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Applied DNA Sciences, Inc. (NASDAQ:APDN)

F1Q 2014 Earnings Conference Call

February 11, 2014 9:00 AM ET

Executives

Debbie Bailey – Director, IR

James Hayward – Chairman, President and CEO

Karol Kain Gray – CFO

Mitchell Miller – Director, Communications

Debbie Bailey

Good morning, and welcome to our Applied DNA Sciences’ Quarterly Conference Call. My name is Debbie Bailey, and I’m the Director of Investor Relations. I would like to thank everyone for joining us here today. Speaking today will be Applied DNA Sciences’ President and CEO Dr. James Hayward; and our CFO Karol Kain Gray.

Please note that some of the information you will hear during our discussion today may consist of forward-looking statements including without limitation those regarding revenue, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings per share and future products. Actual results or trends could differ materially.

For more information, please refer to the risk factors discussed in Applied DNA Sciences’ Form 10-K for fiscal 2013. Applied DNA Sciences assumes no obligation to update any forward-looking statements or information.

At this time, I would like to turn the call over to Dr. Hayward.

James Hayward

Thank you, Debbie, and good morning to our audience, and thank you all for joining us today. To our long-term shareholders, we thank you for your steady support. And to our new investors, a warm welcome rather to the compelling opportunity that is Applied DNA Sciences.

Today, I would like to begin by giving you a current brief overview of the company. Karol will discuss the financial highlights of the first fiscal quarter of 2014. And I will wrap up with a discussion on new customers and achievements, as well as touch on some exciting new trends that could affect our business in the short and long-term.

Located on the campus of Stony Brook University, we are the anchored tenants of the high technology incubator, where we occupy approximately 30,000 square feet of space, encompassing offices, labs and manufacturing facilities. Currently, we have 49 employees, an increase of almost 70% from a year ago.

Using biotechnology as a forensic foundation, Applied DNA Sciences creates unique security solutions, addressing the challenges of modern commerce. It is our goal to help establish secure and flourishing environments that foster quality, integrity and success in every market vertical that we serve.

We are focused intensely on the markets we chose to conquer first: Military Electronics, Security, Cash in Transit and Textiles. Our outreach to inform has been very, very effective. Consequently, very large companies are coming to us. Now we are fully embedded. With increasing frequency, we are leading potential customers that have the largest market capitalizations of any customers in our experience to-date.

Karol Gray will spend time in a minute talking in more depth about our financial results for the first quarter. But let me touch just on the highlights here.

Firstly, we reported almost $600,000 in revenues for the first quarter, an 88% increase in revenues versus the same quarter last year. Now this represents the highest first quarter in our company’s history. Our revenues have increased for each of the last four fiscal years. And in fiscal year 2013, we had our two best quarters ever of $645,000 and $729,000 in Q3 and Q4 respectively.

Management believes that our business growth continues to support these trends, leading we believe to improve revenue results for this fiscal year. You will hear today about some of the opportunities we are driving to put us in position to continue that pattern in this fiscal year.

Last year, we began Q1 with three contracts for DNA marking components for suppliers to DLA. And we ended this quarter with 28 contracts. And that includes seven Original Component Manufacturers and one Prime-Contractor. These later two classes are important, because they represent much broader business opportunities. With the OCMs pushing and the Primes pulling DNA marked parts and authentication to operate at full DNA security.

Other recent highlights include: In December, we launched our groundbreaking new textile identity assurance platform called SigNature T. And our textile business overall is gaining traction and quickly. Our initial program calls for marking of over 50 million kilograms of raw cotton, a process that is already now more than 90% complete. Recently, Supima featured our program in a newsletter featured on your screen that went to all their licensees.

I’d like to read you a brief quote. “Supima had continued to perform random checks and tests over the years to validate specific items to ensure Supima content. With the 2014 Supima license renewal, referring to its renewal with Applied DNA, Supima has expanded the range of testing on two fronts. The first is an increase in the number of fiberTyping tests performed on tested samples. And the second is testing a new development by Applied DNA Sciences SigNature T. Now they continued in their newsletter, Supima and our licensees are committed to ensuring authenticity of product from field to home and we will be vigorously working to continue to ensure the same”.

