10-Q 1 aethlon_10q-093012.htm FORM 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____to_____

 

COMMISSION FILE NUMBER 000-21846

 

AETHLON MEDICAL, INC.

 

(Exact name of registrant as specified in its charter)

 

NEVADA   13-3632859
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

8910 UNIVERSITY CENTER LANE, SUITE 660, SAN DIEGO, CA 92122

(Address of principal executive offices) (Zip Code)

 

 

(858) 459-7800 

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   YES x    NO o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  o Accelerated filer  o

Non-accelerated filer   o

(Do not check if a smaller reporting company)

Smaller reporting company  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES o NO x

 

As of November 13, 2012, the registrant had outstanding 156,956,675 shares of common stock, $.001 par value.

 

 

 
 

 

PART I. FINANCIAL INFORMATION  
     
ITEM 1. FINANCIAL STATEMENTS  
     
  CONDENSED CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 2012 (UNAUDITED) AND MARCH 31, 2012 3
     
  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011 (UNAUDITED) 4
     
  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011 (UNAUDITED) 5
     
  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 7
     
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 27
     
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 32
     
ITEM 4. CONTROLS AND PROCEDURES 32
     
PART II.  OTHER INFORMATION 32
     
ITEM 1. LEGAL PROCEEDINGS 32
     
ITEM 1A. RISK FACTORS 33
     
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 33
     
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 34
     
ITEM 4. MINE SAFETY DISCLOSURES 34
     
ITEM 5. OTHER INFORMATION 34
     
ITEM 6. EXHIBITS 34

 

 

 

2
 

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

AETHLON MEDICAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   September 30,   March 31, 
   2012   2012 
   (Unaudited)     
ASSETS          
Current assets          
Cash  $271,747   $143,907 
Accounts receivable       400,114 
Deferred financing costs   2,273    120,563 
Prepaid expenses and other current assets   63,514    31,452 
Total current assets   337,534    696,036 
           
Property and equipment, net   578    1,465 
Patents and patents pending, net   126,235    130,817 
Deposits   10,376    10,376 
Total assets  $474,723   $838,694 
           
LIABILITIES AND STOCKHOLDERS' DEFICIT          
           
Current Liabilities          
Accounts payable  $616,250   $586,340 
Due to related parties   720,070    730,070 
Notes payable   452,114    654,796 
Convertible notes payable, net of discounts   2,392,179    3,005,473 
Derivative liabilities   3,194,394    3,588,615 
Accrued liquidated damages   437,800    437,800 
Other current liabilities   1,133,269    1,131,221 
Total current liabilities   8,946,076    10,134,315 
           
Commitments and Contingencies (Note 13)          
           
Stockholders' Deficit          
Common stock, par value $0.001 per share; 500,000,000 shares authorized as of September 30, 2012 and 250,000,000 as of March 31, 2012; 153,743,553 and 117,515,892 shares issued and outstanding as of September 30, 2012 and March 31, 2012, respectively   153,746    117,518 
Additional paid-in capital   50,397,321    47,170,146 
Accumulated deficit   (59,022,420)   (56,583,285)
Total stockholders’ deficit   (8,471,353)   (9,295,621)
Total liabilities and stockholders' deficit  $474,723   $838,694 

 

See accompanying notes.

 

3
 

AETHLON MEDICAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Six Month Periods Ended September 30, 2012 and 2011

(Unaudited)

 

   Three Months
Ended
September 30,
2012
   Three Months
Ended
September 30,
2011
   Six Months
Ended
September 30,
2012
   Six Months
Ended
September 30,
2011
 
                 
REVENUES                    
                     
Government contract revenue  $400,114   $   $616,861   $ 
                     
OPERATING EXPENSES                    
                     
Professional fees   450,999    242,001    928,120    610,194 
Payroll and related expenses   559,470    515,622    1,113,566    1,065,555 
General and administrative   189,439    125,334    366,758    239,687 
Total operating expenses   1,199,908    882,957    2,408,444    1,915,436 
OPERATING LOSS   (799,794)   (882,957)   (1,791,583)   (1,915,436)
                     
OTHER EXPENSE (INCOME)                    
Loss on debt conversion   71,080        96,059     
(Gain)/loss on change in fair value of derivative liability   326,138    (1,029,675)   (361,462)   (1,521,502)
Interest and other debt expenses   224,374    600,226    913,062    2,286,140 
Interest income   (62)   (31)   (107)   (882)
Other               360,185 
Total other expense (income)   621,530    (429,480)   647,552    1,123,941 
NET LOSS  $(1,421,324)  $(453,477)  $(2,439,135)  $(3,039,377)
                     
BASIC AND DILUTED LOSS PER COMMON SHARE  $(0.01)  $(0.00)  $(0.02)  $(0.03)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING – BASIC AND DILUTED   144,700,999    99,702,921    135,175,838    93,772,418 

 

 

See accompanying notes.

 

4
 

AETHLON MEDICAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Month Periods Ended September 30, 2012 and 2011

(Unaudited)

 

   Six Months   Six Months 
   Ended   Ended 
   September 30,   September 30, 
   2012   2011 
Cash flows from operating activities:          
           
Net loss  $(2,439,135)  $(3,039,377)
Adjustments to reconcile net loss to net cash used in operating activities:          
           
Depreciation and amortization   5,469    9,773 
Stock based compensation   395,495    448,062 
Loss on debt conversion   96,059     
Non cash interest expense   11,846    538,736 
Fair market value of common stock, warrants and options issued for services   139,182    249,878 
Change in fair value of derivative liabilities   (361,462)   (1,521,502)
Loss on settlement of convertible note termination       360,186 
Amortization of debt discount and deferred financing costs   582,497    1,522,486 
Changes in operating assets and liabilities:          
Prepaid expenses and other assets   (32,062)   18,394 
Accounts receivable   400,114     
Accounts payable and other current liabilities   296,447    377,318 
Due to related parties   (10,000)    
Net cash used in operating activities   (915,550)   (1,036,046)
           
Cash flows from investing activities:          
Purchases of property and equipment       (1,735)
Net cash used in investing activities       (1,735)
           
Cash flows from financing activities:          
Principal repayments of notes payable   (29,610)   (5,000)
Net proceeds from the issuance of convertible notes payable       872,656 
Proceeds from the issuance of common stock   1,073,000     
Proceeds from collection of secured notes receivable       200,000 
Net cash provided by financing activities   1,043,390    1,067,656 
           
Net increase in cash   127,840    29,875 
           
Cash at beginning of period   143,907    15,704 
           
Cash at end of period  $271,747   $45,579 

 

See accompanying notes.

  

5
 

AETHLON MEDICAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

For the Six Month Periods Ended September 30, 2012 and 2011

(Unaudited)

  

   Six Months
Ended
September 30,
2012
   Six Months
Ended
September 30,
2011
 
Supplemental disclosures of cash flow information:          
           
Cash paid during the period for:          
           
Interest  $2,821   $ 
           
Income taxes  $   $ 
           
Supplemental disclosures of non-cash investing and financing activities:          
           
           
Debt and accrued interest converted to common stock  $1,515,062   $1,472,611 
           
Deferred financing costs recorded in connection with debt amendment  $2,500   $ 
           
Debt discount recorded in connection with beneficial conversion feature of convertible notes and related warrants  $   $827,130 
           
           
Reclassification of note payable to convertible notes payable  $75,000   $ 
           
Reclassification of warrant derivative liability into equity  $32,759   $247,608 
           

 

 

See accompanying notes. 

 

 

6
 

 

AETHLON MEDICAL, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2012

 

NOTE 1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

 

Aethlon Medical, Inc. ("Aethlon", the "Company", "we" or "us") is a medical device company focused on creating innovative devices that address unmet medical needs in cancer, infectious disease and other life-threatening conditions. At the core of our developments is the Aethlon ADAPT™ (Adaptive Dialysis-Like Affinity Platform Technology) system, a medical device platform that converges single or multiple affinity drug agents with advanced plasma membrane technology to create therapeutic filtration devices that selectively remove harmful particles from the entire circulatory system without loss of essential blood components. Approval to embark on human trials is still needed to reach commercial viability of the Hemopurifier® and approval by the U.S. Food and Drug Administration ("FDA"). Successful outcomes of human trials will be required by the regulatory agencies of certain foreign countries where we intend to sell this device. We have submitted an Investigational Device Exemption ("IDE") to the FDA. Some of our patents may expire before FDA approval or approval in a foreign country, if any, is obtained. However, we believe that certain patent applications and/or other patents issued more recently will help protect the proprietary nature of the Hemopurifier(R) treatment technology.

 

Our common stock is quoted on the Over-the-Counter Bulletin Board administered by the Financial Industry Regulatory Authority ("OTCBB") under the symbol "AEMD.OB."

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and applicable sections of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary to make the financial statements not misleading have been included. The condensed consolidated balance sheet as of March 31, 2012 was derived from our audited financial statements. Operating results for the six months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending March 31, 2013. For further information, refer to our Annual Report on Form 10-K for the year ended March 31, 2012, which includes audited financial statements and footnotes as of March 31, 2012 and for the years ended March 31, 2012 and 2011.

 

NOTE 2. LIQUIDITY

 

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates, among other things, the realization of assets and the satisfaction of liabilities in the ordinary course of business. We have experienced continuing losses from operations, are in default on certain debt, have negative working capital of approximately $8,609,000, recurring losses from operations and an accumulated deficit of approximately $59,022,000 at September 30, 2012, which among other matters, raises significant doubt about our ability to continue as a going concern. We have not generated significant revenue or any profit from operations since inception. A significant amount of additional capital will be necessary to advance the development of our products to the point at which they may become commercially viable. Our current financial resources are insufficient to fund our 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, 2013 ("fiscal 2013"). Therefore we will be required to seek additional funds through debt and/or equity financing arrangements to finance our current and long-term operations.

 

We are currently addressing our liquidity needs by exploring investment capital opportunities through the private placement of common stock or issuance of additional debt. We believe that our access to additional capital, together with existing cash resources and anticipated receipts under the Defense Advanced Research Projects Agency (DARPA) contract, as discussed in Note 12, will be sufficient to meet our liquidity needs for fiscal 2013. However, no assurance can be given that we will receive any funds in connection with our capital raising efforts. 

 

The unaudited condensed consolidated financial statements do not include any adjustments relating to the recoverability of assets that might be necessary should we be unable to continue as a going concern.

 

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NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The summary of our significant accounting policies presented below is designed to assist the reader in understanding our condensed consolidated financial statements. Such financial statements and related notes are the representations of our management, who are responsible for their integrity and objectivity. These accounting policies conform to GAAP in all material respects, and have been consistently applied in preparing the accompanying condensed consolidated financial statements.

 

PRINCIPLES OF CONSOLIDATION

 

The accompanying condensed consolidated financial statements include the accounts of Aethlon Medical, Inc. and its wholly-owned subsidiary, Exosome Sciences, Inc. (collectively hereinafter referred to as the "Company" or "Aethlon").  There exist no material intercompany transactions or balances between Aethlon and its subsidiary.

 

LOSS PER COMMON SHARE

 

Basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares assumed to be outstanding during the period of computation. Diluted loss per common share is computed similar to basic loss 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. As we had net losses for all periods presented, basic and diluted loss per common share are the same, since additional potential common shares have been excluded as their effect would be antidilutive.

 

The potentially dilutive common shares outstanding at September 30, 2012 and 2011, which include common shares underlying outstanding stock options, warrants and convertible debentures, were 132,459,618 and 110,033,840, respectively.

 

REVENUE RECOGNITION

 

With respect to revenue recognition, we entered into a government contract with DARPA and have recognized revenue during the fiscal year ended March 31, 2012 of $1,358,189 under such contract. We adopted the Milestone method of revenue recognition for the DARPA contract under ASC 605-28 “Revenue Recognition – Milestone Method” and we believe we meet the requirements under ASC 605-28 for reporting contract revenue under the Milestone Method for the fiscal year ended March 31, 2012.

 

In order to account for this contract, the Company identifies the deliverables included within the contract and evaluates which deliverables represent separate units of accounting based on if certain criteria are met, including whether the delivered element has standalone value to the collaborator. The consideration received is allocated among the separate units of accounting, and the applicable revenue recognition criteria are applied to each of the separate units.

