March
10,
2006
Via
Edgar Correspondence File
Mr.
Jim
B. Rosenberg
Senior
Assistant Chief Accountant
Division
of Corporation Finance
United
States Securities and Exchange Commission
100
F
Street, N.E.
Washington,
DC 20549
Dear
Mr.
Rosenberg:
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Re:
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Generex
Biotechnology Corporation.
Form
10-K for the Fiscal Year Ended July 31, 2005
Filed
on October 31, 2005
File
No. 000-25169
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The
following are your comments reproduced, along with our responses in connection
with your March 2, 2006 comment letter, which reviews our Form 10-K for the
fiscal year ended July 31, 2005.
FORM
10-K FOR THE FISCAL YEAR ENDED JULY 31, 2005
Notes
to Consolidated Financial Statements
Note
13 - Convertible Debentures, page 92
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COMMENT
1
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We
note from your disclosure that for certain convertible debentures
you
extended the maturity date and in doing so issued additional warrants
to
the creditors, which you determined to be the reacquisition price
of the
debt on the extinguishment date and recorded a loss on the extinguishment
of the debt. You appear to be implying that the original and new
debt
instruments are "substantially different" as it is defined in EITF
96-19.
Please tell us why you believe the modification caused the new debt
to be
substantially different and why the only loss on extinguishment of
debt
was related to the issuance of the warrants and not also the difference
in
present value of the original debt and the new debt. Please refer
to EITF
96-18.
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Mr.
Jim
B. Rosenberg
March
10,
2006
Page
2
RESPONSE
Background:
$500,000
Convertible Debenture
On
March
28, 2005 the Company issued a Convertible Debenture for gross proceeds of
$500,000, bearing 10% interest per annum due on May 15, 2005. On June 7, 2005
the Company extended the maturity of the Debenture to July 22, 2005
(1st
extension), keeping all other terms unchanged. In consideration for the
extension, the holders received a warrant to purchase 1,219,512 shares of
Company’s stock at $0.82 per share. The warrants were valued at $597,561. The
interest on the note in the amount of $9,854 was added to the face value of
the
new debt. There was no other difference in the present value of the new and
old
debt.
On
July
22, 2005 the Company extended the maturity of the Debenture to September 20,
2005 (2nd
extension), keeping all other terms unchanged. In consideration for the
extension, the holders received warrant to purchase 1,219,512 shares of
Company’s stock at $0.82 per share. The warrants were valued at $524,390. The
interest on the note in the amount of $6,363 was added to the face value of
the
new debt. There was no other difference in the present value of the new and
old
debt.
$100,000
Convertible Debenture
On
April
4, 2005 the Company issued a Convertible Debenture for gross proceeds of
$100,000, bearing 10% interest per annum due on May 15, 2005. On June 7, 2005
the Company extended the maturity of the Debenture to July 22, 2005
(1st
extension), keeping all other terms unchanged. In consideration for the
extension, the holders received a warrant to purchase 243,902 shares of
Company’s stock at $0.82 per share. The warrants were valued at $119,512. The
interest on the note of $1,773 was added to the face value of the new debt.
There was no other difference in the present value of the new and old
debt.
On
July
22, 2005 the Company extended the maturity of the Debenture to September 20,
2005 (2nd
extension), keeping all other terms unchanged. In consideration for the
extension, the holders received warrant to purchase 243,902 shares of Company’s
stock at $0.82 per share. The warrants were valued at $104,878. The interest
on
the note in the amount of $1,270 was added to the face value of the new debt.
There was no other difference in the present value of the new and old
debt.
Guidance:
EITF
96-19 prescribes accounting for a modification or Exchange of Debt instruments.
In particular, the purpose of Issue 96-19 is to determine upon modification
of a
debt instrument, if a substantial change in the terms has occurred and whether
a
debt extinguishment should be recognized as a result. The consensus reached
by
the Task Force in Issue 96-19 is that a modification of a debt instrument is
considered to be substantially different (and should be considered extinguished)
if the present value of the cash flows between the debtor and a creditor has
changed by at least 10 percent. Cash flows can be affected by changes in
principal amounts, interest rates, or maturity or fees exchanged between the
debtor and the creditor to effect changes in certain features of the debt.
