SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
================================================================================
(MARK ONE)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended March 31, 2004
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For transition period from ________ to __________
Commission file number 0-21846
AETHLON MEDICAL, INC.
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(Name of Small Business issuer in its charter)
NEVADA 13-3632859
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7825 FAY AVENUE, SUITE 200,
LA JOLLA, CALIFORNIA 92037
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(Address of principal executive office) (Zip Code)
ISSUER'S TELEPHONE NUMBER (858) 456-5777
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
NONE NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK--$.001 PAR VALUE
(TITLE OF CLASS)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 _
Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.( )
Revenues of the registrant for the fiscal year ended March 31, 2004 were $0.
The aggregate market value of the Common Stock held by non-affiliates
was approximately $4,759,000 based upon the closing price of the Common Stock of
$0.74, as reported by the NASDAQ Over-the-Counter Bulletin Board ("OTCBB") on
June 10, 2004.
The number of shares of the Common Stock of the registrant outstanding
as of June 10, 2004 was 13,389,621.
Transitional Small Business Disclosure Format (check one):
Yes |_| No |X|
TABLE OF CONTENTS
Forward Looking Statements
PAGE
PART I.
Item 1. Description of Business 2
Item 2. Description of Property 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 5
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 6
Item 6. Management's Discussion and Analysis or Plan of Operations 11
Item 7. Financial Statements 24
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 24
Item 8A. Controls and Procedures 24
PART III.
Item 9. Directors and Executive Officers of the Registrant 25
Item 10. Executive Compensation 30
Item 11. Security Ownership of Certain Beneficial Owners and Management
And Related Stockholder Matters 32
Item 12. Certain Relationships and Related Transactions 33
Item 13. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 34
Item 14. Principal Accountant Fees and Services 35
Signatures 36
Certifications
1
FORWARD - LOOKING STATEMENTS
All statements, other than statements of historical fact, included in
this Form 10-KSB are, or may be deemed to be, "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934 (the
"Exchange Act"). Such forward-looking statements involve assumptions, known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of Aethlon Medical, Inc. ("Aethlon
Medical", "We" or the "Company") to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements contained in this Form 10-KSB. Such potential risks
and uncertainties include, without limitation, FDA and other regulatory approval
of our products, patent protection on our proprietary technology, product
liability exposure, uncertainty of market acceptance, competition, technological
change, and other risk factors detailed herein and in other of our filings with
the Securities and Exchange Commission. Each forward-looking statement should be
read in context with, and with an understanding of, the various other
disclosures concerning our Company and our business made elsewhere in this
annual report as well as other public reports filed with the Securities and
Exchange Commission. The forward-looking statements are made as of the date of
this Form 10-KSB, and we assume no obligation to update the forward-looking
statements or to update the reasons actual results could differ from those
projected in such forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL
Aethlon Medical, Inc. ("Aethlon Medical" "We" or the "Company"),
formerly Bishop Equities, Inc. ("Bishop"), was incorporated in Nevada in April
1991 to provide a public vehicle for participation in a business transaction
through a merger with or acquisition of a private company. In March 1993, we
successfully offered our common stock at $6.00 per share through an initial
public offering. In March 1999, Bishop began doing business as "Aethlon Medical,
Inc." In March 2000, the Company's Articles of Incorporation were amended to
formally change the name of the Company from "Bishop Equities, Inc." to "Aethlon
Medical, Inc."
BUSINESS DEVELOPMENT/ACQUISITIONS
On March 10, 1999, (1) Aethlon, Inc., a California corporation
("Aethlon"), (2) Hemex, Inc., a Delaware corporation ("Hemex"), the accounting
predecessor to the Company, and (3) Bishop, a publicly traded "shell" company,
completed an Agreement and Plan of Reorganization (the "Plan") structured to
result in Bishop's acquisition of all of the outstanding common shares of
Aethlon and Hemex (the "Reorganization"). The Reorganization was intended to
qualify as a tax-free transaction under Section 368 (a)(1)(B) of the 1986
Internal Revenue Code, as amended. Under the Plan's terms, Bishop issued 733,500
and 1,350,000 shares of its common stock to the common stock shareholders of
Aethlon and Hemex, respectively, such that Bishop then owned 100% of each
company.
Effective January 1, 2000, we entered into an agreement with a related
party under which an invention and related patent rights for a method of
removing HIV and other viruses from the blood were assigned to us. This
invention further expands the established blood filtration patents already owned
by us. In addition to certain royalty payments equal to 8.75% of net sales of
the patented product, the consideration for the acquired rights included the
additional issuance of shares of our common stock to the inventors upon the
issuance of the patent. On March 4, 2003, the related patent was issued and we
issued 196,078 shares of restricted common stock to the inventors.
On January 10, 2000, we acquired all the outstanding common stock of
Syngen Research, Inc. ("Syngen") in exchange for 65,000 shares of our common
stock in order to establish research facilities in San Diego, California, as
well as employ Dr. Richard Tullis, the founder of Syngen. Dr. Tullis is a
recognized research scientist in the area of DNA synthesis and antisense. Syngen
had no significant assets, liabilities, or operations, and primarily served as
the entity through which Dr. Tullis performed research consulting services. As
such, the acquisition has been accounted for as an acquisition of assets in the
form of an employment contract with Dr. Tullis and not as a business
combination. Dr. Tullis was appointed to the Board of Directors of Aethlon
Medical and was elected its Vice President for Business Development. Effective
June 1, 2001, Dr. Tullis was appointed Chief Scientific Officer of Aethlon
Medical, replacing Dr. Clara Ambrus, who retired from the Company.
2
On April 6, 2000, we completed the acquisition of Cell Activation, Inc.
("Cell"). In accordance with the purchase agreement, we issued 99,152 shares of
restricted common stock and issued 50,148 options to purchase common stock in
exchange for all of the outstanding common shares and options to purchase common
stock of Cell. After the transaction, Cell became our wholly-owned subsidiary.
The acquisition was accounted for as a purchase. At March 31, 2001, we
determined that goodwill recognized in the purchase of Cell was impaired due to
the permanent suspension of operations by Cell, and, accordingly, treated
the related goodwill as fully impaired.
BUSINESS OF ISSUER
We are a development stage therapeutic device company focused on
expanding the applications of our Hemopurifier (TM) platform technology, which
is designed to rapidly reduce the presence of infectious viruses and other
toxins from human blood. In this regard, our core focus is the development of
therapeutic devices that treat HIV/AIDS, Hepatitis-C, and pathogens targeted as
potential biological warfare agents. In pre-clinical testing, we have published
that our HIV-Hemopurifier removed 55% of HIV from human blood in three hours and
in excess of 85% of HIV in twelve hours. Additionally, the HIV-Hemopurifier
captured 90% of gp120, a toxic protein that depletes human immune cells, during
a one-hour pre-clinical blood study. We have also published pre-clinical blood
studies of its HCV-Hemopurifier, which documented the ability to capture 58% of
the Hepatitis-C virus from infected blood in two hours.
The Hemopurifier(TM)
The HemopurifierTM is an expansive platform technology that converges
the established scientific principles of affinity chromatography and
hemodialysis (artificial kidneys) as a means to augment the natural immune
response of clearing infectious viruses and toxins from the blood before cells
and organs can be infected. The therapeutic goal of each Hemopurifier
application is to improve patient survival rates by reducing viral load and
preserving the immune function. We feel that the Hemopurifier will enhance and
prolong the benefit of current infectious disease drug therapies, and fill the
void for patients who inevitably become resistant to drug therapies. The
Hemopurifier is also being positioned to treat patients that might become
infected by a biological agent with no established drug or vaccine treatment.
Biological Weapons
On January 29, 2004, we announced that it we are developing treatments
to combat infectious agents that may be used in biological warfare and
terrorism. This expands our intent to treat infectious diseases beyond HIV/AIDS
and Hepatitis-C. We are working to design Hemopurifiers that can be rapidly
deployed by armed forces as wearable post-exposure treatments on the
battlefield, as well as dialysis-based treatments for civilian populations. We
are focusing our bio-defense strategy on treating "Category A" agents, which are
considered by the Centers for Disease Control (CDC) to be the worst bioterror
threats. These agents include the viruses that cause Smallpox, hemorrhagic
fevers such as Ebola and Marburg, the Anthrax bacteria, and Botulinum toxin.
Each treatment device will be based on the same proprietary HemopurifierTM
filtration technology that is utilized in advancing our HIV/AIDS, and
Hepatitis-C treatments. We have not yet published any data related to the
treatment of any "Category A" agent.
On March 4, 2004, we announced that we have entered into a cooperative
agreement with the National Center for Biodefense (NCBD) at George Mason
University in Manassas, Virginia. The purpose of the agreement is to broaden
scientific resources, and jointly pursue business and funding opportunities
within the federal government.
Treatment Classification
Aethlon Medical's treatments for infectious diseases are classified as
"IMMUNOTHERAPIES" that augment or mimic the immune system's response of clearing
infectious virus, and as "ENTRY INHIBITORS" that curb the re-infection process
by physically removing infectious viruses before healthy cells are infected.
Immunotherapy - The "Immunotherapy" classification is a result of our
ability to mimic the immune system's natural response of generating antibodies
to fight foreign invaders such as viruses. Antibodies are specifically created
by the immune system to attach themselves to the antigens (e.g. proteins and
other component parts of viruses), forming an antigen-antibody complex which
neutralizes the invader. The neutralized antigens are then physically removed
from the bloodstream by organs such as the liver.
3
Our treatment technology uses a hemodialysis cartridge (e.g. artificial
kidney or plasmapheresis cartridge) modified to contain immobilized antibodies
targeted against specific viruses. Viruses in the blood are captured inside the
cartridge through the formation of an antigen-antibody complex, physically
removing the virus from circulation. As a result, the physical elimination of
infectious virus occurs without the side-effects common in drug therapy.
Entry Inhibitor - Our treatment technology is also classified as an
"Entry Inhibitor" since the re-infection process is interrupted when viruses are
removed from circulation before cells can be infected. As a result, the
replication cycle is inhibited as infectious virus is denied entry into the
cells that it seeks to kill. From a therapeutic standpoint, entry inhibitors
represent a departure from the traditional drug action of inhibiting viral
replication within the cells that have already been infected. The novel
therapeutic mechanism offered by "Entry Inhibitors", combined with the high
level of treatment resistance to currently approved drugs, positions "Entry
Inhibitors" as an important new treatment strategy to assist HIV/AIDS and
Hepatitis-C infected individuals in managing their disease.
Heavy Metal Treatments
Historically, the original Hemopurifier treatment applications were
developed to treat individuals burdened with heavy metal intoxicants. Products
developed in this category include treatments for iron overload, aluminum
intoxication, lead poisoning, and cisplatin removal. We are not currently
pursuing the commercialization of these products as we are focused on developing
infectious disease related Hemopurifiers.
Research and Development
In fiscal year 2001, we realigned our research and development
activities from developing Hemopurifiers to treat harmful metals to developing
Hemopurifiers for the treatment of HIV/AIDS and Hepatitis-C. As a result of this
strategic realignment, we initiated the consolidation of all scientific and
administrative functions into our San Diego facilities during the fourth quarter
of fiscal 2001. This consolidation was completed during the first quarter of
fiscal 2002 and our facilities in Buffalo, N.Y. were closed. In 2004, we
expanded our research effort to include the development of Hemopurifiers as
countermeasures against biological weapons.
The cost of research and development, all of which has been charged to
operations, amounted to approximately $400,000 over the last two fiscal years.
Patents
Effective January 1, 2000, we entered into an agreement with a related
party under which an invention and related patent rights for a method of
removing HIV and other viruses from the blood using the Hemopurifier(TM) were
assigned to us by the inventors in exchange for a royalty to be paid on future
sales of the patented product or process and shares of our common stock. On
March 4, 2003, the related patent was issued and we issued 196,078 shares of
restricted common stock. We have applied for and obtained several patents
relating to our HIV-Hemopurifier and related technology. Any resulting medical
device or process will require approval by the U.S. Food and Drug Administration
("FDA"), and we have not yet begun efforts to obtain FDA approval on any
infectious disease related Hemopurifier. Since many of our patents were issued
in the 1980's, they may expire before FDA approval, if any, is obtained.
However, we believe that certain patent applications filed and/or other patents
issued more recently will help to protect the proprietary nature of the
Hemopurifier treatment technology.
INDUSTRY
The industry for treating infectious disease is extremely competitive,
and companies developing new treatment procedures are faced with severe
regulatory challenges. In this regard, only a small percentage of companies that
are developing new treatments will actually obtain approval from the Food & Drug
Administration (FDA) to market their treatments in the United States. Currently,
the market for treating HIV/AIDS and Hepatitis-C (HCV) is comprised of drugs
designed to reduce viral load by inhibiting viral replication or by inhibiting
viruses from infecting healthy cells. Unfortunately, these drugs are toxic, they
are expensive to develop, and inevitably, infected patients will develop viral
strains that become resistant to drug treatment. As a result, patients are left
without treatment options.
COMPETITION
4
We are advancing our Hemopurifier technology as a treatment to enhance
and prolong current drug therapies by removing the viral strains that cause drug
resistance. The Hemopurifier is also designed to prolong life for infected
patients who have become drug resistant and have no other treatment options.
Therefore, we do not believe that the Hemopurifier competes with the current
drug therapy treatment standard. However, if the industry considered the
Hemopurifier to be a potential replacement for drug therapy, then the
marketplace for the Hemopurifier would be extremely competitive. We are also
pursuing the development of Hemopurifiers to be utilized as treatment
countermeasures against biological weapons. In this regard, we are targeting the
treatment of pathogens in which current treatments are either limited or do not
exist. We believe that we are the sole developer of viral filtration systems
(Hemopurifiers) to treat HIV-AIDS, Hepatitis-C, and Biological weapons.
GOVERNMENT REGULATION
Our activities and products are significantly regulated by a number of
governmental entities, including the FDA in the United States. These entities
regulate, among other things, the manufacture, testing, safety, effectiveness,
labeling, documentation, advertising and sale of our future commercial products.
We must obtain regulatory approval for a product in all of these areas before we
can commercialize the product. Product development within this regulatory
framework takes a number of years and involves the expenditure of substantial
resources. Many products that initially appear promising ultimately do not reach
the market because they are found to be unsafe or ineffective when tested. Our
inability to commercialize a product would impair our ability to earn future
revenues.
In the United States, vaccines and immunotherapeutics for human use are
subject to FDA approval as "biologics" under the Public Health Service Act and
"drugs" under the Federal Food, Drug and Cosmetic Act. The steps required before
a new product can be commercialized include: pre-clinical studies in animals,
clinical trials in humans to determine safety and efficacy and FDA approval of
the product for commercial sale.
Data obtained at any stage of testing is susceptible to varying
interpretations, which could delay, limit or prevent regulatory approval.
Moreover, during the regulatory process, new or changed drug approval policies
may cause unanticipated delays or rejection of our product. We may not obtain
necessary regulatory approvals within a reasonable period of time, if at all, or
avoid delays or other problems in testing our products. Moreover, even if we
received regulatory approval for a product, the approval may require limitations
on use, which could restrict the size of the potential market for the product.
A product's safety and effectiveness in one test is not necessarily
indicative of its safety and effectiveness in another test. Moreover, we may not
discover all potential problems with a product even after completing testing on
it. Some of our products and technologies have undergone only pre-clinical
testing. As a result, we do not know whether they are safe or effective for
humans. Also, regulatory authorities may decide, contrary to our findings, that
a product is unsafe or not as effective in actual use as its test results
indicated. This could prevent the product's widespread use, require its
withdrawal from the market or expose us to liability.
The FDA requires that the manufacturing facility that produces a
licensed product meet specified standards, undergo an inspection and obtain an
establishment license prior to commercial marketing. Subsequent discovery of
previously unknown problems with a product or its manufacturing process may
result in restrictions on the product or the manufacturer, including withdrawal
of the product from the market. Failure to comply with the applicable regulatory
requirements can result in fines, suspensions of regulatory approvals, product
recalls, operating restrictions and criminal prosecution.
Because we may market our products abroad, we will be subject to
varying foreign regulatory requirements. Although international efforts are
being made to harmonize these requirements, applications must currently be made
in each country. The data necessary and the review time varies significantly
from one country to another. Approval by the FDA does not ensure approval by the
regulatory bodies of other countries.
Any future collaborators will also be subject to all of the
above-described regulations in connection with the commercialization of products
utilizing our technology.
5
PRODUCT LIABILITY
The risk of product liability claims, product recalls and associated
adverse publicity is inherent in the testing, manufacturing, marketing and sale
of medical products. We do not have clinical trial liability insurance coverage.
There can be no assurance that future insurance coverage will to be adequate or
available. We may not be able to secure product liability insurance coverage on
acceptable terms or at reasonable costs when needed. Any liability for mandatory
damages could exceed the amount of our coverage. A successful product liability
claim against us could require us to pay a substantial monetary award. Moreover,
a product recall could generate substantial negative publicity about our
products and business and inhibit or prevent commercialization of other future
product candidates.
SUBSIDIARIES
We have four dormant wholly-owned subsidiaries, Aethlon, Inc., Cell
Activation, Inc., Syngen Research, Inc., and Hemex, Inc.
EMPLOYEES
At March 31, 2004, we had two full-time employees, comprised of our
Chief Executive Officer and our Chief Scientific Officer. We utilize, whenever
appropriate, contract and part time professionals in order to conserve cash and
resources. We believe that our employee relations are good. None of our
employees is represented by a collective bargaining unit.
WHERE YOU CAN FIND MORE INFORMATION
We file annual reports on Form 10-KSB, quarterly reports on Form
10-QSB, current reports on Form 8-K and proxy and information statements and
amendments to reports files or furnished pursuant to Sections 13(a) and 15(d) of
the Securities Exchange Act of 1934, as amended. The public may read and copy
these materials at the SEC's Public Reference Room at 450 Fifth St NW,
Washington, DC 20549. The public may obtain information on the operation of the
public reference room by calling the SEC at 1-800-SEC-0330. The SEC also
maintains a website (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding other companies, like us,
that file materials with the SEC electronically. Our headquarters are located at
7825 Fay Avenue, Suite 200, La Jolla, CA 92037. Our phone number at that address
is (858) 456-5777. Our website is www.aethlonmedical.com.
ITEM 2. DESCRIPTION OF PROPERTY
We currently rent approximately 1,000 square feet of laboratory space
at 3344 Industrial Court, San Diego 92121, California on a month-to-month basis
at a lease rate of $1,200 per month. We also lease approximately 1,200 square
feet of executive office space at 7825 Fay Avenue, Suite 200, La Jolla,
California 92037 at the rate of $3,425 per month on a month-to-month lease for
use as its principal executive offices.
ITEM 3. LEGAL PROCEEDINGS
We may be involved from time to time in various claims, lawsuits,
disputes with third parties or breach of contract actions incidental to the
normal course of business operations. Aethlon Medical is currently not involved
in any such litigation or any pending legal proceedings that we believe could
have a material adverse effect on our financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
LIMITED PUBLIC MARKET FOR SHARES OF COMMON STOCK
Our Common Stock is quoted on the OTCBB. Our trading symbol is "AEMD."
Our Common Stock has had a limited and sporadic trading history.
6
The following table sets forth for the calendar period indicated the
high and low bid prices for our Common Stock as reported by the OTCBB. The
prices represent quotations between dealers, without adjustment for retail
markup, mark down or commission, and do not necessarily represent actual
transactions.
HIGH LOW
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2004
1st Quarter $ 4.25 $ 0.37
2003
4th Quarter $ 0.55 $ 0.36
3rd Quarter $ 1.01 $ 0.25
2nd Quarter $ 0.60 $ 0.20
1st Quarter $ 0.56 $ 0.15
2002
4th Quarter $ 0.85 $ 0.15
3rd Quarter $ 1.05 $ 0.65
2nd Quarter $ 1.95 $ 0.55
1st Quarter $ 2.30 $ 1.15
We have not declared any cash dividends on our common stock since
inception and do not anticipate any in the future. Our current business plan is
to retain any future earnings to finance the expansion and development of our
business. Any future determination to pay cash dividends will be at the
discretion of our board of directors, and will be dependent upon our financial
condition, results of operations, capital requirements and other factors our
board may deem relevant at that time.
There are approximately 800 record holders of our Common Stock at June
10, 2004. The number of registered shareholders includes any beneficial owners
of common shares held in street name.
The transfer agent and registrar for our common stock is Computershare
Trust Company, located in Denver, Colorado.
