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 March 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 March 31,
2006, was 118,582,385 shares, held by approximately 1,380 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 MARCH 31, 2006
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheet: 1
March 31, 2006 (Unaudited)
Condensed Consolidated Statements of Losses: 2
Three Months Ended March 31, 2006 and 2005 (Unaudited) and
the Period from September 16, 2002 (Date of Inception) Through
March 31, 2006 (Unaudited)
Condensed Consolidated Statement of Stockholder's Equity (Deficiency): 3
For the Period from September 16, 2002 (Date) of Inception Through
March 31 2006 (Unaudited)
Condensed Consolidated Statements of Cash Flows: 18
Three Months Ended March 31, 2006 and 2005 (Unaudited) and
the Period from September 16, 2002 (Date of Inception) Through
March 31, 2006 (Unaudited)
Notes to Unaudited Condensed Consolidated Financial Information: 19-42
March 31, 2006
Item 2. Management Discussion and Analysis 43
Item 3 Controls and Procedures 63
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 65
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 66
Item 3. Defaults Upon Senior Securities 66
Item 4. Submission of Matters to a Vote of Security Holders 66
Item 5. Other Information 66
Item 6. Exhibits 67
Signatures 68
-i-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
APPLIED DNA SCIENCES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2006
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 77,715
Advances and other receivables 3,128
------------
Total current assets 80,843
Property, plant and equipment - Net of accumulated depreciation of $6,265 42,337
Deposits and prepaid expenses 23,382
Intangible assets:
Patents, net of accumulated amortization of $15,168 (Note B) 19,089
Intellectual Property , net of accumulated amortization of $1,010,454 (Note B) 8,420,446
------------
Total $ 8,586,097
============
Assets
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,274,400
Accrued liabilities due related parties 2,496
Note payable (Note D) 510,429
------------
Total current liabilities 2,787,325
Warrant Liability (Note G) 6,787,395
Convertible Note payable, net of unamortized discount (Note D) 676,790
Commitments and contingencies (Note I)
Deficiency in Stockholders' Equity:
Preferred stock, par value $.001 per share; 10,000,000 shares authorized; 6
60,000 issued and outstanding
Common stock, par value $.001 per share; 250,000,000 shares authorized;
118,582,385 shares issued and outstanding 118,582
Common stock subscription (200,000)
Additional paid-in-capital 88,220,817
Total Accumulated Deficit (89,804,818)
------------
Total Deficiency in Stockholders' Equity (1,665,413)
------------
Total liabilities and Deficiency in Stockholders' equity $ 8,586,097
============
See accompanying notes to unaudited condensed consolidated financial statements
-1-
APPLIED DNA SCIENCES, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF LOSSES
(Unaudited)
For the Three For the Six
Months Ended Months Ended September 16, 2002
March 31 March 31 (Date of Inception)
through
2006 2005 2006 2005 March 31, 2006
------------- ------------- ------------- ------------- -------------
(as restated (as restated
see Note I) see Note I)
Operating expenses:
Selling, general and
administrative $ 1,009,934 $ 10,406,288 $ 3,088,661 $ 21,199,209 $ 67,937,350
Research and development 75,033 -- 91,303 -- 968,711
Depreciation and amortization 341,676 7,306 684,375 12,027 1,043,802
------------- ------------- ------------- ------------- -------------
Total operating expenses 1,426,643 10,413,594 3,864,339 21,211,236 69,949,863
Operating loss (1,426,643) (10,413,594) (3,864,339) (21,211,236) (69,949,863)
Net gain/(loss) on revaluation of
warrant liability 4,846,273 13,310,729 12,973,966 10,174,403 30,872,773
Other income (expense) (3,520) 3,100 9,493 3,415 40,835
Interest income (expense) (59,597) (19,567,738) (79,403) (23,515,586) (50,768,563)
Income (taxes) benefit -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Net Income (Loss) $ 3,356,513 $ (16,667,503) $ 9,039,717 $ (34,549,004) $ (89,804,818)
Earnings (Loss) per common share:
Basic $ .03 $ (0.31) $ .08 $ (0.86) $ (2.03)
Diluted
Weighted average shares
outstanding:
Basic 116,483,044 53,044,883 114,487,589 40,082,628 44,237,067
Diluted 116,593,508 53,044,883 116,593,508 40,082,628
See accompanying notes to unaudited condensed 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
MARCH 31, 2006 (Unaudited)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common 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
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
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common 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 $
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,
on 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
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
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
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 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 in July 2003 - - 20,000 2 19,998 - - - 20,000
Common stock issued
in exchange for
exercised of options
previously
subscribed at $1.00 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 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 in September 2003 - - 95,000 10 94,991 - - - 95,001
Common stock subscription
receivable reclassification
adjustment - - - - - - 2,600 - 2,600
Common Stock subscribed to
at $2.50 per share in
September 2003 - - - - - 300,000 - - 300,000
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)
========= =========== =========== =========== =========== ========== =========== =========== ===========
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
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 Dec 2003 - 10,223,166 (10,223,166) - - - -
Common Stock issued
pursuant to subscription
at $2.50 share in Jan 2004 41,600 20,800 83,200 (104,000) - - -
Common stock issued in
exchange for consulting
services at $2.95 per
share, Jan 2004 13,040 6,520 31,948 - - - 38,468
Common stock issued in
exchange for consulting
services at $2.60 per
share, Jan 2004 123,000 61,500 258,300 - - - 319,800
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common stock issued in
exchange for consulting
services at $3.05 per
share, Jan 2004 1,000 500 2,550 - - - 3,050
Common stock issued in
exchange for employee
services at $3.07 per
share, Feb 2004 6,283 3,142 16,147 - - - 19,289
Common stock issued in
exchange for consulting
services at $3.04 per
share, Mar 2004 44,740 22,370 113,640 - - - 136,010
Common Stock issued for
options exercised at
$1.00 per share in Mar
2004 55,000 27,500 27,500 - - - 55,000
Common stock issued in
exchange for employee
services at $3.00 per
share, Mar 2004 5,443 2,722 13,623 - - - 16,345
Common stock issued in
exchange for employee
services at $3.15 per
share, Mar 2004 5,769 2,885 15,292 - - - 18,177
Preferred shared
converted to common
shares for consulting
services at $3.00 per
share, Mar 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, Mar 2004 8,806 4,400 22,238 - - - 26,639
Common Stock issued
pursuant to
subscription at $2.50
per share in Mar. 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, Apr 2004 9,860 4,930 20,511 - - - 25,441
Common stock issued in
exchange for consulting
services at $2.35 per
share, Apr 2004 11,712 5,856 21,667 - - - 27,523
Common stock issued in
exchange for consulting
services at $1.50 per
share, Apr 2004 367,500 183,750 367,500 - - - 551,250
Common stock returned
to treasury at
$0.065 per share,
Apr 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) - -
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common stock issued in
exchange for consulting
services at $0.86 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, Jun 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
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
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common stock issued in
exchange for consulting
services at $0.46 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
Warrants issued to
consultants in the
fourth quarter 2004 2,019,862 2,019,862
Net Loss - - - - - (19,358,259)(19,358,259)
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
September 30, 2004 60,000 6 23,981,054 11,990,527 6,118,993 - (1,000)(22,815,034) (4,706,508)
========= =========== =========== =========== =========== ========== =========== =========== ===========
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common 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, Oct 2004 - - (1,069,600) (534,800) (107,298) - - - (642,098)
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 share in
October 2004 - - 500,000 250,000 50,000 (300,000) - - -
Common stock issued in
exchange for consulting
services by noteholders
at $0.50 per share
in October 2004 - - 532,500 266,250 - - - - 266,250
Common Stock issued
pursuant to subscription
at $0.50 share in
October 2004 - - 500,000 250,000 - - - - 250,000
Common Stock issued pursuant
to subscription at $0.45
share in October 2004 - - 1,000,000 500,000 (50,000) (450,000) - - -
Common stock issued in
exchange for consulting
services by noteholders
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 share
in November 2004 - - 100,000 50,000 (3,000) - - - 47,000
Common Stock issued in
exchange for consulting
services at $0.80 share
in November 2004 - - 300,000 150,000 90,000 - - - 240,000
Common Stock issued in
exchange for consulting
services at $1.44 share
in November 2004 - - 115,000 57,500 108,100 - - - 165,600
Common Stock issued in
exchange for employee
services at $1.44 share
in November 2004 - - 5,000 2,500 4,700 - - - 7,200
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common Stock issued in
exchange for employee
services at $0.60 share
in November 2004 - - 60,000 30,000 6,000 (4,000) - - 32,000
Beneficial Conversion
discount relating to
Notes Payable - - - - 936,541 - - - 936,541
Beneficial Conversion
Feature relating to
Warrants - - - - 528,459 - - - 528,459
Common stock issued at
$0.016 in exchange for
note payable in December
2004 5,500,000 2,750,000 (2,661,500) 88,500
Common Stock issued in
exchange for consulting
services at $1.44 share
in December 2004 - - 5,796,785 2,898,393 5,418,814 - - - 8,317,207
Common stock issued
pursuant to subscription
at $0.50 per share in
December 2004 - - 2,930,000 1,465,000 - (125,000) - - 1,340,000
Warrants issued to
consultants in
December 2004 - - 394,698 394,698
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 1,199,503 (407,830) - - - 791,673
Common Stock issued in
exchange for consulting
services at $1.30 per share
in January 2005 - - 315,636 157,818 252,509 - - 410,327
Common Stock issued in
settlement of debt at
$0.33 per share in February
2005 - - 75,757 37,879 (12,879) - - - 25,000
See accompanying notes to unaudited condensed consolidated financial statements
-11-
A development stage company)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY, (DEFICIENCY)
FOR THE PERIOD SEPTEMBER 16, 2002 (DATE OF INCEPTION) THROUGH
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
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
Common Stock issued in
settlement of debt at
$0.40 per share in February
2005 - - 1,500,000 750,000 (150,000) - - - 600,000
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 2005 - - 17,236 8,618 11,548 - - 20,166
Common stock issued
pursuant to subscription
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
pursuant to subscription
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
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common Stock issued in
exchange for consulting
services at $0.92 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
pursuant to subscription
at $0.50 per share
in March 2005 - - 1,240,000 620,000 - - - - 620,000
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 2005 - - - (32,312,879) 32,312,879 - - - -
Beneficial Conversion
discount relating to
Notes Payable in March
2005 - - - - 4,179,554 - - - 4,179,554
Beneficial Conversion
Feature relating to
Warrants in March 2005 - - - - 3,191,446 - - - 3,191,446
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
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common Stock issued in
exchange for consulting
services at $0.75 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
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)
Warrants issued to consultants
and Employees during the quarter
ended June 30, 2005 - - - - 849,046 - - - 849,046
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 intellectual
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
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common Stock issued in
exchange for consulting
services at $0.48 per share
in August 2005 - - 250,000 250 119,750 - - - 120,000
Common Stock issued in
exchange for consulting
services at $0.94 per share
in September 2005 - - 121,985 122 168,217 - - - 168,339
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) (353,232) 56,000 1,000 - (296,972)
Adjustment to
warrants previously issued
and canceled during the year
ended Sept 30, 2005 - - - - (287,440) - - - (287,440)
Cumulative effect of
Warrant revaluation - - - - 7,005,371 - - 23,419,121 (16,413,750)
Net Loss - - - - - - - (52,610,380) (52,610,380)
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Balance as of September
30, 2005 60,000 $ 6 112,230,392 $ 112,230 $88,885,173 $ 20,000 $ - $(98,844,535) $(9,827,126)
