Helix BioMedix (HXBM) 10-Q 2008 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

Commission file number: 33-20897-D

HELIX BIOMEDIX, INC.

(Exact name of registrant as specified in its charter)

Delaware	91-2099117
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

22118-20^th Avenue SE, Suite 204, Bothell, Washington 98021

(Address of principal executive offices)

(425) 402-8400

(Registrant’s telephone number, including area code)

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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  ¨            Smaller reporting company  x

(Do not check if a smaller reporting company)

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

As of May 8, 2008, 25,653,512 shares of the registrant’s common stock were issued and outstanding.

HELIX BIOMEDIX, INC.

FORM 10-Q

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Balance Sheets (unaudited)	1
	Condensed Statements of Operations (unaudited)	2
	Condensed Statements of Stockholders’ Equity (Deficit) (unaudited)	3
	Condensed Statements of Cash Flows (unaudited)	4
	Notes to Condensed Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 4.	Controls and Procedures	25
PART II - OTHER INFORMATION
Item 1A.	Risk Factors	26
Item 6.	Exhibits	28
Signatures		29

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements.

HELIX BIOMEDIX, INC.

CONDENSED BALANCE SHEETS

(Unaudited)

	March 31, 2008			December 31, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	3,164,994		$	461,290
Marketable securities, current		—			700,000
Accounts receivable, net		102,091			83,915
Inventory		50,513			65,279
Prepaid expenses and other current assets		138,130			144,074
Total current assets		3,455,728			1,454,558
Marketable securities, non-current		170,000			—
Deposits		8,522			8,522
Property and equipment, net		118,257			126,509
Intangible assets, net		412,763			432,482
Total assets	$	4,165,270		$	2,022,071
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	96,724		$	95,071
Accrued compensation and benefits		84,562			63,813
Accrued expenses		78,894			60,269
Deferred revenue		—			130,000
Derivative liabilities, including related party		1,514,225			—
Total current liabilities		1,774,405			349,153
Deferred rent		2,211			2,205
Convertible note payable, related party, less unamortized discount of $558,420		3,191,580			—
Accrued interest on convertible note payable, related party		30,247			—
Total liabilities		4,998,443			351,358
Commitments and contingencies
Stockholders’ equity (deficit):
Preferred stock, $0.001 par value, 25,000,000 shares authorized; no shares issued or outstanding		—			—
Common stock, $0.001 par value, 100,000,000 shares authorized; 25,653,512 shares outstanding at March 31, 2008, and December 31, 2007		25,654			25,654
Additional paid-in capital		27,983,084			29,211,972
Accumulated deficit		(28,841,911	)		(27,566,913	)
Total stockholders’ equity (deficit)		(833,173	)		1,670,713
Total liabilities and stockholders’ equity (deficit)	$	4,165,270		$	2,022,071

The accompanying notes are an integral part of the financial statements.

1

HELIX BIOMEDIX, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended March 31,
	2008			2007
Revenue:
Licensing and development fees	$	147,062		$	29,494
Peptide sales		93,308			28,928
Total revenue		240,370			58,422
Operating expenses:
Cost of peptide sales		69,384			—
Other cost of revenue		38,781			—
Research and development		195,177			205,497
Marketing and business development		114,687			104,211
General and administrative		433,369			390,707
Accounting, legal and professional fees		160,815			148,477
Depreciation and amortization		35,049			44,422
Total operating expenses		1,047,262			893,314
Loss from operations		(806,892	)		(834,892	)
Other income (expense):
Interest income		18,790			22,403
Interest expense on convertible note payable, related party		(30,578	)		—
Accretion of discount on convertible note payable, related party, net		(285,415	)		—
Change in value of derivative instruments, including related party, net		(140,903	)		—
Unrealized loss on marketable securities		(30,000	)		—
Other income (expense), net		(468,106	)		22,403
Net loss	$	(1,274,998	)	$	(812,489	)
Basic and diluted net loss per share	$	(0.05	)	$	(0.03	)
Weighted average shares outstanding		25,653,512			23,569,902

The accompanying notes are an integral part of the financial statements.

2

HELIX BIOMEDIX, INC.

CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

For the Year Ended December 31, 2007 and for the Three Months Ended March 31, 2008

(Unaudited)

	Common Stock
	Number of Shares	Amount		Additional Paid-in Capital			Accumulated Deficit			Stockholders’ Equity
Balance at December 31, 2006	22,788,514	$	22,788	$	26,908,198		$	(24,132,909	)	$	2,798,077
Proceeds from 2007 private placement, net	2,864,998		2,866		2,140,492			—			2,143,358
Stock-based compensation	—		—		163,282			—			163,282
Net loss for the year	—		—		—			(3,434,004	)		(3,434,004	)
Balance at December 31, 2007	25,653,512		25,654		29,211,972			(27,566,913	)		1,670,713
Stock-based compensation	—		—		26,429			—			26,429
Reclassification of warrants and options from equity to derivative liabilities	—		—		(1,255,317	)		—			(1,255,317	)
Net loss	—		—		—			(1,274,998	)		(1,274,998	)
Balance at March 31, 2008	25,653,512	$	25,654	$	27,983,084		$	(28,841,911	)	$	(833,173	)

The accompanying notes are an integral part of the financial statements.

3

HELIX BIOMEDIX, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three months ended March 31,
	2008			2007
Cash flows from operating activities
Net loss	$	(1,274,998	)	$	(812,489	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		35,049			44,422
Stock-based compensation expense		26,429			21,458
Interest expense on convertible note payable, related party		30,578			—
Accretion of discount on convertible note payable, related party		285,415			—
Change in valuation of derivative instruments, including related party, net		140,903			—
Unrealized loss on marketable securities		30,000			—
Changes in assets and liabilities:
Accounts receivable		(18,176	)		(34,047	)
Inventory		14,766			—
Prepaid expenses and other current assets		35,043			9,217
Deposits		—			(4,311	)
Accounts payable		1,653			10,872
Accrued compensation and benefits		20,749			(54,452	)
Accrued expenses		18,631			76,108
Deferred revenue		(130,000	)		(10,000	)
Net cash used in operating activities		(783,958	)		(753,222	)
Cash flows from investing activities
Purchases of marketable securities		—			(350,000	)
Proceeds from sales of marketable securities		500,000			330,000
Purchase of property and equipment		(7,078	)		(1,752	)
Net cash provided by (used in) investing activities		492,922			(21,752	)
Cash flows from financing activities
Proceeds from issuance of convertible note payable, related party		3,000,000			—
Financing costs related to convertible note payable, related party		(5,260	)		—
Proceeds from issuance of common stock and warrants, net		—			2,143,358
Net cash provided by financing activities		2,994,740			2,143,358
Net increase in cash and cash equivalents		2,703,704			1,368,384
Cash and cash equivalents at beginning of period		461,290			1,276,901
Cash and cash equivalents at end of period	$	3,164,994		$	2,645,285

The accompanying notes are an integral part of the financial statements.

4

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation and Preparation

The accompanying unaudited condensed financial statements of Helix BioMedix, Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted for interim financial information in accordance with the SEC rules and regulations for quarterly reporting. In the opinion of management, the accompanying unaudited condensed financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and its results of operations and cash flows for the periods indicated. These condensed financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2007, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 21, 2008.

Use of Estimates

The preparation of the Company’s financial statements in conformity with the United States generally accepted accounting principles requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the balance sheets and the reported amounts of revenue and expenses during the reporting periods. Significant items subject to such estimates and assumptions include the carrying amount of investments, property, plant and equipment, and intangibles; valuation allowances for receivables, inventories and deferred income tax assets; and valuation of stock-based compensation and obligations related to outstanding warrants and options classified as derivative liabilities and measured through earnings at each reporting period. Actual results could differ from those estimates.

The results of operations for the three months ended March 31, 2008, are not necessarily indicative of the results of operations that may be achieved for the entire year ending December 31, 2008.

Reclassification

Reclassifications of prior years’ balances have been made to conform to the current format.

In the Condensed Statements of Operations, the reclassifications include (1) consulting fees being included in general and administrative expenses as they were not significant for the periods presented and (2) marketing and business development expenses being separated from general and administrative expenses. These reclassifications had no impact on the financial results in the periods presented.

Valuation of Warrants and Non-Employee Stock Options Accounted for as Derivative Liabilities

In accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and Emerging Issues Task Force Issue (EITF) No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19), the Company is required to classify the fair value of warrants and non-employee stock options as derivative liabilities as there is the potential that the Company will have an insufficient number of authorized common shares available to settle these instruments as a result of the issuance of the convertible note payable on February 14, 2008 to a related party and the potential contractual obligation to grant the associated warrant (See Note 2).

The Company values these warrants and options using a Black-Scholes model and uses estimates for an expected dividend yield, a risk-free interest rate, and expected volatility (see Note 6). At each reporting period, as long as the warrants and non-employee stock options are outstanding and there is the potential for an insufficient number of authorized shares available to settle these instruments, the warrants and options will be revalued and any difference from the previous valuation date will be recognized as a change in fair value in the Company’s statement of operations.

5

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Valuation of Warrant Related to Convertible Note Payable, Related Party

In accordance with SFAS 133 and EITF 00-19, the Company is required to classify the fair value of the warrant that may be granted in connection with the convertible note payable to related party as a derivative liability as there is the potential that the Company will have an insufficient number of authorized common shares available to settle this instrument.

