SA Analysis
Applied DNA Sciences: An Unique Biotech Company Targeting The Anti-Counterfeiting Market
May 15 2014, 08:29 | by Grant Zeng
about: APDN
Summary
The only company that offers botanical DNA-based anti-counterfeiting solutions.
Revenue grew 85% and 86% for fiscal 1Q14 and 1H14 respectively, and will continue to grow in the rest of 2014 and beyond.
Valuation is very attractive.
Background
Applied DNA Sciences, Inc. (OTCQB:APDN) is a biotech company engaged in the research, development and commercialization of botanical-DNA based security and authentication solutions that can help protect the products, brands and intellectual property of companies, governments and consumers from theft, counterfeiting, fraud and diversion.
Currently, Applied DNA markets two principal anti-counterfeiting and product authentication solutions: SigNature DNA and BioMaterial Genotyping, both can be used in numerous industries, including cash-in-transit (transport and storage of banknotes), textiles and apparel, electronics, identity cards and other secure documents, pharmaceuticals, wine, and luxury consumer goods. Both platforms have spawned a series of product offerings which differ by the industry vertical to which the product is sold.
The Company's flagship product offering, SigNature DNA, uses the DNA of plants to manufacture highly customized and encrypted botanical DNA markers (SigNature DNA Markers) which are used to mark and authenticate products in a unique manner that essentially cannot be replicated. SigNature DNA Markers have been embedded into a range of products, including various inks, dyes, textile treatments, thermal ribbons, threads, varnishes and adhesives. These items can then be tested for the presence of SigNature DNA Markers through an instant field detection or a forensic level authentication. SigNature DNA Markers provide a secure, accurate and cost-effective means for users to incorporate forensic SigNature DNA Markers in a broad range of items, such as recovered banknotes, branded textiles and apparel products, pharmaceuticals and cosmetic products, identity cards and other secure documents, digital media, artwork and collectibles and fine wine. The forensic Signature DNA Markers can then be quickly and reliably authenticated to identify original products. Having the ability to reliably authenticate and identify counterfeit versions of such items enables companies and governments to detect, deter, interdict and prosecute counterfeiting enterprises and individuals.
BioMaterial GenoTyping refers to the development of genetic assays to distinguish between varieties or strains of biomaterials, such as cotton, wool, tobacco, fermented beverages, natural drugs and foods that contain their own source DNA. Applied DNA has developed two proprietary genetic tests: FiberTyping and PimaTyping, to track American Pima cotton from the field to finished garments. These genetic assays provide the cotton industry with the first authentication tools that can be applied throughout the U.S. and worldwide cotton industry from cotton growers, mills, wholesalers, distributors, manufacturers and retailers through trade groups and government agencies. Similar genetic assays can be developed for any biologically-derived product.
Applied DNA is currently focusing its efforts on the general anti-counterfeiting industry.
Counterfeiting, product diversion, piracy, forgery and identity theft, create significant and growing problems to companies in a wide range of industries as well as governments and individuals worldwide. The U.S. Chamber of Commerce reported in 2007 that counterfeiting and piracy cost the U.S. economy between $200-$250 billion per year, or an estimated 750,000 American jobs, and pose a real threat to consumer health and safety. The World Customs Organization and Interpol estimate that annual global trade in illegitimate goods was $650 billion in 2007.
The anti-counterfeiting business has broad application across many industries and government agencies.
Counterfeiting can occur in almost every industry and to every product. Applied DNA provides novel, effective, accurate, and easy to use anti-counterfeiting solutions to governments, companies and individuals to protect their tangible and intangible products.
Competitive Advantages of SigNature DNA
Counterfeiting has become a worldwide problem and as companies in almost every industry begin to address this problem, this will create huge opportunities for companies engaged in anti-counterfeiting business, such as Applied DNA.
Historically, counterfeiting, product diversion and other types of fraud have been combated by embedding various authentication systems and rare and easily distinguishable materials into products, such as radio frequency identification (RFID) devices and banknote threads in packaging, integrated circuit chips and magnetic strips in automatic teller machine cards, holograms on currency, elemental taggants in explosives, and radioactivity and rare molecules in crude oil. These techniques are effective but have generally been reverse-engineered and are easily replicated by counterfeiters, which limits their utilization as forensic methods for authentication of the sources of products and other items.
However, Applied DNA's principal product SigNature DNA uses a unique DNA technology which can not be replicated. Every living organism has a unique DNA code that determines the character and composition of its cells. The core technology of Applied DNA is to use the DNA of everyday plants to mark objects in a unique manner, and then identify these objects by detecting the absence or presence of the DNA.