========= =========== =========== =========== =========== ========== ======== ============= =============
See accompanying notes to unaudited condensed consolidated financial statements
-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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
--------- ----------- ----------- ----------- ----------- ---------- ----------- ----------- -----------
Common stock issued
pursuant to subscription
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 penalty shares
issued pursuant to pending
SB-2 registration
at $0.51 per share in
December 2005 - - 505,854 506 257,481 - - - 257,987
Fair value related to
warrants issued in
November 2005 - - - - 563,750 - - - 563,750
Effect of Warrant
Revaluation - - - - (1,758,900) - 8,127,693 6,368,793
Net Loss - - - - - - - (2,444,489) (2,444,489)
-------- ---------- ----------- ---------- ----------- ---------- -------- ------------ -----------
Balance as of December
31, 2005 60,000 $ 6 112,926,246 $ 112,926 $88,032,313 $(200,000) $ - $(93,161,331) $ 5,216,086
======== ========== =========== ========== =========== ========== ======== ============ ===========
See accompanying notes to unaudited condensed consolidated financial statements
-16-
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
MARCH 31, 2006 (Unaudited)
(Continued)
Deficit
Additional Accumulated
Preferred Paid in Common Stock During
Preferred Shares Common Common Stock Capital Stock Subscription Development
Shares Amount Shares Amount Amount Subscribed Receivable Stage Total
------ --- ----------- --------- ----------- --------- ----- ------------ ------------
Common Stock
returned in
January 2006,
previously issued
for services
rendered at $0.60
per share (250,000) (250) (149,750) (150,000)
Penalty shares
issued pursuant to
pending SB-2
registration at
$0.32 per share in
January 2006 806,212 806 257,182 257,988
Penalty shares
issued pursuant to
pending SB-2
registration at
$0.20 per share in
January 2006 1,289,927 1,290 256,695 257,985
Warrants issued in
January 2006 43,100 43,100
Common Stock
issued in exchange
for consulting
services at $0.17
share in February
2006 160,000 160 27,040 27,200
Common Stock
issued in exchange
for consulting
services at $0.16
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)
Valuation of
Warrant
Liabilities in
connection with
Private Placement
(Note C) (730,111) (730,111)
Net Loss 3,356,513 3,356,513
Balance as of March
------ --- ----------- --------- ----------- --------- ----- ------------ ------------
31, 2006 60,000 6 118,582,385 $ 118,582 $88,220,817 $(200,000) $ - $(89,804,818) $ (1,665,412)
====== === =========== ========= =========== ========= ===== ============ ============
See accompanying notes to unaudited condensed consolidated financial statements
-17-
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the period
September 16,
2002 (date of
For the Six Months Ended Inception)
March 31, Through March
2006 2005 31, 2006
Net cash used in operating activities $(1,508,503) $(5,312,827) $(14,197,587)
(44,972) (28,288) (97,682)
Net cash used in investing activities
Net cash provided by financing activities 1,600,000 8,314,300 14,372,984
Net increase in cash and cash equivalents 46,525 2,973,185 77,715
Cash and cash equivalents at beginning of period 31,190 1,832 --
Cash and cash equivalents at end of period $ 77,715 $ 2,975,017 $ 77,715
Supplemental Disclosures of Cash Flow Information:
Cash paid during period for interest -- -- --
Cash paid during period for taxes -- -- --
Non-cash transaction
Common stock issued for services 710,200 -- 31,316,573
Common stock issued in exchange for intellectual property -- -- 14,689,100
Common stock issued in exchange for previously incurred debt
Common stock penalty shares issued pursuant to pending SB-2 registration 773,958 -- 1,550,487
Common stock canceled-previously issued for services rendered (480,000) -- (1,243,845)
Common stock retired
Amortization of beneficial conversion feature -- -- 10,461,000
Preferred Shares in exchange for services -- -- 1,500,000
Warrants issued to consultants 606,850 -- 3,583,016
Acquisition:
Common stock retained -- -- 1,015
Assets acquired -- -- (135)
Total consideration paid -- -- 880
Organization expenses - note issued in exchange of shares retired -- -- 88,500
See accompanying notes to unaudited condensed consolidated financial statements
-18-
APPLIED DNA SCIENCES, INC
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2006
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements as of March
31, 2006 and for the six month periods ended March 31, 2006 and 2005 have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"), including Form 10-QSB and Regulation S-B. The
information furnished herein reflects all adjustments (consisting of normal
recurring accruals and adjustments), which are, in the opinion of management,
necessary to fairly present the operating results for the respective periods.
Certain information and footnote disclosures normally present in annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted pursuant to such
rules and regulations. The Company believes that the disclosures provided are
adequate to make the information presented not misleading. These financial
statements should be read in conjunction with the audited financial statements
and explanatory notes for the year ended September 30, 2005 as disclosed in the
company's 10-KSB for that year as filed with the SEC, as it may be amended.
The results of the six month period ended March 31, 2006 are not
necessarily indicative of the results to be expected for the full year ending
September 30, 2006.
Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results could differ from those estimates.
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 March 31, 2006, the Company has accumulated losses of
$89,804,818.
The unaudited condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany transactions and balances have been eliminated in the consolidated
financial statements.
Reclassification
Certain prior period amounts have been reclassified for comparative
purposes.
- 19 -
Stock-Based Compensation
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued FASB Statement No. 123R (revised 2004), "Share-Based Payment" which is a
revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation".
Statement 123R supersedes APB opinion No. 25, "Accounting for Stock Issued to
Employees", and amends FASB Statement No. 95, "Statement of Cash Flows".
Generally, the approach in Statement 123R is similar to the approach described
in Statement 123. However, Statement 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
income statement based on their fair values. Pro-forma disclosure is no longer
an alternative. This statement does not change the accounting guidance for share
based payment transactions with parties other than employees provided in
Statement of Financial Accounting Standards No. 123(R). This statement does not
address the accounting for employee share ownership plans, which are subject to
AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans." On April 14, 2005, the SEC amended the effective date of the
provisions of this statement. The effect of this amendment by the SEC is that
the Company had to comply with Statement 123R and use the Fair Value based
method of accounting no later than the first quarter of 2006. The Company
implemented SFAS No. 123(R) on January 1, 2006 using the modified prospective
method. The fair value of each option grant issued after January 1, 2006 will be
determined as of grant date, utilizing the Black-Scholes option pricing model.
The amortization of each option grant will be over the remainder of the vesting
period of each option grant.
As more fully described in financial statements as included in Form
10-KB for the year ended September 30, 2005, the Company granted stock options
over the years to employees of the Company under a non-qualified employee stock
option plan. As of September 30, 2005, 3,660,000 options were outstanding and
exercisable. The Company did not grant any stock options to employees during the
quarter ended March 31, 2006. The Company did not recognize compensation expense
related to employees stock options in the quarter ended March 31, 2006. The
impact on earnings for the remainder of fiscal 2006 for stock based compensation
will depend on future stock option issuances.
In prior years, the Company applied the intrinsic-value method
prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," to account for the issuance of stock options to
employees and accordingly compensation expense related to employees' stock
options were recognized in the prior year financial statements to the extent
options granted under stock incentive plans had an exercise price less than the
market value of the underlying common stock on the date of grant.
Had compensation costs for the Company's stock options been determined
based on the fair value at the grant dates for the awards, the Company's net
loss and loss per share would have been as follows:
- 20 -
For the six months ended
------------------------
March 31, 2006 March 31, 2005
Net income (loss) attributable to common
stockholders -as reported and restated $ 9,039,717 $(34,549,004)
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 based
method (SFAS No. 123)
- -
Net Income (loss) -Pro Forma $ 9,039,717 (34,549,004)
Net Income (loss) attributable to common
stockholders - Pro forma $ 9,039,717 (34,549,004)
Basic income (loss) per share -as reported $ 0.08 $ (0.86)
Basic income (loss) per share - Pro forma $ 0.08 $ (0.86)
Diluted income (loss) per share -as reported $ 0.08 $ (0.86)
Diluted income (loss) per share - Pro forma $ 0.08 $ (0.86)
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 on March 7, 2006, 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 record the derivatives and
related warrants at their fair values as of the inception date of the Note
Agreement (estimated at $858,600) 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 at March 31, 2006 totaled $730,111.
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
157.55%; and risk free interest rate of 4.82% 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).
New Accounting Pronouncements
FAS 129-1. In April 2004, the FASB issued FASB Staff Position (FSP)
129-1, "Disclosure Requirements under SFAS 129, "Disclosure of Information about
Capital Structure," Relating to Contingently Convertible Securities." The FSP
interprets how the disclosure provisions of SFAS 129 apply to contingently
convertible securities and their potentially dilutive effect on earnings per
share. The Company is in a loss position for the three and nine months ended
October 2, 2004, therefore, adoption of this FSP did not have a material effect
on the Company's financial position, results of operations, or cash flows.
- 21 -
Staff Accounting Bulletin No. 107. In March 2005, the staff of the SEC
issued Staff Accounting Bulletin No. 107 (" SAB 107 "). The interpretations in
SAB 107 express views of the staff regarding the interaction between SFAS 123(R)
and certain SEC rules and regulations and provide the staff's views regarding
the valuation of share-based payment arrangements for public companies. In
particular SAB 107 provides guidance related to share-based payment transactions
with nonemployees, the transition from public entity status, valuation methods
(including assumptions such as expected volatility and expected term), the
accounting for certain redeemable financial instruments issued under share-based
payment arrangements, the classification of compensation expense, non-GAAP
financial measures, first-time adoption of SFAS 123(R) in an interim period,
capitalization of compensation cost related to share-based payment arrangements,
the accounting for income tax effects of share-based payment arrangements upon
adoption of SFAS 123(R), the modification of employee share options prior to
adoption of SFAS 123(R) and disclosures in Management's Discussion and Analysis
subsequent to adoption of SFAS 123(R).
SFAS 154. In May 2005 the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 154, "Accounting Changes and Error Corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 requires
retrospective application to prior periods' financial statements for changes in
accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. SFAS 154 also
requires that retrospective application of a change in accounting principle be
limited to the direct effects of the change. Indirect effects of a change in
accounting principle, such as a change in non-discretionary profit-sharing
payments resulting from an accounting change, should be recognized in the period
of the accounting change. SFAS 154 also requires that a change in depreciation,
amortization, or depletion method for long-lived, non-financial assets be
accounted for as a change in accounting estimate effected by a change in
accounting principle. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
Early adoption is permitted for accounting changes and corrections of errors
made in fiscal years beginning after the date this Statement is issued. The
Company does not expect the adoption of this SFAS to have a material impact on
its consolidated financial position, results of operations or cash flows.
NOTE B - INTANGIBLE ASSET AMORTIZATION
The Company has adopted SFAS No. 142, Goodwill and Other Intangible
Assets, whereby the Company periodically test 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.
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 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.
