of 1999). We have been
current in our reporting requirements for the last six years, however, there can
be no assurance that in the future we will always be current in our reporting
requirements.
Our Common Stock is Subject to the "Penny Stock" Rules of the SEC and the
Trading Market in Our Securities is Limited, Which Makes Transactions in Our
Stock Cumbersome and May Reduce the Value of an Investment in Our Stock.
The SEC has adopted Rule 15g-9 which establishes the definition of a
"penny stock," for the purposes relevant to us, as any equity security that has
a market price of less than $5.00 per share or with an exercise price of less
than $5.00 per share, subject to certain exceptions. For any transaction
involving a penny stock, unless exempt, the rules require:
o that a broker or dealer approve a person's account for
transactions in penny stocks; and
o the broker or dealer receive from the investor a written
agreement to the transaction, setting forth the identity and
quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny
stocks, the broker or dealer must:
o obtain financial information and investment experience
objectives of the person; and
o make a reasonable determination that the transactions in penny
stocks are suitable for that person and the person has
sufficient knowledge and experience in financial matters to be
capable of evaluating the risks of transactions in penny
stocks.
The broker or dealer must also deliver, prior to any transaction in a
penny stock, a disclosure schedule prescribed by the SEC relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the
suitability determination; and
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o that the broker or dealer received a signed, written agreement
from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in
securities subject to the "penny stock" rules. This may make it more difficult
for investors to dispose of our common stock and cause a decline in the market
value of our stock.
Disclosure also has to be made about the risks of investing in penny
stocks in both public offerings and in secondary trading and about the
commissions payable to both the broker-dealer and the registered representative,
current quotations for the securities and the rights and remedies available to
an investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
ITEM 3. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures: As of December 31,
2006, our management carried out an evaluation, under the supervision of the
Company's Chief Executive Officer (who is its principal executive officer and
principal financial officer), of the effectiveness of the design and operation
of the Company's system of disclosure controls and procedures pursuant to the
Securities and Exchange Act and Rules 13a-15(e) and 15d-15(e) thereunder. Based
upon that evaluation, the Company's Chief Executive Officer concluded that the
Company's disclosure controls and procedures were not effective, as of the date
of their evaluation, for the purposes of recording, processing, summarizing and
timely reporting material information required to be disclosed in reports filed
by the Company under the Securities Exchange Act of 1934.
As previously disclosed in our Current Reports on Form 8-K, filed on
May 18, 2006 and October 2, 2006, as a result of comments raised by the SEC, we
determined that accounting errors were made in connection with
o accounting for and disclosing the fair value of warrants and
options to acquire our common stock issued to non-employees as
a current period expense;
o accounting for and disclosing the fair value of shares issued
to a former Director in exchange for previously incurred debt;
o accounting for and disclosing the fair value of warrants
issued to note holders and consultants having registration
rights; and
o accounting for and disclosing the revaluation for warrant
liabilities as of each reporting period.
Based on the impact of the aforementioned accounting errors, we
determined to restate our consolidated financial statements as of September 30,
2005 and for the year ended September 30, 2005 and the quarterly unaudited data
for the first three quarters of 2006 and all of 2005.
b) Changes in internal controls: Except as described below, there were
no changes in internal controls over financial reporting that occurred during
the period covered by this report that have materially affected, or are
reasonably likely to materially effect, our internal control over financial
reporting.
Changes in Internal Controls
In addition to the remedial measures undertaken during the three months
ended September 30, 2006, that we have subsequently implemented the following
additional measures to address the identified material weaknesses:
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o We reviewed all convertible securities to identify any
securities that may have embedded beneficial conversion
features or derivatives; and
o We have improved the supervision and training of our
accounting staff to understand and implement applicable
accounting requirements, policies and procedures applicable to
the accounting and disclosure of convertible securities and
derivatives.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. Except as
described below, we are currently not aware of any such legal proceedings that
we believe will have, individually or in the aggregate, a material adverse
affect on our business, financial condition or operating results.
Paul Reep v. Applied DNA Sciences, Inc., Case No.: BC345702
Plaintiff Paul Reep, a former employee, commenced this action against
us on January 10, 2006. Mr. Reep asserts eight causes of action for breach of
contract, breach of an oral agreement, negligent misrepresentation, interference
with prospective business advantages, defamation, fraud, accounting and
constructive trust, unjust enrichment. The relief sought includes declaratory
relief, unspecified compensatory damages, unpaid salary, unspecified penalties
under the California Labor Code, interest, and attorneys' fees. We have
successfully moved the court to indefinitely stay all proceedings in this matter
in light of a forum selection clause designating Nevada state courts as the
proper forum. Attorneys for Reep have indicated that they intend to file suit in
Nevada, but to date have not done so. We intend to vigorously defend any case
brought against us by Reep.