The Company uses a series of patented technologies to create unique SigNature DNA Markers from plant DNA and apply them to a broad range of products.
We believe the key characteristics and benefits of the SigNature DNA offering are as follows:
The SigNature DNA markers are virtually impossible to copy: The Company uses DNA segments from one or more botanical sources, rearranges them into unique encrypted sequences, and then implement anti-counterfeit techniques. Because the portion of DNA in a SigNature DNA Marker used to identify the marker is so minute, it cannot be detected unless it is amplified. This amplification can only be achieved by applying matching strands of DNA (primer), and polymerase chain reaction (PCR) techniques. The sequence of the relevant DNA in a SigNature DNA Marker must be known in order to manufacture the primer for that DNA. As a result, the effort required to find, amplify, select and clone the relevant DNA in a SigNature DNA Marker would involve such enormous effort and expense that SigNature DNA Markers are virtually impossible to copy.
Simple and rapid authentication: The Company offers rapid readers capable of instantly testing for the presence or absence of any of the SigNature DNA Markers. In addition, when a forensic level of authentication is necessary, the Company offers in-house forensic DNA authentication, that will confirm authentication sequences in approximately 24-48 hours.
Low cost and high accuracy: The amount of DNA required for each marker is minute. The Company manufactures the identifying segment of DNA to be used in a SigNature DNA Marker by cloning them inside microorganisms such as yeast or bacteria, which are highly productive and inexpensive to grow. As a result, SigNature DNA Markers are relatively inexpensive when compared to other anti-counterfeiting devices. The probability of mistakenly identifying a SigNature DNA Marker is less than 1 in 1 trillion, so the authentication systems are highly accurate, and in fact, the SigNature PCR Kits can authenticate to a forensic level.
Easily integrated with other anti-counterfeit technologies: The Company's SigNature DNA Markers can be embedded onto RFID devices, banknote threads, labels, serial numbers, holograms, and other marking systems using inks, threads and other media. By so doing, poorly resolved platforms can be elevated to a forensic level and those that may be copied (such as holograms, UV and IR markers, RFID's and others) are now rendered uncopiable by the DNA.
Broad applicability and ingestible: The SigNature DNA Markers can be embedded into almost any consumer product, and virtually any other item. For instance, the indelible SigNature DNA Markers are safe to consume and can be used in pharmaceutical drug tablets and capsules.
The competitive advantages of SigNature DNA are summarized below:
SigNature DNA® Out Performs Others
Platform
Forensic Quality
Size of Marker
Scope
Security
Stability
Safety
SigNature DNA
v
v
v
v
v
v
Highest
large Complex
Unlimited Markers
Can not be copied
Stable and Tested
Safe, "Green" Botanical
Non DNA Taggants
x
x
x
x
x
x
Low to None
Varies
Limited Markers
Can be copied
can be unstable
Varies
Source: Applied DNA and Zacks Investment Research
Applied DNA Sciences is the only company that offers botanical DNA-based anti-counterfeiting solutions. Synthetic DNA is also used by other companies, but we believe Applied DNA's botanical DNA has many advantages over synthetic DNA.
Botanical DNA is double stranded vs synthetic DNA which is typically single stranded; Single stranded DNA is less stable
Botanical DNA is more complex making it harder to duplicate than synthetic DNA
Synthetic DNA has shorter sequences, limited size and requires sequencing for authentication. Sequencing is more prone to contamination than genotyping which is what Applied DNA uses to detect DNA.
Broad Applicability of Products and Services
The Company's SigNature DNA offering is as broadly applicable, convenient and inexpensive as existing authentication systems, while highly resistant to reverse-engineering or replication, so that it can either be applied independently or supplement existing systems in order to allow for a forensic level of authentication of the sources of a broad range of items, such as artwork and collectibles, fine wine, consumer products, digital and recording media, pharmaceuticals, financial instruments, identity cards and official documents.
The SigNature DNA solution consists of three steps: creating and encapsulating a specific encrypted DNA segment, applying it to a product or other item, and detecting the presence or absence of the specific segment. The first two steps are controlled exclusively by Applied DNA and its certified agents ensure the security of SigNature DNA Markers. Once applied, the presence of any of the SigNature DNA Markers can be detected by either Applied DNA or a customer in a simple spot test, or a sample taken from the product or other item can be analyzed forensically to obtain definitive proof of the presence or absence of a specific type of SigNature DNA Marker.
The SigNature DNA Markers may be directly embedded in products or other items, or otherwise attached by embedding them into media that is incorporated in or attached to the product or item. For example, the SigNature DNA Markers can be directly embedded in paper, metal, plastics, stone, ceramic, and other materials. The SigNature DNA Marker can be embedded in different media such as ink, adhesive, varnish, and thermal transfer ribbon to form a ready to use product.