- 22 -
The identifiable intangible assets acquired and their carrying value at
March 31, 2006 are:
Weighted
Average
Amortizable Gross Amortization
Intangible Carrying Accumulated Residual Period
Assets Amount Amortization Net Value (Years)
Trade secrets and
developed
technologies 9,430,900 1,010,454 8,420,446 -- 7
Patents 34,257 15,168 19,089 5
----------- --------- --------- ------------- -----
Total Amortized
Identifiable
Intangible Assets $ 9,465,157 $ 1,025,622 $8,439,535 -- 6.99
=========== =========== ========== ============= ====
Total amortization expense charged to operations for the six months
ended March 31, 2006 and 2005 were $ 677,040 and $7,306 respectively.
NOTE C - NOTES PAYABLE
Notes payable at March 31, 2006 consist of the following:
10% Secured Convertible Promissory Notes , net of
unamortized debt discount of $ 823,210 (see below) $ 676,790
4% convertible note payable, unsecured, and due August
1, 2005; currently in default; Noteholder has the
option to convert unpaid principal together with accrued
and unpaid interest to 180,000 shares of the Company's
restricted common stock. The Company is in default under
the terms of the Note Agreements. 410,429
7.5% note payable to BioCogent, Ltd., an entity
controlled by the Company's President and CEO ;
unsecured and repayment of principal and accrued and
unpaid interest due upon the earlier of the (i) receipt
by the Company of $250,000 in debt or, equity or other
infusion of capital or (ii) by June 30, 2006. 100,000
-------------
1,187,219
Less : Current portion (510,429)
$ 676,790
10% Secured Convertible Promissory Notes
On March 8, 2006, in connection with a private placement, the Company
issued 10% Secured Convertible Promissory Notes in the aggregate principal
amount of $1,500,000 (the "Serial Notes") and warrants to purchase 3,000,000
shares of the Company's common stock to accredited investors. The Serial Notes
bear interest at 10%, mature on September 7, 2007 and are convertible into the
Company's common stock, at the holder's option, at fifty cents ($.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. 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.
- 23 -
The warrants are exercisable until 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 warrents 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 Company may exercise its right of
redemption by written notice to the registered holder of the warrant together
with payment of $1.25 or its British Sterling equivalent. 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
$35,390 was recorded for the three months ended March 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.
Future minimum principal payments are as follows under notes payable for
the year ending March 31, 2006:
2006 $ 510,429
2007 1,500,000
---------
$ 2,010,429
- 24 -
NOTE D - CAPITAL STOCK
The Company is authorized to issue 10,000,000 shares of preferred stock
with a $.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.
In October 2002 the Company issued 602,000 shares of common stock in
exchange for services valued at $0.065 per share. In accordance with EITF 96-18
the measurement date to determine fair value was in October 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 $0.065 per share, which presents the fair value of the services
received which did not differ materially from the value of the stock issued.
In November and December 2002, the Company issued 876,000 shares of
common stock in exchange for subscription at $0.065 per share. In accordance
with EITF 96-18 the measurement date to determine fair value was in October
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 $0.065 per share, which presents the fair value of the
services received which did not differ materially from the value of the stock
issued.
In January 2003, the Company canceled 836,000 shares of common stock
previously issued in exchange for consulting services.
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 $.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 January 2003, the Company issued 586,250 shares of common stock in
exchange for consulting services. In accordance with EITF 96-18 the measurement
date to determine fair value was in October 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 $0.13 per
share, which presents the fair value of the services received which did not
differ materially from the value of the stock issued.
In February 2003, the Company issued 9,000 shares of common stock in
exchange for consulting services. In accordance with EITF 96-18 the measurement
date to determine fair value was in October 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 $0.065 per
share, which presents the fair value of the services received which did not
differ materially from the value of the stock issued.
- 25 -
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 March 2003, the Company issued 91,060 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $2.53 per share, which represents the fair value of the services
received which did not differ materially from the value of the stock issued.
In March 2003, the Company issued 6,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.065 per share, which represents the fair value of the services
received which did not differ materially from the value of the stock issued. In
March 2003, the Company received subscription for 18,000 shares of common stock
in exchange for cash at $1 per share.
On April 1, 2003, the Company issued 860,000 shares of common stock in
exchange for consulting services provided to the Company. In accordance with
EITF 96-18 the measurement date to determine fair value was in October 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 $0.065 per share, which presents the fair value of the services
received which did not differ materially from the value of the stock issued.
On April 9, 2003, the Company issued 18,000 shares of common stock in
exchange for previously issued options to purchase the Company's common stock at
$1.00 per share.
On April 9, 2003, the Company issued 9,000 shares of common stock in
exchange for consulting services provided to the Company. In accordance with
EITF 96-18 the measurement date to determine fair value was in October 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 $0.065 per share, which presents the fair value of the services
received which did not differ materially from the value of the stock issued.
On April 23, 2003, the Company issued 5,000 shares of common stock in
exchange for consulting services provided to the Company. The Company valued the
shares issued at approximately $2.50 per share, which represents the fair value
of the services received which did not differ materially from the value of the
stock issued.
On June 12, 2003, the Company issued 10,000 shares common stock in
exchange for consulting services provided to the Company. The Company valued the
shares issued at approximately $2.50 per share, which represents the fair value
of the services received which did not differ materially from the value of the
stock issued.
On June 17 2003, the Company issued 50,000 shares of common stock in
exchange for cash at $1.00 per share.
On June 30, 2003, the Company issued 270,000 shares of common stock in
exchange for consulting services provided to the Company. In accordance with
EITF 96-18 the measurement date to determine fair value was in October 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 $0.065 per share, which presents the fair value of the services
received which did not differ materially from the value of the stock issued.
- 26 -
On June 30, 2003, the Company received $10,000 as subscription for
options to purchase the Company's common stock at $1.00 per share.
In June, 2003, the Company received $48,000 in connection with a
subscription to purchase the Company's common stock pursuant to a private
placement.
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 July 2003 the Company issued 213,060 shares of common stock for
consulting services provided to the Company. The Company valued the shares
issued at approximately $2.01 per share, which represents the fair value of the
services received which did not differ materially from the value of the stock
issued.
In July 2003, the Company canceled 24,000 shares of common stock,
previously issued for services valued at $2.50 per share.
In July 2003, the Company received $20,000 in exchange for previously
issued options to purchase the Company's common stock at $1.00 per share.
In July 2003, the Company issued 10,000 shares of common stock for cash
previously subscribed at $1.00 per share.
In August 2003, the Company issued 172,500 shares of common stock in
exchange for consulting services provided to the Company. The Company valued the
shares issued at approximately $2.38 per share, which represents the fair value
of the services received which did not differ materially from the value of the
stock issued
In August 2003, the Company received $29,000 in exchange for previously
issued options to purchase the Company's common stock at $1.00 per share.
In September 2003, the Company issued 395,260 shares of common stock in
exchange for consulting services provided to the Company. The Company valued the
shares issued at approximately $2.42 per share, which represents the fair value
of the services received which did not differ materially from the value of the
stock issued.
In September 2003, the Company issued 19,200 shares of common stock for
cash previously subscribed at $2.50 per share.
In September 2003, the Company issued 6,400 shares of common stock
issued in exchange for cash at $2.50 per share pursuant to private placement.
In September 2003, the Company received $95,000 in exchange for
previously issued options to purchase the Company's common stock at $1.00 per
share.
- 27 -
In September 2003, the Company received $2,600 in connection with a
subscription to purchase the Company's common stock pursuant to a private
placement.
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 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.
In October 2003, the Company issued 287,439 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $2.85 per share for a total of $820,418, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In October 2003, the Company issued 120,000 shares of common stock for
shares previously subscribed at $2.50 per share in September 2003. In October
2003, the Company canceled 100,000 shares of common stock previously issued in
exchange for services at $2.50 per share.
In November 2003, the Company issued 100,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $3.00 per share, 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 sold 100,000 shares of common stock
subscribed for cash at $2.50 per share pursuant to private placement.
In December 2003, the Company sold 6,400 shares of common stock
subscribed for cash at $2.50 per share pursuant to private placement.
In December 2003, the Company issued 2,125,500 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $2.59 per share, which represents the fair value of the services
received which did not differ materially from the value of the stock issued.
In December 2003, the Company received $104,000 in exchange for a common
stock subscription at $2.50 per share pursuant to private placement.
In January 2004, the Company issued 41,600 shares of common stock at
$2.50 share pursuant to a subscription made on December 2003.
In January 2004, the Company issued 13,040 shares of common stock at
$2.95 per share in exchange for consulting services valued at $38,468.
In January 2004, the Company issued 123,000 shares of common stock at
$2.60 per share in exchange for consulting services valued at $319,800.
In January 2004, the Company issued 1,000 shares of common stock at
$3.05 per share in exchange for consulting services valued at $3,050.
In February 2004, the Company issued 6,283 shares of common stock at
$3.07 per share in exchange for employee services valued at $19,288.
- 28 -
In March 2004, the Company issued 44,740 shares of common stock at $3.04
per share in exchange for consulting services valued at $136,010.
In March 2004, the Company issued 55,000 of common stock for options
exercised at $1.00 per share.
In March 2004, the Company issued 5,443 shares of common stock at $3.00
per share in exchange for employee services valued at $16,344.
In March 2004, the Company issued 5,769 shares of common stock at $3.15
per share in exchange for employee services valued at $18,177.
In March 2004, the Company converted 5,000 preferred shares into 125,000
shares of common stock at $3.00 per share in exchange for employee services
valued at $375,000.
In March 2004, the Company issued 8,806 shares of common stock at $3.03
per share in exchange for employee services valued at $26,639.
In April 2004, the Company issued 22,500 shares of common stock at $0.10
for subscription of warrants to be exercised.
In April 2004, the Company issued 9,860 shares of common stock at $2.58
per share in exchange for employee services valued at $25,441.
In April 2004, the Company issued 11,712 shares of common stock at $2.35
per share in exchange for consulting services valued at $27,523.
In April 2004, the Company issued 367,500 shares of common stock at
$1.50 per share in exchange for consulting services valued at $551,250.
In April 2004, the Company retired 50,000 shares of common stock
previously issued for consulting services at $0.065 per share or $3,250.
In May 2004, the Company converted 4,000 preferred shares into 100,000
shares of common stock at $1.01 per share in exchange for consulting services
valued at $101,250.
In May 2004, the Company issued 10,000 shares of common stock at $0.10
per share in a stock subscription for $1,000.
In May 2004, the Company issued 137,000 shares of common stock at $0.86
per share in exchange for consulting services valued at $119,233.
In May 2004, the Company issued 26,380 shares of common stock at $1.15
per share in exchange for consulting services valued at $30,337.
In June 2004, the Company retired 5,000 shares of common stock
previously issued for consulting services at $0.065 per share or $325.
In June 2004, the Company issued 270,500 shares of common stock at $0.67
per share in exchange for consulting services valued at $180,560.
In June 2004, the Company issued 8,000 shares of common stock at $0.89
per share in exchange for consulting services valued at $7,120.
- 29 -
In June 2004, the Company issued 50,000 shares of common stock at $0.645
per share in exchange for consulting services valued at $32,250.
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 July 2004, the Company issued 100,000 shares of common stock at $0.54
per share in exchange for consulting services valued at $54,000.
In July 2004, the Company issued 5,000 shares of common stock at $0.72
per share in exchange for consulting services valued at $3,600.
In July 2004, the Company issued 100,000 shares of common stock at $0.47
per share in exchange for consulting services valued at $47,250.
