Applied DNA Sciences' (APDN) CEO James Hayward on Q1 2017 Results - Earnings Call Transcript

| About: Applied DNA (APDN)
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Applied DNA Sciences, Inc. (NASDAQ:APDN) Q1 2017 Earnings Conference Call February 9, 2017 4:30 PM ET

Executives

James Hayward - CEO

Beth Jantzen - CFO

Analysts

Craig Pierce - Morgan Stanley

Operator

Good afternoon, and welcome to the Applied DNA Fiscal First Quarter 2017 Earnings Conference Call. All participants will be on listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Beth Jantzen CFO. Please go ahead Ma'am.

Beth Jantzen

Thank you. Good afternoon everyone, and thank you for joining us for our fiscal 2017 first quarter results conference call. A copy of the Company’s earnings press release and the accompanying PowerPoint presentation to this call are available for download on the Investor Relations section of the Applied DNA Web site.

With me on the call today is Dr. James Hayward, Chairman and CEO. As a reminder, please note that some of the information you will hear today during our discussion 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 2016. Applied DNA Sciences assumes no obligation to update any forward-looking statements or information.

Before starting the call, I want to inform you that I’ll be at a Source Capital Disrupted Growth and Healthcare Conference on Wednesday, February 15th in New York City. The conference is open to members of the institutional investment community and if you would like to schedule meeting with us please contact Debbie Bailey.

Now I would like to start off by discussing the results of our fiscal first quarter and then Dr. James Hayward will provide an update to you on the Company’s progress activities and strategies.

Starting with the statement of operations, total revenues to the quarter were $903,000. This represents a 32% decrease compared with 1.3 million reported in the first quarter of fiscal 2016 and a 45% decrease as compared to 1.6 million reported in the fourth quarter of fiscal 2016. Compared to the first fiscal quarter of 2016, product revenues remain flat with a slight increase of 2% for the first fiscal quarter of 2017.

With increases in textiles and consumer asset marketing revenues offset primarily by decrease in bulk DNA production for diagnostics and therapeutics. The increase in textiles was from revenue for the shipment of DNA to marked organic cotton, a new cotton fiber for us. As well as the shipment installation of two DNA transfer units. We also were able to recognize a portion of the differed revenue from September 30, 2016 as commitments we received for Lonestar cotton and we expect to continue to receive commitments throughout the year. The hold on bulk DNA sales has occurred as we complete quality audits by our diagnostic and therapeutic customers upon transition from Vandalia. In parallel we are seeing increased interest from new companies with responses to our new proposals and quotes sent out.

Service revenues decreased 69% from Q1 '16 to Q1 '17, mainly due to conclusion of the two government contract awards discussed in previous calls. To remind you of the breakout between product and service revenues; Service revenues include our pilot projects and any research and/or development contracts as well as Authenticating and fiberTyping services. All other revenues are recorded as product revenues and cost of revenues relates only to product revenues. Cost for service revenues are reflected in R&D and SG&A.

The higher cost of revenue as a percentage of products revenue 39% versus 27% during the three months ended December 31st 2016 as compared to the same period in the prior fiscal year, is due primarily to lower sales in our higher margins, bulk DNA products for diagnostic and therapeutic applications, offset by an increase in lower margin sales for asset marketing products by 44%. As well as DNA transfer systems which enabled revenues of SigNature T.

Operating expenses were $4.6 million for the quarter ended December 31, 2016, an increase of $458,000 or 11% from $4.1 million for the same period in the prior fiscal year. This increase is primarily attributable to an increase in SG&A of $732,000 or 23%, offset by decreases in R&D and depreciation and amortization expenses.

The increase in SG&A from $3.2 million in the first fiscal quarter of 2016 to $3.9 million in the first quarter of fiscal 2017 was due to an increase in stock-based compensation expense, which is a non-cash expense, offset by decreases in both legal and accounting fees.

Net loss for the first fiscal quarter of 2017 was $4 million compared with a net loss of $2.9 million for the same period in the prior fiscal year. For Q1 2017, excluding non-cash expenses, adjusted EBITDA was a negative $2.3 million compared to a negative $2.2 million for the same quarter last fiscal year, and a negative $1.7 million in the prior fiscal quarter. Year-over-year EBITDA did not materially change. EBITDA was lower compared to last quarter primarily due to the decrease in revenue. As, we know these non-cash items have no impacts on our liquidity.

Turning to the balance sheet. Cash and cash equivalents totaled $6.7 million at December 31st compared to $4.5 million at September 30, 2016. The increased cash balance is primarily a result of a $5 million private placement and that we completed last November.

