NORTHWEST BIOTHERAPEUTICS INC - Quarter Report: 2006 September (Form 10-Q)

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NORTHWEST BIOTHERAPEUTICS, INC.

TABLE OF CONTENTS

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NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

Condensed Balance Sheets
(in thousands)

See accompanying notes to condensed financial statements.

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NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

Condensed Statements of Operations
(in thousands, except per share data)
(Unaudited)

See accompanying notes to condensed financial statements.

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Northwest Biotherapeutics, Inc.
(A Development Stage Company)

Condensed Statements of Cash Flows
(in thousands)
(Unaudited)

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See accompanying notes to condensed financial statements.

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Northwest Biotherapeutics, Inc.
(A Development Stage Company)

Notes to Condensed Financial Statements
(unaudited)

1. Basis of Presentation

The accompanying condensed financial statements are unaudited and include the accounts of Northwest Biotherapeutics, Inc. (the “Company”). The accompanying unaudited condensed financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). All normal recurring adjustments which are necessary for the fair presentation of the results for the interim periods are reflected herein. Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of results to be expected for a full year.

The auditor’s report on the financial statements for the fiscal year ended December 31, 2005 states that because of recurring operating losses, a working capital deficit, and a deficit accumulated during the development stage, there is substantial doubt about the Company’s ability to continue as a going concern. A “going concern” opinion indicates that the financial statements have been prepared assuming the Company 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. See further discussion with respect to liquidity in Note 4.

2. Summary of significant accounting policies

The significant accounting policies used in the preparation of the Company’s condensed financial statements are disclosed in the Annual Report on Form 10-K for the year ended December 31, 2005. Significant accounting policies that are new or were changed in fiscal 2006 are disclosed below.

Share-based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment.” SFAS No. 123(R) requires the measurement and recognition of compensation for all stock-based awards including stock options and employee stock purchases under a stock purchase plan, based on estimated fair values. SFAS No. 123(R) supersedes previous accounting under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and SFAS 123, “Accounting for Stock-Based Compensation” for periods beginning January 1, 2006.

The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. In accordance with the modified prospective transition method, the Company’s condensed financial statements for periods prior to the first quarter of 2006 have not been restated to reflect this change. Stock-based compensation recognized during the period is based on the value of the portion of the stock-based award that will vest during the period, adjusted for expected forfeitures. Stock-based compensation recognized in the Company’s condensed financial statements for the three and nine months ended September 30, 2006 includes compensation cost for stock-based awards granted prior to, but not fully vested as of December 31, 2005 and stock-based awards granted subsequent to December 31, 2005, as applicable.

3. Share-Based Compensation Plans

Effective January 1, 2006, the Company adopted SFAS No. 123(R), which establishes accounting for stock-based awards exchanged for goods or services, using the modified prospective transition method. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, recognized over the requisite service period. Previously, the Company applied APB Opinion No. 25 and related interpretations, as permitted by SFAS No. 123.

For options and warrants issued to non-employees, the Company recognizes stock compensation costs utilizing the fair value methodology prescribed in SFAS No. 123(R) over the related period of benefit.

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Determining Fair Value Under SFAS No. 123(R)

Valuation and Amortization Method. The Company estimates the fair value of stock-based awards granted using the Black-Scholes option valuation model. The Company amortizes the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods.

Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures.

Expected Volatility. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of its common stock. The volatility factor used in the Black-Scholes option valuation model is based on the Company’s historical stock prices over the most recent period commensurate with the estimated expected life of the award.

Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award.

Expected Dividend Yield. The Company has never paid any cash dividends on common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeitures. The Company uses historical data to estimate pre-vesting option forfeitures. The Company records stock-based compensation only for those awards that are expected to vest.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. There were no shares purchased under the Company’s employee stock purchase plan during the three and nine months ended September 30, 2006 and 2005.

The stock-based compensation expense recognized in those condensed financial statements related to stock-based awards under SFAS No. 123(R) totaled approximately $400 and $2,100 for the three and nine months ended September 30, 2006, respectively. At September 30, 2006 the Company had non-vested stock options covering approximately 43,500 shares of common stock that had a weighted average grant date fair value of $0.12. As of September 30, 2006, the Company had approximately $2,000 of total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans. Total unrecognized compensation cost will be adjusted for any future changes in estimated forfeitures. The Company expects to recognize this cost over the next two years.

Pro Forma Information Under SFAS No. 123 and APB Opinion No. 25

Prior to January 1, 2006, stock-based compensation plans were accounted for using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. No stock-based compensation was reflected in net loss in the three and nine months ended September 30, 2005, as all stock options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. Had compensation cost for the plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, net loss and basic and diluted net loss per share would have been changed to the pro forma amounts indicated below (in thousands, except for per share data):

There were no stock options granted during the three or nine month periods ended September 30, 2006.