In August 2004, the Company converted 2,000 preferred shares into 50,000
shares of common stock at $0.39 in exchange for consulting services valued at
$19,500.
In August 2004, the Company issued 100,000 shares of common stock at
$0.39 in exchange for consulting services valued at $39,000.
In August 2004, the Company issued 100,000 shares of common stock at
$0.50 in exchange for consulting services valued at $50,250.
In August 2004, the Company issued 200,000 shares of common stock at
$0.56 in exchange for consulting services valued at $112,500.
In August 2004, the Company issued 92,500 shares of common stock at
$0.41 in exchange for consulting services valued at $37,645
In September 2004, the Company issued 1,000,000 shares of common stock
at $0.52 in exchange for consulting services valued at $517,500.
In September 2004, the Company issued 45,000 shares of common stock at
$0.50 in exchange for consulting services valued at $22,288.
In September 2004, the Company converted 4,000 preferred shares into
100,000 shares of common stock at $0.54 in exchange for consulting services
valued at $54,000.
In September 2004, the Company issued 60,000 convertible preferred
shares at $25.00, in exchange for consulting services valued at $1,500,000.
In October 2004, the Company issued 200,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.68 per share for a total of $136,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In October 2004, shareholders returned 1,069,600 shares to treasury
issued earlier in exchange for services valued at $642,098.
In October 2004, the Company issued 82,500 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.60 per share for a total of $49,500, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
- 30 -
In October 2004, the Company sold 500,000 shares of common stock
subscribed for cash at $0.60 per share pursuant to private placement.
In October 2004, the Company issued 532,500 shares of common stock to
existing noteholders. The Company valued the shares issued at approximately
$0.50 per share for a total of $266,250.
In October 2004, the Company sold 500,000 shares of common stock
subscribed for cash at $0.50 per share pursuant to private placement.
In October 2004, the Company sold 1,000,000 shares of common stock
subscribed for cash at $0.45 per share pursuant to private placement.
In October 2004, the Company issued 315,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.45 per share for a total of $141,750, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In November 2004, the Company issued 100,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.47 per share for a total of $47,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In November 2004, the Company issued 300,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.80 per share for a total of $240,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In November 2004, the Company issued 115,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $1.44 per share for a total of $165,600, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In November 2004, the Company issued 5,000 shares of common stock in
exchange for employee services. The Company valued the shares issued at
approximately $1.44 per share for a total of $7,200, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In November 2004, the Company issued 60,000 shares of common stock in
exchange for employee services. The Company valued the shares issued at
approximately $0.60 per share for a total of $36,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
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 December 2004, the Company issued 5,796,785 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $1.44 per share for a total of $8,317,207, which represents the
fair value of the services received which did not differ materially from the
value of the stock issued.
In December 2004, the Company issued 2,930,000 shares of common stock
subscribed for cash at $0.50 per share pursuant to the exercise terms of a
promissory note payable.
- 31 -
During the three months ended March 31, 2005, the Company received $
10,750 in exchange for previously issued options to purchase the Company's
common stock at $ .10 per share.
In January 2005, the Company received $2,500 in exchange for previously
issued options to purchase the Company's common stock at $ .10 per share.
In January 2005, we exchanged $537,500 of previously issued convertible
notes payable for 1,628,789 shares of common stock.
In January 2005, the Company received $ 1,750 in exchange for previously
issued options to purchase the Company's common stock at $.10 per share.
In January 2005, we exchanged $791,673 of previously issued convertible
notes payable for 2,399,012 shares of common stock.
In January, 2005, the Company issued 315,636 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $1.30 per share for a total of $410,327, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In February 2005, we exchanged $25,000 of previously issued convertible
notes payable for 75,757 shares of common stock.
In February 2005, the Company received $2,000 in exchange for previously
issued options to purchase the Company's common stock at $ .10 per share.
In February 2005, we exchanged $200,000 of previously issued convertible
notes payable for 606,060 shares of common stock.
In February 2005, the Company received $ 4,500 in exchange for
previously issued options to purchase the Company's common stock at $ .10 per
share.
In February 2005, we exchanged $600,000 of previously issued convertible
notes payable for 1,500,000 shares of common stock.
In February 2005, we exchanged $91,883 of previously issued convertible
notes payable for 278,433 shares of common stock.
In February, 2005, the Company issued 17,236 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $1.17 per share for a total of $20,166, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In February, 2005, the Company exchanged $150,000 of previously issued
convertible notes payable for 300,000 shares of common stock .
In February, 2005, the Company issued 716,500 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.95 per share for a total of $680,675, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In February, 2005, the Company issued 10,500 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.95 per share for a total of $9,975, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
- 32 -
In March, 2005, the Company exchanged $ 6,601,000 of previously issued
convertible notes payable for 13,202,000 shares of common stock.
In March, 2005, the Company issued 185,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $1.19 per share for a total of $220,150, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In March 2005, the Company received $ 60,000 in exchange for previously
issued options to purchase the Company's common stock at $ .60 per share.
In March, 2005, the Company issued 1,675,272 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.98 per share for a total of $1,641,767, which represents the
fair value of the services received which did not differ materially from the
value of the stock issued.
In March, 2005, the Company issued 24,333 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.92 per share for a total of $22,386, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In March, 2005, the Company issued 15,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.99 per share for a total of $14,850, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In March, 2005, the Company exchanged $ 620,000 of previously issued
convertible notes payable for 1,240,000 shares of common stock.
In March, 2005, the Company canceled shares previously issued within the
quarter for exchange of debt valued at $250,000.
In March, 2005, the Company issued 10,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.89 per share for a total of $8,900, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
The Company recognized an imbedded beneficial conversion feature present
in the January/February Offering note ("January/February PPM"). 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 $ 4,179,554 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 Bridge Offering. Upon conversion of the debt to common
stock, the debt discount attributed to the beneficial conversion feature was
charged in full to operations as interest expense.
The Company recognized the value attributable to the warrants in the
amount of $3,191,446 to additional paid in capital and a discount against the
January/February 2005 PPM.
For the year ended September 30, 2005, the Company reclassified the
$7,371,000 to Warrant Liability (see Note B).
- 33 -
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 was charged to operations during
the period ended March 31, 2005.
In April, 2005, the Company issued 160,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.80 per share for a total of $128,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In April, 2005, the Company issued 40,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.80 per share for a total of $32,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In April, 2005, the Company issued 850,000 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 $637,500, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In April 2005, we exchanged $165,000 of previously issued convertible
notes payable for 500,000 shares of common stock. In April, 2005, a shareholder
returned 10,000 shares previously issued for services valued at $34,200 in
exchange for a cash settlement.
In April 2005, we exchanged previously issued convertible notes payable
for 75,758 shares of common stock.
In April 2005, the Company issued 50,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.68 per share for a total of $34,000, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In June 2005, a shareholder returned 10,000 shares previously issued for
services valued at $5,000.
In June 2005, the Company cancelled 300,000 stock options previously
granted valued at $180,000.
In July 2005, the Company issued 157,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.60 per share for a total of $94,200, 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 (see Note C).
In July 2005, the Company issued 640,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.60 per share for a total of $384,000, 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 8,000,000 shares of its common stock
without restriction to employees in exchange for services rendered. . The
Company valued the shares issued at approximately $0.48 per share for a total of
$3,840,000, which represents the fair value of the services received which did
not differ materially from the value of the stock issued. Since the Company
issued the shares without restriction, the Company may have violated federal and
state securities laws in connection with the issuance of those shares (see Note
I).
- 34 -
In July 2005, the Company issued 121,985 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.94 per share for a total of $168,339, 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 250,000 shares of its common stock
without restriction to consultants in exchange for services rendered. The
Company valued the shares issued at approximately $0.48 per share for a total of
$120,000, which represents the fair value of the services received which did not
differ materially from the value of the stock issued. Since the Company issued
the shares without restriction, the Company may have violated federal and state
securities laws in connection with the issuance of those shares (see Note I).
In connection with the $7,371,000 convertible debt financing completed
during the quarter ended March 31, 2005, the Company was obligated, pursuant to
a registration rights agreement, to complete an effective registration statement
with the SEC of the common stock underlying the convertible debt (see Note I).
Pursuant to the registration rights agreement, the Company is obligated to pay
the investors liquidated damages an amount equal to 3.5% of the face value
amount of the previously issued convertible notes, or approximately $258,000 per
month should the registration statement not be declared effective by the SEC by
July , 2005. The penalties may be paid in cash or shares of the Company's
unregistered common stock, at the sole option of the Company.
As of the date of the financial statements, the registration statement
has not been declared effective, and as a result the Company has incurred and
charged to operations $2,277,535 in liquated damages. As of March 31, 2006, the
Company has issued 3,807,375 shares of its restricted common stock representing
$1,503,540 of liquidated damages for failing to complete an effective
registration statement. The Company valued the shares at the respective dates of
issuance based upon the shares current market value. The balance due, or $
773,995 is included in accounts payable and accrued expenses as of March 31,
2006
In September 2005, the Company issued 185,000 shares of common stock in
exchange for consulting services. The Company valued the shares issued at
approximately $0.94 per share for a total of $173,900, which represents the fair
value of the services received which did not differ materially from the value of
the stock issued.
In September, 2005, the Company cancelled 740,000 shares previously
issued for services valued at $296,972.
In September, 2005, the Company cancelled warrants previously issued
valued at $287,440.
In October, 2005, the Company issued 400,000 shares of common stock in
exchange for cash at $0.50 per share for a total of $200,000.
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.
- 35 -
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 in
exchange for cash at $0.50 per share for a total of $20,000.
In January, 2006, the Company cancelled 250,000 shares previously issued
for services valued at $150,000.
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
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.
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
shareholders 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 and placement of convertible debentures.
Warrants Outstanding Warrants Exercisable
--------------------------------------------------- ------------------------------
Remaining Weighted Weighted
Number Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
$ .10 105,464 3.29 $ .10 105,464 & .10
.20 5,000 2.64 .20 5,000 .20
.50 8,550,000 4.72 .50 8,550,000 .50
.55 9,000,000 2.22 .55 9,000,000 .55
.60 9,132,000 3.13 .60 9,132,000 .60
.70 950,000 1.64 .70 950,000 .70
.75 17,727,000 3.50 .75 17,727,000 .75
1.00 100,000 0.55 1.00 100,000 1.00
------- -------
45,569,464 45,569,464
========== ==========
- 36 -
Transactions involving warrants are summarized as follows:
Number of Shares Weighted Average
Price Per Share
------------------ ----------------
Balance, September 30, 2003 383,500 $1.38
Granted 4,574,753 0.58
Exercised (88,000) 1.00
Canceled or expired - -
----------- ------
Balance, September 30, 2004 4,870,253 0.63
Granted 33,453,000 0.71
Exercised (207,500) 0.34
Canceled or expired (1,033,786) 0.65
----------- ------
Balance, September 30, 2005 37,081,967
0.67
Granted 8,700,000 0.51
Exercised - -
Canceled or expired (212,503) 1.31
----------- ------
Balance, March 31, 2006 45,569,464 $ 0.63
=========== ======
In the quarter ended March 31, 2006, the Company issued 5,500,000
warrants to the holders of the Company's $550,000 notes payable (see Note C)
with a $0.50 exercise price and a five year life. For the first 36 months, the
warrants include anti dilution protection assuming no adjustment in the exercise
price per share of Common Stock upon any reverse split of the Company's common
stock. The estimated value of the warrants granted to Note holders was
determined using the Black-Scholes pricing model and the following assumptions:
contractual term of 5 years, a risk free interest rate of 4.55%, a dividend
yield of 0% and volatility of 42.8%. The amount of the expense charged to
operations for warrants was $563,750 and $394,698, respectively, for the three
months ended March 31, 2006 and 2005.
