apdn’s technology. we believe the same ... - maxim...

EQUITY RESEARCHINITIATION

Brian Kinstlinger, CFA(212)[email protected]

Software & Services

APDN - NASDAQ January 12, 2015

Closing Price 01/12/2015 $2.73Rating: Buy12-Month Target Price: $7.0052-Week Range: $2.02 - $10.80Market Cap ($M): $48Shares O/S: 17Float: 78.2%Avg. Daily Volume (000): 90Dividend Yield: 0.00%Dividend: $0.00Risk Profile: HighFiscal Year End: September

Revenue ('000) 2014E 2015E 2016E1Q 597A 1,045 2,0912Q 637A 988 2,9633Q 841A 1,304 3,5864Q 646A 1,500 4,125FY 2,721 4,837 12,764

GAAP EPS 2014E 2015E 2016E1Q (0.48)A (0.13) (0.07)2Q (0.20)A (0.13) (0.03)3Q (0.14)A (0.13) (0.03)4Q (0.15)A (0.11) 0.00FY (0.97) (0.49) (0.13)

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8

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0Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15

1.2

1

0.8

0.6

0.4

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Price Volume

Volume (MM) Price (USD)APDN

Source: Factset

Applied DNA Sciences Inc. BuyAPDN’s DNA-Based Products are Effective and Likely toDisrupt the Anti-Counterfeiting and Authentication MarketsSummary

• Initiating coverage of APDN, a provider of botanical DNA-based anti-counterfeiting and authentication solutions, with a Buy rating and a $7 pricetarget.

• The anti-counterfeiting market is estimated at about $66 billion by Markets andMarkets, and we believe APDN’s DNA-based solution is more effective thanthe traditional technologies and is unmatched in the market.

• APDN has 8 to 10 pilot programs that have the potential to exponentiallyincrease revenue and drive profitability.

• We expect a retailer or producer of plastic will be the early adopter and thenthe entire supply chain will likely be pressured to adopt DNA marking.

• Several key wins within the federal government are establishing APDN as atrusted federal partner and will add a much-needed recurring revenue base.

DetailsThe demand for anti-counterfeiting solutions is large and growing. Marketresearcher Markets and Markets puts the anti-counterfeiting market at $66 billion,with a predicted 14% five-year compounded annual growth rate. Technology has hadlimited impact on counterfeiting, as it has almost doubled over the last five years. Thissuggests that solutions such as bar-coding and authentication marks are not effectivein preventing counterfeiting, in our view. We believe APDN’s botanical DNA-basedauthentication is differentiated and more effective than the traditional authenticationsolution, and, therefore, the company is positioned to become a meaningful playerin the anti-counterfeiting market.

Strong government contract wins will be the foundation for recurring revenueand growth, in our view. The Defense Logistics Agency (DLA) is a largebuyer of semiconducters used for everything from aircrafts to medical equipment.Approximately 15% of the chips are counterfeit—but through APDN’s SigNature DNAmarking, counterfeiting has been greatly reduced. Not only is the program expectedto expand given its success, APDN has been awarded other similar federal contractsthat should generate $500,000 per quarter to expand the federal supply by 100.Once that is completed, we would expect each of the identified suppliers to licenseAPDN’s technology.

Numerous pilots have the potential to validate DNA marking and drive muchstronger fundamentals. APDN is working on 8 to 10 pilots, which we believe inmany cases will be the initial dominoes that could drive profitability and exponentialgrowth in revenue. One such example is its announced pilot with the world’seighth-largest plastic producer, Borealis (ticker), to authenticate its raw materialthrough the supply chain. Not only could Borealis become APDN’s first large-scalecustomer, but this could also force each of the players in its supply chain to licenseAPDN’s technology. We believe the same benefits can be achieved in textiles,pharmaceuticals, electronics, and other industries, for many of which APDN isalready performing pilots. We believe the benefits of DNA authentication providedifferentiation to its users and protect brand dilution by curbing counterfeits.

We initiate coverage of APDN with a Buy rating and $7 price target. Our target isbased on 12x our FY2016 revenue estimate of $12.8 million. APDN currently tradesat 10x our FY2015 revenue estimate, and we expect the P/S to expand as pilotsbecome meaningful revenue-generating contracts and validate its anti-counterfeitand authentication products. We believe a domino effect will occur that will lead toabnormally strong top-line growth. As a disrupter in the anti-counterfeiting sector, webelieve APDN should trade at a hefty premium to the peer group.

SEE PAGES 14 - 16 FOR IMPORTANT DISCLOSURES AND DISCLAIMERS

COMPANY PROFILE

Applied DNA Sciences Inc.

50 Health Sciences Dr.

Stony Brook, NY 11790

(631) 240-8800

Web Site: www.adnas.com

Company Description: Applied DNA Sciences uses biotechnology as a forensic foundation. APDN

provides DNA-based marking that helps prevent counterfeiting through authentication and can be

used for security purposes, such as reducing crime and identifying burglars.

Dr. James Hayward has been the Chairman of Applied DNA Sciences since 2007 and CEO since

2006. He has over 15 years of experience in the consumer product, biotech, and pharmaceutical

industries. He served as General Partner of Double D Venture Fund, a venture capital firm based in

New York. He founded Collaborative Laboratories Inc. in 1990 and served as its President.

Prior to APDN, he served as Vice President of Personal Care & Life Sciences for BASF Catalysts

LLC since 2004. From 1990 to 2004, he served as Chairman and CEO of Collaborative Group Ltd. In

1983, Dr. Hayward was one of the founding Principals and Research Director of Europe’s first

liposome company, Biocompatibles Ltd. From 1984 to 1989, he was responsible for product

development at Esteé Lauder Companies, where he served as Director of Research Worldwide.

Since June 2004, Dr. Hayward has been the Chairman of Evotope Biosciences Inc.