 

A milestone is an event having all of the following characteristics:

 

(1) There is substantive uncertainty at the date the arrangement is entered into that the event will be achieved. A vendor’s assessment that it expects to achieve a milestone does not necessarily mean that there is not substantive uncertainty associated with achieving the milestone.

 

(2) The event can only be achieved based in whole or in part on either: (a) the vendor’s performance; or (b) a specific outcome resulting from the vendor’s performance.

 

(3) If achieved, the event would result in additional payments being due to the vendor.

 

A milestone does not include events for which the occurrence is either: (a) contingent solely upon the passage of time; or (b) the result of a counterparty’s performance.

 

The policy for recognizing deliverable consideration contingent upon achievement of a milestone must be applied consistently to similar deliverables.

 

The assessment of whether a milestone is substantive is performed at the inception of the arrangement. The consideration earned from the achievement of a milestone must meet all of the following for the milestone to be considered substantive:

 

8
 

(1) The consideration is commensurate with either: (a) the vendor’s performance to achieve the milestone; or (b) the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the vendor’s performance to achieve the milestone;

 

(2) The consideration relates solely to past performance; and

 

(3) The consideration is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

 

A milestone is not considered substantive if any portion of the associated milestone consideration relates to the remaining deliverables in the unit of accounting (i.e., it does not relate solely to past performance). To recognize the milestone consideration in its entirety as revenue in the period in which the milestone is achieved, the milestone must be substantive in its entirety. Milestone consideration cannot be bifurcated into substantive and nonsubstantive components. In addition, if a portion of the consideration earned from achieving a milestone may be refunded or adjusted based on future performance, the related milestone is not considered substantive.

 

PATENTS

 

We capitalize the cost of patents, some of which were acquired, and amortize such costs over the estimated useful life, upon issuance of the patent.

 

RESEARCH AND DEVELOPMENT EXPENSES

 

We incurred research and development expenses during the three and six month periods ended September 30, 2012 and 2011, which are included in various operating expense line items in the accompanying condensed consolidated statements of operations. Our research and development expenses in those periods were as follows:

 

   September 30,   September 30, 
   2012   2011 
           
Three months ended  $360,090   $117,820 
Six months ended  $649,787   $318,859 

 

FAIR VALUE OF DERIVATIVE FINANCIAL INSTRUMENTS

 

The fair value of certain convertible notes and related warrants at September 30, 2012 and March 31, 31, 2012 are $3,194,394 and $3,588,615, respectively, based upon a third party valuation report that we commissioned. Warrants classified as derivative liabilities are reported at their estimated fair value, with changes in fair value being reported in current period results of operations.

 

EQUITY INSTRUMENTS FOR SERVICES PROVIDED BY PARTIES OTHER THAN EMPLOYEES

 

We account for transactions involving goods and services provided by third parties where we issue equity instruments as part of the total consideration using the fair value of the consideration received (i.e., the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.

 

In transactions, when the value of the goods and/or services is not readily determinable and (1) the fair value of the equity instruments is more reliably measurable and (2) the counterparty receives equity instruments in full or partial settlement of the transactions, we use the following methodology:

 

(a)   For transactions where goods have already been delivered or services rendered, the equity instruments are issued on or about the date the performance is complete (and valued on the date of issuance).

 

(b)   For transactions where the instruments are issued on a fully vested, non-forfeitable basis, the equity instruments are valued on or about the date of the contract.

 

(c)   For any transactions not meeting the criteria in (a) or (b) above, we re-measure the consideration at each reporting date based on its then current stock value.

 

9
 

IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS

 

We review our long-lived assets 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. We believe that no impairment occurred at or during the three and six months ended September 30, 2012 and 2011.

 

BENEFICIAL CONVERSION FEATURE OF CONVERTIBLE NOTES PAYABLE

 

The convertible feature of certain notes payable provides for a rate of conversion that is below the market value of our common stock. Such feature is normally characterized as a "Beneficial Conversion Feature" ("BCF"). We record the estimated fair value of the BCF, when applicable, in the condensed consolidated financial statements as a discount from the face amount of the notes. Such discounts are accreted to interest expense over the term of the notes using the effective interest method.

 

DERIVATIVE LIABILITIES AND CLASSIFICATION

 

We evaluate free-standing derivative instruments (or embedded derivatives) to properly classify such instruments within equity or as liabilities in our financial statements. Our policy is to settle instruments indexed to our common shares on a first-in-first-out basis.

 

The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.

 

On April 1, 2009 we adopted new guidance, as codified in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815-40, Derivatives and Hedging, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (previously EITF 07-5), that requires us to apply a two-step model in determining whether a financial instrument or an embedded feature is indexed to our own stock and thus enables it to qualify for equity classification. We have identified several convertible debt or warrant agreements in which the embedded conversion feature or exercise price contains certain provisions that may result in an adjustment of the conversion or exercise price, which results in the failure of the these instruments to be considered to be indexed to our stock. Accordingly, under this guidance, we are required to record the estimated fair value of these instruments as derivative liabilities (see Note 9).

 

We re-measure the estimated fair value of derivative liabilities at each reporting period and record changes in fair value in other expense (income) in the current statement of operations.

 

REGISTRATION PAYMENT ARRANGEMENTS

 

We account for contingent obligations to make future payments or otherwise transfer consideration under a registration payment arrangement separately from any related financing transaction agreements, and any such contingent obligations are recognized only when it is determined that it is probable that the Company will become obligated for future payments and the amount, or range of amounts, of such future payments can be reasonably estimated (see Note 7).

 

STOCK-BASED COMPENSATION

 

Employee stock options and rights to purchase shares under stock participation plans are accounted for under the fair value method. Accordingly, share-based compensation is measured when all granting activities have been completed, generally the grant date, based on the fair value of the award. The exercise price of options is generally equal to the market price of the Company's common stock (defined as the closing price as quoted on the OTCBB) on the date of grant. Compensation cost recognized by the Company includes (a) compensation cost for all equity incentive awards granted prior to, but not yet vested as of April 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of the then current accounting standards, and (b) compensation cost for all equity incentive awards granted subsequent to April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of subsequent accounting standards. We use a Binomial Lattice option pricing model for estimating fair value of options granted (see Note 10).

 

10
 

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. We record a valuation allowance for deferred tax assets when, based on our 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.

 

SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS

 

There were no recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, or the Securities and Exchange Commission during the six months ended September 30, 2012 or that were issued in prior periods but do not become effective until future periods that in the opinion of management had, or are expected to have a material impact on our present or future consolidated financial statements.

 

NOTE 4. NOTES PAYABLE

 

Notes payable consist of the following:

 

   September 30, 2012   March 31, 2012 
   Principal Balance   Accrued Interest   Principal Balance   Accrued Interest 
12% Notes payable, past due  $185,000   $312,187   $185,000   $298,312 
10% Note payable, past due   5,000    5,625    5,000    5,375 
IP Law Firm Note, past due           29,610    986 
Law Firm Note           75,000    104 
Tonaquint Note   262,114    2,054    360,186    1,835 
Total  $452,114   $319,866   $654,796   $306,612 

 

During the six month period ended September 30, 2012, we recorded interest expense of $32,447 related to the contractual interest rates of our notes payable.

 

12% NOTES

 

From August 1999 through May 2005, we entered into various borrowing arrangements for the issuance of notes payable from private placement offerings (the "12% Notes"). On April 21, 2010, a holder of $100,000 of the 12% Notes converted his principal balance and $71,758 of accrued interest into 687,033 shares of common stock at an agreed conversion price of $0.25 per share. We incurred a loss upon this conversion of $68,703 since the closing price of our common stock was $0.35 at the date of conversion. At September 30, 2012, 12% Notes with a principal balance of $185,000 are outstanding, all of which are past due, in default, and bearing interest at the default rate of 15%. At September 30, 2012, interest payable on the 12% Notes totaled $312,187 and we are recording interest at the default rate of 15%.

 

10% NOTES

 

At September 30, 2012, one 10% Note in the amount of $5,000, which is past due and in default, remained outstanding. At September 30, 2012, interest payable on this note totaled $5,625 and we are recording interest at the default rate of 15%.

 

Management's plans to satisfy the remaining outstanding balance on these 12% and 10% Notes include converting the notes to common stock at market value or repayment with available funds.

 

IP LAW FIRM NOTE

 

On August 2, 2011, we entered into a Promissory Note with our intellectual property law firm for the amount of $49,610, which represented the amount we owed to that firm. The Promissory Note called for monthly payments of $5,000 from August 2011 through December 2011 and bore interest at 10% per annum.  We paid off this note and related accrued interest with cash in April 2012.

 

11
 

LAW FIRM NOTE

 

On March 22, 2012, we entered into a Promissory Note with our corporate law firm for the amount of $75,000, which represented the majority of the amount we owed to that firm. The Promissory Note has a maturity date of December 31, 2012 and bears interest at five percent per annum.  The note is convertible at the option of the holder into shares of our common stock at a 10% discount to the market price of the common stock on the date prior to conversion with a floor price on such conversions of $0.08 per share.  This ability of the holder to convert became exercisable upon the amendment of the Articles of Incorporation increasing the authorized shares of our common stock to a number greater than 250,000,000.  As that increase in the authorized number of shares of our common stock was approved by our stockholders at a Special Stockholders Meeting on June 4, 2012, this note was reclassified to a convertible note as of June 30, 2012 (see Note 5).   

 

TONAQUINT NOTE

 

On June 28, 2011, we entered into a Termination Agreement with Tonaquint, Inc. (see Note 5) under which both parties agreed that in consideration of the termination of a warrant, the waiving of all fees, penalties, the creation of the selling program and other factors, we agreed to issue an unsecured non-convertible promissory note (the "New Note") in the principal amount of $360,186, which provides for annual interest at a rate of 6%, payable monthly in either cash or our stock, at our option. The New Note originally had a maturity date of April 30, 2012.  We subsequently extended the note initially to July 31, 2012 and then subsequently to July 31, 2013 and converted $100,572 of the principal and $19,614 of the accrued interest related to the note into common stock (see Note 6). We also recorded into principal $2,500 of the lender’s legal fees related to documentation of the extension agreement. We recorded a loss on conversion of $50,262 on those partial conversions. At September 30, 2012, the balance of this note was $262,114 and accrued interest totaled $2,054.

 

NOTE 5. CONVERTIBLE NOTES PAYABLE

 

Convertible Notes Payable consisted of the following at September 30, 2012:

 

   Principal   Unamortized
Discount
   Net
Amount
   Accrued
Interest
 
                 
Amended and Restated Series A 12% Convertible Notes, past due  $885,000   $   $885,000   $309,750 
2008 10% Convertible Notes, past due   25,000        25,000    13,542 
December 2006 10% Convertible Notes, past due   17,000        17,000    14,521 
October & November 2009 10% Convertible Notes   50,000    (2,664)   47,336    17,500 
April 2010 10% Convertible Note   75,000    (7,072)   67,928    20,188 
September 2010 10% Convertible Notes, past due   308,100        308,100    29,285 
April 2011 10% Convertible Notes, past due   400,400        400,400    70,070 
July and August 2011 10% Convertible Notes, $257,656 past due   357,655        357,655    44,380 
September 2011 Convertible Notes, past due   208,760        208,760     
Law Firm Note   75,000        75,000    1,979 
Total – Convertible Notes  $2,401,915   $(9,736)  $2,392,179   $521,215 

 

All but two of the Convertible Notes Payable in the above table are presently past due or will be due within one year of the September 30, 2012 balance sheet date. As a result, we expect to amortize all but $4,284 of the remaining discounts during the fiscal year ending March 31, 2013.

 

During the six months ended September 30, 2012, we recorded interest expense of $287,272 related to the contractual interest rates of our convertible notes and interest expense of $461,707 related to the amortization of debt discounts on the convertible notes for a total of $769,568.

