UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





(Mark
One)





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





For
the fiscal year ended December 31, 2009





 ̈
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the transition period
from                    to





Commission
File Number: 001-32587





PHARMATHENE,
INC.


(Exact
name of registrant as specified in its charter)





Delaware
              
              20-2726770(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer Identification No.)





One Park Place, Suite 450, Annapolis,
      MD
                        
                        21401(Address
      of principal executive offices)
                        
                        (Zip
      Code)





(410)
269-2600


(Registrant’s
telephone number, including area code)





Securities
registered pursuant to Section 12(b) of the Act:





Title of Each Class:
              
              Name of Each Exchange on Which
      Registered:Common
      Stock, par value $0.0001 per share
              
              NYSE
      Amex





Securities
registered pursuant to Section 12(g) of the Act:


None


Indicate
      by check mark if the registrant is a well-known seasoned issuer, as
      defined in Rule 405 of the Securities Act.
                                                                              
                                                                              Yes
                                                                               ̈
                                                                              No
                                                                              xIndicate
      by check mark if the registrant is not required to file reports pursuant
      to Section 13 or 15(d) of the Act.
                                                                              
                                                                              Yes
                                                                               ̈
                                                                              No
                                                                              xIndicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days.
                                                                              
                                                                              Yes
                                                                              x
                                                                              No
                                                                               ̈Indicate
      by check mark whether the registrant has submitted electronically and
      posted on its corporate Web site, if any, every Interactive Data file
      required to be submitted and posted pursuant to Rule 405 of Regulation S-T
      (§232.405 of this chapter) during the preceding 12 months (or for such
      shorter period that the registrant was required to submit and post such
      files).
                                                                              
                                                                              Yes
                                                                               ̈
                                                                              No
                                                                               ̈Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the
      best of registrant’s knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-K or any
      amendment to this Form 10-K.
                                                                              
                                                                              Yes
                                                                               ̈
                                                                              No
                                                                              xIndicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company.  See the definitions of “large accelerated filer,”
      “accelerated filer” and “smaller reporting company” in Rule 12b—2 of the
      Exchange Act.  (Check
one):





 ̈
            Large
      Accelerated Filer
             ̈
            Accelerated
      Filer
             ̈
            Non-Accelerated
      Filer
            x
            Smaller
      Reporting Company





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





The
aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant was $34,560,632 based upon the closing price of
the common equity on the NYSE Amex on the last business day of the registrant’s
most recently completed second fiscal quarter (June 30, 2009).





The
number of shares of the registrant’s Common Stock, par value $0.0001 per share,
outstanding as of March 15, 2010 was 28,435,598.





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the registrant’s definitive Proxy Statement for its 2010 Annual Meeting of
Stockholders or Annual Report on Form 10-K/A, to be filed on or before April 30,
2010, are incorporated by reference into Part III of this Report.













TABLE
OF CONTENTS




PagePART
      I
              
              3Business
              3Risk
      Factors
              27Unresolved
      Staff Comments
              43Properties
              43Legal
      Proceedings
              43Reserved
              44PART
      II
              
              44Market
      for Registrant’s Common Equity and Related Stockholder
    Matters
              44Selected
      Financial Data
              44Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              45Quantitative
      and Qualitative Disclosures about Market Risk
              55Financial
      Statements and Supplementary Data
              55Changes
      In and Disagreements with Accountants on Accounting and Financial
      Disclosure
              55Controls
      and Procedures
              55Other
      Information
              56PART
      III
              
              56Directors,
      Executive Officers and Corporate Governance
              56Executive
      Compensation
              56Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
              57Certain
      Relationships and Related Transactions, and Director
      Independence
              57Principal
      Accountant Fees and Services
              57PART
      IV
              
              57Exhibits
      and Financial Statement Schedules
              57





i





Special
Note Regarding Forward-Looking Statements




This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”).  This information may involve known and unknown risks,
uncertainties and other factors that are difficult to predict and may cause our
actual results, performance or achievements to be materially different from
future results, performance or achievements expressed or implied by any
forward-looking statements.  These risks, uncertainties and other
factors include, but are not limited to, risk associated with the
following:





·
                the reliability of the results
      of the studies relating to human safety and possible adverse effects
      resulting from the administration of the Company’s product
      candidates,
  ·
                unexpected funding delays
      and/or reductions or elimination of U.S. government funding for one or
      more of our development
programs,
  ·
                the award of government
      contracts to our
competitors,
  ·
                unforeseen safety
      issues,
  ·
                challenges related to the
      development, technology transfer, scale-up, and/or process validation of
      manufacturing processes for our product
  candidates,
  ·
              unexpected determinations that
      these product candidates prove not to be effective and/or capable of being
      marketed as products,




as
well as risks detailed under the caption “Risk Factors” in this Report on Form
10-K and in our other reports filed with the U.S. Securities and Exchange
Commission (the “SEC”) from time to time hereafter.  Forward-looking
statements describe management’s current expectations regarding our future
plans, strategies and objectives and are generally identifiable by use of the
words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,”
“intend,”  “project,” “potential” or “plan” or the negative of these words
or other variations on these words or comparable terminology.  Such
statements include, but are not limited to:




·
              statements about potential
      future government contract or grant
  awards,




·
            potential payments under
      government contracts or
grants,




·
            potential regulatory
      approvals,




·
            future product
      advancements,




·
            anticipated financial or
      operational results,
and




·
            expected benefits from our
      acquisition of the biodefense vaccines business (“Avecia Acquisition”)
      from Avecia Biologics Limited and certain of its affiliates (“Avecia”) in
      April 2008.




Forward-looking
statements are based on assumptions that may be incorrect, and we cannot assure
you that the projections included in the forward-looking statements will come to
pass.











We
have based the forward-looking statements included in this Annual Report on
Form 10-K on information available to us on the date of this Annual Report,
and we assume no obligation to update any such forward-looking statements, other
than as required by law.  Although we undertake no obligation to revise or
update any forward-looking statements, whether as a result of new information,
future events or otherwise, you are advised to consult any additional
disclosures that we may make directly to you or through reports that we, in the
future, may file with the SEC, including Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q and Current Reports on
Form 8-K.




All
forward-looking statements included herein are expressly qualified in their
entirety by the cautionary statements contained or referred to elsewhere in this
Annual Report.  Unless otherwise indicated, the information in this
annual report is as of December 31, 2009.











Item
1.     Business.




Background
of PharmAthene, Inc.




PharmAthene, Inc. was incorporated
under the laws of the State of Delaware as Healthcare Acquisition Corp. (“HAQ”)
on April 25, 2005, a special purchase acquisition corporation formed solely to
acquire a then unidentified business.  HAQ became a public company on
August 3, 2005.  On August 3, 2007, HAQ acquired a Delaware
corporation which at the time was known as “PharmAthene, Inc.” (the “Merger”);
effective upon the consummation of the Merger, HAQ changed its name from
“Healthcare Acquisition Corp.” to “PharmAthene, Inc.” and former PharmAthene
changed its name to “PharmAthene US Corporation.”  Through February
27, 2009, our operations were conducted by PharmAthene US
Corporation.  Effective February 27, 2009, PharmAthene US Corporation
was merged with and into PharmAthene, Inc., with PharmAthene, Inc. being the
surviving corporation.




In March 2008, PharmAthene Inc.,
through its wholly-owned subsidiary PharmAthene UK Limited, acquired
substantially all the assets and liabilities related to the biodefense vaccines
business (the “Avecia Acquisition”) of Avecia Biologics Limited (along with its
affiliates, “Avecia”).  In February 2009, PharmAthene US Corporation
was merged with and into PharmAthene, Inc., with PharmAthene, Inc. being the
surviving corporation.




Our
executive offices are located at One Park Place, Suite 450, Annapolis, Maryland
21401 and our telephone number is 410-269-2600.  Our stock trades on
the NYSE Amex (formerly the NYSE Alternext US or the American Stock Exchange)
under the symbol “PIP.”