The Company values this warrant using a Black-Scholes model and uses estimates for an expected dividend yield, a risk-free interest rate, and expected volatility together with management’s estimate of the probability of issuance of the warrant. At each reporting period, as long as the warrant is potentially issuable, or is outstanding, and there is the potential for an insufficient number of authorized shares available to settle the warrant, the warrant will be revalued and any difference from the previous valuation date will be recognized as a change in fair value in the Company’s statement of operations.

Valuation of Derivative Asset Related to Convertible Note Payable, Related Party

In accordance with SFAS 133, the Company is required to separately account for the fair value of the Company’s right to call the convertible note payable, related party and automatically convert it to equity at the price of equity securities issued in the sale of shares of its equity securities that raises an aggregate amount of at least $5.0 million on or before June 29, 2008 (See Note 2).

The Company values the call option using a Black-Scholes model and uses estimates for an expected dividend yield, a risk-free interest rate, and expected asset-based volatility, together with management’s estimate of the probability of exercise of the call option. At each reporting period, as long as the call option is outstanding, the call option will be revalued and any difference from the previous valuation date will be recognized as a change in fair value in the Company’s statement of operations. The right associated with the call option expires on June 29, 2008 if unexercised.

Recent Accounting Pronouncements

There have been no significant changes during the three months ended March 31, 2008 in recent accounting pronouncements other than as described in Note 4 that have a material impact on the Company’s results of operations and financial position from those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

The Company implemented SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115,” and EITF No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities,” effective January 1, 2008, the implementation of which did not have an impact on the Company’s financial statements.

Note 2. Related Party Transaction

On February 14, 2008, the Company issued to RBFSC, Inc. (RBFSC), a related party, a convertible promissory note (the Note) in the principal amount of $3.0 million with an interest rate of 8% per annum. The principal balance and accrued interest are due on the earlier of February 14, 2010, or upon an event of default under the Note, including in the event that the Company files for bankruptcy. In the event that the Company closes an equity financing on or before June 29, 2008 (Equity Financing), in which the Company sells shares of its equity securities for an aggregate amount of at least $5.0 million, the unpaid balance of the Note and related accrued interest will automatically convert into the equity securities issued in the Equity Financing, at the price of such equity securities issued in the Equity Financing. In the event the Company does not consummate an Equity Financing on or before June 29, 2008, the unpaid balance of the Note and related accrued interest may be converted, at the option of the holder, into common shares at a price equal to 80% of the average per share closing price of the Company’s common stock during the preceding 90-day period, and the Company shall issue to RBFSC a warrant to purchase that number of shares of its common stock equal to $750,000 divided by the per share closing sale price of the Company’s common stock on the date of issuance. The president and director of RBFSC is Frank T. Nickell, who beneficially owned approximately 26.1% of the Company’s outstanding common stock as of March 19, 2008. The debt issuance costs of $5,260 are included in other current assets and are being amortized using the effective interest method.

6

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Due to the indeterminate number of common shares which might be issued under the embedded conversion feature and the warrant related to the Note, the Company has recorded the value of the warrant related to the Note as a derivative liability at its fair value in accordance with SFAS 133 and EITF 00-19, as there is a potential that the Company would have an insufficient number of authorized shares to settle these obligations. In addition, the Company must re-measure the fair value of this derivative liability at the end of each reporting period. The Company estimated the fair value of the warrant associated with the Note to be $280,347 at February 14, 2008. As of March 31, 2008, the Company estimated the fair value of this derivative liability had increased to $503,122, and as a result, recognized the change in value of $222,775 in its statement of operations. The contingently issuable warrant associated with the Note has a five-year term from June 30, 2008. The fair value of this warrant was determined by applying management’s estimate of the probability of issuance of the warrant together with the Black-Scholes option pricing model with the following key assumptions:

	February 14, 2008		March 31, 2008
Risk-free interest rate	2.81	%	2.46	%
Expected dividend yield	0		0
Expected term in years	5.00		5.00
Expected volatility	98	%	98	%

The Note also includes embedded features in the form of a call option and put option that are required to be separately accounted for at fair value on the balance sheet and with changes in value in the statement of operations under SFAS 133 as the features are not clearly and closely related to the convertible note debt instrument. The embedded put option, which gives the holder the right to demand repayment in the case of default, was determined by management to have no material value at February 14, 2008 or March 31, 2008, based on an analysis of the rights this feature contains and the likelihood of its exercise. The embedded call option gives the Company the right to call the Note and automatically convert it into the equity securities issued in the Equity Financing. The Company estimated the fair value of the call option associated with the Note to be $186,512 at February 14, 2008. As of March 31, 2008, the Company estimated the fair value of this derivative asset had decreased to $24,170, and as a result, recognized the change in value of $162,342 in its statement of operations. The fair value of this derivative asset, included in other current assets, was determined by applying management’s estimate of the probability of the Company’s exercising the call option together with the Black-Scholes option pricing model with the following key assumptions:

	February 14, 2008		March 31, 2008
Risk-free interest rate	2.26	%	1.32	%
Expected dividend yield	0		0
Expected term in years	0.37		0.25
Expected volatility	79	%	79	%

The Company accounts for the Note in accordance with SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150), as the conversion feature embedded in the Note results in the holder receiving a fixed monetary value through the receipt of a variable number of the Company’s common shares. The Company determined the value of the Note at February 14, 2008 to be $2,906,165, which represented the gross proceeds from the debt financing less the fair value of the warrant associated with the Note, offset by the fair value of the call option held by the Company. The Note is being accreted from its carrying value of $2,906,165 at February 14, 2008 to its settlement amount of $3,750,000 at June 29, 2008, the first possible settlement date, through the statement of operations using the effective interest method. As of March 31, 2008, an expense of $285,415 has been recorded as accretion of discount on convertible note payable, related party, thereby increasing the carrying value of the Note to $3,191,580.

For the three months ended March 31, 2008, interest expense resulting from the stated interest rate related to the Note was $30,578. The effective interest rate related to the Note for the period from the issuance date through June 29, 2008, including accretion of discount, is 24.9%.

7

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 3. Marketable Securities

At December 31, 2007, the Company had $700,000 of investment in auction rate securities (ARS), classified as current available-for-sale marketable securities. These securities are structured to allow for interest rate resets at approximately every 28 days, but with contractual maturities that are well in excess of ten years. Historically, the carrying value of ARS approximated fair value due to the frequent interest rate resets. Until early February 2008, the ARS market was fairly liquid and the Company was able to auction to sell these securities at par at the end of each reset period or continue to hold them. During the first two months of 2008, the Company liquidated $500,000 of its investment in ARS at par and held the proceeds in cash and cash equivalents. Of the remaining ARS held by the Company, an aggregate of $100,000 (par value) was issued by state agencies and is supported by student loans for which repayment is substantially guaranteed by the U.S. government under the Federal Family Education Loan Program (FFELP). The remaining $100,000 (par value) of the Company’s ARS was issued by municipalities and repayment is insured by MBIA Insurance Corporation, a bond insurance company. The Company’s ARS are rated by the major independent rating agencies as AAA investments.

During February 2008, ARS increasingly failed at auction due to sell orders exceeding buy orders. Since March 2008, the Company’s ARS have experienced failed auctions. The Company concluded that the fair value of these ARS at March 31, 2008 was $170,000, a decline of $30,000 from par value. The Company considered this decline in fair value as other than temporary and, accordingly, has recorded an unrealized loss on marketable securities of $30,000 in other non-operating expense in the first quarter of 2008. Further, in the event that the Company needs to access this $170,000 of its investments in ARS, the Company may not be able to do so without a loss of principal until (1) a future auction of these securities is successful, (2) the Company is able to sell the securities in a secondary market, or (3) the issuer calls the securities pursuant to a mandatory tender or redemption prior to maturity. As such, the Company’s investment in ARS currently lacks short-term liquidity and was therefore reclassified as non-current marketable securities as of March 31, 2008. The Company will continue to monitor and evaluate these investments as there is no assurance as to when the market for this investment class will stabilize.

Note 4. Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (SFAS 157), except with respect to non-financial assets and liabilities that are subject to a one-year deferral allowed by FASB Staff Position (FSP) FAS 157-2, “Effective Date of FASB Statement No. 157.” This statement defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. The standard applies to assets and liabilities that are carried at fair value on a recurring basis. On February 12, 2008, FSP FAS 157-2 was issued delaying the effective date of SFAS 157 until fiscal years beginning after November 15, 2008 for non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis at least annually. In accordance with SFAS 157, these inputs are summarized in the three broad levels listed below:

• Level 1 – Quoted prices in active markets for identical securities;

• Level 2 – Other significant observable inputs (including quoted prices in active markets for similar securities); and

• Level 3 – Significant unobservable inputs (including the Company’s own assumptions in determining fair value of investments).

8

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2008:

	Level 1	Level 2	Level 3		Total
Assets
Marketable securities, non-current (Note 3)	—	—	$	170,000	$	170,000
Derivative asset related to convertible note payable, related party (Note 2)				24,170		24,170
	—	—	$	194,170	$	194,170
Liabilities
Derivative liability related to convertible note payable, related party (Note 2)			$	503,122	$	503,122
Derivative liability related to outstanding warrants and non-employee options (Note 6)				1,011,103		1,011,103
			$	1,514,225	$	1,514,225

At March 31, 2008, there was insufficient observable ARS market information available for the Company to determine the fair value of its investment using level 1 or level 2 inputs. Therefore, the Company’s management estimated fair value by incorporating assumptions that market participants would use in their estimates of fair value. These assumptions included credit quality, estimates on the probability of the issue being called prior to final maturity, the liquidity of the securities and indications of value from reports of developing secondary markets.