As discussed during prior quarterly calls, our current cotton contract includes extended payment terms that result in a longer collection period and slower cash inflows. As a result, our total accounts receivable for cotton customers as of December 31, 2016 was approximately 6.8 million, of which 920,000 is included in long-term accounts receivable. The decrease in long term accounts receivable of 615,000 from 1.5 million at September 30 to 920,00 at December 31, was reclassified to current accounts receivable as it is expected to be collected within 12 months from calendar year end. This is also true for the decrease in long term differed revenue of $432,000.

Also, as of December 31, 2016, 2.1 million was included in total differed revenue both current and long term for shipments of DNA concentrates during fiscal 2016, but this is changing. For our most recent two cotton orders, we negotiated better payment terms allowing earlier revenue recognition and we are working to improve terms on the cotton orders going forward. We will let you know when we do.

Along with our partners, we are getting better at predicting the needs for the Ginning season. Also, we are receiving better data from both the Gins and electronically from our new model DNA Transfer System which results in us having a better understanding of how much SigNature T DNA has been used through December 31st to mark cotton.

As of January 31st, we have received full payment on all of the cotton that was marked during last Ginning season to 2015 plus 2016 season. The current Ginning season is not yet completed and as it comes to a close, we expect additional commitments to release more of the differed revenues in this current quarter of fiscal Q2 and throughout remainder of fiscal 2017.

As of December 31, 2016, our average monthly cash burn rate for fiscal 2017 was approximately 750,000 compared to approximately 950,000 in the prior fiscal year. The decreased burn rate for fiscal 2017 compared to fiscal 2016 is primarily due to increased cash receipts during the first quarter of fiscal 2017.

As of January 31st, our cash position is approximately $5.6 million. We continue to closely monitor our spending and intend to remain disciplined and continue to strategically manage costs in line with our current and near future market opportunities. We estimate that our cash and cash equivalents, along with the collection of our current receivables are sufficient to fund operations for the next 12 months.

Thank you for joining us today, and I would now like to turn it over to Jim for his comments.

James Hayward

Well, thank you Beth and thank you everyone for joining our call this afternoon, particularly those impacted by the weather.

Over the past few years we have steadily advanced the development and commercial rollout of our core technology platform SigNature DNA. A precision engineered mark that has not and cannot be copied nor broken. Shielding our core technology is a portfolio of intellectual property that today stands at 44 patterns and 84 patterns pending. The majority of which add additional layers of protection and complexity to our engineered mark. It's highly secure robust, durable and cost effective. SigNature DNA markers can be used as a forensic compliment to barcodes, watermarks, holograms, RFIDs, micro dots or any other security platform.

In supply chains DNA is a force that will shape the future of business. Our company provides not just the product and a service, but a platform that can change how an entire marketplace or commercial ecosystem works. We've expanded market awareness of our solutions and driven adoption across business verticals with near term drivers of growth, where our experience is cloneable. Market adoption is gradually accelerating although until now not as fast as I would have liked. We have made substantial progress in building demand and our base of business. verticals such as Mil-Gov, textiles and consumer asset marking have been the early adopters of our core technology and have driven our results to date. Also, we are now able to move more quickly from pilot studies to commercialization in related market verticals.

Our finances give you a static view of our business that is what is happening at this point in time. But I would like to try to do today is to dive a little deeper into some key areas to give you further insight into our business model and to help connect the dots to the revenue and cost drivers that are in place today. Now our number of employees has remained static and tightly controlled. Since payroll is our highest expense. While keeping our headcount, we've added new skills and assets such as bringing production to CGMP compliance for [indiscernible] regulated production. We've cultivated the highest quality standards and remain compliant with our two ISO qualities standards. The size of our tagged universe is steadily increasing with over 66,000 unique molecular tags deployed globally.

To build our business in this vertical we have begun the process of submitting a drug master file to the FDA that will enable us to go to market with SigNature DNA and enhances the opportunities for adoptions by drug manufactures. Now there is no 'approval' of such a drug master file, it's simply paves way from manufacturer to adopt our technology faster. But it does take a significant amount of time to prepare and filed this document with the FDA. We expect to have our drug master file submitted within the next 30 days.

Now we have maintained strong relationships with our government and military customers. Our footprint in Mil-Gov today spans three departments of defense agencies and three non-DOD agencies. To date over 750,000 micro circuits have been DNA marked. These components find their way into mission critical systems. Our strategy in this vertical is two pronged; One, to expand our footprint among military defense department agencies. And two, to drive adoption of our DNA mark, validate and authenticate solutions developed under past military awards to the commercial OEM market, critical aspect of our plan.

