Form 10-Q

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.

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 October 31, 2008, 25,653,512 shares of the registrant’s common stock were issued and outstanding.

For the Year Ended December 31, 2007 and for the Nine Months Ended September 30, 2008

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 (U.S. GAAP) 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.

The preparation of the Company’s financial statements in conformity with U.S. GAAP 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, but are not limited to, 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, notes payable and obligations related to derivative instruments. Actual results could differ from those estimates.

The results of operations for the three and nine months ended September 30, 2008, are not necessarily indicative of the results of operations that may be achieved for the entire year ending December 31, 2008.

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

In the Condensed Statements of Operations, the reclassifications include (1) marketing and business development expenses being separated from general and administrative expenses, and (2) fees received from a related party and associated costs being presented as administrative services revenue and cost of administrative services revenue, respectively. These reclassifications had no impact on the financial results in the periods presented.

The Company generates revenue from technology licenses, joint development agreements, peptide sales and providing administrative services to a related party. 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, the Company follows 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 the Company’s control. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the Company allocates 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, the Company estimates the period based upon other factors contained within the agreement. Management continually reviews these estimates, which could result in a change in the deferral period and the timing and the amount of revenue recognized.

The Company accounts for its derivative instruments in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19), which require derivative instruments to be classified as permanent equity, temporary equity or as assets or liabilities. In general, the Company’s derivative instruments that either require net-cash settlement or are presumed to require net-cash settlement are recorded as assets and liabilities at fair value and the Company’s derivative instruments that require settlement in shares are recorded as equity instruments.

Valuation of Warrants and Stock Options Unrelated to the Issuance of Convertible Note Payable

In connection with 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, the Company classified the fair value of warrants and non-employee stock options (Other Warrant Liabilities) as derivative liabilities as there was a potential that the Company would not have a sufficient number of authorized common shares available to settle these instruments (see Note 2). The Company valued these warrants and options using a Black-Scholes model and used 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 were outstanding and there was the potential for an insufficient number of authorized shares available to settle these instruments, the warrants and options were revalued and any difference from the previous valuation date was recognized as a change in fair value in the Company’s statement of operations.

On June 27, 2008, the Company entered into an amendment to the convertible note payable (see Note 2) which effectively extinguished the original note payable and related derivative instruments, including the potential contractual obligation to grant the associated warrant. In accordance with the guidance of EITF Issue No. 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments,” the Company accounted for this modification as an extinguishment of the original note payable and recorded the amended note payable as new debt. Among other changes, the amended note limits the number of shares issuable under it and therefore eliminates the net-cash settlement requirement for Other Warrant Liabilities. As a result, the Company is no longer required to account for Other Warrant Liabilities as derivative liabilities. The June 27, 2008 fair value of the Other Warrant Liabilities was therefore reclassified to additional paid-in capital.

In accordance with SFAS 133 and EITF 00-19, the Company classified the fair value of the warrant that may have been granted in connection with the convertible note payable issued on February 14, 2008 (see Note 2) as a derivative liability as there was a potential that the Company would not have a sufficient number of authorized common shares available to settle this instrument. The Company valued this warrant using a Black-Scholes model and used 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 was potentially issuable and there was a potential for an insufficient number of authorized shares available to settle the warrant, the warrant was revalued and any difference from the previous valuation date was recognized as a change in fair value in the Company’s statement of operations.

In connection with the issuance of the amended note payable, the Company issued to the related party a warrant to purchase up to 750,000 shares of the Company’s common stock at an exercise price of $1.00 per share. Pursuant to the guidance in EITF 00-19, this warrant is accounted for as an equity instrument.

Valuation of Conversion Rights Related to Convertible Note Payable, Related Party

In connection with the issuance of the convertible note payable on February 14, 2008 and under the guidance of SFAS 133, the Company was required to separately account for the fair value of the Company’s right to automatically convert the note payable 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 $5,000,000 on or before June 29, 2008 (see Note 2).

On June 27, 2008, the Company entered into an amendment to the convertible note payable (see Note 2) which effectively extinguished the original note payable, including its embedded derivative instruments. The June 27, 2008 fair value of the separately-accounted-for embedded derivative instruments was credited to additional paid-in capital as part of recording the capital transaction resulting from the extinguishment of the original note payable.

Pursuant to the guidance in SFAS 133, EITF 00-19 and other relevant literature, the conversion rights of the amended convertible note payable are not required to be accounted for separately.

The convertible note payable issued on February 14, 2008 and subsequently amended on June 27, 2008 includes a call option which gives the holder the right to demand repayment in the case of default. Under the guidance of SFAS 133, the Company is required to separately account for the fair value of the call option. The Company determined that the call option had no value at February 14, 2008 or at each of the interim reporting dates since then based on an analysis of the rights this feature contained and the likelihood of its exercise.

Valuation of Prepayment Right Related to Convertible Note Payable, Related Party

The convertible note payable issued on February 14, 2008 and subsequently amended on June 27, 2008 allows the Company to prepay the unpaid balance of the convertible note and accrued interest at any time and without penalty. Under the guidance of SFAS 133, the Company is required to separately account for the fair value of the prepayment right. The Company determined that this right had no value at February 14, 2008 or at each of the interim reporting dates since then based on an analysis of the right and the likelihood of its exercise.

With the exception of those discussed below and in Note 4, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2008 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.

In March 2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This standard is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact, if any, SFAS No. 161 will have on its financial position, results of operations or cash flows.

In April 2008, the FASB issued FASB Staff Position (FSP) No. 142-3, “Determination of the Useful Life of Intangible Assets” (FSP 142-3), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The guidance in FSP 142-3 for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after adoption, and the disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, adoption. The Company is currently evaluating the impact, if any, FSP 142-3 will have on its financial position, results of operations or cash flows.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162), which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS 162 will become effective 60 days following approval by the Securities and Exchange Commission of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not expect the adoption of SFAS 162 will have a material effect on its financial position, results of operations or cash flows.

In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock” (EITF 07-5), which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. EITF 07-5 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact, if any, EITF 07-5 will have on its financial position, results of operations or cash flows.

In June 2008, the FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5” (EITF 08-4). The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” that result from EITF Issue No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” and SFAS Issue No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” EITF 08-4 is effective for financial statements issued for fiscal years ending after December 15, 2008 and early application is permitted. The Company is currently evaluating the impact of EITF 08-4 on its financial position, results of operations or cash flows.