For Applied DNA, this endorsement fosters constructive dialog with a more than 300 brand owners and manufacturers who want to ensure themselves and their customers that their Pima cotton products are foreseen and unadulterated.

In January, we signed a global exclusive agreement with international wool supplier, H. Dawson Wool, for the use of Applied DNA’s SigNature T Anti-Counterfeiting System in the DNA marking and authentication of wool fiber, similar to what we’ve done in cotton.

H. Dawson Wool will use SigNature T to assure the originality and authenticity of loose wool fiber that will be DNA-marked and traceable in-products created by their customers such as manufacturers of wool carpets and fashion houses producing high-end apparel and other articles made from wool.

This contract extends the fast growing universe of DNA-marked goods from cotton to wool, two of the main pillars of the world textile supply chain. It creates strong potential for growing authentication demand in these businesses, the point at which our customers gain the most value and our firm’s revenue benefits become concomitantly higher. Request for our SigNature DNA technology in textiles are coming at us rapidly now, and from a global customer base.

The other main stay in our business, Cash in Transit, also demonstrated growth, when in January we expanded this business to include Poland’s CBZ, who has an impressive list of clients including the largest cash in transit security companies in Poland, the major banks, the army, police and in Polish Post Office.

The developments of this historic first quarter and those in the periods since the end of December show vividly the expandability and extensibility of our platforms. We are expanding existing technologies into related verticals, and we are extending proven successes in markets into adjacent customer segments.

And now it’s my pleasure to introduce our CFO, Karol Gray, who will discuss our financial results in more detail.

Karol Kain Gray

Thank you, Jim. Good morning, everyone, and thank you for joining us on the call today. I would like to take a few minutes to review the 10-Q financials that were filed yesterday, on February 10, 2014 with the Securities Exchange Commission.

Due to the increase in our unaffiliated market cap, exceeding $75 million, we are no longer considered a smaller reporting company, and have been classified as an accelerated filer.

This change in filing status requires the company to follow different guidelines, such as the decrease of time for the following of the 10-K and 10-Q. We will now be subject to audit of our internal controls, which will be conducted by our independent auditors at the end of our fiscal year as is the standard in-practice for all companies. You should also expect to see expanded disclosures on the narrative, both 10-K and 10-Q. This change went into effect with the filing of this 10-Q.

As Jim has reported, we closed the first quarter of our fiscal year ending December 31, 2013, reporting revenues of approximately $600,000, which is an 88% increase from the same quarter of the prior fiscal year.

The 88% increase is primary due to an increase in sales to supplies to the United States Defense Logistics Agency, DLA, and as well as the textile industry.

During the quarter ended December 31, 2013, the company renewed three contracts and executed four new contracts with DLA suppliers, compared with three contracts that were executed during the same period last year.

This increase is also attributable to the mid-term reporting of revenues from the Small Business Innovation Research, known as SBIR, Phase I bridge option award extended from the Missile Defense Agency.

We continue to look forward building our revenues as we close contracts in all our vertical markets, particularly in the areas of Security, Textiles and Cash and Valuables in Transit.

In summary, Applied DNA Sciences has reported its highest revenues during the first quarter in the company’s history. And once again as a reminder, fiscal year 2013, we did have our two best quarters ever of $645,000 and $729,000 in quarter three and quarter four.

The revenues for this quarter compared to the past two quarters were lower due to slight delays in contract signing, stemming from the condensed quarter of the last fiscal year and the calendar year.

As Jim mentioned, the first quarter of the last year represented the bottom baseline of an upward swing in revenue over the course of prior fiscal year. And again we are building momentum to exceed last year’s performance.

Underlying this momentum are certain positive factors. As reported in the 10-Q under Note A in the concentration section, the company’s ranking is earned from our sales products joined this quarter, included an aggregate of a 11% from one customer compared to 65% from two customers in the same prior period.

This means that our customer base is growing along with our revenue. Over the last year, we have undertaken refinements in several aspects of our business operations, resulting in improvements in sales, production and manufacturing areas.

As a result, we have enhanced our ability forecast revenue by customer and product, with the cost funding improvement in our ability to anticipate and deliver against demand.

