NORTHWEST BIOTHERAPEUTICS INC - Annual Report: 2006 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

Commission file number 0-26825

 

NORTHWEST BIOTHERAPEUTICS, INC.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, Including Area Code:

(425) 608-3000

 

Securities Registered Pursuant to Section 12(b) of the Act:

None

 

Securities Registered Pursuant to Section 12(g) of the Act:

 

Common Stock, $0.001 Par Value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the closing price on the consolidated transaction reporting system on June 30, 2006 was approximately $16.3 million. This number is provided only for purposes of this Annual Report on Form 10-K and does not represent an admission that any particular person is an affiliate of registrant.

 

As of March 5, 2007, the Registrant had an aggregate of 65,241,287 shares of common stock issued and outstanding.

 

Documents Incorporated by Reference: Portions of the Registrant’s Definitive Information Statement relating to the election of directors and other matters in lieu of an annual meeting of stockholders are incorporated by reference into Part III of this Report.

 

 

TABLE OF CONTENTS

 

 

Forward-Looking Statements

 

The following description of our business, discussion and analysis of our financial condition and results of operations should be read in conjunction with the information included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those projected. The words “believe,” “expect,” “intend,” “anticipate,” and similar expressions are used to identify forward-looking statements, but their absence does not mean that such statement is not forward-looking. You are encouraged to carefully review the various disclosures made by us in this report and in the documents incorporated herein by reference, in our previous SEC filings, and those factors described under “Risk Factors,” beginning on page 19 of this Annual Report on Form 10-K. These factors, among others, could cause results to differ materially from those presently anticipated by us. In addition, past financial or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. We can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations and financial condition. Except as required by law, we undertake no obligation to publicly revise our forward-looking statements to reflect events or circumstances that arise after the filing of this Annual Report on Form 10-K or documents incorporated by reference herein that include forward-looking statements.

 

In this Annual Report on Form 10-K, references to “Northwest Biotherapeutics,” the “Company,” “we,” “us,” and “our” refer to Northwest Biotherapeutics, Inc.

 

Overview

 

Northwest Biotherapeutics, Inc. was incorporated in Delaware in July 1998. We are a development stage biotechnology company focused on discovering, developing, and commercializing immunotherapy products that safely generate and enhance immune system responses to effectively treat cancer. Currently approved cancer treatments are frequently ineffective and can cause undesirable side effects. Our approach in developing cancer therapies utilizes our expertise in the biology of dendritic cells, which are a type of white blood cells that activate the immune system. Our primary activities since incorporation have been focused on advancing a proprietary dendritic cell immunotherapy for prostate and brain cancer together with strategic and financial planning, and raising capital to fund our operations. We completed an initial public offering of our common stock in December 2001.

 

We have two basic technology platforms applicable to cancer therapeutics; dendritic cell-based cancer vaccines, which we call DCVax^® and monoclonal antibodies for cancer therapeutics. DCVax^® is our registered trademark. Our DCVax^® dendritic cell-based cancer vaccine program is our main technology platform.

 

Recapitalization

 

Since the beginning of 2002, we recognized that we did not have sufficient working capital to fund our operations beyond 12 months and needed to raise additional capital from third parties in order to continue our clinical and research programs. In April 2002, we retained an investment bank to assist us in raising capital. Due to the economic climate in 2002 and declining stock prices of biotechnology companies in general, as well as our own stock price, we were unable to raise additional capital. In July 2002 we retained an additional investment banking firm to assist us in exploring various strategic options including raising additional capital, licensing our technology to a third party, or merging with another company. We contacted over 50 biotechnology companies and over 20 large pharmaceutical companies in an attempt to explore these options without success.

 

From September 2002 through approximately September 2004, we reduced our staff from 67 to 8 employees, withdrew our investigational new drug application, or IND, for our Phase III clinical trial for hormone refractory prostate cancer and our IND for our Phase I trial for non-small cell lung cancer from the U.S. Food and Drug

Administration, or FDA, and inactivated our Phase II clinical trial for brain cancer, which remained open with the FDA. In addition, we moved our corporate headquarters several times, each time to smaller facilities in order to reduce our monthly rent expense. During this time, we attempted to obtain capital from various sources, but were not successful. On November 13, 2003, we borrowed $335,000 from members of our management, pursuant to a series of convertible promissory notes (and associated warrants to purchase an aggregate of 3.7 million shares of our stock at $0.04 per share).

 

Beginning in 2004, we undertook a significant recapitalization whereby we have raised an aggregate of approximately $17.0 million in gross proceeds from issuances of debt and equity through a series of private placements. These financings included:

 

 

In April 2006, Toucan Capital elected to convert all of its promissory notes, including all accrued interest thereon, into a newly designated series of preferred stock, Series A-1 Preferred Stock, in accordance with the terms of the notes at a conversion price of $1.60 per share. The Series A-1 Preferred Stock is substantially identical to

Series A Preferred Stock with the exception of the issuance price per share and liquidation preference per share (which are $1.60 per share, rather than $0.04 per share in the case of Series A) and the ratio at which the shares are convertible into common stock (which is 1-for-40, or 1 share of Series A-1 Preferred Stock for 40 shares of common stock, rather than 1-for-1 in the case of Series A).

 

Simultaneously with Toucan Capital’s loan conversion, Alton Boynton, the Company’s President and Marnix Bosch, the Company’s Chief Technical Officer, each elected to convert the principal and accrued interest on their respective loans into 2,195,771 and 491,948 shares, respectively of the Company’s common stock, and in conjunction with the PIPE Financing, exercised their warrants on a net exercise basis for 1,895,479 and 424,669 shares of the company’s common stock respectively.

 

As a result of the financings described above, Toucan Capital currently holds:

 

 

As a result of the financings described above, Toucan Partners currently holds:

 

 

Upon issuance and finalization of terms, the warrants held by Toucan Capital and Toucan Partners described above are fully vested and exercisable and generally have an exercise period of seven years from their respective dates of issuance.

 

As a result of the PIPE Financing, the investors in the PIPE Financing initially acquired:

 

 

The investments made by Toucan Capital and Toucan Partners were made pursuant to the terms and conditions of a recapitalization agreement originally entered into on April 26, 2004 with Toucan Capital. The recapitalization agreement, as amended, originally contemplated the investment of up to $40 million through the issuance of new securities to Toucan Capital and a syndicate of other investors to be determined.

 

We and Toucan Capital amended the recapitalization agreement in conjunction with each successive loan agreement. The amendments generally (i) updated certain representations and warranties of the parties made in the

recapitalization agreement, and (ii) made certain technical changes in the recapitalization agreement in order to facilitate the bridge loans described therein.

 

As of March 5, 2007, Toucan Capital and Toucan Partners collectively have beneficial ownership of approximately 396.8 million shares of our capital stock, representing a beneficial ownership of approximately 86% of our outstanding common stock on an as converted-to-common stock basis. Such amounts exclude the effects of the amendments to the Toucan Partners convertible promissory notes in an aggregate principal amount of $950,000. The amounts also exclude any shares issuable to Toucan Partners pursuant to the 2007 Convertible Notes and 2007 Warrants as these are not currently convertible or exercisable for a determinable number of shares. Toucan Capital and Toucan Partners each has a right of first refusal to participate in our future issuances of debt or equity securities. For additional information concerning Toucan Capital, Toucan Partners, and our recapitalization, see the section of this report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Board Composition

 

On December 17, 2004, Dr. Randall L.W. Caudill and Mr. Wayne L. Pines resigned as members of our board of directors. Since their resignations we have had a sole director, Alton L. Boynton, Ph.D., who is also our President. These board resignations and the subsequent restructuring were anticipated based on the April 26, 2004 recapitalization agreement.

 

In connection with our January 26, 2005 issuance of Series A Preferred Stock to Toucan Capital we amended the Recapitalization Agreement and the term sheet included therein to provide that: (i) as of January 26, 2005, the authorized number of our directors shall be one; (ii) the authorized number of directors may not be increased or decreased without the consent of the holders of a majority of the shares of convertible preferred stock; (iii) the holders of a majority of the shares of convertible preferred stock, acting in their sole discretion, may require us to increase the total number of authorized directors up to a maximum of seven directors; and (iv) any newly created directorships shall be designated by the holders of a majority of the shares of convertible preferred stock, acting in their sole discretion, to be filled by either: (A) an outside director with significant industry experience, who is reasonably acceptable to the holders of a majority of the convertible preferred stock, to be elected by the holders of our common stock (an “Independent Industry Expert Directorship”); or (B) a director to be designated by the holders of a majority of the convertible preferred stock (a “Preferred Directorship”). Up to four directorships shall be designated as Preferred Directorships, up to two directorships shall be designated as Independent Industry Expert Directorships, and one director shall be our chief executive officer. We currently have only one director, Dr. Boynton.

 

Going Concern

 

Our financial statements for the year ended December 31, 2006 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. Nevertheless, we have experienced recurring losses from operations and have a deficit accumulated during the development stage of approximately $84.1 million. Our independent auditors indicated in their report on our December 31, 2006 financial statements included in this Annual Report on Form 10-K that there is substantial doubt about our ability to continue as a going concern.

 

Cognate Therapeutics

 

On July 30, 2004, we entered into a service agreement with Cognate Therapeutics, Inc. (now known as Cognate BioServices, Inc.), or Cognate, a contract manufacturing and services organization, the majority of which is owned by Toucan Capital. In addition, two of the principals of Toucan Capital are members of Cognate’s board of directors. Under the agreement we agreed to utilize Cognate’s services for an initial two-year period, related primarily to manufacturing DCVax^® product candidates, regulatory advice, research and development preclinical activities and managing clinical trials. We continue to utilize Cognate’s services as of the date of this report; however, we have not formally amended or extended the original service agreement. We recognized approximately $3.5 million and $2.4 million of research and development costs relative to this agreement in 2005 and 2006. As of

December 31, 2006 we owed Cognate $2.2 million for services rendered pursuant to this agreement. We are currently incurring and paying approximately $250,000 per month for Cognate’s services rendered.

 

Website Access to Reports

 

Our website is located at: http://www.nwbio.com. Our periodic filings with the Securities and Exchange Commission, or SEC, are available on our website by clicking on “News and Investor” to “Stock Quote” to “Real-Time SEC Filings.” Additionally, our press releases can be accessed on our website through clicking on “News and Investor” to “Stock Quote” to “Press Releases.” The “Archive” button will display our historical press releases. The SEC also maintains an Internet site that contains reports that we have filed with it at http://www.sec.gov. The information contained on, or accessible through, our website is not incorporated into nor a part of this Annual Report on Form 10-K.

 

Industry Background

 

Incidence of Cancer in the United States

 

The American Cancer Society estimates that in the United States, men have a 1 in 2 lifetime risk of developing cancer, while women have a risk of 1 in 3. Doctors are expected to diagnose approximately 1.44 million new cases of cancer in the United States during 2007. Cancer is the second leading cause of death in the United States after heart disease and was estimated to result in approximately 559,650 deaths, or 1,533 per day, in 2007. The direct medical costs related to treating cancer in the United States were estimated to be $78.2 billion in 2006. Our initial therapeutic targets, prostate, brain and lung cancers, cause approximately 36% of the cancer deaths in the United States each year. The American Cancer Society estimated that the incidence of new diagnosis and deaths resulting from several common cancers during 2007 would be as follows:

 

 

Cancer

 

Cancer is characterized by aberrant cells that multiply uncontrollably. As cancer progresses, the cancer cells may invade other tissues throughout the body producing additional cancers, called metastases. Cancer growth can cause tissue damage, organ failure and, ultimately, death. Many immunologists believe that cancer cells occur frequently in the human body, yet are effectively controlled by the immune system because these cells are recognized as aberrant. Cancer growth occurs if this natural process fails.

 

Cancer cells produce abnormal kinds and amounts of substances called antigens, which may be distinguishable from those produced by healthy cells. The use of these cancer-associated antigens is essential to the development of products that may be capable of stimulating the immune system to seek and destroy cancer cells marked by these antigens.

 

The Human Immune System

 

The immune system is the body’s defense mechanism responsible for recognizing and eliminating cancer cells, viruses, bacteria and other disease-causing organisms. This system consists of populations of white blood cells whose components are responsible for initiating the cellular immune response, and the humoral, or antibody-based, immune response.

 

Dendritic cells, a component of white blood cells, initiate the cellular immune response by processing and displaying disease-associated antigen fragments on their outer cell surface, where they are recognized by white blood cells, known as naive T cells, that have not yet been exposed to antigens. Upon exposure to these antigen fragments, naive T cells become disease-specific Helper T cells or Killer T cells. Helper T cells then induce Killer T cells to seek and destroy the cells marked by the disease-associated antigen.

 

B cells direct the humoral immune response by binding to disease-associated antigens on the surface of various cell types, producing disease-specific antibodies. Helper T cells also enhance B cell production of disease-specific antibodies. These antibodies bind to and initiate the destruction of cells marked by the associated disease-specific antigens.

 

A small population of activated Helper T cells, Killer T cells, and antibody-producing B cells survive for long periods of time, retaining the memory of what the disease fragment looks like. These cells can respond very rapidly to subsequent exposure to disease-specific antigens and fragments. The most effective natural immune response is one in which both Killer T cells and antibody-producing B cells are activated.