He serves on the boards of the Council on Biotechnology and the Research Foundation of the State

of New York. Since 2001, he has been a Director of Q-RNA Inc and also is a Director of Softheon, Inc

and the Long Island Life Sciences Initiative (LILSI), Long Island Association Inc., Stony Brook

Foundation, and the New York Biotechnology Association Inc. Dr. Hayward has more than 50 patents

and original publications to his credit regarding the applications of liposomes. He received his

Doctorate in Molecular Biology and Biophysics from SUNY at Stony Brook. Dr. Hayward received his

Bachelors degree in Biology and Chemistry from the State University of New York at Oneonta in 1976

and his Ph.D. in Molecular Biology from the State University of New York at Stony Brook in 1983.

Karol Kain Gray has been CFO of APDN since 2013 and is also the CFO and Executive Director of

the Stony Brook Foundation. Previously, Ms. Gray served as the VP of Finance & Administration and

CFO at the University at Stony Brook. Ms. Gray graduated with a Bachelor in Business Administration

from Hofstra University.

Risks:

The likely need for capital

Proving the value of its products to commercial customers

Turning pilots into contracts

Foreign exchange rates

Institutional Ownership: 4.0%

Insider Ownership: 23.0% (Source: Bloomberg)

Balance Sheet Summary ($M):

(As of September 30th, 2014)

Equity: ($1)

Assets: $4

Analysts Covering APDN: 1

# of Buys: 1

# of Holds:

# of Sells:

(excluding Maxim Group LLC)

Consensus non-GAAP EPS:

Current Year: (0.58)

Next Year: N/A

Investor Relations Contact:

Debbie Bailey

Director, Investor Relations

[email protected]

631-240-8817

2Maxim Group LLC

Applied DNA Sciences Inc. (APDN)

mailto:[email protected]

INVESTMENT THESIS

APDN’s botanical DNA-based marking is unmatched in a large and growing anti-

counterfeiting market. Market researcher Markets and Markets puts the anti-counterfeiting

market at $66 billion, with a predicted 14% five-year compounded annual growth rate. Technology

has had a limited impact on counterfeiting, as it has almost doubled over the last five years.

Taggants, holograms, inks & dyes, and other authentication technologies such as watermarks and

digital features lack the reliability that DNA provides. We believe each of these authentication

solutions can be comprised as technology improves. However, the bottom line is that we do not

believe counterfeiters can beat science (DNA), and therefore we believe APDN has the potential to

gain significant share of this market.

Each of APDN’s large pilots programs has the ability to drive profitability and provide

further validation of it products. APDN has 8 to 10 pilot programs that range from a large

retailer, plastics producer, automotive company, an agriculture company and a local government.

Although APDN already has some smaller customers using its DNA marking solutions, several of

these pilots are with Fortune 100 companies and would be game-changers for APDN, in our view.

Given the early success of its DNA marking, the pilots are now funded by the prospective

customers, and that suggests customers understand the value and are working with APDN in its

build out, in our opinion.

Pilot with Borealis could be a first mover, in our opinion. In March 2014, Borealis AG agreed

to pay $350,000 for a pilot to authenticate its polyolefin products. We believe the pilot has been

highly successful in eliminating lower quality plastic from entering the supply chain. As a result, we

believe Borealis could become the first domino in the plastics supply chain to drop. Not only do we

estimate that Borealis would generate significantly more than $10 million of recurring annual

revenue for APDN, but we also expect that it would also force each of the players in its supply

chain to adopt APDN’s DNA marking technology. We estimate that over a three-year transition to

DNA marking, the entire supply chain could generate more than $40 million in annual revenue.

The domino effect could be even larger, in our view. We believe adoption of DNA marking by a

company like Borealis would lead to a much larger trend. First, we believe Borealis would gain

share given its plastics would be authenticated, whereas other suppliers are more likely to produce

lower-quality plastics. Furthermore, if the members of the supply chain adopted DNA-marking,

other plastics suppliers that use the same supply chain would not be benefiting from the

technology. As a result, we believe competitors will be compelled to evaluate DNA authentication.

We believe these trends will extend to other industries such as textiles, pharmaceutical drugs,

electronics, and many more.

We believe a significant expansion within its federal business is likely. APDN has become a

trusted partner through authenticating microchips used by DLA. APDN has been tasked with

expanding the number of federal suppliers by 100 and we believe this implies that the additional

suppliers would also need to use APDN’s technology, which means a number of revenue streams.

This is on top of two recent federal contracts that will provide $2 million of annual revenue in 2015

and 2016. One of the contracts is a pilot to DNA brand 100,000 units for the Office of the Secretary

of Defense (on behalf of DLA), which purchases 145 million different units that could potentially be

marked.

We believe APDN is entering a multi-year hyper growth period. With a handful of large pilots

and the success of its botanical-based DNA marking in past pilots, we forecast APDN will grow its

revenue from $2.7 million in FY2014 to $4.8 million in FY2015 and $12.7 million in FY2016. We

point out that several of the large pilots (including Borealis and the large unnamed retailers) have

the potential to generate more revenue annually than our total FY2016 estimate. Furthermore, we

believe large contracts to license DNA marking will not add an equal percentage of expenses, and

therefore we expect APDN to narrow its loss per share to $0.49 in FY2015 and $0.13 in FY2016,

from a loss per share of $0.97 in FY2014. While we expect APDN to achieve profitability in

FY2017, several large contracts in its pipeline could lead to profitability sooner than expected.

We initiate coverage of Applied DNA Sciences (APDN) with a Buy rating and a $7 price

target. Our target is based on 12x our FY2016 revenue estimate of $12.8 million. Given its

technology is differentiated, effective, and a disrupter, we believe APDN can gain significant share

of the anti-counterfeiting market and believe it should trade at a hefty premium to capture the

abnormally fast growth rate that we predict over the next five years.

3Maxim Group LLC


COMPANY OVERVIEW

APDN was founded in 1983 as Datalink Systems, before changing its name to Applied DNA Sciences,

Inc. in 2002. As part of its restructuring effort, the company brought James Hayward on as CEO and

moved its headquarters to Stony Brook University’s Long Island High Technology Incubator, from

California. This was the beginning of its shift to an operational stage from a developmental stage.