PENNY STOCK
Until our shares qualify for inclusion in the NASDAQ system, the public
trading, if any, of our common stock will be on the OTC Bulletin Board. As a
result, an investor may find it more difficult to dispose of, or to obtain
accurate quotations as to the price of, our common stock offered. Our common
stock is subject to provisions of Section 15(g) and Rule 15g-9 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), commonly referred to as
the "penny stock rule." Section 15(g) sets forth certain requirements for
transactions in penny stocks, and Rule 15g-9(d) incorporates the definition of
"penny stock" that is found in Rule 3a51-1 of the Exchange Act. The SEC
generally defines "penny stock" to be any equity security that has a market
price less than $5.00 per share, subject to certain exceptions. If our common
stock is deemed to be a penny stock, trading in the shares will be subject to
additional sales practice requirements on broker-dealers who sell penny stock to
persons other than established customers and accredited investors. "Accredited
investors" are persons with assets in excess of $1,000,000 or annual income
exceeding $200,000 or $300,000 together with their spouse. For transactions
covered by these rules, broker-dealers must make a special suitability
determination for the purchase of such security and must have the purchaser's
written consent to the transaction prior to the purchase. Additionally, for any
transaction involving a penny stock, unless exempt, the rules require the
delivery, prior to the first transaction, of a risk disclosure document,
prepared by the SEC, relating to the penny stock market. A broker-dealer also
must disclose the commissions payable to both the broker-dealer and the
registered representative, and current quotations for the securities. Finally,
monthly statements must be sent disclosing recent price information for the
penny stocks held in an account and information on the limited market in penny
stocks. Consequently, these rules may restrict the ability of a broker-dealer to
trade and/or maintain a market in our common stock and may affect the ability of
our shareholders to sell their shares.
7
RECENT SALES OF UNREGISTERED SECURITIES
CONVERTIBLE DEBT
In April 2003, we issued a 9% convertible note in the amount of
$150,000. The note was convertible at $0.25 until June 30, 2003, at which time
the conversion feature expired. This transaction was exempt from registration
pursuant to Regulation D promulgated under the Securities Act of 1933.
In March 2004, we issued a 10% convertible note in the amount of
$50,000 for cash. The note was due on April 30, 2004 and was converted at $0.44
per share in May 2004. This transaction was exempt from registration pursuant
to Regulation D promulgated under the Securities Act of 1933.
COMMON STOCK AND WARRANTS
In April 2003, we issued 600,000 shares of restricted common stock at a
price of $0.25 per share for cash totaling $150,000. In connection with the
issuance of these shares, we granted the stockholder 600,000 warrants to
purchase our common stock at $0.25 per share. The warrants vested immediately
and expire in April 2005. This transaction was exempt from registration pursuant
to Regulation D promulgated under the Securities Act of 1933.
In May 2003, we issued 40,000 shares of restricted common stock at a
price of $0.25 per share for cash totaling $10,000. In connection with the
issuance of these shares, we granted the stockholder 40,000 warrants to purchase
common stock of the Company at $0.25 per share. The warrants vested immediately
and expire in May 2004. This transaction was exempt from registration pursuant
to Regulation D promulgated under the Securities Act of 1933.
In May 2003, we issued 10,000 shares of restricted common stock at a
price of $0.25 per share for services in the amount of $2,500. This transaction
was exempt from registration pursuant to Section 4(2) of the Securities Act of
1933.
In July 2003, we issued 380,000 shares of restricted common stock at
prices between $0.25-$0.30 per share for cash totaling $100,000. In connection
with the issuance of these shares, we granted the stockholders 380,000 warrants
to purchase our common stock at prices between $0.25-$0.30 per share. The
warrants vested immediately and expire in July 2004. These transactions were
exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
In September 2003, we issued 160,000 shares of restricted common stock
at a price of $0.25 per share for cash totaling $40,000. In connection with the
issuance of these shares, we granted the stockholder 160,000 warrants to
purchase our common stock at a price of $0.25 per share. The warrants vested
immediately and expire in September 2004. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In September 2003, we issued 60,000 shares of restricted common stock
for cash totaling $15,000, in connection with the exercise of 60,000 warrants to
purchase our common stock at $0.25 per share. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In October 2003, we issued 80,000 shares of restricted common stock for
cash totaling $20,000, in connection with the exercise of 80,000 warrants to
purchase our common stock at $0.25 per share. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In November 2003, we issued 100,000 shares of restricted common stock
at a price of $0.25 per share for cash totaling $25,000. In connection with the
issuance of these shares, we granted the stockholders 100,000 warrants to
purchase our common stock at a price of $0.25 per share. The warrants vested
immediately and expire in November 2004. These transactions were exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In November 2003, we issued 11,017 shares of restricted common stock at
a price of $0.50 per share in connection with the conversion of $5,000 of notes
payable plus accrued interest. This transaction was exempt from registration
pursuant to Regulation D promulgated under the Securities Act of 1933.
8
In November 2003, we issued 100,000 shares of restricted common stock
for cash totaling $25,000, in connection with the exercise of 100,000 warrants
to purchase our common stock at $0.25 per share. This transaction was exempt
from registration pursuant to Regulation D promulgated under the Securities Act
of 1933.
In December 2003, we issued 20,000 shares of restricted common stock at
a price of $0.25 per share for cash totaling $5,000. In connection with the
issuance of these shares, we granted the stockholders 20,000 warrants to
purchase our common stock at a price of $0.25 per share. The warrants vested
immediately and expire in December 2004. These transactions were exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In December 2003, we issued 461,667 shares of restricted common stock
at a price of $0.25 per share and 461,667 warrants to purchase common stock at
an exercise price of $0.25 per share, in connection with the conversion of
$100,000 of notes payable plus accrued interest. The warrants vested immediately
and are exercisable through December 2004. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In December 2003, we issued 120,000 shares of restricted common stock
for cash totaling $30,000, in connection with the exercise of 120,000 warrants
to purchase our common stock at $0.25 per share. This transaction was exempt
from registration pursuant to Regulation D promulgated under the Securities Act
of 1933.
In January 2004, we issued 26,000 shares of restricted common stock at
a price of $0.25 per share for cash totaling $6,500. In connection with the
issuance of these shares, we granted the stockholders 6,500 warrants to purchase
our common stock at a price of $0.25 per share. The warrants vested immediately
and expire in January 2005. These transactions were exempt from registration
pursuant to Regulation D promulgated under the Securities Act of 1933.
In January 2004, we issued 161,334 shares of restricted common stock at
a price of $0.25 per share and 161,334 warrants to purchase common stock at an
exercise price of $0.25 per share, in connection with the conversion of $35,000
of notes payable plus accrued interest. The warrants vested immediately and are
exercisable through January 2005. This transaction was exempt from registration
pursuant to Regulation D promulgated under the Securities Act of 1933.
In January 2004, we issued 62,000 shares of restricted common stock at
a price of $0.40 per share for services in the amount of approximately $25,000.
This transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In February 2004, we issued 100,000 shares of restricted common stock
for cash totaling $25,000, in connection with the exercise of 100,000 warrants
to purchase our common stock at $0.25 per share. This transaction was exempt
from registration pursuant to Regulation D promulgated under the Securities Act
of 1933.
In February 2004, we issued 139,063 shares of restricted common stock
at a price of $0.25 per share and 139,063 warrants to purchase common stock at
an exercise price of $0.25 per share, in connection with the conversion of
$25,000 of notes payable plus accrued interest. The warrants vested immediately
and are exercisable through February 2005. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In February 2004, we issued 190,185 shares of restricted common stock
at a prices between $0.50 - $0.54 per share for services in the amount of
approximately $105,000. This transaction was exempt from registration pursuant
to Section 4(2) of the Securities Act of 1933.
In March 2004, we issued 125,000 shares of restricted common stock at
prices between $0.30 - $1.125 per share for cash totaling $50,625. In connection
with the issuance of these shares, we granted the stockholders 125,000 warrants
to purchase our common stock at prices between $0.30 - $1.125 per share. The
warrants vested immediately and expire in March 2005. These transactions were
exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
9
In March 2004, we issued 80,000 shares of restricted common stock for
cash totaling $20,000, in connection with the exercise of 80,000 warrants to
purchase our common stock at $0.25 per share. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In March 2004, we issued 854,574 shares of restricted common stock at a
prices between $0.35-$0.65 per share in connection with the conversion of
$242,500 of notes payable plus accrued interest. This transaction was exempt
from registration pursuant to Regulation D promulgated under the Securities Act
of 1933.
In March 2004, we issued 73,529 shares of restricted common stock at a
price of $0.34 per share for services in the amount of approximately $25,000.
This transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
The following table sets forth March 31, 2004 information on our equity
compensation plans (including the potential effect of debt instruments
convertible into common stock) in effect as of that date:
(a) (b) (c)
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available
of outstanding options, outstanding options, for future issuance
warrants and rights (1)(2) warrants and rights under equity
compensation plans
(excluding securities
reflected in column
(a))(3)
Equity compensation
plans approved by
security holders 47,500 $2.75 452,500
Equity compensation
plans not approved by
security holders (1) 5,236,379 2.29 N/A
---------- ------ ----------
Totals 5,283,879 2.32 452,500
(1) The description of the material terms of non-plan issuances of
equity instruments is discussed in Notes 4, 5 and 6 to the
accompanying consolidated financial statements.
(2) Net of equity instruments forfeited, exercised or expired.
(3) This column does not include 926,475 shares of common stock
that remain to be issued under the 2003 Consultant Stock Plan.
10
2000 STOCK OPTION PLAN
Our 2000 Stock Option Plan (the "Plan"), adopted by us in August 2000,
provides for the grant of incentive stock options (ISOs") to our full-time
employees (who may also be Directors) and nonstatutory stock options ("NSOs") to
non-employee Directors, consultants, customers, vendors or providers of
significant services. The exercise price of any ISO may not be less than the
fair market value of the Common Stock on the date of grant or, in the case of an
optionee who owns more than 10% of the total combined voting power of all
classes of our outstanding stock, not be less than 110% of the fair market value
on the date of grant. The exercise price, in the case of any NSO, must not be
less than 75% of the fair market value of the Common Stock on the date of grant.
The amount reserved under the Plan is 500,000 options. At March 31, 2004, we had
granted 47,500 options under the Plan, with 452,500 available for future
issuance.
2003 CONSULTANT STOCK PLAN
Our 2003 Consultant Stock Plan (the "Stock Plan"), adopted by us in
August 2003, advances our interests by helping us obtain and retain the services
of persons providing consulting services upon whose judgment, initiative,
efforts and/or services we are substantially dependent, by offering to or
providing those persons with incentives or inducements affording such persons an
opportunity to become owners of our capital stock. Consultants or advisors are
eligible to receive grants under the plan program only if they are natural
persons providing bona fide consulting services to us, with the exception of any
services they may render in connection with the offer and sale of our securities
in a capital-raising transaction, or which may directly or indirectly promote or
maintain a market for our securities.
We reserved a total of 1,000,000 common shares for issuance under the
Stock Plan. The Stock Plan provides for the grants of common stock. No awards
may be issued after the ten year anniversary of the date we adopted the Stock
Plan, the termination date for the plan.
On March 29, 2004, we filed with the SEC a registration statement on
Form S-8 for the purpose of registering 1,000,000 common shares issuable under
the Stock Plan under the Securities Act of 1933.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis should be read in conjunction
with the consolidated Financial Statements and Notes thereto appearing elsewhere
in this report.
Certain statements contained herein that are not related to
historical results, including, without limitation, statements regarding the
Company's business strategy and objectives, future financial position,
expectations about pending litigation and estimated cost savings, are
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Securities Exchange Act") and involve risks and uncertainties. Although we
believe that the assumptions on which these forward-looking statements are based
are reasonable, there can be no assurance that such assumptions will prove to be
accurate and actual results could differ materially from those discussed in the
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, regulatory policies, competition
from other similar businesses, and market and general economic factors. All
forward-looking statements contained in this Form 10-KSB are qualified in their
entirety by this statement.
PLAN OF OPERATION
We are a development stage therapeutic device company that has not yet
engaged in significant commercial activities. The primary focus of our resources
is the advancement of our proprietary Hemopurifier(TM) platform treatment
technology, which is designed to rapidly reduce the presence of infectious
viruses and toxins in human blood. Our main focus during fiscal 2004 was to
prepare our HIV-Hemopurifier to treat HIV/AIDS, and our HCV-Hemopurifier to
treat Hepatitis-C for human clinical trials. We are also working to advance
pathogen filtration devices to treat infectious agents that may be used in
biological warfare and terrorism. See Item 1, " BUSINESS".
11
We plan to continue our research and development activities related to
our Hemopurifier(TM) platform technology, with particular emphasis on the
advancement of our lead product candidates for the treatment of HIV/AIDS. We
plan to continue our pre-clinical trials for both our HIV/AIDS Hemopurifier(TM)
products as well as for our biodefense Hemopurifier(TM) products. We plan to
start small human clinical trials for HIV patients in fiscal 2005. We also plan
to implement a regulatory strategy for the use of our Hemopurifier(TM) for
biodefense treatments in fiscal 2005 pursuant to a recent rule implemented by
the FDA for medical countermeasures to weapons of mass destruction. Under this
rule, in situations where it is deemed unethical to conduct efficacy studies in
humans, a treatment can be reviewed for approval on the basis of efficacy in the
most relevant animal species and safety data in humans.
We expect to add approximately seven additional employees in the next
twelve months, associated with our expanded research and development effort that
will include expanding our goal beyond treating infectious diseases HIV/AID and
Hepatitis-C and new applications to combat infectious agents that may be used in
biological warfare and terrorism. This will involve designing Hemopurifier(TM)
products that can be rapidly deployed by armed forces as wearable post-exposure
treatments on the battlefield, as well as dialysis-based treatments for civilian
populations. This will entail developing the new treatmentdevice based on the
same proprietary Hemopurifier(TM) filtration technology that is utilized in
advancing our HIV/AIDS, and Hepatitis-C treatments. An important part of this
will include our cooperative agreement with the National Center for Biodefense
at George Mason to jointly pursue business and funding opportunities within the
federal government.
Accordingly, due to this increase in activity during the next twelve
months, we anticipate increasing our spending on research and development during
the next twelve months. Additionally, associated with our anticipated increase
in research and development expenditures, we anticipate purchasing significant
amounts of equipment and tenant improvements, during this period to support our
laboratory and testing operations.
Our operations to date have consumed substantial capital without
generating revenues, and we will continue to require substantial and increasing
capital funds to conduct necessary research and development and pre-clinical and
clinical testing of our Hemopurifier(TM) products, and to market any of those
products that receive regulatory approval. We do not expect to generate revenue
from operations for the foreseeable future, and our ability to meet our cash
obligations as they become due and payable is expected to depend for at least
the next several years on our ability to sell securities, borrow funds or a
combination thereof. Our future capital requirements will depend upon many
factors, including progress with pre-clinical testing and clinical trials, the
number and breadth of our programs, the time and costs involved in preparing,
filing, prosecuting, maintaining and enforcing patent claims and other
proprietary rights, the time and costs involved in obtaining regulatory
approvals, competing technological and market developments, and our ability to
establish collaborative arrangements, effective commercialization, marketing
activities and other arrangements. We expect to continue to incur increasing
negative cash flows and net losses for the foreseeable future.
We recorded a consolidated net loss of $1,518,798 or ($0.19) per share
and $2,461,116 or ($0.44)per share for the fiscal years ended March 31, 2004 and
2003, respectively.
Our consolidated operating expenses for fiscal 2004 were $995,549
versus $1,971,385 for fiscal 2003. This decrease in operating expenses of
$975,836 or 49.5% is largely attributable to a reduction in our professional
fees, general and administrative expenses and payroll totaling $641,532, and the
absence of the patent impairment charge of $334,304 incurred in fiscal 2003.
Our capital equipment expenditures were insignificant in fiscal 2003 and 2002.
In fiscal year 2003, we incurred non-cash expenses in the amount of
$334,304 related to the impairment of the carrying value of patents pending. We
capitalize the cost of patents and patents pending, some of which were acquired,
and amortize such costs over the shorter of the remaining legal life or their
estimated economic life, upon issuance of the patent. We write off unamortized
cost of patents and patents pending when we determine there is no future
benefit.
In fiscal year 2003, we also incurred non-cash expenses in the amount
of $114,000 related to options granted to a consultant. These expenses
represented a significant portion of the professional fees that we incurred
during fiscal 2003.
12
Our current plan of operation is to fund our anticipated increased
research and development activities and operations for the near future through
the $673,000 private placement of common stock and the common stock purchase
agreement with Fusion Capital in May 2004, whereby Fusion Capital has committed
to buy up to an additional $6,000,000 of our common stock over a 30-month
period, commencing, at our election, after the Securities and Exchange
Commission has declared effective a registration statement covering such shares.
However, no assurance can be given that we will receive any additional funds
under our agreement with Fusion Capital. Based on our projections of additional
employees for operations and to complete research, development and testing
associated with our Hemopurifier(TM) products, we anticipate that these funds
will satisfy our cash requirements, including this anticipated increase in
operations, in excess of the next twelve months. However, due to market
conditions, and to assure availability of funding for operations in the long
term, we may arrange for additional funding, subject to acceptable terms, during
the next twelve months.
GOING CONCERN
Our independent registered public accounting firm has stated in
their audit report on the Company's March 31, 2004 consolidated financial
statements, that we have a working capital deficit and a significant deficit
accumulated during the development stage. These conditions, among others, raise
substantial doubt about our ability to continue as a going concern.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires us to make judgments, assumptions and estimates that affect the
amounts reported in the consolidated financial statements and the accompanying
notes. The amounts of assets and liabilities reported on our balance sheet and
the amounts of revenues and expenses reported for each of our fiscal periods are
affected by estimates and assumptions, which are used for, but not limited to,
the accounting for the issuance of convertible notes payable and various equity
instruments. Actual results could differ from these estimates. The following
critical accounting policies are significantly affected by judgments,
assumptions and estimates used in the preparation of the financial statements:
ACCOUNTING FOR TRANSACTIONS INVOLVING STOCK COMPENSATION
Financial Accounting Standards Board ("FASB") Interpretation No. 44
("FIN 44"), "ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION,
AN INTERPRETATION OF APB 25" clarifies the application of APB 25 for (a) the
definition of employee for purposes of applying APB 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequence for various modifications to the terms of a previously
fixed stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 is effective July 1, 2000,
but certain provisions cover specific events that occur after either December
15, 1998, or January 12, 2000.
Under Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES," compensation expense is the excess, if any, of the
estimated fair value of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock. Compensation expense,
if any, is recognized over the applicable service period, which is usually the
vesting period.
Statement of Financial Accounting Standards ("SFAS") 123, "ACCOUNTING
FOR STOCK-BASED COMPENSATION," if fully adopted, changes the method of
accounting for employee stock-based compensation plans to the fair value based
method. For stock options and warrants, fair value is estimated using an option
pricing model that takes into account the stock price at the grant date, the
exercise price, the expected life of the option or warrant, stock volatility and
the annual rate of quarterly dividends. Compensation expense, if any, is
recognized over the applicable service period, which is usually the vesting
period. The adoption of the accounting methodology of SFAS 123 is optional and
the Company has elected to continue accounting for stock-based compensation
issued to employees using APB 25; however, pro forma disclosures, as the Company
adopted the cost recognition requirement under SFAS 123, are required to be
presented.
13
SFAS 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND
DISCLOSURE, AN AMENDMENT OF FASB STATEMENT NO. 123," was issued in December 2002
and is effective for fiscal years ending after December 15, 2002. SFAS 148
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results.
STOCK PURCHASE WARRANTS ISSUED WITH NOTES PAYABLE
The Company granted warrants in connection with the issuance of certain
notes payable. Under Accounting Principles Board Opinion No. 14, " ACCOUNTING
FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH STOCK PURCHASE WARRANTS," the relative
estimated fair value of such warrants represents a discount from the face amount
of the notes payable.
BENEFICIAL CONVERSION FEATURE OF CONVERTIBLE NOTES PAYABLE
The convertible feature of certain notes payable provides for a rate of
conversion that is below market value. Such feature is normally characterized as
a "beneficial conversion feature" ("BCF"). Pursuant to Emerging Issues Task
Force Issue No. 98-5 ("EITF Issue No. 98-5"), "ACCOUNTING FOR CONVERTIBLE
SECURITIES WITH BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY ADJUSTABLE
CONVERSION RATIO" and Emerging Issues Task Force Issue No. 00-27, " APPLICATION
OF EITF ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS," the estimated fair
value of the BCF is recorded in the consolidated financial statements as a
discount from the face amount of the notes. Such discounts are amortized to
interest expense over the term of the notes.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
SFAS 144, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED OF" addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. SFAS 144 requires
that long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that their carrying amounts may not be recoverable. If
the cost basis of a long-lived asset is greater than the projected future
undiscounted net cash flows from such asset (excluding interest), an impairment
loss is recognized. Impairment losses are calculated as the difference between
the cost basis of an asset and its estimated fair value. SFAS 144 also requires
companies to separately report discontinued operations and extends that
reporting requirement to a component of an entity that either has been disposed
of (by sale, abandonment or in a distribution to owners) or is classified as
held for sale. Assets to be disposed of are reported at the lower of the
carrying amount or the estimated fair value less costs to sell. The Company
adopted SFAS 144 on January 1, 2002. The provisions of this pronouncement
relating to assets held for sale or other disposal generally are required to be
applied prospectively after the adoption date to newly initiated commitments to
plan to sell or dispose of such asset, as defined, by management. As a result,
management cannot determine the potential effects that adoption of SFAS 144 will
have on the Company's financial statements with respect to future disposal
decisions, if any. Management believes no impairment exists at March 31, 2004.
INCOME TAXES
Under SFAS 109, "ACCOUNTING FOR INCOME TAXES," deferred tax assets and
liabilities are recognized for the future tax consequences attributable to the
difference between the consolidated financial statements and their respective
tax basis. Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts reported for income tax purposes, and (b) tax
credit carryforwards. The Company records a valuation allowance for deferred
income tax assets when, based on management's best estimate of taxable income in
the foreseeable future, it is more likely than not that some portion of the
deferred income tax assets may not be realized.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into any off-balance sheet arrangements that have
or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources and would be
considered material to investors.