The following is a reconciliation of the activities of the ARS during the three months ended March 31, 2008:

Fair value estimates for ARS using significant unobservable inputs (Level 3)
Beginning balance at January 1, 2008	$	700,000
Sales of ARS at par value		(500,000	)
Change in fair value recorded in condensed statements of operations		(30,000	)
Balance at March 31, 2008	$	170,000

The Company estimated the fair value of its derivative instruments using the Black-Scholes pricing model with the key assumptions summarized in Notes 2 and 6. The following is a reconciliation of the activities of the derivative liabilities during the three months ended March 31, 2008:

Fair value estimates for derivative liabilities using significant unobservable inputs (Level 3)
Beginning balance at January 1, 2008	$	—
Reclassification of outstanding warrants and options from equity to derivative liabilities at February 14, 2008		1,255,317
Derivative liabilities related to issuance of convertible note payable, related party		280,347
Change in fair value recorded in condensed statements of operations, net		(21,439	)
Balance at March 31, 2008	$	1,514,225

The following is a reconciliation of the activities of the derivative asset during the three months ended March 31, 2008:

Fair value estimates for derivative asset using significant unobservable inputs (Level 3)
Beginning balance at January 1, 2008	$	—
Derivative asset related to issuance of convertible note payable, related party		186,512
Change in fair value recorded in condensed statements of operations		(162,342	)
Balance at March 31, 2008	$	24,170

9

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 5. Stock-Based Compensation

Stock-Based Compensation

The amount of stock-based compensation expense recognized in the three months ended March 31, 2008 and 2007 related to stock options was $26,429 and $21,458, respectively.

A summary of the Company’s stock compensation expense for the three months ended March 31, 2008 and 2007 is as follows:

	Three Months Ended March 31,
	2008		2007
Research and development	$	—	$	2,990
Marketing and business development		5,060		14,942
General and administrative		21,369		3,526
Total stock-based compensation	$	26,429	$	21,458

In determining the fair value of stock options granted during the quarter ended March 31, 2008 and 2007, the following key assumptions were used in the Black-Scholes option pricing model:

	Three Months Ended March 31,
	2008		2007
Risk-free interest rate	2.9	%	4.6	%
Expected dividend yield	0		0
Expected term in years	5.50		6.25
Expected volatility	100	%	100	%

The risk-free rate is based on the implied yield available on U.S. Treasury zero–coupon issues with an equivalent remaining term. The Company does not anticipate declaring dividends in the foreseeable future. For the three months ended March 31, 2008, expected volatility is based on the annualized daily historical volatility of the Company’s stock price commensurate with the expected term of the option, and other factors, including peer company data. The Company determines the expected term by using the simplified method in accordance with Staff Accounting Bulletin (SAB) 107, as amended by SAB 110, as the mid-point between the vesting period and the contractual term. The Company will continue to use the simplified method until it has sufficient historical data to provide reasonable estimates of expected lives of stock options. The Company’s stock price volatility and option term involves management’s best estimates at that time, both of which impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option. SFAS 123R, “Share-Based Payment”, also requires that the Company recognize compensation expense for only the portion of options or stock units that are expected to vest. Therefore, the Company applies an estimated forfeiture rate that is derived from historical employee termination behavior.

Stock Option Plan

The Helix BioMedix 2000 Stock Option Plan (the 2000 Plan) provides for the issuance of incentive and non-qualified stock options to employees, directors, officers, and consultants and is administered by non-employee directors. The 2000 Plan specifically provides the Company with the ability to repurchase, upon termination of an optionee’s employment, up to 10,000 shares acquired by the optionee through the exercise of options granted thereunder at the then-current fair market value of such shares.

Stock options to purchase the Company’s common stock are granted at the fair market value on the date of grant. Options generally become exercisable beginning one year from the date of grant and expire 10 years from the date of grant. Options granted to non-employee directors are typically non-qualified stock options with a vesting period ranging from immediately upon grant to quarterly over one year. Stock options granted to employees are typically incentive stock options and vest at the rate of 33.33% after one year and 2.78% per month thereafter.

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HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

During each of the three months ended March 31, 2008 and 2007, the Company granted to non-employee directors an aggregate of 120,000 options with an average fair value of $0.62 per share for both periods. There were no employee stock options granted during the first quarter of 2008 or 2007.

A summary of the Company’s stock option activity for the three months ended March 31, 2008 is presented in the following table:

	Shares Subject to Options		Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Outstanding, December 31, 2007	2,978,528		$	1.22	5.27	$	—
Granted	120,000		$	0.80	—		—
Exercised	—			—	—		—
Forfeited	—			—	—		—
Expired	(83,334	)	$	0.75	—		—
Outstanding, March 31, 2008	3,015,194		$	1.22	5.36	$	47,500
Exercisable, March 31, 2008	2,588,249		$	1.32	4.66	$	—

The aggregate intrinsic value in the table above is based on the Company’s closing stock price of $0.69 on March 31, 2008, which would have been received by the optionees had all of the options with exercise prices less than $0.69 been exercised on that date. As of March 31, 2008, total unrecognized stock-based compensation related to non-vested stock options was approximately $186,500, which is expected to be recognized over a weighted-average period of approximately 1.6 years.

The Company has a policy of issuing new shares to satisfy share option exercises.

The Company has reserved 5,355,000 shares of common stock for issuance pursuant to the 2000 Plan. As of March 31, 2008, 2,339,806 shares remained available for grants. Additional information regarding options outstanding as of March 31, 2008, is as follows:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Shares	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
$0.50 - $0.85	815,500	7.84	$	0.68	395,500	$	0.76
$1.00 - $1.00	799,000	4.91	$	1.00	799,000	$	1.00
$1.20 - $1.80	1,241,250	4.15	$	1.63	1,234,305	$	1.63
$1.85 - $2.00	159,444	4.42	$	1.89	159,444	$	1.89
$0.50 - $2.00	3,015,194	5.36	$	1.22	2,588,249	$	1.32

Note 6. Stockholders’ Equity

Warrants and Non-Employee Options

As of December 31, 2007, the Company had 2,700,544 warrants with exercise prices ranging from $0.25 to $6.00 and 330,000 non-employee options with exercise prices ranging from $1.50 to $2.00 outstanding. There were no changes in outstanding warrants or non-employee options during the three months ended March 31, 2008.

Reclassification of Warrants and Non-Employee Stock Options

The Company’s debt financing, as discussed in Note 2 – Related Party Transaction, included a conversion feature and issuable warrant which created the potential for the Company to have an insufficient number of authorized common shares available to settle these instruments. As a result, the Company was required to reclassify, at fair value on February 14, 2008, all warrants and options subject to the provisions of EITF 00-19 from equity to derivative liabilities at fair value. Awards not subject to EITF 00-19 include grants to employees, officers and non- employee directors for board service as long as these grants have not been modified. The Company estimated the fair value of these outstanding warrants and options to be $1,255,317 and $1,011,103 at February 14, 2008 and March 31, 2008, respectively.

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HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

In determining the fair value of these warrants and non-employee stock options, the following key assumptions were used in the Black-Scholes option pricing model:

	February 14, 2008		March 31, 2008
Warrants
Risk-free interest rate	1.9% - 2.8	%	1.6% - 2.5	%
Expected dividend yield	0		0
Expected term in years	1.14 - 5.29		1.02 - 5.25
Expected volatility	98% - 115	%	98% - 115	%
Non-Employee Stock Options
Risk-free interest rate	2.1% - 2.3	%	1.6% - 2.0	%
Expected dividend yield	0		0
Expected term in years	1.50 – 3.63		1.37 – 3.50
Expected volatility	102% - 115	%	103% - 115	%

At each reporting period, as long as the warrants and non-employee options are outstanding and there is the potential for an insufficient number of authorized shares available to settle these instruments, the outstanding warrants and non-employee options will be revalued and any difference from the previous valuation date will be recognized as a change in fair value of derivative liabilities, and charged or credited to the statement of operations in accordance with SFAS 133 and EITF 00-19. From February 14, 2008 to March 31, 2008, the fair value of these derivative liabilities decreased by $244,214.

Equity Financing

On March 5, 2007, the Company closed a private equity financing, receiving cash of $2.0 million in exchange for 2,666,666 shares of $0.001 par value common stock. In a second closing held on March 26, 2007, the Company received cash of $148,750 in exchange for 198,332 shares of $0.001 par value common stock.

The net proceeds of these offerings were used to continue research and development efforts, to fund the out-licensing initiatives for the Company’s peptides and for general corporate purposes.

Note 7. Loss per Share

Loss per share has been computed by dividing net loss by the weighted-average number of shares outstanding during the period. Diluted per share amounts reflect potential dilution from the exercise or conversion of securities into common stock. The Company’s capital structure includes common stock options and common stock warrants, all of which have been excluded from net loss per share calculations as they are antidilutive, as follows:

	Three months ended March 31,
	2008	2007
Weighted average outstanding options	2,967,831	2,932,638
Weighted average outstanding warrants	2,700,544	2,700,544

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HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 8. Property and Equipment

Property and equipment consisted of the following:

	March 31, 2008			December 31, 2007
Machinery and equipment	$	547,514		$	546,496
Furniture and fixtures		54,546			48,486
Leasehold improvements		43,993			43,993
		646,053			638,975
Less accumulated depreciation		(527,796	)		(512,466	)
Property and equipment, net	$	118,257		$	126,509

Aggregate depreciation expense for property and equipment during the three months ended March 31, 2008 and 2007 was $15,330 and $24,702, respectively.

