SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(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, 2005
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.)
3030 Bunker Hill Street, Suite 4000,
San Diego, CALIFORNIA 92109
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(Address of principal executive office) (Zip Code)
ISSUER'S TELEPHONE NUMBER (858) 459-7800
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.[x]
Revenues of the registrant for the fiscal year ended March 31, 2005 were $0. The
aggregate market value of the Common Stock held by non-affiliates was
approximately $3,804,643 based upon the closing price of the Common Stock of
$0.24, as reported by the NASDAQ Over-the-Counter Bulletin Board ("OTCBB") on
June 30, 2005.
The number of shares of the Common Stock of the registrant outstanding as of
June 30, 2005 was 18,806,228.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):
Yes [ ] No [X]
TABLE OF CONTENTS
PAGE
Forward Looking Statements 1
PART I.
Item 1. Description of Business 2
Item 2. Description of Property 15
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 16
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 16
Item 6. Management's Discussion and Analysis or Plan of Operation 21
Item 7. Financial Statements 41
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 41
Item 8A. Controls and Procedures 42
PART III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 43
Item 10. Executive Compensation 49
Item 11. Security Ownership of Certain Beneficial Owners and Management
And Related Stockholder Matters 51
Item 12. Certain Relationships and Related Transactions 53
Item 13. Exhibits 54
Item 14. Principal Accountant Fees and Services 56
Signatures 57
Certifications
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"). The safe harbor for forward looking statements provided by the
Private Securities Litigation Reform Act of 1995 does not apply to us. We note,
however, that 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, Food and Drug Administration
("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.
1
PART I
ITEM 1. DESCRIPTION OF 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 Dr. Julian
Ambrus, the son of Dr. Clara Ambrus who was the original founder of Hemex, Inc.
Under this agreement, 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 our intellectual property portfolio of patents that
have been issued to us and other patents that have been filed by us and are
pending approval. 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. The term of the agreement expires on the
expiration date of the patents or any patent applications filed in connection
with the invention. There have been no sales of the patented product as of July
5 2005. We initially issued 12,500 shares of restricted common stock to the
inventors upon the execution of the agreement. 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.
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.
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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 medical device company that is focused on
commercializing multiple applications of our Hemopurifier(TM) platform
technology, which has been engineered to provide the immune response of clearing
circulating viruses and toxins before the occurrence of cell and organ
infection.
The current focus is the development of the Hemopurifier(TM) as a post
infection treatment for HIV/AIDS, Hepatitis-C, and pathogens that may be target
for use in bio-terror attacks. To date, the Company has conducted and published
studies that measure the ability of the Hemopurifier(TM) to capture HIV,
Hepatitis-C, and gp120, which is a HIV surface protein that destroys immune
cells. The studies have been published in the following journals: American
Clinical Laboratories (November 2001), Journal of Theoretical Medicine (2002),
Therapeutic Apheresis (2001) and Blood Purification (2003 and 2004). The Company
has also presented pre-clinical human blood data which discussed the ability of
the Hemopurifier(TM) to capture a variety of pox viruses related to human
smallpox. All of the studies were conducted in our laboratory facilities under
the supervision of Dr. Richard Tullis, our Chief Science Officer. The cost of
materials required to perform each individual blood study did not exceed
$100,000. Each of the studies encompassed the filling of hollow-fiber dialysis
cartridges with antibodies/affinity agents that have been coupled to agarose
beads and then sealed with the cartridge. As a result, the coupled
antibodies/affinity agents surround the hollow-fibers, which typically have
pores between 200-500 nanometers in size. Infected human blood was then
circulated through the cartridge and data was obtained to verify the
effectiveness of capturing targeted pathogens once they diffused through the
fiber pores and were bound within the immobilized antibody/affinity agents. In
pre-clinical testing, we have published that our HIV-Hemopurifier(TM) removed
55% of HIV from human blood in three hours and in excess of 85% of HIV in twelve
hours. Additionally, the HIV-Hemopurifier(TM) 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(TM), which documented the ability to capture 58% of the
Hepatitis-C virus from infected blood in two hours. As referenced, we have also
demonstrated similar effectiveness in capturing pox viruses related to human
smallpox.
The Company has also conducted animal studies to demonstrate the safety
of the Hemopurifier(TM). These studies were conducted on New Zealand White
Rabbits that received Hemopurifier(TM) treatments for periods up to five hours
on nineteen different occasions as of June 1, 2005 without any material adverse
events. The Hemopurifier(TM) is not a cure for HIV and Hepatitis-C, but serves
as a disease management tool that mimics the immune response of clearing
circulating viruses and toxins before cell and organ infection can occur. We are
also conducting early stage research related to the Hemopurifier's(TM) ability
to clear other pathogens that may be naturally occurring or have been defined as
"Class A" pathogens because of their potential to be weaponized as bioterror
agents. Each target application of the Hemopurifier(TM) will require regulatory
approval before sales of the Hemopurifier(TM) may commence. Since inception, our
only source of revenue has been grants from certain agencies of the Federal
Government, subcontract revenue and sale of research and development. From the
date of our inception through 1999, we received a total of $1,424,012 in grant
income. No grant revenues have been received after 1999. Since then, from time
to time, we have applied for, but have not been awarded, any such grants. Future
income that may be derived as a result of grant submissions is likely to be a
primary source of revenues until such time that our Hemopurifier(TM) has been
approved for sale in the marketplace.
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ANIMAL STUDIES
On May 24, 2005, we disclosed the results of an animal safety study
related to fifteen Hemopurifier(TM) treatment procedures that were performed on
six different New Zealand white rabbits. Treatment times ranged from 45 minutes
to five hours with an average treatment period of 2.9 hours in the study. Blood
flow rates allowed for the entire blood system to circulate through the
Hemopurifier(TM) every twenty minutes. In general, the animals tolerated the
Hemopurifier(TM) treatment well and were able to move about freely within a
restricted space. The most common interruption during the procedure was related
to excessive animal movement that resulted in low arterial side pressures due to
partial occlusion of the catheter. Such issues are not expected in human
treatment. Blood studies of both a control dialysis cartridge and the
Hemopurifier(TM) showed a general diminution of HCT, RBC and several other
parameters except for Na+. In general, the control dialysis cartridge caused
greater decreases in blood cells, metal ions and metabolites than did the
Hemopurifier(TM). Blood changes between the control dialysis cartridge and the
Hemopurifier(TM) were a 32% vs. 20% decrease in thrombocytes and a 12% decrease
vs. an 18% increase in leukocytes respectively. In every case, the observed
blood chemistry changes were temporary and subsided prior to the next treatment.
The attending veterinarian felt that exposure of the rabbits to antigens present
in a companion animal dialysis clinic but not normally present in the rabbit
hatchery (i.e., dogs, cat and other animals undergoing treatment) was the likely
explanation for the increase in leukocyte levels. Regardless, no infections were
ever observed. On two occasions, core body temperature rose from 102.2F degrees
to 105.2F degrees during the Hemopurifier(TM) treatment. However, simply moving
the rabbits from their cages to the treatment facility also produced similar
temperature elevations up to 105F degrees. Such data suggests that the temporary
increase in temperature was not directly related to the Hemopurifier(TM)
treatment. A decrease in thrombocytes is a common consequence associated with
dialysis treatment. In conclusion, we did not observe any adverse events during
the Hemopurifier(TM) animal study. The choice to utilize rabbits in the study
was related to the similarity in the infection pathogenesis of rabbitpox with
human smallpox. As smallpox efficacy studies are not allowed in humans, related
animal studies are the primary challenge for market approval as a treatment
countermeasure.
HUMAN CLINICAL STUDIES
In February 2005, we announced plans to initiate clinical trials in
India to treat persons infected with HIV (the AIDS virus)and HCV (the
Hepatitis-C virus). Mr. Sunil Sawhney, the former Director of Boston Scientific
India, and other regulatory advisors from Qualtran, LLC will manage these trials
on our behalf.
On June 9, 2005, we disclosed that our advisors at Qualtran reached an
agreement with the Apollo Hospital in New Delhi to be a sponsor site for our
HCV clinical trials in India. We also disclosed that we have manufactured and
shipped our Hemopurifier(TM) technology to India for biocompatibility studies,
which are now under way and should be completed by the end of July 2005. The
near term goal of the HCV trial will be to demonstrate safety and observe early
efficacy markers, including viral load reduction as a result of the direct
clearance of circulating HCV by the Hemopurifier(TM). The patient treatment
protocols developed for the trial were designed through a cooperative effort
between our researchers and regulatory advisors in both India and the United
States. We have not yet announced a site location for our HIV/AIDS studies in
India. We intend to initiate human studies in the United States once we have
obtained data from our trials in India that demonstrates a clinical benefit in
patients treated with the Hemopurifier(TM).
THE HEMOPURIFIER(TM)
The Hemopurifier(TM) is an expansive platform technology that converges
the established scientific principles of affinity chromatography (method of
selective capture of proteins, sugars, fats and organic compounds) 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 benefit that is targeted in each
Hemopurifier(TM) application is the improvement of treatment outcomes through
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the reduction of viral load and preservation of the immune function. We believe
that the Hemopurifier(TM) may also enhance and prolong the benefit of current
infectious disease drug therapies, and can fill the void for patients that are
not responsive to drug therapies. The Hemopurifier(TM) may also serve as a first
line of defense in treating pathogens that are currently untreatable with drugs
or vaccines. The Hemopurifier(TM) is also being positioned to treat patients
that might become infected by a biological agent with no established drug or
vaccine treatment.
Traditionally, hemodialysis has been used to remove urea and other
small metabolic toxins that build up in the blood of patients with acute or
chronic kidney failure. Acute renal failure is generally handled in the
intensive care unit using continuous renal replacement therapy (CRRT) while
chronic renal is treated using intermittent, thrice-weekly hemodialysis (IHD) in
a stand-alone dialysis clinic.
While there are several variations of technique, a catheter is most
often the primary method utilized to gain access to the blood, which is then
pumped through a hollow-fiber hemodialysis cartridge. Within the cartridge,
toxic salts, urea and excess water pass through small pores in the walls of the
hollow-fibers and are removed. Proteins and blood cells that are too large to
pass through the membrane are retained. The purified blood is then returned back
into circulation.
There are two issues in kidney dialysis as it is practiced today that
limit its application to a wide array of toxins and pathogens. Both issues are
related to the separation membranes. First, hemodialysis cartridges
non-selectively remove substances of a particular size from the blood. Thus in
addition to removing toxins, the dialyzer may also remove important substances
that the body would prefer to retain. Second, many important toxins are too
large to pass through the dialysis membrane and are therefore not removed even
when it would be desirable.
We have solved these problems by designing a Hemopurifier(TM) cartridge
which has pores large enough to let the largest toxins pass through (i.e.,
particles as large as whole viruses), yet selective enough to remove only the
targeted toxins. We employ the established principals of hollow-fiber dialysis
cartridges, but with pores large enough to allow for circulating infectious
virus and toxins to separate from the blood and diffuse through the fibers so
that they may be captured by affinity agents or antibodies that surround the
fibers. Since the blood serves as a transport mechanism for viruses to infect
cells and organs, the Hemopurifier(TM) disrupts the viral infection cycle.
Materials such as antibodies, which bind only to their corresponding antigen,
provide selectivity, while the use of a sealed cartridge allows the process to
use large pore sizes that are normally incompatible with kidney dialysis.
The Hemopurifier(TM) platform technology is based on the immobilization
of antibodies or affinity agents against infectious disease within hemodialysis
cartridges that traditionally have been established for use in treating kidney
failure. The typical cartridge is a clear plastic cylinder, approximately twelve
inches long and one and one-half inch in diameter. Sealed within the cartridge
are up to 10,000 hollow micro-fibers through which the blood flows during
treatment. The walls of each fiber are porous so that pathogens can diffuse out
of the blood to be captured by the antibodies or affinity agents that surround
each of the fibers. The size of the fiber pores allows for the diffusion and
capture of pathogens up to 500 nanometers in size.
Importantly, the Hemopurifier(TM) cartridge does not require the
development of any new equipment. The cartridge fits directly onto the global
infrastructure of dialysis machines already located in hospitals and clinics.
INFECTIOUS DISEASE
The current treatment for viral illnesses include vaccines and
antiviral drugs. Vaccines have been the most successful in curing viral diseases
(e.g., polio and smallpox). Unfortunately, newly emerging pathogens (e.g.,
SARS), highly mutable RNA viruses (e.g., HIV and Hepatitis C virus) and exotic
5
viruses that might be used in terrorist attacks often do not have vaccine
treatments. Similarly, antiviral drugs are often useful in controlling viral
infections. However, there do not seem to be any general, broad-spectrum
antiviral agents similar to penicillin for bacteria and viruses capable of
rapidly developing drug resistant mutations. In addition, it generally takes
years and hundreds of millions of dollars to develop vaccine and drug candidates
that may or may not be approved by the FDA.
We have submitted proposals to the NIH regarding the use of the
Hemopurifier(TM) as a potential treatment for patients infected with HIV and
Hepatitis-C. We also plan to submit other proposals to the NIH related to the
use of the Hemopurifier(TM) as a countermeasure against biological weapons. We
will make these submissions upon the completion of animal studies that suggest a
potential relevance of the Hemopurifier(TM) as a treatment for pathogens
considered to be the greatest threat as biological weapons. Additionally, we
will seek beneficial relationships with other agencies and organizations upon
the publication of animal studies related to the potential use of the
Hemopurifier(TM) against biological weapon candidates. In this regard, we are
developing a standard Hemopurifier(TM) to be utilized within the established
infrastructure of dialysis machines, as well as Hemopurifiers(TM) that are
designed to be wearable treatment cartridges. The initial application of the
wearable cartridge relies on the blood pressure of the infected patient to drive
the circulation of blood into the cartridge without the need for a pumping
device such as a dialysis machine. Future generations of the Hemopurifier(TM)
may involve the convergence of miniature cartridges with portable wearable pumps
as a means to increase virus and toxin clearance through continuous blood
circulation over extended periods time.
BIOLOGICAL WEAPONS
On January 29, 2004, we announced that 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(TM) 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 Hemopurifier(TM)
filtration technology that is utilized in advancing our HIV/AIDS, and
Hepatitis-C treatments.
On March 4, 2004, we announced a cooperative development 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. Under the terms of the agreement, each party will contribute
to the preparation of proposals. One party will be designated as having the
primary responsibility for the preparation of all technical and non-technical
aspects of the proposal including but not limited to (i) marketing and
promotional effort, (ii) proposal content, assembly and production, (iii)
liaison with government customer personnel, and (iv) oral discussions and
negotiations, if held. The party designated as the subcontractor shall
contribute to the preparation of the proposal to the extent necessary to assure
the inclusion of a thorough and accurate description of its responsibilities to
the proposed project. We will each bear our own expenses for our own performance
of proposal and related work under the cooperative agreement. There are
proprietary data provisions which prohibit George Mason University and us from
using certain information other than in the submission of proposals to
government agencies or reports that must be submitted in connection with George
Mason University's performance. The duration of the agreement last until
earliest of the following events to occur:
6
a) The failure or inability of either party to provide the
support for the preparation of identified proposal
opportunities.
b) Mutual consent of the parties to terminate the agreement.
c) Lapse of 24 months from the effective date of this agreement
without award of a contract to support one or more projects
unless procurement is still open.
d) The indictment, suspension, or debarment by the federal
government of either party.
e) A receiver, trustee in bankruptcy or other custodian of the
property or assets of a party hereto is appointed, or if
either party hereto commits an act of bankruptcy or is
adjudicated bankrupt or insolvent.
f) During the term of the agreement, it is determined that either
party may be ineligible for award due to a conflict of
interest.
MANUFACTURING
We plan to manufacture in our current facilities a small number of
cartridges sufficient to complete clinical trials. Ultimately we will outsource
cartridge manufacturing to a GMP/ISO9001 compliant contract manufacturer.
Hemopurifiers(TM) to treat pathogens that are bioweapons candidates will be sold
directly to the U.S. military and the federal government. Sale of
Hemopurifiers(TM) to treat HIV and Hepatitis C will be directed through
organizations with established distribution channels.
HEAVY METAL TREATMENTS
Prior to developing the Hemopurifier(TM) as a treatment for infectious
disease, the original Hemopurifier(TM) treatment applications were focused on
treat individuals burdened with heavy metal intoxicants. Products developed in
this category include treatments for iron overload, aluminum intoxication, lead
poisoning, and cisplatin removal. Cisplatin is a platinum compound used to treat
cancers but can be toxic in large amounts. The plan to commercialize the iron
and aluminum applications of the Hemopurifier(TM) were discontinued when our
research and development activities were realigned. In fiscal year 2001, we
realigned our research and development activities from developing
Hemopurifiers(TM) to treat harmful metals to developing Hemopurifiers(TM) for
the treatment of HIV/AIDS and Hepatitis-C. Additionally, our management changed
as the Board of Directors appointed Mr. Joyce to replace Mr. Barry as the
President and CEO in June of 2001. We are not currently pursuing the
commercialization of these products as we are focused on developing infectious
disease related Hemopurifiers(TM).
RESEARCH AND DEVELOPMENT
In fiscal year 2001, we realigned our research and development
activities from developing Hemopurifiers(TM) to treat harmful metals to
developing Hemopurifiers(TM) 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(TM)
as countermeasures against biological weapons.
7
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(TM) and related technology. Any resulting
medical device or process will require approval by the FDA, and we have not yet
begun efforts to obtain FDA approval on any infectious disease related
Hemopurifier(TM). 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(TM) treatment
technology. The Hemopurifier(TM) is protected by seven issued patents in the
United States, Europe and Japan. Three additional patent applications deal with
treatments for virus infection and manufacturing methods. The following is a
list of patents and patent applications we currently hold. Patent Issuance #7
below, and application #9 are exclusively licensed to us:
ISSUED PATENTS:
1. Ambrus CA and Horvath C (1986) Removing heavy metal ions from
blood. USA No. 4,612,122 (Issued September 16, 1986).
2. Ambrus CA and Horvath C (1986) Removing heavy metal ions from
blood. Europe No. 0,073,888 (Issued April 23, 1986).
3. Ambrus CA and Horvath C (1986) Removing heavy metal ions from
blood. Japan No: 110,047/82 (Issued June 7, 1994).
4. Ambrus CA and Horvath C (1987) Blood purification. US Patent
No. 4,714,556 (Issued December 22, 1987)
5. Ambrus CA and Horvath C (1988) Blood purification. US Patent
No. 4,787,974 (Issued November 29, 1988)
6. Ambrus CA and Stadler A (2000) Process for immobilizing a
chelator on silica device containing immobilized chelator and
use thereof. US Patent 6,071,412 (Issued June 6, 2000).