14
RISK FACTORS
We have described below a number of uncertainties and risks which, in
addition to uncertainties and risks presented elsewhere in this annual report,
may adversely affect our business, operating results and financial condition.
The uncertainties and risks enumerated below as well as those presented
elsewhere in this annual report should be considered carefully in evaluating our
company and our business and the value of our securities.
Risks Relating To Our Business
WE HAVE ACCUMULATED LOSSES SINCE OUR INCEPTION, AND CURRENTLY HAVE NO PRODUCTS
OR SERVICES ON THE MARKET THAT ARE CURRENTLY GENERATING REVENUES.
Our inability to generate revenues and profits from products we have
recently introduced onto the market could cause us to go out of business and for
you to lose your entire investment. To date, we have engaged primarily in
research, development and clinical testing. Since our inception, we have not
been profitable, and we cannot be certain that we will ever achieve or sustain
profitability. We have incurred a cumulative net loss in the amount of
$17,145,313 from our inception through March 31, 2004. We have no products or
services on the market that are currently generating revenues. Our failure to
generate meaningful revenues and ultimately profits from potential products and
applications of our technology could force us to reduce or suspend our
operations and ultimately go out of business. Developing our product candidates
will require significant additional research and development, including
non-clinical testing and clinical trials, as well as regulatory approval. We
expect these activities, together with our general and administrative expenses,
to result in operating losses for the foreseeable future.
WE MAY FAIL TO OBTAIN GOVERNMENT CONTRACTS TO DEVELOP OUR
HEMOPURIFIER(TM) TECHNOLOGY FOR BIODEFENSE APPLICATIONS.
The U.S. Government has undertaken commitments to help secure improved
countermeasures against bioterrorism. We have filed a proposal with the National
Institutes of Health and anticipate submitting further proposals on U.S.
Government contracts. The process of obtaining government contracts is lengthy
and uncertain and we must compete for each contract. Accordingly, we cannot be
certain that we will be awarded any future government contracts utilizing our
Hemopurifier(TM) platform technology. If the U.S. Government makes significant
future contract awards to our competitors our business will be harmed.
In addition, the determination of when and whether a product is ready
for large scale purchase and potential use will be made by the government
through consultation with a number of governmental agencies, including the Food
and Drug Administration (the "FDA"), the National Institutes of Health, the
Centers for Disease Control and Prevention and the Department of Homeland
Security. The Congress' recent passage of the $5.6 billion Project BioShield
Bill, a comprehensive effort to develop and make available modern, effective
drugs and vaccines to protect against attack by biological and chemical weapons
or other dangerous pathogens, may encourage competitors to develop their own
product candidates. We cannot predict the decisions that will be made in the
future by the various government agencies as a result of such legislation.
IF THE U.S. GOVERNMENT FAILS TO PURCHASE SUFFICIENT QUANTITIES OF ANY FUTURE
BIODEFENSE CANDIDATE UTILIZING OUR HEMOPURIFIER(TM) PLATFORM TECHNOLOGY, WE MAY
BE UNABLE TO GENERATE SUFFICIENT REVENUES TO CONTINUE OPERATIONS.
We cannot be certain of the timing or availability of any future
funding from the U.S. Government, and substantial delays or cancellations of
funding could result from protests or challenges from third parties once such
funding is obtained. If we develop products utilizing our Hemopurifier(TM)
platform technology that are approved by the Food and Drug Administration, but
the U.S. Government does not place sufficient orders for these products, our
future business will be harmed.
15
U.S. GOVERNMENT AGENCIES HAVE SPECIAL CONTRACTING REQUIREMENTS, WHICH CREATE
ADDITIONAL RISKS.
Our business plan to provide biodefense product candidates and
HIV-Hemopurifier(TM) candidates may involve contracts with the U.S. Government.
U.S. Government contracts typically contain unfavorable termination provisions
and are subject to audit and modification by the government at its sole
discretion, which subjects us to additional risks. These risks include the
ability of the U.S. Government to unilaterally:
o suspend or prevent us for a period of time from receiving new contracts
or extending existing contracts based on violations or suspected
violations of laws or regulations;
o audit and object to our contract-related costs and fees, including
allocated indirect costs;
o control and potentially prohibit the export of our products; and
o change certain terms and conditions in our contracts.
If we were to become a U.S. Government contractor, we would be required
to comply with applicable laws, regulations and standards relating to our
accounting practices and would be subject to periodic audits and reviews. As
part of any such audit or review, the U.S. Government may review the adequacy
of, and our compliance with, our internal control systems and policies,
including those relating to our purchasing, property, estimating, compensation
and management information systems. Based on the results of its audits, the U.S.
Government may adjust our contract-related costs and fees, including allocated
indirect costs. In addition, if an audit or review uncovers any improper or
illegal activity, we would possibly be subject to civil and criminal penalties
and administrative sanctions, including termination of our contracts, forfeiture
of profits, suspension of payments, fines and suspension or prohibition from
doing business with the U.S. Government. We could also suffer serious harm to
our reputation if allegations of impropriety were made against us. Although
adjustments arising from government audits and reviews have not seriously harmed
our business in the past, future audits and reviews could cause adverse effects.
In addition, under U.S. Government purchasing regulations, some of our costs,
including most financing costs, amortization of intangible assets, portions of
our research and development costs, and some marketing expenses, would possibly
not be reimbursable or allowed under such contracts. Further, as a U.S.
Government contractor, we would be subject to an increased risk of
investigations, criminal prosecution, civil fraud, whistleblower lawsuits and
other legal actions and liabilities to which purely private sector companies are
not.
WE WILL FACE INTENSE COMPETITION FROM COMPANIES THAT HAVE GREATER FINANCIAL,
PERSONNEL AND RESEARCH AND DEVELOPMENT RESOURCES THAN OURS.
These competitive forces may impact our projected growth and ability to
generate revenues and profits, which would have a negative impact on our
business and the value of your investment.
Our competitors are developing vaccine candidates, which could compete
with the hemopurifier(tm) product candidates we are developing. our commercial
opportunities will be reduced or eliminated if our competitors develop and
market products for any of the diseases that we target that:
are more effective;
have fewer or less severe adverse side effects;
are better tolerated;
are more adaptable to various modes of dosing;
are easier to administer;
or are less expensive than the products or product candidates we are
developing.
Even if we are successful in developing effective Hemopurifier(TM)
products, and obtain FDA and other regulatory approvals necessary for
commercializing them, our products may not compete effectively with other
successful products. Researchers are continually learning more about diseases,
which may lead to new technologies for treatment. Our competitors may succeed in
developing and marketing products either that are more effective than those that
we may develop, alone or with our collaborators, or that are marketed before any
products we develop are marketed.
16
Our competitors include fully integrated pharmaceutical companies,
biotechnology companies, universities and public and private research
institutions. Many of the organizations competing with us, have substantially
greater capital resources, larger research and development staffs and
facilities, greater experience in product development and in obtaining
regulatory approvals, and greater marketing capabilities than we do.
The market for medical devices is intensely competitive. Many of our
potential competitors have longer operating histories, greater name recognition,
more employees, and significantly greater financial, technical, marketing,
public relations, and distribution resources than we have. This intense
competitive environment may require us to make changes in our products, pricing,
licensing, services or marketing to develop, maintain and extend our current
technology. Price concessions or the emergence of other pricing or distribution
strategies of competitors may diminish our revenues, adversely impact our
margins or lead to a reduction in our market share, any of which may harm our
business.
OUR HEMOPURIFER(TM) TECHNOLOGY MAY BECOME OBSOLETE.
Our Hemopurifier(TM) products may be made unmarketable by new
scientific or technological developments where new treatment modalities are
introduced that are more efficacious or more economical than our
Hemopurifier(TM) products.
OUR USE OF HAZARDOUS MATERIALS, CHEMICALS AND VIRUSES REQUIRE US TO COMPLY WITH
REGULATORY REQUIREMENTS AND EXPOSES US TO POTENTIAL LIABILITIES.
Our research and development involves the controlled use of hazardous
materials, chemicals and viruses. We are subject to federal, state, local and
foreign laws governing the use, manufacture, storage, handling and disposal of
such materials. Although we believe that our safety procedures for the use,
manufacture, storage, handling and disposal of such materials comply with the
standards prescribed by federal, state, local and foreign regulations, we cannot
completely eliminate the risk of accidental contamination or injury from these
materials. In the event of such an accident, we could be held liable for
significant damages or fines. We currently do not carry insurance to protect us
from these damages. In addition, we may be required to incur significant costs
to comply with regulatory requirements in the future.
WE ARE DEPENDENT FOR OUR SUCCESS ON A FEW KEY EXECUTIVE OFFICERS.
Our success depends to a critical extent on the continued services of
our Chief Executive Officer, James A. Joyce, our Chief Financial Officer, Edward
C. Hall and our Chief Scientific Officer, Richard H. Tullis. Were we to lose one
or more of these key executive officers, we would be forced to expend
significant time and money in the pursuit of a replacement, which would result
in both a delay in the implementation of our business plan and the diversion of
limited working capital. We can give you no assurance that we can find
satisfactory replacements for these key executive officers at all, or on terms
that are not unduly expensive or burdensome to our company. Although the
executives have signed employment agreements providing for their continued
service to the company, these agreements will not preclude any of these
employees from leaving the company. We do not currently carry key man life
insurance policies on any of our key executive officers which would assist us in
recouping our costs in the event of the loss of those officers.
OUR INABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL COULD IMPEDE OUR ABILITY
TO GENERATE REVENUES AND PROFITS AND TO OTHERWISE IMPLEMENT OUR BUSINESS PLAN
AND GROWTH STRATEGIES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND
COULD ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT.
17
We currently have an extremely small staff comprised of three full time
employees and other personnel employed on a contract basis. Although we believe
that these employees, together with the consultants currently engaged by our
company, will be able to handle most of our additional administrative, research
and development and business development in the near term, we will nevertheless
be required over the longer-term to hire highly skilled managerial, scientific
and administrative personnel to fully implement our business plan and growth
strategies. We cannot assure you that we will be able to engage the services of
such qualified personnel at competitive prices or at all, particularly given the
risks of employment attributable to our limited financial resources and lack of
an established track record.
WE PLAN TO GROW VERY RAPIDLY, WHICH WILL PLACE STRAINS ON OUR MANAGEMENT TEAM
AND OTHER COMPANY RESOURCES TO BOTH IMPLEMENT MORE SOPHISTICATED MANAGERIAL,
OPERATIONAL AND FINANCIAL SYSTEMS, PROCEDURES AND CONTROLS AND TO TRAIN AND
MANAGE THE PERSONNEL NECESSARY TO IMPLEMENT THOSE FUNCTIONS. OUR INABILITY TO
MANAGE OUR GROWTH COULD IMPEDE OUR ABILITY TO GENERATE REVENUES AND PROFITS AND
TO OTHERWISE IMPLEMENT OUR BUSINESS PLAN AND GROWTH STRATEGIES, WHICH WOULD HAVE
A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
We will need to significantly expand our operations to implement our
longer-term business plan and growth strategies. We will also be required to
manage multiple relationships with various strategic partners, technology
licensors, customers, manufacturers and suppliers, consultants and other third
parties. This expansion and these expanded relationships will require us to
significantly improve or replace our existing managerial, operational and
financial systems, procedures and controls; to improve the coordination between
our various corporate functions; and to manage, train, motivate and maintain a
growing employee base. The time and costs to effectuate these steps may place a
significant strain on our management personnel, systems and resources,
particularly given the limited amount of financial resources and skilled
employees that may be available at the time. We cannot assure you that we will
institute, in a timely manner or at all, the improvements to our managerial,
operational and financial systems, procedures and controls necessary to support
our anticipated increased levels of operations and to coordinate our various
corporate functions, or that we will be able to properly manage, train, motivate
and retain our anticipated increased employee base.
WE MAY HAVE DIFFICULTY IN ATTRACTING AND RETAINING MANAGEMENT AND OUTSIDE
INDEPENDENT MEMBERS TO OUR BOARD OF DIRECTORS AS A RESULT OF THEIR CONCERNS
RELATING TO THEIR INCREASED PERSONAL EXPOSURE TO LAWSUITS AND SHAREHOLDER CLAIMS
BY VIRTUE OF HOLDING THESE POSITIONS IN A PUBLICLY-HELD COMPANY.
The directors and management of publicly traded corporations are
increasingly concerned with the extent of their personal exposure to lawsuits
and shareholder claims, as well as governmental and creditor claims which may be
made against them, particularly in view of recent changes in securities laws
imposing additional duties, obligations and liabilities on management and
directors. Due to these perceived risks, directors and management are also
becoming increasingly concerned with the availability of directors and officers
liability insurance to pay on a timely basis the costs incurred in defending
such claims. We currently do not carry directors and officers liability
insurance. Directors and officers liability insurance has recently become much
more expensive and difficult to obtain. If we are unable to obtain directors and
officers liability insurance at affordable rates or at all, it may become
increasingly more difficult to attract and retain qualified outside directors to
serve on our board of directors. The fees of directors are also rising in
response to their increased duties, obligations and liabilities as well as
increased exposure to such risks. As a company with a limited operating history
and limited resources, we will have a more difficult time attracting and
retaining management and outside independent directors than a more established
company due to these enhanced duties, obligations and liabilities.
IF WE FAIL TO COMPLY WITH EXTENSIVE REGULATIONS ENFORCED BY DOMESTIC
AND FOREIGN REGULATORY AUTHORITIES, THE COMMERCIALIZATION OF OUR PRODUCT
CANDIDATES COULD BE PREVENTED OR DELAYED.
Our pathogen filtration devices, or Hemopurifier(TM) products, are
subject to extensive government regulations related to development, testing,
manufacturing and commercialization in the United States and other countries.
Our product candidates are in the pre-clinical and clinical stages of
development and have not received required regulatory approval from the FDA to
be commercially marketed and sold. The process of obtaining and complying with
FDA and other governmental regulatory approvals and regulations is costly, time
consuming, uncertain and subject to unanticipated delays. Despite the time and
expense exerted, regulatory approval is never guaranteed. We also are subject to
the following risks and obligations, among others.
18
o The FDA may refuse to approve an application if they believe that
applicable regulatory criteria are not satisfied.
o The FDA may require additional testing for safety and effectiveness.
o The FDA may interpret data from pre-clinical testing and clinical
trials in different ways than we interpret them.
o If regulatory approval of a product is granted, the approval may be
limited to specific indications or limited with respect to its
distribution.
o The FDA may change their approval policies and/or adopt new
regulations.
Failure to comply with these or other regulatory requirements of the FDA may
subject us to administrative or judicially imposed sanctions, including:
o warning letters;
o civil penalties;
o criminal penalties;
o injunctions;
o product seizure or detention;
o product recalls; and
o total or partial suspension of productions.
DELAYS IN SUCCESSFULLY COMPLETING OUR CLINICAL TRIALS COULD JEOPARDIZE OUR
ABILITY TO OBTAIN REGULATORY APPROVAL OR MARKET OUR HEMOPURIFIER(TM) PRODUCT
CANDIDATES ON A TIMELY BASIS.
Our business prospects will depend on our ability to complete clinical
trials, obtain satisfactory results, obtain required regulatory approvals and
successfully commercialize our Hemopurifier(TM) product candidates. Completion
of our clinical trials, announcement of results of the trials and our ability to
obtain regulatory approvals could be delayed for a variety of reasons,
including:
o serious adverse events related to our vaccine candidates;
o unsatisfactory results of any clinical trial;
o the failure of our principal third-party investigators to perform our
clinical trials on our anticipated schedules; and/or
o different interpretations of our pre-clinical and clinical data, which
could initially lead to inconclusive results.
OUR DEVELOPMENT COSTS WILL INCREASE IF WE HAVE MATERIAL DELAYS IN ANY CLINICAL
TRIAL OR IF WE NEED TO PERFORM MORE OR LARGER CLINICAL TRIALS THAN PLANNED.
If the delays are significant, or if any of our Hemopurifier(TM)
product candidates do not prove to be safe or effective or do not receive
required regulatory approvals, our financial results and the commercial
prospects for our product candidates will be harmed. Furthermore, our inability
to complete our clinical trials in a timely manner could jeopardize our ability
to obtain regulatory approval.
THE INDEPENDENT CLINICAL INVESTIGATORS THAT WE RELY UPON TO CONDUCT OUR CLINICAL
TRIALS MAY NOT BE DILIGENT, CAREFUL OR TIMELY, AND MAY MAKE MISTAKES, IN THE
CONDUCT OF OUR CLINICAL TRIALS.
We depend on independent clinical investigators to conduct our clinical
trials. The investigators are not our employees, and we cannot control the
amount or timing of resources that they devote to our product development
programs. If independent investigators fail to devote sufficient time and
resources to our product development programs, or if their performance is
substandard, it may delay FDA approval of our vaccine candidates. These
independent investigators may also have relationships with other commercial
entities, some of which may compete with us. If these independent investigators
assist our competitors at our expense, it could harm our competitive position.
19
THE APPROVAL REQUIREMENTS FOR MEDICAL PRODUCTS USED TO FIGHT BIOTERRORISM ARE
STILL EVOLVING, AND WE CANNOT BE CERTAIN THAT ANY PRODUCTS WE DEVELOP, IF
EFFECTIVE, WOULD MEET THESE REQUIREMENTS.
We are developing product candidates based upon current governmental
policies regulating these medical countermeasure treatments. For instance, we
intend to pursue FDA approval of our proprietary pathogen filtration devices to
treat infectious agents under requirements published by the FDA that allow
the FDA to approve certain vaccines used to reduce or prevent the toxicity of
chemical, biological, radiological or nuclear substances based on human clinical
data to demonstrate safety and immune response, and evidence of effectiveness
derived from appropriate animal studies and any additional supporting data. Our
business is subject to substantial risk because these policies may change
suddenly and unpredictably and in ways that could impair our ability to obtain
regulatory approval of these products, and we cannot guarantee that the FDA will
approve our proprietary pathogen filtration devices.
OUR PRODUCT DEVELOPMENT EFFORTS MAY NOT YIELD MARKETABLE PRODUCTS DUE TO RESULTS
OF STUDIES OR TRIALS, FAILURE TO ACHIEVE REGULATORY APPROVALS OR MARKET
ACCEPTANCE, PROPRIETARY RIGHTS OF OTHERS OR MANUFACTURING ISSUES.
Our success depends on our ability to successfully develop and obtain
regulatory approval to market new filtration devices. We expect that a
significant portion of the research that we will conduct will involve new and
unproven technologies. Development of a product requires substantial technical,
financial and human resources even if the product is not successfully completed.
Our potential products may appear to be promising at various stages of
development yet fail to reach the market for a number of reasons, including the:
o lack of adequate quality or sufficient prevention benefit, or
unacceptable safety during pre-clinical studies or clinical trials;
o failure to receive necessary regulatory approvals;
o existence of proprietary rights of third parties; and/or
o inability to develop manufacturing methods that are efficient,
cost-effective and capable of meeting stringent regulatory standards.
POLITICAL OR SOCIAL FACTORS MAY DELAY OR IMPAIR OUR ABILITY TO MARKET OUR
PRODUCTS.
Products developed to treat diseases caused by or to combat the threat
of bioterrorism will be subject to changing political and social environments.
The political and social responses to bioterrorism have been highly charged and
unpredictable. Political or social pressures may delay or cause resistance to
bringing our products to market or limit pricing of our products, which would
harm our business.
OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD NEGATIVELY
IMPACT OUR PROJECTED GROWTH AND ABILITY TO GENERATE REVENUES AND PROFITS, WHICH
WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
We rely on a combination of patent, patent pending, copyright,
trademark and trade secret laws, proprietary rights agreements and
non-disclosure agreements to protect our intellectual properties. We cannot give
you any assurance that these measures will prove to be effective in protecting
our intellectual properties.
In the case of patents, we cannot give you any assurance that our
existing patents will not be invalidated, that any patents that we currently or
prospectively apply for will be granted, or that any of these patents will
ultimately provide significant commercial benefits. Further, competing companies
may circumvent any patents that we may hold by developing products which closely
emulate but do not infringe our patents. While we intend to seek patent
protection for our products in selected foreign countries, those patents may not
receive the same degree of protection as they would in the United States. We can
give you no assurance that we will be able to successfully defend our patents
and proprietary rights in any action we may file for patent infringement.
Similarly, we can give you any assurance that we will not be required to defend
against litigation involving the patents or proprietary rights of others, or
that we will be able to obtain licenses for these rights. Legal and accounting
costs relating to prosecuting or defending patent infringement litigation may be
20
substantial. Since many of our patents were issued in the 1980's, they may
expire before FDA approval, if any, is obtained. However, we believe that
certain patent applications filed and/or other patents issued more recently will
help to protect the proprietary nature of the Hemopurifier treatment technology.
We also rely on proprietary designs, technologies, processes and know-how not
eligible for patent protection. We cannot give you any assurance that our
competitors will not independently develop the same or superior designs,
technologies, processes and know-how. While we have and will continue to enter
into proprietary rights agreements with our employees and third parties giving
us proprietary rights to certain technology developed by those employees or
parties while engaged by our company, we can give you no assurance that courts
of competent jurisdiction will enforce those agreements.