APDN is a technology company, with a biotechnology platform, used for security applications and

protection from counterfeiting. Supply chains are “leaky.” and materials often get diluted or

counterfeited as suppliers often use cheaper raw material to improve their own profitability. As a result,

APDN has created technology to protect brands and foster quality and integrity. For example, an APDN

study for one retailer revealed that 87% of its clothes were mislabeled; the quality of the clothes was

below what appeared on the labeling.

APDN has seven products that are all based on the same idea of botanical DNA marking for anti-

counterfeiting and product authentication. APDN can mark products with an opaque piece of botanical-

based DNA that cannot be copied and is long lasting. As a result, at any point in a supply chain or in a

finished good, APDN’s customer can trace the entire supply chain and the authenticity of the product.

On November 17, 2014, APDN was up listed and began trading on NASDAQ. APDN raised $9.1 million

in a secondary offering that closed on November 2014, which included 2.8 million shares at $3.24 each

and 2.9 million warrants priced at $3.25 per share. The warrants are exercisable at $3.50. The capital

raise was critical in building out its staff in the field after proof of principal was completed in several

verticals. In addition, the proceeds were used to repurchase previously issued warrants.

Just Scratching the Surface in Several Industries

Textiles

According to Havocscope, a company that collects black market intelligence and identifies security

threats, and the Coalition Against Counterfeiting and Piracy, the market value of counterfeit clothing is

$12 billion. For example, In January 2013, four retailers—Macy’s (M - $66.04 – Hold), Amazon (AMZN

- $291.41 – NR), Leon Max, and Sears (SHLD - $35.33 – NR) —agreed to pay a small fine to settle

Federal Trade Commission (FTC) charges that they violated the Textile Products Identification Act and

the FTC’s Textile Rules by labeling and advertising products sold in stores and online as made of

bamboo, while they actually were made of rayon. Furthermore, Alibaba (BABA - $101.62 – NR) spent

$161 million to combat counterfeiting in just under two years ending in November 2014. In fact, a study

done by APDN for one of its large prospective retail customers discovered that 87% of its labels were

inaccurate. We believe this retailer is not alone, and many use similar supply chains. Some suppliers

choose to use cheaper materials that dilute the quality of the clothes but improve the suppliers’

profitability.

Starting with an early pilot project in 2007, APDN continues to help Supima, a non-profit trade

association of the American Pima cotton growers, to protect the integrity of American Pima, one of the

world’s most desirable luxury cotton fibers, from counterfeiting and blending. Users of American Pima

can prove the authenticity of the cotton by checking its DNA mark. These checks can be done at every

step of the supply chain from grower to ginner to spinner to manufacturer to distributor to retailer.

During November 2013 through February 2014, APDN marked 50 million kg of American Pima cotton.

The Supima brand is used by more than 350 textile mills, manufacturers, and retailers, establishing a

solid market opportunity for APDN.

Pima cotton represents 5% of the overall cotton output in the U.S., or $1.25 billion in value.

Furthermore, demand for Pima cotton is increasing and Pima is scarce. With output expected to

increase by 10-15% in 2015, counterfeiting and bleeding is a chief risk to the retailing industry as

suppliers try to meet the demand. We believe if APDN can protect a national brand successfully

followed by a solid marketing campaign, we believe other retailers would be compelled to evaluate

APDN’s value proposition.

4Maxim Group LLC


In October 2014, APDN announced an agreement with an unnamed textile manufacturer and its retail

partners to protect and preserve the integrity of its supply chain (from grower to consumer).

The domino effect. Realizing how their labels lacked integrity, we expect one large retailer is moving

towards protecting their entire supply chain. This retailer approached its entire supply chain with the

DNA evidence to realize the magnitude the issue and we believe is now in the processing of

establishing a plan to enforce the authenticity of its labels. We believe DNA marking is being evaluated,

and the retailer could mandate it suppliers adopt DNA marking.

Therefore, the first domino would be the large retailer that wants to secure its supply chain—this

revenue opportunity for APDN could be more than $15 million annually at first, in our estimate. Then

there are numerous companies in the supply chain that would each need to adopt the technology to

remain in the supply chain. Fewer counterfeits would lead to lower profitability from suppliers, which

would likely look for modest price increases for their supplies. This process of building out the supply

chain could take several years. However, each of the suppliers could contribute significant revenue to

APDN.

We believe this scenario would lead to other large retailers evaluating their supply chains. First, we

believe the retailer with DNA authenticity would have a competitive advantage in reducing the risk of

counterfeiting. Second, many retailers use the same suppliers, which would then have technology in

place to track the supply chain and to protect against counterfeits and bleeding.

Furthermore, the revenue potential for a large retailer is much more than $10-$15 million in annual

revenue given the number of products and materials that can be supported, in our view.

Industrial Plastics (Polyolefin)

In early 2014, Aston Martin recalled more than 17,500 vehicles because of a problem with fake plastics

supplied from China. Aston Martin said it had received reports that throttle pedal arms broke during

installation, and it discovered that "initial tests on the failed pedal arm have shown that the Tier-Three

Supplier used counterfeit material." The pedal arms were to be made of PA6 material supplied by

DuPont, but the actual material used by a supplier was inferior. We believe this is one of many

examples known and unknown regarding counterfeiting of industrial plastics.

Plastics are used in a wide array of products including piping, injection molding for vehicles, electronics,

and construction in addition to many other uses. Companies sell premium-quality plastic products,

manufactured under the quality control and environmental safety. Like in the Aston Martin case, the

inferior plastics can cause considerable financial damage to a manufacturer or retail company.

Therefore, we believe protecting its quality and integrity makes sense financially.

Borealis is the first domino for industrials plastics, in our view. During March 2014, Borealis signed a

pilot project in which it would pay $350,000 for mutual development with APDN of a supply of DNA

markers for its polyolefin products. The project is for less than one year, and, during that time, Borealis

is determining how effective and feasible the DNA markers are in avoiding inferior production and

bleeding of its plastics.