7. Ambrus JL and Scammurra D (2003) Method for removing HIV and
other viruses from blood. US Patent 6,528,057 (Issued March 4,
2003);
PATENT APPLICATIONS:
8. Ambrus CA and Stadler A (2000) Process for immobilizing a
chelator on silica device containing immobilized chelator and
use thereof. International Application PCT/US99/17125
9. Ambrus JL and Scamurra D (2003) Method for removing HIV and
other viruses from blood. International Application
PCT/US99/19448 (filed August 30, 1999)
10. Tullis, R.H. (2003) Lectin affinity hemodialysis method for
removal of HIV other viruses from blood. US Patent Application
(filed January 3, 2003)
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The issued patents cover a range of applications of the
Hemopurifier(TM) and variations thereof. The initial applications (Ambrus and
Horvath, 1986 and related issues) refer to methods and constructions for
removing heavy metals from blood. The U.S. patent will expire on September 16,
2006. The Japanese patent will expire on June 7, 2011. The European patent
expired on April 23, 2003.
Ambrus and Horvath (1987 and 1988) refer to methods and constructions
for using modified hollow-fiber dialysis devices for removing antigenically
reactive substances from blood (e.g., antibodies, antigens, toxins and pathogens
such as bacteria or viruses). The first of these patents expired on March 13,
2005 and the second will expire on October 22, 2007.
Ambrus and Stadler (2000) refers to improved methods for attaching
chelators to glass beads (silica) in order to more efficiently remove heavy
metals (e.g., iron, lead and aluminum). This patent will expire on July 27,
2018. Ambrus and Scammura (2003) is a patent that speaks to the removal of
viruses and viral fragments from the blood of infected patients using a modified
hollow-fiber dialysis device. This patent will expire in March 5, 2019. The
European application is ongoing.
Tullis R.H. (2003) is a patent application that covers the use of
lectins as an improved means of removing HIV and other viruses from blood.
Lectins are naturally occurring proteins that bind sugars and complex
carbohydrates to form stable complexes. Lectins derived from plants, also known
as plant antibodies, are immobilized within the Hemopurifier(TM) because of
their known ability to selectively bind to HIV and other envelope viruses with
sugar-based surfaces. This patent is not yet issued.
Any resulting medical device or process will require approval by the
FDA, and have not yet begun efforts to obtain FDA approval on any infectious
disease related Hemopurifier(TM). Since many of our patents were issued in the
1980's, some have expired and others may expire before FDA approval, if any, is
obtained. However, we do not believe that the near term expiration of certain
patents will have an adverse material effect on our operations as we believe
that certain patents applications filed and/or other patents issued more
recently will help to protect the proprietary nature of the Hemopurifier(TM)
treatment technology. Additionally, we intend to file new patents as
improvements, modifications, or applications of our Hemopurifier(TM) technology
occur.
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 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
We are advancing our Hemopurifier(TM) technology as a treatment to
enhance and prolong current drug therapies by removing the viral strains that
cause drug resistance. The Hemopurifier(TM) 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(TM) competes with
the current drug therapy treatment standard. However, if the industry considered
the Hemopurifier(TM) to be a potential replacement for drug therapy, then the
marketplace for the Hemopurifier(TM) would be extremely competitive. We are also
pursuing the development of Hemopurifiers(TM) 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
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exist. We believe that we are the sole developer of viral filtration systems
(Hemopurifiers(TM)) to treat HIV-AIDS, Hepatitis-C, and Biological weapons.
However, we face competition from the producers of the following alternative
treatment options for the biodefense industry:
Antibiotics and Anti-Viral Drug Competition
Antibiotics are the most immediately available first line of therapy
for bacterial infections. Unfortunately, bacteria, previously controlled through
the application of antibiotics, are developing widespread resistance to
available treatments. Several bacteria have become completely resistant to many
existing antibiotics and developing new antibiotics is a long, time consuming
process. In addition, treatment with antibiotics poses problems such as being
available in sufficient quantities, uncertainty of which antibiotics are
appropriate to use, efficacy against the particular organism, adverse reactions,
and, timely initiation of therapy and completion of treatment regimens.
For viral infections, specific drugs can be effective, but there are no
drugs that are effective against the broad-spectrum of known pathogenic viruses.
At present, only a few antiviral drugs are available to treat the multitude of
viruses that may be used as biological weapons. For example, Ribavirin is the
treatment of choice for certain hemorrhagic fever viral infections, but has no
current application to Ebola and Marburg infections. Some newer antiviral drugs
have shown significant promise in animal models, and limited case reports in
humans are encouraging. The lack of broad-spectrum antivirals takes on added
significance in light of the ability of many viruses to rapidly develop
resistance.
Current efforts to define the genetic details of normal and pathogenic
agents on a molecular level promise the hope of new points of attack. Genomic
analysis of the viral pathogen and the animal model response to infection
provide valuable information enabling the development of novel treatment and
prevention strategies. However, even the rapid elucidation of the genetic
structure of a specific pathogen does not provide sufficient information to
design an effective cure. For example, while SARS has been known of for more
than a year and several strains have had their complete genetic sequence
determined, no effective treatment has yet emerged.
One promising approach in drug development has been the advent of
combinatorial chemistry, which provides the ability to rapidly synthesize huge
libraries of related compounds, many of which have never been seen before.
However, the real roadblock to progress is the need to laboriously screen each
new compound for efficacy in fighting a particular disease. In that sense,
combinatorial drugs confront the same problem as the traditional method of
screening of plant and animal extracts for active compounds that block viral or
bacterial replication.
Thus while science can radically increase the number of drug
candidates, the slow step will always be showing that they are both effective
and safe. Even effective new drugs represent an irresistible selective pressure
on natural and un-natural pathogens to develop resistance, something at which
they are clearly very efficient.
Vaccine Competition
Historically, the most effective tool in controlling infections has
been vaccines. Polio, measles, mumps and many other viral illnesses are now
controllable and smallpox has been eradicated from nature. Licensed vaccines for
hemorrhagic fever viruses are limited to yellow fever (though others are in the
trial phase of approval). Promising vaccines are being tested for some of the
other diseases, but research is hampered by the need to conduct the studies in
secure laboratories.
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There are other problems with relying on vaccines as our primary
protection against a biological weapons attack. While vaccination may be an
effective prophylaxis in a military setting, it would not work for civilian
populations for several reasons:
o For vaccination to be effective, the target populate must be
known and limited. Expense and logistical challenges would
make it virtually impossible to vaccinate the entire
population of the United States against even a single agent.
o The agent used would have to be known prior to its deployment.
With the exception of the smallpox vaccine, vaccination is of
no use post-exposure to a pathogen.
o Even if every person in the United States could be vaccinated,
it would be impossible to vaccinate him or her against every
agent for which a vaccine is available.
o Even if a vaccine is available, it would only be useful if the
agent involved has not been genetically altered so that it is
drug or vaccine resistant.
Vaccines that are both efficacious and safe are notoriously difficult
to develop. History has shown that developing vaccines can be a slow process and
may not even be possible for highly mutable pathogens like HIV and Hepatitis C.
Moreover, current vaccine strategies often carry significant risk for
complications. For example, smallpox vaccine, which uses attenuated strains of a
live virus, can occasionally cause illness or death by infection from the very
organism that usually provides protection.
In terms of a bioterrorist attack, anthrax vaccine can serve as an
example of our capability in treating a well recognized threat. Only one anthrax
vaccine, licensed in 1970, is available. This vaccine, produced by the Bioport
Corporation, consists of a membrane-sterilized culture filtrate of an avirulent,
non encapsulated strain of anthrax. The data in support of the license consisted
of a single field study. The vaccine efficacy was 92.5% effective in this small
trial. In December 1985, 15 years after the vaccine was licensed, the FDA's
advisory panel reviewed the efficacy of the anthrax vaccine but did not respond
to the effectiveness of the current vaccine to inhalational exposure anthrax
infection.
The shortcomings of the current vaccine have spurred studies of new
anthrax vaccine products. The new vaccines include protective antigen-based
vaccines, e.g., purified protein from B. ANTHRACIS culture or live-attenuated
spore vaccine. One of the immune correlates of protection of anthrax vaccines is
likely to be the antibody response to protective antigen. However, the
quantitative relation of anti-protective antigen antibody to protection has not
been established in humans. The relationship between neutralization of
protective antigen and the lethal effects of anthrax is currently being
investigated by the Department of Defense.
Because of the difficulties associated with classic vaccine
development, new methods for generating vaccines are being researched.
Recombinant DNA technology combined with combinatorial biochemistry is now being
employed in an attempt to rapidly identify and develop vaccine candidates and
passive immunotherapies. In the phage display system, cloned viral or bacterial
proteins, or even cloned antibodies, are individually displayed on the surface
of bacterial viruses. Phage proteins can be rapidly screened to find out which
ones are the most immunologically reactive. Directed evolution can then be used
to make even more effective antigenic materials. Even better, the best of these
are already in a form that can be used to produce enough of the material to test
in animals.
The principal drawback to the system is the need to use fermentation
techniques to produce sufficient quantities of purified material, uncontaminated
by the organisms used to produce them. The amount of material required to
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inoculate a sizeable population requires large fermentation systems, which are
expensive to set up and already in short supply. The restriction on medical
fermentation capacity is already so severe that many companies have had to delay
offering approved products to the public.
GOVERNMENT REGULATION
The Hemopurifier(TM) is a medical device subject to extensive and
rigorous regulation by FDA, as well as other federal and state regulatory bodies
in the United States and comparable authorities in other countries. Therefore,
we cannot assure that our Hemopurifier(TM) technology will successfully complete
any regulatory clinical trial for any of our proposed applications.
One of the main problems facing the FDA is and has been the need to
ensure public safety while at the same time preventing unsafe treatments from
reaching the public. The balance between these competing pressures has resulted
in a long and deliberate process for approving new treatments, which is not
responsive to the urgent need for new treatments presented in the era of
bioterrorism. For most drugs, the principal research and development phases
takes one to three years before a drug is even submitted to FDA for testing. The
clinical research program takes two to 10 years, depending on the agent and
clinical indication. The marketing application review period requires an average
of one year. Once a product is approved for market, long-term post-marketing
surveillance, inspections, and product testing must be performed to ensure the
quality, safety, and efficacy of the product, as well as appropriate product
labeling.
FDA'S PREMARKET CLEARANCE AND APPROVAL REQUIREMENTS. Unless an
exemption applies, each medical device we wish to commercialize in the United
States will require either prior 510(k) clearance or a PMA from FDA. Medical
devices are classified into one of three classes--Class I, Class II, or Class
III--depending on the degree or risk associated with each medical device and the
extent of control needed to ensure safety and effectiveness. Devices deemed to
pose lower risks are placed in either Class I or II, which requires the
manufacturer to submit to FDA a premarket notification requesting permission to
commercially distribute the device. This process is generally known as 510(k)
clearance. Some low risk devices are exempted from this requirement. Devices
deemed by FDA to pose the greatest risk, such as life-sustaining,
life-supporting or implantable devices, or devices deemed not substantially
equivalent to a previously cleared 510(k) device, are placed in Class III,
requiring premarket approval. If any application of the Hemopurifier(TM) is not
cleared as a 510(k), then it is likely that such applications will be classified
as Class III medical device.
510(k) CLEARANCE PATHWAY. When a 510(k) clearance is required, we must
submit a premarket notification to FDA demonstrating that our proposed device is
substantially equivalent to a previously cleared and legally marketed 510(k)
device or a device that was in commercial distribution before May 28, 1976 for
which FDA has not yet called for the submission of a PMA application. By
regulation, FDA is required to clear or deny a 510(k) premarket notification
within 90 days of submission of the application. As a practical matter,
clearance often takes significantly longer. FDA may require further information,
including clinical data, to make a determination regarding substantial
equivalence. If FDA determines that the device, or its intended use, is not
substantially equivalent to a previously-cleared device or use, FDA will place
the device, or the particular use, into Class III.
PREMARKET APPROVAL PATHWAY. A PMA application must be submitted to FDA
if the device cannot be cleared through the 510(k) process. The PMA application
process is much more demanding than the 510(k) premarket notification process. A
PMA application must be supported by extensive data, including but not limited
to technical, preclinical, clinical trials, manufacturing and labeling to
demonstrate to FDA's satisfaction the safety and effectiveness of the device.
12
After a PMA application is submitted and FDA determines that the
application is sufficiently complete to permit a substantive review, FDA will
accept the application for review. FDA has 180 days to review an "accepted" PMA
application, although the review of an application generally occurs over a
significantly longer period of time and can take up to several years. During
this review period, FDA may request additional information or clarification of
the information already provided. Also, an advisory panel of experts from
outside FDA may be convened to review and evaluate the application and provide
recommendations to FDA as to the approvability of the device. In addition, FDA
will conduct a preapproval inspection of the manufacturing facility to ensure
compliance with quality system regulations. New PMA applications or PMA
application supplements are required for significant modification to the
manufacturing process, labeling and design of a device that is approved through
the premarket approval process. Premarket approval supplements often require
submission of the same type of information as a premarket approval application,
except that the supplement is limited to information needed to support any
changes from the device covered by the original premarket approval application
and may not require as extensive clinical data or the convening of an advisory
panel.
CLINICAL TRIALS. Clinical trials are almost always required to support
an FDA premarket application and are sometimes required for 510(k) clearance. In
the United States, these trials generally require submission of an application
for an Investigational Device Exemption, or IDE, to FDA. The IDE application
must be supported by appropriate data, such as animal and laboratory testing
results, showing that it is safe to test the device in humans and that the
testing protocol is scientifically sound. The IDE must be approved in advance by
FDA for a specific number of patients unless the product is deemed a
non-significant risk device eligible for more abbreviated IDE requirements.
Clinical trials for significant risk devices may not begin until the IDE
application is approved by FDA and the appropriate institutional review boards,
or IRBs, at the clinical trial sites. Our clinical trials must be conducted
under the oversight of an IRB at the relevant clinical trial sites and in
accordance with FDA regulations, including but not limited to those relating to
good clinical practices. We are also required to obtain patients' informed
consent that complies with both FDA requirements and state and federal privacy
regulations. We, FDA or the IRB at each site at which a clinical trial is being
performed may suspend a clinical trial at any time for various reasons,
including a belief that the risks to study subjects outweigh the benefits. Even
if a trial is completed, the results of clinical testing may not demonstrate the
safety and efficacy of the device, may not be equivocal or may otherwise not be
sufficient to obtain approval of the product. Similarly, in Europe the clinical
study must be approved by the local ethics committee and in some cases,
including studies with high-risk devices, by the Ministry of Health in the
applicable country.
PERVASIVE AND CONTINUING REGULATION. After a device is placed on the
market, numerous regulatory requirements continue to apply. These include:
o FDA's Quality System Regulation, or QSR, which requires
manufacturers, including third-party manufacturers, to follow
stringent design, testing, control, documentation and other
quality assurance procedures during all aspects of the
manufacturing process;
o labeling regulations and FDA prohibitions against the promotion of
products for uncleared, unapproved or off-label uses;
o clearance or approval of product modifications that could
significantly affect safety or efficacy or that would constitute a
major change in intended use;
o medical device reporting, or MDR, regulations, which require that
manufacturers report to FDA if their device may have caused or
contributed to a death or serious injury or malfunctioned in a way
that would likely cause or contribute to a death or serious injury
if the malfunction were to recur; and
o post-market surveillance regulations, which apply when necessary
to protect the public health or to provide additional safety and
effectiveness data for the device.
13
After a device receives 510(k) clearance or a PMA, any modification
that could significantly affect its safety or effectiveness, or that would
constitute a major change in its intended use, will require a new clearance or
approval. FDA requires each manufacturer to make this determination initially,
but FDA can review any such decision and can disagree with a manufacturer's
determination.
The MDR regulations also require that we report to FDA any incident in
which our product may have caused or contributed to a death or serious injury or
in which our product malfunctioned and, if the malfunction were to recur, would
likely cause or contribute to death or serious injury.
FRAUD AND ABUSE. We may also directly or indirectly be subject to
various federal and state laws pertaining to healthcare fraud and abuse,
including anti-kickback laws. In particular, the federal healthcare program
Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting,
offering, receiving or providing remuneration, directly or indirectly, in
exchange for or to induce either the referral of an individual, or the
furnishing, arranging for or recommending a good or service, for which payment
may be made in whole or part under federal healthcare programs, such as the
Medicare and Medicaid programs. Penalties for violations include criminal
penalties and civil sanctions such as fines, imprisonment and possible exclusion
from Medicare, Medicaid and other federal healthcare programs. The Anti-Kickback
Statute is broad and prohibits many arrangements and practices that are lawful
in businesses outside of the healthcare industry. In implementing the statute,
the Office of Inspector General, or OIG, has issued a series of regulations,
known as the "safe harbors." These safe harbors set forth provisions that, if
all their applicable requirements are met, will assure healthcare providers and
other parties that they will not be prosecuted under the Anti-Kickback Statute.
The failure of a transaction or arrangement to fit precisely within one or more
safe harbors does not necessarily mean that it is illegal or that prosecution
will be pursued. However, conduct and business arrangements that do not fully
satisfy each applicable element of a safe harbor may result in increased
scrutiny by government enforcement authorities, such as the OIG.
INTERNATIONAL. International sales of medical devices are subject to
foreign governmental regulations, which vary substantially from country to
country. The time required to obtain clearance or approval by a foreign country
may be longer or shorter than that required for FDA clearance or approval, and
the requirements may be different.
The primary regulatory environment in Europe is that of the European
Union, which has adopted numerous directives and has promulgated voluntary
standards regulating the design, manufacture, clinical trials, labeling and
adverse event reporting for medical devices. Devices that comply with the
requirements of a relevant directive will be entitled to bear CE conformity
marking, indicating that the device conforms with the essential requirements of
the applicable directives and, accordingly, can be commercially distributed
throughout the member states of the European Union, and other countries that
comply with or mirror these directives. The method of assessing conformity
varies depending on the type and class of the product, but normally involves a
combination of self-assessment by the manufacturer and a third-party assessment
by a notified body, an independent and neutral institution appointed by a
country to conduct the conformity assessment. This third-party assessment may
consist of an audit of the manufacturer's quality system and specific testing of
the manufacturer's device. Such an assessment is required in order for a
manufacturer to commercially distribute the product throughout these countries.