Mr.
Jim
B. Rosenberg
March
10,
2006
Page
3
If
the
new
debt instruments are significantly different from the original debt, the new
debt should be initially recorded at fair value and that amount should be used
to determine the debt extinguishment gain or loss to be recognized and the
effective rate of the new instrument.
At
the
September 15, 2005 EITF meeting, the Task Force reached a consensus on EITF
Issue No. 05-7, "Accounting for Modifications to Conversion Options Embedded
in
Debt Instruments and Related Issues," which the Board ratified on September
28,
2005. Because the determination of whether an extinguishment or modification
has
occurred under Issue 96-19 focuses solely on a differential cash flow analysis,
the consensus in Issue 05-7 included an amendment to Issue 96-19 to include
non-cash changes to the conversion terms under this consensus.
Treatment:
The
value
of the warrants issued to holders of convertible debentures was included in
the
cash flow calculations to test a substantial
modification
rule
under EITF 96-19. The present value of the new debt exceeded 10% threshold,
resulting in the recognition of the new debt and loss
on extinguishment of debt
calculation.
The
decision to include value of the warrants in the cash flow calculations was
supported, in addition to the guidance above, by discussions of similar topics
at SEC (Issue 04-8, Issue 05-7) and speech made by Robert J. Comerford at 2004
AICPA National Conference.
The
small
difference in the present value of the debt resulting from the interest accrual
was ignored due to its size for the purposes of loss on extinguishment
calculation.
The
difference between the fair value of the new debt and value of the old debt
was
recorded as loss on extinguishment of debt.
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COMMENT
2
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We
refer to the warrants that were issued with the $4 million convertible
debenture, $500,000 convertible debenture, $100,000 convertible debenture
and the $2 million convertible debenture. It appears based on the
'Common
Stock Purchase Warrant' agreement for each of the warrants issued
that
there is a provision that allows for a "cashless" exercise of the
warrants. This "cashless" exercise appears to permit net share settlement
of the warrants, thus meeting all three criteria of a derivative
in
paragraph 6 of SFAS 133. Please also refer to DIG Issue A17. In addition
it appears based on the warrant agreements you are required to register
the common stock for which the warrants are exercisable into. To
help us
understand whether the warrants issued meet the scope exception under
paragraph 11(a) of SFAS 133, please tell us your consideration of
all the
conditions in EITF 00-19 for each warrant issuance and whether the
warrants issued should be classified as a liability or as
equity.
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Mr.
Jim
B. Rosenberg
March
10,
2006
Page
4
RESPONSE
Background:
The
Company issued warrants to holders of convertible debentures to purchase common
stock containing the cashless exercise provision (paragraph 3c). The provision
states that if at any time after one year from the date of issuance of the
warrants there is no effective Registration Statement registering the resale
of
the warrant shares, then the warrants may also be exercised at such time by
means of a “cashless exercise”. The holder of the warrants would receive
restricted stock as result of net-share settlement.
Guidance:
Paragraph
6 of SFAS 133 provided the following definition of Derivative
Instruments:
A
derivative instrument is a financial instrument or other contract with all
three
of the following characteristics:
a.
It has
(1) one or more underlyings and (2) one or more notional amounts or payment
provisions or both. Those terms determine the amount of the settlement or
settlements, and, in some cases, whether or not a settlement is required.
b.
It
requires no initial net investment or an initial net investment that is smaller
than would be required for other types of contracts that would be expected
to
have a similar response to changes in market factors.
c.
Its
terms require or permit net settlement, it can readily be settled net by a
means
outside the contract, or it provides for delivery of an asset that puts the
recipient in a position not substantially different from net
settlement.
Paragraph
11(a) of SFAS 133 states that a contract issued by a reporting entity that
is
indexed to its own stock and classified in stockholders’ equity in its statement
of financial position is not considered to be a derivative instruments for
purposes of SFAS 133.