As the eighth-largest producer of polyethylene and polypropylene, Borealis produces about 10 billion

kilograms of plastics annually. Its plastics are used for pipe systems, energy and communication cables,

automotive parts and packing, and other uses. We believe the pilot has been highly effective, and we

expect Borealis to evaluate a much larger implementation of DNA markers for its products. A much

larger implementation and potentially a mandate to its suppliers would drive a number of suppliers to

contract with APDN to implement markers as well. We believe drastically reducing counterfeit plastics

would give Borealis a competitive advantage. For example, in building a water or gas distribution piping

system, dramatically reducing the risk of counterfeits that could cause the system to break would be a

significant differentiator to a potential customer. If Borealis did indeed gain market share as a result of

the DNA markers, we would expect its competitors to evaluate a similar course of action.

Federal Government

Reports of counterfeit electronics began to emerge in 2006 when a coordinated effort of 18 factories in

China was discovered to be copying the entire product line of Japan-based NEC. In 2007, the DOD

initiated a study to assess the frequency of semiconductor counterfeits penetrating the agency. The

study took three years but found that all elements of the supply chain were impacted by counterfeits and

5Maxim Group LLC


that detection technologies were necessary at the manufacturers and distributors. A single F-35 Joint

Strike Fighter jet, for example, is controlled by more than 2,500 semiconductors—clear evidence that

the U.S. military is a huge consumer of semis. Furthermore, a 2012 Senate Armed Services Committee

investigation report uncovered 1,800 cases of suspected counterfeit electronic parts in the defense

supply chain, with the total number of suspected parts exceeding one million.

APDN has been awarded four separate government contracts that we believe have the ability to expand

into major revenue contributors, in addition to adding a base of recurring revenue over the next eight

quarters.

As a result, the company’s first government contract was awarded by the Defense Logistics Agency for

the marking of microchips throughout the supply chain to ensure that they are not compromised.

Obsolete microchips are widely used in the federal government, and they are also targets for

counterfeiters. Once chips are no longer in production, only three distributors sell them. Eventually,

even those distributors will no longer hold them in inventory—at that point, a number of independent

broker distributors will sell those obsolete chips. Essentially, the authenticity of the microchips is

reduced. In fact, during a November 2011 Senate hearing, a report by SMT Corporation (a distributor

specializing in testing microchips against counterfeiting) released findings from a trip to the Shenzhen

microchip marketplace in Guangdong Province, People’s Republic of China, the largest wholesale

distribution area:

1) 30%-40% of the broker-sold products in the area are counterfeit.

2) Local brokers and manufacturers purposely buy counterfeits for a 70% savings off authentic component prices and are fully aware that up to 15% may not function at all.

3) Products sold to brokers outside of China are represented to be new, original factory product at time of sale.

At the end of 2011, and about a year and a half after working with DLA, a bill was passed that contained

a mandate that aimed to eliminate counterfeit electronics from the military supply chain. We believe this

mandate further strengthens the value of APDN’s DNA marking given no other anti-counterfeit tools

have been effective. With DNA marking, the government can track the entire supply chain of a chip,

and when testing shows they are underperforming, DLA can send them back. The government can

then determine which brokers it should buy from.

APDN built a strong business with DLA, in our view, establishing 32 contracts with independent vendors

before DLA consolidated the process and announced it would bring marking in house. We believe other

agencies have similar needs. The project also likely helped the company win another $975,000 million

contract, over two years, to expand the federal supply chain of electronic component manufacturers by

100 vendors. The benefit of the contract is that each of vendors would need to agree to contract with

APDN for DNA markings.

After seeing the benefit of authentication for microcircuits, the Office of the Secretary of Defense (OSD)

on behalf of DLA awarded a $3 million contract to authenticate six additional supply groups including: 1)

Electrical and Electronic Equipment Components; 2) Bearings; 3) Vehicular Equipment Components; 4)

Engine Accessories; 5) Pipe, Tubing, Hose, and Fittings; and 6) Hardware and Abrasives. These six

supply groups contain 66 federal supply classes and more than 100 million solicitations per year.

In December 2014, APDN was awarded a fourth contract. Neither the customer nor the contract details

were named, which is typical for government contracts and especially for federal intelligence agencies.

Furthermore, several other federal agencies have approached APDN regarding its markers. We note

these contracts are pilots that could lead to more commercialized programs that could generate several

million dollars in revenue, annually.

Cash and Valuables

Unlike in the United States, many European countries like France, Poland, and Switzerland do not

transport cash in solid armored trucks. With London cash-in transit crime up 170% from 2005 to 2008,

APDN provided a pilot that – through Loomis, an armored cash transporter – protected 1,200 boxes of

cash and 4,000 ATMs. APDN trained all 52 UK metropolitan police departments to recognize the marks.

As a result, cash attacks were down 55% and total losses down 72%. In addition, the marks on the cash

led to 88 convictions with a 100% success rate. For APDN customers, Signature DNA is included in the

transport devices that discharge a liquid dye when the transport box is illegally accessed. The dye is

6Maxim Group LLC


easily identifiable and can be removed from circulation but can also provide attribution that helps with

convictions. Both insurance companies and government agencies are proponents of DNA marking for

cash in transit; the DNA marking helps reduce insurance claims on stolen cash.

One of the large RFPs that we believe APDN is bidding on is a multi-million dollar contract with a

European country to provide cash in transit DNA marking. Furthermore, we believe new legislation

improving security of cash in transit in France by requiring tags will create a substantial opportunity for

APDN. Car theft is a serious problem in Eastern Europe. For example, more than 52,000 car thefts

occur in Lithuania per year, according to the National Council of Crime.

Another revenue opportunity for APDN is acting as an expert witness in court.

Security Through Asset Marking

APDN’s DNA marking provides security for home/business assets and cars. The International Criminal

Police Organization (Interpol) reported that, in 2013, it had received 7.2 million records of reported

stolen motor vehicles from 130 different countries. Furthermore, the FBI estimates that the value of

stolen motor vehicles in the U.S. was more than $4.3 billion in 2012. About 70% of stolen cars are

broken down, and parts are sold individually. For cars, APDN marks are applied to various car parts at

the point of sale. When a car is stolen, it is often stripped, and the parts are sold separately. APDN’s

digital marking applies a VIN number and the owner’s information, which is stored in a cloud-based

registry. Two well-known automakers have already chosen APDN’s anti-theft technology to mark its

parts that are exported into Scandinavia. Arrests are publicized once made via DNA markers.