We continue to work with DLA to consider additional asset classes, we are working towards rolling out additional electronic items for DLA to mark while focusing on non-electronic items to be marked by manufactures which DLA and other agencies can then purchase. We are encouraged by the support from manufactures outside the electronic industry.

Now, we have also invested time and effort into the universal label platform. We have announced our work with Action Pack as a channel partner and we are collaborating to broaden our collective reach. Since labels are used regardless of commodity and are also easy to counterfeit, forensic labels become a first step in the DNA solution set. Action Pack has begun to reach out to their current customer base and we have already completed the first order together for an unnamed prime defense contractor.

Now, our work with non-DOD agencies remains out of the public domain, but it continues to build. You remember that in May, we announced the blanket purchase agreements spanning five years with the value of $2.5 million. We are beginning to deliver against that contract, but I cannot comment further.

Now the Mil-Gov team is also taking the lead on bridging the gap with textiles to offer policy makers a means by which conflict cotton that is the cotton that arises from forced labor can be halted at the borders. We are requesting additional funding to develop the tools to do this and are hopeful to make progress. For example, we have already cultivated and identified the genetic markers that allow the discrimination of Uzbek cultivars. And as you know Uzbekistan is the largest source globally of conflict cotton harvested with the benefit of forced labor.

Now the match between global trends and our core competencies leads nicely to our brand promise, which is to Keeping Life Real and Safe. The match between the social, technical, economic and political trends that are still rapidly altering commercial eco-systems, and our core competencies all seaming from our skills in DNA and IT. Drive Applied DNA Sciences towards the quality most needed in an uncertain time and that is our brand promise, Keeping Life Real and Safe.

The Internet of Things offers great promise for the quality of life, but it is all put at significant risk because of the threat it brings to the identity of things. It has in part led to the millennial cry of, where does my stuff come from, and it has increased the popularity of farms-to-table and in our experience in textiles from dirt-to-shirt.

Large companies and commercial ecosystems are creating decades long plans for sustainability and responsible sourcing, but how can you prove either of those claims when you are holding physical items in your hand clothing, food or semi-synthetic products such as soaps made from palm oil or the soothing after sun gel made from Aloe plant. There are no tests for these claims, but they can be substantiated with a molecular certificate, such as our SigNature platform that actually carries the information in an embedded edible molecule that cannot be altered or defeated.

Now we have three basic business models that operate within our company they are quite distinct and they bring different values. Integrated they validate one another. In supply chains, we provide DNA tag-ins, we provide service to support monitoring that tag-in throughout the supply chain. In land enforcement and security, we utilize those tags to achieve the goals of law enforcement, and to be able to identify stolen items and people. But in addition, we have an uncommonly valuable asset that we have had to cultivate within the company, and that is the capacity to manufacture DNA in a most unique way.

Throughout the globe there are competitors who manufacture DNA, but they do so typically in live cell systems, in fragmentation or in the growth of mammalian cells. What we have done is taken the methods of PCR which you will note stands for Polymerase Chain Reaction and that is simply and an enzymic method. Non-GMO, it contains only natural materials and is easily controlled, and we now have what we believe is the world's largest capacity to manufacture DNA using that process and so we've created an internal need to an externally available asset.

Now I'm often asked about our lines of revenue and how they relate to our businesses. And if you consider our products and services, we sale DNA, that is DNA in the form of concentrates or sometimes in a carrier or in a finished formulation ready for application. And as the lower image showed on this slide, we also provide the systems for infield tagging and authentication. The upper image is one of our manufacturing scenarios that can be run in series or parallel to manufacture DNA to fit the needs of ourselves or outside customers.

In addition to those products, we provide services, these services can be in the early phase of relationship development and consulting. But we operate under ISO 17025 and so we have full forensic laboratories, the equivalent over crime lab. That allows us to take advantage of the DNA that is associated with natural materials and natural commodities like plant materials.

And of course, we authenticate our own DNA tags. We do that in our own laboratories where we prepare expert witnesses for -- witness reports for legal proceedings or we can do that in field operations. We also have the framework for our customers in an IT format using the secured cloud to be able to track the data and make it available to our customers on and as needed basis. Note that our financials are reported publicly only as the total products and the total services.

I am also asked frequently about the relationship between the various products and industries we work in. And sometimes it's maybe difficult for you to see the relationship that allows us to apply the experience we have learned from one to greatly shortening the learning curve and reaching a commercial state in another. So for example, in beginning with cotton, we first genotyped cotton in order to identify that pima cotton was being heavily substituted. That skill set allowed us to apply genotyping to the detection or in some cases the non-detection of supplements like Aloe used in finished goods in which the DNA might not be persistent and form an argument for why SigNature T is required.