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, which Note was subsequently amended on June 27, 2008 (see below). Prior to such amendment, the principal balance and accrued interest of the Note were 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 closed an equity financing on or before June 29, 2008, in which the Company sold shares of its equity securities for an aggregate amount of at least $5,000,000, the unpaid balance of the Note and related accrued interest would have automatically converted 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 did not consummate an equity financing on or before June 29, 2008, the unpaid balance of the Note and related accrued interest could 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 would have been obligated to issue to RBFSC a warrant (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.

Due to the indeterminate number of common shares which might have been issued under the embedded conversion feature and the Warrant, the Company recorded the value of the Warrant as a derivative liability at its fair value in accordance with SFAS 133 and EITF 00-19, as there was a potential that the Company would not have a sufficient number of authorized shares to settle these obligations. In addition, the Company re-measured the fair value of this derivative liability at the end of each reporting period. The Company estimated the fair value of the Warrant to be $280,347 at February 14, 2008. At 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. At June 27, 2008, the Company estimated the fair value of this derivative liability to be $555,674, and as a result, recognized the change in value of $52,552 in its statement of operations. The fair value of the 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:

The Note also included embedded features in the form of a call option and put option that were required to be separately accounted for at fair value on the balance sheet with changes in value recognized in the statement of operations under SFAS 133 as the features were not clearly and closely related to the convertible note debt instrument. The embedded call option, which gave the holder the right to demand repayment in the case of default, was determined by management to have no 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 put option gave the Company the right to automatically convert the Note into the equity securities issued in the equity financing. The Company estimated the fair value of the put option associated with the Note to be $186,512 at February 14, 2008. At 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. At June 27, 2008, the Company estimated the fair value of this put option to be $0 as the Company was not intending to exercise the option and, as a result, recognized the change in value of $24,170 in its statement of operations. The fair value of this derivative asset was determined by applying management’s estimate of the probability of the Company’s exercising the put option together with the Black-Scholes option pricing model with the following key assumptions:

The Company accounted 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 resulted 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, offset by the fair value of the put option held by the Company. The Note was 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 June 27, 2008, an expense of $831,426 has been recorded as accretion of discount on convertible note payable, related party, thereby increasing the carrying value of the Note to $3,737,591.

For the three and nine months ended September 30, 2008, interest expense resulting from the stated interest rate related to the Note was $57,863 and $151,561, respectively.

On June 27, 2008, the Company entered into a First Amendment to Note and Warrant Purchase Agreement and Convertible Promissory Note with RBFSC pursuant to which (1) the Note was amended (the Amended Note) as follows: (i) the maturity date of the Amended Note is July 1, 2011, and (ii) the Amended Note is convertible (a) upon the consummation by the Company of an equity financing with proceeds to the Company of at least $7,500,000, whereupon the Amended Note shall be converted automatically into shares of the Company’s capital stock issued in the equity financing at a price equal to the lesser of the per share price of the securities issued and sold in the equity financing and $1.00, (b) upon the consummation of a sale of substantially all of the Company’s assets or a merger or consolidation of the Company in which the Company’s stockholders will hold, in the aggregate, less than 50% of the voting power of the combined entity, whereupon the Amended Note shall be converted automatically into shares of the Company’s common stock at a price equal to the lesser of the per share price attributed to the Company’s common stock in connection with such transaction and $1.00, or (c) voluntarily by RBFSC at and as of the maturity date into shares of the Company’s common stock at a price equal to $1.00; and (2) the Warrant was amended and restated in its entirety such that RBFSC shall be entitled to purchase up to 750,000 shares of the Company’s common stock at an exercise price of $1.00 per share (the Restated Warrant), which Restated Warrant was issued by the Company concurrent with the issuance of the Amended Note.

Under the guidance of EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments,” the Company determined that the terms of the Amended Note reflect a substantial modification to the Note based on an analysis of cash flows for the Amended Note compared to the Note and, as a result, accounted for this modification as an extinguishment of the Note. As the Note was a debt to a related party, the Company recorded the debt extinguishment as a capital transaction under Accounting Principles Board (APB) Opinion 26, “Early Extinguishment of Debt.” The Amended Note was accounted for as new debt and was recorded at its $3,000,000 face value because the estimated June 27, 2008 fair value of the Amended Note exceeded its face value.

During the third quarter of 2008, the Company began efforts to obtain additional capital through an offering of unsecured convertible notes payable (Debt Offering). As of September 30, 2008, the Company had received an aggregate of $735,000 of subscription deposits toward the Debt Offering. These funds are being held by the Company until achievement of the minimum aggregate subscription level of $1.5 million for the Debt Offering, at which time the Company will issue convertible notes payable to the subscribing investors and the restrictions on use of the funds will be released. Until the Company has achieved the minimum aggregate subscription level required to effectuate the issuance of the debt, deposits received toward the Debt Offering are presented as restricted cash and other current liabilities on the Company’s balance sheet.

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 and 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.

During February 2008, ARS increasingly failed at auction due to sell orders exceeding buy orders. At March 31, 2008, the Company estimated the fair value of its then remaining $200,000 of ARS to be $170,000, a decline of $30,000 from par value. The Company considered this decline in fair value as other than temporary and, accordingly, recorded an unrealized loss on marketable securities of $30,000 in other non-operating expense in the first quarter of 2008. During the third quarter of 2008, an aggregate of $150,000 of these ARS was redeemed at par by the issuers and converted into cash, resulting in a realized gain of $25,000. The Company also received a written notification from an investment firm indicating its intent to purchase at par the remaining $50,000 of ARS from the Company no later than November 28, 2008.

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 FSP 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 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:

The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. The following table provides the fair value measurements of applicable Company assets and liabilities by level within the fair value hierarchy as of September 30, 2008. These assets and liabilities are measured on a recurring basis.

At September 30, 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, management estimated fair value based on the commitment from an investment firm to purchase the Company’s ARS at par by November 28, 2008.

The following is a reconciliation of the activities of the ARS during the nine months ended September 30, 2008:

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 nine months ended September 30, 2008:

The following is a reconciliation of the activities of the derivative asset during the nine months ended September 30, 2008:

The amount of stock-based compensation expense recognized in the three months ended September 30, 2008 and 2007 related to stock options was approximately $21,600 and $58,200, respectively. For the nine months ended September 30, 2008 and 2007, stock-based compensation expense was approximately $144,300 and $135,800, respectively. Stock-based compensation for the nine months ended September 30, 2008 included approximately $60,100 of expense resulting from modification of two option grants.