 

The immune system response to cancer is generally characterized by the following sequence:

 

 

Limitations of Current Cancer Therapies

 

Traditional Cancer Therapy Approaches

 

Cancer is characterized by aberrant cells that multiply uncontrollably. As cancer progresses, the cancer cells may invade other tissues throughout the body producing additional cancers, called metastases. Effective therapies must attack the cancer both at its site of origin and at sites of metastases. Traditional treatments for cancer include:

 

 

Current Cancer Immunotherapy Approaches

 

Immunotherapy can stimulate and enhance the body’s natural mechanism for destroying pathogens, such as cancer cells, and may overcome many of the limitations of traditional cancer therapies. Immunotherapy may be particularly useful to augment traditional cancer therapies. In recent years, two cancer immunotherapy approaches have emerged, with FDA approved products to address the limitations of traditional therapies:

 

 

Our Approaches

 

We have developed two proprietary approaches, DCVax^® and therapeutic antibodies, for stimulating and enhancing a patient’s natural cellular, humoral or antibody immune response to cancer. Given appropriate funding for future development, we believe that DCVax^® and therapeutic antibody products may overcome certain limitations of current cancer therapies and offer cancer patients safe and effective treatment alternatives, alone or in combination with other therapies.

 

DCVax^®

 

Our DCVax^® platform combines our expertise in dendritic cell biology, immunology and antigen discovery with our proprietary process of producing and activating dendritic cells outside a patient’s body to develop therapeutic products designed to stimulate beneficial immune responses to treat cancer. We believe that DCVax^® has the following significant characteristics, the combination of which we believe makes it a potentially attractive alternative to current therapies.

 

 

 

Therapeutic Antibody

 

Our therapeutic antibody program is based on combining our expertise in monoclonal antibodies, immunology and antigen discovery. We co-developed an initial therapeutic antibody product candidate with Medarex, Inc. This collaboration enabled us to create a proprietary fully human monoclonal antibody-based prostate cancer product candidate. Our interest in that product candidate now has been acquired by Medarex and is in a FDA Phase II clinical trial; we have no continuing right in such product candidate.

 

Products derived from our therapeutic antibody efforts are intended to have the following characteristics, the combination of which will make them potentially attractive alternatives to current therapies:

 

 

In addition, we believe that therapeutic antibodies may be useful for the development of cancer diagnostic imaging products.

 

Our Clinical and Preclinical Development Programs

 

We submitted an investigational new drug application, or IND, with the FDA on December 8, 2004 for restarting our Phase III clinical trial for prostate cancer, DCVax^®-Prostate. The IND cleared the FDA on January 8, 2005. This Phase III clinical trial is based on promising clinical data from a previously conducted Phase I/II clinical trial. That double blinded, placebo controlled Phase III clinical trial was planned for 600 patients at 30-50 sites throughout the United States; however, we are considering other trial designs that may enable us to reduce the number of patients required. In any case, the trial will focus on non-metastatic hormone-independent prostate cancer patients.

 

We have also cleared with the FDA a Phase II clinical trial for DCVax^®-Brain for patients with Glioblastoma multiforme, the most lethal form of brain cancer. This Phase II trial, which commenced in December of 2006, aims at enrolling approximately 141 patients with newly diagnosed Glioblastoma multiforme.

 

We have completed substantial research and pre-clinical testing phases for four additional product candidates. We have been issued broad patent coverage by the United States Patent Office which gives us antibody therapeutic rights to a cancer protein that plays a key role in the progression of primary cancers and in the metastatic process. The protein is known as CXCR4, and is over-expressed in more than 75% of cancers and involved in all three critical functions of primary tumors and metastatic tumors: proliferation of the primary tumor, migration of cancer cells out of the primary tumor, and establishment of distant metastatic sites.

 

The following table summarizes the targeted indications and status of our product candidates:

 

 

 

 

Phase I: Evaluation of safety and dosing.

 

Phase III: Larger scale evaluation of safety and efficacy.

 

Our DCVax^® Platform

 

The DCVax^® platform uses our proprietary process to produce and activate dendritic cells outside of a patient’s body. Our Phase I/II clinical trial results for DCVax^®-Prostate suggested that these cells can generate an effective immune system response when administered therapeutically. Manufacture of a DCVax^® product takes approximately 30 days to complete for DCVax^®-Prostate and approximately 10 days for DCVax^®-Brain, and is characterized by the following sequence:

 

 

We believe that our DCVax^® platform affords us the flexibility to target many different forms of cancer through pairing of dendritic cells with cancer-associated antigens, pieces of cancer-associated antigens or deactivated whole cancer cells. We have either patented or licensed critical intellectual property regarding this technology.

 

DCVax^® Product Candidates

 

DCVax^®-Prostate

 

DCVax^®-Prostate, our initial dendritic cell-based product candidate, resulted from combining our DCVax^® platform with the cancer-associated antigen prostate specific membrane antigen, or PSMA. Prostate specific membrane antigen is located on the surface of prostate cells. It is expressed at very low levels on benign or healthy prostate cells, and at much higher levels on prostate cancer cells. Because PSMA is over-expressed in virtually all prostate cancers, it represents an effective target for prostate cancer therapeutics. The results from our Phase I/II clinical trial provided us with important results supporting the potential value of our DCVax^® platform as the basis for new cancer immunotherapies.

 

In September 1999, we filed an application to conduct a Phase I/II clinical trial for DCVax^®-Prostate to treat late-stage prostate cancer patients for whom hormone therapy was no longer effective. This trial was carried out at M.D. Anderson Cancer Center and at UCLA, involved the administration of DCVax^®-Prostate to thirty-two evaluable patients in order to establish the safety and efficacy of three different dosage levels of DCVax^®-Prostate.

 

We observed stabilization of disease at 26 weeks in 52% (16 of 31) of the patients in our Phase I/II clinical trial. Twelve of these stable patients did not have measurable metastatic disease at the time of treatment and all twelve were stable, as measured by radiographic criteria, at weeks 26 to 28 with a median time to progression of 59 weeks. Patients with measurable metastatic disease in our Phase I/II clinical trial had a median time to progression of 20 weeks. Eighty-three percent (83%) of patients had an immune response following treatment with DCVax^®-Prostate, as measured by the amount of immune-reactive substances found in the blood of patients, which formed specifically in response to PSMA.

 

Target Market.  The American Cancer Society estimated that 218,890 new cases of prostate cancer would be diagnosed in the United States during 2007. Deaths from prostate cancer are estimated at 27,050 for 2007. We estimate that there is an initial DCVax^®-Prostate target population consisting of approximately 100,000 patients with late stage, or hormone refractory, prostate cancer.

 

Current Treatments.  Existing treatments for localized prostate cancer include surgery and various forms of radiation therapy. The current standard-of-care for treating metastatic prostate cancer is hormone therapy. Although this therapy achieves temporary tumor control, the National Cancer Institute’s 1989-1996 five-year survival rate for metastatic prostate cancer is only 33%. Moreover, hormone therapy may cause significant adverse side effects, including bone loss, hot flashes, impotence and blood clots. Disease progression in the presence of hormone therapy occurs on average in two years, and is then classified as hormone refractory prostate cancer. Approximately 50% of patients with hormone refractory prostate cancer will die within two years of its onset. Currently, the only FDA approved treatment for hormone refractory prostate cancer are chemotherapy and radioactive pharmaceuticals, which can alleviate cancer-related symptoms but may cause significant adverse side effects and do not prolong survival. A large fraction of hormone refractory patients do not have objective metastatic disease as measured by bone and CT scans. We believe that DCVax^®-Prostate addresses this critical unmet medical need.

 

DCVax^®-Brain

 

DCVax^®-Brain uses our DCVax^® platform in combination with glioblastoma tumor cell lysate antigens. Our clinical collaborators at the University of California at Los Angeles, or UCLA, conducted two Phase I clinical trials to assess the safety and efficacy of dendritic cell-based immunotherapy for glioblastoma, GMB. They have informed us that in the first Phase I trial that DCVax^®-Brain had been administered to 12 patients and that the second Phase I trial has been administered to 17 patients. The patients in both trials were treated with of care with DCVax^®-Brain being administered as an adjuvant.

 

When we analyze the data from both of these trials together, the newly diagnosed GBM patients treated with DCVax^®-Brain show a delay in the time to recurrence or progression of disease from 8.1 months with standard of care treatments to 18.1 months with DCVax^®-Brain (p<0.00001). DCVax^®-Brain increased median overall survival from 17 months with standard of care treatments to 33.8 months (p=0.0044) for DCVax^®-Brain treated patients. Ten of the 19 patients remain alive for periods ranging to date from 10 to 80 months. Similarly, in recurrent (late stage) patients, DCVax^®-Brain has increased median survival from 6.4 months for historical controls receiving standard of care to 13.2 months for patients receiving DCVax^®-Brain.

 

We have recently filed for authorization for use of DCVax^®-Brain therapeutic vaccine to the Swiss Institute of Public Health. Approval of this application would include authorization to import/export the product in Switzerland and treat patients diagnosed with glioma, the most lethal type of brain cancer in selected centers in Switzerland. We expect to receive a decision on this application during Q3 of 2007. We intend to pursue early marketing opportunities in other countries in 2007.

 

Target Market.  The American Cancer Society estimated that about 20,500 new cases of brain cancer would be diagnosed in the United States during 2007. Deaths from brain cancer are estimated at about 12,740 per year. The most common and lethal form of brain cancer is glioblastoma, the indication we are targeting with DCVax^®-Brain. We estimate that our DCVax^®-Brain could address a population consisting of approximately 12,500 new patients per year. The incidence of newly diagnosed malignant primary brain cancers in Europe is approximately 50,000 per year with about 20,000 of these being GBM.

 

Current Treatments.  Existing treatments for glioblastoma include surgery, radiation and chemotherapy. These existing treatments are often used in various combinations and/or sequences and have significant adverse side effects. In its most recent study, The National Institutes of Health reported that the 1989-1996 five-year survival rate for all brain cancer patients was only 31%. Following initial treatment, virtually all cases of this cancer recur, with a life expectancy of approximately one year following recurrence. Few effective therapies exist for these patients. We believe that DCVax^®-Brain may address this critical unmet medical need.

 

DCVax^®-Lung/ DCVax^®-LB

 

DCVax^®-Lung. was designed to use our DCVax^® platform in combination with isolated and deactivated lung cancer cells as antigens. Although we received clearance from the FDA to conduct a Phase I clinical trial to assess the safety of DCVax^®-Lung, due to lack of financial resources, we suspended the initiation of this trial.

 

DCVax^®-LB is a further extension of the DCVax^® platform for the treatment of resectable solid tumors. Like DCVax^®-Lung, DCVax^®-LB uses autologous DC pulsed with isolated and deactivated tumor cells for the formulation of the treatment. In addition, the autologous DC used to formulate DCVax^®-LB are activated (or matured) with heat-killed and formalin-fixed BCG mycobacteria, analogous to the activation process used in the manufacturing of DCVax-Prostate. We have filed an Investigational New Drug application (IND) containing a protocol for a Phase I trial in non-small cell lung cancer with the Food and Drug Administration (FDA); this IND was cleared to proceed by the FDA in the first quarter of 2006. This clinical trial has not yet been initiated.

 

Target Market.  The American Cancer Society estimated that 213,380 new cases of lung cancer would be diagnosed in the United States during 2007. Approximately 80% of these cases are expected to be attributable to non-small cell lung cancer, the indication we were targeting with DCVax^®-Lung and are now targeting with DCVax^®-Direct. Deaths from all forms of lung cancer are estimated at 160,390 per year for 2007.

 

Current Treatments.  Existing treatments for non-small cell lung cancer include surgery and radiation therapy, which are used in various combinations. These treatments have significant adverse side effects. In its most recent study, the National Institutes of Health reported that the 1989-1996 five-year survival rate for non-small cell lung cancer patients was only 6.2%. Following initial treatment, virtually all cases of this cancer recur, with a life expectancy of approximately one year following recurrence. No effective therapy exists for these patients.

 

DCVax^®-Direct

 

DCVax^®-Direct uses our DCVax^® platform to produce dendritic cells suitable for direct injection into solid tumors. Several scientific studies have shown that dendritic cells injected into solid tumors in animal models can result in tumor regression. We have continued pre-clinical development of this application with positive preclinical animal data. The dendritic cells used in the formulation of DCVax^®-Direct are activated with heat-killed and formalin-fixed BCG mycobacteria and interferon gamma, but they are not loaded with tumor antigens prior to injection. Rather, the antigen loading takes place in vivo after injection of the DCVax^®-Direct dendritic cells into the tumor tissue, typically following radiation therapy, chemotherapy, or other treatments that kill tumor cells.

 

We have filed an Investigational New Drug application IND containing a Phase I clinical trial protocol for treatment of up to four different cancers with DCVax^®-Direct with the Food and Drug administration. This IND was cleared to proceed for the treatment of ovarian cancer in the second quarter of 2006, with the other three indications awaiting identification of clinical investigators. This clinical trial has not been initiated. We have filed an additional Phase I clinical trial protocol under this IND for the treatment of unresectable squamous cell carcinoma of the head and neck. This clinical trial protocol was cleared by the FDA in the third quarter of 2006. This trial has not been initiated.

 

Target market:  The American Cancer Society estimated that 22,430 new cases of ovarian cancer and 34,360 new cases of head and neck cancer, the initial targets for DCVax^®-Direct, would be diagnosed in the United States during 2007. Deaths from all solid tumors are estimated at approximately 1,100,000 per year for 2007.