Unless
the context otherwise requires, all references in this report to the “Company”,
“PharmAthene”, “we”, “us” or “our” refers to the business of the combined
company after the Merger and to the business of former PharmAthene prior to the
Merger, and “HAQ” refers to the business of Healthcare Acquisition Corp. and its
subsidiaries, as a combined entity, prior to the Merger.  Unless the
context otherwise requires, the information contained in this report gives
effect to the consummation of the Merger of August 3, 2007 and the change of our
name from “Healthcare Acquisition Corp.” to “PharmAthene, Inc.”




Overview




We are a
biodefense company engaged in the development and commercialization of medical
countermeasures against biological and chemical weapons.  We currently have
five product candidates in various stages of development:




·
              SparVaxTM,
      a second generation recombinant protective antigen (“rPA”) anthrax
      vaccine,




·
            Valortim®,
      a fully human monoclonal antibody (an identical population of highly
      specific antibodies produced from a single clone) for the prevention and
      treatment of anthrax
infection,




·
            Protexia®,
      a recombinant enzyme (butyrylcholinesterase), which mimics a natural
      bioscavenger for the prevention or treatment of nerve agent poisoning by
      organophosphate compounds, including nerve gases and
      pesticides,




·
            a
      third generation rPA anthrax vaccine,
and





3





·
              RypVaxTM,
      a recombinant dual antigen vaccine for pneumonic and bubonic plague
      (“rYP”).




Recent
Developments




In January 2010, we submitted a
proposal to the U.S. Department of Health and Human Services (HHS), operating
through the Biomedical Advanced Research and Development Authority (BARDA),
for  work under our existing research and development contract with
BARDA for the development of SparVaxTM (HHSO100200900103C) to cover remaining
transfer and validation of the bulk drug substance manufacturing process to
final scale as well as work related to bulk drug substance chemistry
manufacturing and controls (CMC), development of analytical methods, and
generation of data to support target expiration dating and non-clinical data in
two animal species, all within the original contract statement of
work.




In February 2010, we entered into a
contract modification to fund that work.  During the base period of
performance under the contract modification, i.e., through December 31, 2012, we
could receive payments of up to approximately $61 million on a
cost-reimbursement-plus-fixed-fee basis, assuming that all milestones are
achieved.  Under the contract modification, the government, at its
sole discretion, may exercise three contract options during the base period of
performance.  Assuming that the government exercises all three
options, we could receive up to an additional $17 million.  In March
2010, a third party filed a bid protest with the U.S. Government Accountability
Office (GAO), challenging the decision by HHS to enter into the contract
modification.  On March 19, 2010 HHS suspended performance under the
modification pursuant to the automatic stay provisions of the Federal
Acquisition Regulations (or FAR), pending a decision by the GAO on the
protest.  A ruling on the protest is expected no later than June 11,
2010.




On February 1, 2010, we furthermore
submitted a white paper under BAA-BARDA-09-34 requesting additional funding to
further support our development efforts on SparVaxTM to cover development of an
alternative formulation of the vaccine, stability testing, and pre- pivotal
non-clinical animal and human clinical studies required to support a Biologics
License Application (BLA) and potential use under an Emergency Use Authorization
(EUA).  If BARDA finds our white paper submission acceptable, it will
request a formal proposal, which we believe could occur in the first half of
2010, with potential funding under the BAA possible by the end of
2010.




In February 2010, we received notice
from the National Institutes of Allergy and Infectious Disease (“NIAID”) raising
concerns regarding performance under our existing contract with them related to
our third-generation anthrax vaccine program, and directing us to explain how we
plan to cure the deficiencies.  In accordance with the timeline
specified by NIAID, we responded in March 2010 proposing, among other things, a
revised development program and timeline.




Developments
during the year ended December 31, 2009




March
2009 Public Offering




On March
27, 2009, we closed on the public sale of an aggregate of 2,116,055 newly issued
shares of our common stock at $2.60 per share and warrants to purchase an
aggregate of 705,354 shares of our common stock at an exercise price of $3.00
per share, resulting in aggregate gross proceeds of $5,501,743.  The
warrants became exercisable on September 27, 2009 and will expire on September
27, 2014.