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
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Exercisable Exercise
(Years) Price Price
------ ----------- --------------- ----- --------- ---------
$ .68 3,660,000 3.75 $.68 3,660,000 $.68
- 37 -
Transactions involving stock options issued to employees are summarized
as follows:
Weighted Average
Number of Shares Price Per Share
Outstanding at October 1, 2003 - $ -
Granted 3,660,000 .68
Exercised - -
Cancelled or expired - -
Outstanding at September 30, 2005 3,660,000 $ .68
Granted - -
Exercised - -
Cancelled or expired - -
Outstanding at March 31, 2006 3,660,000 $ .68
Employee options outstanding and options exercisable at March 31, 2006
had no intrinsic value. Aggregate intrinsic value represents the difference
between the Company's closing stock price on the last trading day of the fiscal
period, which was $ .19 as of March 31, 2006, and the exercise price multiplied
by the number of options outstanding. Total intrinsic value of options exercised
was $ 0 for the three-month periods ended March 31, 2006 and 2005, respectively.
There was no unrecognized stock-based compensation expense related to non-vested
stock options during the period ended March 31, 2006.
NOTE F - 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 has accounted 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 valued the warrants using the
Black-Scholes option pricing model. and Hedging Activities," the Company
revalued the warrants as of March 31, 2006 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 4.82 % , and a volatility of 157.55%.
The difference between the fair value of the warrants on September 30, 2005 and
December 31, 2005 of $ 16,413,750 and $ 10,044,957, respectively, has been
recorded as a gain on revaluation of warrant liability in the consolidated
condensed statement of losses.
- 38 -
NOTE G- RELATED PARTY TRANSACTIONS
On July 15, 2005, we 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 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. 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.
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 March 31, 2006 totaled $20,532 with $3,128
occurring in the three months ended March 31, 2006.
- 39 -
On March 29, 2006, and April 13, 2006, the Company borrowed $200,000 in
the aggregate, at a rate of 7.5% per annum, from BioCogent, Ltd., ("BioCogent"),
an entity controlled by the Company's President and Chief Executive Officer.
These loans are 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 by the
Company of its securities for gross proceeds of at least $250,000 (see Note C).
NOTE H - COMMITMENTS AND CONTINGENCIES
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.
The Company has an employment agreement with the Company's President and
Chief Executive Officer. In addition to salary provisions, the agreement
includes defined commitments should the employee terminate the employment with
or without cause.
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. 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.
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. Subsequent to the date of the
financial statements, the Company and the Plaintiff settled the dispute and the
Company has recorded the settlement amount as of March 31, 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 has recorded the settlement amount as of March 31, 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 has recorded the settlement amount as of March 31, 2006.
- 40 -
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 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 F). In connection with the $ 7,371,000 million convertible debt
financing in the quarter ended March 30, 2005, the Company was obligated to
complete a stock registration by June 2005. Since the registration was not
effective by June 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. For the period ended March 31, 2006, the Company has charged $773,995 to
operations representing the penalties and has included this amount in accounts
payable and accrued expenses.
Matters Voluntarily Reported to the SEC and Securities Act Violations
We previously disclosed that we were investigating the circumstances
surrounding certain issuances of shares to employees and consultants in 2005,
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. Our investigation is continuing. 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.
- 41 -
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
NOTE I - RESTATEMENT
The accompanying financial statements as of March 31, 2005 and for the three and
six month period ended March 31, 2005 have been restated to present the effects
of revaluing the Company's warrants.
The result of the restatement is to reflect gain on warrant revaluation of
$13,310,729 and $10,174,403 for the and to increase the interest expense related
to warrant financing costs for the three and six month periods ended March 31,
2005 by $ 11,932,175 and $ 14,312,214. Net income (loss) for the three and six
month periods ended March 31, 2005 increased by $ 13,554 and $ (5,502,811). The
Company has also increased Selling, General and Administrative expense by
$1,365,000 compared to the previous March 31, 2005 10-QSB for compensation
expenses. The changes in reported amounts are summarized as follows:
Following is a reconciliation of the Company's restatement of the
Condensed Consolidated Statement of Operations for the periods ended March 31,
2005.
Three Months Ended March 31, 2005 Six Months Ended March 31, 2005
(As Restated) (As Reported) (As Restated) (As Reported)
------------- ------------- ------------- -------------
Operating expenses:
Selling, general and
administrative $ 10,406,288 $9,041,288 $ 21,199,209 19,834,209
Research and development - - - -
Depreciation and
amortization 7,306 7,306 12,027 12,027
------------ ----------- ------------ -----------
Total operating expenses 10,413,594 9,048,594 21,211,236 19,846,236
Operating loss (10,413,594) (9,048,594) (21,211,236) (19,846,236)
Net gain/(loss) on
revaluation of warrant
liability 13,310,729 - 10,174,403 -
Other income (expense) 3,100 3,100 3,415 3,415
Interest income
(expense) (19,567,738) (7,635,563) (23,515,586) (9,203,372)
------------ ----------- ------------ -----------
Net Income (Loss) (16,667,503) (16,681,057) (34,549,004) (29,046,193)
Gain (Loss) per common
share $ (0.31) $ (0.31) $ (0.86) $ (0.72)
(basic and assuming
dilution)
Weighted average shares
outstanding 53,044,883 53,044,883 40,082,628 40,082,628
NOTE J - SUBSEQUENT EVENTS
On April 13, 2006, the Company borrowed $100,000, at a rate of 7.5% per
annum, from BioCogent, Ltd., ("BioCogent") whose President and Chief Executive
Officer and sole stockholder is James A. Hayward, one of the Company's directors
and its Chief Executive Officer ("Dr. Hayward"). This loan is 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 by the Company of its securities for gross
proceeds of at least $250,000 (see Note C).
In May, 2006 the Company signed a Business Development and Trademark
License Agreement with Dr. Suwelack Skin & Health Care AG ("Dr. Suwelack")
providing Dr. Suwelack rights to use the Company's SigNature(TM) logo, which is
printed with ink containing the Company's proprietary encrypted botanical DNA
technology, and to participate in the Company's SigNature(TM) Program. The terms
of this one year license agreement provide Suwelack with a limited,
non-exclusive, non-transferable right to use the SigNature(TM) logo on its
packaging and labels. Dr. Suwelack will pay us a one time license fee in the
amount of EUR15,000 in consideration for the use of the Company's SigNature(TM)
logo. EUR7,500 of the license fee was due upon signing of the agreement and the
remaining 50% is due upon receipt of the shipped labels. Dr. Hayward serves on
Dr. Suwelack's board of directors. BioCogent, whose President and Chief
Executive Officer and sole stockholder is Dr. Hayward, provides consulting
services to Dr. Suwelack. Dr. Suwelack and BioCogent recently reached an
agreement in principle, with respect to which no written agreement has been
executed, by which BioCogent will continue to provide consulting services to Dr.
Suwelack and Dr. Hayward will serve as Dr. Suwelack's president on a part-time
basis reporting to Dr. Suwelack's Chief Executive Officer.
- 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 27A of the Securities Act of 1933 as amended, and 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
prospectus. 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.
PLAN OF OPERATIONS
Sales and Marketing
We believe our revenues will come from three sources:
o direct sales to manufacturers, distributors, and/or retailers;
o sales through our OEM relationships; and
o authentication (laboratory) services.
We employ a multi-tier sales and marketing strategy involving our
marketing and sales staff working together with high-level contacts in target
industries and our OEM base. We are attempting to develop strategic alliances
and marketing partners by setting up alliances with Biowell Technology, Inc.'s
("Biowell") technology partners, granting licenses to existing anti-counterfeit
suppliers and partner with industry leaders for intellectual property
development.
We are cognizant that no technology exists today to enable someone in
the street to ascertain, at the point of purchase, whether an expensive product,
or a child's foodstuff, or pharmaceutical product is genuine, worth the money
being paid and safe to use or ingest. No brand owner is able to rapidly
determine whether a product is real of fake. Many multi-billion dollar brands
have no technology to protect against counterfeiting, to detect its occurrence
and to interdict or prosecute the counterfeiter. No company has the capability
to determine with forensic certainty that it is subject to attack. Such
companies remain seriously exposed to product liability, loss of consumer
confidence and loss of revenues. Governments have no rapid detection system to
determine at the point of entry, inspection or seizure whether products are real
or fake. A major thrust of our marketing efforts is to work with consumer
groups, media, corporate officers, government departments, customs, insurers and
others to bring home the message that, in a world of criminality and terrorism,
no-one is safe.
- 43 -
Business Strategy and Approach
We have established integrated business operations addressing and
servicing the needs of the global security marketplace on the part of
corporations and governments for; anti-counterfeiting, fraud prevention, product
authentication, brand protection, supply chain management and protection.
Intellectual Property Development, Product Operations & Partnerships
We have proprietary DNA security technology, and develop security
solutions that protect corporate and intellectual property from counterfeiting,
fraud, piracy and product diversion using botanical DNA as an encrypted/code
molecule that can be embedded in inks, paper, substrates, liquids, textiles,
thread, plastics, holograms and microchips.
We produce security solutions customized to our customer's needs. We
market and sell DNA anti-counterfeit and fraud prevention solutions that
integrate into, and layer with, existing security solutions. These DNA security
features are integrated at the original equipment manufacturer level with ink,
paper, liquids, thread and hologram producers, who in turn sell/supply finished
security products such as primary and secondary product packaging for
pharmaceuticals, beauty products, textiles, currency, passports, ID cards, etc.
We have strict protocols for specifying, integrating, testing, shipping and
confirming the presence of DNA in any given product.
We plan to develop new product lines that will address specific new
challenges in the security marketplace, and bring these advances to target
industries, customers and countries.
Additionally, we will identify strategic partnerships and co-marketing
ventures, and licensees to work with us to develop, market and sell our
biotechnological security products. This will include sub-licensing the
technology to key partners in specific sectors with an established base of
customers. These partners will be able to enhance their product lines and client
services by adding our technology to the existing security matrix in their
products, providing an enhanced solution to deter fraud and counterfeiting.
Management Strategy
We anticipate a period of rapid change as we begin commercialization of
the products now available subsequent signing of our licenses with Biowell, (b)
the establishment of our prototyping labs at the State University of New York at
Stony Brook ("Stony Brook University"), and (c) the availability of products
that have recently been commercialized in Asia by Biowell.