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4. Liquidity

Since 2004, the Company has undergone a significant recapitalization pursuant to which Toucan Capital Fund II, L.P. (“Toucan Capital”), has loaned it $6.75 million and Toucan Partners, LLC, an affiliate of Toucan Capital (“Toucan Partners”), has loaned the Company $950,000. On January 26, 2005, the Company entered into a securities purchase agreement with Toucan Capital pursuant to which they purchased 32.5 million shares of the Company’s 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 Series A-1 Preferred Stock.

On October 30, 2006, the Company received a cash advance in the amount of $500,000 from Toucan Partners. The Company and Toucan Partners are presently negotiating the terms pursuant to which this cash advance will be required to be repaid. These funds enabled the Company to continue to operate and advance programs, while attempting to raise additional capital.

On March 30, 2006, the Company entered into an equity financing (“PIPE Financing”) with unrelated investors pursuant to which aggregate gross proceeds of approximately $5.5 million was raised.

As of November 6, 2006, the Company had cash in the amount of $613,000. The Company is considered illiquid as this cash is not considered sufficient to fund the recurring operating and associated financing costs for the next month. Approximately $3.9 million of the Company’s current liabilities at September 30, 2006 were payable to related parties, net of the related debt discount. During October 2006, the Company paid $250,000 of the remaining current related party liabilities recorded as of September 30, 2006. In addition to the recurring operating costs, the Company has two remaining payments due to the Washington State Department of Revenue totaling approximately $168,000 as of November 6, 2006. The final payment is due in mid-December 2006. See Note 9 for further discussion.

The Company needs to raise significant additional funding to continue its operations, conduct research and development activities, pre-clinical studies and clinical trials necessary to bring its product candidates to market. However, additional funding may not be available on terms acceptable to the Company 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 the Company’s stockholders. For ongoing operating capital the Company intends 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 the Company 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. The Company does not believe that its 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 the Company were to pursue a liquidation, it is highly unlikely that any proceeds would be received by the holders of the Company’s common stock. If the Company is unable to obtain significant additional capital in the near-term, it may cease operations at anytime.

There can be no assurance that the Company’s efforts to seek funding will be successful. If the Company’s capital raising efforts are unsuccessful, the Company’s inability to obtain additional cash as needed could have a material adverse effect on its financial position, results of operations and its ability to continue its existence. The Company’s independent auditors have indicated in their report on the financial statements, included in the December 31, 2005 annual report on Form 10-K, that there is substantial doubt about the Company’s ability to continue as a going concern.

5. Net Income (Loss) Per Share Applicable to Common Stockholders

For the nine months ended September 30, 2006, options to purchase 286,000 shares of common stock and warrants to purchase 569,000 shares of common stock were not included in the computation of diluted net income (loss) per share because they were anti-dilutive. For the nine months ended September 30, 2006, options to purchase 278,000 shares of common stock and warrants to purchase 166 million shares of common stock were included in the computation of diluted net income (loss) per share because they were dilutive. Convertible debt having a face value of $950,000 is also considered to be dilutive for purposes of computing diluted net income (loss) per share. The conversion of the convertible debt increases the number of shares outstanding for purposes of computing diluted net income (loss) per share by 25,529,000 shares for the nine month period ended September 30, 2006. Preferred stock, Series A and A-1, which is convertible into 225,175,000 shares of common stock is also considered to be dilutive for purposes of computing diluted net income per share for the nine months ended September 30, 2006, and is included in such computation. In determining the amount of net income used to compute diluted earnings per share, the Company applied the “if converted method”. Accordingly, net income for the nine months ended September 30, 2006, has been increased by approximately $65,000, representing interest expense that would have been avoided if the debt had been converted as of January 1, 2006. Additionally, net income for nine months ended September 30, 2006, has been decreased by approximately $243,000 representing the expense for the unamortized discount of the beneficial conversion feature as of January 1, 2006. Options, warrants, convertible debt and convertible preferred stock outstanding were all considered anti-dilutive for the three and nine months ended September 30, 2005, and for the three-months ended September 30, 2006, due to net losses.

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6. Notes Payable

Management Loans

On November 13, 2003, the Company borrowed an aggregate of $335,000 from certain members of its management which enabled the Company to continue operating into the first quarter of 2004. On April 17, 2006, the outstanding principal balance on the remaining notes, and the related accrued interest, were converted into 2,687,719 shares of common stock. Accordingly, as of September 30, 2006 all of these loans have either been repaid or converted into common stock.

As part of the November 13, 2003 loan from management, the lenders received warrants initially exercisable to acquire an aggregate of 3.7 million shares of the Company’s common stock. These warrants were set to expire in November 2008 and were subject to certain anti-dilution adjustments. In connection with the April 26, 2004 recapitalization agreement, the warrants were amended to remove the anti-dilution provisions and set the warrant exercise price at the lesser of (i) $0.10 per share or (ii) a 35% discount to the average closing price during the twenty trading days prior to the first closing of the sale by the Company of convertible preferred stock as contemplated by the recapitalization agreement but not less than $0.04 per share.