 

Current treatments:  Current treatments for solid tumors typically involve cytotoxic therapy aimed at killing tumor cells. Such treatments include radiation therapy, chemotherapy, or other cell killing treatments such as cryotherapy. These treatments prepare the tumor tissue for the injection of DCVax^®-Direct.

 

DCVax^®-L

 

DCVax^®-L (L for lysate) was designed to use our DCVax^® platform in combination with patient specific tumor lysate. Thus, following surgery the tumor is prepared as a lysate for loading into autologous dendritic cells. The patient’s tumor lysate contains cancer specific biomarkers which will be added to the patient’s own dendritic cells and subsequently injected back into the patient to elicit a cancer specific immune response. We have filed an Investigational New Drug application IND containing a Phase I clinical trial protocol for treatment of ovarian cancer with DCVax^®-L with the Food and Drug administration. This IND was cleared to proceed for the treatment of ovarian cancer in the second quarter of 2006. This clinical trial has not been initiated.

 

Target Market.  The American Cancer Society estimated that approximately 22,000 new cases of ovarian cancer were diagnosed in 2005 and that there were approximately 16,210 deaths from the disease. Once ovarian cancer has recurred, there are currently no treatments effective in curing the disease. Thus, new treatment modalities that prevent or delay cancer recurrence are of importance in prolonging survival in women with ovarian cancer.

 

Current Treatments.  Standard therapy includes surgical debulking, followed by chemotherapy with a taxane/platinum combination for 6-8 cycles. Of the patients who present with advanced stage disease (III or IV), 70% will have a complete clinical remission following surgery and chemotherapy, with no evidence of disease by physical exam, radiographic imaging (such as CT or MRI) and normalization of the CA125 tumor marker. For most of these patients, the ovarian cancer will recur within two years, with median time to progression of 20 months for optimally surgically cytoreduced patients and 18 months for patients with suboptimal reduction. Once ovarian cancer has recurred, it is not considered curable and progression to death is usually inevitable, despite aggressive chemotherapy strategies. The overall five year survival for advanced ovarian cancer remains at 20-30%.

 

Our Therapeutic Antibody Platform

 

Our therapeutic antibody platform is based on combining our expertise in monoclonal antibodies, immunology and antigen discovery with potential collaborators who have expertise in humanized and fully human monoclonal antibody development. We develop our therapeutic antibody products candidate in the following sequence:

 

 

We believe that, given additional funding, our antigen discovery program may enable us to identify and develop cancer-associated antigens for the therapeutic antibody platform, potentially expanding our portfolio of potential therapeutic products. We expect that the antibodies generated by the therapeutic antibody platform may be useful as potential products or as products coupled with cytotoxins or radioactive agents.

 

Therapeutic Antibody Product Candidates

 

Lung, Breast, Brain, Colon, Melanoma, and Prostate, and Other Cancers

 

We have selected a cancer-associated antigen, CXCR4, for non-small cell lung cancer, breast cancer, glioblastoma, colon cancer, melanoma, prostate, pancreas, kidney, ovarian, and certain blood cancers. We have been issued a United States patent to the use of antibodies to CXCR4, a protein found to be over expressed in greater than 75% of cancers and involved in three critical functions of cancer cells that include cell proliferation, cell migration and establishment of metastatic sites in distant organs and tissues.

 

Manufacturing

 

We currently rely, and expect to continue to rely, upon specialized third-party manufacturers to produce our product candidates for pre-clinical, clinical and commercial purposes. Furthermore, the product candidates under development by us have never been manufactured on a commercial scale and may not be able to be manufactured at a cost or in sufficient quantities to make commercially viable products.

 

Marketing

 

In the event that we secure funding and develop an approved product, we plan to market that product in partnership with one or more established pharmaceutical companies. Our collaboration with these companies may take the form of royalty agreements, licensing agreements or other co-marketing arrangements. The oncology market in the United States is characterized by highly concentrated distribution channels. To be successful in producing a commercially viable product, we may need to develop a direct sales force to market that product in the United States.

 

Intellectual Property

 

We seek to protect our commercially relevant proprietary technologies through patents both in the United States and abroad. We have twenty issued and licensed patents (nine in the United States and eleven in foreign jurisdictions) and 137 patent applications pending (15 in the United States and 122 in foreign jurisdictions) which cover the use of dendritic cells in DCVax^® as well as targets for either our dendritic cell or monoclonal antibody therapy candidates. The issued patents expire at dates from 2015 to 2018. We intend to continue using our scientific expertise to pursue and patent new developments with respect to uses, methods, and compositions to enhance our position in the field of cancer treatment.

 

Any patents that we obtain may be circumvented, challenged or invalidated by our competitors. Our patent applications may not result in the issuance of any patents, and any patents that may be issued may not offer any protection against others who seek to practice the claimed inventions. We have obtained licenses for certain technologies that we use, but we may be unable to maintain those licenses and may be unable to secure additional licenses in the future. Thus, we may be forced to abandon certain product areas or develop alternative methods for operating in those areas.

 

In addition to patents, we rely on copyright protection, trade secrets, proprietary know-how and trademarks to maintain our competitive position. Our future success will depend in part on our ability to preserve our copyrights and trade secrets. Although our officers, employees, consultants, contractors, manufacturers, outside scientific collaborators, sponsored researchers and other advisors are required to sign agreements obligating them not to disclose our confidential information, these parties may nevertheless disclose such information and compromise our confidential data. We may not have adequate remedies for any such breach. It is also possible that our trade secrets or proprietary know-how will otherwise become known or be independently replicated or otherwise circumvented by competitors.

 

Our technologies may infringe the patents or violate other proprietary rights of third parties. In the event of infringement or violation, we may be prevented from pursuing further licensing, product development or commercialization. Such a result would materially adversely affect our business, financial condition and results of operations.

 

If we become involved in any litigation, interference or other administrative proceedings, we will incur substantial expenses and the efforts of our technical and management personnel will be significantly diverted. An adverse determination may subject us to significant liabilities or require us to seek licenses, which may not be available. We may also be restricted or prevented from manufacturing and selling our products, if any, in the event of an adverse determination in a judicial or administrative proceeding, or if we fail to obtain necessary licenses. In addition, any potential litigation or dispute may, as a result of our lack of funding, require us to further reduce or even curtail our operations entirely.

 

Competition

 

The biotechnology and biopharmaceutical industries are characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. Several companies, such as Cell Genesys, Inc., Dendreon Corporation, CancerVax, Immuno-Designed Molecules, Inc. and Argos Therapeutics, Inc., are actively involved in research and development of cell-based cancer therapeutics. Of these companies, we believe that only Dendreon, and Cell Genesys are carrying-out Phase III clinical trials with a cell-based therapy and they are doing so in a patient population that does not compete with our Phase III DCVax^®-Prostate product candidate. No cell-based therapeutic product is currently available for commercial sale. Additionally, several companies, such as Medarex, Inc., Amgen, Inc., Agensys, Inc., and Genentech, Inc. are actively involved in research and development of monoclonal antibody-based cancer therapies. Currently, at least seven antibody-based products are approved for commercial sale for cancer therapy. Genentech is also engaged in several Phase III clinical trials for additional antibody-based therapeutic products for a variety of cancers, and several other companies are in early stage clinical trials for such products. Many other third parties compete with us in developing alternative therapies to treat cancer, including:

 

 

Most of our competitors have significantly greater resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing. In addition, many of these competitors have become more active in seeking patent protection and licensing arrangements in anticipation of collecting royalties for use of technology they have developed. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors may prevent us from recruiting and retaining qualified scientific and management personnel, or from acquiring technologies complementary to our programs.

 

We expect that our ability to compete effectively will be dependent upon our ability to:

 

 

Governmental Regulation

 

Governmental authorities in the United States and other countries extensively regulate the pre-clinical and clinical testing, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution, among other things, of immunotherapeutics. In the United States, the FDA subjects pharmaceutical and biologic products to rigorous review. Even if we ultimately receive FDA approval for one or more of our products, if

we or our partners do not comply with applicable requirements, we may be fined, our products may be recalled or seized, our production may be totally or partially suspended, the government may refuse to approve our marketing applications or allow us to distribute our products, and we may be criminally prosecuted. The FDA also has the authority to revoke previously granted marketing authorizations.

 

In order to obtain approval of a new product from the FDA, we must, among other requirements, submit proof of safety and efficacy as well as detailed information on the manufacture and composition of the product. In most cases, this proof requires documentation of extensive laboratory tests, and pre-clinical and clinical trials. This testing, and the preparation of necessary applications and processing of those applications by the FDA are expensive and typically take several years to complete. The FDA may not act quickly or favorably in reviewing these applications, and we may encounter significant difficulties or costs in our efforts to obtain FDA approvals that could delay or preclude us from marketing any products we may develop. The FDA also may require post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any approvals that could restrict the commercial applications of these products. Regulatory authorities may withdraw product approvals if we fail to comply with regulatory standards or if we encounter problems following initial marketing. With respect to patented products or technologies, delays imposed by the governmental approval process may materially reduce the period we might have the exclusive right to exploit the products or technologies.

 

After an IND application becomes effective, a sponsor may commence human clinical trials in the United States. The sponsor typically conducts human clinical trials in three sequential phases, but these phases may overlap. In Phase I clinical trials, the product is tested in a small number of patients or healthy volunteers, primarily for safety at one or more doses. In Phase II, in addition to safety, the sponsor evaluates the efficacy of the product in a patient population somewhat larger than Phase I clinical trials. Phase III clinical trials typically involve additional testing for safety and clinical efficacy in an expanded population at geographically dispersed test sites. The sponsor must submit to the FDA a clinical plan, or protocol, accompanied by the approval of a clinical site responsible for ongoing review of the investigation, prior to commencement of each clinical trial. The FDA or a clinical site may order the temporary or permanent discontinuation of a clinical trial at any time, if the trial is not being conducted in accordance with FDA or clinical site requirements or presents a danger to its subjects.

 

The sponsor must submit to the FDA the results of the pre-clinical and clinical trials, together with, among other data, detailed information on the manufacture and composition of the product, in the form of a new drug application or, in the case of a biologic, a biologics license application. The FDA is regulating our therapeutic vaccine product candidates as biologics and, therefore, we must submit biologics license applications, or BLA to the FDA to obtain approval of our products. The clinical trial process generally takes several years, and the FDA reviews the BLA and, when and if it decides that adequate data is available to show that the new compound is both safe and effective and that all other applicable requirements have been met, the FDA approves the drug or biologic for marketing. The amount of time taken for this approval process is a function of a number of variables, including the quality of the submission and studies presented, the potential contribution that the compound will make in improving the treatment of the disease in question, and the workload at the FDA. It is possible that our product candidates will not successfully proceed through this approval process or that the FDA will not approve them in any specific period of time.

 

The FDA may, during its review of a new drug application or biologics license application, ask for additional test data. If the FDA does ultimately approve a product, it may require post-marketing testing, including potentially expensive Phase IV studies, and surveillance to monitor the safety and effectiveness of the drug. In addition, the FDA may in some circumstances impose restrictions on the use of an approved drug, which may be difficult and expensive to administer, and may require prior approval of promotional materials.

 

Before approving a new drug application or biologics license application, the FDA also will inspect the facilities at which the product is manufactured and will not approve the product unless the manufacturing facilities are in compliance with guidelines for the manufacture, holding, and distribution of a product. Following approval, the FDA periodically inspects drug and biologic manufacturing facilities to ensure continued compliance with manufacturing guidelines. Manufacturers must continue to expend time, money and effort in the areas of production, quality control, record keeping and reporting to ensure full compliance with those requirements. The labeling, advertising, promotion, marketing and distribution of a drug or biologic product must also be in

compliance with FDA regulatory requirements. Failure to comply with applicable requirements can lead to the FDA demanding that production and shipment cease, and, in some cases, that the manufacturer recall products, or to FDA enforcement actions that can include seizures, injunctions and criminal prosecution. These failures can also lead to FDA withdrawal of approval to market the product.

 

We, and our partners, are also subject to regulation by the Occupational Safety and Health Administration, the Environmental Protection Agency, the Nuclear Regulatory Commission and other foreign, federal, state and local agencies under various regulatory statutes, and may in the future be subject to other environmental, health and safety regulations that may affect our research, development and manufacturing programs. We are unable to predict whether any agency will adopt any regulation, which could limit or impede on our operations.

 

Sales of pharmaceutical products outside the United States are subject to foreign regulatory requirements that vary widely from country to country. Whether or not we have obtained FDA approval, we must obtain approval of a product by comparable regulatory authorities in foreign countries prior to the commencement of marketing the product in those countries. The time required to obtain this approval may be longer or shorter than that required for FDA approval. The foreign regulatory approval process includes all the risks associated with FDA regulation set forth above, as well as country-specific regulations.

 

Employees

 

Beginning in September 2002, we reduced our research and administrative staff approximately 94%, from 67 employees to a remaining staff of three full-time employees and two part-time employees, as of March 5, 2007. Each of our employees has signed a confidentiality and invention assignment agreement, and none are covered by a collective bargaining agreement. We have never experienced employment-related work stoppages and consider our employee relations to be positive.

 

This section briefly discusses certain risks that should be considered by our stockholders and prospective investors. You should carefully consider the risks described below, together with all other information included in this Annual Report on Form 10-K and the information incorporated by reference. If any of the following risks actually occur, our business, financial condition or operating results could be harmed. In such case, you could lose all or a portion of your investment.