LEGISLATIVE ACTIONS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS ARE LIKELY TO
IMPACT OUR FUTURE FINANCIAL POSITION AND RESULTS OF OPERATIONS.
There have been regulatory changes, including the Sarbanes-Oxley Act of
2002, and there may potentially be new accounting pronouncements or additional
regulatory rulings which will have an impact on our future financial position
and results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes
as well as proposed legislative initiatives following the Enron bankruptcy are
likely to increase general and administrative costs. Further, proposed
initiatives are expected to result in changes in certain accounting rules,
including legislative and other proposals to account for employee stock options
as a compensation expense. These and other potential changes could materially
increase the expenses we report under generally accepted accounting principles,
and adversely affect our operating results.
OUR PRODUCTS MAY BE SUBJECT TO RECALL OR PRODUCT LIABILITY CLAIMS.
Our Hemopurifier(TM) products may be used in connection with medical
procedures in which it is important that those products function with precision
and accuracy. If our products do not function as designed, or are designed
improperly, we may be forced by regulatory agencies to withdraw such products
from the market. In addition, if medical personnel or their patients suffer
injury as a result of any failure of our products to function as designed, or an
inappropriate design, we may be subject to lawsuits seeking significant
compensatory and punitive damages. Any product recall or lawsuit seeking
significant monetary damages may have a material affect on our business and
financial condition.
RISKS RELATING TO AN INVESTMENT IN OUR SECURITIES
TO DATE, WE HAVE NOT PAID ANY CASH DIVIDENDS AND NO CASH DIVIDENDS WILL BE PAID
IN THE FORESEEABLE FUTURE.
We do not anticipate paying cash dividends on our common shares in the
foreseeable future, and we cannot assure an investor that funds will be legally
available to pay dividends, or that even if the funds are legally available,
that the dividends will be paid.
THE APPLICATION OF THE "PENNY STOCK" RULES COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR COMMON SHARES AND INCREASE YOUR TRANSACTION COSTS TO SELL THOSE
SHARES.
21
As long as the trading price of our common shares is below $5 per
share, the open-market trading of our common shares will be subject to the
"penny stock" rules. The "penny stock" rules impose additional sales practice
requirements on broker-dealers who sell securities to persons other than
established customers and accredited investors (generally those with assets in
excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). For transactions covered by these rules, the broker-dealer
must make a special suitability determination for the purchase of securities and
have received the purchaser's written consent to the transaction before the
purchase. Additionally, for any transaction involving a penny stock, unless
exempt, the broker-dealer must deliver, before the transaction, a disclosure
schedule prescribed by the SEC relating to the penny stock market. The
broker-dealer also must disclose the commissions payable to both the
broker-dealer and the registered representative and current quotations for the
securities. Finally, monthly statements must be sent disclosing recent price
information on the limited market in penny stocks. These additional burdens
imposed on broker-dealers may restrict the ability or decrease the willingness
of broker-dealers to sell our common shares, and may result in decreased
liquidity for our common shares and increased transaction costs for sales and
purchases of our common shares as compared to other securities.
OUR COMMON SHARES ARE THINLY TRADED, SO YOU MAY BE UNABLE TO SELL AT OR NEAR ASK
PRICES OR AT ALL IF YOU NEED TO SELL YOUR SHARES TO RAISE MONEY OR OTHERWISE
DESIRE TO LIQUIDATE YOUR SHARES.
Our common shares have historically been sporadically or
"thinly-traded" on the OTCBB, meaning that the number of persons interested in
purchasing our common shares at or near ask prices at any given time may be
relatively small or non-existent. This situation is attributable to a number of
factors, including the fact that we are a small company which is relatively
unknown to stock analysts, stock brokers, institutional investors and others in
the investment community that generate or influence sales volume, and that even
if we came to the attention of such persons, they tend to be risk-averse and
would be reluctant to follow an unproven company such as ours or purchase or
recommend the purchase of our shares until such time as we became more seasoned
and viable. As a consequence, there may be periods of several days or more when
trading activity in our shares is minimal or non-existent, as compared to a
seasoned issuer which has a large and steady volume of trading activity that
will generally support continuous sales without an adverse effect on share
price. We cannot give you any assurance that a broader or more active public
trading market for our common shares will develop or be sustained, or that
current trading levels will be sustained.
THE MARKET PRICE FOR OUR COMMON SHARES IS PARTICULARLY VOLATILE GIVEN OUR STATUS
AS A RELATIVELY UNKNOWN COMPANY WITH A SMALL AND THINLY-TRADED PUBLIC FLOAT,
LIMITED OPERATING HISTORY AND LACK OF REVENUES WHICH COULD LEAD TO WIDE
FLUCTUATIONS IN OUR SHARE PRICE. THE PRICE AT WHICH YOU PURCHASE OUR COMMON
SHARES MAY NOT BE INDICATIVE OF THE PRICE THAT WILL PREVAIL IN THE TRADING
MARKET. YOU MAY BE UNABLE TO SELL YOUR COMMON SHARES AT OR ABOVE YOUR PURCHASE
PRICE, WHICH MAY RESULT IN SUBSTANTIAL LOSSES TO YOU.
The market for our common shares is characterized by significant price
volatility when compared to seasoned issuers, and we expect that our share price
will continue to be more volatile than a seasoned issuer for the indefinite
future. The volatility in our share price is attributable to a number of
factors. First, as noted above, our common shares are sporadically and/or thinly
traded. As a consequence of this lack of liquidity, the trading of relatively
small quantities of shares by our shareholders may disproportionately influence
the price of those shares in either direction. The price for our shares could,
for example, decline precipitously in the event that a large number of our
common shares are sold on the market without commensurate demand, as compared to
a seasoned issuer which could better absorb those sales without adverse impact
on its share price. Secondly, we are a speculative or "risky" investment due to
our limited operating history and lack of revenues or profits to date, and
uncertainty of future market acceptance for our potential products. As a
consequence of this enhanced risk, more risk-adverse investors may, under the
fear of losing all or most of their investment in the event of negative news or
lack of progress, be more inclined to sell their shares on the market more
quickly and at greater discounts than would be the case with the stock of a
seasoned issuer. The following factors may add to the volatility in the price of
our common shares: actual or anticipated variations in our quarterly or annual
operating results; acceptance of our proprietary technology as viable method of
augmenting the immune response of clearing viruses and toxins from human blood;
government regulations, announcements of significant acquisitions, strategic
partnerships or joint ventures; our capital commitments; and additions or
22
departures of our key personnel. Many of these factors are beyond our control
and may decrease the market price of our common shares, regardless of our
operating performance. We cannot make any predictions or projections as to what
the prevailing market price for our common shares will be at any time, including
as to whether our common shares will sustain their current market prices, or as
to what effect that the sale of shares or the availability of common shares for
sale at any time will have on the prevailing market price.
Shareholders should be aware that, according to SEC Release No.
34-29093, the market for penny stocks has suffered in recent years from patterns
of fraud and abuse. Such patterns include (1) control of the market for the
security by one or a few broker-dealers that are often related to the promoter
or issuer; (2) manipulation of prices through prearranged matching of purchases
and sales and false and misleading press releases; (3) boiler room practices
involving high-pressure sales tactics and unrealistic price projections by
inexperienced sales persons; (4) excessive and undisclosed bid-ask differential
and markups by selling broker-dealers; and (5) the wholesale dumping of the same
securities by promoters and broker-dealers after prices have been manipulated to
a desired level, along with the resulting inevitable collapse of those prices
and with consequent investor losses. Our management is aware of the abuses that
have occurred historically in the penny stock market. Although we do not expect
to be in a position to dictate the behavior of the market or of broker-dealers
who participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities. The occurrence of these patterns or practices
could increase the volatility of our share price.
VOLATILITY IN OUR COMMON SHARE PRICE MAY SUBJECT US TO SECURITIES LITIGATION.
The market for our common
shares is characterized by significant price volatility when compared to
seasoned issuers, and we expect that our share price will continue to be more
volatile than a seasoned issuer for the indefinite future. In the past,
plaintiffs have often initiated securities class action litigation against a
company following periods of volatility in the market price of its securities.
We may in the future be the target of similar litigation. Securities litigation
could result in substantial costs and liabilities and could divert management's
attention and resources.
OUR OFFICERS AND DIRECTORS OWN OR CONTROL APPROXIMATELY 22% OF OUR OUTSTANDING
COMMON SHARES, WHICH MAY LIMIT THE ABILITY OF YOURSELF OR OTHER SHAREHOLDERS,
WHETHER ACTING SINGLY OR TOGETHER, TO PROPOSE OR DIRECT THE MANAGEMENT OR
OVERALL DIRECTION OF OUR COMPANY. ADDITIONALLY, THIS CONCENTRATION OF OWNERSHIP
COULD DISCOURAGE OR PREVENT A POTENTIAL TAKEOVER OF OUR COMPANY THAT MIGHT
OTHERWISE RESULT IN YOU RECEIVING A PREMIUM OVER THE MARKET PRICE FOR YOUR
COMMON SHARES.
As of June 10, 2004, our officers and directors beneficially own or
control approximately 22% of our outstanding common shares. These persons will
have the ability to control substantially all matters submitted to our
shareholders for approval and to control our management and affairs, including
extraordinary transactions such as mergers and other changes of corporate
control, and going private transactions.
A LARGE NUMBER OF COMMON SHARES ARE ISSUABLE UPON EXERCISE OF OUTSTANDING COMMON
SHARE PURCHASE OPTIONS, WARRANTS AND CONVERTIBLE PROMISSORY NOTES. THE EXERCISE
OR CONVERSION OF THESE SECURITIES COULD RESULT IN THE SUBSTANTIAL DILUTION OF
YOUR INVESTMENT IN TERMS OF YOUR PERCENTAGE OWNERSHIP IN THE COMPANY AS WELL AS
THE BOOK VALUE OF YOUR COMMON SHARES. THE SALE OF A LARGE AMOUNT OF COMMON
SHARES RECEIVED UPON EXERCISE OF THESE OPTIONS OR WARRANTS ON THE PUBLIC MARKET
TO FINANCE THE EXERCISE PRICE OR TO PAY ASSOCIATED INCOME TAXES, OR THE
PERCEPTION THAT SUCH SALES COULD OCCUR, COULD SUBSTANTIALLY DEPRESS THE
PREVAILING MARKET PRICES FOR OUR SHARES.
As of June 10, 2004, there are outstanding non-variable
priced common share purchase options and warrants entitling the holders to
purchase 6,010,060 common shares at a weighted average exercise price of $1.83
per share. The exercise price for all of the aforesaid warrants, both variable
and non-variable priced, may be less than your cost to acquire our common
shares. In the event of the exercise or conversion of these convertible
securities, you could suffer substantial dilution of your investment in terms of
your percentage ownership in the company as well as the book value of your
common shares. In addition, the holders of the common share purchase options or
warrants may sell common shares in tandem with their exercise of those options
or warrants to finance that exercise, or may resell the shares purchased in
order to cover any income tax liabilities that may arise from their exercise of
the options or warrants.
23
OUR ISSUANCE OF ADDITIONAL COMMON SHARES, OR OPTIONS OR WARRANTS TO PURCHASE
THOSE SHARES, WOULD DILUTE YOUR PROPORTIONATE OWNERSHIP AND VOTING RIGHTS.
We are entitled under our certificate of incorporation to issue up to
25,000,000 shares of common stock. After taking into consideration our
outstanding common stock at June 10, 2004, we will be entitled to issue up to
11,610,379 additional common shares. Our board may generally issue shares of
common stock, or options or warrants to purchase those shares, without further
approval by our shareholders based upon such factors as our board of directors
may deem relevant at that time. It is likely that we will be required to issue a
large amount of additional securities to raise capital to further our
development. It is also likely that we will be required to issue a large amount
of additional securities to directors, officers, employees and consultants as
compensatory grants in connection with their services, both in the form of
stand-alone grants or under our stock plans. We cannot give you any assurance
that we will not issue additional common, or options or warrants to purchase
those shares, under circumstances we may deem appropriate at the time.
THE ELIMINATION OF MONETARY LIABILITY AGAINST OUR DIRECTORS, OFFICERS AND
EMPLOYEES UNDER OUR CERTIFICATE OF INCORPORATION AND THE EXISTENCE OF
INDEMNIFICATION RIGHTS TO OUR DIRECTORS, OFFICERS AND EMPLOYEES MAY RESULT IN
SUBSTANTIAL EXPENDITURES BY OUR COMPANY AND MAY DISCOURAGE LAWSUITS AGAINST OUR
DIRECTORS, OFFICERS AND EMPLOYEES.
Our certificate of incorporation contains provisions which eliminate
the liability of our directors for monetary damages to our company and
shareholders. Our bylaws also require us to indemnify our officers and
directors. We may also have contractual indemnification obligations under our
agreements with our directors, officers and employees. The foregoing
indemnification obligations could result in our company incurring substantial
expenditures to cover the cost of settlement or damage awards against directors,
officers and employees, which we may be unable to recoup. These provisions and
resultant costs may also discourage our company from bringing a lawsuit against
directors, officers and employees for breaches of their fiduciary duties, and
may similarly discourage the filing of derivative litigation by our shareholders
against our directors, officers and employees even though such actions, if
successful, might otherwise benefit our company and shareholders.
ANTI-TAKEOVER PROVISIONS MAY IMPEDE THE ACQUISITION OF OUR COMPANY.
Certain provisions of the Nevada General Corporation Law have
anti-takeover effects and may inhibit a non-negotiated merger or other business
combination. These provisions are intended to encourage any person interested in
acquiring us to negotiate with, and to obtain the approval of, our Board of
Directors in connection with such a transaction. However, certain of these
provisions may discourage a future acquisition of us, including an acquisition
in which the shareholders might otherwise receive a premium for their shares. As
a result, shareholders who might desire to participate in such a transaction may
not have the opportunity to do so.
ITEM 7. FINANCIAL STATEMENTS
The financial statements listed in the accompanying Index to Financial
Statements are attached hereto and filed as a part of this Report under Item 13.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 8A. EVALUATION OF CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
of the Exchange Act as of a date (the "Evaluation Date") within 90 days prior to
filing the Company's March 31, 2004 Form 10-KSB. Based upon that evaluation, our
CEO and CFO concluded that, as of March 31, 2004, our disclosure controls and
procedures were effective in timely alerting management to the material
information relating to us (or our consolidated subsidiaries) required to be
included in our periodic filings with the SEC. Based on their most recent
evaluation as of the Evaluation Date, our CEO and the CFO have also concluded
that there are no significant deficiencies in the design or operation of
internal controls over financial reporting, at the reasonable assurance level,
which are reasonably likely to adversely affect our ability to record, process,
summarize and report financial information, and such officers have identified no
material weaknesses in our internal controls over financial reporting.
24
Changes in Controls and Procedures
There were no significant changes made in our internal controls over
financial reporting during the quarter ended March 31, 2004 that have materially
affected or are reasonably likely to materially affect these controls. Thus, no
corrective actions with regard to significant deficiencies or material
weaknesses were necessary.
Limitations on the Effectiveness of Internal Control
Our management, including the CEO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
necessarily prevent all fraud and material errors. An internal control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations on all internal control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within Aethlon Medical have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, and/or by management override of
the control. The design of any system of internal control is also based in part
upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions. Over time, controls may become inadequate
because of changes in circumstances, and/or the degree of compliance with the
policies and procedures may deteriorate. Because of the inherent limitations in
a cost-effective internal control system, financial reporting misstatements due
to error or fraud may occur and not be detected on a timely basis.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16 (a) of the Securities Exchange Act of 1934 requires our
officers, directors, and persons who own more than 10% of a registered class of
our equity securities to file reports of ownership and changes in ownership with
the SEC and Nasdaq. Officers,
directors, and greater than 10% beneficial owners are required by SEC regulation
to furnish the Company with copies of all Section 16 (a) forms they file. We
believe that all filing requirements applicable to its officers, directors, and
greater than 10% beneficial owners were complied with.
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The names, ages and positions of our directors and executive officers
as of March 31, 2004 are listed below:
NAMES TITLE OR POSITION AGE
----- ----------------- ---
James A. Joyce (1) Chairman, President, Chief Executive 42
Officer and Secretary
Richard H. Tullis, PhD (2) Vice President, Chief Scientific Officer 59
and Director
Edward C. Hall (3) Vice President, Chief Financial Officer 63
Franklyn S. Barry, Jr. Director 64
Edward G. Broenniman Director 67
Calvin M. Leung (4) Director 66
25
(1) Effective June 1, 2001, Mr. Joyce was appointed our President and
Chief Executive Officer, replacing Mr. Barry, who continues as a member of the
board of directors. Mr. Barry also served as a consultant to us on strategic
business issues from June 1, 2001 to May 31, 2003.
(2) Also effective June 1, 2001, Dr. Tullis was appointed as the
Company's Chief Scientific Officer, replacing Dr. Clara M. Ambrus, who retired.
(3) Effective August 14, 2002 Mr. Hall was elected our Vice President
and Chief Financial Officer, replacing Robert S. Stefanovich, who resigned July
26, 2002.
(4) Effective June 30, 2003 Mr. Leung was elected to our board of
directors.
Resumes of Management:
James A. Joyce, Chairman, President and CEO
-------------------------------------------
Mr. Joyce is the founder of Aethlon Medical, and has been the Chairman
of the Board and Secretary since March 1999. On June 1, 2001, our Board of
Directors appointed Mr. Joyce with the additional roles of President and CEO. In
February of 1993, Mr. Joyce founded James Joyce & Associates, an organization
that provided management consulting and corporate finance advisory services to
CEOs and CFOs of publicly traded companies. Previously, Mr. Joyce was Chief
Executive Officer of Mission Labs, Inc., and a principal in charge of U.S.
operations for London Zurich Securities, Inc. Mr. Joyce is a graduate from the
University of Maryland.
Edward C. Hall, Vice President, Chief Financial Officer
-------------------------------------------------------
Mr. Hall has been Vice President, Chief Financial Officer of the
Company since August 2002. Mr. Hall has held senior financial executive
positions with both public and privately-held life sciences and technology
companies for over 25 years. Prior to his appointment as Chief Financial Officer
of Aethlon Medical, he served as Vice President and Chief Financial Officer of
Chromagen, Inc, a biotech tools company which develops proteomic and genomic
assays for use in drug discovery. Prior to that Mr. Hall was Vice President,
Finance and Chief Financial Officer of Cytel Corporation, a biotech company and
developer of anti-inflammatory drugs. Mr. Hall is a Partner of Tatum CFO
Partners, LLP.
Richard H. Tullis, Ph.D., Vice President, Chief Scientific Officer
------------------------------------------------------------------
Dr. Tullis has been Vice President and a director of the Company since
January 2000 and Chief Scientific Officer since June 2001. Dr. Tullis has
extensive biotechnology management and research experience, and is the founder
of Syngen Research, a wholly-owned subsidiary of Aethlon Medical, Inc.
Previously, Dr. Tullis co-founded Molecular Biosystems, Inc., a former NYSE
company. At Molecular Biosystems, Dr. Tullis was Director of Research and
Development, Director of Oligonucleotide Hybridization, Senior Research
Scientist and Member of the Board of Directors. In research, Dr. Tullis
developed and patented the first application of oligonucleotides to antisense
antibiotics and developed new methods for the chemical synthesis of DNA via
methoxy-phosphorochloridites. Dr. Tullis also co-developed the first
applications of covalently coupled DNA-enzyme conjugates using synthetic
oligonucleotides during his tenure at Molecular Biosystems. In 1985, Dr. Tullis
founded, and served as President and CEO of Synthetic Genetics, Inc., a pioneer
in custom DNA synthesis, which was sold to Molecular Biology Resources in 1991.
Dr. Tullis also served as interim-CEO of Genetic Vectors, Inc., which completed
its IPO under his management, and was co-founder of DNA Sciences, Inc., a
company that was eventually acquired by Genetic Vectors. Dr Tullis received his
Ph.D. in Biochemistry and Cell Biology from the University of California at San
Diego, and has done extensive post-doctoral work at UCSD, USC, and The Scripps
Research Institute.
26
Franklyn S. Barry, Jr.
----------------------
Mr. Barry has over 25 years of experience in managing and building
companies. He was President and Chief Executive Officer of Hemex from April 1997
through May 31, 2001 and our President and CEO from March 10, 1999 to May 31,
2001. He became a director of Aethlon Medical on March 10, 1999. From 1994 to
April 1997, Mr. Barry was a private consultant. Included among his prior
experiences are tenures as President of Fisher-Price and as co-founder and CEO
of Software Distribution Services, which today operates as Ingram Micro-D, an
international distributor of personal computer products. Mr. Barry serves on the
Board of Directors of Merchants Mutual Insurance Company.
Edward G. Broenniman
--------------------
Mr. Broenniman became a director of Aethlon Medical on March 10, 1999.
Mr. Broenniman has 30 years of management and executive experience with
high-tech, privately held growth firms where he has served as a CEO, COO, or
corporate advisor, using his expertise to focus management on increasing
profitability and stockholder value. He is the Managing Director of The Piedmont
Group, LLC, a venture advisory firm. Mr. Broenniman recently served on the Board
of Directors of publicly traded QuesTech (acquired by CACI International), and
currently serves on the Boards of four privately-held firms. His nonprofit
Boards are the Dingman Center for Entrepreneurship's Board of Advisors at the
University of Maryland, the National Association of Corporate Directors,
National Capital Chapter and the Board of the Association for Corporate Growth,
National Capital Chapter.