During March 2006, warrants for the purchase of 3.6 million shares of common stock were exercised on a net exercise basis resulting in the issuance of approximately 3.3 million shares of common stock. The remaining 100,000 management warrants were exercised during the second quarter of 2006. As a result, an aggregate of 3.4 million shares of common stock were issued to current and prior members of management.

Two former members of the Company’s management, who had participated as lenders in the Company’s 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 the Company’s common stock due to the alleged triggering of an anti-dilution provision in the warrant agreements. The Company does not believe that these claims have merit, and intends to vigorously oppose such claims.

Toucan Capital Loans

From February 2004 through March 2006, the Company entered into multiple agreements with Toucan Capital and Toucan Partners, all of which relate to and were intended by the parties to implement the terms and conditions of the recapitalization agreement originally entered into on April 26, 2004 with Toucan Capital. The recapitalization agreement, as amended, 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.

The Company and Toucan Capital amended the recapitalization agreement in conjunction with each successive loan agreement. The amendments (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.

Pursuant to the recapitalization agreement, as amended, the Company borrowed an aggregate of $6.75 million from Toucan Capital, from February 2, 2004 through September 7, 2005. In connection with the loans from Toucan Capital, the Company issued warrants to purchase 122.5 million aggregate shares of capital stock. These warrants provide Toucan Capital the ability to purchase 66 million and 56.5 million aggregate shares of capital stock at an exercise price of $0.01 per share and $0.04 per share, respectively. The warrant exercise period is seven years from the issuance date of the warrant and the related convertible notes.

On April 17, 2006, Toucan Capital elected to convert all of its convertible promissory notes and the related accrued interest into approximately 4.8 million shares of the Company’s Series A-1 Preferred Stock. The Series A-1 Preferred Stock is substantially identical to the Company’s Series A Preferred Stock, except that (i) the issuance price and liquidation preference of the Series A-1 Preferred Stock are each $1.60 per share (as opposed to $0.04 per share for the Series A Preferred Stock), and (ii) each share of Series A-1 Preferred Stock is convertible into 40 shares of Common Stock (as opposed to one share of common stock in the case of the Series A Preferred Stock). The foregoing differences result in the Series A-1 Preferred Stock being economically equivalent to the Series A Preferred Stock.

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In conjunction with the conversion of Toucan Capital’s notes into Series A-1 Preferred Stock, on April 17, 2006, the Company entered into an Amended and Restated Investor Rights Agreement (the “IRA”) with Toucan Capital. The IRA implements the provisions of the binding term sheet the Company executed on April 26, 2004, under which Toucan Capital and other investors, such as Toucan Partners, who are holders of Series A or Series A-1 Preferred Stock receive registration rights in respect of the shares of common stock issuable upon conversion of the Series A Preferred Stock and Series A-1 Preferred Stock held by such investors, as well as the shares of common stock underlying the warrants held by such investors.

Toucan Partners Loans

The Company borrowed $950,000 from Toucan Partners, an affiliate of Toucan Capital, from November 14, 2005 to March 9, 2006, comprised of the loans listed below. The conversion shares are based upon the outstanding principal and accrued interest as of September 30, 2006:

Proceeds from the issuance of $950,000 senior convertible promissory notes and warrants between November 14, 2005 and March 9, 2006 were allocated between the notes and warrants on a relative fair value basis. The value allocated to the warrants on the date of the grant was approximately $587,000. The fair value of the warrants was determined using the Black-Scholes option pricing model with the following assumptions: expected dividend yield of 0%, risk-free interest rate ranging from 4.1% to 4.4%, volatility ranging between 398% and 408%, and a contractual life of 7 years. The value of the warrants was recorded as a deferred debt discount against the $950,000 proceeds of the notes. In addition, a beneficial conversion feature related to the notes was determined to be approximately $363,000. As a result, the total discount on the notes equaled $950,000 which is being amortized over the twelve-month term of the respective notes. Amortization of deferred debt discount of approximately $239,000 and $655,000 was recorded for the three and nine months ended September 30, 2006, respectively. Interest accretion on the notes of approximately $24,200 and $65,900 was recorded for the three and nine months ended September 30, 2006, respectively.

On October 30, 2006, the Company received a cash advance in the amount of $500,000 from Toucan Partners. The Company and Toucan Partners are presently negotiating the terms pursuant to which this cash advance will be required to be repaid.

7. Liability for Potentially Dilutive Securities in Excess of Authorized Number of Common Shares

In accordance with EITF 00-19, the Company accounts 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 the Company’s authorized shares as of December 31, 2005 when the Company 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

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December 31, 2005 totaling approximately $604,000 was recognized as a liability on December 31, 2005. This liability was required to be evaluated 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, the Company recognized a loss totaling $2.1 million with respect to the revaluation of this warrant liability. Further, during March 2006, the Company 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, the Company 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 zero and $7.1 million during the three and nine month period ended September 30, 2006, respectively, 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.