4





Avecia
Settlement Agreement




In June
2009, PharmAthene and Avecia entered into a settlement agreement (i) to resolve
certain issues related to the wind down and cancellation of work related to our
rPA vaccine program being conducted at Avecia Biologics, Ltd. pursuant to a
master services agreement (“MSA”) between our two organizations, and (ii) to
accelerate the payment of certain deferred consideration related to the
acquisition of all of the assets of Avecia’s biodefense vaccines business in
April 2008 (the “Avecia Acquisition”).  In accordance with the
settlement agreement, we paid Avecia $7.0 million of the remaining deferred
purchase price consideration under the Avecia Acquisition (and as a result our
then existing letter of credit that had supported the deferred consideration and
the related requirement to maintain restricted cash as collateral for the letter
of credit was terminated) in June 2009 and we agreed to pay Avecia approximately
$1.8 million related to past performance and raw materials under the MSA and
approximately $3.0 million in cancellation fees.




In June
2009, the Company expensed as allowable costs under its government contract the
$1.8 million payment for past contract performance and recognized related
contract revenues.  The Company also accrued the $3.0 million
cancellation fee in June 2009.




Contemplated
Exit Activities




In the
second quarter 2009, our existing research and development contract for SparVaxTM
was transferred from NIAID to BARDA.  In the third quarter 2009 BARDA
and PharmAthene modified the existing statement of work to include, among other
things, the completion of on-going stability studies and development of potency
assays along with certain manufacturing scale-up and technology transfer
activities to a U.S.-based manufacturer for the bulk drug substance for
SparVaxTM.  We then entered into a corresponding subcontract with our
U.S.-based manufacturer.




As a
result of the transfer of the contract and modification of the statement of
work, we have been transitioning development and manufacturing activities as
well as other general and administrative functions from the UK to the
U.S.  In connection with this transition, we anticipate relocating our
UK operations, including terminating our UK workforce, by June 30,
2010.  In the year ended December 31, 2009, we expensed approximately
$2.1  million of costs associated with these exit
activities.




July
2009 Private Placement




Our 8%
senior unsecured convertible notes, which we originally issued in August 2007,
accrued interest at an interest rate of 8% per annum and were to mature on
August 3, 2009 (the “Old Notes”).  The principal amount of the Old
Notes and any accrued interest were convertible into shares of PharmAthene
common stock at the option of the holder at any time based on a conversion rate
of $10.00 per share.  In July 2009, we cancelled a portion of the Old
Notes, and issued new convertible notes and stock purchase warrants to holders
of the cancelled notes as well as to certain new note investors in a private
placement (the “July 2009 Private Placement”).  Specifically, in
connection with the July 2009 Private Placement, we:




·
              exchanged
      a portion of our Old Notes in the aggregate principal amount plus accrued
      interest totaling $8.8 million for new two-year 10% unsecured senior
      convertible notes, which are convertible into common shares at a
      conversion price of approximately $2.54 per share (the “New Convertible
      Notes”) and cancelled the corresponding Old
  Notes;




·
              issued
      additional New Convertible Notes in the aggregate principal amount of
      $10.5 million to new note
investors;





5





·
              issued
      to the recipients of the New Convertible Notes stock purchase warrants to
      purchase up to 2,572,775 shares of common stock at $2.50 per share, which
      warrants are exercisable from January 28, 2010 through January 28, 2015;
      and




·
              used
      the proceeds from the sale of the New Convertible Notes to repay $5.5
      million of our Old Notes that were not exchanged for the New Convertible
      Notes and warrants and repaid all outstanding amounts and fees under an
      existing senior secured credit
facility.




As of
December 31, 2009, the total value of the New Convertible Notes, including
accretion from additional interest expense (as described in Note 9 to our
consolidated financial statements), was approximately $17.4
million.




2007
Credit Facility




In March
2007, we entered into a $10 million senior secured credit facility with Silicon
Valley Bank and Oxford Finance Corporation.  In July 2009, we repaid
all outstanding amounts due under the credit facility along with certain
prepayment fees.  In connection with the credit facility, we issued to
the lenders certain stock purchase warrants, which expire on March 30, 2017, to
purchase an aggregate of 100,778 shares of the Company’s common stock at $3.97
per share.




