•  improving signal processing during biomedical imaging; and

 

Blue Sky Restrictions on Resale

 

The selling stockholders named in this prospectus may offer and sell the shares covered by this prospectus in states of the United States only where exemptions from registration under state securities laws are available.  Investors and securities professionals are advised to check each state’s securities laws and regulations (known as “Blue Sky” laws) or to check with management of the company to ascertain whether an exemption exists for the sale of our shares in a particular state.

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DIRECTORS, EXECUTIVE OFFICERS, CONTROL PERSONS AND MANAGEMENT

 

Our executive officers and directors are:

 

H. Craig Dees, Ph.D., 55, has served as our Chief Executive Officer and as a member of our Board of Directors since we acquired PPI, a privately held Tennessee Corporation on April 23, 2002. Before joining us, from 1997 to 2002 he served as senior member of the management team of Photogen Technologies, Inc., including serving as a member of the Board of Directors of Photogen from 1997 to 2000. Prior to joining Photogen, Dr. Dees served as a Group Leader at the Oak Ridge National Laboratory and as a senior member of the management teams of LipoGen Inc., a medical diagnostic company which used genetic engineering technologies to manufacture and distribute diagnostic assay kits for auto-immune diseases, and TechAmerica Group Inc., now a part of Boehringer Ingelheim Vetmedica, Inc., the U.S. animal health subsidiary of Boehringer Ingelhem GmbH, an international chemical and pharmaceutical company headquartered in Germany. He earned a Ph.D. in Molecular Virology from the University of Wisconsin–Madison in 1984.

 

Timothy C. Scott, Ph.D., 49, has served as our President and as a member of our Board of Directors since we acquired PPI on April 23, 2002. Prior to joining us, Dr. Scott was a senior member of the Photogen management team from 1997 to 2002, including serving as Photogen’s Chief Operating Officer from 1999 to 2002, as a director of Photogen from 1997 to 2000, and as interim CEO for a period in 2000. Before joining Photogen, he served as senior management of Genase LLC, a developer of enzymes for fabric treatment and held senior research and management positions at Oak Ridge National Laboratory. Dr. Scott earned a Ph.D. in Chemical Engineering from the University of Wisconsin–Madison in 1985.

 

Eric A. Wachter, Ph.D., 45, has served as our Vice President – Pharmaceuticals and as a member of our Board of Directors since we acquired PPI on April 23, 2002. Prior to joining us, from 1997 to 2002 he was a senior member of the management team of Photogen, including serving as Secretary and a director of Photogen since 1997 and as Vice President and Secretary and a director of Photogen since 1999. Prior to joining Photogen, Dr. Wachter served as a senior research staff member with Oak Ridge National Laboratory. He earned a Ph.D. in Chemistry from the University of Wisconsin–Madison in 1988.

 

Peter R. Culpepper, 48, was appointed to serve as our Chief Financial Officer in February 2004. Previously, Mr. Culpepper served as Chief Financial Officer for Felix Culpepper International, Inc. from 2001 to 2004; was a Registered Representative with AXA Advisors, LLC from 2002 to 2003; has served as Chief Accounting Officer and Corporate Controller for Neptec, Inc. from 2000 to 2001; has served in various Senior Director positions with Metromedia Affiliated Companies from 1998 to 2000; has served in various Senior Director and other financial positions with Paging Network, Inc. from 1993 to 1998; and has served in a variety of financial roles in public accounting and industry from 1982 to 1993. He earned a Masters in Business Administration in Finance from the University of Maryland–College Park in 1992. He earned an AAS in Accounting from the Northern Virginia Community College–Annandale, Virginia in 1985. He earned a B.A. in Philosophy from the College of William and Mary–Williamsburg, Virginia in 1982. He is a licensed Certified Public Accountant in both Tennessee and Maryland.

 

Stuart Fuchs, 60, has served as a member of our Board of Directors since January 23, 2003. He is the co-founder and has been a managing principal of Gryffindor, a Chicago-based venture capital firm, since January 2000. Before joining Gryffindor, he was a founding stockholder of several biotech companies, including Angiogen LLC (since 1998), which develops combinations of drugs to stimulate in vivo production of factors that inhibit the growth of blood vessels in tumors, and Nace Pharma LLC (since 1996), which develops drugs that employ novel drug delivery technologies. Through Nace Resources Inc., a Delaware corporation providing strategic and financial advice to companies in the technology sector, Mr. Fuchs has formed or participated in groups of investors on behalf of several companies, including Miicro Inc., Celsion Corp. and Photogen. Before founding Nace Resources Inc., he served for 19 years as an investment banker with Goldman, Sachs & Co., where he co-managed the firm’s public finance activities for the Midwest region. Before joining Goldman, Sachs & Co., Mr. Fuchs was a lawyer in private practice with Barrett Smith Schapiro & Simon in New York. Mr. Fuchs holds an A.B. degree from Harvard College and a J.D. from Harvard Law School and is a member of the Association of the Bar of the City of New York.

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Directors, Executive Officers and Other Stockholders

 

The table below shows the amount of our common stock beneficially owned as of November 26, 2007, by each of our directors and officers, all executive officers and directors as a group, and each person whom we believe beneficially owns more than 5% of our outstanding voting stock.

 

Name and Address (1)		Amount and Nature of Beneficial Ownership (2)			Percentage of Class (3)
Directors and Executive Officers:
H. Craig Dees		2,839,525	(4)		5.6
Timothy C. Scott		2,797,632	(5)		5.5
Eric A. Wachter		3,447,351	(6)		6.8
Peter R. Culpepper		1,216,665	(7)		2.4
Stuart Fuchs		976,418	(8)		2.0
All directors and executive officers as a group (5 persons)		11,277,591	(9)		20.6
Other Stockholders:
Dr. Donald E. Adams 370 Crestmont Drive San Luis Obispo, California 93401		7,176,123	(10)		14.1
Gryffindor Capital Partners I, L.L.C. 150 North Wacker Drive, Suite 800 Chicago, IL 60606`		5,552,918	(11)		10.5

 

 

(1)	If no address is given, the named individual is an executive officer or director of Provectus Pharmaceuticals, Inc., whose business address is 7327 Oak Ridge Highway, Suite A, Knoxville, Tennessee 37931.
(2)	Shares of common stock that a person has the right to acquire within 60 days of November 30, 2007 are deemed outstanding for computing the percentage ownership of the person having the right to acquire such shares, but are not deemed outstanding for computing the percentage ownership of any other person. Except as indicated by a note, each stockholder listed in the table has sole voting and investment power as to the shares owned by that person.
(3)	As of November 26, 2007, there were 49,207,614 shares of common stock issued and outstanding.
(4)	Dr. Dees’s beneficial ownership includes 536 shares held by Dees Family Foundation, an entity established for the benefit of Dr. Dees’s family, and 1,385,416 shares subject to options that are exercisable within 60 days

 

 

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(5)	Dr. Scott’s beneficial ownership includes 55,996 shares held by Scott Family Investment Limited Partnership, a limited partnership established for the benefit of Dr. Scott’s family, and 1,441,666 shares subject to options which are exercisable within 60 days.
(6)	Dr. Wachter’s beneficial ownership includes 4,867 shares held by the Eric A. Wachter 1998 Charitable Remainder Unitrust and 1,216,666 shares subject to options which are exercisable within 60 days. Dr. Wachter’s beneficial ownership also includes 330,881 shares of Common Stock underlying Warrants.
(7)	Mr. Culpepper’s beneficial ownership includes 1,001,084 shares subject to options which are exercisable within 60 days.
(8)	Mr. Fuchs’s beneficial ownership includes 226,459 shares held by SFF Limited Partnership, a limited partnership of which Mr. Fuchs is the general partner; 348,499 shares in an IRA of Mr. Fuchs; 175,000 shares subject to options which are exercisable within 60 days; and 226,460 shares held by Gryffindor Capital Partners I, L.L.C., a Delaware limited liability company of which Mr. Fuchs is the managing principal (“Gryffindor”).
(9)	Includes 5,219,832 shares subject to options which are exercisable within 60days.
(10)	Dr. Adams’s beneficial ownership includes 5,526,123 shares directly held. Dr. Adams’s beneficial ownership also includes 1,650,000 shares of Common Stock underlying Warrants.
(11)	Gryffindor’s beneficial ownership includes 1,559,793 shares directly held and 226,459 shares held by SFF Limited Partnership, a limited partnership of which Stuart Fuchs, one of our directors, is the general partner. Gryffindor disclaims beneficial ownership of the shares held by SFF Limited Partnership. Gryffindor’s beneficial ownership also includes 3,766,666 shares of Common Stock underlying Warrants.

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EXECUTIVE COMPENSATION

 

The table below shows the compensation for services in all capacities we paid during the years ended December 31, 2006 and 2007 to our Chief Executive Officer, Chief Financial Officer and our two other most highly paid executive officers:

 

Summary Compensation Table

 

Name and Principal Position	Year	Salary ($)	Bonus ($)	Option Awards ($)(1)	All Other Compensation ($)(2)	Total ($)
H. Craig Dees, CEO	2006	333,333	127,308	459,208	30,288	950,137
	2007	375,000	344,996	564,078	31,731	1,315,805
Timothy C. Scott, President	2006	333,333	127,308	459,208	30,288	950,137
	2007	375,000	344,996	564,078	31,731	1,315,805
Eric A. Wachter, VP-Pharmaceuticals	2006	333,333	127,308	459,208	30,288	950,137
	2007	375,000	344,996	564,078	31,731	1,315,805
Peter R. Culpepper, CFO	2006	333,333	127,308	436,833	30,288	927,762
	2007	375,000	344,996	578,534	31,731	1,330,261

 

(1)

The value represented for each Named Executive is the aggregate compensation expense for such person’s stock options awards recognized by the Company during the year indicated which include awards granted prior to 2006, for financial statement reporting purposes as computed in accordance with FAS 123R. The assumptions used in determining the listed valuations are provided in Note 5 to the Consolidated Financial Statements, beginning on page F-16. Each named full-time employee except the CFO is also a director of the Company. Included is each applicable employee’s director compensation of 50,000 stock options each year granted at an exercise price of $1.50 during 2007 and $1.02 during 2006 which is the fair market price on the date of issuance. The options vested immediately on the date of grant and expire in 2017 and 2016, respectively. For purposes of estimating the fair value of each stock option on the date of grant, the Company utilized the Black-Scholes option-pricing model which totaled $69,850 in 2007 and $48,000 in 2006 for the 50,000 options.

 

(2)           Other compensation represents unused vacation that was paid out.

 

 

 

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Outstanding Equity Awards at Fiscal Year-End

 

	Option Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable	Number of Securities Underlying Unexercised Options (#) Unexercisable (1)	Option Exercise Price ($)	Option Expiration Date
H. Craig Dees	18,750	--	0.32	2013
	25,000	--	0.60	2013
	300,000	--	1.10	2014
	25,000	--	0.95	2014
	150,000	150,000	0.64	2015

	200,000	100,000	0.75	2015
	25,000	--	0.62	2015
	133,333	66,667	0.94	2015
	50,000	--	1.02	2016
	333,333	666,667	1.02	2016
	50,000	--	1.50	2017
Timothy C. Scott	75,000	--	0.32	2013
	25,000	--	0.60	2013
	300,000	--	1.10	2014
	25,000	--	0.95	2014
	150,000	150,000	0.64	2015
	200,000	100,000	0.75	2015
	25,000	--	0.62	2015
	133,333	66,667	0.94	2015
	50,000	--	1.02	2016
	333,333	666,667	1.02	2016
	50,000	--	1.50	2017
Eric A. Wachter	75,000	--	0.32	2013
	25,000	--	0.60	2013
	75,000	--	1.10	2014
	25,000	--	0.95	2014
	150,000	150,000	0.64	2015
	200,000	100,000	0.75	2015
	25,000	--	0.62	2015
	133,333	66,667	0.94	2015
	50,000	--	1.02	2016
	333,333	666,667	1.02	2016
	50,000	--	1.50	2017
Peter R. Culpepper	159,419	75,000	1.10	2014
	100,000	--	1.25	2014
	--	150,000	0.64	2015
	200,000	100,000	0.75	2015
	133,332	41,668	0.94	2015
	333,333	666,667	1.02	2016

 

(1)

The unexercisable options for each Named Executive vest at the same rate for the respective equity award. The 150,000 and 666,667 unexercisable options vest over two years beginning in 2008. The 100,000 and 66,667 unexercisable options vest over one year beginning in 2008. The remaining unexercisable options of 75,000 and 41,668 for Peter R. Culpepper vest over one year beginning in 2008.

 

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Employment Agreements

 

On January 4, 2005, we entered into executive employment agreements with each of H. Craig Dees. Ph.D., Timothy C. Scott, Ph.D., Eric A. Wachter, Ph.D., and Peter R. Culpepper, CPA, to serve as our Chief Executive Officer, President, Executive Vice President and Chief Financial Officer, respectively. Each agreement provides that such executive will be employed for a one-year term with automatic one-year renewals unless previously terminated pursuant to the terms of the agreement or either party gives notice that the term will not be extended. Each executive’s initial base salary is $200,000 per year and is subject to adjustment by our Board of Directors. Executives are also entitled to participate in any incentive compensation plan or bonus plan adopted by us without diminution of any compensation or payment under the agreement. Executives are further entitled to reimbursement for all reasonable out-of-pocket expenses incurred during his performance of services under the agreement.

 

Each agreement generally provides that if the executive’s employment is terminated prior to a change in control (as defined in the agreement) (1) due to expiration or non-extension of the term by us, or (2) by us for any reason other than for cause (as defined in the agreement), then such executive shall be entitled to receive payments under the agreement as if the agreement was still in effect through the end of the period in effect as of the date of such termination. If the executive’s employment (1) is terminated by the company at any time for cause, (2) is terminated by executive prior to, and not coincident with, a change in control or (3) is terminated by executive’s death, disability or retirement prior to a change in control, the executive (or his estate, as the case may be) shall be entitled to receive payments under the agreement through the last date of the month of such termination, a pro rata portion of any incentive or bonus payment earned prior to such termination, any benefits to which he is entitled under the terms and conditions of the pertinent plans in effect at termination and any reasonable expenses incurred during the performance of services under the agreement.