Similarly, total potential outstanding common stock exceeded the Company’s authorized shares on July 30, 2004 when an additional $2.0 million loan, convertible into common stock, was received from Toucan Capital and an additional warrant was issued. The fair value of the warrant shares in excess of the authorized shares was approximately $2.8 million and was recognized as a liability on July 30, 2004. During the fourth quarter of 2004, the Company received three additional loans from Toucan Capital, convertible into shares of common stock totaling $1.25 million and additional warrants were issued with each loan. The total fair value of the warrant shares in excess of the authorized shares was approximately $1.5 million and was recognized as a liability at the dates of issuance of the convertible debt and warrants. This liability was evaluated at each reporting date and any changes in value were included in other income/(expense) until enough shares were authorized to cover all potentially convertible instruments. Effective December 29, 2004, the number of authorized common shares was increased to 300 million. The liability for potential shares in excess of total authorized shares was revalued at that date. This valuation resulted in a fourth quarter loss of approximately $1.0 million, due to net increases in the net fair value of the related warrants at that date. This loss was offset against the September 30, 2004 gain of approximately $717,000 for a net loss as of December 31, 2004 of approximately $368,000, included in the fiscal 2004 statement of operations as a warrant valuation.

8. Private Placement

On March 30, 2006, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with a group of accredited investors pursuant to which the Company agreed to sell an aggregate of approximately 39.5 million shares of its common stock, at a price of $0.14 per share, and to issue, for no additional consideration, warrants to purchase up to an aggregate of approximately 19.7 million shares of the Company’s common stock. The PIPE Financing closed and stock was issued to the new investors in early April and the Company received gross proceeds of approximately $5.5 million, before offering expenses of approximately $442,000.

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.

Under the Purchase Agreement, the Company agreed to register for resale under the Securities Act of 1933, as amended (the “Securities Act”) both the shares of common stock and the shares of common stock underlying the warrants. Under the terms of the Purchase Agreement, the Company was required to file a registration statement with the Securities and Exchange Commission (“SEC”) within 45 days of the transaction closing date. The Company also agreed to other customary obligations regarding registration, including matters relating to indemnification, maintenance of the registration statement, payment of expenses, and compliance with state “blue sky” laws. The registration statement was filed on May 19, 2006 and amendments to the registration statement were filed on July 17 and September 29, 2006. The registration statement was declared effective by the SEC on October 11, 2006. Because the registration statement was not declared effective by the SEC on or prior to September 1, 2006, the Company paid liquidated damages to the investors, in the aggregate of one percent (1%) of the aggregate purchase price of the shares per month, or $74,000. As of September 30, 2006, we expensed approximately $55,000 of these liquidated damages and they are recorded in accrued expenses.

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9. Contingencies

The Company signed an engagement letter, dated October 15, 2003, with Soma Partners, LLC (“Soma”), a New Jersey-based investment bank, pursuant to which the Company 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 the Company 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 the Company with Toucan Capital. The Company vigorously disputed Soma’s claims on multiple grounds, contending the Company 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 the Company 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 Company strongly disputed Soma’s claims and defended itself.

The arbitration proceedings occurred from March 8-10, 2005 and on May 24, 2005, the arbitrator ruled in favor of the Company and denied all claims of Soma. In particular, the arbitrator decided that the Company did not owe Soma the large fees and warrants sought by Soma, that the Company would not owe Soma fees in connection with future financings, if any, and that the Company had no obligation to pay any of Soma’s attorneys’ fees or expenses. The arbitrator agreed with the Company that the only amount owed Soma was $6,702.87, which payment was 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 in the Company’s favor.

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

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. The Company believes that this latest appeal is without merit and intends to vigorously defend the appeal.

Two former members of the Company’s management, who participated as lenders in the Company’s 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. The Company does not believe that these claims have merit, and intends to vigorously oppose such claims.

The Company has no other legal proceeding pending at this time.

Sales Tax Assessment

The Company received a tax assessment of $492,000 on October 21, 2003 related to the abandonment of tenant improvements at a facility it had previously leased on which use tax payments to the State of Washington had been deferred, including the disposal and impairment of previously qualified tax deferred equipment. The Company appealed this assessment and was granted a partial reduction in the assessment on July 8, 2005. The Company filed an addendum to its appeal petition on December 2, 2005. The net assessment, through December 31, 2005, of approximately $336,000, inclusive of accrued interest, was being carried as an estimated liability on the Company’s balance sheet and included in general and administrative expense. On August 10, 2006 the Company’s appeal was denied. In September 2006, the Company entered into an agreement with the State of Washington to pay an aggregate of approximately $336,000, plus interest at a rate of 4% per year over a four month period commencing on September 11, 2006. As of September 30, 2006, the Company still owes the State of Washington approximately $254,000. This balance is recorded in accrued expense, tax liability on the balance sheet.

In February 2004, the Company 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. The finalization of this refund request is expected in late 2006. The Company may not be successful in its efforts to receive a tax refund.