ISO 9001 and ISO 13845 certifications are voluntary harmonized standards.
Compliance establishes the presumption of conformity with the essential
requirements for a CE Marking.
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
14
from one country to another. Approval by the FDA does not ensure approval by the
regulatory bodies of other countries nor does an approval in another country
ensure approval by the FDA..
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 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, 2005, we had seven full-time employees, comprised of our
Chief Executive Officer, our Chief Science Officer, our Director of
Administrative Services, two research associates, a senior bioengineer and
laboratory manager. 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
3030 Bunker Hill Street, Suite 4000, San Diego, CA 92109. Our phone number at
that address is (858) 459-7800. Our website is www.aethlonmedical.com.
ITEM 2. DESCRIPTION OF PROPERTY
We currently rent approximately 3,200 square feet of executive office
space and laboratory space at 3030 Bunker Hill Street, Suite 4000, San Diego,
California 92109 at the rate of $7,520 per month on a lease that expires on July
12, 2006.
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. We are 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.
15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 10, 2005, Aethlon Medical, Inc. (the "Company") held a special
meeting of stockholders at the Company's executive offices for the following
purposes: (1) to ratify the appointment of Squar, Milner, Reehl & Williamson,
L.L.P ("Squar Milner"), as the Company's independent auditors for the fiscal
year ending March 31, 2005 and (2) to approve an amendment to the Company's
Articles of Incorporation to increase the number of authorized shares of the
Company's common stock from 25,000,000 to 50,000,000. Stockholders holding an
aggregate of 10,624,365 shares of common stock of the Company voted in favor to
ratify the appointment of Squar Milner as the Company's independent auditors and
stockholders holding an aggregate of 10,238,794 shares of common stock of the
Company voted in favor of approving the amendment to the Company's Articles of
Incorporation to increase the number of authorized shares of common stock from
25,000,000 to 50,000,000. The number of shares voting in favor of the two
proposals was sufficient for the approval of both proposals. The number of
shares voting against and/or abstaining from the vote were as follows: Proposal
1: 80,776 shares; Proposal 2: 469,347 shares.
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 Over-The-Counter Bulletin Board. Our
trading symbol is "AEMD."
Our Common Stock has had a limited and sporadic trading history.
The following table sets forth for the calendar period indicated the quarterly
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
---- ---
2005
1st Quarter $ 0.50 $ 0.25
2nd Quarter $ 0.33 $ 0.22
2004
4th Quarter $ 1.00 $ 0.46
3rd Quarter $ 0.95 $ 0.44
2nd Quarter $ 1.70 $ 0.54
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
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.
16
There are approximately 1,403 record holders of our Common Stock at
June 24, 2005. 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.
RECENT SALES OF UNREGISTERED SECURITIES
We have sold or issued the following securities not registered under
the Securities Act in reliance upon the exemption from registration pursuant to
Section 4(2) of the Securities Act or Regulation D of the Securities Act during
the three year period ending on the date of filing of this registration
statement. Except as stated below, no underwriting discounts or commissions were
payable with respect to any of the following transactions.
CONVERTIBLE DEBT
In March 2004, we issued a 10% convertible note to RP Capital, LLC an
accredited investor, 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 2004, the Company issued 500,000 shares of restricted common
stock to an accredited individual investor in connection with the exercise of
warrants at $0.25 per share for cash totaling $125,000. This transaction was
exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
In April 2004, the Company issued 17,143 shares at $1.75 per share to
an accredited individual investor for investor relations services in the amount
of $30,000. This transaction was exempt from registration pursuant to Section
4(2) of the Securities Act of 1933.
In April 2004, the Company issued 50,000 shares of restricted common
stock to Fusion Capital Fund II, LLC, a accredited institutional investor, for a
financing commitment to provide $6,000,000 under a registered private placement.
In connection with the $6,000,000 financing the Company paid a fee to Fusion
Capital in the amount of 418,604 shares of common stock. This transaction was
exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
In May 2004, the Company issued 225,000 shares of common stock at $0.44
per share and 225,000 warrants to purchase our common stock at a price of $0.76
per share to legal counsel for legal services in the amount of approximately
$99,000. This transaction was exempt from registration pursuant to Section
4(2)of the Securities Act of 1933.
In May 2004, a $50,000 10% convertible note was converted at $0.44 per
share for 113,636 shares of common stock and 113,636 warrants to purchase our
common stock at a price of $0.76 per share. This transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
In May 2004, we issued fourteen accredited investors a total of
1,529,545 shares of restricted stock at a price of $0.44 per share for cash
totaling $673,000. In connection with the issuance of these shares, we granted
the stockholders 1,529,545 warrants to purchase our common stock at a price of
$0.76 per share. The warrants vested immediately and expire on fifth anniversary
from the date of a registration statement covering the common stock underlying
such warrants is declared effective. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
17
In July 2004, we issued 10,715 shares of restricted common stock at
$0.70 per share to an accredited individual for employee placement services in
the amount of $7,500. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
In July 2004, we issued 6,850 shares of restricted common stock at
$0.73 per share to an accredited individual for consulting services on
opportunities for our Hemopurifier(TM) within the biodefense marketplace in the
amount of $5,000. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
In August 2004, we issued a one-year warrant to purchase 7,000 shares
of common stock at $0.55 per share to an accredited corporate entity in
conjunction with a $6,000 fee for investor and public relations services. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933,
In September 2004, we issued 479,513 shares of restricted common stock
to LH Financial (Esquire Trade and Finance), an accredited investor, in
conjunction with the conversion of $125,000 in principal amount of notes, plus
accrued interest, at $0.34 per share, in accordance with their convertible note
agreement. This transaction was exempt from registration pursuant to Regulation
D promulgated under the Securities Act of 1933.
In October 2004, we issued two $40,000 10% one year promissory notes
each with 80,000 three-year warrants to purchase common stock at $0.50 and
44,444 three-year warrants to purchase common stock at $0.90 for cash in the
total amount of $80,000 to two accredited individual investors. In accordance
with GAAP, the proceeds of the financing have been allocated to the debt and the
warrants, based on their relative fair values. Accordingly, a discount of
$46,000 has been recorded as a reduction in the debt balance, and the
off-setting credit has been recorded as additional paid-in capital. The debt
discount is amortized and charged to interest expense over the life of the debt.
At March 31, 2004, approximately $23,000 of such discount was unamortized and is
included in notes payable in the accompanying consolidated balance sheet. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In October 2004, we issued a $50,000 10% one-year promissory note plus
100,000 three-year warrants to purchase common stock at $0.50 and 55,555
three-year warrants to purchase common stock at $0.90 for cash in the amount of
$50,000 to an accredited individual investor. In accordance with GAAP, the
proceeds of the financing have been allocated to the debt and the warrants,
based on their relative fair values. Accordingly, a discount of $38,000 has been
recorded as a reduction in the debt balance, and the off-setting credit has been
recorded as additional paid-in capital. The debt discount is amortized and
charged to interest expense over the life of the debt. At March 31, 2005,
approximately $22,000 of such discount was unamortized and is included in notes
payable in the accompanying consolidated balance sheet. This transaction was
exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.
In November 2004, we issued 60,000 shares of restricted common stock to
an accredited individual investor in connection with the exercise of 60,000
warrants at $0.25 per share for consideration of a $15,000 reduction in the
principal amount of a 10% one-year promissory note. This transaction was exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933.
In December 2004, the Company issued 461,667 shares of restricted
common stock to two accredited individual investors in connection with the
exercise of 461,667 warrants at $0.25 per share held by an institutional
investor. This transaction was exempt from registration pursuant to Section 4(2)
of the Securities Act of 1933.
18
In December 2004, the Company repaid two $25,000 12% promissory notes,
including accrued interest, through the issuance of 87,303 restricted common
shares at $0.49 per share to each of two separate accredited individual
investors. These transactions were exempt from registration pursuant to Section
4(2) of the Securities Act of 1933.
In December 2004, the Company issued 20,000 shares of restricted common
stock to an accredited individual investor in connection with the exercise of a
warrant to purchase 20,000 shares of common stock at $0.25 per share for
consideration of a $5,000 reduction in the principal amount of a 10% one-year
note, resulting in a remaining note balance of $30,000 at December 31, 2004.
This transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In December 2004, the Company issued 60,000 shares of restricted common
stock at $0.50 per share under a consulting agreement with an accredited
individualinvestor, for investor relations consulting services to the Company.
This transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In January 2005, the Company issued 55,556 shares of restricted common
stock at $0.36 per share and a warrant to purchase 55,556 shares of common stock
at $0.44 per share for cash in the amount of $20,000 to an accredited individual
investor. This transaction was exempt from registration pursuant to Section
4(2)of the Securities Act of 1933.
In January 2005, the Company issued 66,666 shares of restricted common
stock at $0.45 per share to an accredited individual investor under a consulting
agreement for investor relations consulting services to the Company. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In January 2005, the Company issued 25,834 shares of restricted common
stock to an accredited individual investor in connection with the exercise of a
warrant to purchase 25,834 shares of common stock at $0.25 per share. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In February 2005, the Company issued 139,063 shares of restricted
common stock to an accredited individual investor in connection with the
exercise of a warrant to purchase 139,063 shares of common stock at $0.25 per
share. This transaction was exempt from registration pursuant to Section 4(2) of
the Securities Act of 1933.
In February 2005, the Company issued 90,000 shares of restricted common
stock at $0.27 per share and a three-year warrant to purchase 90,000 shares of
common stock at $0.34 per share for cash in the amount of $24,300 to an
accredited individual investor. This transaction was exempt from registration
pursuant to Section 4(2)of the Securities Act of 1933.
19
EQUITY COMPENSATION PLANS
SUMMARY EQUITY COMPENSATION PLAN DATA
The following table sets forth March 31, 2005 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) 9,927,229 0.79 N/A
----------- ------ --------
Totals 9,974,729 0.82 452,500
(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 143,828 shares of common stock that remain to
be issued under the 2003 Consultant Stock Plan at March 31, 2005.
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, 2005, we had
granted 47,500 options under the 2000 Stock Option 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.
20
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.
At March 31, 2005, 143,828 shares of common stock remain to be issued
under the 2003 Consultant Stock Plan. To date we have issued 1,966,415 options
(of which 637,800 have been exercised or cancelled) outside both the 2005
Directors Compensation Plan and 2000 Stock Option Plan.
2005 DIRECTORS COMPENSATION PROGRAM
Upon the recommendation of our Compensation Committee, in February
2005, we adopted our 2005 Directors Compensation Program (the "Directors
Compensation Program") which advances our interest by help us to obtain and
retain the services of outside directors 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.
Under the Directors Compensation Program, a newly elected director will
receive a one time grant of a non-qualified stock option of 1.5% of the common
stock outstanding at the time of election. The options will vest one-third at
the time of election to the board and the remaining two-thirds will vest equally
at year end over three years. Additionally, each director will also receive an
annual $25,000 non-qualified stock option retainer, $15,000 of which is to be
paid at the first of the year to all directors who are on the Board prior to the
first meeting of the year and a $10,000 retainer will be paid if a director
attends 75% of the meetings either in person, via conference call or other
electronic means. The exercise price for the options under the Directors
Compensation Program will equal the average closing of the last ten (10) trading
days prior to the date earned. At March 31, 2005 under the 2005 Directors
Compensation Program we had issued 1,337,825 options to outside directors and
3,965,450 options to employee-directors for a total of 5,303,275 options.
STAND-ALONE GRANTS
From time to time our Board of Directors grants common share purchase
options or warrants to selected directors, officers, employees, consultants and
advisors in payment of goods or services provided by such persons on a
stand-alone basis outside of any of our formal stock plans. The terms of these
grants are individually negotiated.
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.
We recorded consolidated net losses of ($2,096,951) or ($0.15) per
common share and ($1,518,798) or ($0.19) per common share for the fiscal years
ended March 31, 2005 and 2004, respectively.
Our consolidated operating expenses for fiscal 2005 were $2,183,377
versus $995,549 for fiscal year 2004. This increase in operating expenses
amounting to $1,187,828 or 119.00% is largely attributable to a increase in our
professional fees by $409,050 or 120.4%, to $748,837, principally due to higher
legal, accounting, technical and other professional services; an increase in
21
payroll and related expenses by $582,838, or 139.6%, to $1,000,324, principally
due to an increase in the salary of our CEO, CSO and the addition of full-time
administrative and laboratory personnel since mid-year; and an increase in
general and administrative expenses in the amount of $224,940, or 94.4% to
$434,216, due to increased insurance, warrant expense and rent costs. Our
capital equipment expenditures were approximately $30,000 in fiscal year 2005
and $5,000 in 2004.
PLAN OF OPERATION
Our current plan of operation is to fund our anticipated increased
research and development activities and operations for the near future through
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, that commenced, at our election, after the SEC
declared effective a registration statement under Form SB-2 on December 7, 2004
covering such shares. In the fiscal year ended March 31, 2005, we received
$440,000 under this arrangement. 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 and equipment 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.
We are a development stage medical 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 year 2004 was to
prepare our HIV-Hemopurifier(TM) to treat HIV/AIDS, and our HCV-Hemopurifier(TM)
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 "DESCRIPTION OF BUSINESS" above.
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
conduct human clinical trials for HIV and HCV patients by early fall of 2005. We
also plan to implement a regulatory strategy for the use of our Hemopurifier(TM)
for biodefense treatments in fiscal year 2006 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 additional employees in the next twelve months, as
required to support our increased research and development effort that will
include expanding our goal beyond treating infectious diseases HIV/AIDS 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 treatment device 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 University to jointly pursue business and funding opportunities
within the federal government.
22
Accordingly, due to this increase in activity during the next twelve
months, we anticipate continuing to increase our spending on research and
development during this period. Additionally, associated with our anticipated
increase in research and development expenditures, we anticipate purchasing
additional amounts of equipment 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, as well as 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, as well as 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.
Convertible Notes and Notes
At March 31, 2005 there are no convertible notes outstanding. At March
31, 2004, there were two convertible notes outstanding. One in the amount of
$125,000, plus accrued interest, was converted to stock in September 2004. The
second convertible note outstanding at March 31, 2004 in the amount of $50,000
was converted to stock in 2004.
At March 31, 2005, there are $537,500 in principal amount of notes
outstanding with 16 noteholders. Our 12% one year notes in the principal amount
of $272,500, due between August 2000 and September 2001 have no acceleration
provisions. We increased the interest to 15% in FY 2002. One 12% note in the
amount of $12,500 and a 10% note in the amount of $10,000 were repaid in June
and July 2004, respectively. Our remaining 10% note, in the principal amount of
$5,000, was due May 2002. The 10% notes have no acceleration provisions. One
two-month note in the amount of $150,000, due June 25, 2003, currently bears
interest at 18%. The note's conversion rights have expired and it has no
acceleration provisions. In October 2004, three 10% notes in the total amount of
$130,000 were issued with warrants attached. In November and December 2004,
principal amounts of $15,000 and $5,000, respectively, of a 10% note issued in
October 2004 were used to pay for the exercise of warrants, resulting in a
reduction in the principal amount of the note. In December 2004, the Company
repaid two $25,000 12% promissory notes, including accrued interest, through the
issuance of restricted common shares.
Securities Issued for Services
We have issued securities in payment of services to reduce our
obligations and to avoid using our cash resources. In the year ended March 31,
2005 we issued 1,412,625 common shares for services. 854,978 of the shares
issued were unregistered. We issued 468,604 restricted common shares for
commitment and financing fees associated with the $6 million commitment from
Fusion Capital; 225,000 restricted common shares for payment of legal services
associated with the related private placement and Form SB-2 registration
statement, 10,715 restricted common shares for employment placement fees;
143,809 restricted common shares were issued for investor relations and 6,850
restricted common shares were issued for technical consulting. In addition,
557,647 shares, registered under a Form S-8 registration statement, were issued
as follows: for corporate and SEC legal advice, 356,547 shares; for regulatory
and technical consulting, 132,236 shares; for employment placement fee, 46,364
shares and for achievement of employee goals and objectives, 22,500 shares. The
23
value of services purchased with registered and restricted shares was
approximately $337,000. The average price discount of common stock issued for
these services, weighted by the number of shares issued for services in this
period, was approximately 36%.
In fiscal year 2004, we issued 335,714 restricted common shares
consisting of 200,185 restricted common shares in payment of investor relations,
consulting and services for investor research report on the Company and investor
relations programs and investor meetings; 73,529 restricted common shares in
payment of corporate legal services related to SEC filings, issuance of
securities and general corporate matters; and 62,000 restricted common shares
for consulting for biodefense marketing, and technical analytical services, all
totaling approximately $138,000. The average price discount of common stock
issued for services in this period, weighted by the number of shares issued for
services in this period, was approximately 46%.
Securities Issued for Debt
We have also issued securities for debt to reduce our obligations to
avoid using our cash resources. In the fiscal year ended March 31, 2005 we
issued 847,755 common shares for repayment in full of notes, including accrued
interest. The price discount of common stock issued for debt in this period,
weighted by number of shares issued for conversion of debt in this period, was
approximately 41%, partially due to a substantial discount in the conversion of
the $125,000 convertible note in accordance with its original terms in 2001. In
fiscal year 2004, we issued 813,365 shares of stock for debt. The average price
discount of common stock issued for debt in this period, weighted by number of
shares issued for conversion of debt in this period, was approximately 47%. The
percentage excludes shares issued in one transaction determined by formula from
a preexisting agreement.
Prospects for Debt Conversion
We seek, where possible, to convert our debt and accounts payable to
stock and/or warrants in order to reduce our cash liabilities. Our success at
accomplishing this depends on several factors including market conditions,
investor acceptance and other factors, including our business prospects.
GOING CONCERN
Our independent registered public accounting firm has stated in their
audit report on our March 31, 2005 consolidated financial statements, that we
have a working capital deficiency and a significant deficiency 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 various equity instruments and convertible
notes payable. 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 consolidated financial
statements:
24
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
we have elected to continue accounting for stock-based compensation issued to
employees using APB 25; however, pro forma disclosures, as we adopted the cost
recognition requirement under SFAS 123, are required to be presented.
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.
In December 2004, the FASB issued SFAS No. 123-R, "Share-Based
Payment," which requires that the compensation cost relating to share-based
payment transactions (including the cost of all employee stock options) be
recognized in the financial statements. That cost will be measured based on the
estimated fair value of the equity or liability instruments issued. SFAS No.