Our net loss for the quarter ending December 31, 2013 was $6.3 million, in comparison to the $8.7 million loss reported for the last year’s first quarter, a 28% reduction. It’s important to note that approximately $2.6 million of this loss compares to the $6.3 million from the prior year. And this is considered to be a non-cash accounting entry related to the value of certain lines and has no impact on our liquidity.

Due to certain preventions in the warrant agreement related to our past financing, we are required to adjust the value of the warrants to reflect the current market value. The $2.6 million reported in the consolidated statement of operations, represents the change in market value during the first quarter in fiscal year 2014.

The statement of operations will continue to be impacted by the fluctuation in the fair market value of our warrants until they are fully executed – or exercised, excuse me.

During the month of December, approximately $18 million of these warrants were exercised leaving 22 million warrants outstanding that are recorded at fair market values.

Some other non-cash transactions included a $1.1 million in stock-based compensation which were mostly employee options, a $105,000 for depreciation and amortization, and $15,000 in bad debt expense.

Our research and development expenses increased by 211% or $311,000 from the prior year’s first quarter. This increase is attributable to increased laboratory space and the need to expand our technology platform and product offerings remain at the forefront at our industry.

Selling, general and administrative expenses experienced – increased by 38% or $1.3 million, due to the increase in headcount from 29 to 49 employees.

In summary, our net loss after non-cash expenses was $2.4 million for the first quarter of fiscal year 2014. We will continue to manage our operations responsibly and monitor our expenses carefully.

I have highlighted the balance sheet, income statement and other financial data that I hope you might find interesting.

I would like to now ask Jim to cover his report, and I thank you for your time and attention.

James Hayward

Thank you, Karol. And I must say this is really the first full quarter that we’ve had the pleasure of working together with you and speaking on behalf of the whole management team after telling about [indiscernible] impact. And I am sure the shareholders are beginning to see that as well.

And we’ve had several important media events in our first quarter and in the subsequent period. On December 8, the Wall Street Journal reported on our alliance with Supima to launch our identity assurance program with Supima cotton.

In Spain, the National News reported the use of trained German Shepherds. I must say this got us by surprise, to sniff out DNA-marked copper and other parts from landfills were still in goods areas, thereby returning them to their rightful owners.

Now while we were surprised, this was the first program to use dogs to detect our products. But we have since learned of similar programs with our products in other countries beyond Spain.

And in Canada, Applied DNA was featured on the Discovery Channel’s tech news magazine called Daily Planet, using a Brooklyn New York Brink's facility, and on standing Brink forensic lab as the stage. The segment demonstrated the use of our DNAnet with Smoke Cloak/Fog delivery system in staged catch of a “bad guy”.

The segment in terms informative, funny and dramatic was filmed on location at Applied DNA’s lab in Stony Brook, and had an ultra-high security facility owned by our customer Brink's.

Our DNA Fog product is often packaged with our Centri [ph] DNA anti-intrusion spread. While DNA Fog protects an entire large space, Centri [ph] targets a single individual. Together, they represent cutting-edge technology that can position security companies at the head of the technology pack.

Now finally, I want to point out to you that in our opinion, there is increasing and renewed pressure, which will provide incentives for our military electronics companies to adopt our platform. A second government regulation implementing the language in the National Defense Authorization Act, Section 818, requiring anti-counterfeit systems for government suppliers has been issued for comment by the Department of Defense.

And the threat of cyber terrorism, so evident in the news today is driving the military and other agencies to look even more closely at the connection between counterfeit hardware and the malware that can compromise military systems.

Now I am really looking forward to hearing your questions.

Question-and-Answer Session

Mitchell Miller

Hello, I am Mitchell Miller. And I’ll be posing those questions. I am the Director of Communications at Applied DNA. Hello everyone. Jim, we have a few questions today by various channels. Eric wrote us an email, and it asks us this. Counterfeiting in pharmaceuticals seems like such an obvious business for APDN to be in? He says, I saw a special on 60 Minutes, and realized how serious this problem is. Is there a timeline to begin seeing your technology appearing in it?