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10. Commitments

On February 14, 2006, the Company and The Regents of the University of California entered into a clinical study for the University of California at Los Angeles (“UCLA”) to carry out a booster vaccination immunotherapy program. During the study, patients will receive up to five boosters over a 12 month period. The Company will pay approximately $216,000 over the course of the study. Approximately $68,000 has been paid as of September 30, 2006. The Company will incur no other costs in connection with this study, unless prior approval by the parties is made in writing.

11. 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 the Company 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 consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS 157”). FAS 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. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is evaluating the possible impact of FAS 157 on the financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those statements included with this report. 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 (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are subject to certain risks and uncertainties that could cause 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 some forward-looking statements are expressed differently. Many factors could affect our actual results, including those factors described under “Risk Factors.” These factors, among others, could cause results to differ materially from those presently anticipated by us. You should not place undue reliance on these forward-looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. We undertake no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise, after the date of this Form 10-Q.

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Overview

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. 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. Additional activities have included pre-clinical development of antibody drugs targeting CXCR4, a chemokine receptor that plays a central role in all three phases of cancer progression: expansion of the primary tumor, migration of tumor cells and establishment of distant metastases. We completed an initial public offering of our common stock in December 2001.

Since 2002, we have only been able to obtain enough capital resources to pursue our strategic plans at a very minimal level. We presently have approval from the U.S. Food and Drug Administration, or FDA, to conduct a Phase III trial for DCVax^®-Prostate, our product candidate for a possible prostate cancer treatment and a Phase II clinical trial to evaluate our DCVax^®-Brain product candidate as a possible treatment for Glioblastoma Multiforme. However, we do not presently have adequate resources to complete the trials once they begin. We also have FDA approval to begin Phase I studies for several other DCVax^®-product candidates.

As of November 6, 2006 we had cash in the amount of $613,000. Included in this cash balance is a advance in the amount of $500,000 received from Toucan Partners on October 30, 2006. We are presently negotiating the terms pursuant to which this cash advance will be required to be repaid. 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 $3.9 million of our current liabilities at September 30, 2006 were payable to related parties, net of the related debt discount. During October 2006, we paid $250,000 of the related party liabilities recorded as of September 30, 2006. In addition to the recurring operating costs, we have two remaining payments due to the Washington State Department of Revenue totaling approximately $168,000 as of November 6, 2006. The final payment is due to the Department of Revenue in mid-December 2006.

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 shareholders. We will have to seek additional funds from Toucan Capital, Toucan Partners or, another third party, who are not obligated to provide us with any financing. Any additional equity financing with Toucan Capital, Toucan Partners or any other third party is likely to be dilutive to stockholders and 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 any time.

Our financial statements for the year ended December 31, 2005 and nine months ended September 30, 2006 were 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 since inception, have a working capital deficit of $4.0 million, and have a deficit accumulated during the development stage of $82.0 million, as of September 30, 2006, that raises substantial doubt about our ability to continue as a going concern and our auditors have issued an opinion on the December 31, 2005 financial statements which states that there is substantial doubt about our ability to continue as a going concern.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The critical accounting policies that involve significant judgments and estimates used in the preparation of our financial statements are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005. New critical accounting policies that involve significant judgments and estimates are disclosed below.

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On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), which requires the measurement and recognition of compensation for all stock-based awards, including stock options and employee stock purchases under a stock purchase plan, based on estimated fair values. Under SFAS No. 123(R), we use the Black-Scholes option pricing model as our method of valuation for stock-based awards. Our determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected life of the award, our expected stock price, volatility over the term of the award and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with SFAS No. 123(R), the Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.

Prior to the adoption of SFAS No. 123(R), we determined our employee stock option compensation costs as the difference between the estimated fair value of our common stock and the exercise price of options on their date of grant pursuant to APB No. 25. Prior to our initial public offering, our common stock was not actively traded. The fair value of our common stock for purposes of determining compensation expense for this period was determined based on our review of the primary business factors underlying the value of our common stock on the date such option grants were made, viewed in light of the expected initial public offering price per share prior to the initial public offering of our common stock. The actual initial public offering price was significantly lower than the expected price used in determining compensation expense. Also, on an ongoing basis the estimate of expense for stock options and warrants is dependant on factors such as expected life and volatility of our stock. To the extent actual expense is different than that estimated, the actual expense that would have been recorded may be substantially different.

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Results of Operations

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

Research and development expenses include salary and benefit expenses and costs of laboratory supplies used in our internal research and development projects. From our inception through September 30, 2006, we incurred costs of approximately $34.7 million associated with our research and development activities (not including clinical trial and related expenses). 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.

During the three and nine months ended September 30, 2006 we realized a net loss of $1.8 million and a net income of $662,000, respectively. This net income for the nine month period was generated from the reversal of previously recorded non-cash items as further described in Total Other Income (Expense), Net. We do not expect similar transactions in the future.

Three Months Ended September 30, 2005 and 2006

Total Revenues. We recognized $80,000 in revenues during the three months ended September 30, 2006 as compared to $15,000 in revenue for the three months ended September 30, 2005. To date, our revenues have primarily been derived from the sale of research materials, licenses, contract research and development services and research grants from the federal government. Effective December 31, 2005, we have withdrawn from selling research materials.