123-R covers a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS No.123-R replaces
SFAS No. 123 and supersedes APB 25. As originally issued, SFAS No. 123
established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that pronouncement
permitted entities to continue applying the intrinsic-value model of APB 25,
provided that the financial statements disclosed the pro forma net income or
loss based on the preferable fair-value method.
Small Business Issuers are required to apply SFAS No. 123-R in the
first interim or annual reporting period of the registrant's first fiscal year
that begins after December 15, 2005. Thus, the Company's consolidated financial
statements will reflect an expense for (a) all share-based compensation
arrangements granted on or after January 1, 2006 and for any such arrangements
that are modified, cancelled, or repurchased on or after that date, and (b) the
portion of previous share-based awards for which the requisite service has not
been rendered as of that date, based on the grant-date estimated fair value.
Management has not yet determined the future effect of FAS 123-R on its
consolidated financial statements.
25
STOCK PURCHASE WARRANTS ISSUED WITH NOTES PAYABLE
We 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. Such discounts are amortized to interest expense over the
term of the notes.
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 disposal generally are required to be applied
prospectively after the adoption date to newly initiated commitments to sell or
otherwise 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 noted no indicators requiring review for
impairment during the year ended March 31, 2005.
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 tax
assets when, based on management's best estimate of taxable income (if any) in
the foreseeable future, it is more likely than not that some portion of the
deferred tax assets may not be realized.
26
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.
RISK FACTORS
An investment in our common shares involves a high degree of risk and
is subject to many uncertainties. These risks and uncertainties may adversely
affect our business, operating results and financial condition. In such an
event, the trading price for our common shares could decline substantially, and
you could lose all or part of your investment. In order to attain an
appreciation for these risks and uncertainties, you should read this annual
report in its entirety and consider all of the information and advisements
contained in this annual report, including the following risk factors and
uncertainties.
RISKS RELATING TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY WITH SIGNIFICANT LOSSES AND
EXPECTLOSSES TO CONTINUE FOR THE FORESEEABLE FUTURE.
We have yet to establish any history of profitable operations. We have
not had any revenues for the past three years. We have incurred annual operating
losses of $2,183,377, $995,549 and $1,971,385, respectively, during the past
three fiscal years of operation. As a result, at March 31, 2005, we had an
accumulated operating deficit of $14,600,917. We have incurred net losses from
continuing operations of $2,096,951, $1,518,798 and $2,361,116 for the fiscal
years ending March 31, 2005, 2004 and 2003, respectively, during the past three
years. As a result, at March 31, 2005, we had an accumulated deficit of
$19,142,264. Our revenues have not been sufficient to sustain our operations. We
expect that our revenues will not be sufficient to sustain our operations for
the foreseeable future. Our profitability will require the successful
commercialization of our Hemopurifier(TM) technology. No assurances can be given
when or if this will occur or that we will ever be profitable.
WE HAVE RECEIVED AN OPINION FROM OUR AUDITORS REGARDING OUR ABILITY TO
CONTINUE AS A GOING CONCERN
Our independent auditors noted in their report accompanying our
financial statements for our fiscal year ended March 31, 2005 that we had net
losses since our inception, had a working capital deficit and that a significant
amount of additional capital, approximately $5,000,000 as estimated by
management, will be necessary to advance the development of our products to the
point at which we may become commercially viable and stated that those
conditions raised substantial doubt about our ability to continue as a going
concern. Note 1 to our financial statements addressed management's plans to
address these matters. We cannot assure you that our business plans will be
successful in addressing these issues. This opinion about our ability to
continue as a going concern could affect our ability to obtain additional
financing at favorable terms, if at all, as such an opinion may cause investors
to lose faith in our long term prospects. If we cannot successfully continue as
a going concern, our shareholders may lose their entire investment in our common
shares.
WE WILL REQUIRE ADDITIONAL FINANCING TO SUSTAIN OUR OPERATIONS AND
WITHOUT IT WE WILL NOT BE ABLE TO CONTINUE OPERATIONS.
At March 31, 2005 and March 31, 2004, we had a working capital deficit
of approximately $3,348,510 and $3,930,000, respectively. The independent
auditors' report for the year ended March 31, 2005, includes an explanatory
paragraph stating that our recurring losses from operations and working capital
deficiency raise substantial doubt about our ability to continue as a going
concern. We have a net operating cash flow deficit of $1,559,366 for the year
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ended March 31, 2005, a net operating cash flow deficit of $542,056 for the year
ended March 31, 2004 and for the year ended March 31, 2003, a net operating cash
flow deficit of $514,503. We do not currently have sufficient financial
resources to fund our operations or those of our subsidiaries. Therefore, we
need additional funds to continue these operations.
In our agreement with Fusion Capital, we have the right to receive
$10,000 per trading day unless our stock price equals or exceeds $1.00, in which
case the daily amount may be increased under certain conditions as the price of
our common stock increases. Fusion Capital does not have the right nor the
obligation to purchase any shares of our common stock on any trading days that
the market price of our common stock is less than $0.25. We initially
registered, pursuant to the Form SB-2, 7,431,819 shares for sale by Fusion
Capital (excluding the warrant to purchase 568,181 shares of common stock, the
568,181 shares of common stock already purchased by Fusion Capital and the
shares of common stock issuable to Fusion Capital as commitment shares). As a
result, the market price of our common stock to Fusion Capital will have to
average at least $.81 per share for us to receive, in addition to the $250,000
we have already received from Fusion Capital, the maximum proceeds of $6,250,000
without registering additional shares of common stock. Assuming a purchase price
of $0.25 per share (the closing market price of our common stock on June 15,
2005) and the purchase by Fusion Capital of the full 7,431,819 shares under the
common stock purchase agreement, the remaining proceeds to us, taking into
account the $440,000 already purchased with 1,401,378 shares through March 31,
2005, would only be $1,507,610 in addition to the $250,000 we had already
received before the SB-2 became effective, unless we choose to register more
than 7,431,819 shares, which we have the right, but not the obligation, to do.
The extent we rely on Fusion Capital as a source of funding will depend
on a number of factors including, the prevailing market price of our common
stock and the extent to which we are able to secure working capital from other
sources, such as through the commercialization or licensing of our
Hemopurifier(TM) technology. If obtaining sufficient financing from Fusion
Capital were to prove prohibitively expensive and if we are unable to
commercialize and sell our Hemopurifier(TM) technology, we will need to secure
another source of funding in order to satisfy our working capital needs. Even if
we are able to access the full $6,000,000 under the common stock purchase
agreement with Fusion Capital (in addition to the $250,000 we have already
received), we may still need additional capital to fully implement our business,
operating and development plans. Should the financing we require to sustain our
working capital needs be unavailable or prohibitively expensive when we require
it, the consequences would be a material adverse effect on our business,
operating results, financial condition and prospects.
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 submitted two Small Business
Innovative Research (SBIR) grant proposals, one in 2002 and the other in April
2004, with the National Institutes of Health that relate to the use of our
Hemopurifier(TM) as a countermeasure treatment against certain biological
weapons and anticipate submitting further proposals on U.S. Government
contracts. The first proposal in 2002 was reviewed but not scored. We expanded
the proposal, submitted the proposal in 2004 and it was again reviewed but not
scored. We intend to revise and resubmit the proposal in August 2005. We have
not had any material discussions with the National Institutes of Health.
According to the National Institutes of Health, approximately half of all
proposals are not given a score. Proposals that are not scored are not eligible
for funding. Proposals which are reviewed and scored may or may not be funded.
The majority of SBIR proposals are therefore not funded. Delays in the review
process come from several sources. There are only three SBIR application periods
each year (April 1, August 1 and December 1). Since the review process takes
four to six months to complete, two granting periods typically pass for each
revision and response. For applications that are funded, an additional delay of
six months is expected. We therefore should expect a response to the next
proposal in February of 2006 and with approval, funding would be possible as
early as September 2006.
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The Hemopurifier(TM) has not been approved for use by any government
agency, nor have we received any contracts to purchase the Hemopurifier(TM).
Since inception, we have not generated revenues from the sale of any product
based on our Hemopurifier(TM) technology platform. 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.
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 U.S. Food and Drug Administration
(the "FDA"), but the U.S. Government does not place sufficient orders for these
products, our future business will be harmed.
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
29
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) medical device 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:
o are more effective;
o have fewer or less severe adverse side effects;
o are better tolerated;
o are more adaptable to various modes of dosing;
o are easier to administer; or
o 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.
The Congress' passage of the 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.
Our competitors include fully integrated pharmaceutical companies and
biotechnology companies as well as 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 (if any), adversely impact
our margins or lead to a reduction in our market share (if any), any of which
may harm our business.
30
WE HAVE LIMITED MANUFACTURING EXPERIENCE.
To achieve the levels of production necessary to commercialize our
Hemopurifier(TM) products, we will need secure manufacturing agreements with
manufacturers which comply with good manufacturing practices standards and other
standards prescribed by various federal, state and local regulatory agencies in
the U.S. and any other country of use.
We have limited experience manufacturing products for testing purposes
and no experience manufacturing products for large scale commercial purposes. We
will likely outsource the manufacture of our Hemopurifier(TM) products to third
parties operating FDA-certified facilities. To date, we have manufactured
devices on a small scale for testing purposes. There can be no assurance that
manufacturing and control problems will not arise as we attempt to commercialize
our products or that such manufacturing can be completed in a timely manner or
at a commercially reasonable cost. Any failure to surmount such problems could
delay or prevent commercialization of our products and would have a material
adverse effect on us.
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 and/or more economical than our
Hemopurifier(TM) products. The Homeland Security industry is growing rapidly
with many competitors trying to develop products or vaccines to protect against
infectious disease. Any one of our competitors could develop a more effective
product which would render our technology obsolete.
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. The primary hazardous materials include
chemicals needed to construct the Hemopurifier(TM) cartridges and HIV and
Hepatitis C infected plasma samples used in preclinical test of the
Hemopurifier(TM). All other chemicals are fully inventoried and reported to the
appropriate authorities, such as the fire department, who inspect the facility
on a regular basis. 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. We have had no incidents or problems involving hazardous chemicals or
biological samples. 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
INABILITY TO RETAIN THOSE OFFICERS WOULD IMPEDE OUR BUSINESS PLAN AND GROWTH
STRATEGIES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE
OFYOUR INVESTMENT.
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 Science 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. The loss of Dr. Tullis would harm the clinical development of
our products due to his unique experience with the Hemopurifier(TM) technology.
The loss of Dr. Tullis and/or Mr. Joyce would be detrimental to our growth as
they possess unique knowledge of our business model and infectious disease which
would be difficult to replace within the biotechnology field. We can give you no
assurance that we can find satisfactory replacements for these key executive
31
officers at all, or on terms that are not unduly expensive or burdensome to our
company. Although Mr. Joyce and Mr. Tullis have signed employment agreements
providing for their continued service to our company, these agreements will not
preclude them from leaving our company. Mr. Hall is a part-time employee and his
employment is severable by either party upon 30-days notice. 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.
We currently have an extremely small staff comprised of seven full time
employees consisting of our Chief Executive Officer, our Chief Science Officer,
our Director of Administrative Services, two research associates, a senior
bioengineer and a lab manager, as well as 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. Due to the specialized scientific
nature of our business, we are highly dependent upon our ability to attract and
retain qualified scientific, technical and managerial personal. Competition for
these individuals, especially in San Diego where many bio-technology companies
are located, is intense and we may not be able to attract, assimilate or retain
additional highly qualified personnel in the future. 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
32
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. We may lose potential independent board members and management
candidates to other companies in the biotechnology field that have revenues or
have received greater funding to date which can offer greater compensation
packages. 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 may 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 OF 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.
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 FDA, the National
Institutes of Health, the Centers for Disease Control and Prevention and the
Department of Homeland Security. 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. Such regulatory approval (if any) and product development requires
several years. Despite the time and expense exerted, regulatory approval is
never guaranteed. We also are subject to the following risks and obligations,
among others.
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.
33
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 medical device
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 medical device 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.
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 medical devices 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.
34
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 previously planned products have not become marketable products due
in part to our transition in 2001 from a focus on utilizing our Hemopurifier(TM)
technology on treating harmful metals to treating infectious diseases prior to
our having completed the FDA approval process. Our transition was made in order
to focus on larger markets with an urgent need for new treatment and to take
advantage of the sense of greater sense of urgency surrounding acute and chronic
infectious diseases. Prior to initiating the development of infectious disease
Hemopurifiers(TM), we successfully completed an FDA approved Phase I human
safety trial of a Hemopurifier(TM) to treat aluminum and iron intoxication.
Since changing the focus to infectious disease research, we have not initiated
an FDA approved human clinical trial as the development of the technology is
still continuing and will require both significant capital and scientific
resources. Our pending products face similar challenges of obtaining successful
clinical trials in route to gaining FDA approval prior to commercialization.
Additionally, our limited financial resources hinder the speed of our
product development due to personal constraints.
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. Bioterrorism has become the focus of political debates
especially with the upcoming presidential elections, both in terms of how to
approach bioterrorism and the amount funding the government should provide for
any programs involving homeland protection. Government funding for products on
bioterrorism could be reduced which would hinder our ability to obtain
governmental grants.
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.
35
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 cannot 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 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(TM)
treatment technology.
The Hemopurifier(TM) is protected by seven issued patents, in the
United States, Europe and Japan, six of which we own and one which we own the
exclusive license. Three additional patent applications deal with treatments for
virus infection and manufacturing methods, two of which we own and one which we
own the exclusive license.
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.
THE PATENTS WE OWN COMPRISE A MAJORITY OF OUR ASSETS WHICH COULD LIMIT
OUR FINANCIAL VIABILITY.
The Hemopurifier(TM) is protected by seven issued patents, in the
United States, Europe and Japan, six of which we own and one which we own the
exclusive license. These patents comprise a majority of our assets. At March 31,
2005, our patents comprised 71.2% of all assets. If our existing patents are
invalidated or if they fail to provide significant commercial benefits, it will
severely hurt our financial condition as a majority of our assets would lose
their value. Further, since our patents are written down over the course of
their term until they expire, our assets comprised of patents will continually
be written down until they lose value altogether.
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 have
increased our general and administrative costs as we have incurred increased
legal and accounting fees to comply with such rule changes. 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.
36
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. 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 product recall or lawsuit seeking significant monetary
damages may have a material affect on our business and financial condition. Any
liability for mandatory damages could exceed the amount of our coverage.
Moreover, a product recall could generate substantial negative publicity about
our products and business and inhibit or prevent commercialization of other
future product candidates.
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.
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. As of June 30, 2005, our average trading
volume per day for the past three months was approximately 58,657 shares a day
37
with a high of 241,800 shares traded and a low of 5,600 shares traded. 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.
Fusion Capital's purchase of $10,000 of our common stock each trading
day could cause our common stock price to decline due to the additional shares
available in the market, particularly in light of the relatively thin trading
volume of our common stock. Using the closing price on June 15, 2005, of $0.25
as an example, Fusion Capital would be issued approximately 40,000 shares each
trading day if we elected to have them purchase the daily purchase amount,
whereas our average trading volume for the prior three months is 84,435 per day.
The market price of our common stock could decline given our minimal average
trading volume compared to the number of shares potentially issuable to Fusion
Capital and the voting power and value of your investment would be subject to
continual dilution if Fusion Capital purchases the shares and resells those
shares into the market, although there is no obligation for Fusion Capital to
sell such shares. Any adverse affect on the market price of our common stock
would increase the number of shares issuable to Fusion Capital each trading day
which would increase the dilution of your investment. Although we have the right
to reduce or suspend Fusion Capital purchases at any time, our financial
condition at the time may require us to waive our right to suspend purchases
even if there is a decline in the market price. Sales of large amount of these
shares in the public market could substantially depress the prevailing market
prices for our shares, especially with our thin trading volume as there would be
difficulty for the market to absorb the sale of such shares without an adverse
effect on the share price. If that were to happen, the value of your investment
could decline substantially.
Contractual 9.9% beneficial ownership limitations prohibit Fusion
Capital, together with its affiliates, from beneficially owning more than 9.9%
of our outstanding common stock. This 9.9% limitation does not prevent Fusion
Capital from purchasing shares of our common stock and then reselling those
shares in stages over time where Fusion Capital and its affiliates do not, at
any given time, beneficially own shares in excess of the 9.9% limitation.
Consequently, these limitations will not necessarily prevent substantial
dilution of the voting power and value of your investment.
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. In fact, during the 52-week period ended June 30, 2005, the high and low
sale prices of a share of our common stock were $1.00 and $0.22, respectively.
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
38
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
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 15% EXCLUDING
ALL OPTIONS AND WARRANTS EXERCISABLE WITHIN 60 DAYS OF JUNE 30, 2005) OF OUR
OUTSTANDING COMMON SHARES, WHICH MAY LIMIT THE ABILITY OF YOURSELF OR OTHER
SHAREHOLDERS, WHETHER ACTING INDIVIDUALLY 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.
39
As of June 30, 2005 our officers and directors beneficially own or
control approximately 15% (excluding all options and warrants exercisable within
60 days of June 30, 2005) 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 30, 2005, there are outstanding non-variable priced common
share purchase options and warrants entitling the holders to purchase 11,101,158
common shares at a weighted average exercise price of $0.80 and $3.02,
respectively per share. There are no shares underlying promissory notes
convertible into common stock. The exercise price for all of the aforesaid
warrants, may be less than your cost to acquire our common shares. In the event
of the exercise of these 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.
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
50,000,000 shares of common stock. After taking into consideration our
outstanding common stock at June 30, 2005, we will be entitled to issue up to
31,193,772 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 shares of common stock, or options or warrants
to purchase those shares, under circumstances we may deem appropriate at the
time.
OUR ISSUANCE OF ADDITIONAL COMMON SHARES IN EXCHANGE FOR SERVICES OR
TOREPAY DEBT, WOULD DILUTE YOUR PROPORTIONATE OWNERSHIP AND VOTING RIGHTS AND
COULD HAVE A NEGATIVE IMPACT ON THE MARKET PRICE OF OUR COMMON STOCK.
Our board may generally issue shares of common stock to pay for debt or
services, without further approval by our shareholders based upon such factors
as our Board of Directors may deem relevant at that time. For the past three
years, we issued a total of 2,861,123 shares for debt to reduce our obligations,
including accrued interest. The average price discount of common stock issued
for debt in this period, weighted by the number of shares issued for debt in
such period was approximately 32%, 47% and 41% for the years ended 2003, 2004
and 2005, respectively. For the past three years we issued a total of 1,545,044
shares in payment for services. The average price discount of common stock
issued for services for services in this period, weighted by the number of
shares issued for services in such period was (54%), 46% and 36% for the years
40
ended 2003, 2004 and 2005, respectively. It is likely that we will issue
additional securities to pay for services and reduce debt in the future. We
cannot give you any assurance that we will not issue additional shares of common
stock under circumstances we may deem appropriate at the time.