Furthermore, stickers are applied to cars that say “DNA protected” on its windshield.

As it relates to asset marking, homeowners and businesses can use DNAnet In the event of a crime.

The fleeing offender is sprayed with a permanent, fluorescent DNA taggant. As the crime is

investigated, the fluorescing DNA mark can assist police in linking the offender and stolen items to a

specific crime scene, creating a greater ability to identify and convict. The DNAnet mark emits a Bright

Red UV Signal making it easy to identify on the spot. Once the signal has been detected, the evidence

is sent to Applied DNA Sciences for forensic evaluation.

We also note that fake IDs can be combated with APDN’s technology. Havocscope reports that the

value of counterfeit identification and passports is currently $100 million. In addition, the European

parliament estimates that between 500,000 and 1 million biometric passports in France are counterfeit,

as false documents were used to obtain them.

Counterfeit Statistics Suggest Other Industries Need DNA Marking

We believe that a number of other industries would benefit from DNA marking, including

pharmaceuticals, art and collectibles, commercial electronics, agrochemical, and food and beverage.

We expect APDN to begin pilot programs in many of these industries over the next two years.

We believe pharmaceutical drugs have the most glaring need for DNA marking, as counterfeit drugs

generated an estimated $75 billion in revenue in 2010, according to the National Association of Boards

of Pharmacy. This accounted for 1-2% of all drugs sold in the U.S. The World Health Organization

(WHO) estimates the annual worldwide "take" from counterfeit drugs to be around $20 billion USD, a

figure that is expected to double by the end of this decade. In some countries, counterfeit prescription

drugs comprise as much as 70% of the drug supply and have been responsible for thousands of deaths

in some of the world's most impoverished nations, according to WHO. While counterfeits in other

industries either lead to a financial loss of diluted brand integrity, fake drugs can kill. This makes a

crackdown on fakes more urgent.

Art historian Thomas Hoving estimates that various types of forged art comprise up to 40% of the art

market. For example, Knoedler & Company, one of New York’s oldest private galleries until it closed in

2011, sold over $80 million worth of forged paintings that were passed off as masterpieces, and

lawsuits are ongoing. As it relates to collectibles, autograph forgers have been known to put the

7Maxim Group LLC


signatures of former players on old baseballs to drive up prices of the memorabilia. Detection remains

difficult despite some tools to guard against memorabilia fraud.

The European Crop Protection Association’s statistics shows that nearly 10% of the pesticides used in

Europe are counterfeit, suggesting another market opportunity for APDN.

The National Center for Food Protection and Defense estimates that Americans pay $10 billion to $15

billion annually for fake food—often due to product laundering, dilution, and intentionally false labeling.

Large Procurements as a Means To Profitability

APDN is working on 8 to 10 pilots, which we believe could drive profitability and exponential growth in

revenue. Included in these pilots is a large retailer for its labeling of Supima cotton, a German

automaker, an agrochemical company, home asset management for a city, a cash-in-transit contract for

a country, and the Borealis pilot.

We believe these contracts are each worth between $3 million and $30 million. In some cases, we

expect that they would start a chain reaction that could drive adoption by suppliers as well. As the

related costs for these programs are minimal, just two of the contracts (and in some cases, just one)

would lead to profitability for APDN, in our opinion.

Competition

APDN competes with a number of companies that provide authentication products and services;

however, we are not aware of any companies that are also using DNA to check authentication. APDN

competes against integrated circuit chip and magnetic strips, hologram marks, taggants, and

fluorescence that can be revealed through x-ray fluorescence. Among the public companies in its peer

group are Collectors Universe Inc. (CLCT – $21.12 – NR), De La Rue Plc (DELRF.PK – $7.66 – NR),

Digimarc Corp (DMRC - $26.85 - NR), Inksure Technologies (INKS.PK - $0.02 - NR), Nanotech

Security Corp. (NTS.V - $1.24 – NR) and opSec Security Group plc. (OSGFF.PK - $0.54 – NR).

For example, CLCT authenticates and grades baseball cards and other items such as coins, stamps,

and sports memorabilia. Through authentication and grading of a baseball card, the value Is

exponentially increased. Sports card grading has become standard for high-priced cards, allowing

collectors to buy with confidence.

De La Rue, the world’s largest commercial bank note and passport printer, has a segment that develops

a variety of security solutions to protect against fraud and counterfeits, ranging from high-security

substrates, inks, and printed features to 3D holograms. Digimarc has a division that develops anti-piracy

and copyright communication solutions, including barcoding and ID recognition applications.

Risks

Inability to turn pilots into contracts – If APDN is unable to prove the value of DNA marking, then the

pilot customers will likely not award large-scale projects to the company.

Capital – APDN may require more capital than our model currently forecasts to invest in sales and

marketing. We estimate APDN will need to raise around $12 million over the next two years.

Losses on pilots – Although many of the pilots have been funded recently by the customers, future

customers may not choose to pay for a pilot, and this could drive incremental losses.

Recent Results

APDN posted revenue of $3 million in 2014, representing 34% year-over-year growth. Top-line growth

was driven by a new contract with DLA, in addition to several funded pilots. The company increased

SG&A 18% y/y and R&D 88% y/y as the company prepared for a more commercialized product and the

8Maxim Group LLC


numerous ongoing pilots. As a result, the operating loss in 2014 was $12.3 million, compared to $10.2

million in 2013. APDN's loss per share narrowed to $0.97 in 2014, from $1.51 in 2013, given a lower

reduction in the fair value of its warrants liability that runs through other income.