 

In the event that coincident with or following a change in control, the executive’s employment is terminated or the agreement is not extended (1) by action of the executive including his death, disability or retirement or (2) by action of the company not for cause, the executive (or his estate, as the case may be) shall be entitled to receive payments under the agreement through the last date of the month of such termination, a pro rata portion of any incentive or bonus payment earned prior to such termination, any benefits to which he is entitled under the terms and conditions of the pertinent plans in effect at termination and any reasonable expenses incurred during the performance of services under the agreement. In addition, the company shall pay to the executive (or his estate, as the case may be), within 30 days following the date of termination or on the effective date of the change in control (whichever occurs later), a lump sum payment in cash in an amount equal to 2.90 times the base salary paid in the preceding calendar year, or scheduled to be paid to such executive during the year of such termination, whichever is greater, plus an additional amount sufficient to pay United States income tax on the lump sum amount paid.

 

The following table shows the base salary compensation these officers would have received under the employment agreements had a change in control occurred as of December 31, 2007.

 

Name		Amount
H. Craig Dees, Ph.D.	$	1,160,000
Timothy C. Scott, Ph.D.	$	1,160,000
Eric A. Wachter, Ph.D.	$	1,160,000
Peter R. Culpepper, CPA, MBA	$	1,160,000

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Equity Compensation Plan Information

 

The table below sets forth certain information regarding shares available as of December 31, 2007 for issuance under our equity compensation plans:

 

Category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted-average exercise price of outstanding options, warrants and rights	(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by stockholders	8,903,169	$ 0.93	600,000
Equity compensation plans not approved by stockholders	0	$ --	0
Total	8,903,169	$ 0.93	600,000

 

Director Compensation

 

Three of our four directors, Drs. Dees, Scott and Wachter, are also full-time employees. As discussed under the heading “Executive Compensation,” they are compensated for their service in those roles. Other than the options described below, they are not separately compensated for their service as directors.

 

Mr. Fuchs does not receive cash compensation for his service as a member of the Board of Directors, although he is reimbursed for expenses incurred in fulfilling his duties as a director, including attending meetings.

 

On the date of each annual meeting of stockholders, each member of the Board of Directors receives options exercisable for shares of our common stock. In 2006, each of our directors received 50,000 options.

 

 

Name	Fees Earned or Paid in Cash ($)	Stock Awards ($)	Option Awards ($)	Non-Equity Incentive Plan Compensation Earnings ($)	Nonqualified Deferred Compensation Earnings ($)	All Other Compensation ($)(2)	Total ($)
Stuart Fuchs			69,850				69,850

 

(1) Our other 3 directors are also full-time employees whose compensation is discussed under the heading “Executive Compensation.”

 

(2) A total of 50,000 stock options were granted at an exercise price of $1.50 which is the fair market price on the date of issuance. The options vested immediately on the date of grant and expire in 2017. For purposes of estimating the fair value of each stock option on the date of grant, the Company utilized the Black-Scholes option-pricing model.

 

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BUSINESS

 

Overview

 

Provectus, and its seven wholly owned subsidiaries:

 

·  Xantech Pharmaceuticals, Inc.;

 

·  Pure-ific Corporation;

 

·  Provectus Biotech, Inc.;

 

·  Provectus Devicetech, Inc.;

 

·  Provectus Imaging, Inc.;

 

·  IP Tech, Inc.; and

 

·  Provectus Pharmatech, Inc.

 

(which we refer to as our subsidiaries) develop, license and market and plan to sell products in three sectors of the healthcare industry:

 

·	Over-the-counter products, which we refer to in this report as “OTC products;”

 

·	Prescription drugs; and

 

·	Medical device systems.

 

We manage Provectus and our subsidiaries on an integrated basis and when we refer to “we” or “us” or “the company” in this Prospectus, we refer to all eight corporations considered as a single unit. Our principal executive offices are located at 7327 Oak Ridge Highway, Suite A, Knoxville, Tennessee 37931, telephone (865) 769-4011.

 

Through discovery and use of state-of-the-art scientific and medical technologies, the founders of our pharmaceutical business have developed a portfolio of patented, patentable, and proprietary technologies that support multiple products in the prescription drug, medical device and OTC products categories. These patented technologies are for:

 

·	treatment of cancer;

 

·	novel therapeutic medical devices;

 

·	enhancing contrast in medical imaging;

 

·	improving signal processing during biomedical imaging; and

 

·	enhancing production of biotechnology products.

 

Our prescription drug products encompass the areas of dermatology and oncology and involve several types of small molecule-based drugs. Our medical device systems include therapeutic and cosmetic lasers, while our OTC products address markets primarily involving skincare applications. Because our prescription drug candidates and medical device systems are in the early stages of development, they are not yet on the market and there is no assurance that they will advance to the point of commercialization.

 

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Our first commercially available products are directed into the OTC market, as these products pose minimal or no regulatory compliance barriers to market introduction. For example, the active pharmaceutical ingredient (API) in our ethical products is already approved for other medical uses by the FDA and has a long history of safety for use in humans. This use of known APIs for novel uses and in novel formulations minimizes potential adverse concerns from the FDA, since considerable safety data on the API is available (either in the public domain or via license or other agreements with third parties holding such information). In similar fashion, our OTC products are based on established APIs and, when possible, utilize formulations (such as aerosol or cream formulations) that have an established precedent. (For more information on compliance issues, see “Federal Regulation of Therapeutic Products.” In this fashion, we believe that we can diminish the risk of regulatory bars to the introduction of safe, consumer-friendly products and minimize the time required to begin generating revenues from product sales. At the same time, we continue to develop higher-margin prescription pharmaceuticals and medical devices, which have longer development and regulatory approval cycles.

 

Over-the-Counter Pharmaceuticals

 

Our OTC products are designed to be safer and more specific than competing products. Our technologies offer practical solutions for a number of intractable maladies, using ingredients that have limited or no side effects compared with existing products. To develop our OTC products, we typically use compounds with potent antibacterial and antifungal activity as building blocks and combine these building blocks with anti-inflammatory and moisture-absorbing agents. Products with these properties can be used for treatment of a large number of skin afflictions, including:

 

·	hand irritation associated with use of disposable gloves;

 

·	eczema; and

 

·	mild to moderate acne.

 

Where appropriate, we have filed or will file patent applications and will seek other intellectual property protection to protect our unique formulations for relevant applications.

 

GloveAid

 

Personnel in many occupations and industries now use disposable gloves daily in the performance of their jobs, including:

 

·	Airport security personnel;

 

·	Food handling and preparation personnel;

 

·	Sanitation workers;

 

·	Postal and package delivery handlers and sorters;

 

·	Laboratory researchers;

 

·	Health care workers such as hospital and blood bank personnel; and

 

·	Police, fire and emergency response personnel.

 

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Accompanying the increased use of disposable gloves is a mounting incidence of chronic skin irritation. To address this market, we have developed GloveAid, a hand cream with both antiperspirant and antibacterial properties, to increase the comfort of users’ hands during and after the wearing of disposable gloves. During 2003, we ran a pilot scale run at the manufacturer of GloveAid. We now intend to license this product to a third party with experience in the institutional sales market.

 

Pure-ific

 

Our Pure-ific line of products includes two quick-drying sprays, Pure-ific and Pure-ific Kids, that immediately kill up to 99.9% of germs on skin and prevent regrowth for 6 hours. We have determined the effectiveness of Pure-ific based on our internal testing and testing performed by Paratus Laboratories H.B., an independent research lab. Pure-ific products help prevent the spread of germs and thus complement our other OTC products designed to treat irritated skin or skin conditions such as acne, eczema, dandruff and fungal infections. Our Pure-ific sprays have been designed with convenience in mind and are targeted towards mothers, travelers, and anyone concerned about the spread of sickness-causing germs. During 2003 and 2004, we identified and engaged sales and brokerage forces for Pure-ific. We emphasized getting sales in independent pharmacies and mass (chain store) markets. The supply chain for Pure-ific was established with the ability to support large-scale sales and a starting inventory was manufactured and stored in a contract warehouse/fulfillment center. In addition, a website for Pure-ific was developed with the ability for supporting online sales of the antibacterial hand spray. During 2005 and 2006, most of our sales were generated from customers accessing our website for Pure-ific and making purchases online. We now intend to license the Pure-ific product and sell the underlying assets.

 

Acne

 

A number of dermatological conditions, including acne and other blemishes result from a superficial infection which triggers an overwhelming immune response. We anticipate developing OTC products similar to the GloveAid line for the treatment of mild to moderate cases of acne and other blemishes. Wherever possible, we intend to formulate these products to minimize or avoid significant regulatory bars that might adversely impact time to market.

 

Prescription Drugs

 

We are developing a number of prescription drugs which we expect will provide minimally invasive treatment of chronic severe skin afflictions such as psoriasis, eczema, and acne; and several life-threatening cancers such as those of the liver, breast and prostate. We believe that our products will be safer and more specific than currently existing products. Use of topical or other direct delivery formulations allows these potent products to be conveniently and effectively delivered only to diseased tissues, thereby enhancing both safety and effectiveness. The ease of use and superior performance of these products may eventually lead to extension into OTC applications currently serviced by less safe, more expensive alternatives. All of these products are in the pre-clinical or clinical trial stage.

 

Dermatology

 

Our most advanced prescription drug candidate for treatment of topical diseases on the skin is PH-10, a topical gel. Rose Bengal, the active ingredient in PH-10, is “photoactive” it reacts to light of certain wavelengths, increasing its therapeutic effects. PV-10 also concentrates in diseased or damaged tissue but quickly dissipates from healthy tissue. By developing a “photodynamic” treatment regimen (one which combines a photoactive substance with activation by a source emitting a particular wavelength of light) around these two properties of PV-10, we can deliver a higher therapeutic effect at lower dosages of active ingredient, thus minimizing potential side effects including damage to nearby healthy tissues. PV-10 is especially responsive to green light, which is strongly absorbed by the skin and thus only penetrates the body to a depth of about three to five millimeters. For this reason, we have developed PH-10 combined with green-light activation for topical use in surface applications where serious damage could result if medicinal effects were to occur in deeper tissues.

 

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Acute psoriasis. Psoriasis is a common chronic disorder of the skin characterized by dry scaling patches, called “plaques,” for which current treatments are few and those that are available have potentially serious side effects. According to Roenigk and Maibach (Psoriasis, Third Edition, 1998), there are approximately five million people in the United States who suffer from psoriasis, with an estimated 160,000 to 250,000 new psoriasis cases each year. There is no known cure for the disease at this time. According to the National Psoriasis Foundation, the majority of psoriasis sufferers, those with mild to moderate cases, are treated with topical steroids that can have unpleasant side effects. None of the other treatments for moderate cases of psoriasis have proven completely effective. The 25-30% of psoriasis patients who suffer from more severe cases generally are treated with more intensive drug therapies or PUVA, a light-based therapy that combines the drug Psoralen with exposure to ultraviolet A light. While PUVA is one of the more effective treatments, it increases a patient’s risk of skin cancer.

 

We believe that PH-10 activated with green light offers a superior treatment for acute psoriasis because it selectively treats diseased tissue with negligible potential for side effects in healthy tissue; moreover, the therapy has shown promise in comprehensive Phase 1 clinical trials. The objective of a Phase 1 clinical trial is to determine if there are safety concerns with the therapy. In these studies, involving more than 50 test subjects, PH-10 was applied topically to psoriatic plaques and then illuminated with green light. In our first study, a single-dose treatment yielded an average reduction in plaque thickness of 59% after 30 days, with further response noted at the final follow-up examination 90 days later. Further, no pain, significant side effects, or evidence of “rebound” (increased severity of a psoriatic plaque after the initial reduction in thickness) were observed in any treated areas. This degree of positive therapeutic response is comparable to that achieved with potent steroids and other anti-inflammatory agents, but without the serious side effects associated with such agents. We are continuing the required Food and Drug Administration reporting to support the active Investigational New Drug application for PH-10’s Phase 2 clinical trials on psoriasis. The required reporting includes the publication of results regarding the multiple treatment scenario of the active ingredient in PH-10. We are now conducting Phase 2 studies, in which we expect to assess the potential for remission of the disease using a regimen of weekly treatments similar to those used for PUVA.

 

Actinic Keratosis. According to Schwartz and Stoll (Fitzpatrick’s Dermatology in General Medicine, 1999), actinic keratosis, or “AK” (also called solar keratosis or senile keratosis), is the most common pre-cancerous skin lesion among fair-skinned people and is estimated to occur in over 50% of elderly fair-skinned persons living in sunny climates. These experts note that nearly half of the approximately five million cases of skin cancer in the U.S. may have begun as AK. The standard treatments for AK (primarily comprising excision, cryotherapy, and ablation with topical 5-fluorouracil) are often painful and frequently yield unacceptable cosmetic outcomes due to scarring. Building on our experience with psoriasis, we are assessing the use of PH-10 with green-light activation as a possible improvement in treatment of early and more advanced stages of AK. We completed an initial Phase 1 clinical trial of the therapy for this indication in 2001 with the predecessor company that was acquired in 2002. This study, involving 24 subjects, examined the safety profile of a single treatment using topical PH-10 with green light photoactivation and no significant safety concerns were identified. We have decided to prioritize further clinical development of PH-10 for treatment of psoriasis and eczema rather than AK at this time since the market is much larger for psoriasis and eczema.

 

Severe Acne. According to Berson et al. (Cutis. 72 (2003) 5-13), acne vulgaris affects approximately 17 million individuals in the U.S., causing pain, disfigurement, and social isolation. Moderate to severe forms of the disease have proven responsive to several photodynamic regimens, and we anticipate that PH-10 can be used as an advanced treatment for this disease. Pre-clinical studies show that the active ingredient in PH-10 readily kills bacteria associated with acne. This finding, coupled with our clinical experience in psoriasis and actinic keratosis, suggests that therapy with PH-10 will exhibit no significant side effects and will afford improved performance relative to other therapeutic alternatives. If correct, this would be a major advance over currently available products for severe acne.

 

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As noted above, we are researching multiple uses for PH-10 with green-light activation. Multiple-indication use by a common pool of physicians - dermatologists, in this case - should reduce market resistance to this new therapy.

