AEMD: Encouraging Meeting With CEO Jim Joyce

Zacks Small Cap Research

By Brian Marckx, CFA

Q3 10-Q (ending 12/31/2013):
Aethlon Medical (OTC BB:AEMD) filed their 10-Q for the fiscal third quarter 2014 ending 12/31/2013 on February 11th.  Revenue of $76k was entirely from work under the subcontract agreement that the company has with Battelle related to the $22.8 million systems integrator contract with DARPA.  Revenue missed our $496k estimate as AEMD did not book any DARPA related milestone revenue during the quarter but subsequent to quarter end billed DARPA $353k.

Through December AEMD had billed $3.4 million under the DAPRA awards, which represents $1.97 million under the initial year-1 contract and $1.42 million under the year-2 contract (worth $1.6 million and containing eight milestones), which was awarded to the company in August 2012.  We forecasted the final $197k milestone under the year-2 contract and ~$300k under the year-3 contract (which was awarded to the company in September and, initially was to pay up to $1.53 million if all eight milestones were met) to be paid in Q3.  We have now pushed back these forecasted receipts to fiscal Q4 and Q1 2015.

DARPA has the option of entering into the remainder of the proposed contract for years four and five.  In the 10-Q AEMD notes that due to budget restrictions, DARPA plans to reduce the scope of AEMD's contract for years three through five.  The three through five year contracts were initially worth ~$3.2M.  Due to the budget change, this amount will now be ~$2.4M (the breakdown per contract-year was not disclosed). We have adjusted our model to account for the change.

We also model additional, although relatively minimal revenue from the Battelle contract throughout fiscal 2014 and into 2015.  As a reminder, AEMD's subcontract is a time and materials contract so the total that AEMD will eventually bill will not be known until their work is completed.  We do, however, think it's likely that there will be additional revenue contribution from this contract.

Q3 operating expenses were $1.3M, compared to our $1.1M estimate - the majority of the difference related to expenses of Exosome Sciences.  Operating loss was $1.2M, compared to our $514k estimate - the difference mostly related to the delayed revenue relative to our forecast.  Q3 net income and EPS were ($2.3) million and ($0.01) and included a $1.0M accrual related to a possible lawsuit settlement (if settled, it would be in the form of equity). 

Cash
Aethlon continues to successfully raise operating capital on a regular basis and continues to make progress on cleaning up the balance sheet.  During Q3 AEMD raised $3.2M from the sale of equity and repaid $200k of notes payable.  We view the pricing, size and terms of the most recent equity raise as indicative of the continued and, potentially, growing interest in AEMD.  Subsequent to quarter end another $17k in debt was repaid.  Aethlon exited fiscal Q3 with $1.9M in cash and equivalents, compared to $9k at the end of fiscal Q2 2014 (9/30/2013). Cash used in operations was $839k in Q3.

We continue to expect cash generated from government and other contracts along with additional funds raised through the sale of securities to fund the company over the near-to-mid term.

Along with their ongoing ability to continue to raise operating capital, we have been encouraged, from the standpoint of strengthening their financial position and balance sheet, by the success of converting some of their outstanding debt to stock.  While a substantial portion of debt remains in default, the company continues to make progress on cleaning up their balance sheet, which we view as meaningful from a de-risking perspective.  We reiterate, however, as we have in the past, that Aethlon will need to raise a substantial amount of cash, enter into partnering arrangements or score additional valuable contracts/grants in order to complete the recently announced U.S. safety study and to be able to maintain operations for the longer-term.  Nonetheless, we believe management's recent progress should not be marginalized.

On the operational side, AEMD now has another potentially significant iron in the fire with its Exosome Sciences business.  In late 2013 Exosome Sciences was resumed and a lab opened in New Jersey where that business is working from.  The recent relatively large capital raise provided initial funding to commence work at the lab.  Initially this is expected to focus on exosomes' role in cancer diagnosis.  We met with Jim Joyce at the JP Morgan healthcare conference in San Francisco in January and came away encouraged that the Exosome Sciences team has already made progress in advancing their lead diagnostic ELLSA assay.  With research on exosomes still in its infancy, AEMD clearly sees a real opportunity with the potential to be at the cusp of research and a leading knowledge base in the role that exosomes play in the progression of cancer.

And while we do not currently model a contribution from the Exosome Sciences business, we do view this has possessing potential upside to AEMD's core business, particularly over the longer-term.  We will update our model to incorporate a contribution from Exosome Sciences depending on its progression and when there's more insight into likelihood and timing of revenue generation.

Relative to Hemopurifier AEMD remains focused on not only the HCV opportunity but also sees real potential with cancer secreted exosomes and other areas, including for bioterror agents and pathogens.  Aethlon also remains encouraged that there is a potential opportunity for use of Hemopurifier therapy for compassionate use.

We have updated our model for Q3 results and made minor changes as a result of the decrease in DARPA budget related to contract years 3,4 and 5. 

A copy of the full research report can be downloaded here >>  Aethlon Medical Report

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