Note 9. Intangible Assets

Identifiable intangible assets consisted of the following as of March 31, 2008 and December 31, 2007:

	March 31, 2008			December 31, 2007
Antimicrobial technology	$	222,187		$	222,187
Licensing agreements		61,391			61,391
Patents, pending and approved		834,301			834,301
Total intangible assets		1,117,879			1,117,879
Less accumulated amortization		(705,116	)		(685,397	)
Intangible assets, net	$	412,763		$	432,482

Amortization expense for intangible assets during the three months ended March 31, 2008 and 2007 was $19,719 and $19,720, respectively.

Note 10. Liquidity and Capital Resources

The Company incurred a net loss of $1,274,998 for the three months ended March 31, 2008, and cash used in operations of $783,958. Cash provided by investing activities of $492,922 for the three months ended March 31, 2008, primarily represented the proceeds from sales of auction rate securities, partially offset by the acquisition of assets. Cash flow from financing activities was $2,994,740 for the three months ended March 31, 2008, which reflects the net proceeds from the Company’s issuance of a convertible note. (See Note 2 – Related Party Transaction).

At March 31, 2008, the Company had $3,164,994 in cash and cash equivalents, and $170,000 in non-current marketable securities, as discussed in Note 3. The Company estimates that its cash and cash equivalents will be sufficient to fund its operations at planned levels for the remainder of 2008.

The Company plans to raise substantial additional capital in order to maintain the current level of operations beyond 2008, continue commercialization of its technology and advance its pharmaceutical programs. The Company may raise additional capital through equity or debt financing. However, there is no assurance that additional funding will be available on favorable terms, if at all. If adequate funds are not available, the Company would be required to significantly reduce the scope of operations, which would significantly impede its ability to proceed with current operational plans and could lead to the curtailment of its business.

Note 11. Concentration of Risks

The Company maintains its cash balances in one financial institution, which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash.

13

HELIX BIOMEDIX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

A significant portion of the Company’s revenue is concentrated with a limited number of customers. The following individual customers accounted for 10% or more of revenue for the three months ended March 31, 2008 and 2007:

	March 31, 2008		March 31, 2007
Customer A	17	%	19	%
Customer B	17	%	1	%
Customer C	—		—
Customer D	54	%	—

Note 12. Commitments and Contingencies

Purchase Commitment

In August 2007, the Company entered into an agreement with Peptisyntha, Inc. for the purchase of a certain peptide over a period of eighteen months from the agreement date. The aggregate purchase requirement under this agreement over the eighteen-month period is $234,000. As of March 31, 2008, the Company had placed orders totaling approximately $109,400 under this agreement.

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

Forward-Looking Statements

Our disclosure and analysis in this Quarterly Report contain forward-looking statements, which provide our current expectations or forecasts of future events. Forward-looking statements include, without limitation:

• statements concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth;

• statements about our product development schedule;

• statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments, and any other sources to meet these requirements;

• statements about our plans, objectives, expectations, and intentions; and

• other statements that are not historical facts.

Words such as “may,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “could,” “future,” “target,” and similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in Part II, Item 1A, “Risk Factors” in this Quarterly Report and in Part I, Item 1A, “Risk Factors” in our most recent Annual Report on Form 10-K for the year ended December 31, 2007. You should carefully consider these factors in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Quarterly Report or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we file from time to time with the Securities and Exchange Commission, or SEC, after the date of this Quarterly Report.

Business Overview

Helix BioMedix, Inc. is a biopharmaceutical company with an extensive library of structurally diverse bioactive peptides and patents covering hundreds of thousands of peptide sequences. Our mission is to enrich clinical practice and the patient/consumer experience by developing and commercializing topically-applied products which offer the benefits of our advanced bioactive small molecule peptide technology. Our vision is to be recognized as the world leader in the identification, qualification and commercialization of natural and synthetic peptides.

We have developed short, small-chain peptides with anti-infective, anti-inflammatory properties such as the stimulation of cell proliferation and migration. These peptides are targeted for use as ingredients in cosmetics and as new topical therapeutics. Possible applications include anti-aging skin care, acne treatment, wound healing, and the treatment of fungal dermatoses.

During our initial commercialization efforts, we successfully identified and characterized bioactivities exhibited by natural innate-immunity peptide sequences that have potential cosmetic and therapeutic applications. By re-engineering these peptides, we created small, cost-effective bioactive molecules that not only are capable of delivering demonstrable benefits in skin care products but also have the potential to deliver therapeutic benefits as topically applied dermatological products. Subsequently, we have leveraged our knowledge of peptide sequences to expand the application of such molecules to multiple areas within dermatology.

In addition to our focus on peptides for use in cosmetic skin care and dermatological therapies, we believe our peptide library also promises new opportunities in certain therapeutic areas such as the prevention of Methicillin ResistantS. aureus (MRSA) infection.

Our business was incorporated on February 2, 1988, and until 2000, we operated primarily as a technology development company, generating a portfolio of intellectual property focused on identifying and developing synthetic bioactive peptides. In 2000, we started to place more emphasis on applying and commercializing the extensive library of patented bioactive peptides that we have developed. During 2007, we began commercializing our peptide technology through license agreements with skin care product manufacturers and consistently generated more than insignificant revenue, which we believe is key evidence that our technology has been accepted in the marketplace. During the third quarter of 2007, we moved from the development stage to the commercialization stage of our business.

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Our goal is to increase our focus on our pharmaceutical programs, and one of our objectives for 2008 is to initiate clinical development of our lead drug candidates. To that end we are exploring both potential partnership opportunities with pharmaceutical companies and potential sources of funding to support in-house clinical development work. We currently believe that in-house clinical development will be required to advance these programs prior to partnering with a pharmaceutical company.

Our website is located atwww.helixbiomedix.com. Information contained on our website is not part of, and is not incorporated into, this Quarterly Report. Our filings with the SEC are available without charge on our website.

Consumer Programs

In 2004, we initiated license agreements with skin care contract manufacturers and materials suppliers for inclusion of certain of our proprietary cosmetics peptides in anti-acne and anti-aging skin care products. We rely on these industry supplier licensees to develop new product opportunities that incorporate our peptides and to create both awareness and demand for our technology among their skin care customer companies.

We believe our peptide technology further holds potential as a technology platform for skin care industry leaders. We collaborate directly with leading skin care companies to identify opportunities for strengthening their brand position with proprietary products featuring our peptide technology.

In 2006, we initiated our first efforts to directly participate in the development of private label products containing our peptide technology. The first such product was developed through a license agreement with DermaVentures, LLC (DermaVentures), a related party, and was launched in late 2007. We plan to introduce additional new products into the marketplace through partnerships with skin care and personal care marketing companies.

Anti-Acne Programs

Acne is the most common skin disorder in the United States, affecting 40 to 50 million Americans. Nearly 85 percent of all people have acne at some point in their lives. By the mid-teens, more than 40 percent of adolescents have acne or acne scarring which requires treatment by a dermatologist. In 2004, the total direct cost associated with the treatment of acne exceeded $2.2 billion in the United States, including substantial costs for prescription and over-the-counter products.

We believe one of our lead peptides promises significant advantages for skin care companies in the over-the-counter acne treatment market. This proprietary peptide may be formulated into products with certain over-the-counter anti-acne ingredients for improvement in blemish-clearing benefits. The skin care benefits of this peptide derive from its ability to bind to a pro-inflammatory substance on the cell wall of the acne-causing bacteria. This pro-inflammatory substance is known to cause much of the redness associated with acne breakouts but, when bound to our peptide, is rendered inactive. Laboratory and clinical testing confirm the additional treatment benefits and higher level of consumer satisfaction associated with formulations that contain our peptide.

A number of companies have formulated and launched anti-acne products incorporating this peptide under license from us. We believe the use of this peptide is advantageous for globally marketed anti-acne products, not only because it supports more favorable outcomes with salicylic acid–based treatment products, but also because it offers a favorable alternative to benzyol peroxide, an ingredient that is limited in application due to regulatory restrictions in certain markets as well as its potential harshness on sensitive skin. We anticipate further anti-acne product introductions in 2008.

Anti-Aging Programs

We have identified and qualified a number of peptides that target changes in the appearance of skin associated with the aging process. Because there are anti-aging skin benefits that derive from the skin’s natural healing process, much of the anti-aging aspect of our peptide library has been derived from the screening processes associated with our pharmaceutical wound healing programs.

Peptides that target improvement in the appearance of aging skin may affect one or more of the age-related skin characteristics: lines and wrinkles, loss of elasticity, loss of firmness and definition, appearance of darkened areas or general unevenness of skin tone, rough texture, and thinning of the skin.