The
Financial Accounting Standards Board, Derivatives Implementation Group (DIG),
Statement 133 Implementation Issue No. A17 addresses the issue of if an option,
warrant or other contract provides for net share settlement as a settlement
alternative, would that meet the net settlement criterion in paragraphs 6 (c),
9(a) and 57(c)(1) as delivery of “any other asset, whether or not it is readily
convertible to cash”. The DIG concluded that if either party could net share
settle the contract, then it would be considered a derivative, regardless of
whether the net shares received were readily convertible to cash or restricted
for more than 31 days. They went on to state, issuers of net shares settled
contracts should consider whether such contracts qualify for the scope exception
in paragraph 11(a) of Statement 133.
Mr.
Jim
B. Rosenberg
March
10,
2006
Page
5
Paragraph
8 of EITF 00-19 provides for initial classification in equity if the contract
requires physical settlement or net-share settlement. In
addition, EITF 00-19, paragraph 13 provides a list of all of the criteria’s that
the contract must meet in order to be classified as equity.
Following
is a list of the criteria as presented in EITF 00-19 and discussion of its
relevance to the contract:
The
contract permits the company to settle in unregistered
shares.
The
Warrant can be exercised during the life of the contract for shares of the
Company regardless if the underlying shares are registered or not. The contract
specifies that if the shares are not registered, net-share settlement provision
applies. The contract does not specify any circumstances under which net-cash
settlement would be permitted (part (a) of paragraph 17), but it provides
net-share settlement alternative (part (b)). Thus the exception specified in
paragraph 17 does not apply. The contract meets this condition.
The
company has sufficient authorized and unissued shares available to settle the
contract after considering all other commitments that may require the issuance
of stock during the maximum period the derivative contract could remain
outstanding.
The
Warrant can be exercised into a set amount of shares, known at inception, that
can only be reduced if net-share settlement provision applies. The Company
has
sufficient number of shares unissued to settle the contract. The contract meets
this condition.
The
contract contains an explicit limit on the number of shares to be delivered
in a
share settlement.
The
Warrant can be exercised into a maximum number of shares known in the beginning
which is not in excess of the shares authorized, unissued shares therefore
the
net-share settlement is with in the control of the company The contract meets
this condition.
There
are no required cash payments to the counterparty in the event the company
fails
to make timely filings with the SEC.
There
are
no net-cash settlement provisions in the event the company does not make timely
filings with the SEC in the contract. The contract meets this
condition.
Mr.
Jim
B. Rosenberg
March
10,
2006
Page
6
There
are no required cash payments to the counterparty if the shares initially
delivered upon settlement are subsequently sold by the counterparty and the
sales proceeds are insufficient to provide the counterparty with full return
of
the amount due (that is, there are no cash settled "top-off" or "make-whole"
provisions).
There
are
no “top-off” or “make whole” provisions in the contract. The contract meets this
condition.
The
contract requires net-cash settlement only in specific circumstances in which
holders of shares underlying the contract also would receive cash in exchange
for their shares.
There
are
no net-cash settlement provisions in the contract. The contract meets this
condition.
There
are no provisions in the contract that indicate that the counterparty has rights
that rank higher than those of a shareholder of the stock underlying the
contract.
There
are
no such provisions in the contract which give the holder the rights of a
creditor in the event of bankruptcy. The contract meets this
condition.
There
is no requirement in the contract to post collateral at any point or for any
reason.
There
is
no requirement to post collateral of any kind in the contract. The contract
meets this condition.
Treatment:
The
warrants issued to Convertible Debenture holders represent permanent equity
as
it requires physical settlement, or, in case of failure of registration process,
net-share settlement. The net-share settlement can be done with the restricted
stock as specifically stated in the agreement. In no instances cash settlement
or asset outflow is possible because of the provisions of this contract. The
warrant represents permanent equity, thus meeting the exception under paragraph
11(a) of SFAS 133.
In
connection with its response to the comments of the SEC staff regarding the
above referenced 10-K, Generex Biotechnology Corporation (the “Company”)
acknowledges that:
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the
Company is responsible for the adequacy and accuracy of the disclosure
in
the filings;
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staff
comments or changes to disclosure in response to staff comments do
not
foreclose the Commission from taking any action with respect to the
filings; and
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Mr.
Jim
B. Rosenberg
March
10,
2006
Page
7
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the
Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
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Sincerely, |
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/s/ Rose C.
Perri
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Rose C. Perri |
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Chief Financial Officer |
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Generex Biotechnology Corporation |
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