 

We will need to raise additional capital, which may not be available.

 

As of March 5, 2007, we had less than $100,000 of cash. We are considered illiquid as this cash is not considered sufficient to fund the recurring operating and associated financing costs for the next month. Approximately $5.7 million of our $6.5 million current liabilities at December 31, 2006 were payable to related parties, net of the related debt discount. We pay approximately $250,000 of the related party liabilities balance per month. Further, during the last quarter of 2006, we commenced clinical trials which will increase our current cash needs.

 

These related parties have not yet agreed to any refinancing, deferral or conversion to equity, and may not do so. If these related party liabilities, the majority of which is currently due, are required to be repaid in the near-term our cash is not considered sufficient to fund our current liabilities. Accordingly, we may not be able to continue meeting our obligations on an ongoing basis, if at all. We need to raise significant additional funding to continue our operations, conduct research and development activities, pre-clinical studies and clinical trials necessary to bring our product candidates to market. However, additional funding may not be available on terms acceptable to us or at all. The alternative of issuing additional equity or convertible debt securities also may not be available and, in any event, would result in additional dilution to our stockholders. For ongoing operating capital we intend to seek additional funds from Toucan Capital, Toucan Partners, an affiliate of Toucan Capital, or other third parties. Neither Toucan Capital, Toucan Partners, or any other third parties is obligated to provide us any additional funds. Any additional financing with Toucan Capital, Toucan Partners or any other third party is likely to be dilutive to stockholders, and any debt financing, if available, may include additional restrictive covenants. We do not believe that our assets would be sufficient to satisfy the claims of all of our creditors in full and to satisfy aggregate liquidation preferences of our preferred stock. Therefore, if we were to pursue a liquidation it is highly unlikely that

any proceeds would be received by our common stockholders. If we are unable to obtain significant additional capital in the near-term, we may cease operations at anytime.

 

Our auditors have issued a “going concern” audit opinion.

 

Our independent auditors have indicated in their report on our December 31, 2006 financial statements included in this report that there is substantial doubt about our ability to continue as a going concern. A “going concern” opinion indicates that the financial statements have been prepared assuming we will continue as a going concern and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Therefore, you should not rely on our consolidated balance sheet as an indication of the amount of proceeds that would be available to satisfy claims of creditors, and potentially be available for distribution to stockholders, in the event of a liquidation.

 

We have reduced business umbrella, auto, crime and fiduciary, and directors and officers liability insurance coverage.

 

Due to rising insurance premiums for most business insurance coverage, our reduced level of operating activity, and reduced liability exposure through the cessation of all clinical trials, we lowered the levels of all of our insurance coverage. When our finances permit and when our level of operating activities rise, our insurance needs will be reassessed. Making a material reduction in our insurance coverage may make it difficult for us to acquire new directors and officers, and will also result in increased exposure to potential liabilities arising from any future litigation, either of which may materially harm our business and results of operations.

 

We expect to continue to incur substantial losses, and we may never achieve profitability.

 

We have incurred net losses every year since our incorporation in July 1998 and, as of December 31, 2006, we had a deficit accumulated during the development stage of approximately $84.1 million. We have had net losses applicable to common stockholders as follows:

 

 

We expect that these losses will continue and anticipate negative cash flows from operations for the foreseeable future. Because of our current cash position, we will need to secure additional funding to continue operations. In addition, we will need to generate revenue sufficient to cover operating expenses and research and development costs to achieve profitability. We may never achieve or sustain profitability.

 

As a company in the early stage of development with an unproven business strategy, our limited history of operations makes an evaluation of our business and prospects difficult.

 

We have had a limited operating history and are at an early stage of development. We may not be able to achieve revenue growth in the future. We have generated the following limited revenues:

 

 

We have derived most of these limited revenues from:

 

 

 

In the future, we anticipate that revenues, if any, will be derived through grants, partnering agreements, and, ultimately, the commercialization of our product candidates.

 

We may not be able to retain existing personnel.

 

Since September 2002, we reduced our research and administrative staff approximately 94%, from 67 employees to a remaining staff of three full-time employees and two part-time employees, as of March 5, 2007. The uncertainty of our cash position, workforce reductions, and the volatility in our stock price may create anxiety and uncertainty, which may adversely affect employee morale and cause us to lose employees whom we would prefer to retain. To the extent that we are unable to retain our existing personnel, our business and financial results may suffer.

 

We have no manufacturing capabilities, which could adversely impact our ability to commercialize our product candidates.

 

We have no manufacturing facilities nor expertise to produce our product candidates. We have never manufactured, on a commercial scale, any of our research products. Even if one or more of our product candidates is approved for marketing, we may not be able to enter into agreements with contract manufactures for the manufacture of any of our product candidates at a reasonable cost or in sufficient quantities to be profitable.

 

Because we lack sales and marketing experience, we may experience significant difficulties
commercializing our research product candidates.

 

The commercial success of any of our product candidates will depend upon the strength of our sales and marketing efforts. We do not have a sales force and have no experience in the sales, marketing or distribution of products. To fully commercialize our product candidates, we will need to create a substantial marketing staff and sales force with technical expertise and the ability to distribute these products. As an alternative, we could seek assistance from a third party with a large distribution system and a large direct sales force. We may be unable to put either of these plans in place. In addition, if we arrange for others to market and sell our products, our revenues will depend upon the efforts of those parties. Such arrangements may not succeed. Even if one or more of our product candidates is approved for marketing, if we fail to establish adequate sales, marketing and distribution capabilities, independently or with others, our business will be seriously harmed.

 

Our success partially depends on existing and future collaborators.

 

The success of our business strategy may partially depend upon our ability to develop and maintain multiple collaborations and to manage them effectively. The success of our restructured operations will depend on our ability to attract collaborators to our research initiatives and to a lesser extent our ability to attract customers to our research products. Due to concerns regarding our ability to continue operations, these third parties may decide not to conduct business with us, or may conduct business with us on terms that are less favorable than those customarily extended by them. If either of these events occurs, our business could suffer significantly.

 

Our success also depends partially upon the performance of our partners. We cannot directly control the amount and timing of resources that our existing or future collaborators devote to the research, development or marketing of our product candidates. As a result, those collaborators:

 

 

We may have disputes with our collaborators, which could be costly and time consuming. Our failure to successfully defend our rights could seriously harm our business, financial condition and operating results. We intend to continue to enter into collaborations in the future. However, we may be unable to successfully negotiate any additional collaborations and any of these relationships, if established, may not be scientifically or commercially successful.

 

We also work with scientists and medical professionals at academic and other institutions, including the University of California, Los Angeles, M.D. Anderson Cancer Center and the H. Lee Moffitt Cancer Center some of whom have conducted research for us or assist us in developing our research and development strategy. These scientists and medical professionals are not our employees. They may have commitments to, or contracts with, other businesses or institutions that limit the amount of time they have available to work with us. We have little control over these individuals. We can only expect them to devote to our projects the amount of time required by our license, consulting and sponsored research agreements. In addition, these individuals may have arrangements with other companies to assist in developing technologies that may compete with ours. If these individuals do not devote sufficient time and resources to our programs, our business could be seriously harmed.

 

Competition in our industry is intense and most of our competitors have substantially greater resources than we have.

 

The biotechnology and biopharmaceutical industries are characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. Several companies, such as Cell Genesys, Inc., Dendreon Corporation, Immuno-Designed Molecules, Inc., and Antigenics, are actively involved in the research and development of cell-based cancer therapeutics. Of these companies, we believe that only Dendreon and Cell Genesys are carrying-out Phase III clinical trials with a cell-based therapy. No dendritic cell-based therapeutic product is currently approved for commercial sale. Additionally, several companies, such as Medarex, Inc., Amgen, Inc., Agensys, Inc., and Genentech, Inc., are actively involved in the research and development of monoclonal antibody-based cancer therapies. Currently, at least seven antibody-based products are approved for commercial sale for cancer therapy. Genentech is also engaged in several Phase III clinical trials for additional antibody-based therapeutics for a variety of cancers, and several other companies are in early stage clinical trials for such products. Many other third parties compete with us in developing alternative therapies to treat cancer, including:

 

 

Most of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing than we do. In addition, many of these competitors have become active in seeking patent protection and licensing arrangements in anticipation of collecting royalties for use of technology they have developed. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These third parties compete with us in recruiting and retaining qualified scientific and management personnel, as well as in acquiring technologies complementary to our programs.

 

We expect that our ability to compete effectively will be dependent upon our ability to:

 

 

 

Our competitors may develop more effective or affordable products, or achieve earlier patent protection or product marketing and sales than we may. As a result, any products we develop may be rendered obsolete and noncompetitive.

 

Our intellectual property rights may not provide meaningful commercial protection for our research products or product candidates, which could enable third parties to use our technology, or very similar technology, and could reduce our ability to compete in the market.

 

We rely on patent, copyright, trade secret and trademark laws to limit the ability of others to compete with us using the same or similar technology in the United States and other countries. However, as described below, these laws afford only limited protection and may not adequately protect our rights to the extent necessary to sustain any competitive advantage we may have. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and we may encounter significant problems in protecting our proprietary rights in these countries.

 

We have twenty issued and licensed patents (nine in the United States and eleven in foreign jurisdictions) and 137 patent applications pending (15 in the United States and 122 in foreign jurisdictions) which cover the use of dendritic cells in DCVax^® as well as targets for either our dendritic cell or fully human monoclonal antibody therapy candidates. The issued patents expire at various dates from 2015 to 2023.

 

We will only be able to protect our technologies from unauthorized use by third parties to the extent that they are covered by valid and enforceable patents or are effectively maintained as trade secrets. The patent positions of companies developing novel cancer treatments, including our patent position, generally are uncertain and involve complex legal and factual questions, particularly concerning the scope and enforceability of claims of such patents against alleged infringement. Recent judicial decisions are prompting a reinterpretation of the limited case law that exists in this area, and historical legal standards surrounding questions of infringement and validity may not apply in future cases. A reinterpretation of existing law in this area may limit or potentially eliminate our patent position and, therefore, our ability to prevent others from using our technologies. The biotechnology patent situation outside the United States is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the United States and other countries may therefore diminish the value of our intellectual property.

 

We own, or have rights under licenses to a variety of issued patents and pending patent applications. However, the patents on which we rely may be challenged and invalidated, and our patent applications may not result in issued patents. Moreover, our patents and patent applications may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. We also face the risk that others may independently develop similar or alternative technologies or design around our patented technologies.

 

We have taken security measures to protect our proprietary information, especially proprietary information that is not covered by patents or patent applications. These measures, however, may not provide adequate protection of our trade secrets or other proprietary information. We seek to protect our proprietary information by entering into confidentiality agreements with employees, partners and consultants. Nevertheless, employees, collaborators or consultants may still disclose our proprietary information, and we may not be able to protect our trade secrets in a meaningful way. If we lose any employees, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees despite the existence of nondisclosure and confidentiality agreements and other contractual restrictions to protect our proprietary technology. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets.

 

Our success will depend partly on our ability to operate without infringing or misappropriating the
proprietary rights of others.

 

Our success will depend to a substantial degree upon our ability to develop, manufacture, market and sell our research products and product candidates without infringing the proprietary rights of third parties and without breaching any licenses we have entered into regarding our product candidates.

 

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and biopharmaceutical industries generally. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and can divert management’s attention from our core business. We may be exposed to future litigation by third parties based on claims that our products infringe their intellectual property rights. This risk is exacerbated by the fact that there are numerous issued and pending patents in the biotechnology industry and the fact that the validity and breadth of biotechnology patents involve complex legal and factual questions for which important legal principles remain unresolved.

 

Our competitors may assert that our products and the methods we employ are covered by U.S. or foreign patents held by them. In addition, because patents can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our products may infringe. There could also be existing patents of which we are not aware that one or more of our products may inadvertently infringe.

 

If we lose a patent infringement lawsuit, we could be prevented from selling our research products or product candidates unless we can obtain a license to use technology or ideas covered by such patent or are able to redesign our products to avoid infringement. A license may not be available at all or on terms acceptable to us, or we may not be able to redesign our products to avoid any infringement. If we are not successful in obtaining a license or redesigning our products, we may be unable to sell our products and our business could suffer.

 

We use hazardous materials and must comply with environmental, health and safety laws and
regulations, which can be expensive and restrict how we do business.

 

We store, handle, use and dispose of controlled hazardous, radioactive and biological materials in our business. Our current use of these materials generally is below thresholds giving rise to burdensome regulatory requirements. Our development efforts, however, may result in our becoming subject to additional requirements, and if we fail to comply with applicable requirements we could be subject to substantial fines and other sanctions, delays in research and production, and increased operating costs. In addition, if regulated materials were improperly released at our current or former facilities or at locations to which we send materials for disposal, we could be strictly liable for substantial damages and costs, including cleanup costs and personal injury or property damages, and incur delays in research and production and increased operating costs.

 

Insurance covering certain types of claims of environmental damage or injury resulting from the use of these materials is available but can be expensive and is limited in its coverage. We have no insurance specifically covering environmental risks or personal injury from the use of these materials and if such use results in liability, our business may be seriously harmed.

 

Toucan Capital and Toucan Partners beneficially own the vast majority of our stock and, as a result, the trading price for our shares may be depressed and these stockholders can take actions that may be adverse to your interests.