 

Oncology

 

Oncology is another major market where our planned products may afford competitive advantage compared to currently available options. We are developing PV-10, a sterile injectible form of Rose Bengal, for direct injection into tumors. Because PV-10 is retained in diseased or damaged tissue but quickly dissipates from healthy tissue, we believe we can develop therapies that confine treatment to cancerous tissue and reduce collateral impact on healthy tissue. During 2003 and 2004, we worked toward completion of the extensive scientific and medical materials necessary for filing an Investigational New Drug (IND) application for PV-10 in anticipation of beginning Phase 1 clinical trials for breast and liver cancer. This IND was filed and allowed by the FDA in 2004 setting the stage for two Phase 1 clinical trials; namely, treating metastatic melanoma and recurrent breast carcinoma. We started both of these Phase 1 clinical trials in 2005 and completed the initial Phase 1 objectives for both in 2006.

 

Liver Cancer. The current standard of care for liver cancer is ablative therapy (which seeks to reduce a tumor by poisoning, freezing, heating, or irradiating it) using either a localized injection of ethanol (alcohol), cryosurgery, radiofrequency ablation, or ionizing radiation such as X-rays. Where effective, these therapies have many side effects and selecting therapies with fewer side effects tends to reduce overall effectiveness. Combined, ablative therapies have a five-year survival rate of 33% - meaning that only 33% of those liver cancer patients whose cancers are treated using these therapies survive for five years after their initial diagnoses. In pre-clinical studies we have found that direct injection of PV-10 into liver tumors quickly ablates treated tumors, and can trigger an anti-tumor immune response leading to eradication of residual tumor tissue and distant tumors. Because of the natural regenerative properties of the liver and the highly localized nature of the treatment, this approach appears to produce no significant side effects. Based on these encouraging preclinical results, we are assessing strategies for initiation of clinical trials of PV-10 for treatment of liver cancer.

 

Breast Cancer. Breast cancer afflicts over 200,000 U.S. citizens annually, leading to over 40,000 deaths. Surgical resection, chemotherapy, radiation therapy, and immunotherapy comprise the standard treatments for the majority of cases, resulting in serious side effects that in many cases are permanent. Moreover, current treatments are relatively ineffective against metastases, which in many cases are the eventual cause of patient mortality. Pre-clinical studies using human breast tumors implanted in mice have shown that direct injection of PV-10 into these tumors ablates the tumors, and, as in the case of liver tumors, may elicit an anti-tumor immune response that eradicates distant metastases. Since fine-needle biopsy is a routine procedure for diagnosis of breast cancer, and since the needle used to conduct the biopsy also could be used to direct an injection of PV-10 into the tumor, localized destruction of suspected tumors through direct injection of PV-10 clearly has the potential of becoming a primary treatment. We are evaluating options for expanding clinical studies of direct injection of PV-10 into breast tumors while completing expanded Phase 1 clinical studies of our indication for PV-10 in recurrent breast carcinoma.

 

Prostate Cancer. Cancer of the prostate afflicts approximately 190,000 U.S. men annually, leading to over 30,000 deaths. As with breast cancer, surgical resection, chemotherapy, radiation therapy, and immunotherapy comprise the standard treatments for the majority of cases, and can result in serious, permanent side effects. We believe that direct injection of PV-10 into prostate tumors may selectively ablate such tumors, and, as in the case of liver and breast tumors, may also elicit an anti-tumor immune response capable of eradicating distant metastases. Since trans-urethral ultrasound, guided fine-needle biopsy and immunotherapy, along with brachytherapy implantation, are becoming routine procedures for diagnosis and treatment of these cancers, we believe that localized destruction of suspected tumors through direct injection of PV-10 can become a primary treatment. We are evaluating options for initiating clinical studies of direct injection of PV-10 into prostate tumors, and expect to formulate final plans based on results from clinical studies of our indications for PV-10 in the treatment of liver and breast cancer.

 

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Metastatic Melanoma. Melanoma is expected to strike 60,000 people in the U.S. this year, leading to 8,100 deaths. The incidence of melanoma in Australia, where our expanded Phase 2 clinical study is currently underway, is up to 5X that of the U.S. There have been no significant advances in the treatment of melanoma for approximately 30 years. We are continuing Phase 2 clinical studies in both Australia and the U.S. of direct injection of PV-10 into melanoma lesions and we completed the expanded Phase 1 clinical studies of our indication for PV-10 in Stage 3 and Stage 4 metastatic melanoma.

 

Medical Devices

 

We have medical device technologies to address two major markets:

 

·	cosmetic treatments, such as reduction of wrinkles and elimination of spider veins and other cosmetic blemishes; and

 

·	therapeutic uses, including photoactivation of PH-10 other prescription drugs and non-surgical destruction of certain skin cancers.

 

We expect to further develop medical devices through partnerships with, or selling our assets to, third-party device manufacturers or, if appropriate opportunities arise, through acquisition of one or more device manufacturers.

 

Photoactivation. Our clinical tests of PH-10 for dermatology have, up to the present, utilized a number of commercially available lasers for activation of the drug. This approach has several advantages, including the leveraging of an extensive base of installed devices present throughout the pool of potential physician-adopters for PH-10.  Access to such a base could play an integral role in early market capture. However, since the use of such lasers, which were designed for occasional use in other types of dermatological treatment, is potentially too cumbersome and costly for routine treatment of the large population of patients with psoriasis, we have begun investigating potential use of other types of photoactivation hardware, such as light booths. The use of such booths is consistent with current care standards in the dermatology field, and may provide a cost-effective means for addressing the needs of patients and physicians alike. We anticipate that such photoactivation hardware would be developed, manufactured, and supported in conjunction with one or more third-party device manufacturer.

 

Melanoma. A high priority in our medical devices field is the development of a laser-based product for treatment of melanoma. We have conducted extensive research on ocular melanoma at the Massachusetts Eye and Ear Infirmary (a teaching affiliate of Harvard Medical School) using a new laser treatment that may offer significant advantage over current treatment options. A single quick non-invasive treatment of ocular melanoma tumors in a rabbit model resulted in elimination of over 90% of tumors, and may afford significant advantage over invasive alternatives, such as surgical excision, enucleation, or radiotherapy implantation. Ocular melanoma is rare, with approximately 2,000 new cases annually in the U.S. However, we believe that our extremely successful results could be extrapolated to treatment of primary melanomas of the skin, which have an incidence of over 60,000 new cases annually in the U.S. and a 6% five-year survival rate after metastasis of the tumor. We have performed similar laser treatments on large (averaging approximately 3 millimeters thick) cutaneous melanoma tumors implanted in mice, and have been able to eradicate over 90% of these pigmented skin tumors with a single treatment. Moreover, we have shown that this treatment stimulates an anti-tumor immune response that may lead to improved outcome at both the treatment site and at sites of distant metastasis. From these results, we believe that a device for laser treatment of primary melanomas of the skin and eye is nearly ready for human studies. We anticipate partnering with, or selling our assets to, a medical device manufacturer to bring it to market in reliance on a 510(k) notification. For more information about the 510(k) notification process, see “Federal Regulation of Therapeutic Products.” 

 

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Research and Development

 

We continue to actively develop projects that are product directed and are attempting to conserve available capital and achieve full capitalization of our company through equity and convertible debt offerings, generation of product revenues, and other means. All ongoing research and development activities are directed toward maximizing shareholder value and advancing our corporate objectives in conjunction with our OTC product licensure, our current product development and maintaining our intellectual property portfolio.

 

Production

 

We have determined that the most efficient use of our capital in further developing our OTC products is to license the products and sell the underlying assets for upfront cash consideration.

 

Sales

 

Our first commercially available products are directed into the OTC market, as these products pose minimal or no regulatory compliance barriers to market introduction. In this fashion, we believe that we can diminish the risk of regulatory bars to the introduction of products and minimize the time required to begin generating revenues from product sales. At the same time, we continue to develop higher-margin prescription pharmaceuticals and medical devices, which have longer development and regulatory approval cycles.

 

We have commenced limited sales of Pure-ific, our antibacterial hand spray. We sold small amounts of this product during 2004, 2005 and 2006. We will continue to seek additional markets for our products through existing distributorships that market and distribute medical products, ethical pharmaceuticals, and OTC products for the professional and consumer marketplaces through licensure, partnership and asset sale arrangements, and through potential merger and acquisition candidates.

 

In addition to developing and selling products ourselves on a limited basis, we are negotiating actively with a number of potential licensees for several of our intellectual properties, including patents and related technologies. To date, we have not yet entered into any licensing agreements; however, we anticipate consummating one or more such licenses in the future.

 

Intellectual Property

 

Patents

 

We hold a number of U.S. patents covering the technologies we have developed and are continuing to develop for the production of prescription drugs, medical devices and OTC pharmaceuticals, including those identified in the following table:

 

U.S. Patent No.	Title	Issue Date	Expiration Date
5,829,448	Method for improved selectivity in -activation of molecular agents	November 3, 1998	October 30, 2016
5,832,931	Method for improved selectivity in photo-activation and detection of diagnostic agents	November 10, 1998	October 30, 2016
5,998,597	Method for improved selectivity in -activation of molecular agents	December 7, 1999	October 30, 2016
6,042,603	Method for improved selectivity in photo-activation of molecular agents	March 28, 2000

6,331,286	Methods for high energy phototherapeutics	December 18, 2001	December 21, 2018
6,451,597	Method for enhanced protein stabilization and for production of cell lines useful production of such stabilized proteins	September 17, 2002	April 6, 2020
6,468,777	Method for enhanced protein stabilization and for production of cell lines useful production of such stabilized proteins	October 22, 2002	April 6, 2020
6,493,570	Method for improved imaging and photodynamic therapy	December 10, 2002	December 10, 2019
6,495,360	Method for enhanced protein stabilization for production of cell lines useful production of such stabilized proteins	December 17, 2002	April 6, 2020
6,519,076	Methods and apparatus for optical imaging	February 11, 2003	October 30, 2016
6,525,862	Methods and apparatus for optical imaging	February 25, 2003	October 30, 2016
6,541,223	Method for enhanced protein stabilization and for production of cell lines useful production of such stabilized proteins	April 1, 2003	April 6, 2020
6,986,740	Ultrasound contrast using halogenated xanthenes	January 17, 2006	September 9, 2023
6,991,776	Improved intracorporeal medicaments for high energy phototherapeutic treatment of disease	January 31, 2006	May 5, 2023
7,036,516	Treatment of pigmented tissues using optical energy	May 2, 2006	January 28, 2020

        We continue to pursue patent applications on numerous other developments we believe to be patentable. We consider our issued patents, our pending patent applications and any patentable inventions which we may develop to be extremely valuable assets of our business.

 

Trademarks

 

We own the following trademarks used in this document: GloveAid(TM) and Pure-ific(TM) (including Pure-ific(TM) and Pure-ific(TM) Kids). We also own the registered trademark PulseView®. Trademark rights are perpetual provided that we continue to keep the mark in use. We consider these marks, and the associated name recognition, to be valuable to our business.

 

Material Transfer Agreement

 

We have entered into a Material Transfer Agreement dated as of July 31, 2003 with Schering-Plough Animal Health Corporation, which we refer to as “SPAH”, the animal-health subsidiary of Schering-Plough Corporation, a major international pharmaceutical company. This Material Transfer Agreement is still in effect. We refer to this agreement in this report as the “Material Transfer Agreement.” Under the Material Transfer Agreement, we will provide SPAH with access to some of our patented technologies to permit SPAH to evaluate those technologies for use in animal-health applications. If SPAH determines that it can commercialize our technologies, then the Material Transfer Agreement obligates us and SPAH to enter into a license agreement providing for us to license those technologies to SPAH in exchange for progress payments upon the achievement of goals. The Material Transfer Agreement covers four U.S. patents that cover biological material manufacturing technologies (i.e., biotech related). The Material Transfer Agreement continues indefinitely, unless SPAH terminates it by giving us notice or determines that it does not wish to secure from us a license for our technologies. The Material Transfer Agreement can also be terminated by either of us in the event the other party breaches the agreement and does not cure the breach within 30 days of notice from the other party. We can give you no assurance that SPAH will determine that it can commercialize our technologies or that the goals required for us to obtain progress payments from SPAH will be achieved.

 

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Competition

 

In general, the pharmaceutical industry is intensely competitive, characterized by rapid advances in products and technology. A number of companies have developed and continue to develop products that address the areas we have targeted. Some of these companies are major pharmaceutical companies that are international in scope and very large in size, while others are niche players that may be less familiar but have been successful in one or more areas we are targeting. Existing or future pharmaceutical, device, or other competitors may develop products that accomplish similar functions to our technologies in ways that are less expensive, receive faster regulatory approval, or receive greater market acceptance than our products. Many of our competitors have been in existence for considerably longer than we have, have greater capital resources, broader internal structure for research, development, manufacturing and marketing, and are in many ways further along in their respective product cycles.

 

At present, our most direct competitors are smaller companies that are exploiting niches similar to ours. In the field of photodynamic therapy, one competitor, QLT, Inc., has received FDA approval for use of its agent Photofrin® for treatment of several niche cancer indications, and has a second product, Visudyne®, approved for treatment of certain forms of macular degeneration. Another competitor in this field, Dusa Pharmaceuticals, Inc. received FDA approval of its photodynamic product Levulan® Kerastik® for treatment of actinic keratosis. We believe that QLT and Dusa, among other competitors, have established a working commercial model in dermatology and oncology, and that we can benefit from this model by offering products that, when compared to our competitors’ products, afford superior safety and performance, greatly reduced side effects, improved ease of use, and lower cost, compared to those of our competitors.

 

While it is possible that eventually we may compete directly with major pharmaceutical companies, we believe it is more likely that we will enter into joint development, marketing, or other licensure arrangements with such competitors. Eventually, we believe that we will be acquired.

 

We also have a number of market areas in common with traditional skincare cosmetics companies, but in contrast to these companies, our products are based on unique, proprietary formulations and approaches. For example, we are unaware of any products in our targeted OTC skincare markets that our similar to our Pure-ific products. Further, proprietary protection of our products may help limit or prevent market erosion until our patents expire.

 

Federal Regulation of Therapeutic Products

 

All of the prescription drugs and medical devices we currently contemplate developing will require approval by the FDA prior to sales within the United States and by comparable foreign agencies prior to sales outside the United States. The FDA and comparable regulatory agencies impose substantial requirements on the manufacturing and marketing of pharmaceutical products and medical devices. These agencies and other entities extensively regulate, among other things, research and development activities and the testing, manufacturing, quality control, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our proposed products. While we attempt to minimize and avoid significant regulatory bars when formulating our products, some degree of regulation from these regulatory agencies is unavoidable. Some of the things we do to attempt to minimize and avoid significant regulatory bars include the following:

 

·	Using chemicals and combinations already allowed by the FDA;

 

·	Carefully making product performance claims to avoid the need for regulatory approval;

 

·	Using drugs that have been previously approved by the FDA and that have a long history of safe use;

 

 

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·	Using chemical compounds with known safety profiles; and

 

·	In many cases, developing OTC products which face less regulation than prescription pharmaceutical products.