 

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Convertible Notes Payable consisted of the following at March 31, 2012:

 

   Principal   Unamortized
Discount
   Net
Amount
   Accrued
Interest
 
                 
Amended and Restated Series A 12% Convertible Notes, past due  $900,000   $   $900,000   $168,750 
2008 10% Convertible Notes, past due   25,000        25,000    11,667 
December 2006 10% Convertible Notes, past due   17,000        17,000    13,246 
October & November 2009 10% Convertible Notes, $25,000 past due   75,000    (4,833)   70,167    22,500 
April 2010 10% Convertible Note   75,000    (10,107)   64,893    16,438 
September 2010 10% Convertible Notes   338,100        338,100    70,804 
April 2011 10% Convertible Notes   400,400        400,400    40,040 
July and August 2011 10% Convertible Notes   357,655    (109,911)   247,744    24,262 
September 2011 Convertible Notes   238,760    (106,932)   131,828     
November 2011 Convertible Notes   525,000    (51,220)   473,780    39,177 
February 2012 Convertible Notes   525,000    (188,439)   336,561    12,120 
Total – Convertible Notes  $3,476,915   $(471,442)  $3,005,473   $419,004 

 

AMENDED AND RESTATED SERIES A 12% CONVERTIBLE NOTES

 

In June 2010, we entered into Amended and Restated 12% Series A Convertible Promissory Notes (the "Amended and Restated Notes") with the holders of certain promissory notes previously issued by the Company (“Amended Series A 10% Convertible Notes” or the "Prior Notes"), and all amendments to the Prior Notes.

 

The Amended and Restated Notes, in the principal amount of $900,000 matured on December 31, 2010. In connection with the restructuring we paid $54,001 of accrued and default interest through the date of the restructuring, liquidated damages of $205,000 and $54,003 of prepaid interest through the expiration date in the aggregate amount of $313,004 through the issuance of units ("Units") at a fixed rate of $0.20 per Unit, each Unit consisting of one share of our common stock and one common stock purchase warrant to purchase one share of our common stock at a fixed exercise price of $0.20 per share as prescribed in the Amended and Restated Note Agreement.  The noteholders have antidilution price protection on the Amended and Restated Notes.

 

In addition to the extension of the expiration date of the Amended and Restated Notes to December 31, 2010, we agreed to increase the annual interest rate from ten percent to twelve percent. We also agreed to change the exercise prices on all of the warrants held by the noteholders to $0.20 per share, to change certain formerly contingent warrants to non-contingent warrants and to extend the expiration date of their warrants to February 2016.

 

As of December 31, 2010, the Amended and Restated Notes matured and as of September 30, 2012 remain in default. We are accruing interest at the revised default rate of 20% following the expiration date of December 31, 2010.

 

In June 2012, the holder of $15,000 of the Amended and Restated Notes converted his principal and related accrued interest into common stock per the conversion formula.

 

We have begun discussions with the noteholders regarding an extension to the notes but there can be no assurance that we will be able to do so on terms that we deem acceptable or at all.  At September 30, 2012, the balance of the Amended and Restated Notes was $885,000 and interest payable on the Amended and Restated Notes totaled $309,750.

 

2008 10% CONVERTIBLE NOTES

 

One 2008 10% Convertible Note in the amount of $25,000 which matured in January 2010 remained outstanding at September 30, 2012. This note is convertible into our common stock at $0.50 per share. At September 30, 2012, the $25,000 principal balance was in default and interest payable on the remaining note totaled $13,542 and we are recording interest at the default rate of 15%..

 

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DECEMBER 2006 10% CONVERTIBLE NOTES

 

At September 30, 2012, $17,000 of the December 2006 10% Notes remained outstanding and in default. These notes are convertible into our common stock at $0.17 per share. At September 30, 2012, the $17,000 balance of the notes was in default and interest payable on those notes totaled $14,521 and we are recording interest at the default rate of 15%.

 

OCTOBER & NOVEMBER 2009 10% CONVERTIBLE NOTES

 

In October and November 2009, we raised $430,000 from the sale to accredited investors of 10% convertible notes ("October & November 2009 10% Convertible Notes"). The October & November 2009 10% Convertible Notes matured at various dates between April 2011 and May 2011 and are convertible into our common stock at a fixed conversion price of $0.25 per share prior to maturity. The investors also received matching three year warrants to purchase unregistered shares of our common stock at a price of $0.25 per share.  We measured the fair value of the warrants and the beneficial conversion feature of the notes and recorded a 100% discount against the principal of the notes. We are amortizing this discount using the effective interest method over the term of the notes.

 

Deferred financing costs of $20,250 incurred in connection with this financing were issued in the form of a convertible note with warrants on the same terms as those received by the investors.  We capitalized the $20,250 of deferred financing costs and amortized them over the term of the notes using the effective interest method.

 

Prior to March 31, 2012, $355,000 of the October and November 2009 financing had been converted to common stock. On March 31, 2012, we agreed to extend the expiration date and to change the exercise price of certain warrants of one of the note holders by two years in exchange for the extension of $50,000 of the October & November 2009 10% Convertible Notes and the $75,000 April 2010 10% Convertible Note (see below) by that same two year period.  We recorded a charge of $77,265 relating to this modification.

 

At June 30, 2012, there were two notes remaining, one for $25,000 which was past due and the other for $50,000, which had been extended.  

 

In July 2012, we issued 461,409 shares of common stock to the holder of the $25,000 note in exchange for the value of the principal and related accrued interest of $8,000 under the same terms that we used to sell units consisting of one share of common stock and one-half of a stock purchase warrant on June 29, 2012 (see Note 6). As part of that structure, the noteholder also received seven year warrants to purchase 230,705 share of common stock at a price of $0.107 per share. We recorded a loss on conversion of $45,796 on the conversions.

 

At September 30, 2012, there was one note remaining for $50,000 and interest payable on that note was $17,500.  

 

APRIL 2010 10% CONVERTIBLE NOTE

 

In April 2010, we raised $75,000 from the sale to an accredited investor of a 10% convertible note. The convertible note matures in October 2011 and is convertible into our common stock at a fixed conversion price of $0.25 per share prior to maturity. The investor also received three year warrants to purchase 300,000 unregistered shares of our common stock at a price of $0.25 per share.

 

We measured the fair value of the warrants and the beneficial conversion feature of the notes and recorded a 100% discount against the principal of the notes. We amortized this discount using the effective interest method over the term of the note.

 

On March 31, 2012, we agreed to extend the expiration date and to change the exercise price of certain warrants of the note holder by two years in exchange for his extension of $50,000 of the October & November 2009 10% Convertible Notes and the $75,000 April 2010 10% Convertible Note by that same two year period.  We recorded a charge of $77,265 relating to this modification.

 

At September 30, 2012, the remaining outstanding principal balance is $75,000 and interest payable on this note totaled $20,188. 

 

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JULY 2010 6% CONVERTIBLE NOTES

 

In July 2010, we entered into a Note and Warrant Purchase Agreement (the "Purchase Agreement") with Tonaquint, Inc., a Utah corporation (the "Investor"), whereby we issued and sold, and the Investor purchased: (i) a Convertible Promissory Note of the Company in the principal amount of $890,000 (the "Company Note") and (ii) a Warrant to purchase common stock of the Company (the "Warrant"). As consideration for the issuance and sale of the Company Note and Warrant, the Investor paid cash in the amount of $400,000 and issued two Secured Trust Deed Notes to us (the "Trust Notes") each in the principal amount of $200,000. The variance of $90,000 represents fees and expenses paid by us and an original issue discount which was recorded as deferred offering costs.

 

The Company Note is convertible into shares of the Company's common stock, at the option of the Investor, at a price per share equal to (a) the principal and interest due under the Company Note divided by (b) 80% of the average of the closing bid price for the three (3) trading days with the lowest closing bid prices during the twenty (20) trading days immediately preceding the conversion date (the “Conversion Price”). In no event shall the Conversion Price be greater than the "Ceiling Price", which is $0.30 per share. The principal and interest subject to conversion under the Note shall be eligible for conversion in tranches ("Tranches"), as follows: (1) an initial Tranche in an amount equal to $450,000 and any interest and/or fees accrued thereon under the terms of the Company Note and the other Transaction Documents (as defined in the Purchase Agreement), and (2) two additional subsequent Tranches each in an amount equal to $220,000 and any interest or fees accrued thereon under the terms of the Company Note or the other Transaction Documents. The first subsequent Tranche shall correspond to payment of the first Trust Note and the second subsequent Tranche shall correspond to payment of the second Trust Note (as defined in the Purchase Agreement). The Investor's right to convert any of the subsequent Tranches is conditioned upon the Investor’s payment in full of the Trust Notes corresponding to such subsequent Tranche.  Accordingly, principal and interest under the Company Note may only be converted by the Investor in proportion to the amounts paid under each of the Trust Notes.  However, up to $450,000 may be converted at the Investor's option at any time, representing amounts paid by the Investor on the closing of the transaction on July 15, 2010 (the "Closing").  The Company Note bears interest at a rate of 6% per annum. The maturity date of the Company Note was July 15, 2011. The Company Note contains "anti-dilution" protection, such that if the Company issues and sells common stock, or securities convertible into or exercisable for common stock of the Company, at a price per share that is less than the applicable Conversion Price, then the Conversion Price is adjusted downward to match such lower issuance price. However, in no event will the Conversion Price based on anti-dilution adjustments be lower than the "Floor Price" which is $0.20 per share.

 

The number of shares of Common Stock that may be issued to the lender pursuant to a conversion of this Note, combined with an exercise of the Warrant, shall not exceed a cap determined by (a) dividing the sum of (i) the face amount of this Note, plus (ii) an amount equal to all interest that would accrue under this Note during its term (assuming no payments of principal or interest are made prior to the Maturity Date), by (b) a price per share of Common Stock equal to $0.20 (the Floor Price).

 

The Company Note also contains other standard adjustment features for stock splits, recapitalizations and similar occurrences. The Company Note contains standard events of default related to payment, performance of certain covenants and bankruptcy events. We have granted the Investor a security interest in the Trust Notes under the terms of the Security Agreement. The sole collateral for the Company's payment and performance obligation under the Company Note is the Trust Notes.  The Warrant entitles the Investor to purchase 3,636,364 shares of common stock at an exercise price of $0.231 per share. The Warrant contains "anti-dilution" protection, such that if we issue and sell common stock, or securities convertible into or exercisable for common stock of the Company, at a price per share that is less than the price, then the price is adjusted downward to match such lower issuance price. The Warrant also contains other standard adjustment features for stock splits, recapitalizations and similar occurrences.

 

We recorded a debt discount of $890,000 based on the estimated fair value of the derivative liabilities associated with the warrants and embedded conversion feature which was amortized using the effective interest method over the term of the note.

 

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On June 28, 2011, we entered into a Termination Agreement with Tonaquint under which both parties agreed to terminate the warrant to prevent continuing dilution of our common stock and to eliminate confusion or disagreement as to the number of shares of common stock available for issuance under the warrant in the future. Accordingly, under the Termination Agreement we issued 3,599,913 shares of common stock upon the final exercise of the warrant, whereupon the warrant was terminated and is of no further force or effect. The Termination Agreement also provides for a "Common Stock Sale Limitation" on all of our common stock held by Tonaquint, Inc. Under the "Common Stock Sale Limitation", the daily limitation on the number of shares of common stock which Tonaquint, Inc. may sell into the market on any trading day is limited to the greater of (i) $5,000 of sales amount, or (ii) 10% of the Average Daily Volume of our common stock sold on the Over The Counter Bulletin Board, where the Average Daily Volume shall mean the average daily volume for the prior three month period as reported on each trading day on Yahoo Finance with respect to our common stock. Under the terms of the Termination Agreement, Tonaquint, Inc. has waived and released us from any obligation to pay or perform any fees, penalties, costs, or assessments that were or are due, or would have become due, under the convertible note, the warrant and the note purchase agreement. In consideration of the termination of the warrant, the waiving of all fees, penalties, the creation of the selling program and other factors, we agreed to issue an unsecured non-convertible promissory note (the "New Note") in the principal amount of $360,185, which provides for annual interest at a rate of 6%, payable monthly in either cash or our stock, at our option. The New Note originally had a maturity date of April 30, 2012 and was subsequently extended to July 31, 2013. At September 30, 2012, the balance of this note was $262,114 and interest payable totaled $2,054 (see Note 4).