We have organized our resources to manage our commercialization
effectively, optimizing the delivery of new prototypes for customers, and
managing outsourcing especially through our OEMs. Our Chief Executive Officer is
responsible for the strategic direction, coordinating with our overseas
technology partner Biowell, scientific development, operations and corporate
governance, business development and sales, including relations with US and
foreign government agencies, developing business relationships with target
corporations and OEM's, and securing revenues. Our Controller and acting Chief
Financial Officer cover overall financial management, financial reporting,
corporate administration and investors relations. Our marketing department
develops strategic awareness of our technologies across target industry sectors,
their associated media and lobbying companies and liaises with regulatory bodies
(EPA, FDA, etc) and industry associations (CTFA, PHARMA, etc). Our Chairman
oversees the operations of Biowell, including the development of all Asian
territorial sales that are subject to royalty payments due to us. Both our
Chairman and our Strategic Technology Development Officer manage the development
of core DNA sciences for current and future applications. Our Strategic
Technology Development Officer is principally engaged in the productization of
DNA markers for specific industry applications, and for liaison with
corresponding scientists from our principal OEM partners, e.g., petroleum
markers, chemical markers, markers for precious stones, DNA-encrypted inks, DNA
markers for the pharmaceutical industry, etc.
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Consultant & Enforcement Operations
As nations are threatened by terrorism and corporations try to prevent
corporate fraud, counterfeiting, product diversion and industrial espionage, the
need for secure anti-counterfeiting and identification systems increases. Our
technology can provide important and cost-effective support for local, state,
and federal governments as well as corporations doing business with highly
sensitive information or products susceptible to counterfeit. Our
anti-counterfeiting technology can be used for the following types of
identification and important government documents:
o Passports
o Green cards
o Visas
o Driver's licenses
o Social Security cards
o Student visas
o Military ID's
o Other important Identity cards and official documents
We intend to work in collaboration with Biowell and other security
organizations in order to continue to research and develop new product lines
derived from, but not limited to, DNA technology. Research and development of
new product lines is an ongoing commitment and is currently underway in the
Biowell labs and will continue in the U.S. at our new facilities established at
the Long Island High Technology Incubator (LIHTI) at Stony Brook University.
Research and development objectives include the development of a new line of
detection technologies that will provide faster and more convenient ways to
authenticate DNA, continuous effort to incorporate our DNA markers with various
products for new applications, and establishment of a leading DNA authentication
service lab. We believe that we will obtain commercial revenues for these
efforts within 12-24 months, although no assurances can be given that we will
ever generate revenues. Our prototyping laboratory will customize
"off-the-shelf" products for new customers on a case-by-case basis. These new
products are typically newly configured labels, inks or packing elements. We
have identified several options for remote detection and faster detection
methodologies.
We will consult with our clients on a total security service offering;
how to protect their brands, intellectual property, products and physical
security access and how to reduce risk exposure, product liability exposure and
product recall liabilities. We plan to offer worldwide DNA analysis services
supporting the authentication of products and the detection, interdiction,
deterrence and prosecution of counterfeiters and related crimes, through our
subcontractors, sub-licensees and security industry collaborative partners.
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International Sub-License Operations
Developing Technology - We have an in-depth understanding of DNA
microchip design and applications. We will jointly develop DNA-holograms and
DNA-Hologram-RFID devices, DNA-inks, DNA-dyes and DNA-security labels with
leading original equipment manufacturers in these specialist fields.
We will utilize our existing relationships and develop new ones to
introduce our anti-counterfeiting technology to generate business. Each industry
has unique requirements and needs for their anti-counterfeit solutions, and we
believe our DNA technology will provide maximum security technologies. For
example, our smart packaging solutions with DNA security markers in ink, paper
and holograms has widespread application in packaging for pharmaceuticals,
cosmetics, automotive markets, passports, ID's and currency. Our proprietary
technology offers immediate and affordable detection and security for their
brands and products.
Strong Technology Alliances - Our technology can also provide advanced
security dimensions to:
o Electronics security: access and physical/plant security
(biometric security cards enhanced with DNA)
o Security Holograms (DNA enhanced)
o Security papers and printing
o Holograms (DNA holograms)
o Other security-related products and systems
Law Enforcement Expertise - The resources of our collaborative partners
in the security industry include former federal law enforcement, security, and
intelligence officers who provide us with extensive contacts and hands-on
experience in:
o Intellectual property investigation
o Counter-intelligence
o Personal security services
o Anti-counterfeit technologies
o Secure communications and data management
Critical Accounting Policies
Financial Reporting Release No. 60, published by the SEC, recommends
that all companies include a discussion of critical accounting policies used in
the preparation of their financial statements. While all these significant
accounting policies impact our financial condition and results of operations, we
view certain of these policies as critical. Policies determined to be critical
are those policies that have the most significant impact on our consolidated
financial statements and require management to use a greater degree of judgment
and estimates. Actual results may differ from those estimates.
- 46 -
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 liaiblity
o Fair value of intangible assets
Equity Issued with Registration Rights
In connection with placement of our convertible notes and warrants to
certain investors during the fiscal quarter ended March 31, 2005, 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 during the
fiscal quarter ended March 31, 2005, 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.
Use of Estimates
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and revenue and expenses during the
reporting period. 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.
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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 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.
Revenues
Since our inception on September 16, 2002, we have not generated
material revenues from operations. We believe we will begin generating revenues
from operations in the fiscal year as we transition from a development stage
enterprise to that of an active growth stage company, although no assurances can
be given that we will generate any revenues from operations.
Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the six month period
ended March 31, 2006 compared to same period in 2005 decreased $18.111 million
or 85% to $3.089 million from $21.199 million in the prior period due to
non-recurring financing and related costs incurred during the March 2005
quarter.
Research and Development
Research and development expenses increased $91,303 for the six month
period ended March 31, 2006 compared to the same period in 2005 from $0 to
$91,303 primarily due to startup of collaboration with The Center for
Biotechnology at Stony Brook University.
Depreciation and Amortization
In the six month period ended March 31, 2006, depreciation and
amortization increased $672,000 for the period compared to the same period in
2005 from $12,000 to $684,000. In the year ended September 30, 2005, we
capitalized $9.431 million related to an intellectual property asset
acquisition. As a result, we recorded amortization expense totaling $677,040 for
the six month period ended March 31, 2006 compared to no intangible asset
amortization in the three months ended March 31, 2005. We estimate a seven year
useful life that commenced during the fourth fiscal quarter of 2005.
Total Operating Expenses
Total operating expenses during the six months ended March 31, 2006
decreased to $3.864 million from $21.211 million, or a decrease of $17.347
million as a result of the combination of factors listed above.
Gain
Gain on revaluation of warrant liability increased by $2.800 million to
$12.974 million from $10.174 million for the six month periods ended March 31,
2006 and 2005, respectively.
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Interest Expenses
Interest expense, for the six month period ended March 31, 2006
decreased to $79,000 from $23.516 million in the same period of 2005, an
increase of $23.436 million primarily resulting from the reduction in financing
in 2006 as compared to 2005.
Net Income
Net Income for the six month period ended March 31, 2006 increased to
$9.040 million from a loss of $34,549 million in the prior period as a result of
the combination of factors described above.
Liquidity and Capital Resources
Our liquidity needs originate from 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 the six month period ended March 31, 2006, we completed two
additional private placements of debt and associated warrants. In November,
2005, we issued and sold a promissory note in principal amount of $550,000. We
issued warrants to purchase a total of 5,500,000 shares of our common stock at
an exercise price of $0.50 per share to certain persons designated by
International Allied Fund, and paid $55,000 in cash to VC Arjent for its
services as the placement agent for this placement. All principal and accrued
but unpaid interest under this note was paid in full shortly after the closing
of and from the proceeds of the March 8, 2006 offering. 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 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 incurred $375,000 in
commissions, fees and expenses which was paid at closing.
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, Ltd., a New York
corporation ("BioCogent") whose President and Chief Executive Officer and sole
stockholder is James A. Hayward, on of our directors and our Chief Executive
Officer. These loans are 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 will be used for general corporate purposes. The note issued on March 29,
2006 was repaid with interest in May, 2006.
Substantially all of the real property used in our business is leased
under operating lease agreements.
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As of March 31, 2006, we had a working capital deficit of $2,706,482 as
a result of our operating losses from our inception through March 31, 2006. We
generated a cash flow deficit of $14,197,587 from operating activities from our
inception on September 16, 2002 through March 31, 2006. Cash flows used in
investing activities was $97,682 during this period. We met our cash
requirements during this period through the receipt of $14,372,984 in the form
of private placement of our common stock, the issuance of convertible notes (net
of repayments and costs), and advances from the Company's officers, principal
shareholders and third parties.
As of March 31, 2006, we had $2,010,429 in outstanding notes payables.
Please see Note C in our unaudited financial statements included in this Form
10-QSB for the terms of such notes payable.
We expect capital expenditures to be less than $500,000 fiscal 2006. Our
primary investments will be in laboratory equipment to support prototyping and
our authentication services.
While we have raised capital to meet our working capital needs in the
past, and will require additional financing within the next 12 months in order
to meet our current and projected cash flow deficits from operations and
development. We have sufficient funds to conduct our operations for several
months, but not for 12 months or longer. 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 October 21, 2005, 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.
- 50 -
In connection with the January and February 2005 Placement, we granted
the investors registration rights. Pursuant to the registration rights
agreement, if we did not file the registration statement by February 15, 2005,
or if we did not have the registration statement 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 $257,985, 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. All of the
liquidated damages that we paid were paid in common stock, although any future
payments of liquidated damages may, at our option, be made in cash. If we decide
to pay the 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. The issuance of shares upon payment of 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.
Liquidated damages in the form of common stock were paid for the period from
June 15, 2005 to December 15, 2005. We believe that we have no enforceable
obligation to pay further liquidated damages since the shares we agreed to
register for resale are eligible for resale under Rule 144 of the Securities Act
of 1933, as amended, and such continuing liquidated damages are grossly
inconsistent with actual damages to the purchasers of the notes and warrants.
However, we are seeking to confirm this position by obtaining the waiver and
release of the holders of these securities of further liquidated damages. If
these persons do not waive and release and successfully bring a claim against us
with respect to such liquidated damages, it could result in a significant
decrease in our liquidity or assets, which could result in the reduction or
termination of our business. As of March 31, 2006 we have accrued $773,995 in
penalties representing the further liquidated damages associated with our
failure to file the registration statement by the deadline and have included
this amount in accounts payable and accrued expenses.
Matters Voluntarily Reported to the SEC and Securities Act Violations
We previously disclosed that we were investigating the circumstances
surrounding certain issuances of shares to employees and consultants in 2005,
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. Our investigation is continuing. 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 our common stock under federal and applicable state
securities laws were not available, we may be subject to claims by federal and
state regulators for any such violations. In addition, if any purchaser of our
common stock were to prevail in a suit resulting from a violation of federal or
applicable state securities laws, we 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, we are 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 we would prevail in any such litigation.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
- 51 -
Product Research and Development
As a result of the recent financings, we anticipate expending $500,000
of available cash towards research and development activities 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 not anticipate the acquisition of any
material property, plant or equipment during the next 12 months.
Number of Employees
From our inception through the period ended March 31, 2006, we have
mainly relied on the services of outside consultants for services. We currently
have five employees. In order for us to attract and retain quality personnel, we
anticipate we will have to offer competitive salaries to future employees. We
anticipate that it may become desirable to add additional full and or part time
employees to discharge certain critical functions during the next 12 months.
This projected increase in personnel is dependent upon our ability to generate
revenues and obtain sources of financing. There is no guarantee that we will be
successful in raising the funds required or generating revenues sufficient to
fund the projected increase in the number of employees. As we continue to
expand, we will incur additional cost for personnel.