 

As of March 5, 2007, Toucan Capital and Toucan Partners collectively beneficially owned an aggregate of approximately 396.8 million shares of our common stock issuable pursuant to conversion of Series A Preferred Stock, Series A-1 Preferred Stock, convertible notes, and warrants, representing beneficial ownership of approximately 86% of our outstanding common stock, on an as-converted to common stock basis. Such amounts exclude the effects of the amendments to the Toucan Partners convertible promissory notes in an aggregate principal amount of $950,000. The amounts also exclude any shares issuable to Toucan Partners pursuant to the 2007 Convertible Notes and 2007 Warrants as these are not currently convertible or exercisable for a determinable number of shares. The notes held by Toucan Partners are currently convertible into common stock or Series A Preferred Stock at its election, at the price of $0.04, or Series A-1 Preferred Stock at the price of $1.60 per share. The Series A Preferred

Stock and Series A-1 Preferred Stock is similarly convertible into common stock (at the rate of 1-for-1 in the case of Series A Preferred Stock and at the rate of 1-for-40 in the case of Series A-1 Preferred Stock). The warrants held by Toucan Capital are exercisable at exercise prices ranging from $0.01 to $0.04 per share. The warrants held by Toucan Partners are exercisable at a price to be determined as defined in the 2007 Convertible Notes and Warrants. This significant concentration of ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. Toucan Capital and Toucan Partners have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they can dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you.

 

In addition, Toucan Capital and Toucan Partners each has a right of first refusal to participate in our future issuances of debt or equity securities Also, under the terms of our recapitalization agreement, we are required to consult with Toucan Capital on how we conduct many aspects of our business. As a result, Toucan Capital has significant influence in regard to how we conduct our business, and with its stock ownership, could influence any matters requiring stockholder approval. This influence may cause us to conduct our business differently from the way we have in the past. The concentration of ownership may also delay, deter or prevent acts that would result in a change in control, which, in turn, could reduce the market price of our common stock.

 

There may not be an active, liquid trading market for our common stock.

 

On December 14, 2001, our common stock was listed on the NASDAQ National Market. Prior to that time there was no public market for our common stock. On December 23, 2002, our common stock was delisted from the NASDAQ National Market and our common stock is currently listed on the Over The Counter Bulletin Board, or OTCBB, which is generally recognized as being a less active market than the NASDAQ National Market. You may not be able to sell your shares at the time or at the price desired. There may be significant consequences associated with our stock trading on the OTCBB rather than a national exchange. The effects of not being able to list our securities on a national exchange include:

 

 

Our common stock may experience extreme price and volume fluctuations, which could lead to costly
litigation for us and make an investment in us less appealing.

 

The market price of our common stock may fluctuate substantially due to a variety of factors, including:

 

 

 

The market prices of the securities of biotechnology companies, particularly companies like ours without earnings and consistent product revenues, have been highly volatile and are likely to remain highly volatile in the future. This volatility has often been unrelated to the operating performance of particular companies. In the past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Moreover, market prices for stocks of biotechnology-related and technology companies occasionally trade at levels that bear no relationship to the operating performance of such companies. These market prices generally are not sustainable and are subject to wide variations. Whether or not meritorious, litigation brought against us following fluctuations in the trading prices of our securities could result in substantial costs, divert management’s attention and resources and harm our financial condition and results of operations.

 

Our incorporation documents, and bylaws and stockholder rights plan may delay or prevent a change in our management.

 

Our Seventh Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, our Second Amended and Restated Bylaws, or Bylaws and stockholder rights plan contain provisions that could delay or prevent a change in our management team. Some of these provisions:

 

 

These provisions could allow our board of directors to affect your rights as a stockholder since our board of directors can make it more difficult for common stockholders to replace members of the board. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace our current management team. In addition, we are party to an investor rights agreement which includes protective provisions affording certain assurances to investors which could have the potential to discourage a change in control.

 

Because our common stock is subject to “penny stock” rules, the market for the common stock may be limited.

 

Because our common stock is subject to the SEC’s penny stock rules, broker-dealers may experience difficulty in completing customer transactions and trading activity in our securities may be adversely affected. Under the “penny stock” rules promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), broker-dealers who recommend such securities to persons other than institutional accredited investors:

 

 

As a result of these rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and stockholders may find it more difficult to sell our securities.

 

The resale, or the availability for resale, of the shares issued in the PIPE Financing could have a
material adverse impact on the market price of our common stock.

 

In March 2006, we entered into the PIPE Financing, consisting of a private placement of an aggregate of approximately 39.5 million shares and accompanying warrants to purchase an aggregate of approximately 19.7 million shares. In connection with the PIPE Financing, we agreed to register the resale of the shares of common stock sold in the PIPE Financing and the shares underlying the warrants issued in the PIPE Financing. The resale of a substantial number of such shares, or even the availability of these shares for resale, could have a material adverse impact on our stock price.

 

Certain material weaknesses have been identified in our internal controls.

 

Peterson Sullivan, PLLC, our independent registered public accounting firm has informed us that the following deficiencies in our internal controls constitute material weaknesses under Auditing Standard No. 2 “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements” established by the Public Company Accounting Oversight Board:

 

 

If we fail to maintain adequate controls, our business and results of operations could be harmed and we might not be able to provide reasonable assurance as to our financial results or meet our reporting obligations.

 

None.

 

We maintain our headquarters in Bothell, Washington where we currently sublease approximately 2,325 square feet of general administration space. Our current lease expires on June 30, 2007.

 

SOMA Arbitration

 

We were parties to an engagement letter, dated October 15, 2003, with SOMA Partners, LLC, or SOMA, a New Jersey-based investment bank, pursuant to which we engaged them to locate potential investors. Pursuant to the terms of the engagement letter, any disputes arising between the parties would be submitted to arbitration in the New York metropolitan area. A significant dispute arose between the parties. SOMA filed an arbitration claim against us with the American Arbitration Association in New York, NY claiming unpaid commission fees of $186,000 and seeking declaratory relief regarding potential fees for future transactions that may be undertaken by us with Toucan Capital. We vigorously disputed SOMA’s claims on multiple grounds. We contended that we only owed SOMA approximately $6,000.

 

SOMA subsequently filed an amended arbitration claim, claiming unpaid commission fees of $339,000 and warrants to purchase 6% of the aggregate securities issued to date, and seeking declaratory relief regarding potential fees for future financing transactions which may be undertaken by us with Toucan Capital and others, which could potentially be in excess of $4 million. SOMA also requested the arbitrator award its attorneys’ fees and costs related to the proceedings.

 

The arbitration proceedings occurred from March 8-10, 2005 and on May 24, 2005, the arbitrator ruled in our favor and denied all claims of SOMA. In particular, the arbitrator decided that we did not owe SOMA the fees and

warrants sought by Soma, that we would not owe SOMA fees in connection with future financings, if any, and that we had no obligation to pay any of SOMA’s attorneys’ fees or expenses. The arbitrator agreed with us that the only amount we owed SOMA was $6,702.87, which payment we made on May 27, 2005.

 

On August 29, 2005, SOMA filed a notice of petition to vacate the May 24, 2005 arbitration award issued by the Supreme Court of the State of New York.

 

On December 30, 2005, the Supreme Court of the State of New York dismissed SOMA’s petition, denying SOMA’s August 29, 2005 motion to vacate the May 24, 2005 award.

 

On February 3, 2006, SOMA filed another notice of appeal with the Supreme Court of the State of New York.

 

On December 6, 2006, we filed our brief for this appeal and on December 12, 2006, SOMA filed its reply brief. As of the date of the filing of this report, the Supreme Court of the State of New York has yet to act on this matter. We believe that SOMA’s latest appeal is without merit and we intend to vigorously defend the appeal.

 

Management Warrants

 

On November 13, 2003, we borrowed an aggregate of $335,000 from certain members of our management. As part of this loan, the lenders received warrants exercisable to acquire an aggregate of 3.7 million shares of our common stock. From March 2006 through May 2006, all of these warrants were exercised for common stock on a net exercise basis, pursuant to the terms of the warrants.

 

Two former members of management who had participated as lenders in our management loans have claimed that they are entitled to receive, for no additional cash consideration, an aggregate of up to approximately 9.5 million additional shares of our common stock due to the alleged triggering of an anti-dilution provision in the warrant agreements. We do not believe that these claims have merit, and intend to vigorously defend such claims.

 

We have no other legal proceedings pending at this time.

 

There were no matters submitted for stockholders’ approval in the quarter ended December 31, 2006.

 

Market Information and Price Range of Common Stock

 

Our common stock is quoted on the OTCBB under the symbol “NWBT.OB.” Public trading of our common stock commenced on December 14, 2001 on the NASDAQ National Market. Prior to that time, there was no public market for our stock. On December 23, 2002, our common stock was delisted from NASDAQ and subsequently commenced trading on the OTCBB. The following table summarizes our common stock’s high and low sales prices for the periods indicated as reported by the OTCBB. These prices do not include retail markups, markdowns or commissions.

 

 

As of March 5, 2007, there were approximately 244 holders of record of our common stock. Such holders include any broker or clearing agencies as holders of record but exclude the individual stockholders whose shares are held by brokers or clearing agencies.

 

Dividend Policy

 

We have never declared or paid cash dividends on our capital stock. We currently intend to retain future earnings, if any, to fund the development and growth of our business and do not currently anticipate paying any cash dividends in the foreseeable future. The payment of future dividends, if any, will be determined by our board of directors.

 

The following selected financial data as of and for each of the years ending December 31, 2002 to December 31, 2006 and for the period from our inception through December 31, 2006 is derived from our audited consolidated financial statements. The financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our financial statements and notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K.

 

 

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 8. “Financial Statements and Supplementary Data” included below in this Annual Report on Form 10-K. Operating results are not necessarily indicative of results that may occur in future periods.

 

This discussion and analysis contains forward-looking statements that involve a number of risks, uncertainties and assumptions. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, those set forth in “Item 1A. Risk Factors” in this Annual Report. All forward-looking statements included in this Annual Report are based on information available to us on the date of this Annual Report and, except as required by law, we undertake no obligation to update publicly or revise any forward-looking statements.

 

Overview

 

We have experienced recurring losses from operations, have a working capital deficit of $5.9 million and have a deficit accumulated during the development stage of $84.1 million at December 31, 2006.

 

Recapitalization

 

Since the beginning of 2002, we recognized that we did not have sufficient working capital to fund our operations beyond 12 months and needed to raise additional capital from third parties in order to continue our clinical and research programs. In April 2002, we retained an investment bank to assist us in raising capital. Due to the economic climate in 2002 and declining stock prices of biotechnology companies in general, as well as our own stock price, we were unable to raise additional capital. In July 2002, we retained an additional investment banking firm to assist us in exploring various strategic options including raising additional capital, licensing our technology to a third party, or merging with another company. We contacted over 50 biotechnology companies and over 20 large pharmaceutical companies in an attempt to explore these options without success.

 

From September 2002 through approximately September 2004, we reduced our staff from 67 to 8 employees, withdrew our investigational new drug application, or IND, for our Phase III clinical trial for hormone refractory prostate cancer and our IND for our Phase I trial for non-small cell lung cancer from the U.S. Food and Drug Administration, or FDA, and inactivated our Phase II clinical trial for brain cancer, which remained open with the FDA. In addition, we moved our corporate headquarters several times, each time to smaller facilities in order to reduce our monthly rent expense. During this time, we attempted to obtain capital from various sources, but were not successful. On November 13, 2003, we borrowed $335,000 from members of our management pursuant to a series of convertible promissory notes and associated warrants to purchase an aggregate of 3.7 million shares of our common stock.

 

Beginning in 2004, we undertook a significant recapitalization whereby we have raised an aggregate of approximately $17.0 million in gross proceeds from issuances of debt and equity through a series of private placements. These financings included:

 

 

 

In April 2006, Toucan Capital elected to convert all of its promissory notes, including all accrued interest thereon, into a newly designated series of preferred stock, Series A-1 Preferred Stock, in accordance with the terms of the notes at a conversion price of $1.60 per share. The Series A-1 Preferred Stock is substantially identical to Series A Preferred Stock with the exception of the issuance price per share and liquidation preference per share (which are $1.60 per share, rather than $0.04 per share in the case of Series A) and the ratio at which the shares are convertible into common stock (which is 1-for-40, or one share of A-1 Preferred Stock for forty shares of common stock, rather than 1-for-1 in the case of Series A).

 

Simultaneously with Toucan Capital’s loan conversion, Alton Boynton, the Company’s President and Marnix Bosch, the Company’s Chief Technical Officer, each elected to convert the principal and accrued interest on their respective loans into 2,195,771 and 491,948 shares of the Company’s common stock, and in conjunction with the PIPE Financing, exercised their warrants for the issuance of 1,895,479 and 424,669 shares of the company’s common stock, respectively.

 

As a result of the financings described above, Toucan Capital currently holds:

 

 

 

As a result of the financings described above, Toucan Partners currently holds:

 

 

Upon issuance and finalization of terms, the warrants held by Toucan Capital and Toucan Partners described above are fully vested and exercisable and generally have an exercise period of seven years from their respective dates of issuance.

 

As a result of the PIPE Financing, the investors in the PIPE Financing initially purchased:

 

 

The investments made by Toucan Capital and Toucan Partners were made pursuant to the terms and conditions of a recapitalization agreement originally entered into on April 26, 2004 with Toucan Capital. The recapitalization agreement, as amended, originally contemplated the investment of up to $40 million through the issuance of new securities to Toucan Capital and a syndicate of other investors to be determined.