Calvin M. Leung
----------------
Mr. Leung became a director of Aethlon Medical on June 30, 2003. He is
the President of Mandarin Investment Corporation, specializing in investment,
development and management of mobile home and recreational vehicle parks in
California, Arizona and the Midwest since 1975. He has syndicated a number of
land and housing developments in the western United States.
Mr. Leung, born in Hong Kong, received his advanced education in the
United States where he was awarded a doctorate degree in psychology specializing
in experimental research. He taught at the university level for several years.
Our Board of Directors has the responsibility for establishing broad
corporate policies and for overseeing our overall performance. Members of the
Board are kept informed of our business activities through discussions with the
President and other officers, by reviewing analyses and reports sent to them,
and by participating in board and committee meetings. Our bylaws provide that
each of the directors serves for a term that extends to our next Annual Meeting
of Shareholders. Our Board of Directors presently has an Audit Committee and a
Compensation Committee on each of which Messrs. Barry and Broenniman and Leung
serve. Mr. Barry is Chairman of the Audit Committee, and Mr. Broenniman is
Chairman of the Compensation Committee.
Non-employee Board members are accruing stock options and cash
compensation according to the plan approved in August 2000. Employee directors
receive no compensation.
FAMILY RELATIONSHIPS.
There are no family relationships between or among the directors,
executive officers or persons nominated or charged by us to become directors or
executive officers
There are no arrangements or understandings between any two or more of
our directors or executive officers. There is no arrangement or understanding
between any of our directors or executive officers and any other person pursuant
to which any director or officer was or is to be selected as a director or
officer, and there is no arrangement, plan or understanding as to whether
non-management shareholders will exercise their voting rights to continue to
elect the current board of directors. There are also no arrangements, agreements
or understanding between non-management shareholders that may directly or
indirectly participate in or influence the management of our affairs.
27
REGULATORY AND CLINICAL ADVISOR
Kenneth R. Michael, Pharm.D., R.A.C.
Dr. Michael is the President of KRM Associates LLC, a regulatory and
clinical affairs consulting organization. He is the former VP of Regulatory
Affairs and Quality Assurance at Siemens Medical Systems, and he is the founder,
past President and Chairman of The Regulatory Affairs Professional Society. He
is also the founder of the San Diego Regulatory Affairs Network.
SCIENTIFIC ADVISORY BOARD
Jean-Claude Chermann, Ph.D.
Dr. Chermann is a pioneer in the study of retroviruses, and was the
principal investigator of the research team that collaborated in the first
isolation and characterization of HIV at the Pasteur Institute in 1983. Dr.
Chermann was also the Director of Research of INSERM (French National Institute
of Health and Medical Research) and also held the position of Director of
Research of Unit INSERM U322 on "Retrovirus and Associated Diseases" from 1989
until June 2001 when he accepted his current role as Chief Scientific Director
of Urrma Biopharma based in Montreal, Canada, and Research & Development
Director of URRMA R&D, based in Aubagne, France.
Larry Cowgill, D.V.M., Ph.D.
Dr. Cowgill is a Professor in the Department of Medicine and
Epidemiology at the School of Veterinary Medicine, University of
California--Davis and has nearly 30 years of experience as a clinical instructor
in small animal internal medicine, nephrology and hemodialysis. He currently
Heads the Companion Animal Hemodialysis Units at the Veterinary Medical Teaching
Hospital at UC Davis and the UC Veterinary Medical Center-San Diego. Dr. Cowgill
is also Associate Dean for Southern California Clinical Programs and is
Co-Director of the University of California Veterinary Medical Center-San Diego.
Prior to his appointment at the University of California, he was a National
Institutes of Health (NIH) Special Research Fellow at the University of
Pennsylvania School of Veterinary Medicine and at the Renal Electrolyte Section
at the University of Pennsylvania School of Medicine, where he conducted
research in basic renal physiology and clinical nephrology. Dr. Cowgill received
his D.V.M. from the University of California--Davis School of Veterinary
Medicine and his Ph.D. in Comparative Medical Sciences from the University of
Pennsylvania, where he also completed his internship and Residency training in
Small Animal Internal Medicine. He became a Diplomat of the American College of
Veterinary Internal Medicine in 1977. Dr. Cowgill has published extensively in
the area of veterinary nephrology and has established a Clinical Fellowship in
Renal Medicine and Hemodialysis, which is the first of its kind in veterinary
Medicine.
Pedro Cuatrecasas, M.D.
Dr. Cuatrecasas was President of the Pharmaceutical Research Division
of Parke-Davis Co., and Corporate Vice President for Warner Lambert Company from
1989 until his retirement in 1997. From 1986 to 1989, he served as SVP and
Director of Glaxo Inc. For the prior 10 years, he was VP/R&D and Director, of
the Burroughs Wellcome Company. During his career in pharmaceutical research, he
was involved in the discovery, development and marketing registration of more
than 40 novel medicines. Dr. Cuatrecasas is widely recognized for the invention
and development of affinity chromatography. He is a member of the National
Academy of Sciences, The Institute of Medicine, and the American Academy of Arts
& Sciences, and he has authored more than 400 original publications.
Nathan W. Levin, M.D.
Dr. Levin is recognized as a leading authority within the hemodialysis
industry. He is the Medical and Research Director of the Renal Research
Institute, LLC, a joint venture between Fresenius Medical Care - North America
and Beth Israel Medical Center, New York. Dr. Levin also serves as Professor of
Clinical Medicine at the Albert Einstein College of Medicine.
28
Raveendran (Ravi) Pottathil, Ph.D.
Dr. Pottathil was the Section Manager for Retroviruses (focus on HIV
and HCV) and Tumor markers and PCR diagnostics at Hoffman La Roche from 1985 to
1992. He then co-founded Specialty Biosystems, Inc, a venture of Specialty Labs,
one of the largest independent reference laboratories in California. Dr.
Pottathil has also advised the World Health Organization's Sexually Transmitted
Diseases and Global Vaccination Program. Dr. Pottathil has worked with Dr.
Robert Huebner of the NIH in immunology and virology at The Jackson Laboratory,
and with Drs. David Lang and Wolfgang Joklik at Duke University on interferons,
anti-tumor RNAs and antigenic suppression of tumorigenic retroviruses. Academic
positions include: Assistant Professor at the University of Maryland School of
Medicine; Associate Professor at the City of Hope Medical Center in Duarte,
California where he published extensively with Dr. Pedro Cuatrecasas (one of
developers of affinity chromatography); and Adjunct Professor in Cellular and
Molecular Biology at Down State Medical Center and Rutgers University. As a
virologist and molecular biologist, Dr. Pottathil has over 40 refereed
publications to his credit and has been a Director of OncQuest, Inc., GeneQuest,
Inc., Specialty Laboratories Asia in Singapore and Specialty Ranbaxy in India.
Currently, Dr. Pottathil is the President of AccuDx, Inc. a pharmaceutical
diagnostics company he founded in 1996.
Claudio Ronco, M.D.
Dr. Ronco is the Director of the Dialysis and Renal Transplantation
Programs of St. Bartolo Hospital in Vicenza, Italy. He has published 17 books on
nephrology and dialysis and has written or co-authored over 350 scientific
articles. Dr. Ronco also serves on the editorial board of 12 scientific
journals, is a director of three international scientific societies, and is
recognized as being instrumental in the introduction of continuous
hemofiltration and high flux dialysis in Europe.
Ken Alibek, M.D., Ph.D., D.Sc.
Dr. Alibek is the Executive Director of Education at the National
Center for Biodefense at George Mason University (GMU), and is a Distinguished
Professor at GMU as well. Dr. Alibek specializes in medical and scientific
research dedicated to developing new forms of protection against biological
weapons and other infectious diseases.
Formerly, Dr. Alibek was a Soviet Army Colonel, and served as First
Deputy Chief of the civilian branch of the Soviet Union's biological weapons
program until he defected to the United States in 1992 and subsequently served
as a consultant to numerous U.S. government agencies in the areas of medical
microbiology, biological weapons defense, and biological weapons
nonproliferation. Dr. Alibek has worked with the National Institutes of Health,
testified extensively before the U.S. Congress on nonproliferation of biological
weapons and is the author of Biohazard: The Chilling True Story of the Largest
Covert Biological Weapons Program in the World--Told from Inside by the Man Who
Ran It, published by Random House Books. He holds numerous patents, is widely
published in science journals, and has provided over 300 lectures and
presentations to military and civilian universities, as well as foreign
governments. The December 2003 issue of the Acumen Journal of Life Sciences
named Dr. Alibek as one of top five biological warfare experts in the nation.
Charles Bailey, Ph.D.
Dr. Bailey is the former commander of the U.S. Army Medical Research
Institute of Infectious Diseases (USAMRIID). Dr. Bailey has 25 years U.S. Army
experience in R&D and management in infectious diseases and biological warfare
defense. As an officer of the Defense Intelligence Agency, Dr. Bailey wrote
extensively on foreign biological warfare capabilities. Dr. Bailey is currently
the Executive Director for Research & International Relations at the National
Center for Biodefense at George Mason University (GMU), and is a Distinguished
Professor of Biology at GMU as well. The Acumen Journal of Life Sciences named
Dr. Bailey as one of the top five biological warfare experts in the nation.
Members of the Scientific Advisory Board do not receive any compensation for
service on the Board. From time to time, as management sees fit, we may engage
them on consulting assignments for a fee on specific projects.
29
INVOLVEMENT IN LEGAL PROCEEDINGS.
To the best of our knowledge, during the past five years, none of the
following occurred with respect to a present or former director or executive
officer of the Company: (1) any bankruptcy petition filed by or against any
business of which such person was a general partner or executive officer either
at the time of the bankruptcy or within two years prior to that time; (2) any
conviction in a criminal proceeding or being subject to a pending criminal
proceeding (excluding traffic violations and other minor offenses); (3) being
subject to any order, judgment or decree, not subsequently reversed, suspended
or vacated, of any court of any competent jurisdiction, permanently or
temporarily enjoining, barring, suspending or otherwise limiting his involvement
in any type of business, securities or banking activities; and (4) being found
by a court of competent jurisdiction (in a civil action), the SEC or the
Commodities Futures Trading Commission to have violated a federal or state
securities or commodities law, and the judgment has not been reversed, suspended
or vacated.
CODE OF ETHICS
Our Board of Directors is in the process of preparing a code of ethics
which would apply to all of our officers, directors and employees.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth compensation received for the fiscal
years ended March 31, 2002 through 2004 by our Chief Executive Officer and all
executive officers.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
-------------------------------- -----------------------------
AWARDS
------------------
OTHER PAYOUTS/
ANNUAL RESTRICTED OPTIONS LTIP OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION STOCK SARs PAYOUTS COMPENSATION
POSITION YEAR ($)(1) ($) ($) ($) (#) ($) (1)
-------- ---- ------ --- --- --- --- --- ---
James A. Joyce 2004 180,000 - -
Chairman, 2003 180,000 - 250,000
President/CEO 2002 180,000
Richard H. Tullis, 2004 150,000 - -
Ph.D. Vice President, 2003 150,000 - 250,000
Chief Scientific Officer 2002 150,000 30,000
Edward C. Hall (2) 2004 28,530(2) - -
Vice President, Chief 2003 25,000
Financial Officer 2002 N/A
(1) The remuneration described in the above table does not include our cost
of benefits furnished to the named executive officers, including
premiums for health insurance and other personal benefits provided to
such individuals that are extended to all our employees in connection
with their employment. Perquisites and other personal benefits,
securities, or property received by an executive officer are either the
lesser of $50,000 or 10% of the total salary and bonus reported for
each named executive officer, except as otherwise disclosed.
(2) Mr. Hall became a part-time employee and was elected CFO of the Company
on August 14, 2002. He is compensated on an hourly basis, a portion of
which, amounting to $5,706 in fiscal 2004, is paid to Tatum CFO
Partners (Tatum), of which he is a partner.
OPTION/SAR GRANTS IN THE LAST FISCAL YEAR
None.
30
AGGREGATED OPTIONS/SAR EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
The following table sets forth the number of common stock options, both
exercisable and unexercisable, held by each of our Named Executive Officers and
the value of any in-the-money options at March 31, 2004, utilizing a value of
$1.35 per share, the closing price of our common stock on the OTCBB on March 31,
2004:
NUMBER OF VALUE OF
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES MARCH 31, MARCH 31,
ACQUIRED VALUE 2004 2004
ON EXERCISE REALIZED (EXERCISABLE/ (EXERCISABLE/
(#) ($) UNEXERCISABLE) UNEXERCISABLE)
----------- -------- ------------- -------------
James A. Joyce -- $ -- 250,000/-- $0.0/$0.0
Richard H. Tullis -- $ -- 280,000/-- $0.0/$0.0
Edward C. Hall -- $ -- N/A N/A
EMPLOYMENT AGREEMENTS
We entered into an employment agreement with Mr. Joyce effective April
1, 1999. Effective June 1, 2001, Mr. Joyce was appointed our President and Chief
Executive Officer and his base annual salary was increased from $120,000 to
$180,000. Under the terms of the agreement, his employment continues at a salary
of $180,000 per year for successive one year periods, unless given notice of
termination 60 days prior to the anniversary of his employment agreement.
We entered into an employment agreement with Dr. Tullis effective
January 10, 2000. Effective June 1, 2001, Dr. Tullis was appointed our Chief
Scientific Officer of the Company. His compensation under the agreement was
modified in June 2001 from $80,000 to $150,000 per year. Under the terms of the
agreement, his employment continues at a salary of $150,000 per year for
successive one year periods, unless given notice of termination 60 days prior to
the anniversary of his employment agreement.
Both Mr. Joyce and Dr. Tullis' agreements provide for medical insurance
and disability benefits, one year of severance pay if their employment is
terminated by us without cause or due to change in our control before the
expiration of their agreements, and allow for bonus compensation and stock
option grants as determined by our Board of Directors.
Both agreements also contain restrictive covenants preventing
competition with us and the use of confidential business information, except in
connection with the performance of their duties for us, for a period of two
years following the termination of their employment with us.
Effective August 14, 2002, Mr. Hall was elected our Vice President,
Chief Financial Officer. His employment is subject to 30 days' notice, with no
severance pay provisions, in accordance with his employment agreement. He
receives no medical or other benefits from us.
STOCK OPTION GRANTS
Our 2000 Stock Option Plan (the "Plan"), adopted by us in August 2000,
provides for the grant of incentive stock options ("ISOs") to full-time
employees (who may also be Directors) and nonstatutory stock options ("NSOs") to
non-employee Directors, consultants, customers, vendors or providers of
significant services. The exercise price of any ISO may not be less than the
fair market value of our Common Stock on the date of grant or, in the case of an
optionee who owns more than 10% of the total combined voting power of all
classes of our outstanding stock, not be less than 110% of the fair market value
on the date of grant. The exercise price, in the case of any NSO, must not be
less than 75% of the fair market value of our Common Stock on the date of grant.
The amount available under the Plan is 500,000 options.
At March 31, 2004, we had granted 47,500 options under the Plan, with
452,500 available for future issuance. We issued the remaining 1,966,415 options
(of which 637,800 have been exercised or cancelled) outside of the Plan.
At March 31, 2004, we had outstanding options to purchase 1,376,115
shares of our Common Stock. See Item 11, "Security Ownership of Certain
Beneficial Owners and Management."
31
OUTSTANDING STOCK PURCHASE WARRANTS
Common Stock purchase warrants
At March 31, 2004, we had outstanding a total of 3,907,764 warrants,
exercisable at prices between $0.25 - 6.50 per share and with expiration dates
from 2004 - 2007.
See Item 11, "Security Ownership of Certain Beneficial Owners and
Management."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of our Common Stock as of June 10, 2004 for:
- each person known by us to be the beneficial owner of 5% or more of
our Common Stock;
- each of our Directors and each of our executive officers whose name
appears in the summary compensation table (the "Executive
Officers"); and
- all of our Directors and the Executive Officers as a group.
Except as otherwise noted in the footnotes below, the entity,
individual Director or Executive Officer has sole voting and investment
power over such securities.
--------------------------
COMMON
(VOTING)
--------------------------
NAME AND ADDRESS OF BENEFICIAL OWNERS (1) (2) AMOUNT %(3)
----------------------------------------------------- -------------------- -----
Calvin M. Leung (5)(6)(7) 2,352,643 17.2%
P.O. Box 2366
Costa Mesa, CA 92628
Rod Tompkins (6)(8) 1,520,000 11.3%
420 Douglas
Wayne, NE 68787
Fusion Capital Fund II, LLC (6)(9) 1,604,966 9.9%
222 Merchandise Mart Plaza, Suite 9-112
Chicago, IL 60654
James A. Joyce (4)(5)(6)(10) 850,000 6.2%
Franklyn S. Barry, Jr. (5)(11) 418,593 3.0%
Richard H. Tullis (4)(5)(12) 330,000 2.4%
Edward G. Broenniman (5)(13) 261,374 2.0%
Edward C. Hall(4) 0 *
Directors and executive officers, as a group (6 4,212,610 28.7%
members)
----------------------------------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with Rule 13d-3 under
the Securities Exchange Act and is generally determined by voting
power and/or investment power with respect to securities. Except as
indicated by footnote and subject to community property laws where
applicable, we believe that the persons named in the table above have
sole voting and investment power with respect to all shares of Common
Stock shown as beneficially owned by them. Unless otherwise indicated,
the address of each shareholder is 7825 Fay Avenue, La Jolla, CA 92037.
32
(2) A person is deemed to be the beneficial owners of securities that can
be acquired by such person within 60 days from June 10, 2004 upon the
exercise of warrants or options. Each beneficial owner's percentage
ownership is determined by assuming that options and warrants that are
held by such person (but not those held by any other person) and that
are exercisable within 60 days from June 10, 2004.
(3) Assumes 13,389,621 shares of Common Stock outstanding at June 10, 2004.
(4) Executive officer.
(5) Director.
(6) More-than-5% shareholder.
(7) Includes all shares owned by members of Mr. Leung's family and entities
he controls plus 10,000 warrants at $3.00, expiring on January 1, 2006
and 306,000 warrants at $0.25, expiring on July 11, 2004 and January
29, 2005.
(8) Includes 20,000 warrants to purchase common stock at $0.25 per share,
expiring on April 2, 2005.
(9) Includes 568,181 warrants to purchase common stock at $0.76 per share,
expiring on the third anniversary of the date of an effective
registration statement, the initial filing of which is expected to be
on June 29, 2004. Pursuant to the terms of the warrant, Fusion Capital
is not entitled to exercise the warrants to the extent such exercise
would cause the aggregate number of shares of common stock beneficially
owned by the Fusion Capital to exceed 9.9% of the outstanding shares of
the common stock following such exercise.
(10) Includes 250,000 stock options exercisable at $1.90 per share.
(11) Includes options to purchase 412,500 shares at $3.00.
(12) Includes 250,000 stock options exercisable at $1.90 per share and
30,000 stock options exercisable at $2.56 per share.
(13) Includes 53,885 shares owned by Mr. Broenniman's wife and his
options to purchase 3,000 shares at $1.78 and 2,500 shares
at $3.75.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Franklyn S. Barry, Jr., a director and shareholder of Aethlon Medical,
was engaged as a consultant to the Company on strategic and business issues from
June 1, 2001 to May 31, 2003 and was paid $60,000 per year. See Item 9,
"Directors and Executive Officers" and Item 11, "Security Ownership of Certain
Beneficial Owners and Management."
Calvin M. Leung, a director and shareholder of Aethlon Medical, was
previously engaged as our consultant and he and his affiliates have invested
approximately $654,000 in Aethlon Medical to date, through equity and
convertible debt securities. He currently owns 2,036,643 of our common shares
and 316,000 warrants to purchase common stock at prices between $0.25 to $3.00
per share (See ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT)
Certain of our officers and other related parties have advanced us
funds, agreed to defer compensation or paid expenses on behalf of us to cover
short-term working capital deficiencies. These non interest-bearing liabilities
have been included as due to related parties in the accompanying financial
statements.
Effective January 1, 2000, we entered into an agreement with a related
party under which an invention and related patent rights for a method of
removing HIV and other viruses from the blood using the Hemopurifier(TM) were
assigned to us by the inventors in exchange for (a) a royalty to be paid on
future sales of the patented product or process equal to 8.75% of net sales, as
defined and (b) 12,500 shares of our restricted common stock. Upon the issuance
of the first United States patent relating to the invention, we were obligated
to issue an additional 12,500 shares of our restricted common stock to the
inventors. If the market price of our common stock on the date the patent is
issued is below $8 per share, the number of shares to be issued will be that
amount which equates to $100,000 of market value. On March 4, 2003, the related
patent was issued and, as a result, we issued 196,078 shares of our restricted
common stock valued at $100,000 which is included in professional fees in the
accompanying consolidated statements of operations.
We believe that each of the related party transactions discussed above
is on terms as favorable as could have been obtained from unaffiliated third
parties.