A summary of the Company’s stock compensation expense for the three and nine months ended September 30, 2008 and 2007 is as follows:

There were no stock options granted during the three months ended September 30, 2008. For the three months ended September 30, 2007, the Company granted 75,000 options with an estimated weighted-average fair value of $0.59 per share. For the nine months ended September 30, 2008 and 2007, the Company granted 120,000 and 195,000 options, respectively, with an estimated weighted-average fair value of $0.62 and $0.61 per share, respectively. In determining the fair value of stock options granted during the three months ended September 30, 2007 and during the nine months ended September 30, 2008 and 2007, the following key assumptions were used in the Black-Scholes option pricing model:

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 September 30, 2007 and nine months ended September 30, 2008 and 2007, 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 average of 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.

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 with an exercise price equal to the market price of the Company’s common stock 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.

A summary of the Company’s stock option activity for the nine months ended September 30, 2008 is presented in the following table:

The aggregate intrinsic value in the table above is based on the Company’s closing stock price of $0.51 on September 30, 2008, which would have been received by the optionees had all of the options with exercise prices less than $0.51 been exercised on that date. As of September 30, 2008, total unrecognized stock-based compensation related to non-vested stock options was approximately $98,300, which is expected to be recognized over a weighted-average period of approximately 1.24 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 September 30, 2008, 2,339,806 shares remained available for grants. Additional information regarding options outstanding as of September 30, 2008, is as follows:

As of December 31, 2007, the Company had outstanding warrants to purchase up to 2,700,544 shares of the Company’s common stock with per share exercise prices ranging from $0.25 to $6.00 and non-employee stock options to purchase up to 330,000 shares of the Company’s common stock with per share exercise prices ranging from $1.50 to $2.00. During the nine months ended September 30, 2008, the Company issued to RBFSC a warrant to purchase up to 750,000 shares of its common stock at $1.00 per share in connection with the Amended Note discussed in Note 2.

The Company’s convertible note payable issued on February 14, 2008, as discussed in Note 2, 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 outstanding 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 the outstanding warrants and options subject to EITF 00-19 to be $1,255,317, $1,011,103 and $781,677 at February 14, 2008, March 31, 2008 and June 27, 2008, respectively.

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:

At each reporting period, as long as the warrants and non-employee options were outstanding and there was a potential for an insufficient number of authorized shares available to settle these instruments, the outstanding warrants and non-employee options were revalued and any difference from the previous valuation date was 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. The fair value of these derivative liabilities decreased by $244,214 from February 14, 2008 to March 31, 2008, and further decreased by $229,428 from March 31, 2008 to June 27, 2008.

On June 27, 2008, the Company entered into an amendment to the convertible note payable (See Note 2) which effectively extinguished the original note payable and related derivative instruments. In accordance to the guidance of EITF No. 96-19, the Company accounted for this modification as an extinguishment of the original note payable. As a result of the modification, outstanding warrants and non-employee options were no longer considered to include a “net cash settlement” provision within the meaning of EITF 00-19, and, therefore, the Company reclassified their fair value from derivative liabilities to equity.

On March 5, 2007, the Company closed a private equity financing, receiving cash of approximately $2.0 million in exchange for 2,666,666 shares of 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 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.

Net 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:

Property and equipment consisted of the following as of September 30, 2008 and December 31, 2007:

Aggregate depreciation expense for property and equipment during the three months ended September 30, 2008 and 2007 was $12,497 and $24,425, respectively. Aggregate depreciation expense for property and equipment during the nine months ended September 30, 2008 and 2007 was $43,008 and $72,947, respectively.

Identifiable intangible assets consisted of the following as of September 30, 2008 and December 31, 2007:

Amortization expense for intangible assets during the three months ended September 30, 2008 and 2007 was $19,721 and $19,749, respectively. Amortization expense for intangible assets during the nine months ended September 30, 2008 and 2007 was $59,160 and $59,191, respectively.

Total comprehensive loss for the three months ended September 30, 2008 was $780,264 compared to $899,768 for the same period in 2007. For the nine months ended September 30, 2008, total comprehensive loss was $3,486,007 compared to $2,543,419 for the nine months ended September 30, 2007. The difference between net loss as reported and total comprehensive loss is the unrealized gain on the Company’s marketable securities.

For the nine months ended September 30, 2008, the Company incurred a net loss of $3,491,007. At September 30, 2008, the Company had $1,728,225 in cash and cash equivalents and $50,000 in marketable securities, as discussed in Note 3. As of September 30, 2008, the Company also held $735,000 of cash deposits toward the Company’s current Debt Offering, classified as restricted cash and other current liabilities on the balance sheet. For the nine months ended September 30, 2008, cash used in operations was $2,351,140, cash used in investing activities was $111,665, primarily representing the restricted cash of $735,000 related to the Debt Offering partially

offset by proceeds from sales and redemption of ARS of $650,000, and cash provided by financing activities was $3,729,740, which included approximately $2,994,700 of net proceeds from the issuance of a convertible note payable to a related party and $735,000 of subscription deposits for the Debt Offering.

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, among other things, would be required to significantly reduce the scope of its operations, which would significantly impede its ability to proceed with current operational and business plans.

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.

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 and nine months ended September 30, 2008 and 2007:

David H. Kirske resigned as the Company’s Vice President and Chief Financial Officer on June 23, 2008. In connection therewith and in consideration of a release by Mr. Kirske of the Company and its affiliates and contingent on the expiration of the revocation period thereunder, the Company agreed to pay Mr. Kirske following his resignation an aggregate amount of $90,000, payable in accordance with the Company’s customary payroll schedule, together with a $17,500 cash payment. In addition, the Company agreed to extend the period during which Mr. Kirske may exercise his vested options from 90 days to three years from the date of his resignation.

On June 30, 2008, the Company amended its employment agreement with Robin L. Carmichael, the Company’s Vice President, Marketing and Business Development, pursuant to which Ms. Carmichael’s annual base salary was increased from $200,000 to $225,000 effective May 15, 2008 and the vesting schedule of Ms. Carmichael’s performance stock options was amended as follows: (i) if the Company recognizes net revenue (as defined in the employment agreement) of at least $1.0 million but less than $1.25 million in 2008, an aggregate of 25,000 shares shall vest and become exercisable; (ii) if the Company recognizes net revenue of at least $1.25 million but less than $1.5 million in 2008, an aggregate of 75,000 shares shall vest and become exercisable; and (iii) if the Company recognizes net revenue of at least $1.5 million in 2008, an aggregate of 100,000 shares shall vest and become exercisable.

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 September 30, 2008, the Company had placed orders totaling approximately $131,400 under this agreement. The Company is obligated to fulfill the remaining purchase requirement of approximately $102,600 by January 2009.

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:

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 (SEC) after the date of this Quarterly Report.

Helix BioMedix, Inc. is a biopharmaceutical company with an extensive library of structurally diverse bioactive peptides and a portfolio of 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 and modulatory 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 Resistant S. 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.