Going Concern
The financial statements included in this filing have been prepared in
conformity with generally accepted accounting principles that contemplate the
our continuance of as a going concern. Our cash position may be inadequate to
pay all of the costs associated with testing, production and marketing of
products. Management intends to use borrowings and security sales 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.
Trends, Risks and Uncertainties
We have sought to identify what we believe to be the most significant
risks to our business, but we cannot predict whether, or to what extent, any of
such risks may be realized nor can we guarantee that we have identified all
possible risks that might arise. Investors should carefully consider all of such
risk factors before making an investment decision with respect to our common
stock.
RISK FACTORS
Much of the information included in this quarterly report includes or is
based upon estimates, projections or other "forward-looking statements". Such
forward-looking statements include any projections or estimates made by us and
our management in connection with our business operations. While these
forward-looking statements, and any assumptions upon which they are based, are
made in good faith and reflect our current judgment regarding the direction of
our business, actual results will almost always vary, sometimes materially, from
any estimates, predictions, projections, assumptions or other future performance
suggested herein.
Such estimates, projections or other "forward-looking statements"
involve various risks and uncertainties as outlined below. We caution the reader
that important factors in some cases have affected and, in the future, could
materially affect actual results and cause actual results to differ materially
from the results expressed in any such estimates, projections or other
"forward-looking statements".
- 52 -
Our common shares are considered speculative. Prospective investors
should consider carefully the risk factors set out below.
RISKS RELATING TO OUR BUSINESS
We Have a History Of Losses Which May Continue, Which May Negatively Impact Our
Ability to Achieve Our Business Objectives.
For the six month period ended March 31, 2006, we produced a net income
of $8,269,828 with $12.974 million attributable to the revised classification
and for the three month period ended March 31, 2006, we incurred a net income of
$2,586,624. We cannot assure you that we can achieve or sustain profitability on
a quarterly or annual basis in the future. Our operations are subject to the
risks and competition inherent in the establishment of a business enterprise.
There can be no assurance that future operations will be profitable. Our
revenues and profits, if any, will depend upon various factors, including
whether we will be able to generate revenue. As a result we continue to incur
losses, our accumulated deficit will continue to increase, which might make it
harder for us to obtain financing in the future. We may not achieve our business
objectives and the failure to achieve such goals would have an adverse impact on
us, which could result in reducing or terminating our operations.
If We Are Unable to Obtain Additional Funding Our Business Operations Will be
Harmed and If We Do Obtain Additional Financing Our Then Existing Shareholders
May Suffer Substantial Dilution.
We will require additional funds to sustain and expand our research and
development activities. We anticipate that we will require up to approximately
$500,000 to fund our anticipated research and development operations for the
next twelve months, depending on revenue from operations. Additional capital
will be required to effectively support the operations and to otherwise
implement our overall business strategy. Even if we do receive additional
financing, it may not be sufficient to sustain or expand our research and
development operations or continue our business operations.
There can be no assurance that financing will be available in amounts or
on terms acceptable to us, if at all. The inability to obtain additional capital
will restrict our ability to grow and may reduce our ability to continue to
conduct business operations. If we are unable to obtain additional financing, we
will likely be required to curtail our research and development plans. Any
additional equity financing may involve substantial dilution to our then
existing shareholders.
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 October 21, 2005, our independent auditors stated
that our financial statements for the year ended from September 30, 2005 were
prepared assuming that we would continue as a going concern. Our ability to
continue as a going concern is an issue raised due to our incurring net losses
of $52,847,993 during the period September 16, 2002 (date of inception) to March
31, 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 obtaining
additional funding from the sale of our securities, generating sales or
obtaining loans and grants from various financial institutions where possible.
Our continued net operating losses increase the difficulty in meeting such goals
and there can be no assurances that such methods will prove successful.
- 53 -
Our Research and Development Efforts for New Products May be Unsuccessful.
We will incur significant research and development expenses to develop
new products and technologies. There can be no assurance that any of these
products or technologies will be successfully developed or that if developed
they will be commercially successful. In the event that we are unable to develop
commercialized products from our research and development efforts or we are
unable or unwilling to allocate amounts beyond our currently anticipated
research and development investment, we could lose our entire investment in
these new products and this may materially and adversely affect our business
operations, which would result in loss of revenues and greater operating
expenses.
Our Acquired Technology Has Yet to be Independently Validated
In July 2005, we acquired certain intellectual property. Such
intellectual property relating to the botanical DNA, encapsulation methods,
integrity of the technology and all other stated claims by the seller need to be
independently validated by a third party. Satisfactory completion of this
independent validation will be required prior to their being available for
commercial sale. In the event that some or all of the technology cannot be
independently validated, we will be unable to commercially develop products
utilizing such technology, which could have a materially adverse effect on our
business and results of operations.
Failure to License New Technologies Could Impair Our New Product Development.
To generate broad product lines, it is advantageous to sometimes license
technologies from third parties rather than depend exclusively on 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 or discontinue our
products. There can be no assurance that we will be able to continue 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
share for certain products. Our licenses typically subject us to various
commercializations, 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. We may not receive significant indemnification from
a licensor against third party claims of intellectual property infringement.
We Currently Have Limited Manufacturing, Sales, Marketing or Distribution
Capabilities.
We currently have limited in-house manufacturing capability. We rely on
Biowell and third-party vendors for this service. 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. We
currently have a limited sales and marketing team. If we are not able to develop
greater sales, marketing or distribution capacity, we may not be able to
generate revenue or sufficient revenue to support our operations.
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If We Fail to Introduce New Products, or Our Existing Products are not Accepted
by Potential Customers, We May Not Gain or May Lose Market Share.
Rapid technological changes and frequent new product introductions are
typical for the markets we serve. Our future success will depend in part on
continuous, timely development and introduction of new products that address
evolving market requirements. We believe successful new product introductions
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 market share 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 cannot assure that we will keep pace with the rapid rate of change
in life sciences research or that our new products will adequately meet the
requirements of the marketplace or achieve market acceptance. Some of the
factors affecting market acceptance of new products include:
o availability, quality and price relative to competitive
products;
o the timing of introduction of the product relative to
competitive products;
o customers' opinions of the products' utility;
o ease of use;
o consistency with prior practices;
o scientists' opinions of the products' usefulness;
o citation of the product in published research; and
o general trends in life sciences research.
We have not experienced any difficulties with the preceding factors,
however, there can be no assurance that we will not experience difficulties in
the future. The expenses or losses associated with unsuccessful product
development or lack of market acceptance of our new products could materially
adversely affect our business, operating results and financial condition.
A Manufacturer's Inability to Produce Our Goods on Time and to Our
Specifications Could Result in Lost Revenue and Net Losses
We do not own or operate any manufacturing facilities and therefore
depend upon independent third parties for the manufacture of all of our
products. Our products are manufactured to our specifications. The inability of
a manufacturer to ship orders of our 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 have
a material adverse effect as our revenues would decrease and we would incur net
losses as a result of sales of the product, if any sales could be made. Because
of our business, the dates on which customers need and require shipments of our
security products from us are critical.
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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 an existing manufacturer of ours must be
replaced, we may have to expand our third-party manufacturing capacity. We
cannot assure you that this additional capacity will be available when required
on terms that are acceptable to us or similar to existing terms which we have
with our manufacturers, either from a production standpoint or a financial
standpoint. We do not have long-term contracts with any manufacturer. None of
the manufacturers we use produces our products exclusively.
Should we be forced to replace one or more of 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 of Ours 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 the ultimate
actions of our independent manufacturers. 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 an independent manufacturer of ours, 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.
The Failure To Manage Our Growth In Operations And Acquisitions Of New Product
Lines And New Businesses Could Have A Material Adverse Effect On Us.
The expected growth of our operations (as to which no representation can
be made) will place a significant strain on our current management resources. To
manage this expected growth, we will need to improve our:
o operations and financial systems;
o procedures and controls; and
o training and management of our employees.
Our future growth may be attributable to acquisitions of and new product
lines and new businesses. We expect that future acquisitions, if successfully
consummated, will create increased working capital requirements, which will
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.
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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 will 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.
If We Are Unable to Retain the Services of Messrs. Sheu, Hayward or Liang, or If
We Are Unable to Successfully Recruit Qualified Managerial and Sales Personnel
Having Experience in Business, We May Not Be Able to Continue Our Operations.
Our success depends to a significant extent upon the continued service
of Dr. Jun-Jei Sheu, the Chairman of our Board of Directors; Dr. James A.
Hayward, our Chief Executive Officer; and Dr. Benjamin Liang, our Secretary and
Strategic Technology Development Officer. We do not have employment agreements
with Drs. Sheu, Hayward or Liang. Loss of the services of Drs. Sheu, Hayward or
Liang could have a material adverse effect on our growth, revenues, and
prospective business. We do not maintain key-man insurance on the life of Drs.
Sheu, Hayward or Liang. We are not aware of any named executive officer or
director who has plans to leave us or retire. In addition, in order to
successfully implement and manage our business plan, we will be dependent upon,
among other things, successfully recruiting qualified managerial and sales
personnel having experience in business. Competition for qualified individuals
is intense. There can be no assurance that we will be able to find, attract and
retain existing employees or that we will be able to find, attract and retain
qualified personnel on acceptable terms.
Failure to Attract and Retain Qualified Scientific or Production Personnel Could
Have a Material Adverse Effect On Us.
Recruiting and retaining qualified scientific and production personnel
to perform research and development work and product manufacturing is critical
to our success. 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, there is no assurance that we will be able to continue to
successfully attract qualified personnel. In addition, our anticipated 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. The failure to attract and retain
these personnel or, alternatively, to develop this expertise internally would
adversely affect our business as our ability to conduct research and development
will be reduced or eliminated, resulting in fewer or no products for sale and
lower revenues. We generally do not enter into employment agreements requiring
these employees to continue in our employment for any period of time.
We Need to Expand Our Sales and Support Organizations to Increase Market
Acceptance of Our Products.
We currently have a small customer service and support organization and
will need to increase our staff to support new customers and the expanding needs
of existing customers. The employment market for sales personnel, and customer
service and support personnel in this industry is very competitive, and we may
not be able to hire the kind and number of sales personnel, customer service and
support personnel we are targeting. Our inability to hire qualified sales,
customer service and support personnel may materially adversely affect our
business, operating results and financial condition.
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The DNA Security Technology Industry is Very Competitive, and We May Be Unable
to Continue to Compete Effectively in this Industry in the Future.
We are engaged in a segment of the DNA security technology industry that
is highly competitive. We compete with many other suppliers and new competitors
continue to enter the market. Many of our competitors, both in the United States
and elsewhere, also work with major pharmaceutical, chemical and biotechnology
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 products. It is impossible
to quantify the number of competitors since they include both the companies we
attempt to sell our products and services to through their use of internal
security and various other security product companies. Some of the
anti-counterfeiting and fraud protection competitors that we are aware of
include: Authentix, InkSure, DNA Technologies, Inc., Art Guard International,
Theft Protection Systems, Tracetag and November AG. Although it is impossible to
determine the total market size and market data information because companies
are secretive about what security methods they utilize and how much they spend
on such measures, we have determined that approximate annual sales by some of
our competitors have been as follows:
o InkSure - $1 million
o DNA Technologies, Inc. - $22.6 million
o November AG - $5.8 million
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 materially adversely affected.