Cancellation
of RFP BARDA 08-15 and Modification to Development Approach for rPA Anthrax
Vaccines




In
February 2008, the DHHS issued a formal Request for Proposal (RFP-BARDA-08-15)
for an “Anthrax Recombinant Protective Antigen (rPA) Vaccine for the Strategic
National Stockpile,” which included a requisition for 25 million doses of an rPA
anthrax vaccine.  We submitted an initial response to this
solicitation in July 2008 and subsequently submitted four proposal
revisions.  In December 2009, BARDA canceled the RFP because it did
not believe vaccine developers submitting proposals could have product ready for
FDA licensure within 8 years, and encouraged existing anthrax vaccine developers
to submit product development plans under special instructions to a broad agency
announcement (BAA) issued in March 2009 that supports the advanced research and
development of medical countermeasures for chemical, biological, radiological
and nuclear threats and was modified in December 2009 to address submissions
related to rPA-based anthrax vaccines (BAA-BARDA-09-34).




As
noted above under “Recent Developments”, in February 2010 we entered into
a  modification of our existing contract with BARDA related to
SparVaxTM for up to approximately $78 million over three years (assuming exercise
of all contract options) and submitted a white paper under BAA-BARDA-09-34
requesting additional funding to further support our development efforts on
SparVaxTM.  In March 2010, a third party filed a bid protest with the
GAO challenging the decision by HHS to enter into the contract
modification.  On March 19, 2010 HHS suspended performance under the
modification pursuant to the automatic stay provisions of the FAR, pending a
decision by the GAO on the protest.  A ruling on the protest is
expected no later than June 11, 2010.




Developments
Relating to Valortim®




In March
2009, BARDA issued BAA-BARDA-09-34, which included an advanced development
solicitation for proposals covering anthrax anti-toxins.  We submitted
a proposal in response to this BAA in the second quarter 2009 for additional
advanced development for Valortim®.





6





In August
2009 we began our second Phase I clinical trial of our Valortim® anthrax
anti-toxin fully human monoclonal antibody.  This trial involved the
use of Valortim® in combination with the antibiotic,
ciprofloxacin.  During the course of the study, there were two adverse
reactions in the four subjects dosed, one of which was characterized by the
clinical investigators as a serious adverse event.  While both adverse
reactions resolved after cessation of the administration of Valortim® and
appropriate medical treatment, and neither of the subjects appears to have
experienced any further or lasting adverse consequences, we temporarily halted
the trial, pending satisfactory resolution of an investigation into the possible
causes of the adverse events, in accordance with the requirements of the
clinical trial protocol and informed the U.S. Food and Drug Administration
(“FDA”), the National Institute of Allergy and Infectious Diseases (“NIAID”) and
BARDA of these developments.  The FDA placed the
Valortim®/ciprofloxacin study on partial clinical hold pending the outcome of
the investigation.  This partial clinical hold does not pertain to
other Valortim®-related development efforts under the existing investigational
new drug (“IND”) application, and adverse reactions like those seen in this
trial have been observed before with the administration of other marketed
monoclonal antibodies.




BARDA has
also informed us that they will not make an award with respect to our submission
for additional advanced development for Valortim® under BAA-BARDA-09-34 until
satisfactory resolution of this issue and the clinical hold is lifted, at which
point we expect they will promptly re-commence the negotiation process. The
antibiotic interaction study is not on the critical development path for FDA
licensure for the product. However, it is unclear at this time how long it will
take us to complete our investigation, if and when we will be in a position to
recommence negotiations with BARDA with respect to a potential award under the
BAA, and what the effects of any delay in potential future funding of the
program will be on the overall Valortim® development timeline.