33
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following documents are filed as part of this report on Form
10-KSB:
1. Consolidated Financial Statements for the periods ended March 31,
2004 and 2003:
Independent Auditors' Reports
Consolidated Balance Sheet
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders' Deficit
Notes to Consolidated Financial Statements
2. Exhibits
The following exhibits are being filed with this Annual Report on Form
10-KSB and/or are incorporated by reference therein in accordance with
the designated footnote references:
3.1 Our Articles of Incorporation and Bylaws (1)
3.2 Certificate of Amendment of Articles of Incorporation dated March 28,
2000 (2)
10.1 Employment Agreement between us and Franklyn S. Barry, Jr.
dated April 1, 1999 (3)
10.2 Employment Agreement between us and James A. Joyce dated April
1, 1999 (3)
10.3 Agreement and Plan of Reorganization Between Aethlon Medical and
Aethlon, Inc. dated March 10, 1999 (4)
10.4 Agreement and Plan of Reorganization Between us and Hemex,
Inc. dated March 10, 1999 (4)
10.5 Agreement and Plan of Reorganization Between us and Syngen
Research, Inc. (5)
10.6 Agreement and Plan of Reorganization Between us and Cell
Activation, Inc. (6)
10.7 Common Stock Purchase Agreement between Aethlon Medical and Fusion
Capital Fund II, LLC. (7)
10.8 Registration Rights Agreement between Aethlon Medical and Fusion
Capital Fund II, LLC. (7)
10.9 Form of Securities Purchase Agreement for Private Placement closing on
June 7, 2004 (7)
10.10 Form of Common Stock Purchase Warrant for Private Placement closing on
June 7, 2004 (7)
10.11 Form of Registration Rights Agreement for Private Placement closing on
June 7, 2004 (7)
10.12 2003 Consultant Stock Plan (8)
23.1 Consent of Independent Auditors
31.1 Certification of our Chief Executive Officer and President, pursuant to
Securities Exchange Act rules 13a-14(a) and 15d-14(a) as adopted
pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2 Certification of our Chief Financial Officer, pursuant to Securities
Exchange Act rules 13a-14(a) and 15d-14(a) as adopted pursuant to
Section 302 of the Sarbanes Oxley Act of 2002.
32.1 Statement of our Chief Executive Officer under Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
32.2 Statement of our Chief Financial Officer under Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
34
In accordance with Item 601(b)(32)(ii) of Regulation S-B and SEC
Release Nos. 33-8238 and 34-47986, Final Rule: Management's Reports on Internal
Control Over Financial Reporting and Certification of Disclosure in Exchange Act
Periodic Reports, the certifications furnished in Exhibit 32.1 hereto are deemed
to accompany this Form 10-KSB and will not be deemed "filed" for purpose of
Section 18 of the Exchange Act. Such certifications will not be deemed to be
incorporated by reference into any filing under the Securities Act or the
Exchange Act, except to the extent that the Registrant specifically incorporates
it by reference
(1) Filed with our Registration Statement on Form SB-2 dated December 18,
2000 and incorporated by reference.
(2) Filed with our Annual Report on Form 10-KSB for the year ended March
31, 2000 and incorporated by reference.
(3) Filed with our Annual Report on Form 10-KSB for the year ended March
31, 1999 and incorporated by reference.
(4) Filed with our Current Report on Form 8-K dated March 10, 1999 and
incorporated by reference.
(5) Filed with our Current Report on Form 8-K dated January 10, 2000 and
incorporated by reference.
(6) Filed with our Current Report on Form 8-K dated April 10, 2000 and
incorporated by reference.
(7) Filed with our Current Report on Form 8-K dated June 7, 2004 and
incorporated by reference.
(8) Incorporated by reference from our Registration Statement on Form S-8
(File No. 333-114017) filed on March 29, 2004.
(b) Reports on Form 8-K.
Current Report on Form 8-K dated June 7, 2004 (filed with the SEC on
June 7, 2004) relating to our private placement and common stock purchase
agreement with Fusion Capital Fund II, LLC
* Filed herewith
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for professional services rendered by
Squar, Milner, Reehl & Williamson LLP ("Squar Milner") for the annual audit of
our consolidated financial statements as of and for the fiscal years ended March
31, 2004, and 2003 and fees billed for other services rendered by Squar Milner
during such years:
Fiscal Years Ended March 31,
2004 2003
------- -------
Audit Fees $55,500 $60,000
Audit Related Fees 2,500 (1) -
Tax Fees - -
All Other Fees - -
---------------------------
$58,000 $60,000
===========================
(1) Such amount represents services rendered in connection with Form
S-8.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT
SERVICES OF INDEPENDENT AUDITOR
Our audit committee of the Board of Directors is responsible for
pre-approving all audit and permitted non-audit services to be performed for us
by our independent auditor.
35
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on the 29th day of June 2004.
By: /s/ JAMES A. JOYCE
---------------------------------------------
James A. Joyce
Chairman, President & Chief Executive Officer
By: /s/ EDWARD C. HALL
---------------------------------------------
Edward C. Hall
Vice President and Chief Financial Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JAMES A. JOYCE Chairman of the Board June 29, 2004
-----------------------------
James A. Joyce
/s/ FRANKLYN S. BARRY, JR. Director June 29, 2004
-----------------------------
Franklyn S. Barry, Jr.
/s/ EDWARD G. BROENNIMAN Director June 29, 2004
-----------------------------
Edward G. Broenniman
/s/ RICHARD H. TULLIS Director June 29, 2004
-----------------------------
Richard H. Tullis
/s/ CALVIN M. LEUNG Director June 29, 2004
-----------------------------
Calvin M. Leung
31
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm................... F-1
Consolidated Balance Sheet ................................................ F-2
Consolidated Statements of Operations ..................................... F-3
Consolidated Statements of Stockholders' Deficit........................... F-4
Consolidated Statements of Cash Flows ..................................... F-8
Notes to Consolidated Financial Statements................................. F-9
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To the Board of Directors and Stockholders
Aethlon Medical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Aethlon Medical,
Inc. and Subsidiaries (the "Company"), a development stage company, as of March
31, 2004 and the related consolidated statements of operations, stockholders'
deficit and cash flows for each of the years in the two-year period then ended
and for the period from January 31, 1984 (Inception) to March 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Aethlon Medical,
Inc. and Subsidiaries as of March 31, 2004 and the results of their operations
and their cash flows for the each of the years in the two-year period then ended
and for the period from January 31, 1984 (Inception) to March 31, 2004, in
conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. At March 31, 2004, the
Company has negative working capital of approximately $3,930,000 and a deficit
accumulated during the development stage of approximately $17,145,000. As
discussed in Note 1 to the consolidated financial statements, a significant
amount of additional capital will be necessary to advance the development of the
Company's products to the point at which they may become commercially viable.
These conditions, among others raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans regarding these
matters are also described in Note 1. The accompanying consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Squar, Milner, Reehl & Williamson, LLP
May 18, 2004
Newport Beach, California
F-1
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED BALANCE SHEET
March 31, 2004
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 1,619
Prepaid expenses 5,582
-------------
TOTAL CURRENT ASSETS 7,201
-------------
Property and equipment, net 16,741
Patents, net 237,314
Other assets 20,405
-------------
TOTAL NONCURRENT ASSETS 274,460
-------------
TOTAL ASSETS $ 281,661
=============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,588,381
Due to related parties 1,673,457
Notes payable 500,000
Convertible notes payable 175,000
-------------
TOTAL CURRENT LIABILITIES 3,936,838
-------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Common stock, par value of $0.001, 25,000,000 shares
authorized; 10,649,329 issued and outstanding 10,649
Additional paid in capital 13,479,487
Deficit accumulated during the development stage (17,145,313)
-------------
TOTAL STOCKHOLDERS' DEFICIT (3,655,177)
-------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 281,661
=============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-2
---------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended March 31, 2004 and 2003 and
For the Period January 31,1984 (Inception) Through March 31, 2004
---------------------------------------------------------------------------------------
January 31, 1984
(Inception) Through
2004 2003 March 31, 2004
------------- ------------- -------------
Grant income $ -- $ -- $ 1,424,012
Subcontract income -- -- 73,746
Sale of research and development -- -- 35,810
------------- ------------- -------------
-- -- 1,533,568
OPERATING EXPENSES
Professional fees 339,787 760,949 3,766,626
Payroll and related 417,486 549,611 5,570,510
General and administrative 238,276 326,521 3,482,441
Impairment of intangible assets -- 334,304 1,231,531
------------- ------------- -------------
995,549 1,971,385 14,051,108
------------- ------------- -------------
OPERATING LOSS (995,549) (1,971,385) (12,517,540)
OTHER (INCOME) EXPENSE
Interest expense 523,249 489,731 4,507,581
Interest income -- -- (17,415)
Other -- -- 137,607
------------- ------------- -------------
523,249 489,731 4,627,773
------------- ------------- -------------
NET LOSS $ (1,518,798) $ (2,461,116) $(17,145,313)
============= ============= =============
Basic and diluted loss
per common share $ (0.19) $ (0.44)
============= =============
Weighted average number of common
shares outstanding 8,181,612 5,553,196
============= =============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-3
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
For the Years Ended March 31, 2004 and 2003 and
For the Period January 31, 1984 (Inception) Through March 31, 2004
--------------------------------------------------------------------------------------------------------------
DEFICIT
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
-------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE DEFICIT
------------ ------------ ------------ ------------ ------------
Balance, January 31, 1984 (Inception) -- $ -- $ -- $ -- $ --
Common stock issued for cash
at $1 per share 22,000 22 26,502 -- 26,524
Common stock issued for cash
at $23 per share 1,100 1 24,999 -- 25,000
Common stock issued for cash
at $86 per share 700 1 59,999 -- 60,000
Common stock issued for cash
at $94 per share 160 1 14,999 -- 15,000
Common stock issued for cash
at $74 per share 540 1 39,999 -- 40,000
Common stock issued for cash
at $250 per share 4,678 5 1,169,495 -- 1,169,500
Capital contributions -- -- 521,439 -- 521,439
Common stock issued for
compensation at $103 per share 2,600 3 267,403 -- 267,406
Conversion of due to related
parties to common stock at
$101 per share 1,120 1 113,574 -- 113,575
Conversion of due to related
parties to common stock at
$250 per share 1,741 2 435,092 -- 435,094
Effect of reorganization 2,560,361 2,558 (2,558) -- --
Common stock issued in connection
with employment contract at
$8 per share 65,000 65 519,935 -- 520,000
Common stock issued in connection
with the acquisition of patents
at $8 per share 12,500 13 99,987 -- 100,000
Warrants issued to note holders
in connection with notes payable -- -- 734,826 -- 734,826
Warrantes issued for services -- -- 5,000 -- 5,000
Net loss -- -- -- (4,746,416) (4,746,416)
------------ ------------ ------------ ------------ ------------
BALANCE, MARCH 31, 2000 2,672,500 2,673 4,030,691 (4,746,416) (713,052)
Common stock and options issued
in connection with acquisition of
Cell Activation, Inc. at $7.20
per share 99,152 99 1,067,768 -- 1,067,867
Warrants issued to note holders in
connection with notes payable -- -- 218,779 -- 218,779
Warrants issued to promoter in
connection with notes payable -- -- 298,319 -- 298,319
Beneficial conversion feature of
convertible notes payable -- -- 150,000 -- 150,000
Warrants issued to promoter in
connection with convertible notes
payable -- -- 299,106 -- 299,106
Options issued to directors for
services as board members -- -- 14,163 -- 14,163
Options and warrants issued
for services -- -- 505,400 -- 505,400
Common stock issued for services
at $3 per share 5,500 5 16,495 -- 16,500
Common stock issued for cash
at $1 per share 100,000 100 99,900 -- 100,000
Net loss -- -- -- (4,423,073) (4,423,073)
------------ ------------ ------------ ------------ ------------
BALANCE, MARCH 31, 2001 2,877,152 $ 2,877 $ 6,700,621 $(9,169,489) $(2,465,991)
continued
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-4
BALANCE, MARCH 31, 2001 2,877,152 $ 2,877 $ 6,700,621 $ (9,169,489) $ (2,465,991)
Common stock, warrants and
options issued for accounts
payable and accrued liabilities 21,750 22 243,353 -- 243,375
Common stock issued for services
at $2.65 per share 6,038 6 15,994 -- 16,000
Common stock issued for cash at
$1.00 per share, net of issuance
costs of $41,540 paid to a
related party 730,804 731 688,533 -- 689,264
Common stock issued for services
at $2.75 per share 10,000 10 27,490 -- 27,500
Common stock issued in connection
with license agreement at $3.00
per share 6,000 6 17,994 -- 18,000
Common stock issued to holder of
convertible notes payable at
$3.00 per share 70,586 71 211,687 -- 211,758
Options issued to directors for
services as board members -- -- 7,459 -- 7,459
Common stock issued for cash at
$1.50 per share, net of issuance
costs of $2,500 16,667 17 22,483 -- 22,500
Beneficial conversion feature of
convertible notes payable -- -- 185,000 -- 185,000
Common stock issued for conversion
of convertible notes payable and
accrued interest at an average price
of $1.24 per share 134,165 134 166,352 -- 166,486
Common stock issued for services at
$2.72 per share 9,651 10 26,240 -- 26,250
Options issued to consultant for
services -- -- 562,000 -- 562,000
Common stock and warrants for
services at $1.95 per share 62,327 62 161,475 -- 161,537
Common stock issued for services at
$1.90 per share 9,198 9 17,491 -- 17,500
Stock options exercised for cash 400,000 400 199,600 -- 200,000
Warrants issued to note holders for
90-day forebearance -- -- 118,000 -- 118,000
Common stock and warrants issued to
note holders and vendors in the
debt-to-equity conversion program
at $1.25 per share 816,359 816 1,623,635 -- 1,624,451
Other warrant transactions -- -- (32,715) -- (32,715)
Net loss -- -- -- (3,995,910) (3,995,910)
------------ ------------ ------------ ------------- -------------
BALANCE - MARCH 31, 2002 5,170,697 $ 5,171 $10,962,692 $(13,165,399) $ (2,197,536)
continued.........
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-5
BALANCE - MARCH 31, 2002 5,170,697 $ 5,171 $10,962,692 $(13,165,399) $ (2,197,536)
Proceeds from the issuance of
common stock at $0.50 per share
in connection with the exercise
of options 200,000 200 99,800 -- 100,000
Interest expense related to
beneficial conversion feature -- -- 150,000 -- 150,000
Pro-rata fair value assigned to warrants
issued in connection with
conversion of accounts payable -- -- 71,000 -- 71,000
Pro-rata fair value assigned to warrants
issued in connection with note payable -- -- 30,000 -- 30,000
Issuance of common stock at $1.25
per share in connection with the
conversion of accounts payable 150,124 150 187,505 -- 187,655
Issuance of common stock at $1.25
per share in connection with the
conversion of notes payable 420,000 420 104,580 -- 105,000
Estimated fair value of
options issued for service -- -- 114,000 -- 114,000
Issuance of common stock at $0.25
per share for cash 461,600 462 114,938 -- 115,400
Issuance of common stock at $0.26
per share for cash 19,230 19 4,981 -- 5,000
Issuance of common stock at $1.25
per share for cash 8,000 8 9,992 -- 10,000
Issuance of common stock at $0.65
per share for services 69,231 69 44,931 -- 45,000
Issuance of common stock at $0.51
per share for services 196,078 196 99,804 -- 100,000
Net loss -- -- -- (2,461,116) (2,461,116)
------------ ------------ ------------ ------------- -------------
BALANCE - MARCH 31, 2003 6,694,960 $ 6,695 $11,994,223 $(15,626,515) $ (3,625,597)
CONTINUED.........
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-6
------------ ------------ ------------ ------------- -------------
BALANCE - MARCH 31, 2003 6,694,960 6,695 11,994,223 (15,626,515) (3,625,597)
Proceeds from the issuance of
common stock at $0.25 per share
in connection with the exercise
of warrants 540,000 540 134,460 -- 135,000
Issuance of common stock at $0.25
per share in connection with the
conversion of notes payable,
including interest of $15,099 300,397 300 74,799 -- 75,099
Issuance of common stock at $0.35
per share in connection with the
conversion of notes payable,
including interest of $59,827 813,790 814 284,013 -- 284,827
Issuance of common stock at $0.50
per share in connection with the
conversion of notes payable,
including interest of $509 11,017 11 5,498 -- 5,509
Issuance of common stock at $0.42
per share in connection with the
conversion of notes payable,
including interest of $696 13,725 14 5,682 -- 5,696
Issuance of common stock at $0.65
per share in connection with the
conversion of notes payable,
including interest of $5,088 27,059 27 17,561 -- 17,588
Issuance of common stock at $0.25
per share in connection with the
conversion of notes payable,
including interest of $15,416 461,667 462 114,954 -- 115,416
Issuance of common stock at $0.25
per share for cash 1,226,000 1,226 305,274 -- 306,500
Issuance of common stock at $0.30
per share for cash 180,000 180 53,820 -- 54,000
Issuance of common stock at $0.525
per share for cash 40,000 40 20,960 -- 21,000
Issuance of common stock at $1.125
per share for cash 5,000 5 5,620 -- 5,625
Issuance of common stock at $0.25
per share for services 10,000 10 2,490 -- 2,500
Issuance of common stock at $0.34
per share for services 73,529 73 24,927 -- 25,000
Issuance of common stock at $0.40
per share for services 62,000 62 24,763 -- 24,825
Issuance of common stock at $0.45
per share for services 185,185 185 83,148 -- 83,333
Issuance of common stock at $0.50
per share for services 5,000 5 2,495 -- 2,500
Interest expense related to beneficial
conversion feature -- -- 324,800 -- 324,800
Net loss -- -- -- (1,518,798) (1,518,798)
------------ ------------ ------------ ------------- -------------
BALANCE - MARCH 31, 2004 10,649,329 10,649 13,479,487 (17,145,313) (3,655,177)
============ ============ ============ ============= =============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-7
-------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended March 31, 2004 and 2003 and
For the Period January 31, 1984 (Inception) Through March 31, 2004
-------------------------------------------------------------------------------------------------------------------
January 31, 1984
(Inception)
Through
2004 2003 March 31, 2004
------------- ------------- -------------
Cash flows from operating activities:
Net loss $ (1,518,798) $ (2,461,116) $(17,145,313)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 127,000 159,783 909,915
Gain of sale of property and equipment -- -- (13,065)
Estimated fair value of warrants issued in connection
with accounts payable and debt -- 101,000 2,715,736
Estimated fair value of common stock, warrants and options
issued for services 138,158 259,000 2,268,592
Beneficial conversion feature of convertible notes payable 324,800 150,000 809,800
Impairment of patents and patents pending -- 334,304 334,304
Impairment of goodwill -- -- 897,227
Deferred compensation forgiven -- -- 217,223
Changes in operating assets and liabilities:
Prepaid expenses 4,728 130,478 155,955
Other assets (14,800) (3,650) (20,405)
Accounts payable and accrued liabilities 138,398 474,054 1,772,671
Due to related parties 258,458 341,644 1,673,457
------------- ------------- -------------
Net cash used in operating activities (542,056) (514,503) (5,423,903)
------------- ------------- -------------
Cash flows from investing activities:
Purchases of property and equipment (4,782) (1,198) (214,166)
Patents and patents pending -- (49,034) (352,833)
Proceeds from the sale of property and equipment -- -- 17,065
Cash of acquired company -- -- 10,728
------------- ------------- -------------
Net cash used in investing activities (4,782) (50,232) (539,206)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from the issuance of notes payable -- 65,000 1,480,000
Principal repayments of notes payable (180,000) (10,000) (190,000)
Proceeds from the issuance of convertible notes payable 200,000 275,000 998,000
Proceeds from the issuance of common stock 522,125 230,400 3,676,728
------------- ------------- -------------
Net cash provided by financing activities 542,125 560,400 5,964,728
------------- ------------- -------------
Net (decrease) increase in cash (4,713) (4,335) 1,619
Cash at beginning of period 6,332 10,667 --
------------- ------------- -------------
Cash at end of period 1,619 6,332 1,619
============= ============= =============
Supplemental disclosure of cash flow information -
Cash paid during the period for:
Interest $ 13,000 $ 13,000 $ 220,492
============= ============= =============
Income taxes $ 1,180 $ 1,180 $ 13,346
============= ============= =============
Supplement schedule of noncash investing activities:
Debt converted to common stock $ 407,500 $ 205,000 $ 2,048,094
============= ============= =============
Issuance of common stock, warrants and options for accounts payable $ -- $ 87,655 $ 512,816
============= ============= =============
Issuance of common stock in connection with license agreements $ -- $ -- $ 18,000
============= ============= =============
Net assets of entities acquired in exchange for equity securities $ -- $ -- $ 1,597,867
============= ============= =============
Debt placement fees paid by issuance of warrants $ -- $ -- $ 843,538
============= ============= =============
Patent pending acquired for 12,500 shares of common stock $ -- $ -- $ 100,000
============= ============= =============
Common stock issued for prepaid expenses $ -- $ -- $ 161,537
============= ============= =============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-8
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Aethlon Medical, Inc. ("Aethlon") engages in the research and development of a
medical device known as the Hemopurifier(TM) that removes harmful substances
from the blood. Aethlon is in the development stage on the Hemopurifier(TM) and
significant research and testing are still needed to reach commercial viability.