THE SALE OF OUR COMMON STOCK TO FUSION CAPITAL MAY CAUSE DILUTION AND
THE SALE OF THE SHARES OF COMMON STOCK ACQUIRED BY FUSION CAPITAL COULD CAUSE
THE PRICE OF OUR COMMON STOCK TO DECLINE.
The purchase price for the common stock to be issued to Fusion Capital
pursuant to the common stock purchase agreement will fluctuate based on the
price of our common stock. All shares in this offering are freely tradable.
Fusion Capital may sell none, some or all of the shares of common stock
purchased from us at any time. We expect that the remaining shares under the
agreement will be sold over a period of up to 30 months from December 7, 2004.
Depending upon market liquidity at the time, a sale of shares at any given time
could cause the trading price of our common stock to decline. The sale of a
substantial number of shares of our common stock to Fusion Capital, or
anticipation of such sales, could make it more difficult for us to sell equity
or equity-related securities in the future at a time and at a price that we
might otherwise wish to effect sales.
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.
41
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, 2005 Form 10-KSB. Based upon that evaluation, our
CEO and CFO concluded that, as of March 31, 2005, 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.
CHANGES IN CONTROLS AND PROCEDURES
There were no significant changes made in our internal controls over
financial reporting during the quarter ended March 31, 2005 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.
42
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, except Mr. Calvin Leung, one of our directors, filed a late Form 4
reporting the award of stock options to purchase 339,400 shares of our common
stock.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The names, ages and positions of our directors and executive officers
as of March 31, 2005 are listed below:
NAMES TITLE OR POSITION AGE
---------------------------------------------------------------------------------
James A. Joyce (1) Chairman, President, Chief Executive 43
Officer and Secretary
Richard H. Tullis, PhD (2) Vice President, Chief Science Officer 60
and Director
Edward C. Hall (3) Vice President, Chief Financial Officer 64
Franklyn S. Barry, Jr. Director 65
Edward G. Broenniman Director 68
Calvin M. Leung (4) Director 67
(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) Effective June 1, 2001, Dr. Tullis was appointed as our Chief
Science 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.
43
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
1992, Mr. Joyce founded and was the sole shareholder in James Joyce &
Associates, an organization that provided management consulting and corporate
finance advisory services to CEOs and CFOs of publicly traded companies.
Previously, from 1989 to 1991, Mr. Joyce was Chairman and Chief Executive
Officer of Mission Labs, Inc. Prior to that Mr. Joyce was 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, on a part-time basis. Mr. Hall spends time as CFO as
required by the needs of the Company's business, which have increased in the
last year. Currently, the time that Mr. Hall spends on our business ranges from
several hours to several days per week, depending on the fluctuating financial
management requirements of the business. Mr. Hall has held senior financial
executive positions with both public and privately-held life sciences and
technology companies for over 25 years. In the last five years, prior to his
appointment as Chief Financial Officer of Aethlon Medical, he served as Vice
President and Chief Financial Officer of three companies: Chromagen, Inc, a
private biotech tools company which develops proteomic and genomic assays for
use in drug discovery; Cytel Corporation, a public biotech company and developer
of anti-inflammatory drugs and Medical Device Technologies, a public medical
device company. Mr. Hall is also Vice President, Chief Financial Officer of
Alliance Pharmaceutical Corp., a public research-based pharmaceutical
development company, and he is a Partner of Tatum CFO Partners, LLP.
Richard H. Tullis, Ph.D., Vice President, Chief Science Officer
---------------------------------------------------------------
Dr. Tullis has been Vice President and a director of the Company since
January 2000 and Chief Science 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 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- hosphorochloridites. 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
University of Hawaii.
44
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 currently serves on the
boards of two 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 the next Annual Meeting
of Shareholders of the Company. Our Board of Directors presently has an Audit
Committee and a Compensation Committee on each of which Messrs. Barry,
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 earning stock options and cash
compensation according to the Directors Compensation Program approved in
February 2005.
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
45
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.
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.
SCIENCE ADVISORY BOARD
Each person listed below is a current member of our Science Advisory
Board. The role of the Science Advisory Board is to provide scientific guidance
related to the development of our Hemopurifier(TM) technology. Unlike the
members of our Board of Directors, the Science Advisory Board members are not
involved in the management or operations of our company. Members of the Science
Advisory Board are paid $500 per day for services rendered either on-site or at
a mutually agreeable location.
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.
46
Joseph A. Bellanti, M.D.
------------------------
Dr. Bellanti is the Director of the International Center for Immunology
and Professor of Pediatrics at Georgetown University School of Medicine. He has
authored over 400 scientific articles and 25 books and book chapters in the
areas of Immunology and Virology. Dr. Bellanti's textbook, "Immunology," is used
in medical and graduate schools throughout the country.
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 ten 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 which is a method for the selective
capture of proteins, sugars, fats and inorganic compounds. 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.
47
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.
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.
Members of the Scientific Advisory Board do not receive any monetary
compensation for service on the Board. However, on occasion, the members may be
awarded stock options.
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.
48
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, 2003 through 2005 by our Chief Executive Officer and all
other executive officers.
LONG TERM COMPENSATION
--------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
--------------------------------- ------------------------- ---------
SECURITIES LONG ALL
UNDERLYING TERM OTHER
NAMED EXECUTIVE OFFICER AND RESTRICTED OPTIONS INCENTIVE COMPEN-
PRINCIPAL POSITION YEAR SALARY(1) BONUS OTHER STOCK & SARS PLAN SATION
--------------------------- ------ ---------- --------- ---------- ------------ ----------- ---------- ----------
James A. Joyce 2005 $187,291 $20,000 $ -- $ -- 2,231,100 $ -- $ --
PRESIDENT AND CHIEF 2004 180,000 -- -- -- -- -- --
EXECUTIVE OFFICER 2003 180,000 -- -- -- -- -- --
Richard H. Tullis, Ph.D. 2005 $154,375 $15,000 $ -- $ -- 1,734,350 $ -- $ --
VICE PRESIDENT AND CHIEF 2004 150,000 -- -- -- -- -- --
SCIENCE OFFICER 2003 150,000 -- -- -- 250,000 -- --
Edward C. Hall (2) 2005 $54,635(2) $ -- $ -- $ -- -- $ -- $ --
VICE PRESIDENT, CHIEF 2004 25,216 -- -- -- -- -- --
FINANCIAL OFFICER 2003 12,416 -- -- -- -- -- --
(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 of 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 our Chief
Financial Officer on August 14, 2002. He is compensated on an hourly basis, a
portion of which, amounting to $10,927 in fiscal 2005 was paid to Tatum CFO
Partners, LLP , of which he is a partner. Tatum CFO Partners, LLP is paid a
resource fee for making available its intellectual capital to Mr. Hall as CFO of
the Company, including its on-line contact network and its proprietary financial
data base.
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS GRANT TABLE
The following table provides certain information with respect to
individual grants during the last fiscal year to each of our named executive
officers of common share purchase options or stock appreciation rights ("SARs")
relating to our common shares:
COMMON SHARES AS PERCENTAGE OF
UNDERLYING GRANT OF GRANTS TO ALL EXERCISE OR
NAMED EXECUTIVE OFFICER OPTIONS OR SARS EMPLOYEES BASE PRICE EXPIRATION DATE
----------------------------- ------------------ ------------------- -------------- -------------------
James A. Joyce,
CHAIRMAN, PRESIDENT AND CEO 2,231,100 56.3 $0.38 2/23/2010
Richard H. Tullis, Ph.D,
VICE PRESIDENT, CHIEF
SCIENCE OFFICER 1,734,350 43.7 $0.38 2/23/2010
Edward C. Hall
VICE PRESIDENT, CHIEF
FINANCIAL OFFICER 0 N/A N/A N/A
49
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS EXERCISE AND VALUATION TABLE
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, 2005, utilizing a value of
$0.33 per share, the closing price of the Company's common stock on the
Over-The-Counter Bulletin Board on March 31, 2005:
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
SHARES OPTIONS/SARS OPTIONS/SARS
ACQUIRED VALUE (EXERCISABLE/ (EXERCISABLE/
NAMED EXECUTIVE OFFICER ON EXERCISE REALIZED UNEXERCISABLE) UNEXERCISABLE)
-------------------------------- -------------- ------------ ------------------------ -------------------
James A. Joyce -- -- 1,365,550 /1,115,550 $0 / $0
Richard H. Tullis -- -- 1,147,175 /867,175 $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 President and Chief
Executive Officer and his base annual salary was increased from $120,000 to
$180,000. Effective January 1, 2005, Mr. Joyce's salary was increased from
$180,000 to $205,000 per year. Under the terms of the agreement, his employment
continues at a salary of $205,000 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
Science Officer of the Company. His compensation under the agreement was
modified in June 2001 from $80,000 to $150,000 per year. Effective January 1,
2005 Dr. Tullis' salary was increased from $150,000 to $165,000 per year Under
the terms of the agreement, his employment continues at a salary of $165,000 per
year for successive one-year periods, unless given notice of termination 60 days
prior to the anniversary of his employment agreement. Dr. Tullis was granted
250,000 stock options to purchase our common stock in connection the completing
certain milestones, such as the initiation and completion of certain clinical
trials, the submission of proposals to the FDA and the filing of a patent
application.
Both Mr. Joyce's 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 the Company, 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 and
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
50
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.
Under the Directors Compensation Program, adopted by us in February
2005, a newly elected director will receive a one time grant of a non-qualified
stock option of 1.5% of the common stock outstanding at the time of election.
The options will vest one-third at the time of election to the board and the
remaining two-thirds will vest equally at year end over three years.
Additionally, each director will also receive an annual $25,000 non-qualified
stock option retainer, $15,000 of which is to be paid at the first of the year
to all directors who are on the Board prior to the first meeting of the year and
a $10,000 retainer will be paid if a director attends 75% of the meetings either
in person, via conference call or other electronic means. The exercise price for
the options under the Directors Compensation Program will equal the average
closing of the last ten (10) trading days prior to the date earned. At March 31,
2005 under the 2005 Directors Compensation Program we had issued 1,337,825
options to outside directors and 3,965,450 options to employee-directors for a
total of 5,303,275 options.
At March 31, 2005, we had granted 47,500 options under the 2000 Stock
Option Plan, with 452,500 available for future issuance. At March 31, 2005 we
had issued 5,303,275 options under the Directors Compensation Plan. We issued
1,966,415 options (of which 637,800 have been exercised or cancelled) outside
both the 2005 Directors Compensation Plan and 2000 Stock Option Plan.
At March 31, 2005, we had outstanding options to purchase 6,679,390
shares of our Common Stock. See Item 11, "Security Ownership of Certain
Beneficial Owners and Management."
OUTSTANDING STOCK PURCHASE WARRANTS
Common Stock purchase warrants
At March 31, 2005, we had outstanding a total of 2,833,834 warrants,
exercisable at prices between $0.25 - 5.00 per share and with expiration dates
from 2005 - 2010.
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, as of June 30, 2005, information with
respect to the shares of Common Stock beneficially owned by (i) each
director nominee; (ii) each person (other than a person who is also a
director nominee) who is an executive officer; and (iii) all executive
officers and directors as a group. The term "executive officer" is defined
as the President/Chief Executive Officer, Secretary, Chief Financial
Officer/Treasurer, any vice-president in charge of a principal business
function (such as administration or finance), or any other person who
performs similar policy making functions for the Company. We believe that
each individual or entity named has sole investment and voting power with
respect to shares of common stock indicated as beneficially owned by them,
subject to community property laws where applicable, excepted where
otherwise noted:
51
AMOUNT AND NATURE OF PERCENT OF
TITLE OF CLASS NAME BENEFICIAL OWNERSHIP(1)(2) CLASS
-------------- -------------------------------------------- -------------------------- ----------
Common Stock Calvin M. Leung, Director
P.O. Box 2366 2,077,318 shares(3) 11.0%
Costa Mesa, CA 92628
Common Stock James A. Joyce, Chief Executive Officer and
Director 1,965,550 shares(4) 9.7%
3030 Bunker Hill Street, Suite 4000,
San Diego, CA 92109
Common Stock Richard H. Tullis, Chief Scientific Officer
and Director 1,202,175 shares(5) 6.0%
3030 Bunker Hill Street, Suite 4000,
San Diego, CA 92109
Common Stock Franklyn S. Barry, Director
3030 Bunker Hill Street, Suite 4000, 655,084 shares(6) 3.4%
San Diego, CA 92109
Common Stock Edward G. Broenniman, Director
3030 Bunker Hill Street, Suite 4000, 497,865 shares(7) 2.6%
San Diego, CA 92109
Common Stock Edward C. Hall
3030 Bunker Hill Street, Suite 4000, 0 shares *
San Diego, CA 92109
All Current
Directors and
Executive Officers
as a Group (6 6,397,992 Shares 28.7%
members)
*Less than 1%.
1. Based on 18,806,228 shares of Common Stock outstanding on the transfer
records as of June 30, 2005.
2. Calculated pursuant to Rule 13d-3(d)(1) of the Securities Exchange Act of
1934. Under Rule 13d-3(d)(1), shares not outstanding which are subject to
options, warrants, rights or conversion privileges exercisable within 60 days
are deemed outstanding for the purpose of calculating the number and percentage
owned by such person, but not deemed outstanding for the purpose of calculating
the percentage owned by each other person listed. The Company believes that each
individual or entity named has sole investment and voting power with respect to
shares of Common Stock indicated as beneficially owned by them, subject to
community property laws, where applicable, except where otherwise noted.
3. Includes all shares owned by members of Mr. Leung's family and entities he
controls, 10,000 warrants to purchase common stock at an exercise price of $3.00
and 30,675 stock options exercisable at $0.489 per share.
4. Includes 250,000 stock options exercisable at $1.90 per share and 1,115,550
stock options exercisable at $0.38 per share.
52
5. Includes 250,000 stock options exercisable at $1.90 per share, 30,000 stock
options exercisable at $2.56 per share and 867,175 at $0.38 per share.
6. 30,675 stock options exercisable at $0.489 per share and 205,816 stock
options exercisable at $0.38 per share.
7. Includes 53,885 shares owned by Mr. Broenniman's wife, his 3,000 stock
options exercisable at $1.78, 2,500 stock options exercisable at $3.75, 30,675
stock options exercisable at $0.489 per share and 205,816 stock options
exercisable at $0.38 per share.
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. Mr. Barry had been
our original President and Chief Executive Officer and served in such capacities
until 2001. When Mr. Barry stepped down as our President and Chief Executive
Officer was owed severance equal to one year salary. The consulting agreement
was in lieu of immediate payment to spread the payment of the course of the
agreement and to ensure that Mr. Barry provided transition consultation to Mr.
Joyce on company practices and maintained and manage relationships with certain
employees and vendors. 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 providing as needed business advisory
services to management, including business development services and
introductions to potential investors and merger candidates, and he and his
affiliates have invested approximately $939,500 in Aethlon Medical to date,
through equity and convertible debt securities. $448,000 was invested via
convertible promissory notes from November 2001 through May 2002. The notes
accrued interest at rates ranging from 6.75% to 12% per annum. Mr. Leung
invested $300,000 via the exercise of stock options received while our
consultant for which he received 600,000 shares of restricted common stock. Mr.
Leung and his affiliates also invested during 2003 a total of $146,500 in cash
for 586,000 shares of our restricted common stock. Finally, Mr. Leung and his
affiliates invested approximately $45,000 from September 2003 to February 2004
via the exercise of warrants that resulted in the issuance of 180,000 shares of
our restricted common stock. Mr. Leung worked as our consultant from January 7,
2001 to January 7, 2003. We do not expect Mr. Leung to provide consulting
services now that he is a member of our Board of Directors. He currently owns
2,036,643 of our common shares, 30,675 options to purchase common stock at
$0.489 per share and 10,000 warrants to purchase common stock at an exercise
price of $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 in the aggregate amount of approximately
$1.5 million. Of this amount, our Chief Executive Officer, Mr. James A Joyce, is
owed approximately $296,000 for deferred salary. In addition, we owe Dr. Richard
H Tullis, our Chief Scientific Officer approximately $267,900 in deferred
salary. We also owe our Chief Financial Officer, Mr. Edward C Hall,
approximately $32,767 in deferred salary. We owe Mr. Franklyn S Barry, a
director, a total of approximately $319,800 for deferred salary and consulting
fees from pre-merger in 1999 through May 2003 and approximately $21,000 from
accrued medical benefits. We owe approximately $69,000 to James Joyce and
Associates, a company founded by our current Chief Executive Officer, for
deferred consulting fees on services provided prior to our merger in 1999. We
previously repaid Mr. Barry a total of $20,000 in cash. Additionally, we owe
John Murray, our former Chief
53
Financial Officer, a total of approximately $25,000 for deferred salary and
medical benefits for services rendered from September 2000 through May 2001. We
owe Robert S. Stefanovich, a former Chief Financial Officer, a total of
approximately $91,000 for deferred salary, vacation and medical benefits for
services rendered from July 2001 until July 2002. Additionally, we owe Dr. Clara
Ambrus, the founder of Hemex, Inc., approximately $190,500 for services rendered
from pre-merger in 1999 through March 2002. We owe Edward Broenniman, a board
member, and Linda Broenniman, his wife, an aggregate of approximately $119,000
for services rendered prior to our merger in 1999 and approximately $75,000 for
unpaid expenses and advances to Hemex, Inc. prior to the merger with Aethlon
Medical. Mr. Broenniman was repaid a total of $10,000 in July 2004 against this
debt. We owe approximately $34,500 to directors for deferred directors' fees.
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 Dr. Julian
Ambrus, the son of Dr. Clara Ambrus, who was the original founder of Hemex, Inc.
Under this agreement, 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 was
issued was below $8 per share, the number of shares to be issued was 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. Such shares were recorded at par value since the original patent
acquisition purchase transaction had been measured at $100,000 and recorded as
"patents" in the March 2000 consolidated balance sheet. The 196,078 shares
merely satisfied a contingent obligation under the original purchase agreement.
We believe that each of the related party transactions above, due to
their related party nature, are not necessarily on terms that would have been
obtained from unaffiliated third parties.