 

The regulatory process required by the FDA, through which our drug or device products must pass successfully before they may be marketed in the U.S., generally involves the following:

 

·	Preclinical laboratory and animal testing;

 

·	Submission of an application that must become effective before clinical trials may begin;

 

·	Adequate and well-controlled human clinical trials to establish the safety and efficacy of the product for its intended indication; and

 

·	FDA approval of the application to market a given product for a given indication.

 

For pharmaceutical products, preclinical tests include laboratory evaluation of the product, its chemistry, formulation and stability, as well as animal studies to assess the potential safety and efficacy of the product. Where appropriate (for example, for human disease indications for which there exist inadequate animal models), we will attempt to obtain preliminary data concerning safety and efficacy of proposed products using carefully designed human pilot studies. We will require sponsored work to be conducted in compliance with pertinent local and international regulatory requirements, including those providing for Institutional Review Board approval, national governing agency approval and patient informed consent, using protocols consistent with ethical principles stated in the Declaration of Helsinki and other internationally recognized standards. We expect any pilot studies to be conducted outside the United States; but if any are conducted in the United States, they will comply with applicable FDA regulations. Data obtained through pilot studies will allow us to make more informed decisions concerning possible expansion into traditional FDA-regulated clinical trials.

 

If the FDA is satisfied with the results and data from preclinical tests, it will authorize human clinical trials. Human clinical trials typically are conducted in three sequential phases which may overlap. Each of the three phases involves testing and study of specific aspects of the effects of the pharmaceutical on human subjects, including testing for safety, dosage tolerance, side effects, absorption, metabolism, distribution, excretion and clinical efficacy.

 

Phase 1 clinical trials include the initial introduction of an investigational new drug into humans. These studies are closely monitored and may be conducted in patients, but are usually conducted in healthy volunteer subjects. These studies are designed to determine the metabolic and pharmacologic actions of the drug in humans, the side effects associated with increasing doses, and, if possible, to gain early evidence on effectiveness. While the FDA can cause us to end clinical trials at any phase due to safety concerns, Phase 1 clinical trials are primarily concerned with safety issues. We also attempt to obtain sufficient information about the drug’s pharmacokinetics and pharmacological effects during Phase 1 clinical trial to permit the design of well-controlled, scientifically valid, Phase 2 studies.

 

Phase 1 studies also evaluate drug metabolism, structure-activity relationships, and the mechanism of action in humans. These studies also determine which investigational drugs are used as research tools to explore biological phenomena or disease processes. The total number of subjects included in Phase 1 studies varies with the drug, but is generally in the range of twenty to eighty.

 

Phase 2 clinical trials include the early controlled clinical studies conducted to obtain some preliminary data on the effectiveness of the drug for a particular indication or indications in patients with the disease or condition. This phase of testing also helps determine the common short-term side effects and risks associated with the drug. Phase 2 studies are typically well-controlled, closely monitored, and conducted in a relatively small number of patients, usually involving several hundred people.

 

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Phase 3 studies are expanded controlled and uncontrolled trials. They are performed after preliminary evidence suggesting effectiveness of the drug has been obtained in Phase 2, and are intended to gather the additional information about effectiveness and safety that is needed to evaluate the overall benefit-risk relationship of the drug. Phase 3 studies also provide an adequate basis for extrapolating the results to the general population and transmitting that information in the physician labeling. Phase 3 studies usually include several hundred to several thousand people.

 

Applicable medical devices can be cleared for commercial distribution through a notification to the FDA under Section 510(k) of the applicable statute. The 510(k) notification must demonstrate to the FDA that the device is as safe and effective and substantially equivalent to a legally marketed or classified device that is currently in interstate commerce. Such devices may not require detailed testing. Certain high-risk devices that sustain human life, are of substantial importance in preventing impairment of human health, or that present a potential unreasonable risk of illness or injury, are subject to a more comprehensive FDA approval process initiated by filing a premarket approval, also known as a “PMA,” application (for devices) or accelerated approval (for drugs).

 

We have established a core clinical development team and have been working with outside FDA consultants to assist us in developing product-specific development and approval strategies, preparing the required submittals, guiding us through the regulatory process, and providing input to the design and site selection of human clinical studies. Historically, obtaining FDA approval for photodynamic therapies has been a challenge. Wherever possible, we intend to utilize lasers or other activating systems that have been previously approved by the FDA to mitigate the risk that our therapies will not be approved by the FDA. The FDA has considerable experience with lasers by virtue of having reviewed and acted upon many 510(k) and premarket approval filings submitted to it for various photodynamic and non-photodynamic therapy laser applications, including a large number of cosmetic laser treatment systems used by dermatologists.

 

The testing and approval process requires substantial time, effort, and financial resources, and we may not obtain FDA approval on a timely basis, if at all. Success in preclinical or early-stage clinical trials does not assure success in later stage clinical trials. The FDA or the research institution sponsoring the trials may suspend clinical trials or may not permit trials to advance from one phase to another at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. Once issued, the FDA may withdraw a product approval if we do not comply with pertinent regulatory requirements and standards or if problems occur after the product reaches the market. If the FDA grants approval of a product, the approval may impose limitations, including limits on the indicated uses for which we may market a product. In addition, the FDA may require additional testing and surveillance programs to monitor the safety and/or effectiveness of approved products that have been commercialized, and the agency has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs. Further, later discovery of previously unknown problems with a product may result in restrictions on the product, including its withdrawal from the market.

 

Marketing our products abroad will require similar regulatory approvals by equivalent national authorities and is subject to similar risks. To expedite development, we may pursue some or all of our initial clinical testing and approval activities outside the United States, and in particular in those nations where our products may have substantial medical and commercial relevance. In some such cases any resulting products may be brought to the U.S. after substantial offshore experience is gained. Accordingly, we intend to pursue any such development in a manner consistent with U.S. standards so that the resultant development data is maximally applicable for potential FDA approval.

 

OTC products are subject to regulation by the FDA and similar regulatory agencies but the regulations relating to these products are much less stringent than those relating to prescription drugs and medical devices. The types of OTC products developed and sold by us only require that we follow cosmetic rules relating to labeling and the claims that we make about our product. The process for obtaining approval of prescription drugs with the FDA does not apply to the OTC products which we sell. The FDA can, however, require us to stop selling our product if we fail to comply with the rules applicable to our OTC products.

 

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Employees

 

We currently employ four persons, all of whom are full-time employees.

 

Available Information

 

Provectus Pharmaceuticals, Inc. is subject to the informational requirements of the Securities Exchange Act of 1934, as amended, which we refer to as the “Exchange Act.” To comply with those requirements, we file annual reports, quarterly reports, periodic reports and other reports and statements with the Securities and Exchange Commission, which we refer to as the “SEC.” You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room, at 100 F. Street, N.E., Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at http://www.sec.gov, from which you can access electronic copies of materials we file with the SEC.

 

Our Internet address is http://www.pvct.com. We have made available, through a link to the SEC’s website, electronic copies of the materials we file with the SEC (including our annual reports on Form 10-KSB, our quarterly reports on Form 10-QSB, our current reports on Form 8-K, the Section 16 reports filed by our executive officers, directors and 10% shareholders and amendments to those reports). To receive paper copies of our SEC materials, please contact us by U.S. mail, telephone, facsimile or electronic mail at the following address:

 

Provectus Pharmaceuticals, Inc.

Attention: President

7327 Oak Ridge Highway, Suite A

Knoxville, TN 37931

Telephone: 865/769-4011

Facsimile: 865/769-4013

Electronic mail: info@pvct.com

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion is intended to assist in the understanding and assessment of significant changes and trends related to our results of operations and our financial condition together with our consolidated subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this prospectus. Historical results and percentage relationships set forth in the statement of operations, including trends which might appear, are not necessarily indicative of future operations.

 

Critical Accounting Policies

 

Patent Costs

 

Internal patent costs are expensed in the period incurred. Patents purchased are capitalized and amortized over the remaining life of the patent. The patents are being amortized over the remaining lives of the patents, which range from 11-15 years. Annual amortization of the patents is expected to be approximately $671,000 per year for the next five years.

 

Long-Lived Assets

 

We review the carrying values of our long-lived assets for possible impairment whenever an event or change in circumstances indicates that the carrying amount of the assets may not be recoverable.  Any long-lived assets held for disposal are reported at the lower of their carrying amounts or fair value less cost to sell.

 

Stock-Based Compensation

 

We adopted Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised 2004), “Share-Based Payment (FASB 123R), effective January 1, 2006 under the modified prospective method, which recognizes compensation cost beginning with the effective date (a) based on the requirements of FASB 123R for all share-based payments granted after the effective date and to awards modified, repurchased, or cancelled after that date and (b) based on the requirements of FASB 123 for all awards granted to employees prior to the effective date of FASB 123R that remain unvested on the effective date. There was no cumulative effect of our initially applying this Statement. At September 30, 2007 we have estimated that an additional $603,374 will be expensed over the applicable remaining vesting periods for all share-based payments granted to employees on or before December 31, 2005 which remained unvested on January 1, 2006.

 

The compensation cost relating to share-based payment transactions is measured based on the fair value of the equity or liability instruments issued and is expensed on a straight-line basis. For purposes of estimating the fair value of each stock option or restricted stock unit on the date of grant, we utilized the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected volatility factor of the market price of the company’s common stock (as determined by reviewing its historical public market closing prices). Because our employee stock options and restricted stock units have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options or restricted stock units.

 

For the year ended December 31, 2005 we adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123). If we had elected to recognize compensation expense based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, net loss per share would have been changed.

 

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Research and Development

 

Research and development costs are charged to expense when incurred. An allocation of payroll expenses was made based on a percentage estimate of time spent. The research and development costs include the following: consulting - IT, depreciation, lab equipment repair, lab supplies and pharmaceutical preparations, insurance, legal - patents, office supplies, payroll expenses, rental - building, repairs, software, taxes and fees, and utilities.

 

Contractual Obligations - Leases

 

We lease office and laboratory space in Knoxville, Tennessee, on an annual basis, renewable for one year at our option. We are committed to pay a total of $12,480 in lease payments over three months, which is the remainder of our current lease term at December 31, 2006.

 

Capital Structure

 

Our ability to continue as a going concern is assured due to our financing completed during 2006. At the current rate of expenditures, we will not need to raise additional capital until late 2008, although our existing funds are sufficient to meet anticipated needs throughout 2008 and into 2009.

 

We have implemented our integrated business plan, including execution of the current and next phases in clinical development of our pharmaceutical products and continued execution of research programs for new research initiatives.

 

We intend to proceed as rapidly as possible with the asset sale and licensure of our OTC products that can be sold with a minimum of regulatory compliance and with the further development of revenue sources through licensing of our existing medical device and biotech intellectual property portfolio. Although we believe that there is a reasonable basis for our expectation that we will become profitable due to the asset sale and licensure of our OTC products, we cannot assure you that we will be able to achieve, or maintain, a level of profitability sufficient to meet our operating expenses.

 

Our current plans include continuing to operate with our four employees during the immediate future, but we have added additional consultants and anticipate adding more consultants in the next 12 months. Our current plans also include minimal purchases of new property, plant and equipment, and increased research and development for additional clinical trials.

 

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Plan of Operation

 

With the reorganization of Provectus and PPI and the acquisition and integration into the Company of Valley and Pure-ific, we believe we have obtained a unique combination of OTC products and core intellectual properties. This combination represents the foundation for an operating company that we believe will provide both profitability and long-term growth.  In 2007, we have and will continue to carefully control expenditures in preparation for the asset sale and licensure or spin out of our OTC products, medical device and biotech technologies, and we will issue equity only when it makes sense and primarily for purposes of attracting strategic investors.

 

In the short term, we intend to develop our business by selling the OTC assets and licensing our existing OTC products, principally Pure-Stick, GloveAid and  Pure-ific.  We are also now considering a spin out of the wholly-owned subsidiary that contains the OTC assets.  We will also sell and/or license our medical device and biotech technologies.  In the longer term, we expect to continue the process of developing, testing and obtaining the approval of the U. S. Food and Drug Administration for prescription drugs in particular.  Additionally, we have restarted our research programs that will identify additional conditions that our intellectual properties may be used to treat as well as additional treatments for those and other conditions.

 

We have continued to make significant progress with the major research and development projects expected to be ongoing in the next 12 months.  Our expanded Phase 1 metastatic melanoma clinical trial and the second group of our expanded Phase 1 breast carcinoma clinical trial was completed in April 2007 for approximately $1,000,000 in the aggregate, most of which has been expended in 2005 and 2006.  The planning phase for the expected Phase 2 trial in metastatic melanoma has been completed which will cost approximately $3,000,000 through 2008.  This includes expenditures in 2007 to significantly advance the Phase 2 trial in metastatic melanoma that commenced in August 2007 and which may provide pivotal efficacy.  Additionally, we plan on $1,000,000 of expenditures in 2007 and 2008 to substantially advance our work with other oncology indications which includes the initiation of the third group of our expanded Phase 1 breast carcinoma clinical trial.  Our Phase 2 psoriasis trial commenced in November 2007 and will cost approximately $1,500,000 over 12 months.  Our Phase 1 & 2 liver cancer trial is expected to cost approximately $500,000 in total and is expected to commence in late 2007 or early 2008.

 

Comparison of the Years Ended December 31, 2006 and 2005

 

Revenues

 

OTC Product Revenue decreased by $4,184 in 2006 to $1,368 from $5,552 in 2005. The decrease in OTC Product Revenue resulted from lower online sales. We have discontinued our proof of concept program in November 2006 and have, therefore, ceased selling our OTC products. Medical Device Revenue decreased by $984 in 2006 to $-0- from $984 in 2005. The decrease in Medical Device Revenue resulted due to no emphasis on selling in 2006 versus the sales of three devices in 2005.