Any resulting medical device or process will require approval by the U.S. Food
and Drug Administration ("FDA"), and Aethlon has not yet begun efforts to obtain
any FDA approval, which may take several years. Since many of Aethlon's patents
were issued in the 1980's, they are scheduled to expire in the near future.
Thus, such patents may expire before FDA approval, if any, is obtained. However,
the Company believes that certain patent applications and/or other patents
issued more recently will help to protect the proprietary nature of the
Hemopurifier(TM) treatment technology.
Aethlon is classified as a development stage enterprise under accounting
principles generally accepted in the United States of America ("GAAP"), and has
not generated revenues from its planned principal operations.
Aethlon's common stock is quoted on the Over-the-Counter Bulletin Board of
the National Association of Securities Dealers ("OTCBB") under the symbol
"AEMD."
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Aethlon Medical, Inc. and its inactive legal wholly-owned subsidiaries Aethlon,
Inc., Hemex, Inc., Syngen Research, Inc. and Cell Activation, Inc. (collectively
hereinafter referred to as the "Company"). All significant intercompany balances
and transactions have been eliminated in consolidation.
GOING CONCERN
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern, which contemplates, among other
things, the realization of assets and satisfaction of liabilities in the
ordinary course of business. The Company has negative working capital of
approximately $3,930,000 and a deficit accumulated during the development stage
of approximately $17,145,000 at March 31, 2004, which among other matters, raise
substantial doubt about its ability to continue as a going concern. A
significant amount of additional capital will be necessary to advance the
development of the Company's products to the point at which they may become
commercially viable. The Company intends to fund operations through debt and
equity financing arrangements, which management believes may be insufficient to
fund its capital expenditures, working capital and other cash requirements
(consisting of accounts payable, accrued liabilities, amounts due to related
parties and amounts due under various notes payable) for the fiscal year ending
March 31, 2005. Therefore, the Company will be required to seek additional funds
to finance its long-term operations. The successful outcome of future activities
cannot be determined at this time and there is no assurance that if achieved,
the Company will have sufficient funds to execute its intended business plan or
generate positive operating results.
The consolidated financial statements do not include any adjustments related to
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern.
F-9
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
RISKS AND UNCERTAINTIES
The Company operates in an industry that is subject to intense competition,
government regulation and rapid technological change. The Company's operations
are subject to significant risk and uncertainties including financial,
operational, technological, regulatory and other risks associated with a
development stage company, including the potential risk of business failure.
USE OF ESTIMATES
The Company prepares its consolidated financial statements in conformity with
GAAP, which require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reporting period. Significant estimates made by
management include, among others, realization of long-lived assets. Actual
results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards ("SFAS") No. 107, "DISCLOSURES ABOUT
FAIR VALUE OF FINANCIAL INSTRUMENTS," requires disclosure of fair value
information about financial instruments when it is practicable to estimate that
value. The carrying amount of the Company's cash, accounts payable, accrued
liabilities, notes payable approximates their estimated fair values due to the
short-term maturities of those financial instruments. The fair values of amounts
due to related parties are not determinable as these transactions are with
related parties.
CONCENTRATIONS OF CREDIT RISKS
Cash is maintained at various financial institutions. The Federal Deposit
Insurance Corporation ("FDIC") insures accounts at each institution for up to
$100,000. At times, cash may be in excess of the FDIC insurance limit. The
Company had no amounts exceeding this limit at March 31, 2004.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets,
which range from two to five years. Repairs and maintenance are charged to
expense as incurred while improvements are capitalized. Upon the sale or
retirement of property and equipment, the accounts are relieved of the cost and
the related accumulated depreciation with any gain or loss included in the
statements of operations. Depreciation expense approximated $8,000 and $18,000
for the years ended March 31, 2004 and 2003, respectively.
INCOME TAXES
Under SFAS 109, "ACCOUNTING FOR INCOME TAXES," deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the consolidated financial statements and their respective
tax basis. Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts reported for income tax purposes, and (b) tax
credit carryforwards. The Company records a valuation allowance for deferred tax
assets when, based on management's best estimate of taxable income in the
foreseeable future, it is more likely than not that some portion of the deferred
income tax assets may not be realized.
F-10
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
LONG-LIVED ASSETS
SFAS 144, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF," addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 requires that long-lived
assets be reviewed for impairment whenever events or changes in circumstances
indicate that their carrying amounts may not be recoverable. If the cost basis
of a long-lived asset is greater than the projected future undiscounted net cash
flows from such asset, an impairment loss is recognized.
Impairment losses are calculated as the difference between the cost basis of an
asset and its estimated fair value. SFAS 144 also requires companies to
separately report discontinued operations and extends that reporting requirement
to a component of an entity that either has been disposed of (by sale,
abandonment or in a distribution to owners) or is classified as held for sale.
Assets to be disposed of are reported at the lower of the carrying amount or the
estimated fair value less costs to sell. The Company adopted SFAS 144 on January
1, 2002. The provisions of this pronouncement relating to assets held for sale
or other disposal generally are required to be applied prospectively after the
adoption date to newly initiated commitments to sell or dispose of such assets,
(as defined), by management. As a result, management cannot determine the
potential effects that adoption of SFAS 144 will have on the Company's financial
statements with respect to future disposal decisions, if any. Management
believes no impairment exists at March 31, 2004.
EARNINGS PER SHARE
Under SFAS 128, "EARNINGS PER SHARE," basic earnings per share is computed by
dividing net income available to common stockholders by the weighted average
number of common shares assumed to be outstanding during the period of
computation. Diluted earnings per share is computed similar to basic earnings
per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive
(If the Company had net income in each of the years ended March 31, 2004 and
2003, 2,500,000 and 2,900,000 shares would have been considered additional
common stock equivalents at March 31, 2004 and 2003, respectively, based on the
treasury stock method). As the Company had net losses for the period presented,
basic and diluted loss per share are the same, as any additional common stock
equivalents would be antidilutive.
SEGMENTS
SFAS 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION,"
changes the way public companies report information about segments of their
business in their annual financial statements and requires them to report
selected segment information in their quarterly reports issued to shareholders.
It also requires entity-wide disclosures about the products and services an
entity provides, the foreign countries in which it holds significant assets and
how the Company reports revenues and its major customers. The Company currently
operates in one segment, as disclosed in the accompanying consolidated
statements of operations.
F-11
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
STOCK BASED COMPENSATION
The Company accounts for stock-based compensation issued to employees using the
intrinsic value based method as prescribed by Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock issued to Employees." Under the
intrinsic value based method, compensation expense is the excess, if any, of the
estimated fair value of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock. Compensation expense,
if any, is recognized over the applicable service period, which is usually the
vesting period.
SFAS 123, "Accounting for Stock-Based Compensation," if fully adopted, changes
the method of accounting for employee stock-based compensation plans to the fair
value based method. For stock options and warrants, fair value is estimated
using an option pricing model that takes into account the stock price at the
grant date, the exercise price, the expected life of the option or warrant,
stock volatility and the annual rate of quarterly dividends. Compensation
expense, if any, is recognized over the applicable service period, which is
usually the vesting period.
The adoption of the accounting methodology of SFAS 123 is optional and the
Company has elected to continue accounting for stock-based compensation issued
to employees using APB 25; however, pro forma disclosures, as if the Company had
adopted the cost recognition requirement under SFAS 123, are required to be
presented (see below). For stock-based compensation issued to non-employees, the
Company uses the fair value method of accounting under the provisions of SFAS
123.
Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 44,
"Accounting for Certain Transactions Involving Stock Compensation, an
Interpretation of APB 25" clarifies the application of APB 25 for (a) the
definition of employee for purpose of applying APB 25, (b) the criteria for
determining whether a plan qualifies as a non compensatory plan, (c) the
accounting consequence for various modifications to the terms of a previously
fixed stock option or award and (d) the accounting for an exchange of stock
compensation awards in a business combination. Management believes that the
Company accounts for transactions involving stock compensation in accordance
with FIN 44.
SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123," provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this statement amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.
At March 31, 2004, the Company has one stock-based employee compensation plan
(the "Plan"), which is described more fully in Note 6. The Company accounts for
the Plan under the recognition and measurement principles of APB 25, and related
interpretation. No stock-based compensation cost is recognized in net loss.
Stock options granted under the Plan have exercise prices equal to or greater
than the estimated fair value of the underlying common stock on the dates of
grant. The following table illustrates the effect on net and loss per common
share if the Company had applied the fair value recognition provisions of SFAS
123 to stock-based employee compensation.
F-12
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
STOCK BASED COMPENSATION (continued)
YEAR ENDED MARCH 31,
----------------------------
2004 2003
------------ ------------
Net loss available to common stockholders, as report $ 1,518,798 $ 2,461,116
Pro forma compensation expense 6,000 9,000
------------ ------------
Pro forma net loss available to common stockholders $ 1,524,798 $ 2,470,116
============ ============
Loss per common share, as reported
Basic and diluted $ (0.19) $ (0.44)
Loss per common share, pro forma
Basic and diluted $ (0.19) $ (0.45)
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 146, "Accounting for Costs Associated with Exit and Disposal
Activities," was issued in June 2002 and is effective for exit and disposal
activities initiated after December 31, 2002. The Company is complying with SFAS
No. 146.
SFAS No. 147 relates exclusively to certain financial institutions, and thus
does not apply to the Company.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN No. 45 clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the estimated fair
value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN No. 45 are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002,
while the disclosure requirements became applicable in 2002. The Company is
complying with the disclosure requirements of FIN No. 45. The other requirements
of this pronouncement did not materially affect the Company's consolidated
financial statements.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB 51." The primary objectives of FIN No. 46 are
to provide guidance on the identification of entities for which control is
achieved through means other than voting rights (variable interest entities or
"VIEs") and how to determine when and which business enterprise should
consolidate the VIE. This new model for consolidation applies to an entity for
which either: (1) the equity investors do not have a controlling financial
interest; or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial support
from other parties. In addition, FIN No. 46 requires that both the primary
beneficiary and all other enterprises with a significant variable interest in a
VIE make additional disclosures. As amended in December 2003, the effective
dates of FIN No. 46 for public entities that are small business issuers, as
defined ("SBIs"), are as follows: (a) For interests in special-purpose entities
("SPEs": periods ended after December 15, 2003; and (b) For all other VIEs:
periods ending after December 15, 2004. The December 2003 amendment of FIN No.
46 also includes transition provisions that govern how an SBI which previously
adopted the pronouncement (as it was originally issued) must account for
consolidated VIEs. The Company has determined that it does not have any variable
interest in any SPEs, and is presently evaluating the other effects of FIN No.
46 (as amended) on its consolidated financial statements.
F-13
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS (continued)
In April 2003, the FASB issued SFAS No. 149, "Amendments of Statement 133 on
Derivative Instruments and Hedging Activities," which amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. This pronouncement is effective for contracts entered into
or modified after June 30, 2003 (with certain exceptions), and for hedging
relationships designated after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how a company classifies and measures certain
financial instruments with characteristics of both liabilities and equity, and
is effective for public companies as follows: (i) in November 2003, the FASB
issued FASB Staff Position ("FSP") FAS 150-03 ("FSP 150-3"), which defers
indefinitely (a) the measurement and classification guidance of SFAS No. 150 for
all mandatorily redeemable non-controlling interests in (and issued by)
limited-life consolidated subsidiaries, and (b) SFAS No. 150's measurement
guidance for other types of mandatorily redeemable non-controlling interests,
provided they were created before November 5, 2003; (ii) for financial
instruments entered into or modified after May 31, 2003 that are outside the
scope of FSP 150-3; and (iii) otherwise, at the beginning of the first interim
period beginning after June 15, 2003. The Company adopted SFAS No. 150 on the
aforementioned effective dates. The adoption of this pronouncement did not have
a material impact on the Company's results of operations or financial condition.
Other recent accounting pronouncements are discussed elsewhere in these notes to
the consolidated financial statements.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants, and the Securities and Exchange Commission (the "SEC") did not or
are not believed by management to have a material impact on the Company's
present or future consolidated financial statements.
PATENTS
The Company capitalizes the cost of patents and patents pending, some of which
were acquired, and amortizes such costs over the shorter of the remaining legal
life or their estimated economic life, upon issuance of the patent. There were
no patents pending at March 31, 2004 or 2003. The unamortized cost of patents
and patents pending is written off when management determines there is no future
benefit. During the years ended March 31, 2004 and 2003, zero and $334,000 of
capitalized patent costs were written off, respectively. Accumulated
amortization of patents approximated $102,000 at March 31, 2004. Amortization of
patents and patents pending approximated $23,000 and $15,000 during the years
ended March 31, 2004 and 2003, respectively. Patents include both foreign and
domestic patents.
STOCK PURCHASE WARRANTS ISSUED WITH NOTES PAYABLE
The Company granted warrants in connection with the issuance of certain notes
payable (see Notes 4 and 5). Under Accounting Principles Board Opinion No. 14,
"ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH STOCK PURCHASE WARRANTS,"
the estimated fair value of such warrants represents a discount from the face
amount of the notes payable. Accordingly, the relative estimated fair value of
the warrants has been recorded in the financial statements as a discount from
the face amount of the notes. The discount is amortized using the effective
yield method over the respective lives of the related notes payable.
F-14
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
BENEFICIAL CONVERSION FEATURE OF CONVERTIBLE NOTES PAYABLE
The convertible feature of certain notes payable (see Notes 4 and 5) provides
for a rate of conversion that is below market value. Such feature is normally
characterized as a "beneficial conversion feature" ("BCF"). Pursuant to Emerging
Issues Task Force Issue No. 98-5 ("EITF Issue No. 98-5"), "ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIO" and Emerging Issues Task Force Issue No. 00-27, "
APPLICATION OF EITF ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS," the
Company has determined the fair value of such BCF to be approximately $325,000
and $450,000, for the years ended March 31, 2004 and 2003, respectively.
Accordingly, the relative estimated fair value of the BCF has been recorded in
the consolidated financial statements as a discount from the face amount of the
notes. Such discounts were amortized to interest expense in accordance with the
related conversion feature.
RESEARCH AND DEVELOPMENT EXPENSES
The Company incurred approximately $200,000 of research and development expenses
during each of the two years ended March 31, 2004 and 2003, which are included
in operating expenses in the accompanying consolidated statements of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2003 financial statement
presentation to correspond to the 2004 format.
2. EMPLOYMENT CONTRACT
On January 10, 2000, the Company completed the acquisition of the assets of
Syngen Research, Inc. ("Syngen"). As part of the transaction, the Company
executed a two-year employment contract, as amended, with Syngen's sole
shareholder to perform research. Such employment contract was amortized over
four years on a straight-line basis and was fully amortized as of March 31,
2004.
3. DEBT-TO-EQUITY CONVERSION PROGRAM
In March 2002, the Company extended an offer to certain note holders and vendors
to convert past due amounts into restricted common stock and warrants to
purchase common stock of the Company. The offer entails the conversion of
liabilities at a rate of one share and one-half of a warrant for every $1.25
converted. The warrants have an exercise price of $2.00 per share and expire
three years from the date of issuance.
During the year ended March 31, 2003 and 2002, note holders and vendors
representing liabilities of approximately $188,000 and $1,020,000 converted
their debt in exchange for 150,124 and 816,359 shares of common stock and 75,061
and 408,180 warrants to purchase common stock, respectively. Such warrants were
valued using the Black-Scholes option pricing model based on their estimated pro
rata fair value of approximately $71,000 and $339,000. The warrant conversion
rate was below estimated fair value for warrants issued during the fiscal year
ended March 31, 2002; therefore a BCF approximating $265,000 was recorded during
the year ended March 31, 2002.
F-15
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
4. NOTES PAYABLE
15% AND 12% NOTES
The Company entered into arrangements for the issuance of notes payable from
private placement offerings (the "12% Notes"). The 12% Notes bear interest at
12% per annum, interest payable quarterly, mature one year from the date of
issuance, and carry detachable warrants. At March 31, 2003, all outstanding 12%
Notes had matured, and interest on such notes for periods after maturity is
accruing at the annual rate of 15%.
In January 2002, the Company issued warrants to purchase common stock in
exchange for an additional ninety days to become current with all past due
interest payments related to notes issued in prior years.
During the year ended March 31, 2004, a noteholder converted $12,500 of 15%
promissory notes including interest of $5,088 for 27,059 shares of common stock
and 27,059 warrants to purchase shares of common stock at $0.65 per share (see
Note 6). These warrants were valued using the Black Scholes option pricing model
and the relative fair value was insignificant and was charged to interest
expense upon grant.
During the year ended March 31, 2004, a noteholder converted an aggregate of
$25,000 of 15% promissory notes including interest of $9,766 for 139,063 shares
of common stock and 139,063 warrants to purchase shares of common stock at $0.25
per share (see Note 6). These warrants were valued using the Black Scholes
option pricing model; the relative fair value was insignificant and charged
to interest expense upon grant.
A beneficial conversion feature approximating $37,500 was recorded during the
year ended March 31, 2004 related to the conversion of 15% promissory notes.
All of the outstanding 15% Notes were past due and in default at March 31, 2004.
There were no amounts owed under the 12% Notes at March 31, 2004.
10% NOTES
In December 2002, an existing noteholder increased its advances to the Company
by $40,000 to a total of $140,000. In consideration, the Company granted the
noteholder warrants (see Note 6), cancelled the noteholder's existing $100,000
of convertible debt and replaced it with a secured $140,000 note payable. A
beneficial conversion feature approximating $30,000 was recorded in connection
with the conversion of this note. The new note was paid by the Company in
accordance with the terms of the agreement.
6.75% NOTES
On March 18, 2002, the Company issued a promissory note to a stockholder in the
amount of $50,000, bearing interest at 6.75% per annum and maturing in May 2002.
Such note was converted in March 2003 (see Note 6).
In May 2002, the Company issued notes payable totaling $25,000, bearing interest
at 6.75% per annum, maturing in July 2002. The notes were converted into shares
of the Company's common stock in March 2003 (see Note 6).
There were no amounts owed under the 6.75% Notes at March 31, 2004.
The Company is currently seeking other financing arrangements to retire all past
due notes payable.
F-16
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
5. CONVERTIBLE NOTES PAYABLE
8% CONVERTIBLE NOTE
In November 2000, the Company issued convertible notes payable ("8% Convertible
Notes"), bearing interest at 8% per annum, with principal and accrued interest
due on November 1, 2002. The 8% Convertible Notes require no payment of
principal or interest during the term and may be converted to common stock of
the Company at any time at the option of the holder. The number of common shares
issuable upon conversion is equal to the total principal and unpaid interest as
of the date of conversion, divided by the conversion price. The conversion price
per share was changed effective August 31, 2001 to the lesser of (a) 80% of the
closing market price for the common stock; or (b) 70% of the average of the
three lowest closing market prices for the common stock for the ten trading days
prior to conversion. Such change resulted in additional BCF approximating
$57,000 during the year ended March 31, 2002.
During fiscal year 2002, the holder converted principal and accrued interest of
approximately $49,000 into 40,267 shares of common stock, leaving principal of
$350,000 and interest thereon due and outstanding. The average conversion price
was approximately $1.22 per share.
The 8% Convertible Notes required the Company to file an effective registration
statement by February 2001. The Company filed a Form SB-2 with the SEC in
December 2000; however, such registration statement was never declared effective
and subsequently abandoned. However, as the underlying securities are no longer
restricted under Rule 144 of the Securities Act of 1933, the Company no longer
plans on filing a registration statement in connection with this transaction.
The Company expensed and accrued penalties approximating $150,000 at March 31,
2004 in connection with not filing an effective registration statement. The
Company does not believe it will incur any additional charges and is in the
process of renegotiating all penalties that have been recorded to date.
In March 2004, the noteholder converted $225,000 of principal and accrued
interest in the amount of $59,827 into 813,790 shares of common stock.
9% CONVERTIBLE NOTE
In April 2003, the Company issued a convertible note in the amount of $150,000
("9% Convertible Note"), bearing interest at 9% per annum, with principal and
interest due in June 2003, which is in default. The 9% Convertible Note required
no payment of principal or interest during the term and was convertible into
common stock of the Company at the conversion price of $0.25 per share through
June 2003 at the option of the shareholder. The Company has recorded a
beneficial conversion feature ("BCF") of $150,000 in connection with the
issuance of the note and amortized such amount to interest expense upon issuance
based on the related conversion feature. As this note is no longer convertible,
such amount has been recorded under notes payable in the accompanying
consolidated balance sheet.
F-17
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
5. CONVERTIBLE NOTES PAYABLE (continued)
10% CONVERTIBLE NOTES
From time to time, the Company issued convertible notes payable ("10%
Convertible Notes") to various investors, bearing interest at 10% per annum,
with principal and interest due six months from the date of issuance. The 10%
Convertible Notes require no payment of principal or interest during the term
and may be converted to common stock of the Company at the conversion price of
$0.50 per share at any time at the option of the noteholder.
In April 2002, the Company issued a 10% Convertible Note in the amount of
$50,000. The conversion price of this note was $1.25 at the time of issuance,
but in August 2002, the Company reduced the conversion price to $0.50.
During the year ended March 31, 2003, the Company issued additional 10%
Convertible Notes totaling $225,000, of which $30,000 was converted into
restricted common stock (see Note 6).
In November 2003, a noteholder converted $5,000 of principal and accrued
interest of $509 for 11,017 shares of common stock.