 

We and Toucan Capital amended the recapitalization agreement in conjunction with each successive loan agreement. The amendments generally (i) updated certain representations and warranties of the parties made in the recapitalization agreement, and (ii) made certain technical changes in the recapitalization agreement in order to facilitate the bridge loans described therein.

 

However, neither Toucan Capital, Toucan Partners, nor any entity affiliated with either of them are obligated to invest any additional funds in the company.

 

Series A Cumulative Convertible Preferred Stock and Series A-1 Cumulative Convertible Preferred Stock

 

As described above, on January 26, 2005, we entered into a securities purchase agreement with Toucan Capital, pursuant to which it purchased 32.5 million shares of our Series A Preferred Stock at a purchase price of $0.04 per share, for an aggregate purchase price of $1.3 million. The Series A Preferred Stock:

 

(i) is entitled to cumulative dividends at the rate of 10% per year;

 

(ii) is entitled to a liquidation preference in the amount of its initial purchase price plus all accrued and unpaid dividends (to the extent of legally available funds);

 

(iii) has a preference over the common stock, and is on a pari passu basis with the Series A-1 Preferred Stock, with respect to dividends and distributions;

 

(iv) is entitled to participate on an as-converted basis with the common stock on any distributions after the payment of any preferential amounts to the Series A Preferred Stock and the Series A-1 Preferred Stock;

 

(v) votes on an as converted basis with the common stock and the Series A-1 Preferred Stock on matters submitted to the common stockholders for approval and as a separate class on certain other material matters; and

 

(vi) is convertible into common stock on a one-for-one basis (subject to adjustment in the event of stock dividends, stock splits, reverse stock splits, recapitalizations, etc.).

 

The number of shares of common stock issuable upon conversion of each share of Series A Preferred Stock is also subject to increase in the event of certain dilutive issuances in which we sell or are deemed to have sold shares below the then applicable conversion price (currently $0.04 per share). The consent of the holders of a majority of the Series A Preferred Stock is required in the event that we elect to undertake certain significant business actions.

 

As described above, in April 2006, Toucan Capital converted the aggregate principal amount, and all accrued interest thereon into an aggregate of 4.82 million shares of our newly designated Series A-1 Preferred Stock. The Series A-1 Preferred Stock is substantially identical to the Series A Stock described above, although its original issuance price and liquidation preference are $1.60 per share, and its conversion rate is initially 40 shares of common stock per share of Series A-1 Preferred Stock.

 

Toucan Capital Series A Warrant

 

On January 26, 2005, we issued Toucan Capital a warrant, with a contractual life of 7 years, to purchase up to 13.0 million shares of Series A preferred stock with an exercise price of $0.04 per share. The number of shares issuable pursuant to the exercise of the warrant and the exercise price thereof is subject to adjustment in the event of stock splits, reverse stock splits, stock dividends and the like.

 

Toucan Partners Notes

 

We borrowed an aggregate of $950,000 from Toucan Partners from November 2005 to March 2006. Interest accrues on these notes at the rate of 10% per annum, based on a 365-day basis compounded annually from the respective original issuance dates of the notes. These notes (and associated warrants) were amended and restated in April 2007 to conform to the terms of the 2007 Convertible Notes and the 2007 Warrants. The principal amount of, and accrued interest on, these notes, as amended, is convertible at Toucan Partners’ election into common stock or Series A Preferred Stock on the same terms as the 2007 Convertible Notes described below.

 

We also borrowed an aggregate of $3.05 million from Toucan Partners from October 2006 to April 2007 pursuant to a series of promissory notes. The notes mature on June 30, 2007. Interest accrues on these notes at a rate of 10% per annum, based on a 365-day basis compounded annually from the respective original cash advance dates. The principal amount of, and accrued interest on, these notes is convertible at Toucan Partners’ election into any of our equity securities. The conversion terms will not be fixed until a future date at Toucan Partners’ election. The outstanding principal and accrued interest under the 2007 Convertible Notes may be converted (in whole or in part) on conversion terms equal to the terms of any convertible debt financing from an unaffiliated investor in an aggregate principal amount of at least $150,000 on or before May 15, 2007 (a “Qualified Debt Financing”). In the event that a Qualified Debt Financing does not occur, or Toucan Partners elects in its sole discretion to not convert on such terms, the conversion terms shall by subject to further negotiation between us and Toucan Partners.

 

Bridge Warrants

 

Toucan Capital

 

In connection with the loans made by Toucan Capital, Toucan Capital holds a series of 122.5 million warrants to purchase capital stock issued between April 2004 and September 2005. These warrants have a seven year exercise period from their respective issuance dates. The warrants are exercisable for shares of convertible preferred stock if

other investors have purchased in cash a minimum of $15 million of such convertible preferred stock, on the terms and conditions set forth in the Recapitalization Agreement. However, if, other investors have not purchased in cash a minimum of $15 million of such convertible preferred stock, on the terms and conditions set forth in the Recapitalization Agreement, these warrants shall be exercisable for any equity security and/or debt security and/or any combination thereof. As a result, these warrants are currently exercisable at the holder’s election, for shares of common stock or Series A Preferred Stock, or Series A-1 Preferred Stock. The per share exercise price is $0.01 for common stock or Series A Preferred Stock or $0.40 per share for Series A-1 Preferred Stock with respect to 66 million of these warrants. The per share exercise price is $0.04 for common stock or Series A Preferred Stock or $1.60 per share for Series A-1 Preferred Stock with respect to 56.5 million of these warrants.

 

Toucan Partners

 

Toucan Partners holds a series of warrants to purchase capital stock. These warrants were issued between November 2005 and April 2006 and they were amended and restated in April 2007. These warrants have a seven year exercise period from their amended and restated date of April 14, 2007. The foregoing warrants are exercisable on the same terms as the warrants issued in connection with the 2007 Convertible Notes.

 

Toucan Partners also holds a series of warrants issued in connection with the 2007 Convertible Notes (the “2007 Warrants”) that carry 100% warrant coverage. The number of warrant shares issuable upon exercise of each 2007 warrant will be equal to the number of shares that would be issuable if Toucan Partners elected to convert the principal and accrued interest on the corresponding 2007 Convertible Notes determined as of the date of repayment or conversion of such 2007 Convertible Note. The exercise price of each 2007 Warrant will be equal to the conversion price of the corresponding 2007 Convertible Note. Accordingly, the number of shares issuable upon exercise of the warrants and the exercise price of the warrants are currently unknown.

 

Going Concern

 

Our financial statements for the year ended December 31, 2006 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. Nevertheless, we have experienced recurring losses from operations and have a deficit accumulated during the development stage of $84.1 million that raises substantial doubt about our ability to continue as a going concern and our auditors have issued an opinion, for the year ended December 31, 2006, which states that there is substantial doubt about our ability to continue as a going concern.

 

If we are unable to continue as a restructured company, we intend to advance our dendritic cell-based product and monoclonal antibody candidates, pursue potential corporate partnerships for our monoclonal antibody candidates, and further consider other alternatives including the possible sale of some or all of our assets.

 

Expenses

 

From our inception through December 31, 2006, we incurred costs of approximately $35.8 million associated with our research and development activities. Because our technologies are unproven, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates for commercialization.

 

General and administrative expenses include salary and benefit expenses related to administrative personnel, cost of facilities, insurance, legal support, as well as amortization costs of stock options granted to employees and warrants issued to consultants for their professional services.

 

To date, our revenues have primarily been derived from the manufacture and sale of research materials, contract research and development services and research grants from the federal government.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require our management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our financial statements, as well

as the amounts of revenues and expenses during periods covered by our financial statements. The actual amounts of these items could differ materially from those estimates. Our accounting policies are described in more detail in Note 3 to our financial statements included elsewhere in this Form 10-K. We have identified the following as the most critical accounting policies and estimates used in this preparation of our financial statements.

 

Restructuring liabilities.

 

When circumstances warrant, we may elect to discontinue certain business activities or change the manner in which we conduct ongoing operations. When such a change is made, management will estimate the costs to exit a business or restructure ongoing operations. The components of the estimates may include estimates and assumptions regarding the timing and costs of future events and activities that represent management’s best expectations based on known facts and circumstances at the time of estimation. Management periodically reviews its restructuring estimates and assumptions relative to new information, if any, of which it becomes aware. Should circumstances warrant, management will adjust its previous estimates to reflect what it then believes to be a more accurate representation of expected future costs. Because management’s estimates and assumptions regarding restructuring costs include probabilities of future events, such estimates are inherently vulnerable to changes due to unforeseen circumstances, changes in market conditions, regulatory changes, changes in existing business practices and other circumstances that could materially and adversely affect the results of operations.

 

We recognized, for the year ended December 31, 2002, a liability of approximately $929,000 and a loss on facility sublease of $721,000, net of deferred rent write off in estimating the loss of economic benefit from vacating approximately 22,000 square feet of laboratory and administrative space at our prior facility in accordance with EITF 94-3, Accounting for Costs Associated with Exit or Disposal Activities.

 

On June 30, 2003, we entered into a settlement agreement with Nexus Canyon Park, our prior landlord. Under this Settlement Agreement, Nexus Canyon Park agreed to permit premature termination of our prior lease and excuse us from future performance of lease obligations in exchange for 90,000 shares of our unregistered common stock with a fair value of $35,000 and Nexus’ retention of our $1.0 million security deposit. The settlement agreement resulted in an additional loss on facility sublease and lease termination of $174,000, net of deferred rent of $202,000. SFAS 146 Accounting for Costs Associated with Exit or Disposal Activities has replaced EITF 94-3 but similar charges may occur if we have to cancel our current lease or enter into other restructuring transactions.

 

Impairment of Long-Lived Assets

 

As of December 31, 2006, we had approximately $15,000 of property and equipment, net of accumulated depreciation. In accounting for these long-lived assets, we make estimates about the expected useful lives of the assets, the expected residual values of the assets, and the potential for impairment based on events or circumstances. The events or circumstances could include a significant decrease in market value, a significant change in asset condition or a significant adverse change in regulatory climate. Application of the test for impairment requires judgment.

 

During 2003, we recognized non-cash asset impairment losses totaling $987,000, on certain facilities and property and equipment resulting from our decisions to cancel our leases or vacate certain space. The losses on the equipment were determined based on actual sales or disposal of assets. We identified an indicator of impairment with respect to our leasehold improvements as a result of our decision to vacate our prior administrative space. Accordingly, we reduced the carrying value of the assets to their estimated fair value of zero.

 

Stock-Based Compensation

 

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), using the modified prospective method, and therefore were not required to restate prior periods’ results. Under this method, we recognized compensation expense (a) for all equity incentive awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and (b) for all equity incentive awards granted, modified or settled subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R.

 

Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment. We use the Black-Scholes option pricing model to estimate the fair value of employee stock options and rights to purchase shares under stock plans, consistent with the provisions of SFAS No. 123R. Option pricing models, including the Black-Scholes model, also require the use of input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. We estimate the volatility of our common stock based on the historical volatility over the most recent period corresponding with the estimated expected life of the award. We estimate expected life of the award based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. Higher volatility and expected lives result in a proportional increase to share-based compensation determined at the date of grant. The expected dividend rate and expected risk-free rate of return are not as significant to the calculation of fair value. Although the fair value of our share-based awards is determined in accordance with SFAS No. 123R and SAB 107, the Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.

 

In addition, SFAS No. 123R requires us to develop a forfeiture rate which is an estimate of the number of share-based awards that will be forfeited prior to vesting. Quarterly changes in the estimated forfeiture rate can potentially have a significant effect on reported share-based compensation, as the effect of adjusting the forfeiture rate for all expense amortization after January 1, 2006 is recognized in the period the forfeiture estimate is changed.

 

Revenue recognition

 

We earn revenues through research grants and previously earned revenues through sale of research materials and providing research services to third parties. Revenues from sale of research materials are to multiple customers with whom there is no other contractual relationship and are recognized when shipped to the customer and title has passed.

 

Research contracts and grants require us to perform research activities as specified in each respective contract or grant on a best efforts basis, and we are paid based on the fees stipulated in the respective contracts and grants which approximate the costs incurred by us in performing such activities. We recognize revenue under the research contracts and grants based on completion of performance under the respective contracts and grants where no ongoing obligation on our part exists. Direct costs related to these contracts and grants are reported as research and development expenses.

 

Results of Operations

 

Operating costs:

 

Operating costs and expenses consist primarily of research and development expenses, including clinical trial expenses which rise when we are actively participating in clinical trials, and general and administrative expenses.

 

Research and development:

 

Discovery and preclinical research and development expenses include scientific personnel related salary and benefit expenses, costs of laboratory supplies used in our internal research and development projects, travel, regulatory compliance, and expenditures for preclinical and clinical trial operation and management when we are actively engaged in clinical trials.

 

Because we are a development stage company, we do not allocate research and development costs on a project basis. We adopted this policy, in part, due to the unreasonable cost burden associated with accounting at such a level of detail and our limited number of financial and personnel resources. We shifted our focus, starting in 2002, from discovering, developing, and commercializing immunotherapy products to conserving cash and primarily concentrating on securing new working capital to re-activate our two DCVax^® clinical trial programs. Our business judgment continues to be that there is little value associated with evaluating expenditures at the project level since all projects have either been discontinued and/or their respective activity reduced to a subsistence level.