James Hayward

Eric, I can tell you honestly, we are very eager to develop business in pharma. We’ve got you. There are new federal laws that will require measures such as track-and-trace for drug suppliers and we can do that.

Also recent report show that the anti-counterfeiting spending in pharma is close to $80 billion annually. Pharma is a strategic priority for us, and we will keep you informed as we make progress.

Mitchell Miller

Jim, interestingly enough we have related questions, a couple on other verticals people are interested in. Alberto asks if we are progressing in packaging, in particular, pharmaceutical packaging. He wants to know if we need FDA approval for the launch [ph].

James Hayward

Now to the best of our knowledge, we do not need FDA approval to sell DNA-infused packaging labels, such as is done by partner Nissha in Japan. We have had inquiries from other companies in food and drugs and cosmetics and their packaging providers, and believe me, we remain actively engaged.

Mitchell Miller

Okay, here are some other questions about possible verticals, investors are interested. And Todd asks about whether we can help with counterfeit cash, which seems to be a newly growing problem in the U.S. We have at least two other questions about retailers, like Amazon and eBay, who may need help identifying counterfeits coming through them?

James Hayward

And I have to say, I personally am grateful, and we all hear appreciate the strategic suggestions that come from our fellow company owners. But I think our investors can also appreciate that we need to be focused [Technical Difficulty] criteria. Prominent among them are industries where health and safety are at risk, where our lives are in danger.

Mitchell Miller

Okay, thanks. We have two questions that actually came in during the call. Both are to this point. Do we have any other federal contracts pending or signed?

James Hayward

Okay. These questions came in from John and Joel [ph].

Mitchell Miller

That’s right.

James Hayward

And I assume that they are moving to our relationship with the Defense Logistics Agency, which is very strong and ongoing. And yes, we are in talks and negotiations regarding at least one other federal contract. And the business with other government agencies is a distinct possibility. And it holds great potential.

Also I want to take the chance to make a distinction that occasionally it’s not so clear to some people. Please just be clear that the DLA program requiring certain suppliers to use our platform is not a contract between us and DLA. It is a requirement coming from that agency to their own suppliers.

Mitchell Miller

Jim, we have two questions. One from Roger – one of two from him. And I may, about the new Counterfeit Prevention Authentication Program which we call CPA. Both asked, essentially if the program offers some different form of authentication than we’ve been offering so far?

James Hayward

Okay. I do believe that we have to do a better job of explaining this program to people who are not in electronics. I think people in the industry understand it quite well. And there has been quite a lot of interest. But for outsiders it’s simple really. It’s like this. The CPA program offers our longstanding and successful authentication platform.

An in-field UV scan detects the presence of our SigNature DNA, while samples are sent to a lab for a forensic identification. The distinction of the CPA program is that there are over half a million morphed electronic parts now circulating through this supply chain. And companies can take advantage of this CPA program as a turnkey package, which is quick to ramp-up in bring in counterfeit litigation systems online quickly.

Mitchell Miller

Roger does have a second question as I mentioned. Is Brink's a financial partner of Applied DNA?

James Hayward

Brink's is simply a customer with whom we are working closely. They have purchase to unique SigNature DNA mark, capable of deployment by Brink's in various worldwide operations. And they are exploring integration of our technology into their security applications throughout the globe.

Mitchell Miller

Okay. Finally, there is a chat on our webinar screen, and I would mention to investors that anyone dialing in using GoToWebinar can chat us these questions real time. This chat asks, do you have knowledge that the DLA will soon expand its program beyond FSC 5962 parts?

James Hayward

I assure which we did. On the other hand, you can see in the close tolerance [ph] from DLA. That expansion is certainly a distinct possibility. And so we are already working in that area.

Also I think it’s important to see that the world is changing, and phenomena like cyber terrorism is combining with the threat of counterfeiting and is scary, and important way. We believe there is more pressure from the Feds coming to bring anti-counterfeiting systems online in electronics and in many other kinds of material.

And with that, I would like to thank you all for your kind attention. I hope we have satisfied your quest for answers, and I hope you are with us in appreciating the great progress we’ve made in the first quarter of 2014. Thank you. Bye.

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