In December 2003, a noteholder converted $100,000 of principal and accrued
interest of $15,416 for 461,667 shares of common stock and 461,667 warrants to
purchase common stock at $0.25 per share (see Note 6). These warrants were
valued using the Black Scholes option pricing model; the relative pro-rata fair
value was insignificant and was charged to interest expense upon grant.
In January 2004, two noteholders converted $35,000 of principal and accrued
interest of $5,333 for 161,334 shares of common stock and 161,334 warrants to
purchase common stock at $0.25 per share (see Note 6). These warrants were
valued using the Black Scholes option pricing model; the relative pro-rata fair
value was insignificant and was charged to interest expense upon grant.
In March 2004, the Company borrowed $50,000 under a non-interest bearing
convertible note payable, which was due in April 2004. In June 2004, the note
was converted into common stock of the Company at $0.44 per share, in connection
with the terms of the Company's private placement (see Note 10).
In March 2004, a noteholder converted $5,000 of principal and accrued interest
of $696 for 13,725 shares of common stock and 13,725 warrants to purchase common
stock at $0.42 per share (see Note 6). These warrants were valued using the
Black Scholes option pricing model and the relative pro-rata fair value was
insignificant and charged to interest expense upon grant.
A beneficial conversion feature approximating $137,000 and $150,000 was recorded
during each of the years ended March 31, 2004 and 2003, respectively related to
the issuance of 10% Convertible Notes.
All of the 10% Convertible Notes, except the $50,000 borrowed in March 2004,
were past due and in default at March 31, 2004.
F-18
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY
COMMON STOCK
During the year ended March 31, 2003, the Company issued 150,124 shares of
restricted common stock in connection with the conversion of amounts owed to
certain vendors and noteholders approximating $188,000 (see Note 3).
During the year ended March 31, 2003, the Company issued 200,000 shares of
restricted common stock for cash totaling $100,000 in connection with the
exercise of warrants.
During the year ended March 31, 2003, the Company issued 461,600 shares of
restricted common stock at $0.25 per share for cash totaling $115,400. In
connection with the issuance of certain shares, the Company granted the
stockholders warrants to purchase common stock of the Company at $0.25 per
share. The warrants vested immediately and expire through March 2004 (see
below).
During the year ended March 31, 2003, the Company issued 19,230 shares of
restricted common stock at $0.26 per share for cash totaling $5,000.
During the year ended March 31, 2003, the Company issued 8,000 shares of
restricted common stock at $1.25 for cash totaling $10,000.
During the year ended March 31, 2003, the Company issued 420,000 shares of
restricted common stock in connection with the conversion of $75,000 of 6.75%
Notes payable and $30,000 of 10% Convertible Notes (see Notes 4 and 5).
During the year ended March 31, 2003, the Company issued 69,231 shares of
restricted common stock for consulting services valued at $45,000 (estimated
based on the market price on the date of issue) and recorded such amount as
professional fees in the accompanying consolidated financial statements.
During the year ended March 31, 2003, the Company issued 196,078 shares of
restricted common stock in connection with a royalty agreement (see Note 7). The
shares were valued at $100,000 (estimated based on the market price on the date
of issue) and recorded as professional fees in the accompanying consolidated
financial statements.
During the year ended March 31, 2004, the Company issued 540,000 shares of
restricted common stock for cash totaling $135,000 in connection with the
exercise of warrants at $0.25 per share.
During the year ended March 31, 2004, the Company issued 1,226,000 shares of
restricted common stock at $0.25 per share for cash totaling $306,500. In
connection with the issuance of common stock, the Company granted the
stockholders warrants to purchase 1,226,000 shares of common stock. The warrants
vested upon grant and expire through January 2005.
During the year ended March 31, 2004, the Company issued 180,000 shares of
restricted common stock at $0.30 per share for cash totaling $54,000. In
connection with the issuance of common stock, the Company granted the
stockholders warrants to purchase 180,000 shares of common stock. The warrants
vested upon grant and expire through March 2005.
F-19
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY (continued)
COMMON STOCK (continued)
During the year ended March 31, 2004, the Company issued 40,000 shares of
restricted common stock at $0.525 per share for cash totaling $21,000. In
connection with the issuance of common stock, the Company granted the
stockholders warrants to purchase 40,000 shares of common stock. The warrants
vested upon grant and expire through March 2005.
During the year ended March 31, 2004, the Company issued 5,000 shares of
restricted common stock at $1.125 per share for cash totaling $5,625. In
connection with the issuance of common stock, the Company granted the
stockholders warrants to purchase 5,000 shares of common stock. The warrants
vested upon grant and expire through March 2005.
During the year ended March 31, 2004, the Company issued 10,000 shares of
restricted common stock at $0.25 for services valued at $2,500.
During the year ended March 31, 2004, the Company issued 73,529 shares of
restricted common stock at $0.34 for services valued at $25,000.
During the year ended March 31, 2004, the Company issued 62,000 shares of
restricted common stock at $0.40 for services valued at $24,825.
During the year ended March 31, 2004, the Company issued 185,185 shares of
restricted common stock at $0.45 for services valued at $83,333.
During the year ended March 31, 2004, the Company issued 5,000 shares of
restricted common stock at $0.50 for services valued at $2,500.
During the year ended March 31, 2004, noteholders converted $504,135 of
principal and interest into 1,627,655 shares of common stock (see Notes 4 and 5)
and warrants to purchase 802,848 shares of common stock ( see "Warrants" below).
WARRANTS
In January 2002, the Company issued 335,000 warrants to purchase common stock in
exchange for an additional ninety days to become current on all past due
interest payments (see Note 4). The warrants have an exercise price of $2.00 per
share, vest immediately, and expired twelve months from the date of issuance.
Such warrants were valued using the Black-Scholes option pricing model at
approximately $118,000, and were recorded as interest expense.
During the year ended March 31, 2002, the Company granted 239,000 warrants for
services and the satisfaction of certain liabilities. The warrants have exercise
prices ranging from $2.75 through $6.50, vested immediately and are exercisable
through January 2007. The warrants were valued at $118,000, of which $78,000 was
recorded as accounts payable and accrued liabilities in fiscal year 2001.
In August 2002, the Company granted warrants to purchase 52,000 shares of the
Company's restricted common stock at an exercise price of $0.25 per share in
connection with equity fund raising activities. These warrants vested upon grant
and were exercisable through March 2004. As such warrants were issued in
connection with equity fund raising activities, there was no related expense
recorded in the accompanying consolidated financial statements.
F-20
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY (continued)
WARRANTS (continued)
In December 2002, the Company issued 580,000 warrants to purchase common stock
for $0.25 per share, which are exercisable through December 2007 and vested upon
grant. The warrants were issued in connection with a short-term secured note
payable (see Note 4). In accordance with GAAP, the proceeds of the financing
have been allocated to the debt and the warrants based on their relative
estimated fair values. Accordingly, a discount of $30,000 has been recorded as a
reduction of the debt balance and the off-setting credit has been reported as
additional paid-in capital. The debt discount was amortized to interest expense
in the year ended March 31, 2003 in accordance with the short-term nature of the
note payable.
During the year ended March 31, 2003, the Company granted 240,830 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.25 per share, vest immediately and were exercisable through
March 2004. As the warrants were issued in connection with equity financing, no
related expense has been recorded in the accompanying consolidated financial
statements.
During the year ended March 31, 2003, the Company granted 75,061 warrants to
certain vendors in connection with the conversion of amounts owed by the Company
into common stock. The warrants were valued at $71,000 (estimated based on the
relative fair values as determined by the Black Scholes option pricing model
pursuant to SFAS 123), have exercise prices of $2.00, vest immediately and are
exercisable through June 2005.
In March 2003, the Company issued 420,000 warrants to purchase common stock for
$0.25 per share, which were exercisable through March 2004 and vested upon
grant. The warrants were issued in connection with the conversion of notes
payable (see Notes 4 and 5). These warrants were valued using the Black Scholes
option pricing model; the relative pro-rata estimated fair value was
insignificant; and was charged to interest expense upon grant.
During the year ended March 31, 2004, the Company granted 1,226,000 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.25 per share, vest immediately and are exercisable through
March 2005. As the warrants were issued in connection with equity financing, no
related expense has been recorded in the accompanying consolidated financial
statements.
During the year ended March 31, 2004, the Company granted 180,000 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.30 per share, vest immediately and are exercisable through
March 2005. As the warrants were issued in connection with equity financing, no
related expense has been recorded in the accompanying consolidated financial
statements.
During the year ended March 31, 2004, the Company granted 40,000 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.525 per share, vest immediately and are exercisable through
March 2005. As the warrants were issued in connection with equity financing, no
related expense has been recorded in the accompanying consolidated financial
statements.
During the year ended March 31, 2004, the Company granted 5,000 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $1.125 per share, vest immediately and are exercisable through
March 2005. As the warrants were issued in connection with equity financing, no
related expense has been recorded in the accompanying consolidated financial
statements.
As noted under "Common Stock" above, 540,000 of the warrants granted to
investors in connection with the purchase of common stock during the year ended
March 31, 2004 were exercised.
F-21
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY (continued)
WARRANTS (continued)
During the year ending March 31, 2004, the Company issued 762,064 warrants to
purchase common stock for $0.25 per share, which are exercisable through March
2005 and vested upon grant. The warrants were issued in connection with the
conversion of notes payable (see Notes 4 and 5). These warrants were valued
using the Black Scholes option pricing model; the relative pro-rata estimated
fair value was insignificant and was charged to interest expense upon grant.
In the year ending March 31, 2004, the Company issued 13,725 warrants to
purchase common stock for $0.42 per share, which are exercisable through March
2005 and vested upon grant. The warrants were issued in connection with the
conversion of notes payable (see Notes 4 and 5). These warrants were valued
using the Black Scholes option pricing model; the relative pro-rata estimated
fair value was insignificant and was charged to interest expense upon grant.
In the year ending March 31, 2004, the Company issued 27,059 warrants to
purchase common stock for $0.65 per share, which vested upon grant and expire
through March 2005. The warrants were issued in connection with the conversion
of notes payable (see Notes 4 and 5). These warrants were valued using the Black
Scholes option pricing model; the relative pro-rata fair estimated value was
insignificant and was charged to interest expense upon grant.
A summary of the aggregate warrant activity for the years ended March 31, 2004
and 2003 is presented below:
Year Ended March 31,
-----------------------------------------------------
2004 2003
------------------------- -------------------------
Weighted Weighted
Average Exercise Average Exercise
Warrants Price Warrants Price
----------- ----------- ----------- -----------
Outstanding, beginning of year 2,906,746 $ 2.29 1,873,855 $ 3.65
Granted 2,253,848 $ 0.29 1,367,891 0.35
Exercised (540,000) $ 0.25 -- --
Cancelled/Forfeited (712,830) $ 0.25 (335,000) (2.00)
----------- ----------- ----------- -----------
Outstanding, end of year 3,907,764 $ 2.22 2,906,746 $ 2.29
=========== =========== =========== ===========
Exercisable, end of year 3,907,764 $ 2.22 2,906,746 $ 2.29
=========== =========== =========== ===========
Weighted average estimated fair
value of warrants granted $ 0.40 $ 0.38
=========== ===========
The following outlines the significant assumptions used to estimate the fair
value information presented utilizing the Black-Scholes option pricing model:
Years Ended March 31,
2004 2003
----------- -----------
Risk free interest rate 2.50% 3.50%
Average expected life 3 years 2.5 years
Expected volatility 365% 210%
Expected dividends None None
F-22
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY (continued)
WARRANTS (continued)
The detail of the warrants outstanding and exercisable as of March 31, 2004 is
as follows:
Warrants Outstanding Warrants Exercisable
------------------------------------------ ----------------------------
Weighted Weighted Weighted
Average Average Average
Number Remaining Exercise Number Exercise
Range of Exercise Prices Outstanding Life Price Outstanding Price
--------------- ------------- ------------ --------------- ------------
$0.25 2,028,064 1.7 $ 0.25 2,028,064 $ 0.25
$0.30 - $1.13 265,784 0.7 $ 0.39 265,784 $ 1.79
$2.00 - $4.00 711,166 1.3 $ 2.33 711,166 $ 2.33
$5.00 - $6.50 902,750 1.0 $ 5.25 902,750 $ 5.25
--------------- ---------------
3,907,764 3,907,764
=============== ===============
OPTIONS
In August 2000, the Company adopted the 2000 Stock Option Plan ("Stock Option
Plan"), which was approved by its stockholders in September 2000. The Stock
Option Plan provides for the issuance of up to 500,000 options to purchase
shares of common stock. Such options can be incentive options or nonstatutory
options, and may be granted to employees, directors and consultants. The Stock
Option Plan has limits as to the eligibility of those stockholders who own more
than 10% of Company stock, as defined. The options granted pursuant to the Stock
Option Plan may have exercise prices of no less than 100% of fair market value
of the Company's common stock at the date of grant (incentive options), or no
less than 75% of fair market value of such stock at the date of grant
(nonstatutory).
In March 2002, the board of directors granted the Company's Chief Executive
Officer ("CEO") and Dr. Tullis non-qualified stock options to purchase up to
250,000 shares of common stock each, at an exercise price of $1.90 per share
(the estimated fair value at grant date) and expire March 2012. Awards
are earned upon achievement of certain financial and/or research and development
milestones.
In January 2002, the Company granted 400,000 stock options to a consultant for
services rendered valued at $562,000 (estimated based on the Black Scholes
option pricing model pursuant to SFAS 123) in connection with a consulting
agreement. In July 2002, the Company extended the original agreement by six
months to expire July 2003 and granted an additional 200,000 stock options
valued at $114,000 (estimated based on the Black Scholes option pricing model
pursuant to SFAS 123). All 600,000 options have been exercised as of March 31,
2003. The stock options had an exercise price of $0.50, and vested on the grant
dates.
F-23
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
6. STOCKHOLDERS' EQUITY (continued)
OPTIONS (continued)
The following is a status of the stock options outstanding at March 31, 2004 and
the changes during the two years then ended:
Year Ended March 31,
-----------------------------------------------------
2004 2003
------------------------- -------------------------
Weighted Weighted
Average Exercise Average Exercise
Options Price Options Price
----------- ----------- ----------- -----------
Outstanding, beginning of year 1,376,115 $ 2.49 1,376,115 $ 2.49
Granted -- 200,000 0.50
Exercised -- (200,000) (0.50)
Cancelled/Forfeited -- -- --
----------- ----------- ----------- -----------
Outstanding, end of year 1,376,115 $ 2.49 1,376,115 $ 2.49
=========== =========== =========== ===========
Exercisable, end of year 1,363,615 $ 2.51 1,283,530 $ 2.50
=========== =========== =========== ===========
Weighted average estimated fair
value of options granted -- $ 0.57
=========== ===========
The following outlines the significant assumptions used to estimate the fair
value information presented utilizing the Black-Scholes option pricing model for
the year ended March 31, 2003 (there were no issuances in fiscal 2004):
Risk free interest rate 3.50
Average expected life 3 years
Expected volatility 210%
Expected dividends None
The detail of the options outstanding and exercisable as of March 31, 2004 is as
follows:
Options Outstanding Options Exercisable
------------------------------------------ ----------------------------
Weighted Weighted Weighted
Average Average Average
Number Remaining Exercise Number Exercise
Range of Exercise Prices Outstanding Life Price Outstanding Price
--------------- ------------- ------------ --------------- ------------
$0.39 50,848 4.7 years $ 0.39 50,848 $ 0.39
$1.78 - $2.00 515,267 8.9 years $ 1.90 515,267 $ 1.90
$2.25 - $3.00 602,500 4.3 years $ 2.78 590,000 $ 2.78
$3.25 - $3.75 207,500 2.9 years $ 3.27 207,500 $ 3.27
--------------- ---------------
1,376,115 1,363,615
=============== ===============
F-24
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
7. RELATED PARTY TRANSACTIONS
DUE TO RELATED PARTIES
Certain officers of the Company and other related parties have advanced the
Company funds, agreed to defer compensation and/or paid expenses on behalf of
the Company to cover working capital deficiencies. These non interest-bearing
liabilities have been included as due to related parties in the accompanying
consolidated financial statements.
ROYALTY AGREEMENT
Effective January 1, 2000, the Company entered into an agreement with a related
party under which an invention and related patent rights for a method of
removing HIV and other viruses from the blood using the Hemopurifier(TM) were
assigned to the Company by the inventors in exchange for (a) a royalty to be
paid on future sales of the patented product or process equal to 8.75% of net
sales, as defined and (b) 12,500 shares of the Company's common stock. Upon the
issuance of the first United States patent relating to the invention, the
Company was obligated to issue an additional 12,500 shares of common stock to
the inventors. If the market price of the Company's common stock on the date the
patent is issued is below $8 per share, the number of shares to be issued will
be that amount which equates to $100,000 of market value. On March 4, 2003, the
related patent was issued and therefore the Company issued 196,078 shares of
common stock valued at $100,000 which is included in professional fees in the
accompanying consolidated statements of operations (see Note 6).
Other related party transactions are disclosed elsewhere in these notes to
consolidated financial statements.
8. INCOME TAX PROVISION
Income tax expense for the years ended March 31, 2004 and 2003 differed from the
amounts computed by applying the U.S. Federal income tax rate of 34 percent to
the loss from continuing operations before provision for income taxes as a
result of the following:
2004 2003
----------- -----------
Computed "expected" tax benefit $ (516,000) $ (837,000)
Reduction in income taxes resulting from:
Equity instruments issued for services -- 39,000
Interest for warrants and BCF 94,000 85,000
Change in deferred tax assets valuation allowance 583,000 897,000
State and local income taxes,
net of federal benefit (134,000) (162,000)
Other (27,000) (22,000)
----------- -----------
$ -- $ --
=========== ===========
F-25
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
8. INCOME TAX PROVISION (continued)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets at March 31, 2004 are presented below:
Deferred tax assets:
Capitalized research and development $ 1,833,000
Net operating loss carryforwards 2,977,000
-------------
Total gross deferred tax assets 4,810,000
Less valuation allowance (4,810,000)
-------------
Net deferred tax assets $ --
=============
The valuation allowance for deferred tax assets from continuing operations as of
March 31, 2004 and 2003 was $4,810,000 and $4,227,000, respectively.
As of March 31, 2004, the Company had tax net operating loss carryforwards of
approximately $8,000,000 and $3,000,000 available to offset future taxable
Federal and state income, respectively. The carryforward amounts expire in
various years through 2024.
Due to the change in ownership provisions of the Tax Reform Act of 1986, net
operating loss carryforwards for Federal income tax reporting purposes are
subject to annual limitations. Should a change in ownership occur, net operating
loss carryforwards may be limited as to use in future years.
9. COMMITMENTS AND CONTINGENCIES
REGISTRATION RIGHTS AGREEMENTS
The Company is obligated under various agreements to register its common stock,
including the common stock underlying certain warrants and options. The Company
is subject to penalties for failure to register such securities, the amount of
which could be material to the Company's financial condition, results of
operations and cash flows. The Company filed a registration statement on Form
SB-2 with the Securities and Exchange Commission in December 2000 to register
the necessary securities. However, such registration statement was never
declared effective and subsequently abandoned. Management is currently unaware
of any claims related to the lack of registration. However, as the underlying
securities are no longer restricted under Rule 144 of the Securities Act of
1933, the Company no longer plans on filing a registration statement in
connection with this transaction.
EMPLOYMENT CONTRACTS
In addition to the employment contract discussed in Note 2, the Company entered
into an employment agreement with its Chairman of the Board effective April 1,
1999. The agreement, which is cancelable by either party upon sixty days notice,
will be in effect until the employee retires or ceases to be employed by the
Company. The Chairman of the Board was appointed President and Chief Executive
Officer effective June 1, 2001 upon which the base annual salary was increased
from $120,000 to $180,000 and is eligible for an annual bonus at the discretion
of the Board of Directors, of which $0 was earned during each of the years ended
March 31, 2004 and 2003, respectively. Under the terms of the agreement, if the
employee is terminated he may become eligible to receive a salary continuation
payment in the amount of at least twelve months' base salary.
F-26
--------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
--------------------------------------------------------------------------------
10. SUBSEQUENT EVENTS
In June 2004, the Company completed a $673,000 private placement of common stock
with accredited investors, including Fusion Capital Fund II, LLC, a
Chicago-based investor. In connection with the private placement, the Company
entered into a common stock purchase agreement with Fusion Capital, whereby
Fusion Capital has committed to buy up to an additional $6,000,000 of the
Company's common stock over a 30-month period, commencing, at the Company's
election, after the SEC has declared effective a registration statement covering
such shares. The funds the Company has received in connection with this
financing, together with any additional funds the Company may receive from
Fusion Capital under the common stock purchase agreement, will be used to fund
the Company's research and development activities and anticipated operations for
the future. The Company has issued 1,529,545 shares of common stock and
1,529,545 warrants to purchase common stock at $0.76 per share, which vested
upon grant and are exercisable through May 2007, for the funds the Company has
received in connection with this financing.
Subsequent to March 31, 2004, the Company issued 242,143 shares of restricted
common stock at prices ranging from $0.44 to $1.75 for services approximating
$129,000.
Subsequent to March 31, 2004, the Company issued 500,000 shares of restricted
common stock for cash totaling $125,000 in connection with the exercise of
warrants at $0.25 per share.
F-27