ITEM 13. EXHIBITS
The following documents are filed as part of this report on Form 10-KSB:
1. Consolidated Financial Statements for the periods ended March 31, 2005 and
2004:
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
54
2. Exhibits
3.1 Articles of Incorporation of Aethlon Medical, Inc. (1)
3.2 Bylaws of Aethlon Medical, Inc. (1)
3.3 Certificate of Amendment of Articles of Incorporation dated
March 28, 2000 (2)
3.4 Certificate of Amendment of Articles of Incorporation dated
June 13, 2005(3)
10.1 Employment Agreement between Aethlon Medical, Inc. and James
A. Joyce dated April 1, 1999 (4)
10.2 Agreement and Plan of Reorganization Between Aethlon Medical,
Inc. and Aethlon, Inc. dated March 10, 1999 (5)
10.3 Agreement and Plan of Reorganization Between Aethlon Medical,
Inc. and Hemex, Inc. dated March 10, 1999 (5)
10.4 Agreement and Plan of Reorganization Between Aethlon Medical,
Inc. and Syngen Research, Inc. (6)
10.5 Agreement and Plan of Reorganization Between Aethlon Medical,
Inc. and Cell Activation, Inc. (7)
10.6 Common Stock Purchase Agreement between Aethlon Medical, Inc.
and Fusion Capital Fund II, LLC. (8)
10.7 Registration Rights Agreement between Aethlon Medical, Inc.
and Fusion Capital Fund II, LLC. (8)
10.8 Form of Securities Purchase Agreement for Private Placement
closing on June 7, 2004 (8)
10.9 Form of Common Stock Purchase Warrant for Private Placement
closing on June 7, 2004 (8)
10.10 Form of Registration Rights Agreement for Private Placement
closing on June 7, 2004 (8)
10.11 Note Purchase Agreement by and between Aethlon Medical, Inc.
and Fusion Capital Fund II, LLC, dated May 16, 2005.(9)
10.12 Convertible Promissory Note by and between Aethlon Medical,
Inc. and Fusion Capital Fund II, LLC, dated May 16, 2005.(9)
10.13 Form of Common Stock Cashless Purchase Warrant for benefit of
Fusion Capital Fund II, LLC, dated May 16, 2005. (9)
10.14 2003 Consultant Stock Plan (10)
10.15 Lease by and between Aethlon Medical, Inc. and San Diego
Science Center (11)
10.16 Consulting Agreement by and between Aethlon Medical, Inc. and
Jean-Claude Chermann, PhD (11)
10.17 Consulting Agreement by and between Aethlon Medical, Inc. and
Franklyn S. Barry, Jr. (11)
10.18 Patent License Agreement by and amongst Aethlon Medical, Inc.,
Hemex, Inc., Dr. Julian L. Ambrus and Dr. David O. Scamurra
(11)
55
10.19 Employment Agreement by and between Aethlon Medical, Inc. and
Dr.Richard H. Tullis (11)
10.20 Employment Agreement by and between Aethlon Medical, Inc. and
Edward C. Hall (11)
10.21 Cooperative Agreement by and between Aethlon Medical, Inc. and
George Mason University (12)
10.22 Consulting Agreement by and between Aethlon Medical, Inc. and
Dr. Charles Bailey (14)
10.23 Consulting Agreement by and between Aethlon Medical, Inc. and
Dr. Ken Alibek (14)
10.24 Stock Option Agreement by and between Aethlon Medical, Inc.
and James A Joyce*
10.25 Stock Option Agreement by and between Aethlon Medical, Inc.
and Richard Tullis*
10.26 Stock Option Agreement by and between Aethlon Medical, Inc.
and Franklyn S. Barry*
10.27 Stock Option Agreement by and between Aethlon Medical, Inc.
and Ed Broenniman*
10.28 Stock Option Agreement by and between Aethlon Medical, Inc.
and Calvin Leung*
10.29 Warrant for the benefit of Richardson and Patel, LLP*
21 List of subsidiaries (13)
23.1 Consent of Independent Registered Public Accounting Firm
(Squar, Milner, Reehl & Williamson, LLP) *
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 Statement of our Chief Executive Officer and Chief Financial
Officer under Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350)*
* Filed herewith
---------------
(1) December 18, 2000 and incorporated by reference.
(2) Filed with the Company's Annual Report on Form 10-KSB for the year
ended March 31, 2000 and incorporated by reference.
56
(3) Filed with the Company's Current Report on Form 8-K, dated June 10,
2005 and incorporated by reference.
(4) Filed with the Company's Annual Report on Form 10-KSB for the year
ended March 31, 1999 and incorporated by reference.
(5) Filed with the Company's Current Report on Form 8-K dated March 10,
1999 and incorporated by reference.
(6) Filed with the Company's Current Report on Form 8-K dated January 10,
2000 an incorporated by reference.
(7) Filed with the Company's Current Report on Form 8-K dated April 10,
2000 and incorporated by reference.
(8) Filed with the Company's Current Report on Form 8-K dated June 7, 2004
and incorporated by reference.
(9) Filed with the Company's Current Report on Form 8-K dated May 16, 2005
and incorporated by reference.
(10) Incorporated by reference from our Registration Statement on Form S-8
(File No. 333-114017) filed on March 29, 2004.
(11) Filed with the Company's Annual Report on Form 10-KSB/A for the year
ended March 31, 2004 and incorporated by reference.
(12) Filed with the Company's Amendment No.2 to Registration Statement on
Form SB-2 filed on October 28, 2004.
(13) Filed with the Company's Registration Statement on Form SB-2 filed on
July 7, 2004.
(14) Filed with the Company's Amendment No. 3 to Registration Statement on
Form SB-2 filed on November 24, 2004.
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,
2005, and 2004 and fees billed for other services rendered by Squar Milner
during such years:
Fiscal Years Ended March 31,
2005 2004
------- -------
Audit Fees $63,140 $55,500
Audit Related Fees 43,754 2,500 (1)
Tax Fees - -
All Other Fees - -
---------------------------
$106,894 $58,000
===========================
(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.
57
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 13th day of July, 2005.
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 July 13, 2005
-------------------------
JAMES A. JOYCE
/S/ FRANKLYN S. BARRY, JR. DIRECTOR July 13, 2005
--------------------------
FRANKLYN S. BARRY, JR.
/S/ EDWARD G. BROENNIMAN DIRECTOR July 13, 2005
--------------------------
EDWARD G. BROENNIMAN
/S/ RICHARD H. TULLIS DIRECTOR July 13, 2005
-------------------------
RICHARD H. TULLIS
/S/ CALVIN M. LEUNG DIRECTOR July 13, 2005
--------------------------
CALVIN M. LEUNG
58
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
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 PUBLIC 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, 2005 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, 2005. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Aethlon Medical,
Inc. and Subsidiaries as of March 31, 2005 and the consolidated results of their
operations and their 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,
2005, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. At March 31, 2005, the
Company has negative working capital of approximately $3,349,000 and a deficit
accumulated during the development stage of approximately $19,142,000. 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
JUNE 27, 2005
NEWPORT BEACH, CALIFORNIA
F-1
--------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED BALANCE SHEET
MARCH 31, 2005
--------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 8,625
Prepaid expenses 10,188
------------
TOTAL CURRENT ASSETS 18,813
------------
NON-CURRENT ASSETS
Property and equipment, net 30,366
Patents, net 213,923
Other assets 37,250
------------
TOTAL NONCURRENT ASSETS 281,539
------------
TOTAL ASSETS $ 300,352
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,307,512
Due to related parties 1,567,502
Notes payable, net of discounts 492,309
------------
TOTAL CURRENT LIABILITIES 3,367,323
------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Common stock, par value of $0.001, 25,000,000 shares
authorized; 17,014,696 issued and outstanding 17,015
Additional paid-in capital 16,058,278
Deficit accumulated during the development stage (19,142,264)
------------
TOTAL STOCKHOLDERS' DEFICIT (3,066,971)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 300,352
============
--------------------------------------------------------------------------------------------
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, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005
----------------------------------------------------------------------------------------------------------
JANUARY 31, 1984
(INCEPTION) THROUGH
2005 2004 MARCH 31, 2005
--------------------------------------------------------
Grant income $ -- $ -- $ 1,424,012
Subcontract income -- -- 73,746
Sale of research and development -- -- 35,810
--------------------------------------------------------
-- -- 1,533,568
OPERATING EXPENSES
Professional fees 748,837 339,787 4,386,541
Payroll and related 1,000,324 417,486 6,570,834
General and administrative 434,216 238,276 3,945,579
Impairment -- -- 1,231,531
--------------------------------------------------------
2,183,377 995,549 16,134,485
--------------------------------------------------------
OPERATING LOSS (2,183,377) (995,549) (14,600,917)
OTHER (INCOME) EXPENSE
Interest expense (86,426) 523,249 4,421,155
Interest income -- -- (17,415)
Other -- -- 137,607
--------------------------------------------------------
(86,426) 523,249 4,541,347
--------------------------------------------------------
NET LOSS $ (2,096,951) $ (1,518,798) $(19,142,264)
========================================================
Basic and diluted net loss attributable to
common stockholders per share $ (0.15) $ (0.19)
==================================
Weighted average number of common
shares outstanding 14,037,341 8,181,612
==================================
----------------------------------------------------------------------------------------------------------
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, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (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
Warrants 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)
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-4
-----------------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (DEFICIT)
----------- ----------- ----------- ------------ ----------------
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)
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-5
-----------------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (DEFICIT)
----------- ----------- ----------- ------------ ----------------
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 value assigned to warrants
issued in connection with conversion of
accounts payable -- -- 71,000 -- 71,000
Pro-rata 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 market value of options
issued for services -- -- 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
Adjustment booked -- -- (100,000) 100,000 --
Net loss -- -- -- (2,461,116) (2,461,116)
----------- ----------- ----------- ------------ ----------------
BALANCE - MARCH 31, 2003 6,694,960 $ 6,695 $ 11,894,223 $(15,526,515) $ (3,625,597)
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-6
-----------------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (DEFICIT)
----------- ----------- ----------- ------------ ----------------
BALANCE - MARCH 31, 2003 6,694,960 $ 6,695 $ 11,894,223 $(15,526,515) $ (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 $ 13,379,487 $(17,045,313) $ (3,655,177)
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-7
-----------------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (DEFICIT)
----------- ----------- ----------- ------------ ----------------
BALANCE - MARCH 31, 2004 10,649,329 $ 10,649 $13,379,487 $(17,045,313) $ (3,655,177)
Proceeds from the issuance of common
stock at $0.25 per share in connection
with the exercise of warrants 1,126,564 1,127 280,515 -- 281,642
Issuance of common stock at $0.44 per
share for cash 1,415,909 1,416 621,584 -- 623,000
Issuance of common stock at $0.25 per
share for cash 40,233 40 9,960 -- 10,000
Issuance of common stock at $0.28 per
share for cash 35,947 36 9,964 -- 10,000
Issuance of common stock at $0.29 per
share for cash 69,431 69 19,931 -- 20,000
Issuance of common stock at $0.32 per
share for cash 94,449 94 29,906 -- 30,000
Issuance of common stock at $0.33 per
share for cash 60,620 61 19,939 -- 20,000
Issuance of common stock at $0.35 per
share for cash 172,824 173 59,826 -- 59,999
Issuance of common stock at $0.36 per
share for cash 223,756 224 79,776 -- 80,000
Issuance of common stock at $0.37 per
share for cash 108,079 108 39,892 -- 40,000
Issuance of common stock at $0.38 per
share for cash 26,549 27 9,973 -- 10,000
Issuance of common stock at $0.39 per
share for cash 51,748 52 19,948 -- 20,000
Issuance of common stock at $0.40 per
share for cash 25,233 25 9,975 -- 10,000
Issuance of common stock at $0.42 per
share for cash 143,885 144 59,857 -- 60,001
Issuance of common stock at $0.43 per
share for cash 70,467 70 29,930 -- 30,001
Issuance of common stock at $0.45 per
share for cash 22,455 22 9,978 -- 10,000
Issuance of common stock at $0.46 per
share for cash 43,944 44 19,956 -- 20,000
Issuance of common stock at $0.47 per
share for cash 128,836 129 59,872 -- 60,001
Issuance of common stock at $0.52 per
share for cash 95,502 96 49,904 -- 49,999
Issuance of common stock with warrants
at $0.36 per unit for cash 55,556 56 19,944 -- 20,000
Issuance of common stock at $0.27 per
share for cash 90,000 90 24,210 -- 24,300
Issuance of common stock at $0.50 per
share for cash 3,000 3 1,497 -- 1,500
Issuance of common stock to Fusion
Capital for "commitment" shares 50,000 50 (50) -- --
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-8
-----------------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL DURING TOTAL
----------------------------- PAID IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL STAGE EQUITY (DEFICIT)
----------- ----------- ----------- ------------ ----------------
Issuance of common stock to Fusion
Capital for fees 418,604 419 (419) -- (0)
Issuance of common stock at $0.34 per
share in connection with the conversion
of notes payable, including interest
of $38,371 479,513 480 162,891 -- 163,371
Issuance of common stock at $0.44 per
share in connection with the conversion
of notes payable 113,636 114 49,886 -- 50,000
Issuance of common stock at $0.25 per
share in connection with the conversion
of notes payable 80,000 80 19,920 -- 20,000
Issuance of common stock at $0.49 per
share in connection with the conversion
of notes payable 174,606 175 85,382 -- 85,557
Issuance of common stock at $1.75 per
share for services 17,143 17 29,983 -- 30,000
Issuance of common stock at $0.44 per
share for services 265,273 265 116,455 -- 116,720
Issuance of common stock at $0.70 per
share for services 10,715 11 7,489 -- 7,500
Issuance of common stock at $0.73 per
share for services 6,850 7 4,993 -- 5,000
Issuance of common stock at $0.55 per
share for services 46,364 46 25,454 -- 25,500
Issuance of common stock at $0.25 per
share for services 165,492 165 41,208 -- 41,373
Issuance of common stock at $0.45 per
share for services 28,377 28 12,741 -- 12,769
Issuance of common stock at $0.50 per
share for services for deferred
consulting services 60,000 60 (60) -- --
Issuance of common stock at $0.49 per
share for services 25,087 25 12,318 -- 12,343
Issuance of common stock at $0.45 per
share for services for deferred
consulting services 66,666 67 (67) -- --
Issuance of common stock at $0.37 per
share for services 13,369 13 4,987 -- 5,000
Issuance of common stock at $0.42 per
share for services 19,231 19 7,981 -- 8,000
Issuance of common stock at $0.39 per
share for services 18,042 18 6,982 -- 7,000
Issuance of common stock at $0.32 per
share for services 162,678 163 52,382 -- 52,545
Issuance of common stock at $0.31 per
share for services 16,234 16 4,984 -- 5,000
Issuance of common stock at $0.39 per
share for employee bonus 22,500 22 8,754 -- 8,776
Debt discount on debt issued with
detachable warrants -- -- 84,000 -- 84,000
Amortization of deferred consulting
fees -- -- 30,000 -- 30,000
Intrinsic value of options issued to
directors -- -- 424,262 -- 424,262
Net loss -- -- -- (2,096,951) (2,096,951)
----------- ----------- ----------- ------------ --------------
BALANCE - MARCH 31, 2005 17,014,696 $ 17,015 $ 16,058,278 $(19,142,264) $ (3,066,971)
============== ============ ============ ============= ===============
-----------------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
F-9
--------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005
--------------------------------------------------------------------------------------------------------------------------
January 31, 1984
(Inception) Through
2005 2004 March 31, 2005
-------------------------------------------------
Cash flows from operating activities:
Net loss $ (2,096,951) $ (1,518,798) $(19,242,264)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 39,836 127,000 949,752
Amortization of deferred consulting fees 30,000 -- 30,000
Gain of sale of property and equipment -- -- (13,065)
Fair market value of warrants issued in connection
with accounts payable and debt related costs -- -- 2,715,736
Fair market value of common stock, warrants and
options issued for services and interest 339,027 138,158 2,607,619
Intrinsic value of stock options issued
to directors 424,262 -- 424,262
Amortization of debt discount 38,809 324,800 848,609
Beneficial conversion feature of convertible notes payable -- -- 334,304
Impairment of patents and patents pending -- -- 897,227
Impairment of goodwill -- -- 217,223
Changes in operating assets and liabilities:
Prepaid expenses (4,606) 4,728 151,349
Other assets (16,845) (14,800) (37,250)
Accounts payable and accrued liabilities (206,943) 138,398 1,632,226
Due to related parties (105,955) 258,458 1,501,003
-------------------------------------------------
Net cash used in operating activities (1,559,366) (542,056) (6,983,269)
-------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (30,070) (4,782) (244,236)
Patents and patents pending -- -- (352,833)
Proceeds from the sale of property and equipment -- -- 17,065
Cash of acquired company -- -- 10,728
-------------------------------------------------
Net cash used in investing activities (30,070) (4,782) (569,276)
-------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
continued.........
F-10
--------------------------------------------------------------------------------------------------------------------------
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 2005 AND 2004 AND
FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH MARCH 31, 2005 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------
January 31, 1984
(Inception) Through
2005 2004 March 31, 2005
-------------------------------------------------
Cash flows from financing activities:
Net proceeds from the issuance of notes payable 130,000 -- 1,610,000
Principal repayments of notes payable (22,500) (180,000) (212,500)
Proceeds from the issuance of convertible notes payable -- 200,000 998,000
Net proceeds from the issuance of common stock 1,488,942 522,125 5,165,670
-------------------------------------------------
Net cash provided by financing activities 1,596,442 542,125 7,561,170
-------------------------------------------------
Net increase (decrease) in cash 7,006 (4,713) 8,625
Cash at beginning of period 1,619 6,332 --
-------------------------------------------------
Cash at end of period $ 8,625 1,619 $ 8,625
=================================================
Supplemental disclosure of cash flow information
- Cash paid during the period for:
Interest $ 34,766 $ 13,000 255,258
=================================================
Income taxes $ -- $ 1,180 13,346
=================================================
Supplement schedule of noncash investing and
financing activities:
Debt and accrued interest converted to common stock $ 318,925 $ 407,500 2,367,019
=================================================
Debt discount on notes payable issued with
detachable warrants $ 84,000 $ -- $ --
=================================================
Issuance of common stock, warrants and options for
accounts payable $ -- $ -- 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-11
AETHLON MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
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") or the regulatory agency of any foreign country
where it intends to sell its device. Aethlon has not yet begun efforts to obtain
any FDA approval, which may take several years, but it intends to initiate human
trials in India to obtain regulatory approval there. Since many of Aethlon's
patents were issued in the 1980's, some have expired and other are scheduled to
expire in the near future. Thus, some patents may expire before FDA approval or
approval in a foreign country, if any, is obtained. However, the Company
believes that certain patent applications and/or other patents issued more
recently will help 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
administered by 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.(hereinafter
collectively 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 $3,349,000, a deficit accumulated during the development stage of
approximately $19,142,000 at March 31, 2005 and is in default on certain debt
(see Notes 7 and 8), which among other matters, raises 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/or 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, 2006. Therefore, the
Company will be required to seek additional funds to finance its long-term
operations.