Earnings Outlook

We forecast 78% revenue growth in 2015 to $4.8 million. We believe that several contracts that were

expected to close in 4QFY14 were delayed, but APDN is likely to sign several of these new contracts in

FY2015. Management already guided to revenue of more than $1 million in 1QFY15, up from $645,000

in 4QFY14, likely based on several new government orders. Furthermore, APDN has two years of

recurring revenue related to its recent federal contracts wins. Should APDN win one of its large pilot

contracts, we believe there could be considerable upside to our revenue estimates, as many could add

more than $5 million annually. R&D slowed down in 2HFY14, and we expect a modest reduction year-

over-year as a result. Furthermore, the company has cut some overhead in order to achieve profitability

sooner. As a result, we project a loss per share of $0.49 in FY2015 or about half that of FY2014.

Our FY2016 revenue estimate is $12.8 million, or 164% growth. This assumes at least one large pilot

or two medium-sized pilots are converted to revenue-generating contracts. We believe the increase in

expenses associated with this revenue increase will be modest and mostly sales commissions. As a

result, we forecast a loss per share of $0.13 in FY2016. However, we believe profitability could occur in

FY2016 if the pilots with the greatest opportunity convert to signed contracts.

Balance sheet. APDN raised $9.1 million in a secondary offering that closed on November 2014,

which included 2.8 million shares as $3.24 each and 2.9 million warrants priced at $3.25 per share. The

warrants are exercisable at $3.50. The capital raise was critical in building the company’s staff in the

field after proof of principal was completed in several verticals. In addition, the proceeds were used to

repurchase previously issued warrants.

APDN ended FY2014 with $1.4 million in cash and a $1.8 million in short-term debt (promissory note).

However, in November, Mr. Hayward and the other holder of the promissory note agreed to cancel the

note in exchange for a total of 315,171 shares of stock and warrants to purchase an additional 315,171

shares at $3.25. The company used $8.5 million ($0.65 per share) of cash after capital expenditures in

FY2014, and we expect $6.3 million ($0.34 per share) will be used in FY2015. We project free cash

flow of $2.5 million ($0.12 per share) in FY2016 based on the growing revenue and modest GAAP loss

per share. Our model assumes APDN will need to raise about $7 million in FY2015 and $5 million in

FY2016.

Valuation

The market for traditional authentication and anti-counterfeiting products is mature, with a number of

competitors. However, many of the traditional products and technology are not working, in our view,

given the growing problem of counterfeiting. We believe DNA marking for authentication will be

disruptive to the anti-counterfeiting market that is worth more than $66 billion, and since DNA markings

cannot be duplicated or washed up, we expect the technology to be the most effective counterfeit

product in the market. In fact, technology quickly becomes obsolete, and anti-counterfeiting technology

can be beaten over time. However, we do not see DNA as becoming obsolete or circumvented.

APDN trades at 10x our 2015 revenue estimate, or a 28% premium to the two other micro cap providers

of anti-counterfeiting technology. We believe APDN’s technology is the most differentiated and that

several pilots could lead to significant upside to our estimates. Therefore, we expect APDN to warrant

P/S expansion from its current valuation and remain at a premium to the peer group as the product is

validated. As a result, we value APDN at $153 million, or 12x our FY2016 revenue estimate of $12.8

million. Assuming total shares outstanding of 21.45 million (assuming new equity is issued) at the end

of FY2016, this equates to $7 per share. With more than 100% upside, we recommend investors build

a position in APDN ahead of the conversion of the pilots.

9Maxim Group LLC


(in '000s) Growth rate

Market Cap 2014 2015 2016 2015 2015 2016

Digimarc Corp. NASDAQ: DMRC $193,000 $26,320 $32,530 $35,070 23.6% 5.9 5.5

Nanotech Security Corp. TSX: NTS $49,000 $2,530 $7,760 $12,000 206.7% 6.3 4.1

Average 6.1 4.8

Applied DNA Sciences NASDAQ: ADPN $46,000 $2,721 $4,837 $12,764 77.7% 9.5 3.6

Source: Company reports, Thompson One and Maxim Group estimates

Price /RevenueRevenue

Chart 1. Comparison Chart

10Maxim Group LLC


Table 1. Applied DNA Sciences Income Statement

F2013 Dec Mar June Sep F2014 Dec Mar June Sep F2015E F2016E

Revenue $2,036,222 597,354 $637,146 $841,197 $645,527 $2,721,224 $1,045,370 $987,576 $1,303,855 $1,500,000 $4,836,801 $12,764,070

SG&A (indirect) 11,198,505 3,845,578 3,297,739 2,948,452 3,157,984 13,249,753 3,000,000 3,000,000 3,300,000 3,300,000 12,600,000 14,200,000

Research and Development 692,480 459,304 359,782 266,331 215,333 1,300,750 250,000 250,000 250,000 250,000 1,000,000 1,200,000

Depreciation & Amortization 321,074 105,215 106,810 113,424 116,813 442,262 113,000 113,000 113,000 113,000 452,000 452,000

Operating income (10,175,837) (3,812,743) (3,127,185) (2,487,010) (2,844,603) (12,271,541) (2,317,631) (2,375,424) (2,359,145) (2,163,000) (9,215,199) (3,087,930)

Operating margin NM NM NM NM NM NM NM NM NM NM NM -24.2%

Other income (7,510,635) (2,478,907) 376,749 567,953 739,085 (795,120) 50,200 50,200 50,200 50,200 200,800 200,800

EBT (17,686,472) (6,291,650) (2,750,436) (1,919,057) (2,105,518) (13,066,661) (2,267,431) (2,325,224) (2,308,945) (2,112,800) (9,014,399) (2,887,130)

Income taxes (benefit) 0 - - - - - - - - -

Tax rate 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Net income (17,686,472) (6,291,650) (2,750,436) (1,919,057) (2,105,518) (13,066,661) (2,267,431) (2,325,224) (2,308,945) (2,112,800) (9,014,399) (2,887,130)

Net margin -868.6% -1053.3% -431.7% -228.1% -326.2% -480.2% -216.9% -235.4% -177.1% -140.9% -186.4% -22.6%

EPS ($1.51) ($0.48) ($0.20) ($0.14) ($0.15) ($0.97) ($0.13) ($0.13) ($0.13) ($0.11) ($0.49) ($0.13)

YoY change 102.4% -40.5% -26.0% -20.4% -48.0% -35.9% -72.7% -38.1% -11.5% -29.7% -49.5% -72.5%

Share count 11,730,879 13,164,914 13,470,806 13,569,262 13,857,090 13,515,518 17,400,000 18,400,000 18,450,000 19,783,333 18,508,333 21,450,000

Selected Data:

YoY change in total revenue 9.8% 88.0% 84.9% 30.5% -11.5% 33.6% 75.0% 55.0% 55.0% 132.4% 77.7% 163.9%

SG&A to total revenue 550.0% 643.8% 517.6% 350.5% 489.2% 486.9% 287.0% 303.8% 253.1% 220.0% 260.5% 111.2%

Source: Company reports and Maxim Group estimates.

