HepaLife Technologies: Death by Liver Failure?

HepaLife Technologies (HPLF-$1.00), which is focused on the identification and development of cell-based technologies and products, demonstrates the endemic weakness of one shareholder—in this case, one with no scientific credentials—substantially influencing virtually all business strategies requisite to shepherding a medical device through the FDA marketing maze.

Mr. Harmel S. Rayat, 46, is the largest shareholder, beneficially owning 44.21 million shares, constituting about 60 percent of the common stock outstanding, worth an estimated $44.21 million.

[Ed. note. During the past five years, Mr. Rayat has been a busy bio-entrepreneur, serving at various times, as a director, executive officer, and majority stockholder of a number of publicly traded companies. Future postings will unclothe his holdings/influence in these other companies, too.]

In October 2006, Mr. Rayat resigned his positions as president and chief executive officer, but retained the Company’s chief financial officer and principal accounting officer.

Artificial Liver Device

HepaLife’s lead product in development is a cell-supported artificial liver device. The Company is working towards optimizing the hepatic (liver) functionality of a porcine cell line, and subclones thereof, referred to as the “PICM-19 Cell Line.”

The HepaLife Bioartificial Liver device consists of three basic components: (1) a plasma filter, separating the patients blood into blood plasma and blood cells; (2) the bioreactor, a unit filled with PICM-19 cells which biologically mimic the liver’s function; and (3), the HepaDrive, a perfusion system for pumping the patient's plasma through the bioreactor while controlling gas supply and temperature for best possible performance of the cells.

According to US-based, Global Industry Analysts, Inc., one of the world’s largest market research companies, global demand for artificial liver systems is expected to rise to $2.795 billion in 2010, second only to artificial kidney support and more than double the expected $1.31 billion artificial heart market. (July 2007; Artificial Organs - A Global Strategic Business Report)

In early tests, HepaLife’s patented PICM-19 cell line, bioreactor, and HepaDrive perfusion system have demonstrated early success as an integrated system, successfully replicating the liver’s key function – removal of toxic ammonia and synthesis of urea.

Recent Financial Activity

Despite a promising commercial outlook, the ability of HepaLife to obtain additional funding will determine its ability to continue as a going concern, according to the Company’s independent auditors.

The Company has yet to establish any history of profitable operations. HepaLife has had no revenues during the last five fiscal years and does not expect to generate revenues from operations for the foreseeable future. At March 31, 2007, HepaLife had an accumulated deficit of $(11.95) million and a working capital deficit of $(1.19) million.

On May 11, 2007, HepaLife entered into a Securities Purchase Agreement pursuant to which, among other things, the Company issued a Convertible Note to GCA Strategic; the aggregate proceeds of $2,125,000 (85% of the principal amount of the Convertible Note) will be used for working capital and the further development of the Company’s proprietary bioreactor system, the main mechanical component of HepaLife’s patented bioartificial liver device.

This funding will satisfy existing contractual commitments through December 31, 2007; albeit management does not currently have sufficient cash on hand to sustain planned operating activities through the end of 2008.

The dark side to this offering, however, was a death-spiral convert. The conversion price for the common stock to be issued to GCA Strategic pursuant to the conversion provisions of the Convertible Note will fluctuate based on the price of HepaLife’s common stock. Because the price at which the Convertible Note may be converted is variable, the lower HepaLife’s stock price is, the more shares of common stock will have to be issued upon conversion of the Convertible Note.

There is no limit to the number of shares that HepaLife may be required to issue upon conversion of the Convertible Note—as it is dependent upon the share price, which varies from day to day. This could cause significant downward pressure on the price of HepaLife’s common stock. For example, if the share price were to fall to 84 cents, 56 cents, or 28 cents, respectively, the Company would have to issue 2.96 million, 4.44 million, or 8.89 million additional shares, respectively.

To date, most of its operating losses were due to expenses related to HepaLife’s advertising and investor relations program rather than to sponsored research and development programs!

