[AETHLON LOGO HERE] 3030 Bunker Hill Street, Suite 4000
San Diego, CA 92109
858-459-7800
858-272-2738 (fax)
August 9, 2006
Via Edgar and Fax (202) 772-9218
- --------------------------------
Mr. Gary Todd
United States Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street N.W.
Washington, D.C. 20549-0306
Dear Mr. Todd,
Enclosed please find our response to your inquiry dated August 1, 2006 related
to our FORM 10-KSB FOR THE FISCAL YEAR ENDED MARCH 31, 2006, filed June 29, 2006
(File No. 000-21846). We understand and appreciate your assistance in our
Company's compliance with overall disclosure in this, and all of our filings.
Please find our response below and feel free to call me at 858-405-9933 should
you have any questions or require any clarification.
1. WE NOTE THAT YOU INITIALLY ACCOUNTED FOR THE WARRANTS ASSOCIATED WITH
THE 10% CONVERTIBLE NOTES AS LIABILITIES UNDER EITF 00-19. WE ALSO SEE
THAT YOU LATER RECLASSIFIED THE RECORDED LIABILITY TO PERMANENT EQUITY
UPON EFFECTIVENESS OF THE REGISTRATION STATEMENT REQUIRED UNDER THE
FINANCING ARRANGEMENT. YOU FURTHER INDICATE THAT "IF THE EFFECTIVENESS
OF THE REGISTRATION STATEMENT IS NOT MAINTAINED, THE COMPANY COULD
INCUR LIQUIDATED DAMAGES." WE SEE FROM THE RELATED REGISTRATION RIGHTS
AGREEMENT THAT LIQUIDATED DAMAGES COULD INVOLVE CASH OR REGISTERED
STOCK AND APPEAR TO BE UNCAPPED IN AMOUNT. IN LIGHT OF THE CONTINUING
REGISTRATION OBLIGATION, TELL US WHY YOU CONCLUDED THAT
RECLASSIFICATION FROM LIABILITY TO EQUITY WAS APPROPRIATE UNDER EITF
00-19. YOUR RESPONSE AND ANALYSIS OF HOW YOU APPLIED THE REQUIREMENTS
OF EITF 00-19 SHOULD BE DETAILED AND SPECIFIC.
RESPONSE:
- ---------
INTRODUCTION
From the inception of the 10% convertible notes, the Company has accounted for
the warrants (the financial instrument) and the registration rights agreement in
accordance with View C of EITF 05-04 Issues Summary-- "THE EFFECT OF A
LIQUIDATED DAMAGES CLAUSE ON A FREESTANDING FINANCIAL INSTRUMENT SUBJECT TO EITF
ISSUE NO. 00-19". In accordance with View C, the Company believes the warrants
and the registration rights agreement are separate freestanding agreements that
should be accounted for separately because they do not meet all of the four
criteria specified in DIG K-1. Specifically, the two agreements relate to
different risks - the warrant agreement relates to the share price and the
liquidated damages penalty relates to the filing of a registration statement and
having it declared (or maintained) effective and thus fail one of the four DIG
K-1 combining criteria. Consequently, the Company believes it is appropriate to
account for the two agreements separately. Accordingly, the warrant was
evaluated for proper accounting treatment under the provisions of EITF 00-19 and
the registration rights agreement was evaluated under SFAS No. 133. (1)
1 The Company's registration rights agreement is not indexed to the
Company's stock because (a) it is not based on an observable market or
index and (b) when the contingent event occurs it can be settled in
cash.
ACCOUNTING FOR THE WARRANTS
At the commitment date of the financing transaction, the warrants did not meet
all of the criteria for equity classification under EITF 00-19. Specifically,
the warrants required settlement in registered shares. Since the Company did not
have any uncommitted registered shares to settle the warrant obligation, it
classified the warrants as a derivative liability.