 

SEPTEMBER 2010 10% CONVERTIBLE NOTES

 

On September 3, 2010, we entered into a Subscription Agreement with three accredited investors (the “Purchasers”) providing for the issuance and sale of convertible promissory notes and corresponding warrants in the aggregate principal amount of $1,430,000. The initial closing under the Subscription Agreement resulted in the issuance and sale of (i) convertible promissory notes in the aggregate principal amount of $743,600, (ii) five-year warrants to purchase an aggregate of 3,718,000 shares of our common stock at an exercise price of $0.31125 per share, and (iii) five-year warrants to purchase an aggregate of 3,718,000 shares of our common stock at an exercise price of $0.43575 per share. The convertible promissory notes bear interest compounded monthly at the annual rate of ten percent (10%) and matured on September 3, 2011. The aggregate gross cash proceeds were $650,000, the balance of the principal amount representing a due diligence fee and an original issuance discount. The convertible promissory notes are convertible at the option of the holders into shares of our common stock at a price per share equal to eighty percent (80%) of the average of the three lowest closing bid prices of the common stock as reported by Bloomberg L.P. for the principal market on which the common stock trades or is quoted for the ten (10) trading days preceding the proposed conversion date. Subject to adjustment as described in the notes, the conversion price may not be more than $0.30 nor less than $0.20. There are no registration requirements with respect to the shares of common stock underlying the notes or the warrants.

 

The following conversions of the September 2010 10% Convertible Note have taken place during the fiscal year ended March 31, 2012 and the six months ended September 30, 2012:

 

   Six Months Ended September 30, 2012   Fiscal Year Ended
March 31, 2012
 
Principal converted  $30,000   $405,500 
Accrued interest converted  $64,164   $19,255 

 

At September 30, 2012, the remaining principal balance of $308,100 was in default and interest payable on these notes totaled $29,285 and we are recording interest at the default rate of 15%.

 

APRIL 2011 10% CONVERTIBLE NOTES

 

In April 2011, we entered into a Subscription Agreement with two accredited investors (the “Purchasers”) providing for the issuance and sale of convertible promissory notes and corresponding warrants in the aggregate principal amount of $385,000. The closing under the Subscription Agreement resulted in the issuance and sale by us of (i) convertible promissory notes in the aggregate principal amount of $385,000, (ii) five-year warrants to purchase an aggregate of 4,004,000 shares of our common stock at an exercise price of $0.125 per share, and (iii) five-year warrants to purchase an aggregate of 4,004,000 shares of our common stock at an exercise price of $0.175 per share. The convertible promissory notes bear interest compounded monthly at the annual rate of ten percent (10%) and matured on April 1, 2012.  The aggregate gross cash proceeds to us were $350,000, the balance of the principal amount representing a due diligence fee and an original issuance discount. The convertible promissory notes are convertible at the option of the holders into shares of our common stock at a price per share equal to eighty percent (80%) of the average of the three lowest closing bid prices of the common stock as reported by Bloomberg L.P. for the principal market on which the common stock trades or is quoted for the ten (10) trading days preceding the proposed conversion date. Subject to adjustment as described in the notes, the conversion price may not be more than $0.20 nor less than $0.10. There are no registration requirements with respect to the shares of common stock underlying the notes or the warrants.

 

16
 

 

 

In addition, we issued (i) five-year warrants to purchase an aggregate of 812,500 shares of our common stock at an exercise price of $0.125 per share, and (ii) five-year warrants to purchase an aggregate of 812,500 shares of our common stock at an exercise price of $0.175 per share to the Purchasers. These warrants were issued as an antidilution adjustment under certain common stock purchase warrants held by the Purchasers that were acquired from us in September 2010.

 

At September 30, 2012, the outstanding principal balance was $400,400 and was in default and interest payable on these notes totaled $70,070 and we are recording interest at the default rate of 15%.

 

JULY & AUGUST 2011 10% CONVERTIBLE NOTES

 

During the three months ended September 30, 2011, we raised $357,656 in 10% convertible notes.  Those notes had a fixed conversion price of $0.09 per share and carried an interest rate of 10%.  The convertible notes matured in July and August 2012.  We also issued those investors five year warrants to purchase 3,973,957 shares of common stock at $0.125 per share.

 

We measured the fair value of the warrants and the beneficial conversion feature of the notes and recorded a $257,926 discount against the principal of the notes. We amortized this discount using the effective interest method over the term of the note.

 

Effective July 14, 2011 holders of three notes totaling $100,000 agreed to extend the expiration date of their notes to July 13, 2013.

 

At September 30, 2012, the outstanding principal balance was $357,655, of which $257,655 was in default and interest payable on these notes totaled $44,380. Following the expiration of the maturity dates on the $257,655 of notes that are now in default, we began to accrue interest at the default interest rate of 15%.

 

SEPTEMBER 2011 CONVERTIBLE NOTES

 

On September 23, 2011, we entered into a Subscription Agreement with two accredited investors (the “Purchasers”)  providing for the issuance and sale of convertible promissory notes and corresponding warrants in the aggregate principal amount of  $253,760.  The warrants carried a five-year term to purchase an aggregate of 3,625,143 shares of our common stock at an exercise price of $0.10 per share.  The convertible promissory notes do not bear an interest rate and mature on September 23, 2012.  The aggregate net cash proceeds to us were $175,000, the balance of the principal amount representing a due diligence fee and an original issuance discount. The convertible promissory notes are convertible at the option of the holders into shares of our common stock at a price per share equal to $0.07.  Subject to adjustments as described in the notes, the conversion price may not be more than $0.07.  There are no registration requirements with respect to the shares of common stock underlying the notes or the warrants.

 

We measured the fair value of the warrants and the beneficial conversion feature of the notes and recorded a $168,804 discount against the principal of the notes. We amortized this discount using the effective interest method over the term of the note.

 

In March 2012, following the six month anniversary of the note funding, one of the note holders converted $15,000 of principal into common stock and in the six months ended September 30, 2012, that note holder converted an additional $30,000 of principal into common stock.

 

At September 30, 2012, the outstanding principal balance was $208,760 and was in default and there was no accrued interest as these notes do not bear interest.

 

 

 

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NOVEMBER 2011 CONVERTIBLE NOTES

 

In November 2011, we raised $525,000 in 5% Original Issue Discount Unsecured Convertible Debentures from five accredited investors pursuant to which the investors purchased an aggregate principal amount of $525,000 for an aggregate purchase price of $500,000. The debentures bear interest at 20% per annum and matured on April 20, 2012. The debentures will be convertible at the option of the holders at any time into shares of our common stock, at a conversion price equal to $0.0779, subject to adjustment. In connection with the debentures, the purchasers received warrants to purchase 3,369,706 shares of our common stock. The warrants are exercisable for a period of five years from the date of issuance at an exercise price of $0.11, subject to adjustment.

 

Until December 31, 2012, upon any proposed issuance by us of our common stock or equivalents (or a combination thereof as defined in the subscription agreement) for cash consideration, the purchasers may elect, in their sole discretion, to exchange all or some of the debentures then held by such purchaser for any securities issued in a subsequent financing on a $1.00 for $1.00 basis, provided, however , this right shall not apply with respect to (i) an Exempt Issuance (as defined in the debenture) or (ii) an underwritten public offering of our common stock.

 

A Financial Industry Regulatory Authority (FINRA) registered broker-dealer was engaged as placement agent in connection with the transaction.  We paid the placement agent a cash fee in the amount of $50,000 (representing a 8% sales commission and a 2% unaccountable expense allowance) and issued the placement agent or its designees warrants to purchase  an aggregate of 808,729 shares of common stock at $0.11 per share. The warrants issued to the placement agent may be exercised on a cashless basis. In the event the placement agent exercises the warrants on a cashless basis, we will not receive any proceeds.

 

During the six months ended September 30, 2012, all of the outstanding principal balances on these notes and all related accrued interest of $53,803 were converted into common stock.

 

FEBRUARY 2012 CONVERTIBLE NOTES

 

In February 2012, we entered into a subscription agreement with five accredited investors (the “Purchasers”) pursuant to which the Purchasers purchased an aggregate principal amount of $525,000 of 5% Original Issue Discount Unsecured Convertible Debentures for an aggregate purchase price of $500,000 (the “Debenture”). These subscriptions represent the completion of the $1,000,000 securities offering that was initiated and priced in November 2011 (see above).

 

The Debentures bear interest at 20% per annum and matured on April 20, 2012. The Debentures will be convertible at the option of the holders at any time into shares of our common stock, at a conversion price equal to $0.0779, subject to adjustment. In connection with the subscription agreement, the Purchasers received warrants to purchase 3,369,707 shares of our common stock (the “Warrants”). The Warrants are exercisable for a period of five years from the date of issuance at an exercise price of $0.11 per share, subject to adjustment. Each Purchaser may exercise such Purchaser’s Warrant on a cashless basis if the shares of common stock underlying the Warrant are not then registered pursuant to an effective registration statement. In the event the Purchasers exercise the Warrants on a cashless basis, we will not receive any proceeds. The conversion price of the Debenture and the exercise price of the Warrants are subject to customary adjustment provisions for stock splits, stock dividends, recapitalizations and the like.

 

Until December 31, 2012, upon any proposed issuance by us of our Common Stock or Common Stock Equivalents (or a combination thereof as defined in the subscription agreement) for cash consideration (the “Subsequent Financing”), a Purchaser may elect, in its sole discretion, to exchange all or some of the Debenture then held by such Purchaser for any securities issued in a Subsequent Financing on a $1.00 for $1.00 basis, provided, however, this right shall not apply with respect to (i) an Exempt Issuance (as defined in the Debenture) or (ii) an underwritten public offering of our common stock. 

 

Each Purchaser has contractually agreed to restrict its ability to exercise the Warrant and convert the Debenture such that the number of shares of our common stock held by the Purchaser and its affiliates after such conversion or exercise does not exceed 4.99% of our then issued and outstanding shares of common stock.

 

The full principal amount of the Debenture is due upon a default under the terms of the Debenture. The Debenture is a general unsecured debt obligation of ours arising other than in the ordinary course of business which constitutes a direct financial obligation of the Company.

 

18
 

 

A FINRA registered broker-dealer was engaged as placement agent in connection with the transaction.  We paid the placement agent a cash fee in the amount of $50,000 (representing an 8% sales commission and a 2% unaccountable expense allowance) and issued the placement agent or its designees warrants to purchase an aggregate of 815,774 shares of common stock at $0.11 per share. The warrants issued to the placement agent may be exercised on a cashless basis. In the event the placement agent exercises the warrants on a cashless basis, we will not receive any proceeds.

 

During the six months ended September 30, 2012, all of the outstanding principal balances on these notes and all related accrued interest of $55,432 were converted into common stock.

 

LAW FIRM NOTE

 

On March 22, 2012, we entered into a Promissory Note with our corporate law firm for the amount of $75,000, which represented the majority of the amount we owed to that firm. The Promissory Note has a maturity date of December 31, 2012 and bears interest at five percent per annum.  The note is convertible at the option of the holder into shares of our common stock at a 10% discount to the market price of the common stock on the date prior to conversion with a floor price on such conversions of $0.08 per share.  This ability of the holder to convert became exercisable upon the amendment of the Articles of Incorporation increasing the authorized shares of our common stock to a number greater than 250,000,000.  As that increase in the authorized number of shares of our common stock was approved by our stockholders at a Special Stockholders Meeting on June 4, 2012, this note was reclassified to a convertible note as of June 30, 2012 (see Note 4).

 

At September 30, 2012, the outstanding principal balance on this note was $75,000 and the interest payable on this note totaled $1,979.   

 

NOTE 6. EQUITY TRANSACTIONS

 

On April 5, 2012, we completed a unit subscription agreement with one accredited investor (the “Purchaser”)  pursuant to which the Purchaser purchased $200,000 of units (the "Units" and each a "Unit"), with each Unit consisting of (i) one share of Common Stock, par value $0.001 per share (the “Common Stock”) at a price per share of $0.08 and (ii) a warrant to purchase such number of shares of Common Stock as shall equal (a) fifty percent of the Subscription Amount divided by (b) $0.08 (the "Warrant Shares") at an exercise price of $0.125 per Warrant Share, (each, a “Warrant” and collectively, the “Warrants”). Based on the foregoing, Units consisting of 2,500,000 shares of Common Stock and Warrants to purchase 1,250,000 shares of Common Stock were issued on April 5, 2012.

 

The Warrants are exercisable for a period of seven years from the date of issuance at an exercise price of $0.125, subject to adjustments for stock splits, stock dividends, recapitalizations and the like. The Purchaser may exercise the Warrant on a cashless basis if the shares of common stock underlying the Warrant are not then registered pursuant to an effective registration statement. In the event the Purchaser exercises the Warrant on a cashless basis, we will not receive any proceeds.  There are no registration rights with respect to the Warrants or the Warrant Shares.