One of our lead anti-aging peptides targets several aspects of support for the skin’s structural matrix. This peptide has been demonstrated to accelerate the migration of cells from the skin’s uppermost layer to strengthen areas prone to lines and wrinkles and to impart a smoother, firmer appearance. This peptide has been clinically

16

demonstrated to provide benefits equivalent to those of the leading prescription anti-aging products, but without the risk of irritation associated with aggressive retinoids. This peptide has been formulated into various cosmetic skin care products that are currently in the marketplace, and we anticipate further anti-aging product introductions in 2008.

We believe that, through the isolation of peptides derived from naturally recurring sequences that we call Replikines™, and specific combinations of those Replikines™ that we call Combikines™, we can increase the benefits derived from peptide applications in cosmetic anti-aging skin products. In August 2007, we entered into a license agreement with Goldschmidt GmbH, a wholly owned subsidiary of Evonik GmbH, a leading supplier of cosmetic ingredients. The agreement provides exclusive rights to certain of our peptides targeted towards skin care and personal care applications.

Recently identified peptide opportunities for our anti-aging portfolio include a group of synthetic peptides that we have branded as Modukines™. These peptides work to interrupt processes that accelerate the undesirable changes in skin associated with aging, including the accelerated breakdown of collagen and elastin, the skin’s key structural components. We believe several of these Modukines™ hold commercial promise beyond the area of anti-aging skin care as they support the skin’s resiliency.

We are also working to identify opportunities for peptides to interrupt the pathways that lead to undesirable discoloring and mottled skin tone. This effort is timely as hydroquinone, one of the key ingredients used for such cosmetic benefits in the United States, has been under scrutiny by the Food and Drug Administration (FDA), creating a need that we believe may be safely and effectively addressed with peptides that we are currently developing. We have identified numerous opportunities for the addition of peptides into therapeutic moisturizers and shampoos in support of the healthy appearance and comfort of skin and scalp. Potential benefits of adding certain peptides to cosmetically therapeutic moisturizers and hair care products include resistance to secondary infection associated with compromised skin, restoration of healthy appearance to cracked, flaky feet that do not respond to ordinary moisturizers, reduced flaking, and improved comfort associated with conditions of the scalp.

Pharmaceutical Programs

We are developing a novel, broad-spectrum, topical anti-infective for the treatment of skin and wound infections and the prevention ofStaphylococcus aureus (S. aureus) infections including those caused by MRSA. These programs are based upon a first-in-class family of molecules known as lipohexapeptides (or small molecule peptides) that we developed to specifically combine the attributes of small molecule natural products with the advantages of antimicrobial peptides. This new class of anti-infective peptide has demonstrated significant improvement in activity, bothin vitro andin vivo, over traditional antimicrobial peptides.

As with traditional antimicrobial peptides, our lead lipohexapeptides are rapidly cidal, fail to engender resistancein vitro, are readily synthesized and do not exhibit cross-resistance with other antibiotics. However, these molecules also have the advantage of being more stable, safer and more cost-effective to manufacture than traditional antimicrobial peptides. In addition, primarily due to acylation (addition of a lipid), these molecules are significantly more active in complex biological environments such as serum or wound fluid. As a result, lipohexapeptides exhibit potent activity in animal infection models.

In pre-clinical testing our lead molecules exhibited broad-spectrum antimicrobial activity against significant bacterial pathogens such asS. aureus,Streptococcus pyogenes, andPseudomonas aeruginosa,and also pathogenic fungi such as Candida and Trichophyton species. This activity was maintained against antibiotic-resistant organisms such as MRSA and Vancomycin Resistant Enterococci. Our lead molecules have demonstrated significant activity in both bacterial and fungal animal infection models. In aS. aureus abraded skin infection model, our lead lipohexapeptides significantly reduced the number of bacteria following three days of once-daily dosing, and in many cases, our peptide eradicated the pathogen. In a guinea pig dermatophytosis model, our lead peptide candidates significantly reduced pathogen count and delivered clinical benefits comparable to Terbinafine, a drug approved by the FDA for onchomycosis. In both animal models, toxicity was not significantly different from that without peptides.

Acne Anti-infective

The National Institute of Arthritis, Musculoskeletal and Skin Disorders estimate that 17 million people are affected by acne in the United States every year. Acne is the most common skin disorder of adolescence and early adulthood (ages 11-30), affecting 80% of that demographic. Generally, mild to moderate cases are treated with topical medications, with more severe cases being treated with systemic or a combination of topical and systemic therapies. The global market for prescription anti-acne products is currently estimated to be $2.0 billion, and the largest segment of this is attributed to topical medications. While topical antibiotics such as Clindamycin make up a large part of this market, providing significant clinical benefit, the emergence of resistance to antibiotics such as Clindamycin occurred as early as 1979.

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Our lipohexapeptide program is specifically directed at developing small, stable, and highly potent antimicrobial peptides capable of delivering therapeutic benefit within the clinical environment. These molecules overcome the specific challenges typically associated with acne such as the ability to work in an oil and serum environment and the ability to kill organisms deep within a pore. The efficacy observed in the dermatophytosis model described above demonstrates the penetration and antimicrobial effects of these molecules in the hair follicle of the host.

MRSA

There is an ever-increasing global problem of antimicrobial resistance. This phenomenon has been well documented by the Centers for Disease Control and Prevention, which recently identified a 28.5% increase in S. aureus oxacillin (methicillin) resistance in hospitals taking part in the National Nosocomial Infections Surveillance system from 1992-2003. Their report concludes that action is necessary to control the spread of this organism, and, to this end, several European countries have been successful in identifying and treating colonized patients quickly. The ability of lipohexapeptides to safely and effectively killS. aureus in an abraded skin infection model, and the fact that this class of molecule exhibits potent activity against both methicillin and mupirocin (current therapy) resistant strains, support its development potential. The broad spectrum of activity exhibited by lipohexapeptides also enables possible application to chronic wounds, burn wounds, and trauma wounds in which multiple pathogens can cause significant morbidity and mortality. The market for such topical anti-infectives is currently estimated to be $1.5 billion per year.

Topical fungal infections

Trichophyton species are the major cause of a significant number of fungal skin infections including, athlete’s foot, tinea capitis (scalp ringworm) and onychomycosis (nail fungus). Up to 70% of Americans have athlete’s foot at any given time, 13% of United States school children (85% of children in many other countries) test positive for tinea capitis, and 22-40% of Americans 51-100 years of age have onychomycosis. Worldwide sales for prescription topical antifungals consequently exceeded $1.0 billion in 2006, with a similar level of sales for over-the-counter products addressing these conditions. Our pre-clinical data have shown that our lead molecules are capable of treating Trichophyton infections and hold great promise for multiple dermatological indications.

Critical Accounting Policies and Estimates

The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, our management evaluates its estimates and judgments, including those related to revenue recognition, research and development costs, capitalized patent costs and valuation of stock options and warrants. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition.We generate revenue from peptide sales, technology licenses and joint development agreements. Revenue under technology licenses may include up-front payments and royalties from product sales. Revenue associated with joint development agreements primarily consists of payments for completion of development milestones. For agreements with multiple elements, we follow the Emerging Issues Task Force (EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” to determine whether each element can be separated into a unit of accounting based on the following criteria: (1) the delivered items have value to the customer on a stand-alone basis; (2) any undelivered items have objective and reliable evidence of fair value; and (3) delivery or performance of the undelivered items that have a right of return is probable and within our control. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, we allocate revenue among the separate units of accounting based on their estimated fair values. If the criteria are not met, elements included in an arrangement are accounted for as a single unit of accounting and revenue is deferred until the period in which the final deliverable is provided. When the period of deferral cannot be specifically identified from the agreement, we estimate the period based upon other factors contained within the agreement. Our management continually reviews these estimates, which could result in a change in the deferral period and the timing and the amount of revenue recognized.

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• Peptide Sales. Peptide sales are recognized when title transfers to the customer, typically upon shipment, and collection is reasonably assured. In the future, peptide sales may be transacted directly between the licensees and a third-party manufacturer, which could have an adverse effect on our revenue.

• Licensing Fees. We recognize up-front license payments at the point when persuasive evidence of an agreement exists, delivery has occurred or services have been performed, the price is fixed and determinable and collection is reasonably assured. Royalties from licensees are recorded as earned when royalty results are reliably measured and collection is reasonably assured. We rely on the licensees to provide royalty information as it cannot be reasonably estimated.

• Development Fees.We record revenue associated with performance milestones as earned when we have completed the specific milestones as defined in the joint development agreements and there are no uncertainties or contingencies regarding collection of the related payment. Payments received for which the earnings process is not complete are recorded as deferred revenue.

Marketable Securities. Marketable securities, consisting of auction rate securities (ARS), are reported at fair value with the related unrealized gains and losses included as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Realized gains, losses, and declines in value of securities judged to be other than temporary are included in other non-operating income (expense). We estimate fair value based on valuation techniques defined by Financial Accounting Standards Board Statement (SFAS) No. 157, “Fair Value Measurements” (SFAS 157), including using observable inputs such as quoted prices in active market for identical or similar investments. When observable inputs are not sufficiently available, we estimate fair value by incorporating assumptions that market participants would use in their estimates of fair value, which may include credit quality, estimates on the probability of the securities being called prior to final maturity, the liquidity of the securities and indications of value from reports of developing secondary markets for ARS.

Research and Development Costs.Our research and development costs are expensed as incurred. Research and development expenses include, but are not limited to, payroll and benefit expenses, lab supplies and expenses, and external trials and studies. In instances where we enter into agreements with third parties for research and development activities, which may include personnel costs, supplies and other costs associated with such collaborative agreements, we expense these items as incurred.