Business
Concept and Strategy




Our goal
is to become the premier company worldwide specializing in the development and
commercialization of prophylactic and therapeutic drugs for defense against
bioterrorism and emerging infectious diseases.  Our strategy to
achieve this objective includes the following elements:




Maximize the value of our current
product candidate portfolio as well as products that we may acquire in the
future.  Our products target areas that the U.S. government has
identified as having critical biodefense needs and preclinical data supports the
potential of these products to meet those needs.  We intend to develop
these products aggressively while fulfilling the requirements of the U.S.
government’s contracting processes.  Development and contracting
requirements of biodefense products are unique, and we continue to build
capabilities to meet the requirements while developing our
products.




Continue to build and leverage core
capabilities in biodefense.  We have developed and will
continue to develop unique biodefense product development and contracting
capabilities.  Development of these capabilities has required a
substantial investment, which we expect to leverage by acquiring additional
biodefense product candidates through licensing and mergers and
acquisitions.  We believe that product opportunities will come
primarily from companies focused on commercial markets that wish to see their
products or technologies exploited in biodefense.




Biodefense
Industry




Market
Overview




The worldwide biodefense market can
generally be divided into three segments: U.S. civilian, U.S. military,
and non-U.S. markets.  U.S. government funding represents the vast
majority of the worldwide market.  According to the University of
Pittsburgh Medical Center - Center for Biosecurity, U.S. government biodefense
military and civilian spending peaked in fiscal year 2005 at over $8 billion and
has averaged around $5.4 billion in fiscal years 2007, 2008 and
2009.  Funding in fiscal year 2010 is expected to increase only
slightly because of the President’s plan to freeze discretionary government
spending for the next three fiscal years.





7





U.S.
Civilian: The U.S. civilian market includes funds to protect the U.S.
population from biowarfare agents and is largely funded by the Project BioShield
Act of 2004.  Project BioShield, the U.S. government’s largest
biodefense initiative, governs and funds with $5.6 billion the procurement of
biodefense countermeasures for the Strategic National Stockpile (“SNS”) for the
period from July 2004 through 2013.  Of the $5.6 billion, $3.4 billion
was made available through fiscal year 2008, and the remaining $2.2 billion
became available in fiscal year 2009.  At the end of calendar year
2009, approximately $2 billion in procurement contracts had been awarded and
approximately $1 billion had been transferred out of the Project BioShield
Special Reserve funds (“SRF”) for non-procurement related
activities.  Remaining funds in the SRF now approximate $2.5
billion.  Funding available for advanced development of medical
countermeasures is $305 million in fiscal year 2010.  Based on the
President’s proposed budget for fiscal year 2011, which included $476 million
for advanced development, we believe funding amounts may increase in
2011.




Military:   The
U.S. Department of Defense (“DoD”) is responsible for the development and
procurement of countermeasures for the military segment, which focuses on
providing biowarfare protection for military personnel and civilians who are on
active duty.  The President’s request for funding in the DoD fiscal year
2011 budget is approximately $1.5 billion, similar to amounts for 2010 and 2009.
We anticipate that annual funding for these programs through 2013 will continue
in a comparable range.




Non-U.S.
Markets:  Non-U.S. markets address protection against
biowarfare agents for both civilians and military personnel in foreign
countries.  We anticipate that foreign countries will want to procure
biodefense products as they are developed and validated by procurement by the
U.S. government.




Project
BioShield




Project
BioShield, established under the Project BioShield Act of 2004 and the U.S.
government’s largest biodefense initiative, is focused on acquiring products
with low technology risk that will be available for purchase in the near
term.  The U.S. government has identified the following threats as
priorities: anthrax, smallpox, botulinum toxin, radiation, and nerve agent
exposure.  To evaluate and select the best products for these threats,
the DHHS typically issues Requests for Information (“RFI”) followed by Requests
for Proposals (“RFP”).  RFPs detail product and procurement
requirements including treatment types, numbers of doses and delivery
timeframes.  To qualify for Project BioShield funding, products must
demonstrate product efficacy in an animal model and complete advanced
development activities, and companies must show that they can provide sufficient
manufacturing capability.  As of December 31, 2009, 11 awards have
been made under Project BioShield, including those for anthrax, radiation and
botulinum toxin.