 

Research and development

 

Research and development costs totaling $3,016,361 for 2006 included depreciation expense of $4,442, consulting and contract labor of $481,400, lab supplies and pharmaceutical preparations of $259,198, insurance of $43,361, legal of $202,044, payroll of $1,969,474, and rent and utilities of $56,442. Research and development costs totaling $2,044,391 for 2005 included depreciation expense of $1,708, consulting and contract labor of $805,915, lab supplies and pharmaceutical preparations of $111,504, insurance of $120,493, legal of $208,368, payroll of $747,197, and rent and utilities of $49,206. The decrease in consulting is the result of the absence of start-up related consulting costs for the beginning of the clinical trial program. The increase in lab supplies and pharmaceutical preparations is primarily the result of materials necessary to prepare for additional clinical trials expected to commence in early 2007. The increase in payroll is the result of raises and primarily the impact of adopting SFAS No. 123(R).

 

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General and administrative

 

General and administrative expenses increased by $535,263 in 2006 to $3,534,597 from $2,999,334 in 2005. The increase resulted primarily from higher payroll expenses for general corporate purposes due to raises totaling $311,346 and primarily as a result of the impact of adopting SFAS No. 123(R) totaling $912,040, offset by lower consulting expenses and other expenses totaling $688,123.

 

Comparison of Three and Nine Months Ended September 30, 2007 and September 30, 2006

Revenues

OTC Product Revenue decreased by $274 in the three months ended September 30, 2007 to $-0- from $274 in the three months ended September 30, 2006.  OTC Product Revenue decreased by $1,354 in the nine months ended September 30, 2007 to $-0- from $1,354 in the nine months ended September 30, 2006.  We have discontinued our proof of concept program in November 2006 and have therefore ceased selling our OTC products.

Research and development

Research and development costs of $1,079,345 for the three months ended September 30, 2007 included depreciation expense of $2,314, consulting and contract labor of $157,128, lab supplies and pharmaceutical preparations of $10,773, insurance of $55,066, legal of $99,628, payroll of $738,504, and rent and utilities of $15,932.  Research and development costs of $966,558 for the three months ended September 30, 2006 included depreciation expense of $1,079, consulting and contract labor of $186,215, lab supplies and pharmaceutical preparations of $106,938, insurance of $7,500, legal of $62,995, payroll of $588,202, and rent and utilities of $13,629.  The increase in payroll is the result of raises and bonuses.

Research and development costs of $3,231,930 for the nine months ended September 30, 2007 included depreciation expense of $6,942, consulting and contract labor of $461,621, lab supplies and pharmaceutical preparations of $109,784, insurance of $98,722, legal of $243,383, payroll of $2,264,488, and rent and utilities of $46,990.  Research and  development  costs  comprising  the total of $2,231,773 for the nine months ending September 30, 2006 included  depreciation  expense of  $3,023,  consulting  and contract labor of  $325,068, lab supplies and pharmaceutical preparations of $249,105, insurance  of $33,909, legal of $160,767, payroll of $1,418,824, and rent and utilities of $41,077.  The increase in consulting and contract labor is primarily the result of expense necessary to prepare for advanced clinical trials in final preparations to commence in 2007.  The increase in payroll is the result of bonuses, pension expense, raises, and the impact of stock option expense for stock options issued at the end of June 2006 which vest over a three-year period.

General and administrative

General and administrative expenses increased by $637,289 in the three months ended September 30, 2007 to $1,541,364 from $904,075 for the three months ended September 30, 2006.  Approximately $200,000 of the increase resulted from higher payroll expenses for general corporate purposes as a result of raises and bonuses net of a decrease in stock option expense.  Additionally, consulting expense increased $280,000 due to higher investor and public relations expense as well as financial and other consulting expense, and legal expense increased $90,000 due to non-core spinout preparation.

General and administrative expenses increased by $1,456,178 in the nine months ended September 30, 2007 to $3,907,372 from $2,451,194 for the nine months ended September 30, 2006.  Approximately $940,000 of the increase resulted from higher payroll expenses for general corporate purposes as a result of bonuses, pension expense, raises and the impact of stock option expense for stock options issued at the end of June 2006 which vest over a three-year period.  Additionally, consulting expense increased $582,000 due to higher external accounting expense, Sarbanes-Oxley Section 404 implementation expense, financial, investor and public relations expense, and legal expenses for non-core spinout preparation.

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Cash Flow

 

As of September 30, 2007, we held approximately $7,600,000 in cash and short-term United States Treasury Notes.  At our current cash expenditure rate, this amount will be sufficient to meet our current and planned needs in 2007 and 2008. We have been increasing our expenditure rate by accelerating some of our research programs for new research initiatives; in addition, we are seeking to improve our cash flow through the asset sale and licensure of our OTC products as well as other non-core assets.  However, we cannot assure you that we will be successful in selling the OTC and other non-core assets and licensing our existing OTC products.  Moreover, even if we are successful in improving our current cash flow position, we nonetheless plan to require additional funds to meet our long-term needs in 2009 and beyond.  We anticipate these funds will come from the proceeds of private placements, the exercise of existing warrants outstanding, or public offerings of debt or equity securities.

Capital Resources

 

As noted above, our present cash flow is currently sufficient to meet our short-term operating needs.  Excess cash will be used to finance the current and next phases in clinical development of our pharmaceutical products.  We anticipate that any required funds for our operating and development needs beyond 2008 will come from the proceeds of private placements, the exercise of existing warrants outstanding, or public offerings of debt or equity securities.  While we believe that we have a reasonable basis for our expectation that we will be able to raise additional funds, we cannot assure you that we will be able to complete additional financing in a timely manner.  In addition, any such financing may result in significant dilution to shareholders. For further information on funding sources, please see the notes to our financial statements included in this report.

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (“FASB”) released SFAS No. 156, “Accounting for Servicing of Financial Assets,” to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities after they have been initially measured at fair value. SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006. SFAS No. 156 will be effective for the Company as of January 1, 2007, the beginning of the Company’s fiscal-2007 year.  The adoption of SFAS No. 156 did not have a material impact on the Company’s consolidated financial position or results of operations.

 

On July 13, 2006, the FASB issued Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes: an Interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken in a tax return. FIN No. 48 will require companies to include additional qualitative and quantitative disclosures within their financial statements. The disclosures will include potential tax benefits from positions taken for tax return purposes that have not been recognized for financial reporting purposes and a tabular presentation of significant changes during each period. The disclosures will also include a discussion of the nature of uncertainties, factors that could cause a change, and an estimated range of reasonable possible changes in tax uncertainties, FIN No. 48 will also require a company to recognize a financial statement benefit for a position taken for tax return purposes when it will be more-likely-than-not that the position will be sustained. FIN No. 48 will be effective for fiscal years beginning after December 15, 2006. We adopted FIN No. 48 in the first quarter of fiscal 2007, effective as of December 31, 2006, the beginning of the company’s 2007 fiscal year.  The adoption of FIN No. 48 did not have a material impact on the Company’s consolidated financial position or results of operations.

 

46

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The FASB released SFAS No. 157, “Fair Value Measurements,” to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be effective for the Company as of December 30, 2007, the beginning of the Company’s fiscal-2008 year. We are assessing the impact the adoption of SFAS No. 157 will have on the Company’s consolidated financial position and results of operations.

 

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Postretirement Plans: an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires an employer to recognize the over-funded or under-funded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 requires an employer to initially apply the requirement to recognize the funded status of a benefit plan as of the end of the employer’s fiscal year ending after December 16, 2006. In addition, SFAS No. 158 also requires an employer to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position for fiscal years ending after December 15, 2008. The adoption of SFAS No. 158 did not have an impact on the Company’s consolidated financial position or results of operations as the Company does not have a defined benefit plan.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities--Including an amendment of FASB Statement No. 115,” which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is expected to expand the use of fair value measurement, which is consistent with the long-term measurement objectives for accounting for financial instruments. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements.” We are assessing the impact the adoption of SFAS No. 159 will have on the Company’s consolidated financial position and results of operations.

 

DESCRIPTION OF PROPERTY

 

We  lease office and laboratory space in Knoxville, Tennessee, on an annual basis, renewable for one year at our option.  The current lease term expires on March 31, 2008.  

 

CERTAIN RELATIONSHIPS AND TRANSACTIONS AND CORPORATE GOVERNANCE

 

    Other than the compensation arrangements described in the section entitled "Executive Compensation," since January 1, 2007, there has not been, nor is there currently proposed, any transaction or series of transactions to which we were or will be a participant in which the amount involved exceeded or will exceed $120,000 and in which any director, executive officer, holder of more than 5% of our common stock, or any immediate family member of any of the foregoing had or will have a direct or indirect material interest.

 

    One of our directors, Stuart Fuchs, was an affiliate of Chicago Investment Group.  During 2006, Chicago Investment Group served as placement agent for the sale of an aggregate of 866,833 shares of our common stock for an aggregate purchase price of $1,750,125.  We issued warrants to the investors to purchase up to an additional 466,833 shares of our common stock at an exercise price of $0.935 per share.  As compensation for its services as placement agent, we issued 186,683 shares of common stock to Chicago Investment Group and paid commissions of $189,013.

 

    Although the Company's stock is not quoted on NASDAQ, the Company has elected to apply the NASDAQ Marketplace Rules to determine whether its directors are independent.  Based on the relationship and transaction described above, and based on the fact that all our directors, with the exception of Stuart Fuchs, are employed by us, we have determined that none of our directors are independent.

 

47

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LEGAL MATTERS

 

The validity of the shares of common stock offered hereby as to their being fully paid, legally issued and non-assessable will be passed upon for us by Baker, Donelson, Bearman, Caldwell & Berkowitz, P.C., 100 Med Tech Parkway, Suite 200, Johnson City, Tennessee 37604.

 

EXPERTS

 

The financial statements included in this prospectus have been audited by BDO Seidman, LLP, an independent registered public accounting firm, to the extent and for the periods set forth in the report appearing elsewhere herein, and are included in reliance upon such report given upon the authority of said firm as experts in auditing and accounting.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

WHERE YOU CAN FIND MORE INFORMATION

 

We file reports, proxy statements, information statements and other information with the SEC. You may read and copy this information, for a copying fee, at the SEC’s Public Reference Room at 100 F. Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for more information on its public reference rooms. Our SEC filings are also available to the public from commercial document retrieval services, and at the web site maintained by the SEC at http://www.sec.gov.

 

Our Internet address is http://www.pvct.com. We have made available, through a link to the SEC’s Web site, electronic copies of the materials that we file with the SEC (including our annual reports on Form 10-KSB, our quarterly reports on Form 10-QSB, our current reports on Form 8-K, the Section 16 reports filed by our executive officers, directors and 10% stockholders and amendments to those reports). To receive paper copies of our SEC materials, please contact us by U.S. mail, telephone, facsimile or electronic mail at the following address:

 

Provectus Pharmaceuticals, Inc.

Attention: President

7327 Oak Ridge Highway, Suite A

Knoxville, TN 37931

Telephone: 865/769-4011

Facsimile: 865/769-4013

Electronic mail: info@pvct.com

We have filed a registration statement under the Securities Act, with respect to the securities offered pursuant to this prospectus. This prospectus does not contain all of the information set forth in the registration statement, certain parts of which are omitted in accordance with the rules and regulations of the SEC. For further information, reference is made to the registration statement and the exhibits filed as a part thereof, which may be found at the locations and website referred to above.

 

48

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FINANCIAL STATEMENTS

 

Our consolidated financial statements, together with the report thereon of BDO Seidman LLP, independent accountants, are set forth on the pages of this Prospectus indicated below.

 

		Page
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm		F-1
Consolidated Balance Sheets as of December 31, 2006 and 2005		F-2
Consolidated Statements of Operations for the years ended December 31, 2006 and 2005, and cumulative amounts from January 17, 2002 (Inception) through December 31, 2006		F-3
Consolidated Statements of Stockholders’ Equity for years ended December 31, 2006 and 2005, and cumulative amounts from January 17, 2002 (Inception) through December 31, 2006		F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2006 and 2005, and cumulative amounts (unaudited) from January 17, 2002 (Inception) through December 31, 2006		F-6
Notes to Consolidated Financial Statements		F-8
Interim Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2007 (unaudited) and December, 2006 (audited)		F-26
Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2007, the three and nine months ended September 30, 2006, and cumulative amounts from January 17, 2002 (Inception) through September 30, 2007		F-27
Consolidated Statements of Stockholders’ Equity (unaudited) for the nine months ended September 30, 2007, and cumulative amounts from January 17, 2002 (Inception) through September 30, 2007		F-28
Consolidated Statements of Cash Flow (unaudited) for the nine months ended September 30, 2007, the nine months ended September 30, 2006, and cumulative amounts from January 17, 2002 (Inception) through September 30, 2007		F-30
Notes to Consolidated Financial Statements (unaudited)		F-32

49

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors

Provectus Pharmaceuticals, Inc.

 

 We have audited the accompanying consolidated balance sheets of Provectus Pharmaceuticals, Inc., a development-stage company, as of December 31, 2006 and 2005 and the related consolidated statements of operations, stockholders' equity, and cash flows for the period from January 17, 2002 (inception) to December 31, 2006 and for each of the two years in the period ended December 31, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Provectus Pharmaceuticals, Inc. at December 31, 2006 and 2005, and the results of its operations and its cash flows for the period from January 17, 2002 (inception) to December 31, 2006 and for each of the two years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

 

As disclosed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted the fair value method of accounting provisions of Statement of Financial Accounting Standard No. 123 (revised 2004), “Share Based Payment.”