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.

We make available on our website, free of charge, copies of our Annual Report on Forms 10-K and 10-KSB, Quarterly Reports on Form 10-Q and 10-QSB, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after filing or furnishing the information to the SEC. The internet address for the information is www.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 also available to the public at the SEC’s website at www.sec.gov.

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.

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.

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 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.

We are developing a novel, broad-spectrum, topical anti-infective for the treatment of skin and wound infections and the prevention of Staphylococcus 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, both in vitro and in vivo, over traditional antimicrobial peptides.

As with traditional antimicrobial peptides, our lead lipohexapeptides are rapidly cidal, fail to engender resistance in 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 as P. acnes, S. aureus, Streptococcus pyogenes, and Pseudomonas 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 an S. 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.

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 provide clinical benefit and make up a large part of this market, the emergence of resistance to antibiotics such as Clindamycin occurred as early as 1979.

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.

Furthermore, our lipohexapetide offers benefits in anti-inflammatory activity in addition to antimicrobial activities. We believe these properties may provide possible product application in the areas of rosacea and atopic dermatitis and, therefore, could lead to additional market opportunities for us.

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 kill S. 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.

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.

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 technology licenses, joint development agreements, peptide sales and administrative services revenue from a related party. 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.

Marketable Securities. Marketable securities, consisting of auction rate securities (ARS), are reported at estimated 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. Our policy for the capitalization of patent costs is to begin amortization of these costs at the time they are incurred. We periodically 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. We account for our warrants and non-employee stock options in accordance with the provisions of SFAS 133, EITF 00-19 and EITF 96-18, which require these instruments to be classified as permanent equity, temporary equity or as assets or liabilities. In general, warrants and non-employee stock options that either require net-cash settlement or are presumed to require net-cash settlement are recorded as assets and liabilities at fair value, and warrants that require settlement in shares are recorded as equity instruments.

We estimate the fair value of these derivative liabilities and equity instruments 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 derivative liabilities were outstanding and there was a potential for an insufficient number of authorized shares available to settle these instruments, they were revalued and any difference from the previous valuation date would be recognized as a change in fair value in our statement of operations.

Valuation of Conversion Features Related to Convertible Note Payable, Related Party. In accordance with SFAS 133, we were required to separately account for the fair value of our right to automatically convert the note payable to a related party to equity pursuant to the terms of the convertible note payable issued on February 14, 2008 (See Note 2 of our Notes to Condensed Financial Statements). We estimated the fair value of this right using a Black-Scholes model and used 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 put options.

On June 27, 2008, we entered into an amendment to the convertible note payable which effectively extinguished the original note payable, including its embedded derivative instruments. The June 27, 2008 fair value of the separately-accounted-for embedded derivative instruments was credited to additional paid-in capital as part of recording the capital transaction resulting from the extinguishment of the original note payable.

Valuation of Call Option Related to Convertible Note Payable, Related Party. The convertible note payable issued on February 14, 2008 and subsequently amended on June 27, 2008 includes a call option which gives the holder the right to demand repayment in the case of default. Under the guidance of SFAS 133, we are required to separately account for the fair value of the call option. We determined that the call option had no value at February 14, 2008, March 31, 2008, June 30, 2008 or September 30, 2008, based on an analysis of the rights this feature contained and the likelihood of its exercise.

Valuation of Prepayment Right Related to Convertible Note Payable, Related Party. The convertible note payable issued on February 14, 2008 and subsequently amended on June 27, 2008 allows us to prepay the unpaid balance of the convertible note and accrued interest at any time and without penalty. Under the guidance of SFAS 133, we are required to separately account for the fair value of the prepayment right. We determined that this prepayment right had no value at February 14, 2008, March 31, 2008, June 30, 2008 or September 30, 2008, based on an analysis of the right and the likelihood of its exercise.

As of September 30, 2008, our accumulated deficit was approximately $31,057,900. 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 three months ended September 30, 2008 was approximately $767,700, or $0.03 per share, reflecting a decrease of approximately $132,100 compared to $899,800, or $0.04 per share, for the same period in 2007. Excluding the administrative services revenue and related costs from a related party, the decrease in net loss for the third quarter of 2008 compared to the same period in 2007 was primarily due to a decrease in operating expenses of approximately $177,800, partially offset by an increase in interest expense and other non-operating expenses of approximately $43,000. The decrease in operating expenses was primarily attributable to decreases in compensation and benefit expense due to a reduction of headcount, stock-based compensation and general corporate expenses. The increase in non-operating expenses was due primarily to interest expense related to the outstanding convertible note payable.

Net loss for the nine months ended September 30, 2008 was approximately $3,491,000, or $0.14 per share, representing an increase of approximately $947,600 compared to $2,543,400, or $0.10 per share, for the nine months ended September 30, 2007. Excluding the administrative services revenue and related costs from a related party, the increase in net loss for the first nine months of 2008 compared to the same period in 2007 was primarily attributable to increased operating expenses of approximately $75,000 as well as an increase in interest expense and other non-operating expenses relating to the outstanding convertible note payable of $971,200, partially offset by an increase in development fees and royalty revenue of approximately $111,000.

Revenue in the three and nine months ended September 30, 2008 and 2007 consisted primarily of license fees, development fees, peptide sales and administrative services revenue as summarized in the table below.

Revenue for the three months ended September 30, 2008, excluding administrative services revenue from DermaVentures, a related party, compared to the same period last year decreased by approximately $13,400, or 8.4%. The revenue decrease was comprised of a decrease in development fees, partially offset by increases in peptide sales and licensing fees. We did not generate any peptide sales to DermaVentures in the three months ended September 30, 2008 and 2007.

Revenue for the nine months ended September 30, 2008, excluding administrative services revenue from DermaVentures, compared to the same period last year increased by approximately $93,400, or 26.1%, due primarily to an increase in licensing and development fees, partially offset by a decrease in peptide sales. Peptide sales to DermaVentures for the nine months ended September 30, 2008 were $0 compared to $64,400 for the same period in 2007. The fluctuation in development fees during the three and nine months ended September 30, 2008 compared to the same periods in 2007 was attributable to the timing of the achievement of certain milestones under applicable development agreements. The increase in licensing fees during the three and nine months ended September 30, 2008 reflected royalty earned from peptide sales in 2007 and in the earlier part of 2008.

Revenue for the three and nine months ended September 30, 2008 included administrative services revenue received from DermaVentures, a related party, for marketing costs associated with DermaVentures’ product line and other out-of-pocket expenses we incurred on DermaVentures’ behalf. Administrative services revenue is typically invoiced to DermaVentures at cost and therefore has no net effect on net income (loss).