As we deployed SigNature T in cotton fibers, that same industry brought us to polyesters and it was a simple matter to include DNA, a polyester itself in polyester fibers. We expanded then to plastics, from plastics to silicon and now to fertilizers. All part of the same lineal evolution of chemistries. That transferability shortens our sales cycle and development time and gives us a competitive advantage.

Now our value propositions, what do we bring to the actual customer and some are identified here in this slide. Centralize one being that the claims stay with the goods. Typically, what happens in supply chain is, documents travel electronically or as paper goods, all of which can be fraudulently modified, but when the document is in the form of a molecular spreadsheet that actually stays with the goods. It can be there to substantiate all manner of claims like the ones listed in the clear boxes below.

Those value prepositions also help us recover counterfeits and to ensure that our customers retain their market share, in some cases we are hopeful that we will able to avoid certain taxes on behalf of our customers when they bring for example tagged cotton back into the United States and can prove that the fiber's origin was in the U.S. and there are number of other path ways to providing value prepositions to our various customers and these bring the real value to applied DNA in the long-term.

Now customer have come to value forensically provable claims. In the survey that we reported this week with the Harris Poll was extremely valuable in that context. Because of the uncertainty in supply chains consumer realized that the products they get may not be the products they think they are buying, and that was supported by reaching out to a 2,000 panel of customers who clearly showed that forensic proof of claim is an asset worth paying more for and helps to validate our position across very many industry verticals.

You heard at our last quarter about our progress in asset marketing in vehicles in Scandinavia and that's taken an additional turn, that business has essentially doubled in the last 12 months and we are looking for further growth in the future. Now the Swedish dealers have offered an alarm system along with our Smart DNA or Smart DNR [ph] as its marketed locally as a package deal to bring owners of existing BMWs into the dealership to protect their cars. The DNA provided to the owners than used in applications in their home all underwritten by insurers. We hope to bring this kind of platform both to the OEMs manufacturing these products and to other markets beyond Europe.

Now we've spoken at our cotton at great length, but one of the things that excites us most right now is the size of the non-cotton fiber market. And you can see that pictured here quite well in this slide. The size of the non-cotton market is roughly six times the total addressable market of cotton. Manmade fibers are close to 70% of the world's total fiber. And we are making forays into every single one of these fiber types, used in everything from automotive bedding, to non-woven fabrics, to medical devices, to apparel and home goods. And we are very excited about the initial response we've had from that market place and orders are definitely on a rise.

But as has always been the case, our mission is to do well for our investors and do good for humanity at the same time. And we have been marching steadily towards those successes. Now with the characterization of Uzbek cultivars, so that they may in future be identified in finished goods. That is attracting a tremendous amount of attention since all over Europe and in the United States the importation of any fiber that has been the benefit of force labor is a federal crime.

And finally, let me summarize about the advances we are making not only in our business base but in our Company's human capital. Dr. Mehmood Khan, Vice Chairmen of Pepsico and Chief Scientific Officer of Global Research and Development; and Ray Kelly, former Commissioner of the New York Police Department, twice actually, have both recently joined our strategic advisory board. With decades of involvement in global food, beverage and pharmaceutics industries, Dr. Khan is well suited to further our expansion efforts in our core vertical markets. His recent appointment to the Board of Food and Agriculture Research at USTA compliments the development of an opportunity we have in fertilizer tagging.

Ray is twice commissioner of NYPD and he is currently Vice Chairmen of K2 Intelligence. His deep experience in security and law enforcement will directly benefit our Company's efforts in these areas. They joined Bob Catell, Head of the Advisory Board and current Chairmen of the New York States Smart Grid and Chairmen of the Advanced Energy and Research Center at Stony Brook, and former Chairmen and CEO of KeySpan and National Grid. Now these globally recognized experts will provide and valuable insights and guidance to our strategic planning and we are honored to have them.

That concludes my prepared remarks. And I’ll be happy now to open the call to any questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. [Operator Instruction] And our first question comes from Craig Pierce from Morgan Stanley. Please go ahead.

Craig Pierce

Two things come to my mind, I have some others, but the ones that I think would be, well make it three. You covered, Jim, a number of -- you used the expression, I didn’t quite get it completely, but something that's not moved as SaaS up until now as you would, and then you laid out 10 to 15 minutes of things, could you summarize in just a minute or two what are the things that are moving now that were not moving before, that excite you?