The Company then filed a registration statement within the specified period as
required by the noteholders. Such registration statement was declared effective
in January 2006. Pursuant to paragraph 10 of EITF 00-19 below, the Company
re-evaluated the classification of the warrants upon the date the registration
statement became effective:
10. The classification of a contract should be reassessed at each
balance sheet date. If the classification required under this Issue
changes as a result of events during the period, the contract should be
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.... If a contract is reclassified from an asset or
a liability to equity, gains or losses recorded to account for the
contract at fair value during the period that the contract was
classified as an asset or a liability should not be reversed.
Thus, the fair value of the warrant liability was estimated up to the date
effectiveness was obtained and changes in estimated fair value were charged to
the Company's results of operations.
In connection with the effective registration statement, the Company now has
11,500,000 REGISTERED common shares to settle the warrants and conversion
feature under the 10% convertible notes and could settle the warrant and related
obligations immediately if needed. As a result, when the registration statement
became effective in January 2006, the warrants met all of the other criteria
necessary for equity classification under paragraphs 19 through 32 of EITF 00-19
and accordingly, the derivative liability was reclassified.
2
ACCOUNTING FOR THE SEPARATE REGISTRATION RIGHTS AGREEMENT
The separate registration rights agreement was determined to be a derivative
liability in accordance with SFAS No 133 as it is not indexed to the company's
common stock. However, de minimis value was ascribed to such derivative
liability for the reasons described below. Pursuant to paragraph 5 of the EITF
05-04 Abstract, Task Force members expressed a preference for evaluating a
liquidated damages provision based on the probable amount that the issuer would
pay rather than the maximum amount. The Company followed this approach and at
March 31, 2006, it estimated the probability of lapsed effectiveness as very
low. As such, the value ascribed to the registration rights agreement derivative
liability at March 31, 2006 was insignificant. The Company based this
determination on the following: (1) it had just obtained effectiveness and (2)
its evaluation of the probability of an "Event" occurring which could then
trigger liquidated damages, as defined in the registration rights agreement.
Liquidated damages are only payable upon the occurrence of such an Event. The
four defined Events in the agreement and the Company's conclusion as to the
likelihood of each of these events occurring (based on a SFAS No. 5 analysis) is
as follows:
1) A registration statement is not filed on or prior to its respective
filing date.
Evaluation
----------
The Company filed the registration statement under the terms agreed
upon with the holders within the contractual period. Accordingly, the
Company believes the probability of Event 1) above occurring is now
remote.
2) A registration statement filed under the agreement is not declared
effective by the SEC on or prior to 90 days from the filing date.
Evaluation
----------
This event also did not occur as the registration statement was
declared effective prior to the effectiveness date deadline.
Accordingly, the Company believes the probability of Event 2) above
occurring is now remote.
3) After a registration statement is filed with and declared effective by
the SEC, such registration statement ceases to be effective as to all
registrable securities to which it is required to relate at any time
prior to the expiration of the effectiveness period without being
succeeded within ten business days by an amendment to such registration
statement OR by a subsequent registration statement filed with and
declared effective by the SEC.
Evaluation
----------
The Company believes it is within its control to avoid any future
lapsing of the registration statement's effectiveness. Additionally,
even if such future cessation were to occur in the future, by filing an
amendment within 10 days of such cessation, the Company would avoid
triggering a liquidated damages penalty. Accordingly, the Company
believes the probability of Event 3) above occurring is very low.
3
4) The Company's common stock shall be delisted or suspended from trading
on the New York Stock Exchange, American Stock Exchange, the Nasdaq
Stock Market or the Nasdaq OTC Bulletin Board for more than twenty
business days.
Evaluation
----------
The Company's common stock is currently listed on the OTC Bulletin
Board. The Company believes it is within its control to avoid being
delisted. Accordingly, the Company believes the probability of Event 4)
occurring is very low.
Because of the low likelihood of occurrence of the aforementioned Events, the
liquidating damages derivative liability at March 31 2006 was deemed to be
insignificant.
At the Staff's request, we will amend the current disclosures in the Company's
Form 10-KSB for fiscal year ended March 31, 2006 filed on June 29, 2006, to
clarify the positions described above.
Sincerely,
/s/ James W. Dorst
- ------------------
James W. Dorst
Chief Financial Officer
4