Cost of revenue consists of (1) cost of peptides sold, (2) cost of administrative services revenue from DermaVentures, a related party, which includes primarily marketing campaign costs associated with DermaVentures’ product line and other out-of pocket expenses we incur on DermaVentures’ behalf, and (3) 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 and nine months ended September 30, 2008 and 2007.

Cost of peptide sales for the three months ended September 30, 2008 increased by approximately $34,800, or 65.3%, compared to the same period in 2007. This increase in cost was directly proportional to the increase in peptide sales for the three months ended September 30, 2008 as all peptide sales during these periods were sold at cost based on the terms of applicable licensing agreements. Cost of peptide sales for the nine months ended September 30, 2008 increased by approximately $99,800, or 156.7%, compared to the same period in 2007. Peptides sold in the first nine months of 2008 resulted in a 13.3% margin because only a portion of peptides was sold at cost during that period. Peptide sales in the nine months ended September 30, 2007 resulted in a 69.1% margin because the inventory sold in that period had been written down to their net estimated realizable value in 2006.

Cost of administrative services revenue for the three months ended September 30, 2008 consisted primarily of marketing service expenses. Cost of administrative service revenue for the nine months ended September 30, 2008 consisted of approximately $29,200 related to marketing services and $3,100 of reimbursable expenses. Cost of administrative services revenue for the three and nine months ended September 30, 2007 was not material.

Other cost of revenue for the three months ended September 30, 2008 was not material. For the three months ended September 30, 2007, we incurred approximately $20,400 of other cost of revenue which consisted primarily of cost of materials used in development activities. For the nine months ended September 30, 2008 and 2007, other cost of revenue was approximately $38,800 and $20,400, respectively, representing an increase of approximately $18,400, or 90.3%. Other cost of revenue for the first nine months of 2008 was primarily attributable to professional fees incurred in connection with a joint development agreement, while other cost of revenue for the same period in 2007 consisted of materials used in development activities.

Research and development (R&D) expenses consist primarily of compensation 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 three and nine months ended September 30, 2008 and 2007 are summarized in the table below.

R&D expenses for the three months ended September 30, 2008 decreased by approximately $1,000, or less than 1.0%, compared to the three months ended September 30, 2007. This slight decrease was due primarily to lower spending in external studies and other R&D expenses, partially offset by an increase in compensation and benefit expenses.

R&D expenses for the nine months ended September 30, 2008 compared to the same period last year decreased by approximately $15,500, or 2.7%, due primarily to decreases in lab consumables and external studies, travel expenses and stock-based compensation, partially offset by an increase in compensation and benefit expenses.

Compensation and benefit expenses for the three and nine months ended September 30, 2008 included approximately $10,300 and $28,200, respectively, of employee benefits that were allocated to R&D expenses starting in 2008, whereas in previous years they were recorded in general and administrative expenses. For the remainder of 2008, we expect R&D expenses to remain relatively consistent with the level experienced during the first nine months of 2008.

Marketing and business development (M&BD) expenses consist primarily of compensation and benefit expenses, stock-based compensation, consulting fees and various marketing costs. M&BD expenses for the three and nine months ended September 30, 2008 and 2007 are summarized in the table below.

M&BD expenses for the three months ended September 30, 2008, decreased by approximately $36,200, or 28.3%, compared to the same period in 2007. The decrease was primarily attributable to decreases in consulting fees and stock-based compensation, partially offset by an increase in product marketing expenses.

M&BD expenses for the nine months ended September 30, 2008, decreased by approximately $41,800, or 12.4%, compared to the same period in 2007. The decrease was primarily attributable to decreases in compensation and benefit expenses, consulting fees and stock-based compensation, partially offset by an increase in product marketing expenses.

Compensation and benefit expenses for the three and nine months ended September 30, 2008 included approximately $2,300 and $6,900, respectively, of employee benefits that were allocated to M&BD expenses starting in 2008, whereas in previous years they were recorded in general and administrative expenses. For the remainder of 2008, we expect M&BD expenses to increase slightly from the level experienced during the first nine months of 2008 due to anticipated increased activities in product marketing and business development efforts.

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 three and nine months ended September 30, 2008 and 2007 are summarized in the table below.

G&A expenses for the three months ended September 30, 2008, decreased by approximately $132,400, or 25.3%, compared to the same period in 2007. The decrease was primarily due to a decrease in compensation and benefit expenses resulting from a reduction in headcount, as well as lower expenditures in travel expenses, stock-based compensation and general corporate expenses.

G&A expenses for the nine months ended September 30, 2008, decreased by approximately $5,000, or less than 1.0%, compared to the same period in 2007. The slight decrease was primarily due to decreases in travel and general corporate expenses, partially offset by increases in compensation and employee benefit expenses, consulting fees and stock-based compensation.

For the nine months ended September 30, 2008, the increase in compensation and benefit expenses included an aggregate of $107,500 of severance and other cash payments, and the increase in stock-based compensation included approximately $60,100 of expense recorded in connection with the modification of an option grant, all related to the departure of our Chief Financial Officer in June 2008. The decrease in other G&A expenses was primarily due to lower spending in compliance costs associated with the Sarbanes-Oxley Act of 2002, decreased patent maintenance expenses and the reclassification of certain employee benefits from G&A expenses to R&D and M&BD expenses beginning in 2008. For the remainder of 2008, we expect G&A expenses to be consistent with the level experienced during the first nine months of 2008, net of severance expenses.

Accounting, legal and professional fees expenses for the three and nine months ended September 30, 2008 and 2007 are summarized in the table below.

Accounting, legal and professional fees expenses for the three months ended September 30, 2008 decreased by approximately $21,300, or 15.2%, compared to the same period in 2007. The decrease was primarily due to decreases in accounting fees and legal fees associated with patent applications, license agreement negotiations and other corporate matters.

Accounting, legal and professional fees expenses for the nine months ended September 30, 2008 increased by approximately $16,700, or 4.0%, compared to the same period in 2007. The increase was primarily due to an increase in accounting fees, partially offset by a decrease in legal and other professional fees associated with patent applications, license agreement negotiations and other corporate matters, primarily in the first half of 2008.

For the remainder of 2008, we expect accounting, legal and professional fees to increase from the level experienced during the first nine months of 2008 due to increased activities associated with our capital raising efforts.

Depreciation and amortization expenses for the three and nine months ended September 30, 2008 and 2007 are summarized in the table below.