Capitalization of Patent Costs. We capitalize the third-party costs associated with patents that have been issued or entering into licenses associated with our underlying technology. Our policy for the capitalization of patent costs is to begin amortization of these costs at the time they are incurred. We review our patent portfolio to determine whether any such costs have been impaired and are no longer being used in our research and development activities. To the extent we no longer use certain patents, the associated costs will be written-off at that time.

Valuation of Stock Options Granted to Employees, Officers and Non-Employee Directors for Board Service.The fair value of each option granted to employees, officers and non-employee directors for board service is estimated on the date of grant using the Black-Scholes option valuation model. The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and our experience. Options granted are valued using the single option valuation approach, and the resulting expense is recognized using the cliff, straight-line attribution method, consistent with the single option valuation approach. Compensation expense is recognized only for those options expected to vest.

Valuation of Warrants and Non-Employee Stock Options Accounted for as Derivative Liabilities.In accordance with SFAS 133 and EITF 00-19, we are required to classify the fair value of warrants and non-employee stock options as derivative liabilities as there is the potential that we will have an insufficient number of authorized common shares available to settle these instruments as a result of the issuance of the convertible note payable on February 14, 2008 to a related party and the potential contractual obligation to grant the associated warrant.

We value these warrants and options using a Black-Scholes model and use estimates for an expected dividend yield, a risk-free interest rate, and expected volatility. At each reporting period, as long as the warrants and non-employee stock options are outstanding and there is the potential for an insufficient number of authorized shares available to settle these instruments, the warrants and options will be revalued and any difference from the previous valuation date will be recognized as a change in fair value of outstanding warrants in our statement of operations.

Valuation of Warrant Related to Convertible Note Payable, Related Party.In accordance with SFAS 133 and EITF 00-19, we are required to classify the fair value of the warrant that may be granted in connection with the convertible note payable to related party as a derivative liability as there is the potential that we will have an insufficient number of authorized common shares available to settle this instrument.

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We value this warrant using a Black-Scholes model and use estimates for an expected dividend yield, a risk-free interest rate, and expected volatility together with management’s estimate of the probability of issuance of the warrant. At each reporting period, as long as the warrant is potentially issuable, or is outstanding, and there is the potential for an insufficient number of authorized shares available to settle the warrant, the warrant will be revalued and any difference from the previous valuation date will be recognized as a change in fair value of the outstanding warrant in our statement of operations.

Valuation of Derivative Asset Related to Convertible Note Payable, Related Party.In accordance with SFAS 133, we are required to separately account for the fair value of our right to call the convertible note payable, related party and automatically convert it to equity at the price of equity securities issued in the sale of shares of our equity securities that raises an aggregate amount of at least $5.0 million on or before June 29, 2008 (See Note 2 of the Notes to our Condensed Financial Statements).

We value the call option using a Black-Scholes model and use estimates for an expected dividend yield, a risk-free interest rate, and expected asset-based volatility, together with management’s estimate of the probability of exercise of the call option. At each reporting period, as long as the call option is outstanding, the call option will be revalued and any difference from the previous valuation date will be recognized as a change in fair value in our statement of operations. The right associated with the call option expires on June 29, 2008 if unexercised.

Results of Operations

As of March 31, 2008, our accumulated deficit was approximately $28.8 million. We may continue to incur substantial operating losses over the next several years, due principally to the costs associated with our current level of operations, continued commercialization of our technology, and initiation of our pharmaceutical programs. Our net loss for the first quarter of 2008 was approximately $1,275,000, or $0.05 per share, compared to a net loss of approximately $812,500, or $0.03 per share, for the same period in 2007. The increase in net loss for the first quarter of 2008 compared to the same period in 2007 was primarily due to increases in cost of revenue of approximately $108,200, in operating expenses of approximately $45,800 and in net other non-operating expense of approximately $490,500, partially offset by an increase in revenue of approximately $182,000.

Revenue

Revenue in the first quarter of 2008 and 2007 consisted primarily of license fees, development fees and peptide sales as summarized in the table below.

	Three Months Ended March 31,
	2008		2007		Change
License and development fees	$	147,062	$	29,494	398.6	%
Peptide sales		93,308		28,928	222.6	%
Total revenue	$	240,370	$	58,422	311.4	%

Revenue for the three months ended March 31, 2008 compared to the same period last year increased by approximately $182,000 or 311.4%. The increase was comprised of increases in development fees and peptide sales, partially offset by a decrease in licensing fees. Development fees were $130,000 for the first quarter of 2008 compared to $0 in the first quarter of 2007, due to the timing of the achievement of certain milestones. Peptide sales increased by approximately $64,400 or 222.6% while licensing fees decreased by approximately $12,400 or 42.1% for the first quarter of 2008 compared to the same period last year. The decline in licensing fees was due primarily to the timing of royalty reporting from licensees.

Cost of Revenue

Cost of revenue consists of cost of peptides sold and other cost of revenue, which may include the cost of materials used in development activities and professional fees incurred related to development agreements. The following table provides cost of revenue data for the three months ended March 31, 2008. There was no cost of revenue for the three months ended March 31, 2007.

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	Three Months Ended March 31, 2008
Cost of peptide sales	$	69,384
Percentage of total revenue		28.9	%
Percentage of related revenue		74.4	%
Other cost of revenue	$	38,781
Percentage of total revenue		16.1	%
Percentage of related revenue		26.4	%

Cost of peptide sales for the three months ended March 31, 2008 was approximately $69,400 compared to $0 for the same period in 2007. Peptide sales in the first quarter of 2008 resulted in a positive margin because peptides are sold at cost only to certain customers based on the terms of respective licensing agreements. The cost of peptide sales for the three months ended March 31, 2007, was $0 because the peptides sold in that period had been written down to their net estimated realizable value in 2006.

Other cost of revenue for the three months ended March 31, 2008 consisted primarily of professional fees for services performed in connection with a joint development agreement.

Research and Development Expenses

Research and development (R&D) expenses consist primarily of salaries and benefit expenses, stock-based compensation, cost of external studies and trials, and contract and other outside service fees related to our R&D efforts. R&D expenses for the first quarter of 2008 and 2007 are described in the table below.

	Three Months Ended March 31,
	2008			2007			Change
Research and development expenses	$	195,177		$	205,497		(5.0	)%
Percentage of total revenue		81.2	%		351.7	%

R&D expenses for the three months ended March 31, 2008 compared to the same period last year decreased by approximately $10,300 or 5.0%, due primarily to lower spending in lab consumables and external studies of approximately $26,400 and a decrease of approximately $3,000 in stock-based compensation, partially offset by an increase of approximately $15,300 in employee-related expenses and $3,800 of other R&D expenses. For the remainder of 2008, we expect R&D expenses to remain relatively consistent with the level experienced during the first quarter of 2008.

Marketing and Business Development Expenses

Marketing and business development (M&BD) expenses consist primarily of salaries and benefit expenses, stock-based compensation, consulting fees and various marketing costs. M&BD expenses for the first quarter of 2008 and 2007 are described in the table below.

	Three Months Ended March 31,
	2008			2007			Change
Marketing and business development expenses	$	114,687		$	104,211		10.1	%
Percentage of total revenue		47.7	%		178.4	%

M&BD expenses for the three months ended March 31, 2008, increased by approximately $10,500 or 10.1% compared to the same period in 2007. The increase was primarily attributable to increases of approximately $27,300 in consulting fees and $7,000 in marketing expenses, partially offset by approximately $24,300 in employee-related expenses and stock-based compensation. For the remainder of 2008, we expect M&BD expenses to remain relatively consistent with the level experienced during the first quarter of 2008.

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General and Administrative Expenses

General and administrative (G&A) expenses consist primarily of salaries and benefit expenses, stock-based compensation, consulting fees and general corporate expenditures. G&A expenses for the first quarter of 2008 and 2007 are described in the table below.

	Three Months Ended March 31,
	2008			2007			Change
General and administrative expenses	$	433,369		$	390,707		10.9	%
Percentage of total revenue		180.3	%		668.8	%

G&A expenses for the three months ended March 31, 2008, increased by approximately $42,700 or 10.9% compared to the same period in 2007. The increase was primarily due to increases of $17,800 in stock-based compensation, $17,600 in consulting fees, $5,000 in compliance costs associated with the Sarbanes-Oxley Act of 2002 and $9,200 in other G&A expenses, partially offset by a decrease of $6,900 of employee-related expenses. For the remainder of 2008, we expect G&A expenses to remain relatively consistent with the level experienced during the first quarter of 2008.

Accounting, Legal and Professional Fees Expenses

Accounting, legal and professional fees expenses for the first quarter of 2008 and 2007 are described in the table below.

	Three Months Ended March 31,
	2008			2007			Change
Accounting, legal and professional fees expenses	$	160,815		$	148,477		8.3	%
Percentage of total revenue		66.9	%		254.1	%

Accounting, legal and professional fees expenses for the three months ended March 31, 2008, increased by approximately $12,300 or 8.3% compared to the same period in 2007. The increase was primarily attributable to increased financial audit fees and legal fees associated with patent applications, license agreement negotiations and other corporate matters. For the remainder of 2008, we expect accounting, legal and professional fees to increase from the level experienced during the first quarter of 2008 due to increased activities associated with our capital raising efforts.