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Our Trademark and Other Intellectual Property Rights May not be Adequately
Protected Outside the United States, Resulting in Loss of Revenue.
We believe that our trademarks, whether licensed or owned by us, and
other proprietary rights are important to our success and our competitive
position. In the course of our international expansion, we may, however,
experience conflict with various third parties who acquire or claim ownership
rights in certain trademarks. We cannot assure that the actions we have taken to
establish and protect these trademarks and other proprietary rights will be
adequate to prevent imitation of our products by others or to prevent others
from seeking to block sales of our products as a violation of the trademarks and
proprietary rights of others. Also, we cannot assure you that others will not
assert rights in, or ownership of, trademarks and other proprietary rights of
ours or that we will be able to successfully resolve these types of conflicts to
our satisfaction. In addition, the laws of certain foreign countries may not
protect proprietary rights to the same extent, as do the laws of the United
States.
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. We are currently not aware of any intellectual property rights
that are being infringed nor have we received notice from a third party that we
may be infringing on any of their patents.
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.
There is a risk that a court would decide that we are infringing the third
party's patents and would order us to stop the activities covered by the
patents. In addition, there is a risk that a court will 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 licensors'
issued patents or our pending applications or our licensors' 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 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.
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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. We currently do not have
any product liability coverage but are attempting to obtain coverage which we
will believe to be adequate. We cannot assure, however, that we will be able to
obtain or 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 former employees, former officers and directors, and
vendors and service providers. We have faced such claims 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
March 31, 2006, this could result in a significant decrease in our liquidity or
assets, which could result in the reduction or termination of our business.
Our Failure to File a Registration Statement Could Affect Our Financial
Condition and Results of Operations.
In June 2005, we engaged Trilogy Capital Partners, Inc. ("Trilogy") as
consultants. In connection with that engagement we issued Trilogy warrants to
purchase 7,500,000 shares of our common stock at a price of $0.55 per share. We
also agreed to file a registration statement with the SEC with respect to the
shares underlying such warrants no later than the earlier to occur of: (i) 15
days following the effectiveness of the registration statement of which this
prospectus forms a part, or (ii) September 15, 2005. As of the date hereof we
have not filed a registration statement with respect to the shares of our common
stock underlying the warrants we issued to Trilogy. In the event that a claim is
successfully brought by Trilogy against us with respect to this matter, it could
result in a significant decrease in our liquidity or assets, which could result
in the reduction or termination of our business.
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We Were Obligated to Pay Liquidated Damages As a Result of Our Failure to Have a
Registration Statement Declared Effective Prior to June 15, 2005, and any
Payment of Liquidated Damages Will Either Result in Depletion of Our Working
Capital or Issuance of Shares of Common Stock Which Would Cause Dilution to Our
Existing Shareholders.
Pursuant to the terms of our private placement that closed in January
and February 2005, if we did not have a registration statement registering the
shares underlying the 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 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. Thus far we have decided
to pay the 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. The issuance of shares upon payment of 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.
Liquidated damages in the form of common stock were paid for the period
from June 15, 2005 to December 15, 2005. We believe that we have no enforceable
obligation to pay further liquidated damages since the shares we agreed to
register for resale are eligible for resale under Rule 144 of the Securities Act
of 1933, as amended, and such continuing liquidated damages are grossly
inconsistent with actual damages to the purchasers of the notes and warrants.
However, we are seeking to confirm this position by obtaining the waiver and
release of the holders of these securities of further liquidated damages. If
these persons do not waive and release and successfully bring a claim against us
with respect to such liquidated damages, it could result in a significant
decrease in our liquidity or assets, which could result in the reduction or
termination of our business.
Matters Voluntarily Reported to the SEC and Securities Act Violations
We previously disclosed that we were investigating the circumstances
surrounding certain issuances of shares to employees and consultants in 2005,
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. Our investigation is continuing. 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 our common stock under federal and applicable state
securities laws were not available, we may be subject to claims by federal and
state regulators for any such violations. In addition, if any purchaser of our
common stock were to prevail in a suit resulting from a violation of federal or
applicable state securities laws, we 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, we are 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 we would prevail in any such litigation.
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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 March 31, 2006, we had 118,582,385 shares of common stock issued
and outstanding and outstanding options and warrants to purchase
[4,260,000/45,569,464] 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 ("OTC Bulletin
Board"), such as us, must be reporting issuers under Section 12 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
and new management, 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 three 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:
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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.
o 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 Commission 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
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
Evaluation of Disclosure Controls and Procedures
As of March 31, 2006, our management carried out an evaluation, under
the supervision of our Chief Executive Officer and Chief Financial Officer of
the effectiveness of the design and operation of our system of disclosure
controls and procedures pursuant to the Securities and Exchange Act, Rule
13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, our
chief executive officer and chief financial officer concluded that our
disclosure controls and procedures are not effective to provide reasonable
assurance that information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms, and that such
information is not accumulated and communicated to our management, including our
chief executive officer and chief financial officer, as appropriate, to allow
timely decisions regarding required disclosure. Please see the subsection
"Significant Deficiencies In Disclosure Controls And Procedures Or Internal
Controls" below.
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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. As described below, as a result
of our evaluation of our disclosure controls and procedures as of March 31,
2006, we determined that our controls and procedures are not effective and
subsequent to the period of this report, began to implement changes to our
internal controls.
Significant Deficiencies In Disclosure Controls And Procedures Or Internal
Controls
As previously reported, on July 11, 2005, we determined there were
errors in accounting for the valuation of equity consulting service transactions
during the January through March 2005 time period. The valuation resulted in the
overstatement of approximately $2.9 million in services provided. The errors
were discovered in connection with a comment raised by the SEC in their review
and comment on our registration statement on Form SB-2. The SEC requested that
we provided additional disclosure regarding issuances of common stock to
non-employees in exchange for services. Upon reviewing and updating our
disclosure, we discovered our errors. During the quarter ended March 31, 2006,
we implemented the following changes in our internal controls to resolve these
weaknesses and deficiencies:
Establish and maintain a separate binder of all board authorized
activities and a binder with forward looking "budget" of anticipated or
contemplated activity for each of the following:
o shares issued for services;
o shares issued for employees;
o warrant exercises;
o option exercises;
o authorized shares and warrant re-pricing;
o shares issued in exchange for debt; and
o upcoming ESOP grants and exercises;
o require the signature of the principal executive and accounting
officers for all issuances of securities;
o require monthly review of share issuances compared to binders;
and
o authorize our transfer agent to handle and track all warrants
and ESOP grants.
We believe that these actions will correct the material deficiencies and
significant weaknesses in our controls and procedures.
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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 or
claims that we believe will have, individually or in the aggregate, a material
adverse affect on our business, financial condition or operating results.
Crystal Research Associates, LLC v. Applied DNA Sciences, Inc., Docket No.:
L-7947-04
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. We intend to move to vacate the default judgment on various grounds. The
plaintiff has agreed in principle to settle this matter with us in exchange for
a cash payment, but, as of the date hereof, we have not executed a settlement
agreement.
Paul Reep v. Applied DNA Sciences, Inc., Case No.: BC345702
Plaintiff Paul Reep, a former employee, commenced this action against us
in the Superior Court for the Sate of California for the County of Los Angeles
on January 10, 2006. Paul 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 damages and
attorneys' fees. We dispute all of the allegations of this complaint and intend
to vigorously defend this mater. In this matter we have asked the court to make
a judicial determination that an agreement, which we did not authorize and which
is the basis of previously disclosed litigation against us by Paul Reep, our
former employee, and a new action filed by our former employees as set forth in
the subsequent paragraphs is invalid and unenforceable. This matter is in its
early stages.
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, which we did not authorize and which is the basis of previously
disclosed litigation against us by Paul Reep, our former employee, is invalid
and unenforceable. This matter is in its early stages.
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. We dispute all of the allegations and intend to vigorously
defend this action. This matter is in its early stages.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On March 8, 2006, we completed a private placement offering in which 30
units (the "Units") of our securities were sold, each Unit consisting of (i) a
$50,000 Principal Amount 10% Secured Convertible Promissory Note (the "Notes")
and (ii) a warrant (the "Warrants") to purchase 100,000 shares of our common
stock, or an aggregate of $1,500,000 in principal amount of Notes and Warrants
to purchase 3,000,000 shares of common stock, for aggregate gross proceeds of
$1,500,000. The Units were sold pursuant to Subscription Agreements, by and
between each of the purchasers and Applied DNA Operations Management, Inc., our
wholly owned subsidiary. This issuance is considered exempt under Regulation S
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
Litigation
We previously disclosed that plaintiff James Paul Brown, filed an action
against us in the Superior Court for the State of California for the County of
Los Angeles on January 12, 2006 (James Paul Brown v. Applied DNA Sciences, Inc.,
Case No. BC 3457814). The complaint asserted a single cause of action for breach
of an alleged oral consulting agreement. The relief sought included money
damages and attorneys' fees. The parties have executed a settlement agreement,
we have performed our obligations under such agreement, and this matter has been
dismissed with prejudice.
We previously disclosed that plaintiff Rubenstein Public Relations, Inc.
commenced an action against us in the Civil Court of the City of New York,
County of New York, in New York State Rubenstein Public Relations, Inc. v.
Applied DNA Sciences, Inc.). Plaintiff Rubenstein Public Relations, Inc.
asserted a cause of action for breach of contract based upon the allegations
that we failed to make payments pursuant to a March 2005 investor relations
consulting agreement governed by New York law. Rubenstein Public Relations, Inc.
sought damages in the amount $43,000. The parties have executed a settlement
agreement, we have performed our obligations under such agreement, and this
matter has been dismissed with prejudice.
Related Party Transactions
On May 9, 2006, we issued a press release to announce that we had
entered into a Business Development and Trademark License Agreement with Dr.
Suwelack Skin & Health Care AG ("Dr. Suwelack") providing Dr. Suwelack rights to
use our SigNature(TM) logo, which is printed with ink containing our proprietary
encrypted botanical DNA technology, and to participate in our SigNature(TM)
Program. The terms of this one year license agreement provide Suwelack with a
limited, non-exclusive, non-transferable right to use the SigNature(TM) logo on
its packaging and labels. Dr. Suwelack will pay us a one time license fee in the
amount of EUR15,000 in consideration for the use of our SigNature(TM) logo.
EUR7,500 of the license fee was due upon signing of the agreement and the
remaining 50% is due upon receipt of the shipped labels. James A. Hayward, one
of our directors and our Chief Executive Officer ("Dr. Hayward"), serves on Dr.
Suwelack's board of directors. BioCogent, whose President and Chief Executive
Officer and sole stockholder is Dr. Hayward, provides consulting services to Dr.
Suwelack. Dr. Suwelack and BioCogent recently reached an agreement in principle,
with respect to which no written agreement has been executed, by which BioCogent
will continue to provide consulting services to Dr. Suwelack and Dr. Hayward
will serve as Dr. Suwelack's president on a part-time basis reporting to Dr.
Suwelack's Chief Executive Officer.
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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 March 14, 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 March 14, 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
March 14, 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: May 23, 2006 By: /s/ JAMES A. HAYWARD
---------------------
James A. Hayward
Chief Executive Officer (Principal
Executive Officer, Principal Financial
Officer and Principal Accounting Officer)
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