 

On June 19, 2012, we completed a unit subscription agreement with seven accredited investors (the “Purchasers”) pursuant to which the Purchasers purchased $592,000 of units (the "Units" and each a "Unit"), with each Unit consisting of (i) one share of Common Stock at a price per share of $0.072 and (ii) a warrant to purchase such number of shares of Common Stock as shall equal (a) fifty percent of the Subscription Amount divided by (b) $0.072 (the "Warrant Shares") at an exercise price of $0.108 per Warrant Share.

 

On June 26, 2012, we completed a unit subscription agreement with one accredited investor pursuant to which the Purchaser purchased $10,000 of units (the "Units" and each a "Unit"), with each Unit consisting of (i) one share of Common Stock at a price per share of $0.072 and (ii) a warrant to purchase such number of shares of Common Stock as shall equal (a) fifty percent of the Subscription Amount divided by (b) $0.072 (the "Warrant Shares") at an exercise price of $0.107 per Warrant Share.

 

On August 29, 2012, we completed a unit subscription agreement with seven accredited investors (the “Purchasers”) pursuant to which the Purchasers purchased an aggregate of $271,000 (the "Subscription Amount") of restricted Common Stock at a price of $0.08 per share. The Common Stock purchase price under the Subscription Agreement was determined to be 80% of the average closing price of the our Common Stock for the five-day period immediately preceding the date of the Subscription Agreement, resulting in the issuance of 3,387,500 shares of Common Stock.

 

Each Purchaser also received one Common Stock Purchase Warrant for each two shares of Common Stock purchased under the Subscription Agreement. The Warrant exercise price was calculated to be $0.12 per share based upon 120% of the average of the closing prices of our Common Stock for the five-day period immediately preceding the parties entering into the Subscription Agreement.

 

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The Warrants are exercisable for a period of seven years from the date of issuance at an exercise price of $0.12, subject to adjustments for stock splits, stock dividends, recapitalizations and the like. The Purchasers may exercise the Warrants on a cashless basis if the shares of Common Stock underlying the Warrants are not then registered pursuant to an effective registration statement. In the event that a Purchaser exercises the Warrant on a cashless basis, we will not receive any proceeds. There are no registration rights with respect to the Warrants or the Common Stock underlying the Warrants.

 

During the six months ended September 30, 2012, we issued 20,308,316 shares of restricted common stock to holders of notes issued by the Company in exchange for the partial or full conversion of principal and interest of several notes payable in an aggregate amount of $1,515,163 at an average conversion price of $0.07 per share based upon the conversion formulae in the respective notes.

 

During the six months ended September 30, 2012, we issued 116,000 shares of restricted common stock to settle past due accrued interest that we recorded as non-cash interest expense of $11,846.

 

During the six months ended September 30, 2012, we issued 1,553,803 restricted shares of common stock to service providers for investor relations and business development services valued at $139,182 based upon the fair value of the shares issued. The average issuance price on the restricted share issuances was approximately $0.09 per share.

 

In July 2012, we filed a registration statement on Form S-8 for the purpose of registering 5,000,000 common shares issuable under the 2010 Stock Plan under the Securities Act of 1933.

 

On July 24, 2012, we expanded our Board of Directors by an additional two seats and appointed two new outside directors to fill those seats.

 

In July 2012, our Board of Directors approved a new Board Compensation Program (the “New Program”), which modifies and supersedes the 2005 Directors Compensation Program (the “2005 Program”) that was previously in effect. Under the New Program, in which only non-employee Directors may participate, an eligible Director will receive a grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; however for the new non-employee directors, the exercise price for this initial grant, $0.076 per share, is based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date of their appointment (July 24, 2012). These options will have a term of ten years and will be fully vested upon grant. In addition, each existing eligible Director will receive the same grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; provided however that for this current grant only, all of such grants shall be made at an exercise price of $0.076 per share based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date (July 24, 2012) of the appointment of two new directors to our Board of Directors.

 

At the beginning of each fiscal year, each Director eligible to participate in the New Program also will receive a grant of $20,000 worth of options valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year. In addition, under the New Program eligible Directors will receive cash compensation equal to $500 for each committee meeting attended and $1,000 for each formal Board meeting attended.

 

The New Program eliminates the following features of the 2005 Program: (1) the annual payment of $10,000 in cash compensation and (2) the granting of options to Directors based on a percentage of our issued and outstanding common stock.

 

NOTE 7. ACCRUED LIQUIDATED DAMAGES

 

We account for contingent obligations to make future payments or otherwise transfer consideration under a registration payment arrangement separately from any related financing transaction agreements, and any such contingent obligations are recognized only when it is determined that it is probable that we will become obligated for future payments and the amount, or range of amounts, of such future payments can be reasonably estimated.

 

We have entered into registration payment arrangements in connection with certain financing arrangements, pursuant to which we raised an approximate aggregate amount of $2,020,000, that require us to register the shares of common stock underlying the convertible debt and warrants issued in these financing transactions. Under these agreements we are liable for liquidated damages to the investors if we fail to file and/or maintain effective registration statements covering the specified underlying shares of common stock as noted below:

 

  · With respect to a $1,000,000 financing agreement – damages accrue at a rate of 1% - 1.5% per month until such time as the underlying shares of common stock would have been eligible for sale under Rule 144.
  · With respect to financing agreements totaling $715,000 – damages accrue at a rate of 2% per month, subject to an aggregate maximum liquidated damages amount of $150,000.
  · With respect to equity investments totaling $305,000 – damages accrue at a rate of 2% per month until the expiration dates of warrants issued in connection with this financing, which range from December 31,2010 through February 8, 2011 and are payable in common stock.

 

20
 

 

Since we have either failed to file, or failed to maintain the registration obligations under these agreements, as of September 30, 2012 and March 31, 2012, we have accrued estimated aggregate liquidated damages of $437,800 in connection with the liquidated damage provisions of these agreements, which we believe represents our maximum exposure under these provisions.  Accordingly, we do not expect to accrue any further liquidated damages in connection with these agreements.  The actual amount of liquidated damages paid, if any, may differ from our estimates as it is our intention to negotiate with the investors the settlement of liquidated damages due and, as such, the ultimate amounts we may actually pay may be less than the amount currently accrued.

 

NOTE 8. OTHER CURRENT LIABILITIES

 

At September 30, 2012 and March 31, 2012, our other current liabilities were comprised of the following items:

 

   September 30,   March 31, 
   2012   2012 
Accrued interest  $840,866   $725,616 
Accrued legal fees   179,465    179,465 
Deferred rent   6,175    5,607 
Other   106,763    220,533 
Total other current liabilities  $1,133,269   $1,131,221 

 

As of the date of this report, various promissory and convertible notes payable in the aggregate principal amount of $2,291,916 (as identified in Notes 4 and 5 above) have reached maturity and are past due. We are continually reviewing other financing arrangements to retire all past due notes. At September 30, 2012, we had accrued interest in the amount of $787,267 associated with these defaulted notes in accrued liabilities payable (see Notes 4 and 5).

 

NOTE 9. FAIR VALUE MEASUREMENTS

 

We follow FASB ASC 820, "FAIR VALUE MEASUREMENTS AND DISCLOSURES" (“ASC 820”) in connection with assets and liabilities measured at fair value on a recurring basis subsequent to initial recognition. The guidance applies to our derivative liabilities. We had no assets or liabilities measured at fair value on a non-recurring basis for any period reported.

 

ASC 820 requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: We measure the fair value of applicable financial and non-financial assets based on the following fair value hierarchy:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

 

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

 

Level 3: Unobservable inputs that are not corroborated by market data.

 

The hierarchy noted above requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value.

 

The fair value of our recorded derivative liabilities is determined based on unobservable inputs that are not corroborated by market data, which is a Level 3 classification. We record derivative liabilities on our balance sheet at fair value with changes in fair value recorded in our consolidated statements of operations.

 

Our fair value measurements at the September 30, 2012 reporting date are classified based on the valuation technique level noted in the table below (there were no transfers in or out of level 3 for all periods presented):

 

       Quoted Prices   Significant     
       in Active   Other   Significant 
       Markets for   Observable   Unobservable 
   September 30,   Identical Assets   Inputs   Inputs 
Description  2012   (Level 1)   (Level 2)   (Level 3) 
Derivative Liabilities  $3,194,394   $   $   $3,194,394 
Total Assets  $3,194,394   $   $   $3,194,394 

 

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The following outlines the significant weighted average assumptions used to estimate the fair value information presented, in connection with our warrant and embedded conversion option derivative instruments utilizing the Binomial Lattice option pricing model:

 

  Six Months Ended September 30, 2012
Risk free interest rate 0.09% - 0.60%
Average expected life 0.02 – 4.2 years
Expected volatility 76.0% - 102.0%
Expected dividends None

 

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the six months ended September 30, 2012:

 

           Change in   Reclassification     
           estimated fair   of Derivative     
       Recorded   value recognized   Liability to     
   April 1,   New Derivative   in results   Paid in   September 30, 
   2012   Liabilities   of operations   capital   2012 
                          
Derivative liabilities  $3,588,615   $   ($361,462)  ($32,759)  $3,194,394 

 

 

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the six months ended September 30, 2011:

 

           Change in   Reclassification     
           estimated fair   of Derivative     
       Recorded   value recognized   Liability to     
   April 1,   New Derivative   in results   Paid in   September 30, 
   2011   Liabilities   of operations   capital   2011 
                          
Derivative
liabilities
   2,002,896   $1,107,940   ($1,521,502)   (247,608)  $1,341,726 

 

 

The fair value of derivative liabilities that we recorded in the six months ended September 30, 2011 was related to our April 2011 convertible note, July & August 2011 10% convertible notes and the September 2011 convertible note offerings (see Note 5) and was based upon an independent valuation report.

 

NOTE 10. STOCK COMPENSATION

 

The following table summarizes share-based compensation expenses relating to shares and options granted and the effect on basic and diluted loss per common share during the three and six months ended September 30, 2012 and 2011:

 

   Three Months Ended   Three Months Ended   Six Months Ended   Six Months Ended 
   September 30, 2012   September 30, 2011   September 30, 2012   September 30, 2011 
                 
Total share-based compensation expense  $226,196   $224,031   $395,495   $448,062 
                     
Total share-based compensation expense included in net loss  $226,196   $224,031   $395,495   $448,062 
                     
Basic and diluted loss per common share  $(0.00)  $(0.00)  $(0.00)  $(0.01)

 

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The following table breaks out the components of our share-based compensation expenses relating to shares and options granted and the effect on basic and diluted loss per common share during the three and six months ended September 30, 2012 and 2011.

 

   Three Months Ended   Three Months Ended   Six Months Ended   Six Months Ended 
   September 30, 2012   September 30, 2011   September 30, 2012   September 30, 2011 
Vesting of stock options   128,572    127,364    181,047    254,728 
Incremental fair value of option modifications   957        21,114     
Vesting expense associated with CEO restricted stock grant   96,667    96,667    193,334    193,334 
Direct stock grants                
Total share-based compensation expense  $226,196   $224,031   $395,495   $448,062 
                     
Total share-based compensation expense included in net loss  $226,196   $224,031   $395,495   $448,062 
                     
Basic and diluted loss per common share  $(0.00)  $(0.00)  $(0.00)  $(0.01)

 

 

All of the stock-based compensation expense recorded during the six months ended September 30, 2012 and 2011, which totaled $395,495 and $448,062, respectively, is included in payroll and related expense in the accompanying condensed consolidated statements of operations.  Stock-based compensation expense recorded during the three months ended September 30, 2012 and 2011 had no impact on basic and diluted loss per common share. Stock-based compensation expense recorded during the six months ended September 30, 2012 had no impact on basic and diluted loss per common share and the stock-based compensation expense recorded during the six months ended September 30, 2011 increased basic and diluted loss per common share by $0.01.

 

In July 2012, our Board of Directors approved a new Board Compensation Program (the “New Program”), which modifies and supersedes the 2005 Directors Compensation Program (the “2005 Program”) that was previously in effect. Under the New Program, in which only non-employee Directors may participate, an eligible Director will receive a grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; however for the new non-employee directors, the exercise price for this initial grant, $0.076 per share, is based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date of their appointment (July 24, 2012). These options will have a term of ten years and will be fully vested upon grant. In addition, each existing eligible Director will receive the same grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; provided however that for this current grant only, all of such grants shall be made at an exercise price of $0.076 per share based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date (July 24, 2012) of the appointment of two new directors to our Board of Directors.