 

 /s/ BDO Seidman, LLP

 

Chicago, Illinois

March 19, 2007

 

F-1

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PROVECTUS PHARMACEUTICALS, INC. (A Development-Stage Company) CONSOLIDATED BALANCE SHEETS
		December 31, 2006				December 31, 2005
Assets
Current Assets
Cash and cash equivalents		$	638,334			$	6,878,990
United States Treasury Notes, total face value $6,507,019			6,499,034				--
Prepaid expenses and other current assets			173,693				67,962
Total Current Assets			7,311,061				6,946,952
Equipment and Furnishings, less accumulated depreciation of $372,721 and $368,279			30,075				12,287
Patents, net of amortization of $2,762,777 and $2,091,657			8,952,668				9,623,788
Deferred loan costs, net of amortization of $103,018 and $161,004			3,713				709,092
Other assets			27,000				27,000
		$	16,324,517			$	17,319,119
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable - trade		$	64,935			$	90,124
Accrued compensation			265,929				179,170
Accrued common stock costs			17,550				964,676
Accrued consulting expense			42,500				692,512
Other accrued expenses			46,500				61,500
Accrued interest			--				65,055
March 2005 convertible debt, net of debt discount of $2,797 and $884,848			364,703				221,401
November 2005 convertible debt, net of debt discount of $134,008 in 2005			--				334,828
Total Current Liabilities			802,117				2,609,266
March 2005 convertible debt, net of debt discount of $46,039 in 2005			--				322,712
Stockholders' Equity          Preferred stock; par value $.001 per share; 25,000,000 shares authorized; no shares issued and outstanding			--				--
Common stock; par value $.001 per share; 100,000,000 shares authorized; 42,452,366 and 27,822,977 shares issued        and outstanding, respectively			42,452				27,823
Paid-in capital			50,680,353				40,689,144
Deficit accumulated during the development stage			(35,200,405	)			(26,329,826	)
Total Stockholders' Equity			15,522,400				14,387,141
		$	16,324,517			$	17,319,119

See accompanying notes to consolidated financial statements

F-2

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PROVECTUS PHAMACEUTICALS, INC. (A Development-Stage Company) CONSOLIDATED STATEMENTS OF OPERATIONS
		Year Ended December 31, 2006				Year Ended December 31, 2005				Cumulative Amounts from January 17, 2002 (Inception) Through December 31, 2006
Revenues
OTC product revenue		$	1,368			$	5,552			$	25,648
Medical device revenue			--				984				14,109
Total revenues			1,368				6,536				39,757
Cost of sales			875				3,560				15,216
Gross profit			493				2,976				24,541
Operating expenses
Research and development		$	3,016,361			$	2,044,391			$	7,128,207
General and administrative			3,534,597				2,999,334				16,729,968
Amortization			671,120				671,120				2,762,777
Total operating loss			(7,221,585	)			(5,711,869	)			(26,596,411	)
Gain on sale of fixed assets			75				--				55,075
Loss on extinguishment of debt			--				(724,455	)			(825,867	)
Investment income			253,393				--				253,393
Net interest expense			(1,902,462	)			(5,327,529	)			(8,086,595	)
Net loss		$	(8,870,579	)		$	(11,763,853	)		$	(35,200,405	)
Basic and diluted loss per common share		$	(0.23	)		$	(0.62	)
Weighted average number of common shares outstanding - basic and diluted			37,973,403				18,825,670

See accompanying notes to consolidated financial statements

F-3

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PROVECTUS PHAMACEUTICALS, INC. (A Development-Stage Company) CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
		Common Stock
		Number of Shares				Par Value				Paid in capital				Accumulated Deficit				Total
Balance, at January, 17 2002			--			$	--			$	--			$	--			$	--
Issuance to founding shareholders			6,000,000				6,000				(6,000	)			--				--
Sale of stock			50,000				50				24,950				--				25,000
Issuance of stock to employees			510,000				510				931,490				--				932,000
Issuance of stock for services			120,000				120				359,880				--				360,000
Net loss for the period from January 17, 2002 (inception) to April 23, 2002 (date of reverse merger)			--				--				--				(1,316,198	)			(1,316,198	)
Balance, at April 23, 2002			6,680,000			$	6,680			$	1,310,320			$	(1,316,198	)		$	802
Shares issued in reverse merger			265,763				266				(3,911	)			--				(3,645	)
Issuance of stock for services			1,900,000				1,900				5,142,100				--				5,144,000
Purchase and retirement of stock			(400,000	)			(400	)			(47,600	)			--				(48,000	)
Stock issued for acquisition of Valley Pharmaceuticals			500,007				500				12,225,820				--				12,226,320
Exercise of warrants			452,919				453				--				--				453
Warrants issued in connection with convertible debt			--				--				126,587				--				126,587
Stock and warrants issued for acquisition of Pure-ific			25,000				25				26,975				--				27,000
Net loss for the period from April 23, 2002 (date of reverse merger) to December 31, 2002			--				--				--				(5,749,937	)			(5,749,937	)
Balance, at December 31, 2002			9,423,689			$	9,424			$	18,780,291			$	(7,066,135	)		$	11,723,580
Issuance of stock for services			764,000				764				239,036				--				239,800
Issuance of warrants for services			--				--				145,479				--				145,479
Stock to be issued for services			--				--				281,500				--				281,500
Employee compensation from stock options			--				--				34,659				--				34,659
Issuance of stock pursuant to Regulation S			679,820				680				379,667				--				380,347
Beneficial conversion related to convertible debt			--				--				601,000				--				601,000
Net loss for the year ended December 31, 2003			--				--				--				(3,155,313	)			(3,155,313	)
Balance, at December 31, 2003			10,867,509			$	10,868			$	20,461,632			$	(10,221,448	)		$	(10,251,052	)
Issuance of stock for services			733,872				734				449,190				--				449,923
Issuance of warrants for services			--				--				495,480				--				495,480
Exercise of warrants			132,608				133				4,867				--				5,000
Employee compensation from stock options			--				--				15,612				--				15,612
Issuance of stock pursuant to Regulation S			2,469,723				2,469				790,668				--				793,137
Issuance of stock pursuant to Regulation D			1,930,164				1,930				1,286,930				--				1,288,861
Beneficial conversion related to convertible debt			--				--				360,256				--				360,256

Issuance of convertible debt with warrants			--				--				105,250				--				105,250
Repurchase of beneficial conversion feature			--				--				(258,345	)			--				(258,345	)
Net loss for the year ended December 31, 2004			--				--				--				(4,344,525	)			(4,344,525	)
Balance, at December 31, 2004			16,133,876			$	16,134			$	23,711,540			$	(14,565,973	)		$	9,161,701
Issuance of stock for services			226,733				227				152,058				--				152,285
Issuance of stock for interest payable			263,721				264				195,767				--				196,031
Issuance of warrants for services			--				--				1,534,405				--				1,534,405
Issuance of warrants for contractual obligations			--				--				985,010				--				985,010
Exercise of warrants and stock options			1,571,849				1,572				1,438,223				--				1,439,795
Employee compensation from stock options			--				--				15,752				--				15,752
Issuance of stock pursuant to Regulation D			6,221,257				6,221				6,506,955				--				6,513,176
Debt conversion to common stock			3,405,541				3,405				3,045,957				--				3,049,362
Issuance of warrants with convertible debt			--				--				1,574,900				--				1,574,900
Beneficial conversion related to convertible debt			--				--				1,633,176				--				1,633,176
Beneficial conversion related to interest expense			--				--				39,529				--				39,529

 

 

See accompanying notes to consolidated financial statements

                              

F-4

---

 

Beneficial conversion related to convertible debt			--				--				1,633,176				--				1,633,176
Beneficial conversion related to interest expense			--				--				39,529				--				39,529
Repurchase of beneficial conversion feature			--				--				(144,128	)			--				(144,128	)
Net loss for the year ended 2005			--				--				--				(11,763,853	)			(11,763,853	)
Balance, at December 31, 2005			27,822,977			$	27,823			$	40,689,144			$	(26,329,826	)		$	14,387,141
Issuance of stock for services			719,246				719				676,024				--				676,743
Issuance of stock for interest payable			194,327				195				183,401				--				183,596
Issuance of warrants for services			--				--				370,023				--				370,023
Exercise of warrants and stock options			1,245,809				1,246				1,188,570				--				1,189,816
Employee compensation from stock options			--				--				1,862,456				--				1,862,456
Issuance of stock pursuant to Regulation D			10,092,495				10,092				4,120,329				--				4,130,421
Debt conversion to common stock			2,377,512				2,377				1,573,959				--				1,576,336
Beneficial conversion related to interest expense			--				--				16,447				--				16,447
Net loss for the year ended 2006			--				--				--				(8,870,579	)			(8,870,579	)
Balance, at December 31, 2006			42,452,366			$	42,452			$	50,680,353			$	(35,200,405	)		$	15,522,400

See accompanying notes to consolidated financial statements

 

F-5

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PROVECTUS PHARMACEUTICALS, INC. (A Development-Stage Company) CONSOLIDATED STATEMENTS OF CASH FLOW
		Year Ended December 31, 2006				Year Ended December 31, 2005				Cumulative Amounts from January 17, 2002 (Inception) through December 31, 2006
Cash Flows From Operating Activities
Net loss		$	(8,870,579	)		$	(11,763,853	)		$	(35,200,405	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation			4,442				1,708				395,722
Amortization of patents			671,120				671,120				2,762,777
Amortization of original issue discount			1,062,098				2,293,251				3,842,924
Amortization of commitment fee			--				272,540				310,866
Amortization of prepaid consultant expense			84,020				274,337				1,211,207
Amortization of deferred loan costs			705,379				1,411,970				2,257,871
Accretion of United States Treasury Bills			(182,198	)			--				(182,198	)
Loss on extinguishment of debt			--				724,455				825,867
Loss on exercise of warrants			--				236,146				236,146
Beneficial conversion of convertible interest			16,447				39,529				55,976
Convertible interest			122,188				266,504				388,692
Compensation through issuance of stock options			1,862,456				15,752				1,928,479
Compensation through issuance of stock			--				--				932,000
Issuance of stock for services			26,100				388,373				5,995,031
Issuance of warrants for services			201,984				318,704				543,169
Issuance of warrants for contractual obligations			--				985,010				985,010
Gain on sale of equipment			(75	)			--				(55,075	)
(Increase) decrease in assets
Prepaid expenses and other current assets			(21,712	)			46,762				(89,674	)
Increase (decrease) in liabilities
Accounts payable			(25,189	)			(64,090	)			61,290
Accrued expenses			68,743				98,196				533,226
Net cash used in operating activities			(4,274,776	)			(3,783,586	)			(12,261,099	)
Cash Flows From Investing Activities
Proceeds from sale of fixed asset			75				--				180,075
Capital expenditures			(22,230	)			(13,995	)			(39,922	)
Proceeds from investments			11,000,000				--				11,000,000
Purchase of investments			(17,316,836	)			--				(17,316,836	)
Net cash used in investing activities			(6,338,991	)			(13,995	)			(6,176,683	)
Cash Flows From Financing Activities
Net proceeds from loans from stockholder			--				25,000				174,000
Proceeds from convertible debt			--				4,430,836				6,706,795
Net proceeds from sale of common stock			3,183,295				7,477,853				13,148,493
Proceeds from exercise of warrants and stock options			1,189,816				1,203,649				2,398,918
Cash paid to retire convertible debt			--				(1,885,959	)			(2,385,959	)
Cash paid for deferred loan costs			--				(515,582	)			(747,612	)
Premium paid on extinguishments of debt			--				(70,000	)			(170,519	)

 

 

F-6

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Purchase and retirement of common stock			--				--				(48,000	)
Net cash provided by financing activities		$	4,373,111			$	10,665,797			$	19,076,116
Net change in cash and cash equivalents		$	(6,240,656	)		$	6,868,216			$	638,334
Cash and cash equivalents, at beginning of period		$	6,878,990			$	10,774			$	--
Cash and cash equivalents, at end of period		$	638,334			$	6,878,990			$	638,334

Supplemental Disclosure of Cash Flow Information

December 31, 2005

Interest paid of $127,444

Supplemental Disclosure of Noncash Investing and Financing Activities

Year ended December 31, 2006

1.           Issuance of warrants in exchange for prepaid services of $168,039

2.           Debt converted to common stock of $1,576,336

3.           Payment of accrued interest through the issuance of stock of $183,596

4.           Issuance of stock for stock issuance costs of $964,676 incurred in 2005

5.           Stock committed to be issued for services of $650,643 accrued at December 31, 2005 and issued in 2006

6.           Accrual of $17,550 for stock committed to be issued for stock issuance costs

Year ended December 31, 2005

1.           Issuance of warrants in exchange for prepaid services of $68,910

2.           Shareholder debt of $174,000 and accrued interest of $24,528 converted to common stock of $198,528

3.           Debt converted to common stock of $2,537,000

4.           Payment of accrued interest through the issuance of stock of $196,031 and stock committed to be issued of$61,408

5.           Beneficial conversion on convertible debt of $1,633,176

6.           Discount on convertible debt with warrants of $1,574,900

7.           Warrants issued for deferred loan costs of $1,215,700

8.           Accrual of $964,676 for stock committed to be issued for stock issuance costs

9.           Stock committed to be issued for deferred loan costs of $345,645

10.           Stock committed to be issued for consulting expense of $304,998

See accompanying notes to consolidated financial statements

 

 

F-7

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PROVECTUS PHARMACEUTICALS, INC.

(A Development-Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.           Organization and Significant Accounting Policies

Nature of Operations

 

Provectus Pharmaceuticals, Inc. (together with its subsidiaries, the “Company”) is a development-stage biopharmaceutical company that is focusing on developing minimally invasive products for the treatment of psoriasis and other topical diseases, and certain forms of cancer including recurrent breast carcinoma, metastatic melanoma, and liver cancer. The Company intends to license its laser device and biotech technology. Through a previous acquisition, the Company also intends to further develop, if necessary, and license or sell the underlying assets of its over-the-counter pharmaceuticals. To date the Company has no material revenues.

 

Principles of Consolidation

 

Intercompany balances and transactions have been eliminated in consolidation.

 

Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and cash equivalents

 

The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.

 

United States Treasury Notes

 

United States Treasury Notes are classified as held-to-maturity securities and all investments mature within one year. Held-to-maturity securities are stated at amortized cost which approximates market.

 

Deferred Loan Costs and Debt Discounts

 

The costs related to the issuance of the convertible debt, including lender fees, legal fees, due diligence costs, escrow agent fees and commissions, have been recorded as deferred loan costs and are being amortized over the term of the loan using the effective interest method. Additionally, the Company recorded debt discounts related to warrants and beneficial conversion features issued in connection with the debt. Debt discounts are being amortized over the term of the loan using the effective interest method.

 

Equipment and Furnishings

 

Equipment and furnishings acquired through the acquisition of Valley Pharmaceuticals, Inc. (Note 2) have been stated at carry over basis. Other equipment and furnishings are stated at cost. Depreciation of equipment is provided for using the straight-line method over the estimated useful lives of the assets. Computers and laboratory equipment are being depreciated over five years, furniture and fixtures are being depreciated over seven years.