11Maxim Group LLC


Table 2. Applied DNA Sciences Cash Flow Statement

F2013 F2014 F2015E F2016E

Net Income (17,686,472)$ (13,066,661)$ (9,014,399)$ (2,887,130)$

Share-based compensation 1,517,524 1,964,053 2,000,000 2,200,000

Depreciation and amortization 206,344 442,262 300,000 300,000

Fair value of vested options 408,605 69,288 - -

Change in fair value of warrant liability 7,508,146 908,005 - -

Other 220,401 357,256 - -

Gross cash flow (7,825,452) (9,325,797) (6,714,399) (387,130)

Changes in operating assets and liabilities:

Accounts receivables (453,059) (181,935) (515,182) (2,362,500)

Prepaid expenses (109,042) 32,352 (179,180) (550,454)

Accounts payable and accrued liabilities 517,200 527,783 905,241 4,200,000

Deferred revenue - 434,859 466,638 1,837,500

Changes in working capital (44,901) 813,059 677,517 3,124,546

Net cash provide by operating activities (7,870,353) (8,512,738) (6,036,882) 2,737,416

Capital expenditures (636,548) (229,591) (220,000) (220,000)

Free cash flow (8,506,901) (8,742,329) (6,256,882) 2,517,416

Acquisitions (584,080) - -

Net proceeds of common stock 3,900,000 2,156,264 7,000,000 5,000,000

Proceeds from promissory note 1,800,000 (1,800,000) -

Sale of preferred Stock Series A 10,735,000 - - -

Proceeds from warrants/options 151,500 - - -

Cancellation of warrants (60,000) - - -

Other (181,104) - -

Net Cash provided by (used in) financing activities 14,142,420 3,775,160 5,200,000 5,000,000

Cash, beginning of period 724,782$ 6,360,301$ 1,393,132$ 336,250$

Change in cash 5,635,519 (4,967,169) (1,056,882) 7,517,416

Cash, end of period 6,360,301$ 1,393,132$ 336,250$ 7,853,666$

Gross cash flow per share (0.67) (0.69) (0.36) (0.02)

Operating cash flow per share (0.67) (0.63) (0.33) 0.13

Free cash flow per share (0.73) (0.65) (0.34) 0.12

Source: Maxim Group estimates and Company reports

12Maxim Group LLC


Table 3: Applied DNA Sciences Balance Sheet

F2013 F2014 F2015 F2016

Cash and equivalents $6,360,301 $1,393,132 $336,250 $7,853,666

Accounts receivable 672,638 834,818 1,350,000 3,712,500

Prepaid expense 174,096 135,365 314,545 865,000

Total current assets 7,207,035 2,363,315 2,000,795 12,431,165

PP&E 695,995 695,995 615,995 535,995

Deposits 51,260 51,260 51,260 51,260

Intellectual property 420,676 395,487 395,487 395,487

TOTAL ASSETS 8,374,966 3,506,057 3,063,537 13,413,907

Accounts payable and accrued liabilites 966,977 1,494,759 2,400,000 6,600,000

Deferred revenue 148,503 583,362 1,050,000 2,887,500

Promissor notes payable 1,800,000 - -

Convertible notes payable - - - -

Total current liabilities 1,115,480 3,878,121 3,450,000 9,487,500

Warrant liability 2,643,449 1,096,412 1,096,412 1,096,412

Total Shareholders' Equity 4,616,037 (1,468,476) (1,482,875) 2,829,995

TOTAL LIAB. & SHAREHOLDERS. EQUITY 8,374,966 3,506,057 3,063,537 13,413,907

Selected Data:

Working Capital 6,091,555 (1,514,806) (1,449,205) 2,943,665

Current Ratio (times) 6.46 0.61 0.58 1.31

DSO 84 118 82 82

Source: Maxim Group estimates and company reports

13Maxim Group LLC


Related Companies Mentioned in this ReportCompany Ticker Rating 12 Month Price Target Price

01/15/15Amazon.com Inc. AMZN Not Rated - $286.95

Macy's Inc M Hold $48.50 $62.34

DISCLOSURES

Apr 2012 Jul 2012 Oct 2012 Jan 2013 Apr 2013 Jul 2013 Oct 2013 Jan 2014 Apr 2014 Jul 2014 Oct 2014 Jan 2015

18161412108642

Closing Price Target Price

Applied DNA Sciences Inc. Rating History as of 01/09/2015powered by: BlueMatrix


450

400

350

300

250

200

150


Amazon.com Inc. Rating History as of 01/09/2015

NR:NA09/10/14

powered by: BlueMatrix

14Maxim Group LLC



706560555045403530


Macy's Inc Rating History as of 01/09/2015

I:Buy:$50.0002/11/13

Buy:$56.0005/09/13

Hold:$48.5008/13/13

powered by: BlueMatrix

Maxim Group LLC Ratings Distribution As of: 01/15/15

% of CoverageUniverse with Rating

% of Rating for which FirmProvided Banking Services

in the Last 12 months

BuyFundamental metrics and/or identifiable catalysts exist such that weexpect the stock to outperform its relevant index over the next 12 months.

79% 36%

HoldFundamental metrics are currently at, or approaching, industry averages.Therefore, we expect this stock to neither significantly outperform norunderperform its relevant index over the next 12 months.

18% 15%

SellFundamental metrics and/or identifiable catalysts exist such that weexpect the stock to underperform its relevant index over the next 12months.