From inception through March 31, 2007, expenditures for advertising and investor relations aggregated $3.25 million or approximately 27% of total expenditures as compared to total R&D expenses during the same period of $878,376 or approximately 7% of total expenditures.

What majority shareholder benefited handsomely from this disproportionate—and irresponsible—use of capital spending? Harmel S. Rayat.

Prior thereto his Named Executive positions, Mr. Rayat served as the president of several companies that provided financial consulting services to a wide range of emerging growth corporations, including HepaLife. In this lifetime, however, Rayat ran afoul of federal securities laws (regarding unrestricted stock).

SEC Cease-and-Desist Decree

In recent years, many small publicly held companies have hired stock promoters to promote them on stock-picking websites and through mass-mailed e-mail messages. The promoter is often compensated in the form of purportedly unrestricted shares of the company's common stock, which the promoter sells after its promotional activities have attracted investor interest in the company.

Under federal securities laws, a public company cannot distribute unrestricted stock to public investors without first registering the offering with the Commission or having a valid exemption from registration for the transaction. Registration requires a company to provide important information about its finances and business to potential investors, and allows the Commission to review the company's disclosures.

In an attempt to circumvent those registration requirements, certain issuers have sought alternate sources of purportedly "free trading" company stock in order to compensate the stock promoters. In such arrangements, the issuers and promoters are nonetheless participating in an unregistered offering of securities to the public in violation of the federal securities laws, as described below.

In 2003, Rayat, EquityAlert.com, Inc. and Innotech Corporation (public relation firms collectively owned by Rayat)—the respondents—were found to have violated the aforementioned federal securities laws.

Without admitting or denying any of the findings and/or allegations of the U.S. Securities & Exchange Commission the respondents agreed, on October 23, 2003 to cease and desist, among other things, from committing or causing any violations and any future violations.

In addition, Respondents Innotech Corporation and EquityAlert.com, Inc. were ordered to pay disgorgement of $171,370 plus prejudgment interest; but that payment in excess of $31,555.14 was waived because “the Respondents submitted a sworn Statement of Financial Condition dated March 31, 2003, and other evidence, asserting their inability to pay full disgorgement plus prejudgment interest.” [HA! HA!]

If you can do a half-assed job of anything, you're a one-eyed man in a kingdom of the blind. ~ American writer Kurt Vonnegut, Jr. (1922 – 2007)

On April 26, 2002, the 10Q Detective unearthed that HepaLife issued 2.16 million of common shares at a price of $0.05 per share in exchange for the satisfaction of debt owed to Harmel S. Rayat. The debt was for a total of $108,000 due for the forequoted management and consulting (PR) fees.

In March 2007, Rayat disposed of 2.25 million shares at 64 cents per share.

Related Party Transaction(s)

The Company’s administrative office is located in Vancouver, British Columbia, Canada—in a building owned by a private corporation controlled by Mr. Rayat. Ergo, as long as the Company sustains operations, Rayat will receive a monthly rent check of C$3,200 from HepaLife (among other concerns that Rayat has a controlling interest, too).

Working hard to get my fill
Everybody wants a thrill
Paying anything to roll the dice
Just one more time

As of June 8, 2007, HepaLife owed an aggregate of $877,800 to Rayat, pursuant to a prior $1.60 million loan commitment. The loans bear interest at the rate of 8.50% per annum (and are due upon the receipt of the written demand from Mr. Rayat). HepaLife does not currently have sufficient capital on hand to repay these loans. (The Company may not use any of the proceeds from the issuance of the Convertible Note to GCA Strategic to repay these loans.)

Some will win,
some will lose
Some were born to sing the blues
Oh the movie never ends
It goes on and on and on and on ~ Artist: Journey (Don’t Stop Believin’, 1981)

Editor David J. Phillips does not hold a financial interest in HepaLife Technologies. The 10Q Detective has a Full Disclosure Policy.