Cost of Research Material Sales. Cost of research material sales decreased from $3,000 for the three months ended September 30, 2005 to zero costs for the three months ended September 30, 2006. This decrease is related to the fact that we have withdrawn from selling research materials effective December 31, 2005.

Research and Development Expense. Research and development expense decreased slightly from approximately $1.3 million for the three months ended September 30, 2005 to $1.0 million for the three months ended September 30, 2006. This decrease was primarily due to decreased expenditures for consultants in the preparation of and filing an IND with the FDA and decreasing expenditures related to our service agreement for drug manufacturing, regulatory advice, and research and development related to preclinical activities.

General and Administrative Expense. General and administrative expense decreased from $634,000 for the three months ended September 30, 2005 to $493,000 for the three months ended September 30, 2006. This decrease was primarily due to a decrease in the use of consultants and continuing efforts to conserve cash.

Depreciation and Amortization. Depreciation and amortization decreased from $13,000 for the three months ended September 30, 2005 to $10,000 for the three months ended September 30, 2006. This decrease was primarily due to the disposal or impairment of property and equipment in 2005, as well as the fact that certain assets are now fully depreciated.

Total Other Income (Expense), Net. Interest expense decreased from $896,000 for the three months ended September 30, 2005 to $407,000 for the three months ended September 30, 2006. Interest expense is primarily related to the debt discount and interest accretion associated with the secured convertible promissory notes and warrants debt financing. 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 three months ended September 30, 2005.

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Nine Months Ended September 30, 2005 and 2006

Total Revenues. We recognized $80,000 in revenues during the nine months ended September 30, 2006 as compared to $110,000 in revenue for the nine months ended September 30, 2005. To date, our revenues have primarily been derived from the sale of research materials, licenses, contract research and development services and research grants from the federal government. Effective December 31, 2005, we have withdrawn from selling research materials. The $77,000 decrease in grant revenue was attributable to the cessation of the remaining two research grant awards which occurred during the first quarter of 2005.

Cost of Research Material Sales. We did not recognize any cost of research material sales during the nine months ended September 30, 2006 as compared to $8,000 for the nine months ended September 30, 2005. This decrease is related to the fact that we have withdrawn from selling research materials effective December 31, 2005.

Research and Development Expense. Research and development expense decreased from $3.9 million for the nine months ended September 30, 2005 to $2.6 million for the nine months ended September 30, 2006. This decrease was primarily due to decreased expenditures for consultants in the preparation of and filing an IND with the FDA and decreasing expenditure related to our service agreement for drug manufacturing, regulatory advice, and research and development related to preclinical activities.

General and Administrative Expense. General and administrative expense increased from approximately $1.6 million for the nine months ended September 30, 2005 to $1.7 million for the nine months ended September 30, 2006. This increase was primarily due to professional service fees, including legal, accounting and executive search fees, increased fees related to our SEC filings and required communications with our investors and travel expenses partially offset by our initiative to continue to conserve cash.

Depreciation and Amortization. Depreciation and amortization decreased from $52,000 during the nine months ended September 30, 2005 to $29,000 for the nine months ended September 30, 2006. This decrease was primarily due to the disposal or impairment of property and equipment in 2005, as well as the fact that certain assets are now fully depreciated.

Total Other Income (Expense), Net. Interest expense decreased from approximately $2.6 million for the nine months ended September 30, 2005 to $ 2.2 million for the nine months ended September 30, 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 nine months ended September 30, 2005. Additionally, we recorded a warrant valuation gain of $7.1 million during the nine months ended September 30, 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 or loss during the nine months ended September 30, 2005.

Liquidity and Capital Resources

As of November 6, 2006 we had cash in the amount of approximately $613,000. Included in this cash balance is a cash advance in the amount of $500,00 received from Toucan Partners on October 30, 2006. We are presently negotiating the terms pursuant to which this cash advance will be required to be repaid. We consider ourselves illiquid as this cash is not considered sufficient to fund our recurring operating and associated financing costs for the next month. Approximately $3.9 million of our current liabilities at September 30, 2006 were payable to related parties, net of the related debt discount. During October 2006, we paid $250,000 of the remaining current related party liabilities recorded as of September 30, 2006. In addition to the recurring operating costs, we have two remaining payments due to the Washington State Department of Revenue totaling approximately $168,000 as of November 6, 2006. The final payment is due to the Department of Revenue in mid-December 2006.

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 our 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.

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On January 7, 2000, we qualified for the State of Washington’s use tax deferral program for businesses engaged in high technology and research and development activities. Under the deferral program, a business may defer paying sales and use tax upon investments in qualified buildings, qualified machinery and equipment, or pilot scale manufacturing. No repayment of the taxes deferred under this program is required if the business uses the investment project for qualified research and development during the calendar year the investment project is certified by the State of Washington’s Department of Revenue as operationally complete, and for an additional seven calendar years.