Applied DNA has begun offering its products and services in Europe, the United States and Asia. We believe the Company's new DNA extraction protocol and methodologies are more effective than existing forensic systems. The combination of the SigNature DNA and BioMaterial Genotyping solutions covers the total authentication market, is applicable to multiple industry verticals, and can mark physical products on the front end and authenticate forensic DNA sequences on the back end.
A Clear Growth Strategy Is In Place
Applied DNA has begun to generate revenues principally from sales of SigNature DNA and BioMaterial Genotyping offerings. The Company is implementing a series of strategy to expand its product offering and penetrate new markets.
One of the strategies to expand its product offering is to customize and refine solutions to meet potential customers' needs. The Company is continuously attempting to improve its SigNature DNA solution by testing the incorporation of SigNature DNA Markers into different media, such as newly configured labels, inks or packaging elements, for use in new applications. Each prospective customer has specific needs and employs varying levels of existing security technologies with which SigNature DNA must be integrated. The ultimate goal is to develop a secure and cost-effective system for each potential customer that can be incorporated into that potential customer's products or items themselves or their packaging so that they can be tracked throughout the entire supply chain and distribution system.
The Company is also continuing to enhance detection technologies for authentication of its SigNature DNA Markers. The Company has also identified and is further examining opportunities to collaborate with companies and universities to develop a new line of detection technologies that will provide faster and more convenient ways to authenticate its SigNature DNA Markers.
At the front of market penetration and new market identification, Applied DNA is taking measures to target potential high-volume markets. The Company will continue to focus its efforts on target vertical markets that are characterized by a high level of vulnerability to counterfeiting, product diversion, piracy, fraud, identity theft, and unauthorized intrusion into physical locations and databases. Currently, the Company's target markets include art and collectibles, cash-in-transit, fine wine, consumer products, digital and recording media, pharmaceuticals, textile and apparel authentication and secure documents/homeland security. Once these markets have been significantly penetrated, Applied DNA intends to expand into additional related high volume markets.
If deemed appropriate, the Company also intends to pursue strategic acquisitions. These acquisitions should strengthen and complement the Company's core technologies, improve its competitive positioning, allow it to penetrate new markets, and grow its customer base. The Company also intends to work in collaboration with potential strategic partners in order to continue to market and sell new product lines derived from, but not limited to, DNA technology.
With respect to international expansion, in addition to its customers in the UK, the Company is working with Safe Solution to market its product and technology in Scandinavia and has already done some work with the Swedish police. The Company is also partnered with Printcolor who has offices in Switzerland and Germany to sell security inks in Europe, including the recently launched Cashield. The Company also has signed a contract with an international printing company with headquarters in Asia.
We believe Applied DNA is heading into the right direction. If executed correctly, these strategies will strengthen the Company's leadership position in the anti-counterfeiting industry and will ultimately boost the Company's top line and bottom line in the coming years.
Highest Quarterly Revenue Reported for Fiscal 2Q
Total Revenues for the fiscal 2Q14 ended March 31, 2014 were $637,146, an 85% increase year over year. Sequentially, revenues grew 7% for the fiscal second quarter of 2014.
Although second quarter revenues were less than our estimate of $800,000, these are the highest revenues reported for the second quarter of any fiscal year in the history of the company.
(click to enlarge)
During the quarter ended March 31, 2014, the Company entered into approximately $1 million of contracts and purchase orders, some of which are expected to be recognized in future quarters.
As of March 31, 2014, the Company also had $416K in deferred revenue, which will be recognized over the next 12 months.
Total operating expenses for fiscal 2Q14 increased to $3.7 million compared to $3.0 million for fiscal 2Q13, a 27% increase. This increase was primarily attributable to higher salary expense due to an increase in headcount from 38 as of March 31, 2013 to 52 as of March 31, 2014.
Net loss for the three months ended March 31, 2014 decreased to $2,750,436 ($0.00 per share) from a net loss of $3,127,631($0.00 per share) for the three months ended March 31, 2013.
For the first six months of this fiscal year, the Company generated approximately $1.2 million in revenue, an increase of 86% from the same period last fiscal year, the highest revenues reported for the first six months of any fiscal year in the Company's history.
Net loss for the six months ended March 31, 2014 decreased to $9,042,086 ($0.00 per share) from a net loss of $11,832,388 ($0.00 per share) for the six months ended March 31, 2013.
Revenue Will Continue to Grow Going Forward
We think fiscal second quarter was another strong quarter for APDN in terms of financial performance. APDN reported highest second quarter sales in the Company's history.