Depreciation and amortization expenses for the three months ended September 30, 2008, decreased by approximately $12,000, or 27.1%, compared to the same period last year and for the nine month ended September 30, 2008, decreased by approximately $30,000, or 22.7%, compared to the same period last year. The decrease for the three and nine months ended September 30, 2008 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 to be consistent with the levels experienced in the first nine months of 2008.

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 income (expense), net for the three and nine months ended September 30, 2008 and 2007 is summarized in the table below.

Interest Income. Interest income for the three and nine months ended September 30, 2008 decreased by approximately $10,100, or 41.3%, and $22,100, or 30.6%, respectively, compared to the same periods in 2007, due primarily to lower average cash and investment balances and lower interest rates. For the remainder of 2008, we expect interest income to decrease due to lower interest rates and our decreased balance in cash and cash equivalents.

Interest Expense. For the three and nine months ended September 30, 2008, interest expense related to the convertible note payable issued in February 2008 to a related party and amended in June 2008 was approximately $57,900 and $151,600, respectively. We did not incur any interest expense during the three and nine months ended September 30, 2007. We anticipate future quarterly interest expense to remain consistent with the levels experienced in the three and nine months ended September 30, 2008.

Accretion of Discount on Convertible Note Payable, Related Party. For the nine months ended September 30, 2008, accretion of discount on the convertible note payable issued in February 2008 to a related party and amended in June 2008 was approximately $831,400, which represented the increase in carrying value of the convertible note from the issuance date through June 27, 2008. At June 27, 2008, this convertible note payable was effectively extinguished and replaced by an amended note payable (see Note 2 of the Notes to our Condensed Financial Statements). As a result, we expect no further accretion of discount on this convertible note payable.

Change in Value of Derivative Instruments. For the period from February 14, 2008 to June 27, 2008, the change in fair value of the derivative instruments related to the convertible note payable to a related party resulted in a net gain of approximately $11,800, comprised of a decrease of approximately $473,700 in the fair value of outstanding warrants and non-employee stock options, partially offset by a decrease of $186,500 in the fair value of the put option and an increase of approximately $275,400 in the fair value of the warrant related to the original convertible note payable. At the amendment of the convertible note payable on June 27, 2008, in accordance with EITF 96-19, we recorded an extinguishment of the original convertible note payable and reclassified the fair value of the then outstanding derivative instruments to equity. For the three months ended September 30, 2008, there was no change in fair value of the derivative instruments related to the outstanding convertible note payable.

Unrealized Loss and Realized Gain on Marketable Securities. During the first quarter of 2008, we recognized an unrealized loss of $30,000 on our investment in ARS due to the lack of liquidity associated with these investments deemed at that time. During the three months ended September 30, 2008, 75% of our ARS was redeemed at par by the issuers. As a result, we recorded $25,000 of realized gains on investments based on the specific ARS that were redeemed. We expect to liquidate the remaining ARS during the remainder of 2008.

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 September 30, 2008, we had approximately $1,728,200 in cash and cash equivalents and $50,000 in available-

for-sale marketable securities, compared to approximately $461,300 in cash and cash equivalents and $700,000 in available-for-sale marketable securities at December 31, 2007. At September 30, 2008, we also held $735,000 of restricted cash from subscription deposits for the current convertible debt offering. Excluding these deposits, the increase in cash and cash equivalents from December 31, 2007, was primarily attributable to the net proceeds of approximately $2,995,000 from our issuance of a convertible note payable to a related party and $650,000 from sales and redemption of marketable securities, partially offset by cash used in operations of approximately $2,351,100 and capital purchases of approximately $26,700 during the first nine months of 2008.

We use a professional investment management firm to manage a portion of our invested cash. In early February of 2008, we liquidated $500,000 of our ARS and held the proceeds in cash and cash equivalents. During the first quarter of 2008, our ARS increasingly failed at auction due to sell orders exceeding buy orders. Based on the lack of liquidity of these investments and the ARS market condition at the time, we deemed that our ARS were other-than-temporarily impaired and, as a result, recorded an impairment charge of $30,000 in the first quarter of 2008, reducing the fair value of our ARS from $200,000 (par value) to $170,000. During the three months ended September 30, 2008, 75% of our ARS was redeemed at par by the issuers and converted into cash and cash equivalents, resulting in a realized gain of $25,000.

Cash used in operating activities for the nine months ended September 30, 2008 and 2007 was approximately $2,351,100 and $2,369,600, respectively, derived primarily from the net loss for the period plus the net effect of non-cash expenses. The primary working capital uses of cash for the nine months ended September 2008 were increases in receivables and inventory as well as a decrease in deferred revenue, partially offset by an increase in prepaid assets and a decrease in trade payables. Working capital uses of cash for the nine months ended September 2007 were primarily due to increases in receivables and inventory, partially offset by a decrease in prepaid assets and an increase in deferred revenue.

Accounts receivable increased by approximately $24,900 during the nine months ended September 30, 2008, compared to a decrease of $192,400, which included $64,500 of accounts receivable from a related party, for the same period in 2007. The fluctuations were primarily attributable to the timing of peptide shipments, royalty reports received from our licensees and the achievement of certain milestones under applicable license and development agreements. Inventory, comprised mainly of peptides held for resale, increased by approximately $16,300 and $39,000 in the first nine months of 2008 and 2007, respectively, due primarily to purchases for expected peptide sales. Deferred revenue decreased by $130,000 and increased by $69,000 in the nine months ended September 30, 2008 and 2007, respectively, due primarily to the timing of the achievement of certain milestones under applicable license and development agreements.

For the nine months ended September 30, 2008 and 2007, our investing activities consisted primarily of purchases, sales and redemption of available-for-sale marketable securities, cash deposits from the subscription of our current convertible debt offering and acquisition of capital equipment. Cash used in investing activities was approximately $111,700 during the first nine months of 2008, consisting of subscription deposits of $735,000 held as restricted cash related to our current convertible debt offering and purchases of capital equipment of approximately $26,700, partially offset by sale and redemption proceeds of marketable securities of $650,000. For the nine months ended September 30, 2007, cash provided by investing activities was approximately $152,700, consisting of net sales of marketable securities of $180,000, partially offset by the acquisition of capital equipment of approximately $27,300. For 2008, we do not expect the level of capital expenditures to be significant.

For the nine months ended September 30, 2008, cash provided by financing activities was approximately $3,729,700, consisting of approximately $2,994,700 of net proceeds from the issuance of a convertible note payable to a related party (Note 2) and $735,000 of subscription deposits for our current debt offering. For the nine months ended September 30, 2007, cash provided by financing activities was approximately $2,143,400, consisting entirely of net proceeds from the issuance of an aggregate of 2,864,998 shares of our 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 at least for 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, and are currently in the process of raising, 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, among other things, we would be required to significantly reduce the scope of our operations, which would significantly impede our ability to proceed with current operational and business plans.