 

At the beginning of each fiscal year, each Director eligible to participate in the New Program also will receive a grant of $20,000 worth of options valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year. In addition, under the New Program eligible Directors will receive cash compensation equal to $500 for each committee meeting attended and $1,000 for each formal Board meeting attended.

 

In the six months ended September 30, 2012, our Board of Directors granted, to our four outside directors, ten year options to acquire an aggregate of 1,667,105 shares of our common stock, all with an exercise price of $0.076 per share

 

In March 2012, our Chief Executive Officer and our Chief Financial Officer agreed to suspend the exercise of up to 12,588,243 of their stock options, which allowed us to utilize the shares underlying those stock options in capital raising activities while we presented our stockholders with a proposal to increase the number of authorized shares from 250,000,000 to 500,000,000. That proposal was approved by our stockholders at our Special Stockholders’ Meeting on June 4, 2012. Following that approval we extended their stock options by the 70 days, which equaled the number of days that they had unreserved their shares. We valued the change in fair value of their vested stock options due to this extension, and based on the change in fair value, recorded an increase to our stock based compensation expense in the quarter ended June 30, 2012 of $19,838. For their unvested options, we recorded an increase to fair value of $5,100, which will be expensed over the remaining vesting period of those options.

 

The following outlines the significant weighted average assumptions used to estimate the fair value information presented, with respect to stock option grants utilizing the Binomial Lattice option pricing models at, and during the six months ended September 30, 2012:

 

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Risk free interest rate 1.44%
Average expected life    7 years
Expected volatility      117.5%
Expected dividends  None

 

We review share-based compensation on a quarterly basis for changes to the estimate of expected award forfeitures based on actual forfeiture experience. The cumulative effect of adjusting the forfeiture rate for all expense amortization is recognized in the period the forfeiture estimate is changed. The effect of forfeiture adjustments for the six months ended September 30, 2012 was insignificant.

 

The expected volatility is based on the historic volatility. The expected life of options granted is based on the "simplified method" as described in the SEC's guidance due to changes in the vesting terms and contractual life of current option grants compared to our historical grants.

 

Options outstanding that have vested and are expected to vest as of September 30, 2012 are as follows:

 

           Weighted 
       Weighted   Average 
       Average   Remaining 
   Number of   Exercise   Contractual 
   Shares   Price   Term in Years 
                
Vested   18,333,294   $0.30    3.93 
Expected to vest   2,762,504   $0.19    8.61 
Total   21,095,798           

 

A summary of stock option activity during the six months ended September 30, 2012 is presented below:

 

   Amount  

Range of Exercise

 Price

 

Weighted Average

Exercise

 Price

Stock options outstanding at March 31, 2012   19,428,693   $0.21 - $0.41  $0.31
Exercised      $--   
Issued   1,667,105   $0.076  $0.076
Cancelled/Expired      --   
Stock options outstanding at September 30, 2012   21,095,798   $0.076 - $0.41  $0.28
Stock options exercisable at September 30, 2012   18,333,294   $0.076 - $0.41  $0.30

 

At September 30, 2012, there was approximately $574,852 of unrecognized compensation cost related to share-based payments, including our Chief Executive Officer’s restricted stock grant, which is expected to be recognized over a weighted average period of 0.82 years.

 

On September 30, 2012, our stock options had a negative intrinsic value since the closing price on that date of $0.10 per share was below the weighted average exercise price of our stock options

 

NOTE 11.  WARRANTS

 

A summary of warrant activity during the three months ended September 30, 2012 is presented below:

 

   Amount  

Range of Exercise

 Price

 

Weighted Average

Exercise

 Price

Warrants outstanding at March 31, 2012   59,807,849   $0.10 - $0.25  $0.14
Exercised      --   
Issued   8,972,936   $0.107-$0.125  $0.11
Cancelled/Expired      $--   
Warrants outstanding at September 30, 2012   68,780,784   $0.10 - $0.25  $0.14
Warrants exercisable at September 30, 2012   68,780,784   $0.10 - $0.25  $0.14

 

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The following outlines the significant weighted average assumptions used to estimate the fair value information presented, with respect to warrants utilizing the Binomial Lattice option pricing models at, and during the six months ended September 30, 2012:

 

Risk free interest rate 0.086% - 1.56%
Average expected life    5 - 7 years
Expected volatility      91.5 – 94.3%
Expected dividends  None

 

NOTE 12. DARPA CONTRACT AND RELATED REVENUE RECOGNITION

 

As discussed in Note 1, we entered into a government contract with DARPA on September 30, 2011 and commenced work on such contract in October 2011.  Originally, only the base year (year one contract) was effective for the parties, however, effective August 16, 2012, DARPA exercised the option on the second year of the contract.  Years three through five are subject to DARPA exercising their option to enter into contracts for those years.  The year one contract contains eight milestones of which five were achieved during the fiscal year ended March 31, 2012. In June 2012, we invoiced the US Government for the sixth milestone under our DARPA contract in the amount of $216,747 and received that payment. In the September 2012 quarter, we invoiced the US government for the seventh and eighth milestones. The details of the three milestones achieved during the six month period ended September 30, 2012 were as follows:

 

Milestone 2.2.2.3 - Perform preliminary quantitative real time PCR to measure viral load, and specific DNA or RNA targets. The milestone payment was $216,747. Management considers this milestone to be substantive as it was not dependent on the passage of time nor was it based solely on another party's efforts.  We demonstrated that we were able to measure viral load of one or more targets as part of our submission for approval.  The report was accepted by the contracting officer's representative and the invoice was submitted thereafter.  

 

Milestone 2.2.1.4 - Obtain all necessary IRB documentation and obtain both institutional and Government approval in accordance with IRB documentation submission guidance prior to conducting human or animal testing. The milestone payment was $183,367. Management considers this milestone to be substantive as it was not dependent on the passage of time nor was it based solely on another party's efforts.  We obtained all of the required documentation from both institutional and Government authorities. The report was accepted by the contracting officer's representative and the invoice was submitted thereafter.  

 

Milestone M2 – Target capture > 50% in 24 hours for at least one target in blood or blood components. The milestone payment was $216,747. Management considers this milestone to be substantive as it was not dependent on the passage of time nor was it based solely on another party's efforts.  We demonstrated that we were able to capture > 50% in 24 hours of one of the agreed targets in blood or blood components. The report was accepted by the contracting officer's representative and the invoice was submitted thereafter.  

 

NOTE 13. COMMITMENTS AND CONTINGENCIES

 

LEGAL MATTERS

 

From time to time, claims are made against us in the ordinary course of business, which could result in litigation. Claims and associated litigation are subject to inherent uncertainties and unfavorable outcomes could occur, such as monetary damages, fines, penalties or injunctions prohibiting us from selling one or more products or engaging in other activities.

 

The occurrence of an unfavorable outcome in any specific period could have a material adverse effect on our results of operations for that period or future periods. Other than as mentioned here, we are not presently a party to any pending or threatened legal proceedings.

 

25
 

 

On July 5, 2012, Gemini Master Fund, Ltd., a Cayman Islands company ("Gemini"), filed a complaint against the Company in the Supreme Court of the State of New York, County of New York, entitled Gemini Master Fund Ltd. v. Aethlon Medical, Inc., Index No. 652358/2012 (the "Complaint").  In the Complaint, Gemini is seeking relief both in the form of money damages and delivery of shares of the Company's common stock. The Complaint alleges, among other things, that the Company is in default of a certain promissory note originally issued to Gemini on February 12, 2010 by failing to pay the note in full and by failing to honor certain requests by Gemini to convert principal and interest under the note into shares of the Company's common stock.   Complaint also includes allegations that the Company has failed to issue shares upon the presentation of an exercise notice under a warrant originally issued to Gemini on November 22, 2010. The Company believes, among other things, that Gemini’s claims are barred because it received and accepted a payment the Company made in full settlement of Gemini’s claims against the Company and Gemini was informed that acceptance of the payment would settle and discharge the disputed claim. The Company does not believe that additional shares are due to Gemini under either the note or the warrant due to, among other things, a share issuance limitation agreed to by both Gemini and the Company. The lawsuit also alleges that the Company should have issued shares pursuant to the exercise of two warrants. The Company intends to vigorously defend the lawsuit. There can be no assurances, however, that the litigation will be decided in the Company's favor as to all, or any part, of Gemini's Complaint. An adverse decision in the litigation could have an adverse effect on the Company's operations and could be dilutive to the Company's shareholders.

 

LEASES

 

We currently rent approximately 2,300 square feet of executive office space at 8910 University Center Lane, Suite 660, San Diego, CA 92122 at the rate of $6,475 per month on a four year lease that expires in September 2013. We also rent approximately 1,700 square feet of laboratory space at 11585 Sorrento Valley Road, Suite 109, San Diego, California 92121 at the rate of $2,917 per month on a two year lease that expires in October 2014.

 

NOTE 14. SUBSEQUENT EVENTS

 

Management has evaluated events subsequent to September 30, 2012 through the date that the accompanying condensed consolidated financial statements were filed with the Securities and Exchange Commission for transactions and other events which may require adjustment of and/or disclosure in such financial statements.

 

In October 2012, we completed a unit subscription agreement with four accredited investors (the “Purchasers”) pursuant to which the Purchasers purchased an aggregate of $135,000 (the "Subscription Amount") of restricted Common Stock at an average price of $0.074 per share. The Common Stock purchase price under the Subscription Agreement was determined to be 80% of the average closing price of our Common Stock for the five-day period immediately preceding the date of the Subscription Agreement, resulting in the issuance of 1,823,412 shares of Common Stock.

 

Each Purchaser also received one Common Stock Purchase Warrant for each two shares of Common Stock purchased under the Subscription Agreement. The Warrant exercise price was calculated based upon 120% of the average of the closing prices of our Common Stock for the five-day period immediately preceding the parties entering into the Subscription Agreement.

 

In October 2012, we issued 483,638 shares of common stock to the holder of a note payable in exchange for the value of the principal and related accrued interest of $30,000 for a conversion price of $0.062 per share.

 

In October 2012, we issued 466,690 shares of common stock pursuant to our S-8 registration statement covering our Amended 2010 Stock Plan at an average price of $0.10 per share in payment for scientific consulting services valued at $46,669 based on the value of the services provided.

 

In October 2012, we invoiced the US Government for the first milestone in the second year under our DARPA contract in the amount of $208,781.

 

In November 2012, we issued 439,382 shares of common stock to the holder of a note payable in exchange for the value of the principal and related accrued interest of $30,000 for a conversion price of $0.07 per share

 

26
 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion of our financial condition and results of operations should be read in conjunction with, and is qualified in its entirety by, the condensed consolidated financial statements and notes thereto included in Item 1 in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements.

 

FORWARD LOOKING STATEMENTS

 

All statements, other than statements of historical fact, included in this Form 10-Q 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 Exchange Act. Such forward-looking statements involve assumptions, known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of Aethlon Medical, Inc. ("we", "us" 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-Q. Such potential risks and uncertainties include, without limitation, completion of our capital-raising activities, FDA approval of our products, other regulations, patent protection of 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. The forward-looking statements are made as of the date of this Form 10-Q, 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.

 

THE COMPANY

 

We are a medical device company focused on creating innovative devices that address unmet medical needs in cancer, infectious disease and other life-threatening conditions. At the core of our developments is the Aethlon ADAPT™ (Adaptive Dialysis-Like Affinity Platform Technology) system, a medical device platform that converges single or multiple affinity drug agents with advanced plasma membrane technology to create therapeutic filtration devices that selectively remove harmful particles from the entire circulatory system without loss of essential blood components. Approval to embark on human trials is still needed to reach commercial viability of the Hemopurifier® and approval by the U.S. Food and Drug Administration ("FDA"). Successful outcomes of human trials will be required by the regulatory agencies of certain foreign countries where we intend to sell this device. We have submitted an Investigational Device Exemption ("IDE") to the FDA. Some of our patents may expire before FDA approval or approval in a foreign country, if any, is obtained. However, we believe that certain patent applications and/or other patents issued more recently will help protect the proprietary nature of the Hemopurifier(R) treatment technology. . On September 30, 2011, we entered into a contract with the United States of America, issued by SPAWAR Systems Center Pacific, pursuant to a contract award from the Defense Advanced Research Projects Agency (“DARPA”). Under the DARPA award, we have been engaged to develop a therapeutic device to reduce the incidence of sepsis, a fatal bloodstream infection that often results in the death of combat-injured soldiers.  