*See valuation section for company specific relevant indices

3% 0%

I, Brian Kinstlinger, CFA, attest that the views expressed in this research report accurately reflect my personal views about the subject security andissuer. Furthermore, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation or views expressedin this research report.

The research analyst(s) primarily responsible for the preparation of this research report have received compensation based upon various factors,including the firm’s total revenues, a portion of which is generated by investment banking activities.

Maxim Group makes a market in Applied DNA Sciences Inc. and Macy's Inc

Maxim Group managed/co-managed/acted as placement agent for an offering of the securities for Applied DNA Sciences Inc. in the past12 months.

Maxim Group received compensation for investment banking services from Applied DNA Sciences Inc. in the past 12 months.

Maxim Group expects to receive or intends to seek compensation for investment banking services from Applied DNA Sciences Inc. inthe next 3 months.

APDN: For APDN, we use the Russell 2000 Index as the relevant index.M: For Macy's Inc., we use the Morgan Stanley Retail Index (MVR). ** Macy's is covered by Senior Analyst Rick Snyder.

Valuation MethodsAPDN: We value APDN at 12x our 2015 revenue estimateM: Our 12-month target price for Macy’s Inc. is based on M trading at an EV/(EBITDA-Capex) multiple of 7.0x our 2015 EBITDA, in line with thehistorical multiple for M shares.

Price Target and Investment Risks

15Maxim Group LLC


APDN: In addition to market risks, capital constraints and customer adoption of its DNA marking products are the main investment risks.M: Aside from general market and other economic risks, risks particular to our valuation and Hold rating of Macy's include: (1) a decline in comparablestore sales; (2) significant competition in the retail industry; (3) dependence on consumer preferences and spending; (4) unfavorable economicand political conditions; (5) extreme weather conditions or natural disasters; (6) higher-than-anticipated pension costs; and (7) dependence ondesigners and vendors for merchandise.

RISK RATINGS

Risk ratings take into account both fundamental criteria and price volatility.

Speculative – Fundamental Criteria: This is a risk rating assigned to early-stage companies with minimal to no revenues, lack of earnings, balancesheet concerns, and/or a short operating history. Accordingly, fundamental risk is expected to be significantly above the industry. Price Volatility:Because of the inherent fundamental criteria of the companies falling within this risk category, the price volatility is expected to be significant with thepossibility that the investment could eventually be worthless. Speculative stocks may not be suitable for a significant class of individual investors.

High – Fundamental Criteria: This is a risk rating assigned to companies having below-average revenue and earnings visibility, negative cashflow, and low market cap or public float. Accordingly, fundamental risk is expected to be above the industry. Price Volatility: The price volatility ofcompanies falling within this category is expected to be above the industry. High-risk stocks may not be suitable for a significant class of individualinvestors.

Medium – Fundamental Criteria: This is a risk rating assigned to companies that may have average revenue and earnings visibility, positive cashflow, and is fairly liquid. Accordingly, both price volatility and fundamental risk are expected to approximate the industry average.

Low – Fundamental Criteria: This is a risk rating assigned to companies that may have above-average revenue and earnings visibility, positivecash flow, and is fairly liquid. Accordingly, both price volatility and fundamental risk are expected to be below the industry.

DISCLAIMERS

Some companies that Maxim Group LLC follows are emerging growth companies whose securities typically involve a higher degree of risk andmore volatility than the securities of more established companies. The securities discussed in Maxim Group LLC research reports may not besuitable for some investors. Investors must make their own determination as to the appropriateness of an investment in any securities referred toherein, based on their specific investment objectives, financial status and risk tolerance.

This communication is neither an offer to sell nor a solicitation of an offer to buy any securities mentioned herein. This publication is confidentialfor the information of the addressee only and may not be reproduced in whole or in part, copies circulated, or disclosed to another party, withoutthe prior written consent of Maxim Group, LLC (“Maxim”).

Information and opinions presented in this report have been obtained or derived from sources believed by Maxim to be reliable, but Maxim makesno representation as to their accuracy or completeness. The aforementioned sentence does not apply to the disclosures required by NASD Rule2711. Maxim accepts no liability for loss arising from the use of the material presented in this report, except that this exclusion of liability doesnot apply to the extent that such liability arises under specific statutes or regulations applicable to Maxim. This report is not to be relied upon insubstitution for the exercise of independent judgment. Maxim may have issued, and may in the future issue, other reports that are inconsistent with,and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analyticalmethods of the analysts who prepared them and Maxim is under no obligation to ensure that such other reports are brought to the attention ofany recipient of this report.

Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, ismade regarding future performance. Information, opinions and estimates contained in this report reflect a judgment at its original date of publicationby Maxim and are subject to change without notice. The price, value of and income from any of the securities mentioned in this report can fall aswell as rise. The value of securities is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of suchsecurities. Investors in securities such as ADRs, the values of which are influenced by currency volatility, effectively assume this risk. Securitiesrecommended, offered or sold by Maxim: (1) are not insured by the Federal Deposit Insurance Company; (2) are not deposits or other obligationsof any insured depository institution; and (3) are subject to investment risks, including the possible loss of principal invested. Indeed, in the caseof some investments, the potential losses may exceed the amount of initial investment and, in such circumstances, you may be required to paymore money to support these losses.

ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST

16Maxim Group LLC


Capital Markets/Syndicate: 212-895-3695

Corporate Finance: 212-895-3511

Equity/Options Trading: 212-895-3790

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Woodbury, New York San Francisco, California

20 Crossways Park Drive North 50 California Street

Suite 304 Suite 1500

Woodbury, NY 11797 San Francisco, CA 94111

Tel: 516-393-8300 Tel: 415-762-0113

Red Bank, New Jersey Boston, Massachusetts 246 Maple Avenue 225 Franklin Street

Red Bank, NJ 07701 Suite 2607

Tel: 732-784-1900 Boston, MA 02110

Tel: 617-217-2444

Boca Raton, Florida 7900 Glades Road

Boca Raton, FL 33434

Tel: 561-465-2605

Corporate Headquarters The Chrysler Building

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New York, NY 10174

Tel: 212-895-3500

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