We think SG&A expenses will stabilize going forward since the Company has completed the move into new facility. Actually, SG&A expense declined to $3.3 million for 2Q14 from $3.8 million for the 1Q14, a decrease of 13%. APDN is positioned to deliver against high demand while continuing necessary product development without additional major expenditures.
In April, 2014, APDN and a provider of polyolefins signed a term sheet for mutual development and cooperation regarding the supply of markers - and related additives - for polyolefin products. With this agreement, APDN has the opportunity to enter a market for a vital industrial material with estimated production of 140 billion kg per year. The cooperation between the parties will explore and test the feasibility of the project. The contract provides for initial payments to APDN, comprised of development and exclusivity fees. The payment of further installments is dependent on achieving specific performance goals over a defined period of less than one year.
The Company is applying SigNature(R) DNA on a greater scale than it has in the past, expanding the universe of DNA-marked products, which in turn should increase the demand for authentications. The individual size of the Company's customers is also growing with multiple customers having revenues from $3 billion to $30 billion annually.
Therefore we expect continued revenue growth and bottom line improvement in the coming quarters.
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Balance Sheet Remained Relatively Strong
On Jul 22, 2013, APDN announced that it has entered into a Securities Purchase Agreement with an institutional accredited investor, Crede CG III, Ltd. to provide $7.5 million in financing.
Crede is an existing shareholder of the Company. At the initial closing, the Company received gross proceeds of $2,000,000 in exchange for restricted common stock priced at $0.187/share.
Pursuant to the Agreement, the investor is obligated to invest an additional $5,500,000 in the Company on the date a registration statement providing for the resale of the securities issued is declared effective by the Securities and Exchange Commission. This closing will be done at $1,000 per share of preferred stock with a conversion price the lesser of market value or $0.187/share. The investor is limited to 9.9% ownership at any given point in time. The investor is in a "passive" position and will not occupy a Board position. The preferred stock is subject to conversion into common stock at the Company's option following the effectiveness of the registration statement and automatically converts after one year.
Warrants issued as a part of this financing could contribute up to an additional $9.75 million in funds to the company if exercised for cash. The Warrants also have a cashless exercise feature. Warrants would be exercised at a strike price equal to $0.2431 per share which is a 30% premium to the original purchase price of $0.187/share.
This financing comes at an excellent time. It greatly boosted balance sheet of the Company. This financing will allow APDN to continue to scale its operations and broaden its product line to meet the demand of a growing number of contracts in electronics and other verticals, continue to hire top sales, operational, and scientific talent, leverage valuable assets acquired from RedWeb Technologies, and further expand the company's market share in Europe.
As of March31, 2014, Applied DNA had $2.0 in cash. According to our model, the Company's current cash balance along with its current customer base, projected cash flow and the minimum projected revenues for this remaining fiscal year will allow the company to have sufficient capital resources to meet projected cash flow requirements for the next twelve months.
APDN is at a crucial stage in the development of Applied DNA Sciences. The strong balance sheet will enhance its capacity to respond to growth opportunities.
APDN Shares Are Undervalued
We maintain our Outperform rating for APDN shares and reiterate our 12-month price target of $0.25 per share.
We are encouraged by the strong financial performance for the fiscal second quarter and fiscal first half of the year of the Company. Revenue increased 85% for the fiscal 2Q14 and 86% for the fiscal 1H14, respectively, which represented the highest second quarter and first half revenue ever in the Company's history.
Customer base has increased greatly from fiscal 2009 to present.
We remain optimistic about APDN's prospect. APDN's fundamentals remain strong. The Company's technology is unique and has competitive advantages over its peers. The Company is well positioned to boost its top line and bottom line in the coming years. According to our long term financial model, the Company's revenue will grow at a compound annual growth rate (OTCPK:CAGR) of 61% in the next 6 fiscal years from 2014 to 2020. The Company will become profitable in fiscal 2018 with net income of $2.0 million or EPS of $0.00 per share.
APDN is a high growth company. In terms of valuation, we think a P/E of 45x is appropriate for the Company. We apply a P/E of 45x to our estimated EPS of $0.01 in fiscal 2020, discounted at 20% for 5 years, we get our price target of $0.25 per share. This values the company at about $202 million in market cap, which is reasonable in our view. As long as the Company can execute its growth strategy, we believe value should be generated for shareholders.
But Cash burn is still our chief concern at this time.
Since APDN will become profitable in fiscal 2018, the Company still needs to raise funds for its operation until positive cash flow can be generated in 2017. We remind investors that any equity or convertible note financing will dilute the Company's current shareholder base and reduce its per share value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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