 

WHERE YOU CAN FIND MORE INFORMATION

 

We are subject to the informational requirements of the Securities Exchange Act and must file reports, proxy statements and other information with the SEC. The reports, information statements and other information we file with the Commission can be inspected and copied at the Commission Public Reference Room, 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (800) SEC-0330. The Commission also maintains a Web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, like us, which file electronically with the Commission. Our headquarters are located at 8910 University Center Lane, Suite 660, San Diego, CA 92122. Our phone number at that address is (858) 459-7800. Our Web site is http://www.aethlonmedical.com.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2011

 

Revenues

 

We recorded government contract revenue of $400,114 in the three months ended September 30, 2012.  This revenue arose from work performed under our government contract.  On September 30, 2011, we entered into a contract with the United States of America, issued by SPAWAR Systems Center Pacific, pursuant to a contract award from the Defense Advanced Research Projects Agency (“DARPA”). Under the DARPA award, we have been engaged to develop a therapeutic device to reduce the incidence of sepsis, a fatal bloodstream infection that often results in the death of combat-injured soldiers.  The award from DARPA is a fixed-price contract with potential total payments to us of $6,794,389 over the course of five years, including payments of up to $1,975,047 in the first year. Fixed price contracts require the achievement of multiple, incremental milestones to receive the full award during each year of the contract.  Under the terms of the contract, we will perform certain incremental work towards the achievement of specific milestones against which we will invoice the government for fixed payment amounts.  Assuming all such work is performed according to the contract terms, we will receive up to $1,975,047 of contract payments during the first twelve months of the contract with the aggregate payment amounts in years two through five varying between approximately $775,000 and $1.6 million. Originally, only the base year (year one contract) was effective for the parties, however, effective August 16, 2012, DARPA exercised the option on the second year of the contract.  DARPA has the option to enter into the contract for years three through five.  The milestones are comprised of planning, engineering and clinical targets, the achievement of which in some cases will require the participation and contribution of third party participants under the contract.  There can be no assurance that we alone, or with third party participants, will meet such milestones to the satisfaction of the government and in compliance with the terms of the contract or that we will be paid the full amount of the contract revenues during any year of the contract term.  We commenced work under the contract in October 2011.

 

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As of September 30, 2012, we have invoiced for and received eight milestone payments under the DARPA contract totaling $1,975,047.

 

Operating Expenses

 

Consolidated operating expenses for the three months ended September 30, 2012 were $1,199,908 in comparison with $882,957 for the comparable quarter a year ago.  This increase of $316,951, or 35.9%, was due to increases in professional fees of $208,998, in general and administrative expenses of $64,105 and in payroll and related expenses of $43,848.

 

The $208,998 increase in our professional fees was primarily due to DARPA contract related professional fees of $164,485. Other significant factors in the increase were $38,514 of legal fees related to the Gemini litigation and $15,617 of legal fees related to work on resolving our DTC chill and $15,000 of business development expense, all with no comparable expense in the prior period.

 

The $64,105 increase in general and administrative expenses was primarily due to $81,393 in DARPA-related general and administrative expenses.

 

The $43,848 increase in payroll and related expenses was primarily due to increased payroll of $51,250 due to hiring three additional scientists for work under our DARPA contract, which was partially offset by a reduction in stock-based compensation of $12,420.

 

Other Expense (Income)

 

Other expense (income) consist primarily of the change in the fair value of our derivative liability, other expense and interest expense. Other expense (income) for the three months ended September 30, 2012 were other expense of $621,530 in comparison with other income of $429,480 for the comparable quarter a year ago.

 

Change in Fair Value of Derivative Liability

 

Both periods include changes in the fair value of derivative liability. For the three months ended September 30, 2012, the change in the estimated fair value of derivative liability was a charge of $326,138 and for the three months ended September 30, 2011, the change in estimated fair value was a gain of $1,029,675.

 

Interest Expense

 

Interest expense was $224,374 for the three months ended September 30, 2012 compared to $600,226 in the corresponding prior period, a decrease of $375,852. The various components of our interest expense are shown in the following table:

 

   Quarter Ended   Quarter Ended     
   9/30/12   9/30/11   Change 
Interest Expense  $126,100   $121,703   $4,397 
Amortization of Deferred Financing Costs   22,739    78,101    (55,362)
Amortization of Note Discounts   75,535    400,422    (324,887)
Total Interest Expense  $224,374   $600,226   $(375,852)

 

As noted in the above table, the two most significant factors in the $375,852 decrease in interest expense were (a) the $324,887 reduction in the amortization of debt discounts that was largely the result of the completion of the discount amortization on the majority of our convertible notes prior and (b) a $55,362 reduction in the amortization of deferred offering costs that also was largely the result of the completion of the amortization on those costs.

 

Other

 

The three months ended September 30, 2012 contained a $71,080 loss on debt conversion that related to the conversion to equity of $53,516 in principal and accrued interest related to a note payable.

 

Net Loss

 

As a result of the increased expenses noted above, we recorded a consolidated net loss of approximately $1,421,000 and $453,000 for the quarters ended September 30, 2012 and 2011, respectively.

 

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Basic and diluted loss per common share were ($0.01) for the three month period ended September 30, 2012 compared to ($0.00) for the period ended September 30, 2011.

 

SIX MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30, 2011

 

Revenues

 

We recorded government contract revenue of $616,861 in the six months ended September 30, 2012.  This revenue arose from work performed under our government contract.  On September 30, 2011, we entered into a contract with the United States of America, issued by SPAWAR Systems Center Pacific, pursuant to a contract award from the Defense Advanced Research Projects Agency (“DARPA”). Under the DARPA award, we have been engaged to develop a therapeutic device to reduce the incidence of sepsis, a fatal bloodstream infection that often results in the death of combat-injured soldiers.  The award from DARPA is a fixed-price contract with potential total payments to us of $6,794,389 over the course of five years, including payments of up to $1,975,047 in the first year. Fixed price contracts require the achievement of multiple, incremental milestones to receive the full award during each year of the contract.  Under the terms of the contract, we will perform certain incremental work towards the achievement of specific milestones against which we will invoice the government for fixed payment amounts.  Assuming all such work is performed according to the contract terms, we will receive up to $1,975,047 of contract payments during the first twelve months of the contract with the aggregate payment amounts in years two through five varying between approximately $775,000 and $1.6 million. Originally, only the base year (year one contract) was effective for the parties, however, effective August 16, 2012, DARPA exercised the option on the second year of the contract.  DARPA has the option to enter into the contract for years three through five.  The milestones are comprised of planning, engineering and clinical targets, the achievement of which in some cases will require the participation and contribution of third party participants under the contract.  There can be no assurance that we alone, or with third party participants, will meet such milestones to the satisfaction of the government and in compliance with the terms of the contract or that we will be paid the full amount of the contract revenues during any year of the contract term.  We commenced work under the contract in October 2011.

 

As of September 30, 2012, we have invoiced for and received eight milestone payments under the DARPA contract totaling $1,975,047.

 

Operating Expenses

 

Consolidated operating expenses for the six months ended September 30, 2012 were $2,408,444 in comparison with $1,915,436 for the comparable period a year ago.  This increase of $493,008, or 25.7%, was due to increases in professional fees of $317,926, in general and administrative expenses of $127,071 and in payroll and related expenses of $48,011.

 

The $317,926 increase in our professional fees was primarily due to DARPA contract related professional fees of $256,895. Other significant factors in the increase were $135,721 of legal fees related to the Gemini litigation and $17,753 of legal fees related to work on resolving our DTC chill both with no comparable expense in the prior period.

 

The $127,071 increase in general and administrative expenses was primarily due to $143,698 in DARPA-related general and administrative expenses.

 

The $48,011 increase in payroll and related expenses was primarily due to increased payroll of $102,537 due to hiring three additional scientists for work under our DARPA contract, which was partially offset by a reduction in stock-based compensation of $52,567.

 

Other Expense (Income)

 

Other expense (income) consist primarily of the change in the fair value of our derivative liability, other expense and interest expense. Other expense (income) for the six months ended September 30, 2012 were other expense of $647,552 in comparison with other expense of $1,123,941 for the comparable period a year ago.

 

Change in Fair Value of Derivative Liability

 

Both periods include changes in the fair value of derivative liability. For the six months ended September 30, 2012, the change in the estimated fair value of derivative liability was a gain of $361,462 and for the six months ended September 30, 2011, the change in estimated fair value was a gain of $1,521,502.

 

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Interest Expense

 

Interest expense was $913,062 for the six months ended September 30, 2012 compared to $2,286,140 in the corresponding prior period, a decrease of $1,373,078. The various components of our interest expense are shown in the following table:

 

   6 Months Ended   6 Months Ended     
   9/30/12   9/30/11   Change 
Interest Expense  $318,719   $224,917   $93,802 
Amortization of Deferred Financing Costs   120,790    186,699    (65,909)
Non-Cash Interest Expense   11,846    538,736    (526,890)
Amortization of Note Discounts   461,707    1,335,788    (874,081)
Total Interest Expense  $913,062   $2,286,140   $(1,373,078)

 

As noted in the above table, the two most significant factors in the $1,373,078 decrease in interest expense were (a) the $874,081 reduction in the amortization of debt discounts that was largely the result of the completion of the discount amortization on the majority of our convertible notes prior and (b) a $526,890 reduction in our non-cash interest expense that primarily related to a $538,736 adjustment to derivative liabilities that related to the fair value of the April 2011 convertible notes in the September 2011 period with no comparable expense in the September 2012 period.

 

Other

 

The six months ended September 30, 2011 also contained a $360,186 charge relating to the extinguishment of a convertible note and warrant and to the formation of a new note in that amount of $360,185 as a result of that extinguishment. The six months ended September 30, 2012 contained a $96,059 loss on debt conversion that related to the conversion to equity of $113,701 in principal and accrued interest related to a note payable.

 

Net Loss

 

As a result of the increased expenses noted above, we recorded a consolidated net loss of approximately $2,439,000 and $3,039,000 for the six month periods ended September 30, 2012 and 2011, respectively.

 

Basic and diluted loss per common share were ($0.02) for the six month period ended September 30, 2012 compared to ($0.03) for the period ended September 30, 2011.

 

LIQUIDITY AND CAPITAL RESOURCES

 

At September 30, 2012, we had a cash balance of $271,747 and a working capital deficit of $8,608,542. This compares to a cash balance of $143,907 and a working capital deficit of $9,438,279 at March 31, 2012. Between October 1, 2012 and November 13, 2012, we have raised $135,000 from private equity transactions. Our cash at September 30, 2012 plus additional funds raised to date subsequent to September 30, 2012 are not sufficient to meet our funding requirements during the next twelve months. Significant additional financing must be obtained in order to provide a sufficient source of operating capital and to allow us to continue to operate as a going concern. In addition, our current financial resources are insufficient to fund our 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, 2013. 

 

We do not expect revenue from operations will be sufficient to satisfy our funding requirements in the near term, and accordingly, our ability to continue operations and 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. Future capital requirements will depend upon many factors, including progress with pre-clinical testing and clinical trials, the number and breadth of our clinical 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.

 

Should the U.S. Government elect not to exercise the options for years three through five of our DARPA contract, the effects may be material to us. The loss of revenues from the DARPA contract would have a material impact on our revenues, operating cash flows and liquidity.

 

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Beyond the immediate future, we currently believe that the following four areas may generate revenue for us:

 

(1)Developing future products using the Aethlon ADAPTTM system with drug industry collaborators.  Revenues in this area could come from product development fees, fees from research, regulatory and manufacturing support or from downstream royalties;
(2)Applying for and winning additional U.S. Government grant or contract income;  
(3)Licensing or selling our ELLSA research diagnostic tools that identify and quantify exosomes; and
(4)Commercializing the Hemopurifier® in India following a successful result in our Hepatitis-C-oriented clinical trial currently being conducted at the Medanta Medicity Institute (Medicity) in that country. Medicity’s Institutional Review Board has agreed to allow compassionate usage of the Hemopurifier® for individuals who previously failed or subsequently relapsed standard-of-care drug regimens. In addition to offering Hemopurifier® therapy to the citizens of India, HCV-infected individuals from the United States, European Union and other regions of the world may pursue treatment through the expanded access program at Medicity. Details related to treatment protocol, inclusion criteria, patient approval processes and therapy pricing are anticipated to be finalized with Medicity later on in 2012.