 

For the year ended December 31, 2006, of our loss from operations of approximately $6.0 million, approximately 63% of our expended resources were apportioned to the re-activation of our two DCVax^® protocols. From

our inception through December 31, 2006, we incurred costs of approximately $35.8 million associated with our research and development activities. Because our technologies are unproven, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates for commercialization.

 

General and administrative:

 

General and administrative expenses include administrative personnel related salary and benefit expenses, cost of facilities, insurance, travel, legal support, property and equipment depreciation, amortization of stock options and warrants, and amortization of debt discounts and beneficial conversion costs associated with our debt financing.

 

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2006

 

Total Revenues.  Revenues decreased 36% from $124,000 for the year ended December 31, 2005 to $80,000 for the year ended December 31, 2006. The overall decrease is primarily due to the fact we completed two research grants in 2005, offset by a one time sale of certain license rights during 2006.

 

Research and Development Expense.  Research and development expense decreased 16% from $4.5 million for the year ended December 31, 2005 to $3.8 million for the year ended December 31, 2006. This decrease was primarily due to a decrease in contract manufacturing costs.

 

General and Administrative Expense.  General and administrative expense increased 13% from $2.0 million for the year ended December 31, 2005 to $2.3 million for the year ended December 31, 2006. This increase was primarily due to an increase in SEC filing costs and initial investigations into establishing a European presence.

 

Depreciation and Amortization.  Depreciation and amortization decreased 41% from $63,000 for the year ended December 31, 2005 to $37,000 for the year ended December 31, 2006. This decrease was primarily due to the fact that our remaining assets are either fully depreciated or previously impaired. We did not acquire any new assets during the year ended December 31, 2006.

 

Total Other Income (Expense), Net.  Interest expense decreased from approximately $3.5 million for the year ended December 31, 2005 to $2.6 million for the year ended December 31, 2006. This decrease was due primarily to the fact that the Toucan Capital and management loans were converted into equity in April 2006, offset by the fact that the average note payable balance was higher prior to conversion in 2006 as compared to the balances outstanding during the year ended December 31, 2005. Additionally, we recorded a warrant valuation gain of $7.1 million during 2006 with respect to the revaluation of the potential shares that could be issued in excess of the available authorized shares. We did not have a similar gain during 2005.

 

Warrant valuation.  In accordance with EITF 00-19, we account for potential shares that can be converted to common stock, that are in excess of authorized shares, as a liability that is recorded at fair value. Total potential outstanding common stock exceeded our authorized shares as of December 31, 2005 when we entered into another convertible promissory note and warrant agreement with Toucan Partners on December 30, 2005. The fair value of the warrants in excess of the authorized shares at December 31, 2005 totaling approximately $604,000 was recognized as a liability on December 31, 2005. This liability was required to be remeasured at each reporting date with any change in value included in other income/(expense) until such time as enough shares were authorized to cover all potentially convertible instruments. Accordingly, during the first quarter of 2006, we recognized a loss totaling $2.1 million with respect to the revaluation of this warrant liability. Further, during March 2006, we issued an additional warrant to Toucan Partners, along with a convertible promissory note. The fair value of the warrants in excess of the authorized shares was approximately $6.7 million and was recognized as an additional liability as of March 31, 2006. During April 2006, we sold common stock to outside investors in the Pipe Financing. In addition, members of management and Toucan Capital elected to convert their promissory notes and related accrued interest into common stock and Series A-1 Preferred Stock, respectively. As a result, the fair value of the potential common stock in excess of the authorized shares was $24.4 million and was recognized as an additional liability during April 2006.

 

Effective May 25, 2006, the number of authorized common shares was increased to 800 million. The liability for potential shares in excess of total authorized shares was revalued at that date. This valuation resulted in a gain of approximately $7.1 million during year ended December 31, 2006, due to the net decreases in the net fair value of

the related warrants on the date the authorized shares were increased. This gain is included in the statement of operations as a warrant valuation. As we exceeded our authorized shares on December 31, 2005, no corresponding charges to the statement of operations were recorded for the year ended December 31, 2005.

 

Year Ended December 31, 2004 Compared to the Year Ended December 31, 2005

 

Total Revenues.  Revenues decreased 68.2% from $390,000 for the year ended December 31, 2004 to $124,000 for the year ended December 31, 2005. The research material sales component of revenue decreased 27.0% from $52,000 for the year ended December 31, 2004 to $38,000 for the year ended December 31, 2005 as we ceased actively selling research materials effective December 31, 2005. Research grant and other income decreased 74.5% from $338,000 for the year ended December 31, 2004 to $86,000 for the year ended December 31, 2005. This decrease in grant revenue was attributable to the cessation of two research grant awards in the first quarter of 2005.

 

Cost of Research Material Sales.  Cost of research material sales decreased 70.0% from $40,000 for the year ended December 31, 2004 to $12,000 for the year ended December 31, 2005. This decrease was due to lower direct sales and related direct labor costs. We ceased actively selling research materials effective December 31, 2005.

 

Research and Development Expense.  Research and development expense increased 23.4% from $3.6 million for the year ended December 31, 2004 to $4.5 million for the year ended December 31, 2005. This increase was primarily due to increased expenditures for consultants in preparation of regulatory filings with the FDA and entering into a service agreement for drug manufacturing, regulatory advice, research and development related to preclinical activities.

 

General and Administrative Expense.  General and administrative expense decreased 29.5% from $2.8 million for the year ended December 31, 2004 to $2.0 million for the year ended December 31, 2005. This decrease was primarily due to the elimination of two positions in 2005 and continuing to focus on the October 9, 2002 directive from our Board of Directors to initiate immediate actions to conserve cash.

 

Depreciation and Amortization.  Depreciation and amortization decreased 52.2% from $132,000 for the year ended December 31, 2004 to $63,000 for the year ended December 31, 2005. This decrease was primarily due to our continued disposal of all equipment and facilities heretofore necessary for proof-of-principle research and development as we moved forward in focusing on our primary business strategy of recapitalizing the company in anticipation of re-initiating our two clinical trial vaccine prospects.

 

Asset Impairment Loss.  Asset disposal costs of $130,000 for the year ended December 31, 2004 primarily relates to the write-off of unused property and equipment associated with our vacating a 14,000 square foot laboratory and administrative space and entering a sublease for approximately 5,047 square feet of space in 2005 where such assets were not to be utilized.

 

Total Other Income (Expense), Net.  Interest expense increased 99.2% from $1.8 million for the year ended December 31, 2004 to $3.5 million for the year ended December 31, 2005. This increase was due primarily to recognizing interest expense relative to the debt discount and interest accretion associated with the November 13, 2003 secured convertible promissory note and warrant financing and the loans from Toucan Capital and Toucan Partners. Interest income increased from $3,000 for the year ended December 31, 2004 to $5,000 for the year ended December 31, 2005. This increase was primarily due to having comparable higher average cash balances during the year ended 2005.

 

Warrant valuation.  Our total committed outstanding obligations for shares of common stock exceeded our authorized shares on July 30, 2004, when an additional $2.0 million loan, convertible into common stock, was received from Toucan Capital and a warrant was issued. The fair value of the warrant in excess of the authorized shares was approximately $2.8 million and was recognized as a liability on July 30, 2004. This liability must be revalued at each reporting date with any change in valuation included in other income/(expense) until such time as enough shares are authorized to cover all potentially convertible instruments. Our stock price had declined from $0.04 at July 30, 2004 to $0.03 at September 30, 2004, resulting in a warrant valuation gain of approximately $717,000 recognized for the quarter ending September 30, 2004. Additional warrant liability of approximately $1.5 million was recognized for the respective fair market valuations of the additional loans, convertible into shares, received from Toucan Capital, with warrants, on October 22, November 10, and December 27, 2004, for the year

ended December 31, 2004. The aggregate shares by which we exceeded our authorized shares were required to be re-valuated when our stockholders approved an increase in our authorized shares, from 125 million to 300 million shares, which was recorded on December 29, 2004 with the Delaware Secretary of State. The approximate $1.0 million change in fair market valuation during the fourth quarter was recognized in other income as additional expense. The aggregate warrant liability of approximately $4.7 million was reclassified to equity upon approval of the additional authorized shares on December 29, 2004. As of December 31, 2005 our total committed outstanding obligations for shares of common stock exceeded our authorized shares. We have recognized a liability totalling $604,000 representing the fair value of our obligations for shares of common stock in excess of our authorized shares. As we exceeded our authorized shares on December 31, 2005, no corresponding charges to the statement of operations were recorded for the year ended December 31, 2005.

 

Liquidity and Capital Resources

 

General Discussion

 

Since 2004, we have undergone a significant recapitalization pursuant to which Toucan Capital has loaned us an aggregate of $6.75 million and Toucan Partners has loaned us an aggregate of $4.0 million, including $3.05 million of contingently convertible promissory notes. On January 26, 2005, we entered into a securities purchase agreement with Toucan Capital pursuant to which they purchased 32.5 million shares of the our Series A Preferred Stock at a purchase price of $0.04 per share, for a net purchase price of $1.267 million, net of offering related costs of approximately $24,000. In April 2006, $6.75 million of the notes payable plus all accrued interest due to Toucan Capital were converted into shares of our Series A-1 Preferred Stock.

 

The $3.05 million in cash advances received from Toucan Partners from October 2006 through April 2007, which were converted into the 2007 Convertible Notes and 2007 Warrants in April 2007, have enabled us to continue to operate and advance programs, while attempting to raise additional capital. Although these notes are convertible, the conversion terms will not be fixed until a future date at Toucan Partners’ election. The outstanding principal and accrued interest under the 2007 Convertible Notes may be converted (in whole or in part) on conversion terms equal to the terms of any convertible debt financing from an unaffiliated investor in an aggregate principal amount of at least $150,000 on or before May 15, 2007 (a “Qualified Debt Financing”). In the event that a Qualified Debt Financing does not occur, or Toucan Partners elects in its sole discretion to not convert on such terms, the conversion terms shall be subject to further negotiation between us and Toucan Partners.

 

On March 30, 2006, we entered into the PIPE Financing with unrelated investors pursuant to which we raised aggregate gross proceeds of approximately $5.5 million.

 

As of March 5, 2007, we had less than $100,000 in cash. We are considered illiquid as this cash is not considered sufficient to fund the recurring operating and associated financing costs for the next month. Approximately $5.7 million of our $6.5 million current liabilities at December 31, 2006 were payable to related parties, including the manufacturing costs associated with producing our DCvax^® product candidates. The payable balance is reported net of the remaining debt discount. We pay approximately $250,000 of the related party liabilities balance per month related to manufacturing of our DCvax^® product candidates. Further, during the last quarter of 2006, we commenced a clinical trial which has increased our current cash needs.

 

We need to raise significant additional funding to continue our operations, conduct research and development activities, pre-clinical studies and clinical trials necessary to bring our product candidates to market. However, additional funding may not be available on terms acceptable to us or at all. The alternative of issuing additional equity or convertible debt securities also may not be available and, in any event, would result in additional dilution to our stockholders. For ongoing operating capital we intend to seek additional funds from Toucan Capital, Toucan Partners, or other third parties. Neither Toucan Capital, Toucan Partners, or any other third parties is obligated to provide us any additional funds. Any additional financing with Toucan Capital, Toucan Partners or any other third party is likely to be dilutive to stockholders, and any debt financing, if available, may include additional restrictive covenants. We do not believe that our assets would be sufficient to satisfy the claims of all of its creditors in full and to satisfy aggregate liquidation preferences of our preferred stock in full. Therefore, if we were to pursue a liquidation, it is highly unlikely that any proceeds would be received by the holders of our common stock. If we are unable to obtain significant additional capital in the near-term, we may cease operations at anytime.

 

There can be no assurance that our efforts to seek funding will be successful. If our capital raising efforts are unsuccessful, our inability to obtain additional cash as needed could have a material adverse effect on our financial position, results of operations and our ability to continue our existence. Our independent auditors have indicated in their report on the financial statements, included in the December 31, 2006 annual report on Form 10-K, that there is substantial doubt about our ability to continue as a going concern.

 

Contingency

 

In February 2004, we filed a refund request of approximately $175,000 related to certain other state taxes previously paid to the State of Washington’s Department of Revenue. As of December 31, 2006, we received correspondence from the Washington State Department of Revenue setting forth a refund of approximately $36,000. We do not plan to pursue this matter any further.

 

Sources of Cash

 

We generated $6.9 million in cash from financing activities for the year ended December 31, 2006 primarily from the loans from Toucan Capital and the sale of 39 million shares of our common stock to a group of accredited investors pursuant to our PIPE financing. We generated $4.2 million in cash from financing activities during the year ended December 31, 2005 consisting of (i) the January 26, 2005 sale of our newly designated series A preferred stock to Toucan Capital at a purchase price of $0.04 per share, for a net purchase price of $1.276 million, net of issue related costs of approximately $24,000, (ii) loans in the aggregate amount of $2.4 million from Toucan Capital, and (iii) loans in the aggregate amount of $650,000 from Toucan Partners.