The Company is currently addressing its liquidity issue by continually seeking
investment capital through the public markets, specifically, through private
placement of common stock and a common stock purchase agreement with an investor
that has committed to buy up to an additional $6,000,000 of the Company's common
stock over a 30-month period, that commenced, at the Company's election, when
the Securities Exchange Commission (the "SEC") declared effective on December 7,
2004 a registration statement covering such shares. However, no assurance can be
given that the Company will receive any funds in addition to the funds it has
received to date
F-12
AETHLON MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
under such agreement and there is no guarantee that these strategies will enable
the Company to meet its obligations for the foreseeable future. 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.
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 requires 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 periods. Significant
estimates made by management include, among others, realization of long-lived
assets and valuation of deferred tax 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 and 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 and were not necessarily consummated at arm's length.
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, 2005.
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.
F-13
AETHLON MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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
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 noted
no impairment indicators requiring review for impairment during the year ended
March 31, 2005.
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, 2005 and
2004, approximately 2,100,000 and 2,500,000 shares would have been considered
additional common stock equivalents, respectively, based on the treasury stock
method). As the Company had net losses for the periods 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,"
requires public companies 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-14
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
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
measurement 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-based employee 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.
In December 2004, the FASB issued SFAS No. 123-R, "Share-Based Payment," which
requires that the compensation cost relating to share-based payment transactions
(including the cost of all employee stock options) be recognized in the
financial statements. That cost will be measured based on the estimated fair
value of the equity or liability instruments issued. SFAS No. 123-R covers a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans. SFAS No.123-R replaces SFAS No. 123 and
supersedes APB 25. As originally issued, SFAS No. 123 established as preferable
a fair-value-based method of accounting for share-based payment transactions
with employees. However, that pronouncement permitted entities to continue
applying the intrinsic-value model of APB 25, provided that the financial
statements disclosed the pro forma net income or loss based on the preferable
fair-value method.
F-15
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
STOCK BASED COMPENSATION (continued)
Small Business Issuers are required to apply SFAS No. 123-R in the first interim
or annual reporting period of the registrant's first fiscal year that begins
after December 15, 2005. Thus, the Company's consolidated financial statements
will reflect an expense for (a) all share-based compensation arrangements
granted on or after January 1, 2006 and for any such arrangements that are
modified, cancelled, or repurchased on or after that date, and (b) the portion
of previous share-based awards for which the requisite service has not been
rendered as of that date, based on the grant-date estimated fair value.
Management has not yet determined the future effect of FAS 123-R on its
consolidated financial statements.
At March 31, 2005, the Company has one stock-based employee compensation plan
(the "Plan"), which is described more fully in Note 9. The Company accounts for
the Plan under the recognition and measurement principles of APB 25, and related
interpretation. Prior to the year ended March 31, 2005, no stock-based employee
compensation cost was recognized in net loss. Stock options granted under the
Plan had exercise prices equal to or greater than the estimated fair value of
the underlying common stock on the dates of grant. In February 2005, the Company
granted 5,303,275 stock options to directors, all at a price that was $0.08
below the estimated fair value of the underlying common stock on the date of
grant. Accordingly, the Company recorded approximately $424,000 of compensation
expense in the accompanying consolidated statement of operations for the year
ended March 31, 2005. The following table illustrates the effect on net loss and
loss per common share if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation.
YEAR ENDED MARCH 31,
----------------------------
2005 2004
------------ ------------
Net loss available to common stockholders, as reported $ 2,096,951 $ 1,518,798
Add back: Recorded intrinsic value (424,262) --
Pro forma compensation expense 2,386,474 6,000
------------ ------------
Pro forma net loss available to common stockholders $ 4,059,163 $ 1,524,798
============ ============
Loss per common share, as reported
Basic and diluted $ (0.15) $ (0.19)
Loss per common share, pro forma
Basic and diluted $ (0.29) $ (0.19)
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS
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
F-16
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS (continued)
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.
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.
In December 2004, the FASB issued SFAS No. 153, "EXCHANGE OF NONMONETARY ASSETS,
AND AMENDMENT OF APB NO. 29, "ACCOUNTING FOR NONMONETARY TRANSACTIONS." The
amendments made by SFAS No. 153 are based on the principle that exchanges of
nonmonetary assets should be measured using the estimated fair value of the
assets exchanged. SFAS No. 153 eliminates the narrow exception for nonmonetary
exchanges of similar productive assets, and replaces it with a broader exception
for exchanges of nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has "commercial substance" if the future cash flows of the
entity are expected to change significantly as a result of the transaction. This
pronouncement is effective for nonmonetary exchanges in fiscal periods beginning
after June 15, 2005. Management is evaluating the future effect of this
pronouncement.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections," which replaces APB Opinion No. 20 and FASB Statement No. 3. This
pronouncement applies to all voluntary changes in accounting principle, and
revises the requirements for accounting for and reporting a change in accounting
principle. SFAS No. 154 requires retrospective application to prior periods'
financial statements of a voluntary change in accounting principle, unless it is
impracticable to do so. This pronouncement also requires that a change in the
method of depreciation, amortization, or depletion for long-lived, non-financial
assets be accounted for as a change in accounting estimate that is effected by a
change in accounting principle. SFAS No. 154 retains many provisions of APB
Opinion 20 without change, including those related to reporting a change in
accounting estimate, a change in the reporting entity, and correction of an
error. The pronouncement also carries forward the provisions of SFAS No. 3 which
govern reporting accounting changes in interim financial statements. SFAS No.
154 is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. The Statement does not change the
transition provisions of any existing accounting pronouncements, including those
that are in a transition phase as of the effective date of SFAS No. 154.
Management is evaluating the future effect of this pronouncement.
Other recent accounting pronouncements are discussed elsewhere in these notes to
the consolidated financial statements.
F-17
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS (continued)
Other recent accounting pronouncements issued by the FASB (including
its Emerging Issues Task Force), the American Institute of Certified Public
Accountants, and 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.
STOCK PURCHASE WARRANTS ISSUED WITH NOTES PAYABLE
The Company granted warrants in connection with the issuance of certain notes
payable (see Notes 6, 7 and 8). Under Accounting Principles Board Opinion No.
14, "ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH STOCK PURCHASE
WARRANTS", as amended, the relative 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
consolidated 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.
BENEFICIAL CONVERSION FEATURE OF CONVERTIBLE NOTES PAYABLE
The convertible feature of certain notes payable (see Notes 6 and 7) 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 using the effective
yield method. The Company has determined the fair value of such BCF to be
approximately $0 and $325,000 for the years ended March 31, 2005 and 2004,
respectively.
RESEARCH AND DEVELOPMENT EXPENSES
The Company incurred approximately $496,000 and $200,000 of research and
development expenses during the years ended March 31, 2005 and 2004,
respectively, which are included in operating expenses in the accompanying
consolidated statements of operations.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has not entered into any off-balance sheet arrangements that have or
are reasonably likely to have a current or future material effect on the
Company's financial statements.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2004 financial statement
presentation to correspond to the 2005 presentation.
F-18
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at March 31, 2005:
Furniture and office equipment $ 239,073
Accumulated depreciation (208,707)
---------------
$ 30,366
===============
Depreciation expense for the years ended March 31, 2005 and 2004 approximated
$16,000 and $8,000, respectively.
3. PATENTS
Patents include both foreign and domestic patents. There were no patents pending
at March 31, 2005 and there were no patents or patents pending acquired during
the years ended March 31, 2005 and 2004. 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, 2005 and 2004, no capitalized patent
costs were written off. At March 31, 2005, the gross carrying amount of patents
and the related accumulated amortization approximated $339,000 and $125,000,
respectively. Amortization of patents approximated $23,000 and $29,000 during
the years ended March 31, 2005 and 2004, respectively. Amortization expense on
patents is estimated to be approximately $15,000 per year for the next five
fiscal years. The weighted average amortization period for patents was
approximately 14 years at March 31, 2005. Some of the Company's patents have
expired and others may expire before FDA approval, if any, is obtained.
4. OTHER ASSETS
Other assets consist of approximately $17,000 of deposits and approximately
$20,000 of advances to employees.
5. 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, which was subsequently amended to
increase the term to four years, with Syngen's sole shareholder to perform
research. The cost associated with this employment contract was amortized over
four years on a straight-line basis and was fully amortized as of March 31,
2004.
6. DEBT-TO-EQUITY CONVERSION PROGRAM
In March 2002, for a limited time, 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 entailed the
conversion of liabilities at a rate of one share and one-half of a warrant for
every $1.25 converted. The warrants had an exercise price of $2.00 per share and
expired three years from the date of issuance; none are outstanding at March 31,
2005.
7. NOTES PAYABLE
12% AND 15% NOTES
From August 1999 through September 2000, the Company entered into arrangements
for the issuance of notes payable from private placement offerings (the "12%
Notes") in the original aggregate amount of $422,500. The 12% Notes
F-19
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
7. NOTES PAYABLE (continued)
12% AND 15% NOTES (continued)
bore annual interest at 12% (15% after maturity), required interest to be paid
quarterly, matured one year from the date of issuance, and carried detachable
warrants. These notes have no acceleration provisions. In June 2004, one such
note in the principal amount of $12,500 plus accrued interest was repaid. In
December 2004, each of two such notes in the principal amount of $25,000, plus
$17,778 accrued interest, were converted to 87,303 restricted common shares at
$0.49 per share. At March 31, 2005, $272,500 of the 12% Notes were outstanding
and delinquent, in default, and bore interest at 15% (the "15% Notes").
During the year ended March 31, 2004, $37,500 of principal balance of the 15%
Notes held by two noteholders were converted to Company common stock. One
noteholder converted $12,500 of notes including interest of $5,088 for 27,059
shares of common stock and warrants to purchase 27,059 shares of common stock at
$0.65 per share (see Note 9). These warrants were valued using the Black Scholes
option pricing model; the relative fair value was insignificant and was charged
to interest expense upon grant. The second noteholder converted an aggregate of
$25,000 of 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 9). 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 these two notes.
10% NOTES
In October 2004, the Company issued two $40,000, 10% one year promissory notes
each with 80,000 three-year warrants to purchase common stock at $0.50 per share
and 44,444 three-year warrants to purchase common stock at $0.90 per share for
cash in the total amount of $80,000 to two accredited individual investors. In
accordance with GAAP, the proceeds of the financing have been allocated to the
debt and the warrants, based on their relative fair values. Accordingly, a
discount of $46,000 has been recorded as a reduction in the debt balance, and
the off-setting credit has been recorded as additional paid-in capital. The debt
discount is amortized and charged to interest expense over the life of the debt.
At March 31, 2005, approximately $23,000 of such discount was unamortized and is
included in notes payable in the accompanying consolidated balance sheet. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In October 2004, the Company issued a $50,000, 10% one-year promissory note plus
100,000 three-year warrants to purchase common stock at $0.50 per share and
55,555 three-year warrants to purchase common stock at $0.90 per share for cash
in the amount of $50,000 to an accredited individual investor. In accordance
with GAAP, the proceeds of the financing have been allocated to the debt and the
warrants, based on their relative fair values. Accordingly, a discount of
$38,000 has been recorded as a reduction in the debt balance, and the
off-setting credit has been recorded as additional paid-in capital. The debt
discount is amortized and charged to interest expense over the life of the debt.
At March 31, 2005, approximately $22,000 of such discount was unamortized and is
included in notes payable in the accompanying consolidated balance sheet. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933. As of March 31, 2005, $20,000 in principal amount of
this note has been reduced through application of the note to exercise a portion
of the warrants.
The total outstanding balance of the 15% Notes at March 31, 2005 was $272,500,
which is included in notes payable in the accompanying consolidated balance
sheet. The remaining $219,809 net balance included in notes payable is comprised
of the $150,000 9% Convertible Note (see Note 8), one $5,000 10% Convertible
Note (see Note 8), both of which were no longer convertible as of March 31,
2005, and the three 10% notes mentioned above, of which the remaining principal
amounts totaling $110,000 was reduced by the remaining $45,191 unamortized debt
discounts attributed to the warrants attached to these notes.
Notes payable consist of the following at March 31, 2005:
15% Notes payable, all past due $272,500
10% Note payable, past due 5,000
18% Note payable, past due 150,000
10% Notes payable, principal due in
October 2005, net of discounts of $45,191 64,809
--------
$492,309
========
Management's plans to satisfy the remaining outstanding balance on these notes
include converting the notes to common stock at market value or repayment with
available funds.
F-20
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
8. CONVERTIBLE NOTES PAYABLE
8% CONVERTIBLE NOTE
In November 2000, the Company issued convertible notes payable ("8% Convertible
Notes") with original issue amounts totaling $395,000, 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 common 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 common 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 was 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 accrued and expensed penalties approximating $244,000
through March 31, 2004 in connection with not filing an effective registration
statement. During the year ended March 31, 2005 it was discovered that the
penalties did not have to be paid. Accordingly, such amount was reversed in
fiscal 2005 and is included as a credit to interest expense in the accompanying
consolidated statements of operations.
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. At March
31, 2004, this was the only outstanding 8% Convertible Note, which had a
remaining balance of $125,000. This note balance, including accrued interest of
$38,370, was converted in September 2004 to 479,513 shares of common stock at
$0.34 in accordance with the original agreement.
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 and currently bears penalty
interest at 18% per annum. 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 noteholder. The Company recorded a 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, the outstanding balance totaling $150,000 has been recorded as
notes payable in the accompanying consolidated balance sheet. Therefore, there
were no remaining 9% Convertible Notes outstanding as of March 31, 2005.
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. The total amount of
the original notes issued was $275,000.
F-21
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
8. CONVERTIBLE NOTES PAYABLE (continued)
10% CONVERTIBLE NOTES (continued)
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.
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 9). 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. 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 Company's private placement with Fusion Capital.
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. These warrants were valued using the Black Scholes
option pricing model, the relative pro-rata fair value was insignificant, and
charged to interest expense upon grant.
In July 2004, the Company repaid a 10% Convertible Note in the principal amount
of $10,000, plus accrued interest. This note was classified as notes payable as
of March 31, 2004 since the note was no longer convertible at such time.
A BCF approximating $137,000 was recorded during the year ended March 31, 2004
related to the issuance of the 10% Convertible Notes.
A 10% Convertible Note in the amount of $5,000, was past due and in default at
March 31, 2005. As this note is no longer convertible at March 31, 2005, the
outstanding balance is included in notes payable in the accompanying
consolidated balance sheet (see Note 7). At March 31, 2005, interest payable on
this note totaled $1,875.
F-22
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS
2003 CONSULTANT STOCK PLAN
In August 2003, the Company adopted the 2003 Consultant Stock Plan (the "Stock
Plan"), which provides for grants of common stock through August 2013, to assist
the Company in obtaining and retaining the services of persons providing
consulting services for the Company. A total of 1,000,000 common shares are
reserved for issuance under the Stock Plan. On March 29, 2004, the Company filed
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.
2005 DIRECTORS COMPENSATION PROGRAM
In February 2005, the Company adopted the 2005 Directors Compensation Program
(the "Directors Compensation Program") to assist in obtaining and retaining the
services of outside directors. Under the Directors Compensation Program, a newly
elected director will receive a one time grant of a non-qualified stock option
of 1.5% of the common stock outstanding at the time of election. The options
will vest one-third at the time of election to the board and the remaining
two-thirds will vest equally at year end over three years. Additionally, each
director will also receive an annual $25,000 non-qualified stock option
retainer, $15,000 of which is to be paid at the first of the year to all
directors who are on the Board prior to the first meeting of the year and a
$10,000 retainer will be paid if a director attends 75% of the meetings either
in person, via conference call or other electronic means. The exercise price for
the options under the Directors Compensation Program will equal the average
closing of the last ten (10) trading days prior to the date earned.
COMMON STOCK
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.
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 7 and 8)
and warrants to purchase 802,848 shares of common stock ( see "Warrants" below).
In April 2004, the Company issued 500,000 shares of restricted common stock to
an accredited individual investor in connection with the exercise of warrants at
$0.25 per share for cash totaling $125,000. This transaction was exempt from
registration pursuant to Regulation D promulgated under the Securities Act of
1933.
In April 2004, the Company issued 17,143 shares at $1.75 per share to an
accredited individual investor for investor relations services in the amount of
$30,000. This transaction was exempt from registration pursuant to Section 4(2)
of the Securities Act of 1933.
F-23
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
COMMON STOCK (continued)
In April 2004, the Company issued 50,000 shares of restricted common stock to
Fusion Capital Fund II, LLC, an accredited institutional investor, for a
financing commitment to provide $6,000,000 under a registered private placement.
In connection with the $6,000,000 financing the Company paid a fee to Fusion
Capital in the amount of 418,604 shares of common stock. The Company recorded no
expense related to the issuance of these shares since they were related to
equity fund raising activities. This transaction was exempt from registration
pursuant to Regulation D promulgated under the Securities Act of 1933.
In May 2004, the Company issued 225,000 shares of common stock at $0.44 per
share and 225,000 warrants to purchase the Company's common stock at a price of
$0.76 per share to legal counsel for legal services in the amount of $99,000,
which was recorded as expense in the accompanying consolidated financial
statements. This transaction was exempt from registration pursuant to Section
4(2)of the Securities Act of 1933.
In May 2004, a $50,000 10% convertible note was converted at $0.44 per share for
113,636 shares of common stock and 113,636 warrants to purchase the Company's
common stock at a price of $0.76 per share. This transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
In May 2004, the Company issued a total of 1,415,909 shares of restricted stock
at a price of $0.44 per share for cash totaling $623,000 to fourteen accredited
investors. In connection with the issuance of these shares, the Company granted
the stockholders 1,640,908 warrants to purchase the Company's common stock at a
price of $0.76 per share. The warrants vested immediately and expire on the
fifth anniversary from the date when a registration statement covering the
common stock underlying such warrants is declared effective. This transaction
was exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
In July 2004, the Company issued 10,715 shares of restricted common stock at
$0.70 per share to an accredited individual for employee placement services in
the amount of $7,500. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
In July 2004, the Company issued 6,850 shares of restricted common stock at
$0.73 per share to an accredited individual for consulting services on
opportunities for the Company's Hemopurifier(TM) within the biodefense
marketplace in the amount of $5,000. This transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
In September 2004, the Company issued 479,513 shares of restricted common stock
to an accredited investor, in conjunction with the conversion of $125,000 in
principal amount of notes, plus accrued interest, at $0.34 per share, in
accordance with their convertible note agreement (see Note 8). This transaction
was exempt from registration pursuant to Regulation D promulgated under the
Securities Act of 1933.