 

One area of expense that increased over the six months ended September 30, 2012 was in legal fees related to litigation (see note 13 to our financial statements). We incurred $135,721 related to that litigation over the six month period. We have been informed by our insurance carrier that they will cover our legal fees related to that litigation once we have met our $150,000 deductible amount. We met that deductible threshold in October and as a result of the insurance coverage, we expect the operation expenses related to that litigation to decrease in future periods.

 

Cash Flows

 

Cash flows from operating, investing and financing activities, as reflected in the accompanying Condensed Consolidated Statements of Cash Flows, are summarized as follows (in thousands):

 

   (In thousands)
For the six months ended
 
   September 30,
2012
   September 30,
2011
 
Cash (used in) provided by:          
Operating activities  $(915)  $(1,036)
Investing activities       (2)
Financing activities   1,043    1,068 
Net increase in cash  $128   $30 

 

NET CASH FROM OPERATING ACTIVITIES. We used cash in our operating activities due to our losses from operations. Net cash used in operating activities was approximately $915,000 in the six months ended September 30, 2012 compared to net cash used in operating activities of approximately $1,036,000 in the six months ended September 30, 2011, a decrease of $120,000.  The $120,000 decrease was primarily due to receipts under our DARPA contract in the September 2012 period, which were offset for the most part by expenses under that contract.

 

NET CASH FROM INVESTING ACTIVITIES. During the six months ended September 30, 2012, we did not have any investing activities.  During the six months ended September 30, 2011, we used approximately $2,000 in cash for purchases of equipment.

 

NET CASH FROM FINANCING ACTIVITIES. Net cash generated from financing activities decreased from $1,068,000 in the six months ended September 30, 2011 to approximately $1,043,000 in the six months ended September 30, 2012. Included in net cash provided by financing activities in the 2012 period was $1,073,000 in proceeds from the issuance of common stock which was partially offset by approximately $30,000 in repayments of notes payable and related accrued interest in cash.  In the 2011 period, we received $873,000 in proceeds from the issuance of convertible notes payable and $200,000 from the collection of notes receivable associated with certain convertible note transactions.

 

An increase in working capital during the six months ended September 30, 2012 in the amount of approximately $825,000 changed our negative working capital position to approximately ($8,608,000) at September 30, 2012 from a negative working capital of approximately ($9,438,000) at March 31, 2012.  The most significant factors in the increase in working capital noted above were a decrease in current liabilities of approximately $1,188,000 and an increase in cash of approximately $128,000, which were partially offset by the collection of accounts receivable of $400,114.

 

At the date of this filing, we plan to invest significantly into purchases of our raw materials and into our contract manufacturing arrangement subject to successfully raising additional capital.

 

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CRITICAL ACCOUNTING POLICIES

 

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make a number of 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. Such estimates and assumptions affect the reported amounts of expenses during the reporting period. On an ongoing basis, we evaluate estimates and assumptions based upon historical experience and various other factors and circumstances. We believe our estimates and assumptions are reasonable in the circumstances; however, actual results may differ from these estimates under different future conditions.

 

We believe that the estimates and assumptions that are most important to the portrayal of our financial condition and results of operations, in that they require the most difficult, subjective or complex judgments, form the basis for the accounting policies deemed to be most critical to us. These critical accounting policies relate to revenue recognition, measurement of stock purchase warrants issued with notes payable, beneficial conversion feature of convertible notes payable, impairment of intangible assets and long lived assets, stock compensation, and the classification of warrant obligations, and evaluation of contingencies. We believe estimates and assumptions related to these critical accounting policies are appropriate under the circumstances; however, should future events or occurrences result in unanticipated consequences, there could be a material impact on our future financial condition or results of operations.

 

There have been no changes to our critical accounting policies as disclosed in our Form 10-K for the year ended March 31, 2012.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no obligations required to be disclosed herein as off-balance sheet arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

As a Smaller Reporting Company as defined by rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this item.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

DISCLOSURE CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO"), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of a date as of the end of the period covered by this Quarterly Report.

 

Based on such evaluation, our CEO and CFO concluded that, as of the end of such period, our disclosure controls and procedures are not effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are not effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

There have been no changes in our internal control over financial reporting during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

From time to time, claims are made against us in the ordinary course of business, which could result in litigation. Claims and associated litigation are subject to inherent uncertainties and unfavorable outcomes could occur, such as monetary damages, fines, penalties or injunctions prohibiting us from selling one or more products or engaging in other activities.

 

The occurrence of an unfavorable outcome in any specific period could have a material adverse effect on our results of operations for that period or future periods. Other than as set forth here, we are not presently a party to any pending or threatened legal proceedings.

 

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On July 5, 2012, Gemini Master Fund, Ltd., a Cayman Islands company ("Gemini"), filed a complaint against the Company in the Supreme Court of the State of New York, County of New York, , entitled Gemini Master Fund Ltd. v. Aethlon Medical, Inc., Index No. 652358/2012 (the "Complaint").  In the Complaint, Gemini is seeking relief both in the form of money damages and delivery of shares of the Company's common stock. The Complaint alleges, among other things, that the Company is in default of a certain promissory note originally issued to Gemini on February 12, 2010 by failing to pay the note in full and by failing to honor certain requests by Gemini to convert principal and interest under the note into shares of the Company's common stock.   Complaint also includes allegations that the Company has failed to issue shares upon the presentation of an exercise notice under a warrant originally issued to Gemini on November 22, 2010. The Company believes, among other things, that Gemini’s claims are barred because it received and accepted a payment the Company made in full settlement of Gemini’s claims against the Company and Gemini was informed that acceptance of the payment would settle and discharge the disputed claim. The Company does not believe that additional shares are due to Gemini under either the note or the warrant due to, among other things, a share issuance limitation agreed to by both Gemini and the Company. The lawsuit also alleges that the Company should have issued shares pursuant to the exercise of two warrants. The Company intends to vigorously defend the lawsuit. There can be no assurances, however, that the litigation will be decided in the Company's favor as to all, or any part, of Gemini's Complaint. An adverse decision in the litigation could have an adverse effect on the Company's operations and could be dilutive to the Company's shareholders.

 

ITEM 1A. RISK FACTORS.

 

As a Smaller Reporting Company as defined by rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this item.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

During the quarter ended September 30, 2012, we issued the following securities which were not registered under the Securities Act of 1933, as amended, and have not been included previously in a Current Report on Form 8-K. We did not employ any form of general solicitation or advertising in connection with the offer and sale of the securities described below. In addition, we believe the purchasers of the securities are "ACCREDITED INVESTORS" for the purpose of Rule 501 of the Securities Act. For these reasons, among others, the offer and sale of the following securities were made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act or Regulation D promulgated by the SEC under the Securities Act:

 

In July 2012, our Board of Directors approved a new Board Compensation Program (the “New Program”), which modifies and supersedes the 2005 Directors Compensation Program (the “2005 Program”) that was previously in effect. Under the New Program, in which only non-employee Directors may participate, an eligible Director will receive a grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; however for the new non-employee directors, the exercise price for this initial grant, $0.076 per share, is based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date of their appointment (July 24, 2012). These options will have a term of ten years and will be fully vested upon grant. In addition, each existing eligible Director will receive the same grant of $15,000 worth of options to acquire shares of Common Stock, with such grant being valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year; provided however that for this current grant only, all of such grants shall be made at an exercise price of $0.076 per share based on the average of the closing bid prices of the Common Stock for the five trading days preceding the date (July 24, 2012) of the appointment of two new directors to our Board of Directors.

 

At the beginning of each fiscal year, each Director eligible to participate in the New Program also will receive a grant of $20,000 worth of options valued at the exercise price based on the average of the closing bid prices of the Common Stock for the five trading days preceding the first day of the fiscal year. In addition, under the New Program eligible Directors will receive cash compensation equal to $500 for each committee meeting attended and $1,000 for each formal Board meeting attended.

 

The New Program eliminates the following features of the 2005 Program: (1) the annual payment of $10,000 in cash compensation and (2) the granting of options to Directors based on a percentage of our issued and outstanding common stock.

 

Under the New Program, on July 24, 2012, we issued options to acquire up to an aggregate of 1,667,104 shares of restricted common stock at an exercise price of $0.076 per share to our four non-employee Directors.

 

During the three months ended September 30, 2012, we issued 10,221,763 shares of restricted common stock to holders of notes issued by the Company in exchange for the partial or full conversion of principal and interest of several convertible notes payable in an aggregate amount of $752,597 at an average conversion price of $0.07 per share based upon the conversion formulae in the respective notes.

 

During the three months ended September 30, 2012, we issued 3,387,500 shares of restricted common stock and 1,693,750 warrants to purchase restricted common stock to seven accredited investors in exchange for aggregate cash investments of $271,000 at an average purchase price of $0.08 per share.

 

During the three months ended September 30, 2012, we issued 140,909 shares of restricted common stock, valued at $0.11 per share, to a consultant in exchange for $15,000 of corporate communications-related services.

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

As of the date of this report, various promissory and convertible notes payable in the aggregate principal amount of $2,291,916 have reached maturity and are past due. We are continually reviewing other financing arrangements to retire all past due notes. At September 30, 2012, we had accrued interest in the amount of $787,267 associated with these notes and accrued liabilities payable.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

We have no disclosure applicable to this item.

 

ITEM 5. OTHER INFORMATION.

 

(a) In October 2012, we completed a unit subscription agreement with four accredited investors (the “Purchasers”) pursuant to which the Purchasers purchased an aggregate of $135,000 (the "Subscription Amount") of restricted Common Stock at an average price of $0.074 per share. The Common Stock purchase price under the Subscription Agreement was determined to be 80% of the average closing price of our Common Stock for the five-day period immediately preceding the date of the Subscription Agreement, resulting in the issuance of 1,823,412 shares of Common Stock.

 

Each Purchaser also received one Common Stock Purchase Warrant for each two shares of Common Stock purchased under the Subscription Agreement. The Warrant exercise price was calculated based upon 120% of the average of the closing prices of our Common Stock for the five-day period immediately preceding the parties entering into the Subscription Agreement.

 

In October 2012, we issued 483,638 shares of common stock to the holder of a note payable in exchange for the value of the principal and related accrued interest of $30,000 for a conversion price of $0.062 per share.

 

In October 2012, we issued 466,690 shares of common stock pursuant to our S-8 registration statement covering our Amended 2010 Stock Plan at an average price of $0.10 per share in payment for scientific consulting services valued at $46,669 based on the value of the services provided.

 

ITEM 6.  EXHIBITS.

 

(a) Exhibits. The following documents are filed as part of this report:

 

3.1 Articles of Incorporation of Aethlon Medical, Inc., as amended (1)
   
3.2 Bylaws of Aethlon Medical, Inc. (2)
   
4.1 Form of Common Stock Purchase Warrant dated August 29, 2012 (3)
   
10.1 Form of Subscription Agreement dated August 29, 2012 (3)
   
31.1 Certification of Principal Executive 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*
   
31.2 Certification of Principal Financial Officer pursuant to Securities Exchange Act rules 13a- 14(a) and 15d-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002*
   
32.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
   
32.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
   
101 Interactive Data Files

 

* Filed herewith.

 

(1)Incorporated by reference to the filing of such exhibit with the Company's Annual Report on Form 10-K for the year ended March 31, 2012.

 

(2)Incorporated by reference to the filing of such exhibit with the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2012.

 

(3) Incorporated by reference to the filing of such exhibit with the Company’s Current Report on Form 8-K filed on September 6, 2012. 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

  AETHLON MEDICAL, INC.  
       
Date: November 13, 2012  By: /s/ JAMES B. FRAKES  
    JAMES B. FRAKES  
    CHIEF FINANCIAL OFFICER  
    CHIEF ACCOUNTING OFFICER  
       

 

 

 

 

 

 

 

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