 

Federal Grants

 

On April 8, 2003, we were awarded an NIH cancer research grant. The total first year grant award was approximately $318,000, was earned under the grant, and was recognized in revenue through the year ended December 31, 2003. The total award for fiscal 2004-2005 was approximately $328,000, comprised of approximately $198,000 authorized for direct grant research expenditures and approximately $130,000 authorized for use to cover our facilities and administrative overhead costs. This grant’s remaining $35,000 award was recognized in January 2005. This grant ended January 31, 2005.

 

Effective September 10, 2004, we were awarded a small business innovation research grant. The grant award for $100,000 had an award period that commenced September 10, 2004. Approximately $59,000 was earned under the grant and recognized in revenue through the year ended December 31, 2004. The remaining $41,000 of the grant’s aggregate award was recognized through the grant end date of September 9, 2005.

 

Research Reagent Sales

 

On April 21, 2003, we announced our entry into the research reagents market. We earned approximately $38,000 in revenue for the year ended December 31, 2005 from the manufacture and sale of research materials. We ceased actively selling research materials on December 31, 2005.

 

License Fees

 

Our effort to license certain rights, title, and interest to technology relating to the worldwide use of specific antibodies for the diagnostic immunohistochemical market resulted in the July 1, 2003 license agreement with DakoCytomation California, Inc. with the payment of a one-time $25,000 license fee and future non-refundable minimum annual royalty payments of $10,000 credited against any royalty payments made to us. The $10,000 July 2005 and 2006 annual royalty payment was recognized as revenue in both August 2005 and 2006 while a $585 royalty payment on certain product sales was recognized as revenue on July 25, 2005. During 2006 we also sold certain license rights for a one-time fee of $70,000.

 

Management Loans

 

On November 13, 2003, we borrowed an aggregate of $335,000 from certain members of our current and former management. As of December 31, 2006, these notes have either been repaid or converted into common stock.

 

Toucan Capital Loans

 

From February 2, 2004 through December 31, 2005, we issued thirteen promissory notes to Toucan Capital, pursuant to which Toucan Capital loaned us an aggregate of $6.75 million. As discussed above, Toucan Capital converted all of these promissory notes, including accrued interest, into shares of our Series A-1 Preferred Stock in April 2006.

 

Toucan Capital Series A Cumulative Convertible Preferred Stock

 

On January 26, 2005, Toucan Capital purchased 32.5 million shares of our newly designated series A preferred stock at a purchase price of $0.04 per share, for an purchase price of $1.276 million, net of issuance related costs of approximately $24,000.

 

Toucan Partners Loans

 

From November 14, 2005 through March 9, 2006, we issued three promissory notes to Toucan Partners, LLC, an affiliate of Toucan Capital, pursuant to which Toucan Partners has loaned us an aggregate of $950,000. In April 2007, these notes were amended and restated to conform to the 2007 Convertible Notes and 2007 Warrants. Payment is due under the notes upon written demand on or after June 30, 2007. Interest accrues at 10% per annum, compounded annually, on a 365-day year basis. The principal amount of, and accrued interest on, these notes, as amended, is convertible at Toucan Partners’ election into common stock or Preferred Stock on the same terms as the 2007 Convertible Notes described below.

 

We also borrowed an aggregate of $3.05 million from Toucan Partners from October 2006 to April 2007 pursuant to a series of promissory notes. The notes mature on June 30, 2007. Interest accrues on these notes at a rate of 10% per annum, based on a 365-day basis compounded annually from the respective original cash advance dates. The principal amount of, and accrued interest on, these notes is convertible at Toucan Partners’ election into any of our equity securities. The conversion terms will not be fixed until a future date at Toucan Partners’ election. The outstanding principal and accrued interest under the 2007 Convertible Notes may be converted (in whole or in part) on conversion terms equal to the terms of any convertible debt financing from an unaffiliated investor in an aggregate principal amount of at least $150,000 on or before May 15, 2007 (a “Qualified Debt Financing”). In the event that a Qualified Debt Financing does not occur, or Toucan Partners elects in its sole discretion to not convert on such terms, the conversion terms shall by subject to further negotiation between us and Toucan Partners.

 

PIPE Financing

 

On March 30, 2006, we entered into a securities purchase agreement (the “Purchase Agreement”) with a group of accredited investors pursuant to which we sold an aggregate of 39,467,891 shares of our common stock, at a price of $0.14 per share, and issued for no additional consideration, warrants to purchase up to an aggregate of 19,733,945 shares of our common stock. The transaction closed on April 4, 2006 and we received gross proceeds of $5,525,505, before offering expenses. These shares were registered for resale during the year ended December 31, 2006.

 

The warrants expire five years after issuance, and are initially exercisable at a price of $0.14 per share, subject to adjustments under certain circumstances including certain issuances or deemed issuances of shares below $0.14 per share.

 

Other

 

We generated $50,000 in cash from investing activities for the year ended December 31, 2005 compared to $17,000 during the year ended December 31, 2006. The cash provided during both 2005 and 2006 is primarily due to the sale of equipment and supplies.

 

Uses of Cash

 

We used $4.2 million in cash for operating activities during the year ended December 31, 2005, compared to $6.9 million for the year ended December 31, 2006. The increase of approximately 65.7% reflects the increased level of expenditures and business activity associated with identifying future clinical trial sites, research and development expenditures related to preclinical activities, and gradual re-implementation of the contract manufacturing process for our two DCVax^® clinical trial vaccines.

 

Overview of Contractual Obligations

 

On November 4, 2005, we entered into a lease agreement with The International Union of Operating Engineers Local 302 for 2,325 square feet of administrative space in a building located in Bothell, Washington. The initial lease is for a term of 12 months commencing January 1, 2006 and terminating December 31, 2006. This lease has been extended through June 30, 2007.

 

The following table reflects our significant contractual obligations as of December 31, 2006:

 

 

 

 

Recent Accounting Pronouncements

 

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, Accounting for Income Taxes, which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that we recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective beginning January 1, 2007 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the possible impact of FIN 48 on our financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements but does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are evaluating the possible impact of SFAS 157 on the financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, (“SFAS 158”). SFAS 158 requires an

employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for employers with publicly traded equity securities for fiscal years ending after December 15, 2006. We did not experience a material impact from applying SFAS 158.

 

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”). Due to diversity in practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. We do not expect any material impact from applying SAB 108.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We have not yet determined the impact of adopting SFAS 159 on our financial position.

 

Our exposure to market risk is presently limited to the interest rate sensitivity of our cash which is affected by changes in the general level of U.S. interest rates. We are exposed to interest rate changes primarily as a result of our investment activities. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive without significantly increasing risk. To minimize risk, we maintain our cash in interest-bearing instruments, primarily money market funds. Due to the short-term nature of our cash, we believe that our exposure to market interest rate fluctuations is minimal. A hypothetical 10% change in short-term interest rates from those in effect at December 31, 2006 would not have a significant impact on our financial position or our expected results of operations. Our interest rate risk management objective with respect to our borrowings is to limit the impact of interest rate changes on earnings and cash flows. Except for our loans from management, our debt is carried at a fixed 10% rate of interest. We do not have any foreign currency or other derivative financial instruments.

 

Financial Statements

 

Our financial statements required by this item are submitted as a separate section of this Annual Report on Form 10-K. See Item 15(a)(1) for a listing of financial statements provided in the section titled “Financial Statements.”

 

Not applicable.

 

(a) Evaluation of disclosure controls, procedures, and internal controls

 

Our President, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), has concluded that, as of December 31, 2006 our disclosure controls and procedures contained significant internal control weaknesses that, in the aggregate, represent material weaknesses.

 

Material Weakness Identified

 

In connection with the preparation of our financial statements for the year ended December 31, 2006, certain significant internal control deficiencies became evident to management that, in the aggregate, represent material weaknesses, including,

 

(i) lack of independent directors for our audit committee;

 

(ii) lack of an audit committee financial expert;

 

(iii) insufficient personnel in our finance/accounting functions;

 

(iv) insufficient segregation of duties; and

 

(v) insufficient corporate governance policies.

 

As part of the communications by Peterson Sullivan, PLLC, or Peterson Sullivan, with our audit committee with respect to Peterson Sullivan’s audit procedures for fiscal 2006, Peterson Sullivan informed the audit committee that these deficiencies constituted material weaknesses, as defined by Auditing Standard No. 2, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements,” established by the Public Company Accounting Oversight Board, or PCAOB.

 

In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, we intend to take appropriate and reasonable steps to make the necessary improvements to remediate these deficiencies. We intend to consider the results of our remediation efforts and related testing as part of our year-end 2006 assessment of the effectiveness of our internal control over financial reporting. On March 1, 2007, we hired a part-time chief financial officer.

 

On April 14, 2007, a series of cash advances from Toucan Partners, in an aggregate principal amount of $3.05 million, received from October 2006 through April 2007, were converted into a new series of convertible promissory notes and associated warrants (collectively the “2007 Convertible Notes” and “2007 Warrants”). The 2007 Convertible Notes accrue interest at 10% per annum from their respective original cash advance dates. Although these notes are convertible, the conversion terms will not be fixed until a future date at Toucan Partners’ election. The outstanding principal and accrued interest under the 2007 Convertible Notes may be converted (in whole or in part) on conversion terms equal to the terms of any convertible debt financing from an unaffiliated investor in an aggregate principal amount of at least $150,000 on or before May 15, 2007 (a “Qualified Debt Financing”). In the event that a Qualified Debt Financing does not occur, or Toucan Partners elects in its sole discretion to not convert on such terms, the conversion terms shall be subject to further negotiation between Toucan Partners and the Company. These notes carry warrant coverage of 100%. The number of warrant shares issuable upon exercise of each 2007 Warrant will be equal to the number of shares that would be issuable if Toucan Partners elected to convert the principal and accrued interest on the corresponding 2007 Convertible Notes determined as of the date of repayment or conversion of such 2007 Convertible Notes. The exercise price of each 2007 warrant will be equal to the conversion price of the corresponding 2007 Convertible Note. Accordingly, both the number of shares issuable upon exercise of the warrants and the exercise price of the 2007 Warrants are currently unknown.

 

In addition, the convertible promissory notes and associated warrants issued to Toucan Partners in aggregate principal amount of $950,000 from November 2005 through April 2006 were amended and restated effective April 14, 2007. The terms of the amended and restated convertible promissory notes and associated warrants are similar to the terms of the 2007 Convertible Notes and 2007 Warrants. These notes accrue interest at 10% per annum from the respective original issuance dates of the notes.

 

Pursuant to the agreements entered into with Toucan Partners on April 14, 2007, as described above, the Company has issued twelve convertible promissory notes to Toucan Partners whereby Toucan Partners has loaned the Company an aggregate of $4.0 million. The twelve convertible promissory notes mature on June 30, 2007.

 

We will file a definitive Information Statement relating to the election of directors and other matters in lieu of an annual meeting of stockholders, or the 2007 Information Statement, with the SEC, pursuant to Regulation 14C, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of the 2007 Information Statement that specifically address the items set forth herein are incorporated by reference.

 

The information required by Item 10 is hereby incorporated by reference from our 2007 Information Statement under the captions “Election of Directors,” “Certain Additional Information about our Management,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Code of Ethics.”

 

The information required by Item 11 is hereby incorporated by reference from our 2007 Information Statement under the caption “Compensation Discussion and Analysis” and “Compensation of Directors and Executive Officers.”

 

The information required by Item 12 is hereby incorporated by reference from our 2007 Information Statement under the caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

 

The information required by Item 13 is hereby incorporated by reference from our 2007 Information Statement under the caption “Certain Relationships and Related Transactions.”

 

The information required by Item 14 is hereby incorporated by reference from our 2007 Information Statement under the caption “Independent Auditor Firm Fees.”

 

(a)(1) Index to Financial Statements and Independent Auditors Report.

 

The financial statements required by this item are submitted in a separate section as indicated below.

 

 

(2) Index to Financial Statement Schedules

 

All financial statement schedules are omitted since the required information is not applicable, not required or the required information is included in the financial statements or notes thereto.

 

(3) Exhibits

 

See Exhibit Index on page 77.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

Northwest Biotherapeutics, Inc.

Bothell, Washington

 

We have audited the accompanying balance sheets of Northwest Biotherapeutics, Inc. (a development stage company) as of December 31, 2006 and 2005, and the related statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2006, and for the period from March 18, 1996 (date of inception) to December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The Company’s financial statements for the period from March 18, 1996 (date of inception) through December 31, 2003, were audited by other auditors whose report, dated March 12, 2004, except as to Notes 1 and 12, which were as of April 26, 2004, expressed an unqualified opinion on those statements and included an explanatory paragraph that referred to substantial doubt about the Company’s ability to continue as a going concern. The financial statements for the period from March 18, 1996 (date of inception) through December 31, 2003, reflect a net loss of $64,242 (in thousands) of the accumulated deficit as of December 31, 2006. The other auditors’ report has been furnished to us, and our opinion, insofar as it relates to the amounts included for such prior periods, is based solely on the report of such other auditors.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Northwest Biotherapeutics, Inc. (a development stage company) as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006, and for the period from March 18, 1996 (date of inception) to December 31, 2006, in conformity with accounting principles generally accepted in the United States.

 

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has experienced recurring losses from operations since inception, has a working capital deficit, and has a deficit accumulated during the development stage. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

 

March 27, 2007

Seattle, Washington

NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

 

BALANCE SHEETS

 

 

See accompanying notes to financial statements.

NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

 

STATEMENTS OF OPERATIONS

 

 

See accompanying notes to financial statements.

NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

 

STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVE LOSS