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.

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 September 30, 2008:

With the exception of those discussed below and in Note 4 of the Notes to our Condensed Financial Statements, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2008 that would have a material 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.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This standard is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are currently evaluating the impact, if any, this standard will have on our financial position, results of operations or cash flows.

In April 2008, the FASB issued FASB Staff Position No. 142-3 (FSP 142-3), “Determination of the Useful Life of Intangible Assets,” which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The guidance in FSP 142-3 for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after adoption, and the disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, adoption. We are currently evaluating the impact of FSP 142-3 on our financial position, results of operations or cash flows.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162), which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS 162 will become effective 60 days following approval by the SEC of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” We do not expect the adoption of SFAS 162 will have a material effect on our financial position, results of operations or cash flows.

In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock” (EITF 07-5), which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. EITF 07-5 is effective for fiscal years beginning after December 15, 2008. We are currently evaluating the impact, if any, this standard will have on our financial position, results of operations or cash flows.

In June 2008, the FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5” (EITF 08-4). The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” that result from EITF Issue No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” and SFAS Issue No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” EITF 08-4 is effective for financial statements issued for fiscal years ending after December 15, 2008 and early application is permitted. We are currently evaluating the impact of EITF 08-4 on the accounting for our convertible debt and related warrant transactions.

We carried out an evaluation, under the supervision and with the participation of our senior management, including our Chief Executive Officer and Acting 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 Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Acting Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting him 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 September 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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 and our Quarterly Reports on Form 10-Q for the three months ended March 31 and June 30, 2008 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 such reports, except as set forth below. If any of those risks were to occur, our business, operating results and financial condition could be seriously harmed.

Adverse changes in the economy could have a negative impact on our fundraising efforts.

Current and future conditions in the economy have an inherent degree of uncertainty. Adverse changes in the economy or business conditions could delay or impede our ability to successfully obtain additional capital to maintain the current level of operations beyond 2008, continue commercialization of our technology and advance our pharmaceutical programs. If we are unable to raise additional capital, we may be required to severely reduce the scope of our operations or discontinue operations altogether.

To the extent our cash deposits are maintained in accounts that are not insured, such assets could be at risk.

As of September 30, 2008, we maintained approximately $2,368,600, including $735,000 of cash deposits for subscription of convertible notes payable, at major financial institutions in money market accounts insured by the Securities Investor Protection Corporation for up to $500,000 per account. If these financial institutions experience financial difficulty or failure, the assets in these accounts could be at risk, and the loss of which would have an adverse effect on our business and results of operations.

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.


HELIX BIOMEDIX, INC. (Registrant)

By:		/s/ R. Stephen Beatty
		R. Stephen Beatty President and Chief Executive Officer and Acting Chief Financial Officer (Principal Executive Officer and Acting Principal Financial Officer)


Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company x
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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) and Total Comprehensive Income (Loss) (unaudited)		3

Condensed Statements of Cash Flows (unaudited)		4

Notes to Condensed Financial Statements (unaudited)		5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19

Item 4. Controls and Procedures		32

PART II - OTHER INFORMATION

Item 1A. Risk Factors		33

Item 6. Exhibits		34

Signatures		35


	September 30, 2008			December 31, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	1,728,225		$	461,290
Restricted cash – subscription deposits for convertible debt offering (Note 2)		735,000			—
Marketable securities, current		50,000			700,000
Accounts receivable, net		108,829			83,915
Inventory		81,589			65,279
Prepaid expenses and other current assets		99,925			144,074

Total current assets		2,803,568			1,454,558
Deposits		8,522			8,522
Property and equipment, net		110,166			126,509
Intangible assets, net		373,322			432,482

Total assets	$	3,295,578		$	2,022,071

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	139,673		$	95,071
Accrued compensation and benefits		95,014			63,813
Accrued expenses		28,718			60,269
Deferred revenue		—			130,000
Other current liabilities – subscription deposits for convertible debt offering (Note 2)		735,000			—

Total current liabilities		998,405			349,153
Deferred rent		2,221			2,205
Convertible note payable, related party		3,000,000			—
Accrued interest on convertible note payable, related party		150,575			—

Total liabilities		4,151,201			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 September 30, 2008, and December 31, 2007		25,654			25,654
Additional paid-in capital		30,171,643			29,211,972
Accumulated deficit		(31,057,920	)		(27,566,913	)
Accumulated other comprehensive income		5,000			—

Total stockholders’ equity (deficit)		(855,623	)		1,670,713

Total liabilities and stockholders’ equity (deficit)	$	3,295,578		$	2,022,071


	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Revenue:
Licensing and development fees	$	56,859		$	105,971		$	263,251		$	152,212
Peptide sales		89,131			53,397			188,582			141,832
Peptide sales, related party		—			—			—			64,400
Administrative services revenue, related party		10,549			—			32,321			—

Total revenue		156,539			159,368			484,154			358,444
Operating expenses:
Cost of peptide sales		88,062			53,277			163,531			63,698
Cost of administrative services revenue, related party		10,549			—			32,321			—
Other cost of revenue		30			20,396			38,811			20,396
Research and development		173,638			174,615			567,053			582,570
Marketing and business development		91,625			127,805			295,353			337,139
General and administrative		390,068			522,423			1,410,087			1,415,132
Accounting, legal and professional fees		119,560			140,909			439,877			423,132
Depreciation and amortization		32,218			44,172			102,168			132,138

Total operating expenses		905,750			1,083,597			3,049,201			2,974,205

Loss from operations		(749,211	)		(924,229	)		(2,565,047	)		(2,615,761	)
Other income (expense):
Interest income		14,360			24,461			50,224			72,342
Interest expense on convertible note payable, related party		(57,863	)		—			(151,561	)		—
Accretion of discount on convertible note payable, related party		—			—			(831,426	)		—
Change in value of derivative instruments, including related party		—			—			11,803			—
Unrealized loss on marketable securities		—			—			(30,000	)		—
Realized gain on redemption of marketable securities		25,000			—			25,000			—

Other income (expense), net		(18,503	)		24,461			(925,960	)		72,342
Net loss	$	(767,714	)	$	(899,768	)	$	(3,491,007	)	$	(2,543,419	)

Basic and diluted net loss per share	$	(0.03	)	$	(0.04	)	$	(0.14	)	$	(0.10	)

Weighted average shares outstanding		25,653,512			25,653,512			25,653,512			24,966,608