Depreciation and Amortization Expenses

Depreciation and amortization expenses for the first quarter of 2008 and 2007 are described in the table below.

	Three Months Ended March 31,
	2008			2007			Change
Depreciation and amortization expenses	$	35,049		$	44,422		(21.1	)%
Percentage of total revenue		14.6	%		76.0	%

Depreciation and amortization expenses for the three months ended March 31, 2008, decreased by approximately $9,400 or 21.1% compared to the same period last year. The decrease was primarily due to incremental depreciation expenses from assets purchased being offset by reduced depreciation from other assets becoming fully depreciated. For the remainder of 2008, we expect depreciation and amortization expenses for to be consistent with the levels experienced in the first quarter of 2008.

Other Income (Expense)

Other income (expense) consists of interest income, interest expense related to the convertible note payable, accretion of discount on the convertible note payable, change in valuation of derivative instruments and unrealized loss related to ARS deemed to be other than temporary. Other expense, net for the first quarter of 2008 and 2007 are summarized in the table below.

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	Three Months Ended March 31,
	2008			2007		Change
Interest income	$	18,790		$	22,403	(16.1	)%
Interest expense on convertible note payable, related party		(30,578	)		—	*
Accretion of discount on convertible note payable, related party, net		(285,415	)		—	*
Change in value of derivative instruments, including related party, net		(140,903	)		—	*
Unrealized loss on marketable securities		(30,000	)		—	*
Other expense, net	$	(468,106	)	$	22,403	(2,189.5	)%

* percentage not meaningful

Interest Income.Interest income for the first quarter of 2008 decreased by approximately $3,600 or 16.1% compared to the same period in 2007, due primarily to lower interest rates. For the remainder of 2008, we expect interest income to decrease gradually as our balance in cash and cash equivalents decreases.

Interest Expense.During the three months ended March 31, 2008, interest expense related to the convertible note payable issued to a related party in February 2008 was approximately $30,600. As the interest expense recorded in the first three months of 2008 reflected the expense incurred during only a portion of the quarter, we anticipate future quarterly interest expense to exceed the level experienced in the first quarter of 2008 until the note is repaid or converted into our common stock.

Accretion of Discount on Convertible Note Payable, Related Party.Accretion of discount on convertible note payable for the three months ended March 31, 2008 was approximately $285,400, which represented the increase in carrying value of the convertible note from the issuance date of February 14, 2008 through March 31, 2008.

Change in Value of Derivative Instruments. During the three months ended March 31, 2008, the change in fair value of the derivative instruments resulted in a net expense of approximately $140,900, comprised of an increase of approximately $222,800 in the fair value of the warrant related to the convertible note payable and a decrease of $162,300 in fair value of the call option, partially offset by a decrease of approximately $244,200 in the fair value of the outstanding warrants and non-employee stock options. The change in fair value of these derivative instruments depends on a number of factors, including risk-free interest rates, stock price volatility and estimated expected terms for these instruments, and, for the warrant and call option related to the convertible note payable, the probability of exercise. For each reporting period, as long as the derivative instruments are outstanding, or are potentially issuable, and there is the potential for an insufficient number of authorized shares available to settle the derivative liabilities, they will be revalued and any difference from the previous valuation date will be recognized as a change in fair value and charged or credited to change in fair value of derivative liabilities.

Unrealized Loss on Marketable Securities.For the three months ended March 31, 2008, we recognized an unrealized loss of $30,000 on our investment in ARS due to the current lack of liquidity associated with these investments. We will continue to monitor and evaluate these investments as there is no assurance as to when the market for this investment class will stabilize.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the private sale of debt and equity securities. Our principal sources of liquidity are cash, cash equivalents and available-for-sale marketable securities. As of March 31, 2008, we had approximately $3.2 million in cash and cash equivalents and $170,000 in long-term available-for-sale marketable securities, compared to approximately $461,300 in cash and cash equivalents and $700,000 in short-term marketable securities at December 31, 2007. The increase in cash and cash equivalents from December 31, 2007, was primarily attributable to the net proceeds of approximately $3.0 million from our issuance of a convertible note payable and $500,000 from sales of marketable securities, partially offset by cash used in operations of approximately $784,000 during the first three months of 2008.

We use a professional investment management firm to manage a portion of our invested cash. At March 31, 2008, our available-for-sale marketable securities, comprised of ARS, were $200,000 at par value. These securities are structured to allow for interest rate resets at approximately every 28 days, but with contractual maturities that are well in excess of ten years. Historically, the carrying value of ARS approximated fair value due to the frequent interest rate resets. Of the ARS we held, an aggregate of $100,000 (par value) was issued by state agencies and is supported by student loans for which repayment is substantially guaranteed by the U.S. government under the

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Federal Family Education Loan Program (FFELP). The remaining $100,000 (par value) of our ARS was issued by municipalities and repayment is insured by MBIA Insurance Corporation, a bond insurance company. Our ARS are rated by the major independent rating agencies as AAA investments. Until early February 2008, the ARS market was fairly liquid and we were able to auction to sell these securities at par at the end of each reset period or continue to hold them. During February 2008, ARS increasingly failed at auction due to sell orders exceeding buy orders. Since March 2008, we have experienced failed auctions of our ARS. These failures are not believed to be a credit issue, but rather are caused by a lack of liquidity. While we continue to earn and receive interest on these investments, we deemed that the estimated fair value of these ARS no longer approximates par value. We concluded that the fair value of these ARS at March 31, 2008 was $170,000, a decline of $30,000 from par value. We considered this decline in fair value as other than temporary and, accordingly, have recorded an unrealized loss of $30,000 in other non-operating expense in the first quarter of 2008. Further, in the event that we need to access this $170,000 of our investments in ARS, we may not be able to do so without a loss of principal until (1) a future auction of these securities is successful, (2) we are able to sell the securities in a secondary market, or (3) the issuer calls the securities pursuant to a mandatory tender or redemption prior to maturity. As such, our investment in ARS currently lacks short-term liquidity and was therefore reclassified as non-current marketable securities as of March 31, 2008. We will continue to monitor and evaluate these investments as there is no assurance as to when the market for this investment class will stabilize.

Cash used in operating activities for the three months ended March 31, 2008, was approximately $784,000, derived primarily from the net loss for the period of $1,275,000, adjusted by non-cash expenses, including approximately $35,000 of depreciation and amortization of intangible assets, $26,400 of stock-based compensation, $30,600 of interest expense, $285,400 of accretion of discount on the convertible note payable, $140,900 of change in fair value of derivative instruments, $30,000 of unrealized loss on marketable securities and a net decrease of working capital, excluding cash, cash equivalents and available-for-sale marketable securities, of approximately $57,300. Cash used in operations for the three months ended March 31, 2007, was approximately $753,200, due primarily to a net loss for the period of approximately $812,500, adjusted by non-cash expenses, including $44,400 of depreciation and amortization and $21,500 of stock-based compensation, and a net increase in working capital, excluding cash, cash equivalents and available-for-sale marketable securities, of $6,600.

Accounts receivable increased by $18,200 and $34,000 during the three months ended March 31, 2008 and 2007, respectively. The increases were primarily attributable to the timing of peptide orders, royalty reports received from our licensees and the achievement of certain milestones. Inventory, comprised of peptides held for resale, decreased by approximately $14,800 in the first quarter of 2008, due primarily to increased peptide sales. Deferred revenue decreased by $130,000 and $10,000 in the three months ended March 31, 2008 and 2007, respectively. As our deferred revenue is typically associated with license and development agreements, the decreases were due primarily to the timing of the achievement of certain milestones.

During the three months ended March 31, 2008 and 2007, our investing activities consisted primarily of purchases, sales and maturities of available-for-sale marketable securities, and acquisition of capital equipment. Cash provided by investing activities was approximately $492,900 during the first quarter of 2008, consisting of sale proceeds of marketable securities of $500,000, partially offset by purchases of capital equipment of approximately $7,100. For the three months ended March 31, 2007, cash used by investing activities was approximately $21,800, consisting of net purchases of marketable securities of $20,000 and acquisition of capital equipment of approximately $1,800. For 2008, we do not expect the level of capital expenditures to be significant.

Cash provided by financing activities for the three months ended March 31, 2008 and 2007 was approximately $3.0 million and $2.1 million, respectively. In February 2008, we issued to RBFSC, Inc., a related party, a convertible promissory note (the Note) in the principal amount of $3.0 million with an interest rate of 8% per annum. The principal balance and accrued interest are due on the earlier of February 14, 2010, or upon an event of default under the Note, including in the event that we file for bankruptcy. (See Note 2 of the Notes to our Condensed Financial Statements for a detailed discussion of the Note.) On March 5, 2007, we closed a private equity financing, receiving cash of approximately $2.0 million in exchange for 2,666,666 shares of $0.001 par value common stock. In a second closing held on March 26, 2007, we received cash of approximately $148,750 in exchange for 198,332 shares of $0.001 par value common stock.

Based on the current status of our operating plans and product commercialization development, we estimate that our existing cash, cash equivalents and marketable securities will be sufficient to fund our operations at current levels through the remainder of 2008. We will need substantial additional capital in order to maintain the current level of operations beyond 2008, continue commercialization of our technology and advance our pharmaceutical programs. Accordingly, we are making preparations to raise additional funding, which may include debt and/or equity financing. However, there is no assurance that additional funding will be available on favorable terms, if at all. If we are unable to obtain the necessary additional funding, we would be required to significantly reduce the scope of operations, which would significantly impede our ability to proceed with current operational plans and could lead to the curtailment of our business.