 

Long-Lived Assets

 

The Company reviews the carrying values of its long-lived assets for possible impairment whenever an event or change in circumstances indicates that the carrying amount of the assets may not be recoverable. Any long-lived assets held for disposal are reported at the lower of their carrying amounts or fair value less cost to sell.

 

F-8

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Patent Costs

 

Internal patent costs are expensed in the period incurred. Patents purchased are capitalized and amortized over the remaining life of the patent.

 

Patents at December 31, 2006 were acquired as a result of the merger with Valley Pharmaceuticals, Inc. (“Valley”) (Note 2). The majority shareholders of Provectus also owned all of the shares of Valley and therefore the assets acquired from Valley were recorded at their carryover basis. The patents are being amortized over the remaining lives of the patents, which range from 11-15 years. Annual amortization of the patents is expected to be approximately $671,000 per year for the next five years.

 

Revenue Recognition

 

The Company recognizes revenue when product is shipped. When advance payments are received, these payments are recorded as deferred revenue and recognized when the product is shipped.

 

Research and Development

 

Research and development costs are charged to expense when incurred. An allocation of payroll expenses was made based on a percentage estimate of time spent. The research and development costs include the following: consulting - IT, depreciation, lab equipment repair, lab supplies and pharmaceutical preparations, insurance, legal - patents, office supplies, payroll expenses, rental - building, repairs, software, taxes and fees, and utilities.

 

Income Taxes

 

The Company accounts for income taxes under the liability method in accordance with Statement of Financial Accounting Standards No. 109 (“SFAS No. 109”), “Accounting for Income Taxes.” Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established if it is more likely than not that all, or some portion, of deferred income tax assets will not be realized. The Company has recorded a full valuation allowance to reduce its net deferred income tax assets to zero. In the event the Company were to determine that it would be able to realize some or all its deferred income tax assets in the future, an adjustment to the deferred income tax asset would increase income in the period such determination was made.

 

Basic and Diluted Loss Per Common Share

 

Basic and diluted loss per common share and diluted loss per common share is computed based on the weighted Per Common Share average number of common shares outstanding. Loss per share excludes the impact of outstanding options, warrants, and convertible debt as they are antidilutive. Potential common shares excluded from the calculation at December 31, 2006 are 9,014,714 options 26,663,081 warrants and 490,000 shares issuable upon the conversion of convertible debt. Included in the weighted average number of shares outstanding are 165,000 common shares committed to be issued but not outstanding at December 31, 2006.

 

Financial Instruments

 

The carrying amounts reported in the consolidated balance sheets for cash, accounts payable and accrued expenses approximate fair value because of the short-term nature of these amounts. The Company believes the fair value of its fixed-rate borrowings approximates the market value.

 

Stock Based Compensation

 

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) released FASB Statement No. 123 (revised 2004), “Share-Based Payment, (“FASB 123R”).” These changes in accounting replace existing requirements under FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“FASB 123”), and eliminates the ability to account for share-based compensation transaction using APB Opinion No.25, “Accounting for Stock Issued to Employees” (“APB 25”). The compensation cost relating to share-based payment transactions will be measured based on the fair value of the equity or liability instruments issued. This Statement did not change the accounting for similar transactions involving parties other than employees.

 

The Company adopted FASB 123R effective January 1, 2006 under the modified prospective method, which recognizes compensation cost beginning with the effective date (a) based on the requirements of FASB 123R for all share-based payments granted after the effective date and to awards modified, repurchased, or cancelled after that date and (b) based on the requirements of FASB 123 for all awards granted to employees prior to the effective date of FASB 123R that remain unvested on the effective date. There was no cumulative effect of initially applying this Statement for the Company. At December 31, 2006 the Company has estimated that an additional $1,211,371 will be expensed over the applicable remaining vesting periods for all share-based payments granted to employees on or before December 31, 2005 which remained unvested on January 1, 2006.

 

F-9

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The compensation cost relating to share-based payment transactions will be measured based on the fair value of the equity or liability instruments issued and will be expensed on a straight-line basis. For purposes of estimating the fair value of each stock option or restricted stock unit on the date of grant, the Company utilized the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected volatility factor of the market price of the company’s common stock (as determined by reviewing its historical public market closing prices). Because the Company's employee stock options and restricted stock units have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options or restricted stock units.

 

For the year ended December 31, 2005 the Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123). If the Company had elected to recognize compensation expense based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, net loss per share would have been changed to the pro forma amount indicated below:

 

		Year ended December 31, 2005
Net loss, as reported		$	(11,763,853	)
Add stock-based employee compensation expense included in reported loss			15,752
Less total stock-based employee compensation expense determined under the fair value based method for all awards			(791,111	)
Pro forma net loss		$	(12,539,212	)
Basic and diluted loss per common share, as reported		$	(0.62	)
Basic and diluted loss per common share, pro forma		$	(0.67	)

Recent Accounting Pronouncements

 

Effective January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method. See Notes 1 and 5 for information regarding stock-based compensation.

 

The Financial Accounting Standards Board (“FASB”) released SFAS No. 156, “Accounting for Servicing of Financial Assets,” to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities after they have been initially measured at fair value. SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006. SFAS No. 156 will be effective for the Company as of December 31, 2006, the beginning of the Company’s fiscal-2007 year. We do not believe the adoption of SFAS No. 156 will have a material impact on the Company’s consolidated financial position or results of operations.

 

On July 13, 2006, the FASB issued Interpretation No. 48 (“FIN No. 48”) “Accounting for Uncertainty in Income Taxes: an Interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken in a tax return. FIN No. 48 will require companies to include additional qualitative and quantitative disclosures within their financial statements. The disclosures will include potential tax benefits from positions taken for tax return purposes that have not been recognized for financial reporting purposes and a tabular presentation of significant changes during each period. The disclosures will also include a discussion of the nature of uncertainties, factors which could cause a change, and an estimated range of reasonably possible changes in tax uncertainties. FIN No. 48 will also require a company to recognize a financial statement benefit for a position taken for tax return purposes when it will be more-likely-than-not that the position will be sustained.FIN No. 48 will be effective for fiscal years beginning after December 15, 2006. We will adopt FIN No. 48 in the first quarter of fiscal 2007, effective as of December 31, 2006, the beginning of the Company’s 2007 fiscal year. We do not believe the adoption of FIN No. 48 will have a material impact on the Company’s consolidated financial position or results of operations.

 

F-10

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The FASB released SFAS No. 157, “Fair Value Measurements,” to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be effective for the Company as of December 30, 2007, the beginning of the Company’s fiscal-2008 year. We are assessing the impact the adoption of SFAS No. 157 will have on the Company’s consolidated financial position and results of operations.

 

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Postretirement Plans: an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires an employer to recognize the over-funded or under-funded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 requires an employer to initially apply the requirement to recognize the funded status of a benefit plan as of the end of the employer’s fiscal year ending after December 16, 2006. In addition, SFAS No. 158 also requires an employer to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position for fiscal years ending after December 15, 2008. The adoption of SFAS No. 158 will not have an impact on the Company’s consolidated financial position or results of operations as the Company does not have a defined benefit plan.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115,” which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is expected to expand the use of fair value measurement, which is consistent with the long-term measurement objectives for accounting for financial instruments. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements.” We are assessing the impact the adoption of SFAS No. 159 will have on the Company’s consolidated financial position and results of operations.

 

2.           Recapitalization and Merger

 

On April 23, 2002, Provectus Pharmaceutical, Inc., a Nevada corporation and a Merger “blank check” public company, acquired Provectus Pharmaceuticals, Inc., a privately held Tennessee corporation (“PPI”), by issuing 6,680,000 shares of common stock of Provectus Pharmaceutical to the stockholders of PPI in exchange for all of the issued and outstanding shares of PPI, as a result of which Provectus Pharmaceutical changed its name to Provectus Pharmaceuticals, Inc. (the “Company”) and PPI became a wholly owned subsidiary of the Company. Prior to the transaction, PPI had no significant operations and had not generated any revenues.

 

For financial reporting purposes, the transaction has been reflected in the accompanying financial statements as a recapitalization of PPI and the financial statements reflect the historical financial information of PPI which was incorporated on January 17, 2002. Therefore, for accounting purposes, the shares recorded as issued in the reverse merger are the 265,763 shares owned by Provectus Pharmaceuticals, Inc. shareholders prior to the reverse merger.

 

The issuance of 6,680,000 shares of common stock of Provectus Pharmaceutical, Inc. to the stockholders of PPI in exchange for all of the issued and outstanding shares of PPI was done in anticipation of PPI acquiring Valley Pharmaceuticals, Inc, which owned the intellectual property to be used in the Company's operations.

 

On November 19, 2002, the Company acquired Valley Pharmaceuticals, Inc, (“Valley”) a privately-held Tennessee corporation by merging PPI with and into Valley and naming the surviving company Xantech Pharmaceuticals, Inc. Valley had no significant operations and had not generated any revenues. Valley was formed to hold certain intangible assets which were transferred from an entity which was majority owned by the shareholders of Valley. Those shareholders gave up their shares of the other company in exchange for the intangible assets in a non-pro rata split off. The intangible assets were valued based on the market price of the stock given up in the split-off. The shareholders of Valley also owned the majority of the shares of the Company at the time of the transaction. The Company issued 500,007 shares of stock in exchange for the net assets of Valley which were valued at $12,226,320 and included patents of $11,715,445 and equipment and furnishings of $510,875.

 

F-11

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3.           Commitments

 

Leases

 

The Company leases office and laboratory space in Knoxville, Tennessee, on an annual basis, renewable for one year at the option of the Company. The Company is committed to pay a total of $12,480 in lease payments over three months, which is the remainder of its current lease term at December 31, 2006. The Company plans to renew the lease at the end of the current lease term. Rent expense was approximately $49,000 and $45,000 in 2006 and 2005, respectively.

 

Employee Agreements

 

On May 1, 2006, we entered into executive employment agreements with each of H. Craig Dees. Ph.D., Timothy C. Scott, Ph.D., Eric A. Wachter, Ph.D., and Peter R. Culpepper, CPA, to serve as our Chief Executive Officer, President, Executive Vice President and Chief Financial Officer, respectively. Each agreement provides that such executive will be employed for a one-year term with automatic one-year renewals unless previously terminated pursuant to the terms of the agreement or either party gives notice that the term will not be extended. The Company is committed to pay a total of $467,000 over four months, which is the remainder of the current employment agreements at December 31, 2006. Executives are also entitled to participate in any incentive compensation plan or bonus plan adopted by us without diminution of any compensation or payment under the agreement. Executives are further entitled to reimbursement for all reasonable out-of-pocket expenses incurred during his performance of services under the agreement.

 

Each agreement generally provides that if the executive’s employment is terminated prior to a change in control (as defined in the agreement) (1) due to expiration or non-extension of the term by us; or (2) by us for any reason other than for cause (as defined in the agreement), then such executive shall be entitled to receive payments under the agreement as if the agreement was still in effect through the end of the period in effect as of the date of such termination. If the executive’s employment (1) is terminated by the company at any time for cause, (2) is terminated by executive prior to, and not coincident with, a change in control or (3) is terminated by executive’s death, disability or retirement prior to a change in control, the executive (or his estate, as the case may be) shall be entitled to receive payments under the agreement through the last date of the month of such termination, a pro rata portion of any incentive or bonus payment earned prior to such termination, any benefits to which he is entitled under the terms and conditions of the pertinent plans in effect at termination and any reasonable expenses incurred during the performance of services under the agreement.

 

In the event that coincident with or following a change in control, the executive’s employment is terminated or the agreement is not extended (1) by action of the executive including his death, disability or retirement or (2) by action of the company not for cause, the executive (or his estate, as the case may be) shall be entitled to receive payments under the agreement through the last date of the month of such termination, a pro rata portion of any incentive or bonus payment earned prior to such termination, any benefits to which he is entitled under the terms and conditions of the pertinent plans in effect at termination and any reasonable expenses incurred during the performance of services under the agreement. In addition, the company shall pay to the executive (or his estate, as the case may be), within 30 days following the date of termination or on the effective date of the change in control (whichever occurs later), a lump sum payment in cash in an amount equal to 2.90 times the base salary paid in the preceding calendar year, or scheduled to be paid to such executive during the year of such termination, whichever is greater, plus an additional amount sufficient to pay United States income tax on the lump sum amount paid.

 

4.           Equity Transactions

 

(a) During 2002, the Company issued 2,020,000 shares of stock in exchange for consulting services. These services were valued based on the fair market value of the stock exchanged which resulted in consulting costs charged to operations of $5,504,000.

 

(b) During 2002, the Company issued 510,000 shares of stock to employees in exchange for services rendered. These services were valued based on the fair market value of the stock exchanged which resulted in compensation costs charged to operations of $932,000.

 

(c) In February 2002, the Company sold 50,000 shares of stock to a related party in exchange for proceeds of $25,000.

 

F-12

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(d) In June 2002, the Company issued a warrant to a consultant for the purchase of 100,000 shares at $2.29 per share. The warrant is only exercisable upon the successful introduction of the Company to a designated pharmaceutical company. The warrant was forfeited in 2004.

 

(e) In October 2002, the Company purchased 400,000 outstanding shares of stock from one shareholder for $48,000. These shares were then retired.

 

(f) On December 5, 2002, the Company purchased the assets of Pure-ific L.L.C, a Utah limited liability company, and created a wholly owned subsidiary called Pure-ific Corporation, to operate the Pure-ific business which consists of product formulations for Pure-ific personal sanitizing sprays, along with the Pure-ific trademarks. The assets of Pure-ific were acquired through the issuance of 25,000 shares of the Company's stock with a fair market value of $0.50 and the issuance of various warrants. These warrants included warrants to purchase 10,000 shares of the Company's stock at an exercise price of $0.50 issuable on the first, second and third anniversary dates of the acquisition. Accordingly, the fair market value of these warrants of $14,500, determined using the Black-Scholes option pricing model, was recorded as additional purchase price for the acquisition of the Pure-ific assets. In 2004, 20,000 warrants were issued for the first and second anniversary dates. 10,000 of these warrants were exercised in 2004. In 2005, 10,000 warrants were issued for the third anniversary date. In January 2006, 10,000 warrants were exercised in a cashless exercise resulting in 4,505 shares issued. In addition, warrants to purchase 80,000 shares of stock at an exercise price of $0.50 will be issued upon the achievement of certain sales targets of the Pure-ific product. At December 31, 2006 and 2005, none of these targets have been met and accordingly, no costs have been recorded.