	Common Stock			Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income			Stockholders’ Equity (Deficit)			Total Comprehensive Income (Loss)
	Number of Shares	Amount		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income			Stockholders’ Equity (Deficit)			Total Comprehensive Income (Loss)
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	)		(3,434,004	)

Balance at December 31, 2007	25,653,512		25,654		29,211,972			(27,566,913	)		—			1,670,713			(3,434,004	)
Stock-based compensation	—		—		144,322			—			—			144,322			—
Reclassification of warrants and options from equity to derivative liabilities	—		—		(1,255,317	)		—			—			(1,255,317	)		—
Extinguishment of convertible note payable, related party	—		—		733,317			—			—			733,317			—
Reclassification of warrants and options from derivative liabilities to equity	—		—		1,337,349			—			—			1,337,349			—
Unrealized gain on marketable securities	—		—		—			—			30,000			30,000			30,000
Reclassification of realized gain to statement of operations due to redemption of marketable securities	—		—		—			—			(25,000	)		(25,000	)		(25,000	)
Net loss	—		—		—			(3,491,007	)		—			(3,491,007	)		(3,491,007	)

Balance at September 30, 2008	25,653,512	$	25,654	$	30,171,643		$	(31,057,920	)	$	5,000		$	(855,623	)	$	(3,486,007	)

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	February 14, 2008		March 31, 2008		June 27, 2008
Risk-free interest rate	2.81	%	2.46	%	3.36	%
Expected dividend yield	0		0		0
Expected term in years	5.00		5.00		4.75
Expected volatility	98	%	98	%	99	%


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	September 30, 2008
Assets
Marketable securities (Note 3)	$	50,000


	Nine Months Ended September 30, 2008
Fair value estimates for ARS using significant unobservable inputs (Level 3)
Beginning balance at January 1, 2008	$	700,000
Sales and redemption of ARS at par value		(650,000	)
Unrealized loss recorded in condensed statements of operations		(30,000	)
Realized gain recorded in condensed statements of operations		25,000
Unrealized gain recorded in accumulated other comprehensive income (loss)		5,000

Ending balance at September 30, 2008	$	50,000


	Nine Months Ended September 30, 2008
Fair value estimates for derivative liabilities using significant unobservable inputs (Level 3)
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 (Note 2)		280,347
Change in fair value of derivative warrant liability related to the Note recorded in condensed statements of operations (Note 2)		275,327
Change in fair value of derivative liability related to non-employee options and other warrants recorded in condensed statements of operations (Note 6)		(473,642	)
Reclassification of outstanding warrants and options from derivative liabilities to equity due to amendment of convertible note payable on June 27, 2008		(1,337,349	)

Ending balance at September 30, 2008	$	—


	Nine Months Ended September 30, 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		(186,512	)

Ending balance at September 30, 2008	$	—


	Three Months Ended Sept. 30,					Nine Months Ended Sept. 30,
	2008			2007		2008		2007
Research and development	$	—		$	1,429	$	—	$	7,443
Marketing and business development		(172	)		15,916		15,236		47,633
General and administrative		21,773			40,869		129,086		80,682

Total stock-based compensation	$	21,601		$	58,214	$	144,322	$	135,758


	Three Months Ended Sept. 30,			Nine Months Ended Sept. 30,
	2008 *	2007		2008		2007
Risk-free interest rate	—	4.42	%	2.89 – 3.27	%	4.52	%
Expected dividend yield	—	0		0		0
Expected term in years	—	6.25		3.00 – 5.50		6.25
Expected volatility	—	100	%	99% –107	%	100	%


	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, September 30, 2008	3,015,194		$	1.22	4.61	$	2,500

Exercisable, September 30, 2008	2,673,249		$	1.30	4.03	$	—


	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 – $0.70	465,500	6.51	$	0.59	183,555	$	0.70
$0.76 – $0.85	350,000	8.44	$	0.80	290,000	$	0.80
$1.00 – $1.00	799,000	4.41	$	1.00	799,000	$	1.00
$1.20 – $1.48	50,000	6.87	$	1.34	50,000	$	1.34
$1.50 – $1.50	613,750	3.20	$	1.50	613,750	$	1.50
$1.75 – $1.75	60,000	6.25	$	1.75	60,000	$	1.75
$1.80 – $1.80	517,500	2.06	$	1.80	517,500	$	1.80
$1.85 – $1.85	104,444	4.06	$	1.85	104,444	$	1.85
$1.94 – $1.94	30,000	6.30	$	1.94	30,000	$	1.94
$2.00 – $2.00	25,000	0.46	$	2.00	25,000	$	2.00

$0.50 – $2.00	3,015,194	4.61	$	1.22	2,673,249	$	1.30


	Three Months Ended Sept. 30,		Nine Months Ended Sept. 30,
	2008	2007	2008	2007
Weighted average outstanding options	3,015,194	2,867,436	2,999,464	2,885,240
Weighted average outstanding warrants	3,450,544	2,700,544	2,960,580	2,700,544


	September 30, 2008			December 31, 2007
Machinery and equipment	$	547,483		$	546,496
Website		17,000			—
Furniture and fixtures		54,546			48,486
Leasehold improvements		43,993			43,993

		663,022			638,975
Less accumulated depreciation		(552,856	)		(512,466	)

Property and equipment, net	$	110,166		$	126,509


	September 30, 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		(744,557	)		(685,397	)

Intangible assets, net	$	373,322		$	432,482


	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Customer A	87	%	43	%	44	%	40	%
Customer B	—		12	%	15	%	16	%
Customer C	—		18	%	—		23	%
Customer D	—		14	%	27	%	—
Customer G	—		10	%	—		—


	Three Months Ended September 30,				Change		Nine Months Ended September 30,				Change
	2008		2007		Change		2008		2007		Change
License and development fees	$	56,859	$	105,971	(46.3	)%	$	263,251	$	152,212	73.0	%
Peptide sales		89,131		53,397	66.9	%		188,582		141,832	33.0	%
Peptide sales, related party		—		—	*			—		64,400	*
Administrative services revenue, related party		10,549		—	*			32,321		—	*

Total revenue	$	156,539	$	159,368	(1.8	)%	$	484,154	$	358,444	35.1	%


Contractual Obligations and Purchase Commitments	Less than 1 year		More than 1 year		Total
Operating lease	$	76,822	$	12,866	$	89,688
Purchase obligations⁽¹⁾		102,631		—		102,631
Convertible note payable, related party and related accrued interest⁽²⁾		—		3,150,575		3,150,575
Severance payments		45,000		—		45,000

Total contractual obligations and purchase commitments	$	224,453	$	3,163,441	$	3,387,894


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)

10.18*		License Agreement dated August 27, 2008 between the Company and Rodan & Fields, LLC

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