Beginning on October 9, 2002, we initiated a series of substantial steps to conserve cash, including the relocation and consolidation of our facilities. We received a tax assessment of $491,802 on October 21, 2003 in connection with taxes previously deferred under the State of Washington’s use tax deferral. The tax assessment was due to our abandonment of tenant improvements at the prior facility. The tax assessment payment was initially due on November 20, 2003. The net assessment, through December 31, 2005, of approximately $336,000, inclusive of accrued interest, was being carried as an estimated liability on our balance sheet. On August 10, 2006 our appeal was denied. In September 2006, we entered into an agreement with the State of Washington to pay an aggregate of approximately $336,000, plus interest at a rate of 4% per year. The agreement provides for two additional monthly payments totaling approximately $168,000, as of November 6, 2006, which are due in November and December 2006.

In February 2004, we filed a refund request of approximately $175,000 related to certain state taxes previously paid to the State of Washington. The finalization of this refund request is not expected until late 2006.

Since 2004, we have undergone a significant recapitalization, pursuant to which Toucan Capital and Toucan Partners loaned us an aggregate of approximately $7.7 million, excluding $500,000 received from Toucan Partners in October 2006, and purchased $1.3 million in equity. These funds enabled us to continue to operate, and advance our programs, while attempting to raise additional capital. These funds were primarily comprised of $6.75 million from Toucan Capital, which we borrowed from February 1, 2004 through September 2005. Toucan Capital elected to convert these loans and the related accrued interest on the loans into approximately 4.8 million shares of our newly designated Series A-1 Preferred Stock (which are convertible into an aggregate of 192.7 million shares of common stock) as of April 17, 2006. In January 2005, Toucan Capital purchased 32.5 million of Series A Preferred Stock for gross proceeds of $1.3 million. Toucan Capital also has the right to acquire up to approximately 135.5 million shares of capital stock upon exercise of warrants issued in connection with its convertible debt and equity financings.

In connection with the recapitalization, we have also issued three promissory notes to Toucan Partners, pursuant to which it has loaned us an aggregate of $950,000. Toucan Partners has the right, as of September 30, 2006, to convert principal and interest on the above loans to acquire up to approximately 25.5 million shares of our capital stock and has the right to acquire up to an aggregate of 9.5 million shares upon exercise of warrants having a contractual life of 7 years. Including the 32.5 million shares of Series A Preferred Stock and the approximately 4.82 million shares of Series A-1 Preferred Stock held by Toucan Capital, Toucan Capital and Toucan Partners collectively have beneficial ownership of approximately 395.1 million shares of our common stock, which represents beneficial ownership of approximately 86% as of September 30, 2006. Toucan Capital and Toucan Partners each has a right of first refusal to participate in our future issuances of debt or equity securities. In addition, on October 30, 2006, Toucan Partners provided a cash advance in the amount of $500,000, of which the terms of repayment are currently being negotiated.

Our independent auditors have indicated in their report on our financial statements, included in our December 31, 2005 Annual Report on Form 10-K, that there is substantial doubt about our ability to continue as a going concern. 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.

Sources of Cash

Federal Grants

On April 8, 2003, we were awarded a NIH cancer research grant. The total first year grant award was approximately $318,000, 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 final $35,000 award was recognized in January 2005. This grant ended January 31, 2005.

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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. There was approximately $59,000 earned under the grant and recognized in revenue through the year ended December 31, 2004, with the remaining $41,000 of the grant’s aggregate award recognized through the six months ended June 30, 2005.

Research Reagent Sales

On April 21, 2003, we announced our entry into the research reagents market. We earned approximately $23,000 in revenue for the nine months ended September 30, 2005 from the sale of research materials. Effective December 31, 2005, we have withdrawn from selling research materials.

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 $25,000 one-time license fee was received in 2003. We waived the payment of the July 1, 2004 annual royalty payment because of costs incurred by DakoCytomation, on our behalf, regarding purity issues with the initial cell lines. During both the three months ending September 30, 2006 and 2005, we received and recorded the minimum annual royalty payment totaling $10,000.

During the three months ended September 30, 2006, we granted a non-exclusive license to certain of our patent rights and provided certain reagents for a one-time $70,000 license fee.

Management Loan

On November 13, 2003, we borrowed an aggregate of $335,000 from certain members of our management, which enabled us to continue operating into the first quarter of 2004. As of September 30, 2006, all of these management loans have either been repaid or converted into common stock. During the second quarter of 2006, the remaining outstanding principal balance, along with the related accrued interest were converted into 2,687,719 shares of common stock.

As part of the November 13, 2003 loan from management, the lenders received warrants initially exercisable to acquire an aggregate of 3.7 million shares of our common stock, expiring November 2008 and subject to certain anti-dilution adjustments. In connection with the April 26, 2004 recapitalization agreement, the warrants were amended to remove the anti-dilution provisions and set the warrant exercise price at the lesser of (i) $0.10 per share or (ii) a 35% discount to the average closing price during the twenty trading days prior to the first closing of the sale by us of convertible preferred stock as contemplated by the recapitalization agreement but not less than $0.04 per share.