 

(g) In 2003, the Company issued 764,000 shares to consultants in exchange for services rendered, consisting of 29,000 shares issued in January valued at $11,600, 35,000 shares issued in March valued at $11,200, and 700,000 shares issued in October valued at $217,000. The value for these shares was based on the market value of the shares issued. As all of these amounts represented payments for services to be provided in the future and the shares were fully vested and non-forfeitable, a prepaid consulting expense was recorded in 2003 which was fully amortized as of December 31, 2004.

 

(h) In November and December 2003, the Company committed to issue 341,606 shares to consultants in exchange for services rendered. The total value for these shares was $281,500 which was based on the market value of the shares issued. The shares were issued in January 2004. As these amounts represented payments for services to be provided in the future and the shares were fully vested and non-forfeitable, a prepaid consulting expense was recorded in 2003 which was fully amortized as of December 31, 2004.

 

(i) The Company applies the recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” in accounting for stock options and warrants issued to nonemployees. In January 2003, the Company issued 25,000 warrants to a consultant for services rendered. In February 2003, the Company issued 360,000 warrants to a consultant, 180,000 of which were fully vested and non-forfeitable at the issuance and 180,000 of which were cancelled in August 2003 due to the termination of the consulting contract. In September 2003, the Company issued 200,000 warrants to two consultants in exchange for services rendered. In November 2003, the Company issued 100,000 warrants to one consultant in exchange for services rendered. As the fair market value of these services was not readily determinable, these services were valued based on the fair market value, determined using the Black-Scholes option-pricing model. Fair market value for the warrants issued in 2003 ranged from $0.20 to $0.24 and totaled $145,479. As these amounts represented payments for services to be provided in the future and the warrants were fully vested and non-forfeitable, a prepaid consulting expense was recorded in 2003 which was fully amortized as of December 31, 2004.

 

In May 2004, the Company issued 20,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $18,800. In August 2004, the Company issued 350,000 warrants to consultants in exchange for services valued at $329,000. At December 31, 2004, $123,375 of these costs have been charged to operations with the remaining $205,427 recorded as prepaid consulting expense as it represents payments for future services and the warrants are fully-vested and non-forfeitable. In December 2004, the Company issued 10,000 warrants to consultants in exchange for services valued at $3,680. Fair market value for the warrants issued in 2004 ranged from $0.37 to $0.94.

 

In January 2005, the Company issued 16,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $6,944. In February 2005, the Company issued 13,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $13,130. In March 2005, the Company issued 100,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $68,910. In April 2005, the Company issued 410,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $195,900. In May 2005, the Company issued 25,000 warrants to consultants in exchange for services rendered. Consulting costs charged to operations were $9,250. In December 2005, the Company issued 33,583 warrants to consultants in exchange for services. Consulting costs charged to operations were $24,571. The fair market value for the warrants issued in 2005 ranged from $0.37 to $1.01.

 

F-13

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In May 2006, 350,000 warrants were exercised for $334,000 resulting in 350,000 shares issued. During April, May and June, the Company issued 60,000 warrants to consultants in exchange for services. Consulting costs charged to operations were $58,400. In August and September 2006, 732,534 warrants were exercised for $693,357 resulting in 732,534 shares issued. During the three months ended September 30, 2006, the Company issued 335,000 warrants to consultants in exchange for services. At December 31, 2006, $155,814 of these costs have been charged to operations with the remaining $84,019 recorded as prepaid consulting expense as it represents payments for future services and the warrants are fully vested and non-forfeitable. In November 2006, 100,000 warrants were forfeited. During the three months ended December 31, 2006, the Company issued 85,000 warrants to consultants in exchange for services. Consulting costs charged to operations were $71,790. The fair market value for the warrants issued in 2006 ranged from $0.67 to $1.11.

 

(j) In December 2003, the Company commenced an offering for sale of restricted common stock. As of December 31, 2003, the Company had sold 874,871 shares at an average gross price of $1.18 per share. As of December 31, 2003, the Company had received net proceeds of $292,472 and recorded a stock subscription receivable of $87,875 for stock subscriptions prior to December 31, 2003 for which payment was received subsequent to December 31, 2003. The transaction is a Regulation S offering to foreign investors as defined by Regulation S of the Securities Act. The restricted shares cannot be traded for 12 months. After the first 12 months, sales of the shares are subject to restrictions under rule 144 for an additional year. The Company engaged a placement agent to assist the offering. Costs related to the placement agent of $651,771 have been off-set against the gross proceeds of $1,032,118 and therefore are reflected as a direct reduction of equity at December 31, 2003. At December 31, 2003, 195,051 shares had not yet been issued. These shares were issued in the first quarter of 2004.

 

In 2004, the Company sold 2,274,672 shares of restricted common stock under this offering of which 1,672,439 shares were issued in the first quarter 2004 and 602,233 were issued in the second quarter 2004. Shares were sold during 2004 at an average gross price of $1.05 per share with net proceeds of $793,137. Costs related to the placement agent for proceeds received in 2004 of $1,588,627 have been off-set against gross proceeds of $2,381,764.

 

(k) In January 2004, the Company issued 10,000 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $11,500. In March 2004, the Company committed to issue 36,764 shares to consultants in exchange for services. These shares were recorded as a prepaid consulting expense and were fully amortized at December 31, 2004. Consulting costs charged to operations were $62,500. These 36,764 shares, along with 75,000 shares committed in 2003 were issued in August 2004. The 75,000 shares committed to be in 2003 were the result of a cashless exercise of 200,000 warrants in 2003, which were not issued as of December 31, 2003. In August 2004, the Company also issued 15,000 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $25,200. In September 2004, the Company issued 16,666 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $11,666. In October 2004, the Company issued 16,666 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $13,666. In November 2004, the Company issued 16,666 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $11,000. In December 2004, the Company issued 7,500 shares to a consultant in exchange for services rendered. Consulting costs charged to operations were $3,525.

 

In January 2005, the Company issued 7,500 shares to consultants in exchange for services rendered. Consulting costs charged to operations were $4,950. In February 2005, the Company issued 7,500 shares to consultants in exchange for services. Consulting costs charged to operations were $7,574. In April 2005, the Company issued 190,733 shares to consultants in exchange for services. Consulting costs charged to operations were $127,791. In May 2005, the Company issued 21,000 shares to consultants in exchange for services. Consulting costs charged to operations were $11,970.

 

In December 2005, the Company committed to issue 689,246 shares to consultants in exchange for services rendered. 655,663 of these shares of were issued in February 2006 and 33,583 shares were issued in May 2006. The total value for these shares was $650,643 which was based on the market value of the shares issued and was recorded as an accrued liability at December 31, 2005. In February 2006, the Company issued 30,000 shares to consultants in exchange for services. Consulting costs charged to operations were $26,100.

 

(l) On June 25, 2004, the Company entered into an agreement to sell 1,333,333 shares of common stock at a purchase price of $.75 per share for an aggregate purchase price of $1,000,000. Payments were received in four installments, the last of which was on August 9, 2004. Stock issuance costs included 66,665 shares of stock valued at $86,666 and cash costs of $69,000. The cash costs have been off-set against the proceeds received. In conjunction with the sale of the common stock, the Company issued 1,333,333 warrants with an exercise price of $1.00 and a termination date of three years from the installment payment dates. In addition, the Company has given the investors an option to purchase 1,333,333 shares of additional stock including the attachment of warrants under the same terms as the original agreement. This option expired February 8, 2005.

 

F-14

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(m) Pursuant to a Standby Equity Distribution Agreement (“SEDA”) dated July 28, 2004 between the Company and Cornell Capital Partners, L.P. (“Cornell”), the Company may, at its discretion, issue shares of common stock to Cornell at any time until June 28, 2006. As of December 31, 2005 there were no shares issued pursuant to the SEDA. The facility is subject to having in effect a registration statement covering the shares. A registration statement covering 2,023,552 shares was declared effective by the Securities and Exchange Commission on November 16, 2004. The maximum aggregate amount of the equity placements pursuant to the SEDA is $20 million, and the Company may draw down up to $1 million per month. Pursuant to the SEDA, on July 28, 2004, the Company issued 190,084 shares of common stock to Cornell and 7,920 shares of common stock to Newbridge Securities Corporation as commitment shares. These 198,004 shares had a FMV of $310,866 on July 28, 2004 which was being amortized over the term of the commitment period which was one year from the date of registration. The full amount was amortized as of December 31, 2005 with $272,540 amortized in 2005.

 

(n) On November 16, 2004, the Company completed a private placement transaction with 14 accredited investors, pursuant to which the Company sold 530,166 shares of common stock at a purchase price of $0.75 per share, for an aggregate purchase price of $397,625. In connection with the sale of the common stock, the Company also issued warrants to the investors to purchase up to 795,249 shares of our common stock at an exercise price of $1.00 per share. The Company paid $39,764 and issued 198,812 warrants to Venture Catalyst, LLC as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

During the three months ended March 31, 2005, the Company completed a private placement transaction with 8 accredited investors, which were registered effective June 20, 2005, pursuant to which the Company sold 214,666 shares of common stock at a purchase price of $0.75 per share, for an aggregate purchase price of $161,000. In connection with the sale of common stock, the Company also issued warrants to the investors to purchase up to 322,000 shares of common stock at an exercise price of $1.00 per share. The Company paid $16,100 and issued 80,500 warrants to Venture Catalyst, LLC as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

During the three months ended June 30, 2005, the Company completed a private placement transaction with 4 accredited investors, which were registered effective June 20, 2005, pursuant to which the Company sold 230,333 shares of common stock at a purchase price of $0.75 per share, for an aggregate purchase price of $172,750. In connection with the sale of common stock, the Company also issued warrants to the investors to purchase up to 325,500 shares of common stock at an exercise price of $1.00 per share. The Company paid $16,275 and issued 81,375 warrants to Venture Catalyst, LLC as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

During the three months ended September 30, 2005, the Company completed a private placement transaction with 12 accredited investors pursuant to which the Company sold 899,338 shares of common stock at a purchase price of $0.75 per share of which 109,333 are committed to be issued at December 31, 2005, for an aggregate purchase price of $674,500. In connection with the sale of common stock, the Company also issued warrants to the investors to purchase up to 1,124,167 shares of common stock at an exercise price of $0.935 per share. The Company paid $87,685 and committed to issue 79,000 shares of common stock at a fair market value of $70,083 to Network 1 Financial Securities, Inc. as placement agent for this transaction which is accrued at December 31, 2005. The cash and common stock costs have been off-set against the proceeds received.

 

During the three months ended December 31, 2005, the Company completed a private placement transaction with 62 accredited investors pursuant to which the Company sold 10,065,605 shares of common stock at a purchase price of $0.75 per share of which 5,126,019 are committed to be issued at December 31, 2005, for an aggregate purchase price of $7,549,202. In connection with the sale of common stock, the Company also issued warrants to the investors to purchase up to 12,582,009 shares of common stock at an exercise price of $0.935 per share. The Company paid $959,540, issued 46,667 shares of common stock at a fair market value of $46,467, issued 30,550 warrants, and committed to issue 950,461 shares of common stock at a fair market value of $894,593 to a syndicate led by Network 1 Financial Securities, Inc. as placement agent for this transaction which is accrued at December 31, 2005. The cash and common stock costs have been off-set against the proceeds received.

 

In January 2006, the Company issued 5,235,352 shares committed to be issued at December 31, 2005 for shares sold in 2005. In February 2006, the Company issued 1,029,460 shares committed to be issued at December 31, 2005 for stock issuance costs related to shares sold in 2005. The total value for these shares was $964,676 which was based on the market value of the shares issued and was recorded as an accrued liability at December 31, 2005.

 

F-15

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During the three months ended March 31, 2006, the Company completed a private placement transaction with 5 accredited investors pursuant to which the Company sold 466,833 shares of common stock at a purchase price of $0.75 per share for an aggregate purchase price of $350,125. In connection with the sale of common stock, the Company also issued warrants to the investors to purchase up to 466,833 shares of common stock at an exercise price of $0.935 per share. The Company paid $35,013 and issued 46,683 shares of common stock at a fair market value of $41,815 to Chicago Investment Group, L.L.C. as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

In May 2006, the Company completed a private placement transaction with 2 accredited investors pursuant to which the Company sold a total of 153,647 shares of common stock at an average purchase price of $1.37 per share, for an aggregate purchase price of $210,000. In connection with the sale of common stock, the Company also issued warrants to the 2 investors to purchase up to 76,824 shares of common stock at an average exercise price of $2.13 per share.

 

In September 2006, the Company completed a private placement transaction with 7 accredited investors pursuant to which the Company sold a total of 708,200 shares of common stock at a purchase price of $1.00 per share, for an aggregate purchase price of $708,200. The Company paid $92,067 and issued 70,820 shares of common stock at a fair market value of $84,984 to Network 1 Financial Securities, Inc. as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

In October 2006 the Company completed a private placement transaction with 15 accredited investors pursuant to which the Company sold a total of 915,000 shares of common stock at a purchase price of $1.00 per share, for an aggregate purchase price of $915,000. The Company paid $118,950 and issued 91,500 shares of common stock at a fair market value of $118,500 to Network 1 Financial Securities, Inc. as placement agent for this transaction. The cash costs have been off-set against the proceeds received.

 

 During the three months ended December 31, 2006, the Company completed a private placement transaction with 10 accredited investors pursuant to which the Company sold 1,400,000 shares of common stock at a purchase price of $1.00 per share of which 150,000 are committed to be issued at December 31, 2006, for an aggregate purchase price of $1,400,000. The Company paid $137,500, issued 125,000 shares of common stock at a fair market value of $148,750, and committed to pay $16,500 and to issue 15,000 shares of common stock at a fair market value of $17,550 to Chicago Investment Group of Illinois, L.L.C. as a placement agent for this transaction which is accrued at December 31, 2006. The cash and accrued stock costs have been off-set against the proceeds received.

 

(o) The Company issued 175,000 warrants each month from March 2005 to November 2005 resulting in total warrants of 1,575,000 to Gryffindor Capital Partners I, L.L.C. pursuant to the terms of the Second Amended and Restated Note dated November 26, 2004. Total interest costs charged to operations were $985,010.

 

* by /s/H. Craig Dees as Attorney-in-Fact