James Hayward

Well we are seeing progress really in all the categories, but if you talk about the issues that are going to affect our revenues the fastest and the most scalable, it's in supply chains. Whether those are in supply chains, in military applications or commercial applications or pharmaceutics applications, it's definitely complex supply chains. Than most of the issues that really worry the world. If you talk to any CEO of the Fortune 100. There are two things on their lips, it's Uncertainty and Risk, and we can help eliminate both.

Craig Pierce

Okay. Second question is you had reviewed -- not you Jim, but the accounts receivable numbers that are outstanding there was a $6 million figure what do you feel you can count on first pretty certainly by the end of fiscal, in the next three quarters including this one, that you know is coming in as far as receivables among all those numbers. I know a lot of that is not -- it's going to be some time, it might be this fiscal year, it might be next fiscal year, what is the number that you know you've got coming in the next three quarters?

Beth Jantzen

Right. So, I have 6.7 million currently sitting in our current accounts receivable which means that we are expecting to collect all of that by 12-31 of next year, which would mean that some of that could potentially fall into Q1 of our fiscal '18. But I would say, most likely the majority of that or hopefully around 75% of it would come in within this fiscal '16.

Craig Pierce

Okay, so 75% of 6.7 million?

Beth Jantzen

It's 6.1 million that's sitting in current.

Craig Pierce

Okay, 75%. And then finally for me and I'm sure others would want to get in. Burn rate dropped from 2.7 to 2.1. Any sense of what that's going to be in the next three quarters and what would cause those numbers, the burn rate to go up or down from what your gut sense is as far as burn rate going forward through the rest of this fiscal year?

Beth Jantzen

I would say, it should remain fairly consistent with where it was so far for fiscal '17. The one thing that could skew that would be the timing of the collections of the accounts receivable. And [Multiple Speakers] in different quarters and other.

Craig Pierce

Yes, and just a real quick one. What months you considered the Ginning season?

James Hayward

Well, it's really the function of location. Ginning season in California follows of course the harvest. The harvest begins in later August, runs through to around October, so Ginning runs from October usually till later December, early January. As it turns out it's running still right now in February and likely to continue on into February.

Craig Pierce

Okay, so in your press report you talked about this 2017 Ginning season, that really is not a hard calendar, I mean that's just kind of the -- that's almost the fiscal year or certain months of the fiscal year. I mean it's not -- it's cut and dry like, I assumed it to be so.

James Hayward

It does, it slows us to a certain rise and fall in period density [ph] in the course of our fiscal year, that can make forecasting a little difficult especially since the variables include retail of spending demand from the consumer, the farm yield, as well as the quality of the Ginning.

Now one way we can lower that risk that we are contemplating is to Gin on a more global scale. Right now, our focus has been in Texas, in Arkansas and in California.

Craig Pierce

The northern hemisphere?

James Hayward

Yes, if we spread for example to Australia or to other locations, then that focus concentrated seasonality is diminished.

Operator

And our next question comes from Caroline [indiscernible]. Please go ahead. Pardon me but it appears that Caroline is not at her phone.

Unidentified Analyst

I am here, can you hear me?

James Hayward

Yes, we can.

Unidentified Analyst

Okay, thanks. Just a revenue question and a cost question. We are approaching the end of the 2016 -- at least according to what we said to the previous question, approaching the end of the 2016 Ginning season, but only a negotiable amount of differed revenue was recognized in the quarter. And given what seems like the tone of demand I would have expected that you would have received more orders than this implies.

Can you give us a sense of how much differed revenue do you expect to be recognized in Q2 and Q3, or do you think that we'll have to wait until the 2017 ginning season to bring down some of that backlog? And then on the cost side, you've recently added several high-profile members as you said to your strategic advisory board, congratulations, I am just concerned about their potential compensated in your cash position and burn rate, if you can comment on that? Thanks.

James Hayward

Beth has already spoken to the notion of what percentage of that differed revenue we may be able to draw down against. But that business continues to develop customers even now, so that its possible a new customer comes in and draws on an inventory of DNA tagged cotton that is just waiting to be shipped. So that is already happening and we will continue to happen. It's difficult for us to predict however. It's purely a function of demand.

Unidentified Analyst

Okay. And then on the new members of your advisory board, can you comment on how competition is being handled, if any?

Beth Jantzen

So they're being compensated currently with stock options, so it has no impact on our cash burn and cash flow.

Unidentified Analyst

Okay thanks.

Operator

And that concludes our question-and-answer session. I would now like to turn the call -- conference back over to Dr. James Hayward for any closing remarks.

James Hayward

Great. Well, we are grateful for everyone's participation especially in light of the weather and for your persistence. Thank you very much.

Operator

That concludes today's conference. You may now disconnect the lines.

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