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The amount of capital we will need in the future will depend on many factors, including capital expenditures and hiring plans to accommodate future growth, research and development plans, future demand for our products and technology, and general economic conditions.

Contractual Obligations and Purchase Commitments

The following table summarizes our contractual obligations and purchase commitment and the effect such obligations are expected to have on liquidity in future periods as of March 31, 2008:

Contractual Obligations and Purchase Commitments	Less than 1 year		More than 1 year		Total
Operating lease	$	75,700	$	51,464	$	127,164
Purchase obligations(1)		124,627		—		124,627
Convertible note payable, related party and related accrued interest (2)		—		3,030,247		3,030,247
Total contractual obligations and purchase commitments	$	200,327	$	3,081,711	$	3,282,038

(1) On August 2, 2007, we entered into an agreement with Peptisyntha, Inc. for the purchase of a certain peptide over a period of eighteen months from the agreement date. The aggregate purchase requirement under this agreement over the eighteen-month period is $234,000. As of March 31, 2008, we had purchased a total of approximately $109,400 under this agreement.

(2) Not included is the accretion of debt discount related to the convertible note payable, related party. Interest is accrued at the rate of 8% per annum and is due and payable on the earlier of February 10, 2010 or when called by the note holder upon an event of default, including in the event we file for bankruptcy. Assuming no principal prepayments on this convertible note payable and no conversion into equity before February 10, 2010, we would incur approximately $480,700 of total interest on the note.

The settlements of derivative liabilities associated with the convertible note payable, related party are excluded from the above table as reasonably reliable estimates of the timing cannot be made.

Recent Accounting Pronouncements

There have been no significant changes during the three months ended March 31, 2008 in recent accounting pronouncements other than as described in Note 4 of our Notes to Condensed Financial Statements that have an impact on our results of operations and financial position from those described in our Annual Report on Form 10-K for the year ended December 31, 2007.

We implemented SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115,” and EITF No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities,” effective January 1, 2008, the implementation of which did not have an impact on our financial statements.

ITEM 4. Controls and Procedures.

We carried out an evaluation, under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings.

There has been no change in our internal control over financial reporting during the quarter that ended March 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1A. Risk Factors.

There are numerous factors that affect our business and results of operations, many of which are beyond our control. Please see our Annual Report on Form 10-K for the year ended December 31, 2007 for a description of some of the risks and uncertainties that we face. There have been no material changes in our risk factors from those described in that Annual Report, except as set forth below. If any of those risks were to occur, our business, operating results and financial condition could be seriously harmed.

A substantial portion of our investment is invested in auction rate securities which have faced recent market failures. Failures in these auctions may affect our liquidity.

At December 31, 2007, we held $700,000 of investment in the form of auction rate securities (ARS). These securities are structured to allow for interest rate resets at approximately every 28 days, but with contractual maturities that are well in excess of ten years. Until early February 2008, the ARS market was fairly liquid and we were able to auction to sell these securities at par at the end of each reset period or continue to hold them. During the first two months of 2008, we liquidated $500,000 of our investment in ARS at par and held the proceeds in cash and cash equivalents. During February 2008, ARS increasingly failed at auction due to sell orders exceeding buy orders. Since March 2008, our ARS have experienced failed auctions. At March 31, 2008, we held $200,000 (at par value) of investment in the form of ARS. While we continue to earn and receive interest on these investments, the estimated fair value of these ARS no longer approximates par value due to the lack of liquidity. We concluded that the fair value of these ARS at March 31, 2008 was $170,000, a decline of $30,000 from par value. We considered this decline in fair value as other than temporary and, accordingly, have recorded an unrealized loss of $30,000 in other non-operating expense in the first quarter of 2008. Further, in the event that we need to access this $170,000 of our ARS, we may not be able to do so without a loss of principal until (1) a future auction of these securities is successful, (2) we are able to sell the securities in a secondary market which is not currently active, or (3) the issuer calls the securities pursuant to a mandatory tender or redemption prior to maturity. As such, our investment in ARS currently lacks short-term liquidity and was therefore reclassified as non-current marketable securities as of March 31, 2008. We will continue to monitor and evaluate these investments as there is no assurance as to when the market for this investment class will stabilize. If the auctions continue to fail, or we determine that one or more of the assumptions used in estimating the fair value of the auction rate securities needs to be revised, we may be required to record an additional impairment on the auction rate securities in future periods. Additionally, our ability to liquidate and fully recover the carrying value of the ARS in the near term may be limited or not exist.

We issued a convertible promissory note to a related party, the conversion of which could require us to issue a significant number of shares of our common stock and amend our certificate of incorporation to increase the number of shares of common stock reserved for issuance thereunder.

In February 2008, we issued to RBFSC, Inc. (RBFSC) a convertible promissory note in the principal amount of $3.0 million with an interest rate of 8% per annum. All unpaid principal and accrued interest are due on the earlier of February 14, 2010, or upon an event of default under the note, including in the event that we file for bankruptcy. In the event that we close an equity financing on or before June 29, 2008, in which we sell shares of our equity securities for an aggregate amount of at least $5.0 million, the unpaid balance of the note and related accrued interest will automatically convert into the equity securities issued in the equity financing, at the price of such equity securities issued in the equity financing. In the event we do not consummate an equity financing on or before June 29, 2008, the unpaid principal balance of the note and accrued interest may be converted, at the option of the holder, into shares of our common stock at a price equal to 80% of the average per share closing price of our common stock during the 90-day period preceding the conversion date, and we shall issue to RBFSC a warrant to purchase that number of shares of our common stock equal to $750,000 divided by the per share closing sale price of our common stock on June 30, 2008.

As of March 31, 2008, (i) the closing price of our common stock was $0.69 per share and 1,086,956 shares of common stock would have been issuable upon exercise of the warrant as of that date and (ii) the average closing price of our common stock during the preceding 90-day period was $0.68 per share and 5,570,307 shares of common stock would have been issuable upon conversion of the note as of that date. If the price of our common stock declines significantly, RBFSC would be entitled to acquire a significant number of shares of common stock upon conversion or the note and/or exercise of the warrant, which could constitute a majority of our outstanding capital stock. The president and director of RBFSC is Frank T. Nickell, who beneficially owned approximately

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26.1% of our outstanding common stock as of March 19, 2008. In addition, we may not have sufficient shares of our authorized capital stock reserved for issuance upon conversion of the note or exercise of the warrant, and stockholder approval would be required in order to amend our certificate of incorporation to increase our authorized capital stock.

The fair value of our outstanding options and warrants, including the warrant that may be issuable to RBFSC, may vary from time to time upon periodic remeasurement, which could have a material impact on our financial statements and results of operations.

In accordance with SFAS 133 and EITF 00-19, we are required to remeasure the fair value of our outstanding non-employee options and warrants at the end of each reporting period, including the warrant that may be issuable to RBFSC as described above. The fair value of these options and warrants is estimated based on many factors, including risk-free interest rates, stock price volatility and estimated expected terms for these instruments, and may therefore be subject to significant variation, which could have a material impact on our financial statements and results of operations.

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ITEM 6. Exhibits.

Exhibit Number (Referenced to Item 601 of Regulation S-K)	Exhibit Description
2.1	Proposal for Approval of Reincorporation of Helix BioMedix, Inc., a Colorado corporation, from Colorado to Delaware (incorporated by reference to Exhibit 2 to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on April 16, 2001)
3.1	Certificate of Ownership and Merger of Helix BioMedix, Inc. a Delaware corporation and Helix BioMedix, Inc., a Louisiana corporation (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on April 16, 2001)
3.2	Certificate of Incorporation of Helix BioMedix, Inc. (incorporated by reference to Exhibit 3-A to the Company’s Annual Report on Form 10-KSB/A filed with the Securities and Exchange Commission on April 30, 2003)
3.3	Certificate of Amendment to the Certificate of Incorporation of Helix BioMedix, Inc. (incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-KSB/A filed with the Securities and Exchange Commission on April 30, 2003)
3.4	Bylaws of Helix BioMedix, Inc. (incorporated by reference to Exhibit 3-B to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on April 16, 2001)
4.1	Rights Agreement dated August 21, 2003 (incorporated by reference to Exhibit 10.27 to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 26, 2004)
4.2	Acceptance and Acknowledgement of Appointment dated January 4, 2004 (incorporated by reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 26, 2004)
10.16*	Manufacturing and Supply Agreement dated as of January 9, 2008 between the Company and Peptisyntha, Inc.
10.17(a)	Convertible Note and Warrant Purchase Agreement dated as of February 14, 2008 between the Company and RBFSC, Inc.
10.17(b)	Convertible Promissory Note dated as of February 14, 2008 between the Company and RBFSC, Inc.
31.1	Certification of the Company’s Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934
31.2	Certification of the Company’s Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934
32.1	Certification of the Company’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2	Certification of the Company’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

* Confidential treatment has been requested for confidential commercial and financial information pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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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.

May 15, 2008

HELIX BIOMEDIX, INC.
	(Registrant)
By:	/s/ R. Stephen Beatty
	R. Stephen Beatty
	President and Chief Executive Officer
	(Principal Executive Officer)
By:	/s/ David H. Kirske
	David H. Kirske
	Vice President and Chief Financial Officer
	(Principal Financial Officer)

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