During March 2006, warrants for the purchase of 3.6 million shares were exercised on a net exercise basis, resulting in the issuance of approximately 3.3 million shares of common stock. The remaining 100,000 management warrants were exercised during the second quarter of 2006. As a result, an aggregate of 3.4 million shares of common stock were issued to current and prior members of management.

Two of the management lenders, neither of whom are still employed by us, 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 intends to vigorously oppose such claims.

We generated $16,000 in cash from investing activities during the nine months ended September 30, 2006 compared to $68,000 provided by investing activities during the nine months ended September 30, 2005. The cash provided during the nine months ended September 30, 2006 and 2005 consisted of net proceeds from the sale of property and equipment.

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We generated $5.4 million in cash from financing activities for the nine months ended September 30, 2006 primarily related to the sale of the Company’s common stock to certain private equity investors in April 2006. We generated $3.6 million in cash from financing activities during the nine months ended September 30, 2005 consisting primarily of the proceeds received in connection with the issuance of $2.4 million of convertible promissory notes to Toucan Capital, in addition to the January 26, 2005 securities purchase agreement with Toucan Capital pursuant to which they purchased 32.5 million shares of our Series A Preferred Stock at a purchase price of $0.04 per share, for a net purchase price of approximately $1.3 million, net of offering related costs of approximately $24,000.

Uses of Cash

We used $5.1 million in cash for operating activities during the nine months ended September 30, 2006, compared to $3.6 million for the nine months ended September 30, 2005. The increase in cash used in operating activities from 2005 to 2006, was primarily the result of increased expenditures for consultants related to a service agreement for drug manufacturing, regulatory advice, the preparation and submission to the FDA of three new INDs, and research and development related to preclinical activities.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is presently limited to the interest rate sensitivity of our cash and any cash equivalents 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 and cash equivalents in interest-bearing instruments, primarily money market funds. 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. Due to the nature of our cash and cash equivalents, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

Item 4. Controls and Procedures

Our president, who serves as our principal executive, financial and accounting officer, after evaluating, as required, the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), recognized, as of September 30, 2006, our disclosure controls and procedures contained certain internal control weaknesses that, in the aggregate, represent material weaknesses.

The identified weaknesses were anticipated given our status with respect to the fact that we only have three full-time employees. The weaknesses were comprised of: insufficient segregation of duties, insufficient corporate governance policies, and lack of independent directors as of September 30, 2006. Each of these weaknesses is expected to be corrected after raising the additional capital considered necessary to fund our operations. SEC release #33-8545 extends the deadline for section 404 compliance for non-accelerated filers, such as our Company, to the first fiscal year ending on or after July 15, 2007 and the SEC has recently proposed to extend these deadlines further.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As part of the communications by Peterson Sullivan, PLLC (“Peterson Sullivan”) with our audit committee with respect to Peterson Sullivan’s audit procedures for 2005, 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.

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Part II — Other Information

Item 1. Legal Proceedings

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. We strongly disputed Soma’s claims and defended ourselves.

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.

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 oppose such claims.

Item 1A. Risk Factors

This section briefly discusses certain risks that should be considered by our stockholders and prospective investors. Because we continually update our analysis and description of such risks, you should carefully consider the risks described below, together with all other information included in our annual report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on April 18, 2006 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 of your investment.

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We may cease operations at any time; we need to raise additional capital, which may not be available.

As of November 6, 2006, we have approximately $613,000 in cash. Included in this cash balance is an additional cash advance in the amount of $500,00 received from Toucan Partners on October 30, 2006. We are presently negotiating the terms pursuant to which this cash advance will be required to be repaid. We consider ourselves illiquid as this cash is not considered sufficient to fund our recurring operating and associated financing costs. Approximately $3.9 million of our current liabilities at September 30, 2006 were payable to related parties, net of the related debt discount. During October 2006, we paid $250,000 of the related party liabilities recorded as of September 30, 2006. In addition to the recurring operating costs, we have two remaining payments due to the Washington State Department of revenue totaling approximately $168,000. The final payment is due in mid December 2006.

The Company needs to raise significant additional funding to continue its operations, conduct research and development activities, pre-clinical studies and clinical trials necessary to bring its product candidates to market. However, additional funding may not be available on terms acceptable to the Company 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 the Company’s 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 our creditors in full and to satisfy aggregate liquidation preferences of our preferred stock in full. Therefore, if the Company were to pursue a liquidation, it is highly unlikely that any proceeds would be received by the holders of the Company’s common stock. If the Company is unable to obtain significant additional capital in the near-term, we may cease operations at anytime.

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 April 2006, we closed 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 registration statement registering such shares was declared effective by the Securities and Exchange Commission on October 11, 2006. 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.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

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Item 6. Exhibits

a) Exhibits

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SIGNATURES

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

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NORTHWEST BIOTHERAPEUTICS, INC.
(A Development Stage Company)

EXHIBIT INDEX

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