Applied DNA Sciences, Inc. v. Paul Reep, Adrian Butash, John Barnett, Chanty
Cheang, Jaime Cardona, and Angela Wiggins, Case No. CV06-2027 RGK
We filed this action against the defendants, Paul Reep, Adrian Butash,
John Barnett, Chanty Cheang, Jaime Cardona, and Angela Wiggins on April 4, 2006,
in the United States District Court for the Central District of California. In
this matter we have asked the court to make a judicial determination that an
agreement amending the employment contracts of all named defendants, which we
did not authorize and which is the basis of the Reep and Butash litigation
against Applied DNA, is invalid and unenforceable. This matter is in the early
stages of discovery. Trial has been set for April 3, 2007.
Barnett, et al. v. Applied DNA Sciences, et al., Case No.: BC 350904
Plaintiffs John D. Barnett, Jr., Adrian Butash, Jaime A. Cardona, and
Chanty Cheang, our former employees, filed suit against us, Applied DNA
Operations Management, Inc., APDN (B.V.I.), Inc., Peter Brocklesby, James A.
Hayward, and Jun-Jei Sheu in Los Angeles County Superior Court on April 17,
2006. The complaint alleges causes of action for breach of written contract,
breach of oral contract, fraud, violations of the California Labor Code, and
wrongful termination. The complaint seeks $159,000 (trebled to $477,000) in
alleged unpaid salary, $546,000 in severance pay, other unspecified compensatory
and consequential damages, unspecified punitive damages, attorneys' fees and
costs, and interest. With the exception of Peter Brocklesby, all defendants,
including us, have answered the complaint. The trial date has been set for May
21, 2007.
In re the Unemployment Insurance Claims of Adrian Butash, John Barnett, and Paul
Reep, California Unemployment Insurance Appeals Board Case Nos. 1809031,
1801356, and 1842399, respectively.
We are in the process of appealing an administrative law judge's
determination John Barnett, Paul Reep, and Adrian Butash are entitled to
unemployment benefits following their separation from employment with us and
that our unemployment insurance account will be charged. We will appeal on the
determination on the grounds that the claimants were terminated for reasons
other than lack of work. We have filed a notice of appeal, and no trial date has
yet been set.
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Douglas A. Falkner v. Applied DNA Sciences, Inc./N.C. Industrial Commission File
No. 585698
Plaintiff Douglas Falkner ("Falkner") filed a worker's compensation
claim in North Carolina for an alleged work-related neck injury that he alleges
occurred on January 14, 2004. Falkner worked as Business Development and
Operations Manager at our sole East Coast office at the time of the alleged
injury. Plaintiff Falkner was the only employee employed by us in North Carolina
at the time of the alleged injury and we have employed no other employees in
North Carolina at any other time. The claim has been denied and is being
defended on several grounds, including the lack of both personal and subject
matter jurisdiction. Specifically, we contend that we did not employ the
requisite minimum number of employees in North Carolina at the time of the
alleged injury and that the company is therefore not subject to the North
Carolina Workers' Compensation Act. The claim was originally set for hearing in
January 2007, but was continued to allow the parties to engage in further
discovery.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On December 12, 2006 we issued 180,000 shares of common stock in
exchange for our promissory note in principal amount of $410,429 and accrued
interest thereon of $8,883. We valued the shares issued at $0.09 per share for a
total of $16,200. This issuance is considered exempt under Section 3(a)(9) of
the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
4.1 Form of Subscription Agreement, filed as an exhibit to the current
report on Form 8-K filed with the Commission on May 5, 2006 and
incorporated herein by reference.
4.9 Form of 10% Secured Convertible Promissory Note of Applied DNA
Sciences, Inc., filed as an exhibit to the current report on Form 8-K
filed with the Commission on May 5, 2006 and incorporated herein by
reference.
4.10 Form of Warrant Agreement of Applied DNA Sciences, Inc., filed as an
exhibit to the current report on Form 8-K filed with the Commission on
May 5, 2006 and incorporated herein by reference.
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10.4 Form of Registration Rights Agreement of Applied DNA Sciences, Inc.,
filed as an exhibit to the current report on Form 8-K filed with the
Commission on May 5, 2006 and incorporated herein by reference.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 and
Rule 15d-14(a), promulgated under the Securities and Exchange Act of
1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 and
Rule 15d 14(a), promulgated under the Securities and Exchange Act of
1934, as amended.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive
Officer).
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial
Officer).
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SIGNATURES
Pursuant to the requirements 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: February 20, 2007 /s/JAMES A. HAYWARD
-------------------
James A. Hayward
Chief Executive Officer
(Principal Executive Officer,
Principal Financial Officer
and Principal Accounting Officer)
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