In November and December 2004, the Company issued 80,000 shares of restricted
common stock to an accredited individual investor in connection with the
exercise of 80,000 warrants at $0.25 per share for consideration of a $20,000
reduction in the principal amount of a 10% one-year promissory note. This
transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In December 2004, the Company issued 461,667 shares of restricted common stock
to two accredited individual investors in connection with the exercise of
461,667 warrants at $0.25 per share for cash totaling $115,417. This transaction
was exempt from registration pursuant to Section 4(2) of the Securities Act of
1933.
F-24
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
COMMON STOCK (continued)
In December 2004, the Company repaid two $25,000 12% promissory notes, including
accrued interest of $17,778 each, through the issuance of 87,303 restricted
common shares at $0.49 per share to each of two separate accredited individual
investors. These transactions were exempt from registration pursuant to Section
4(2) of the Securities Act of 1933.
In December 2004, the Company issued 60,000 shares of restricted common stock at
$0.50 per share under a consulting agreement with an accredited
individualinvestor, for investor relations consulting services to the Company.
The fair value of the transaction of $30,000 was recorded as deferred
compensation and presented as an offset to additional paid-in capital in the
accompanying consolidated financial statements. Such amount is being amortized
to expense over the six month term of the agreement. At March 31, 2005, $15,000
of such amount remained unamortized. This transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933.
In January 2005, the Company issued 55,556 shares of restricted common stock at
$0.36 per share and a warrant to purchase 55,556 shares of common stock at $0.44
per share for cash in the amount of $20,000 to an accredited individual
investor. This transaction was exempt from registration pursuant to Section
4(2)of the Securities Act of 1933.
In January 2005, the Company issued 66,666 shares of restricted common stock at
$0.45 per share to an accredited individual investor under a consulting
agreement for investor relations services to the Company. The fair value of the
transaction of $30,000 was recorded as deferred compensation and presented as an
offset to additional paid-in capital in the accompanying consolidated financial
statements. Such amount is being amortized to expense over the six month term of
the agreement. At March 31, 2005, $15,000 of such amount remained unamortized.
This transaction was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In January 2005, the Company issued 25,834 shares of restricted common stock to
an accredited individual investor in connection with the exercise of a warrant
to purchase 25,834 shares of common stock at $0.25 per share for cash totaling
$6,459. This transaction was exempt from registration pursuant to Section 4(2)
of the Securities Act of 1933.
In February 2005, the Company issued 139,063 shares of restricted common stock
to an accredited individual investor in connection with the exercise of a
warrant to purchase 139,063 shares of common stock at $0.25 per share for cash
totaling $34,766. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
In February 2005, the Company issued 90,000 shares of restricted common stock at
$0.27 per share and a three-year warrant to purchase 90,000 shares of common
stock at $0.34 per share for cash in the amount of $24,300 to an accredited
individual investor. This transaction was exempt from registration pursuant to
Section 4(2)of the Securities Act of 1933.
During the year ended March 31, 2005, the Company issued an additional total of
1,416,958 shares of restricted common stock at prices ranging from $0.25 to
$0.52 for total cash proceeds of approximately $541,000.
During the year ended March 31, 2005, the Company issued an additional 557,647
shares of restricted common stock at prices ranging from $0.25 to $0.55 under
various consulting service agreements for total recorded value of approximately
$196,000. All services on these agreements were completed and expensed during
the year ended March 31, 2005.
F-25
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
WARRANTS
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
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
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
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
expense has been recorded in the accompanying consolidated financial statements.
During the year ended 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 7 and 8). 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 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 7 and 8). 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 ended 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 7 and 8). 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.
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.
In August 2004, the Company issued a one-year warrant, which vests immediately,
to purchase 7,000 shares of common stock at $0.55 per share to an accredited
corporate entity in conjunction with a $6,000 fee for investor and public
relations services. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
F-26
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
WARRANTS (continued)
During the year ended March 31, 2005, the Company granted 568,181 warrants to an
investor in connection with a commitment fee for the purchase of common stock.
The warrants have an exercise price of $0.76 per share, vest immediately and are
exercisable through May 2009. As the warrants were issued in connection with
equity financing, no expense has been recorded in the accompanying consolidated
financial statements.
During the year ended March 31, 2005, the Company granted 847,727 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.76 per share, vest immediately and are exercisable through
May 2009. As the warrants were issued in connection with equity financing, no
expense has been recorded in the accompanying consolidated financial statements.
During the year ended March 31, 2005, the Company issued 113,636 warrants to
purchase common stock for $0.76 per share, which are exercisable through May
2009 and vested upon grant. The warrants were issued in connection with the
conversion of notes payable (see Notes 7 and 8). 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, 2005, the Company issued 225,000 warrants to
purchase common stock for $0.76 per share, which are exercisable through May
2009 and vested upon grant. The warrants were issued in connection with common
stock issued for legal services expense totaling $99,000 (see "Common Stock"
above).
During the year ended March 31, 2005, the Company issued 260,000 warrants to
purchase common stock for $0.50 per share, which vested upon grant and expire in
October 2007. The warrants were issued in connection with the issuance of notes
payable (see Note 7). These warrants were valued using the Black Scholes option
pricing model; the relative pro-rata estimated fair value is being amortized to
interest expense over the life of the notes.
During the year ended March 31, 2005, the Company issued 144,443 warrants to
purchase common stock for $0.90 per share, which vested upon grant and expire in
October 2007. The warrants were issued in connection with the issuance of notes
payable (see Note 7). These warrants were valued using the Black Scholes option
pricing model; the relative pro-rata estimated fair value was amortized to
interest expense over the life of the notes.
During the year ended March 31, 2005, the Company granted 55,556 warrants to An
investor in connection with the purchase of common stock. The warrants have an
exercise price of $0.44 per share, vest immediately and are exercisable through
January 2008. As the warrants were issued in connection with equity financing,
no expense has been recorded in the accompanying consolidated financial
statements.
During the year ended March 31, 2005, the Company granted 90,000 warrants to
investors in connection with the purchase of common stock. The warrants have an
exercise price of $0.34 per share, vest immediately and are exercisable through
February 2008. As the warrants were issued in connection with equity financing,
no expense has been recorded in the accompanying consolidated financial
statements.
As noted under "Common Stock", 1,206,564 warrants with an exercise price of
$0.25 per share, which were granted to investors in connection with the purchase
of common stock, were exercised during the year ended March 31, 2005.
F-27
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
WARRANTS (continued)
A summary of the aggregate warrant activity for the years ended March 31, 2005
and 2004 is presented below:
Year Ended March 31,
-----------------------------------------------------
2005 2004
------------------------- -------------------------
Weighted Weighted
Average Exercise Average Exercise
Warrants Price Warrants Price
----------- ----------- ----------- -----------
Outstanding, beginning of year 3,793,194 $ 2.22 2,906,746 $ 2.29
Granted 2,311,543 $ 0.71 2,253,848 0.29
Exercised (1,206,564) $ 0.25 (540,000) 0.25
Cancelled/Forfeited (2,064,339) $ 2.75 (827,400) 0.25
----------- --------- ---------- ---------
Outstanding, end of year 2,833,834 $ 0.91 3,793,194 $ 2.22
=========== ========= ========== =========
Exercisable, end of year 2,833,834 $ 0.91 3,793,194 $ 2.22
=========== ========= ========== =========
Weighted average estimated fair
value of warrants granted $ 0.60 $ 0.40
========= =========
The following outlines the significant weighted average assumptions used to
estimate the fair value information presented utilizing the Black-Scholes option
pricing model:
Years Ended March 31,
2005 2004
----------- -----------
Risk free interest rate 2.00% 2.50%
Average expected life 2 years 3 years
Expected volatility 139% 365%
Expected dividends None None
The detail of the warrants outstanding and exercisable as of March 31, 2005 is
as follows:
Warrants Outstanding Warrants Exercisable
--------------------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Number Remaining Exercise Number Exercise
Range of Exercise Prices Outstanding Life (Years) Price Outstanding Price
--------------------------- -------------- ------------- ---------- --------------- ----------
$0.25 185,430 2.72 $ 0.25 185,430 $ 0.25
$0.34 - $0.90 2,311,543 3.76 $ 0.71 2,311,543 $ 0.71
$2.00 - $4.00 302,986 0.82 $ 2.77 302,986 $ 2.77
$5.00 33,875 0.28 $ 5.00 33,875 $ 5.00
-------------- ---------------
2,833,834 2,833,834
============== ===============
F-28
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
OPTIONS
At March 31, 2005 the Company had issued 1,337,825 options to outside directors
and 3,965,450 options to employee-directors under the 2005 Directors
Compensation Program.
From time to time, the Company's Board of Directors grants common share purchase
options or warrants to selected directors, officers, employees, consultants and
advisors in payment of goods or services provided by such persons on a
stand-alone basis outside of any of the Company's formal stock plans. The terms
of these grants are individually negotiated.
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). At March 31, 2005, the Company had granted 47,500 options under
the 2000 Stock Option Plan, with 452,500 available for future issuance.
In March 2002, the Board of Directors granted the Company's Chief Executive
Officer ("CEO") and Chief Scientific Officer ("CSO") 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 of the underlying common stock at
grant date) and expire March 2012. Awards are earned upon achievement of certain
financial and/or research and development milestones. On July 1, 2005, the
Company's CEO forfeited all of his aforementioned 250,000 options.
In February 2005, the Board of Directors granted the Company's Chief Executive
Officer ("CEO")and Chief Scientific Officer ("CSO") non-qualified stock options
to purchase up to 2,231,100 and 1,734,350 shares of common stock, respectively,
at an exercise price of $0.38 per share and vest fifty percent immediately,
twenty-five percent in December 2005 and twenty-five percent in December 2006.
In addition Mr. Calvin Leung, a board member, was granted non-qualified stock
options to purchase up to 308,725 shares at $0.38 that vest fifty percent
immediately, twenty-five percent in December 2005 and twenty-five percent in
December 2006. Messrs. Franklyn S Barry and Edward G Broenniman, board members,
were each granted non-qualified stock options to purchase up to 514,550 shares
at $0.38 that vest forty percent immediately, twenty-five percent in December
2005 and twenty-five percent in December 2006. All of these options granted
expire in 2010 and 2011 and were granted at a price that was $0.08 below the
estimated fair value of the underlying common stock on the date of grant.
Accordingly, the Company recorded approximately $424,000 of compensation expense
in the accompanying consolidated statement of operations for the year ended
March 31, 2005.
The following is a summary of the stock options outstanding at March 31, 2005
and 2004 and the changes during the two years then ended:
Year Ended March 31,
-----------------------------------------------------
2005 2004
------------------------- -------------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
----------- ----------- ----------- -----------
Outstanding, beginning of year 1,376,115 $ 2.49 1,376,115 $ 2.49
Granted 5,303,275 0.38 -- --
Exercised -- -- -- --
Cancelled/Forfeited -- -- -- --
----------- ----------- ----------- ----------
Outstanding, end of year 6,679,390 $ 0.80 1,376,115 $ 2.49
=========== =========== =========== ==========
Exercisable, end of year 3,924,856 $ 1.10 1,363,615 $ 2.51
=========== =========== =========== ==========
Weighted average estimated fair
value of options granted $ 0.45 $ --
=========== ==========
F-29
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
9. EQUITY TRANSACTIONS (continued)
OPTIONS (continued)
The following outlines the significant weighted average assumptions used to
estimate the fair value information presented utilizing the Black-Scholes option
pricing model for the year ended March 31, 2005 (there were no issuances in
fiscal 2004):
Risk free interest rate 3.75
Average expected life 4 years
Expected volatility 225%
Expected dividends None
The detail of the options outstanding and exercisable as of March 31, 2005 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
--------------- ------------- ------------ --------------- ---------
$0.38 - $0.39 5,354,123 5.58 years $ 0.38 2,599,589 $ 0.38
$1.78 - $2.00 515,267 6.91 years $ 1.90 515,267 $ 1.90
$2.25 - $3.00 602,500 2.26 years $ 2.78 602,500 $ 2.78
$3.25 - $3.75 207,500 0.92 years $ 3.27 207,500 $ 3.27
----------- ----------
6,679,390 3,924,856
=========== ==========
10. 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.
Other related party transactions are disclosed elsewhere in these notes to
consolidated financial statements.
11. INCOME TAX PROVISION
Income tax expense for the years ended March 31, 2005 and 2004 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:
F-30
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
11. INCOME TAX PROVISION (continued)
2005 2004
----------- -----------
Computed "expected" tax benefit $(713,000) $(516,000)
Reduction in income taxes resulting from:
Interest for warrants and BCF -- 94,000
Change in deferred tax assets valuation allowance 814,000 583,000
State and local income taxes,
net of federal benefit (125,000) (134,000)
Other 24,000 (27,000)
----------- -----------
$ -- $ --
=========== ===========
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets at March 31, 2005 are presented below:
Deferred tax assets:
Capitalized research and development $ 2,099,000
Net operating loss carryforwards 3,679,000
Equity based compensation 136,000
-----------
Total gross deferred tax assets 5,914,000
Less valuation allowance (5,914,000)
-----------
Net deferred tax assets $ --
===========
As of March 31, 2005, the Company had tax net operating loss carryforwards of
approximately $9,700,000 and $4,500,000 available to offset future taxable
Federal and state income, respectively. The carryforward amounts expire in
various years through 2025.
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.
12. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT CONTRACTS
In addition to the employment contract discussed in Note 3, 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 ("CEO") effective June 1, 2001 upon which the base annual salary was
increased from $120,000 to $180,000. Effective January 1, 2005, the CEO's salary
was increased from $180,000 to $205,000 per year. The CEO is eligible for an
annual bonus at the discretion of the Board of Directors, of which $20,000 and
nil was earned during each of the years ended March 31, 2005 and 2004,
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-31
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
12. COMMITMENTS AND CONTINGENCIES (continued)
EMPLOYMENT CONTRACTS (continued)
The Company entered into an employment agreement with Dr. Tullis effective
January 10, 2000. Effective June 1, 2001, Dr. Tullis was appointed the Company's
Chief Science Officer of the Company. His compensation under the agreement was
modified in June 2001 from $80,000 to $150,000 per year. Effective January 1,
2005 Dr. Tullis' salary was increased from $150,000 to $165,000 per year Under
the terms of the agreement, his employment continues at a salary of $165,000 per
year for successive one-year periods, unless given notice of termination 60 days
prior to the anniversary of his employment agreement. Dr. Tullis was granted
250,000 stock options to purchase the Company's common stock in connection the
completing certain milestones, such as the initiation and completion of certain
clinical trials, the submission of proposals to the FDA and the filing of a
patent application. 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 twelve months base salary.
LEASE COMMITMENTS
The Company leases its office and research and development space under an
operating lease agreement which expires in July 2006.
The Company is committed to make the approximate future aggregate rental
payments under the terms of the lease agreement as noted below.
Year Ended
March 31,
----------
2006 $ 90,000
2007 23,000
----------
Total commitment $ 113,000
==========
Rent expense approximated $106,000 and $57,000 for the years ended March 31,
2005 and 2004, respectively.
13. SUBSEQUENT EVENTS (unaudited)
In April 2005, the Company issued 9,740 shares of common stock pursuant
to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.308 per share in payment for scientific consulting
services to the Company
In April 2005, the Company issued 12,567 shares of common stock
pursuant to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.2984 per share in payment for regulatory affairs
consulting services to the Company
In April 2005, the Company issued 12,567 shares of common stock
pursuant to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.2984 per share in payment for regulatory affairs
consulting services to the Company
In April 2005, the Company issued 15,712 shares of common stock
pursuant to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.2514 per share in payment for regulatory affairs
consulting services to the Company
In April 2005, the Company issued 15,712 shares of common stock
pursuant to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.2514 per share in payment for regulatory affairs
consulting services to the Company
In April 2005, the Company issued 394,235 shares of common stock at
prices between $0.250 to and $0.280 per share to Fusion Capital under its
$6,000,000 common stock purchase agreement. Fusion advanced the Company $100,000
in April 2005 for the purchase of additional shares under such agreement. These
shares are registered pursuant to the Company's Form SB-2 registration statement
effective December 7, 2004.
In May 2005, the Company issued 19,084 shares of common stock pursuant
to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.262 per share in payment for regulatory affairs
consulting services to the Company.
In May 2005, the Company issued 11,450 shares of common stock pursuant
to the Company's S-8 registration statement covering the Company's 2003
Consulting Stock Plan at $0.262 per share to in payment for regulatory affairs
consulting services to the Company.
On May 11, 2005, the Company agreed to issue 836,730 shares of
restricted common stock and a three-year warrant to purchase 418,365 shares of
the Company's restricted common stock at an exercise price of $0.25 to legal
counsel for payment of legal services in the amount of $167,346. The Company and
legal counsel agreed that the issuance of the restricted shares and the warrant
will be delayed until the Company receives shareholder approval to increase the
Company's authorized number of shares of common stock to 50,000,000.
F-32
AETHLON MEDICAL, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
--------------------------------------------------------------------------------
13. SUBSEQUENT EVENTS (unaudited) (continued)
On May 16, 2005 the Company issued Fusion Capital ("Fusion) a $30,000
Convertible Promissory Note (the "Note") with an interest rate of fifteen
percent (15%) per annum that matures on August 15, 2005. The Note is convertible
into shares of restricted common stock at any time at the election of Fusion at
a conversion price equal to $0.20 per share for any conversion occurring on or
prior to the Maturity Date, or at a price equal to the lesser of (i) 75% of the
average of the three (3) lowest closing sale prices of the common shares during
the twelve (12) trading days prior to the submission of a conversion notice or
(ii) $0.20 per share, for any conversion occurring after the Maturity Date. In
addition, the Company issued Fusion a five-year warrant to purchase 300,000
shares of the Company's common stock at an exercise price of $0.25 per share
(the "Warrant"). The Note and the Warrant have piggyback registration rights.
This transaction was exempt from registration pursuant to Regulation D
promulgated under the Securities Act of 1933.
F-33