Anthrax




The three
general modes of infection by Bacillus anthracis (“B. anthracis”), the bacterium
which causes anthrax infection, are by inhalation, ingestion or skin contact
with anthrax spores.  Inhalation is the form of infection most likely
to be lethal.  Inhalation anthrax occurs when anthrax spores become
airborne and enter a person’s body through the lungs.  Inhalation
anthrax is usually fatal if left untreated, and has approximately a 50%
mortality rate in patients treated aggressively with antibiotics and supportive
care.  Persons infected by B. anthracis that is ingested
will suffer from gastrointestinal anthrax; those whose skin comes into contact
with anthrax will suffer from cutaneous anthrax.  Gastrointestinal
anthrax has a 25% to 60% mortality rate if left untreated.  Cutaneous
anthrax generally causes skin infections within a week or two after
exposure.  Cutaneous anthrax is the least fatal.  Without
treatment, up to 20% of all skin infection cases are fatal.  Treated
cutaneous anthrax is rarely fatal.





8





The DoD
estimates that up to ten countries may possess anthrax weapons and an
undetermined number of individuals and terrorist groups could have access to
anthrax.  Anthrax is an effective bioterrorism agent because the
spores are stable, can be milled to a fine powder and may be dispersed widely
with readily available instruments and machinery.  The World Health
Organization estimates that 50 kilograms of B. anthracis spores released
upwind of a city of 500,000 people could result in up to 95,000 fatalities, with
an additional 125,000 persons being incapacitated.




In light
of the limited effectiveness of the use of antibiotics and supportive care, we
believe that this currently available treatment for inhalation anthrax is
suboptimal.  Following exposure, but prior to the onset of symptoms,
antibiotics like ciprofloxacin, doxycycline or penicillin can be used as
post-exposure prophylaxis with the goal of preventing progression of the disease
with a recommended antibiotic course of treatment of 60 days, sometimes in
combination with the administration of anthrax vaccine.  We believe
that both compliance and side effects are problematic for anyone asked to take
antibiotics for such an extended period of time.  Furthermore,
antibiotic resistance, whether naturally occurring or genetically engineered, is
a concern. Products like our two rPA-based anthrax vaccine candidates, which are
designed to be effective in two or three doses, and our monoclonal human
antibody treatment, Valortim®, with a prolonged half-life, might allow for a
shorter duration of antibiotic dosing to achieve adequate post-exposure
prophylaxis.




Chemical Weapons and Nerve
Agents




Chemical
weapons use the toxic properties of chemical substances to produce physiological
effects on an enemy.  Classic chemical weapons, such as chlorine and
phosgene, were employed during World War I and consisted primarily of commercial
chemicals used as choking and blood agents, to cause respiratory damage and
asphyxiation.  Nerve agents, one of the most lethal forms of chemical
weapons, were developed in the 1930s in the years leading up to World War
II.




Nerve
agents function by binding to acetylcholinesterase, an enzyme that normally
causes termination of the activity of the neurotransmitter
acetylcholine.  Nerve agents block the activity of
acetylcholinesterase, allowing the activity of acetylcholine to continue
unchecked.  As a result, nerve impulses are continually transmitted,
causing muscle contractions that do not stop.  This effect is referred
to as a “cholinergic crisis” and results in a loss of muscle control,
respiratory failure, paralysis and convulsions.  Nerve agent exposure
that does not cause death after a short period can lead to permanent brain
damage.




Nerve
agents, which are liquids at room temperature, are generally lethal far more
quickly and in far lower quantities than classic chemical weapons, and are
effective both when inhaled and when absorbed through the skin.  These
agents can be delivered through explosive devices, spray tanks or most liquid or
gas dispersion devices and machinery.




There
currently is only one FDA approved pre-treatment for nerve agents,
pyridostigmine bromide (“PB”).  PB is only approved for the
pre-treatment of exposure to the nerve agent soman.  It confers no
protection on its own but enhances the protection conferred by post-exposure
treatment.  The standard of care for post-exposure treatment involves
repeated doses of a cocktail of drugs including atropine, reactivators including
the oxime 2-PAM, and anti-convulsants.  However, this type of
treatment acts primarily on the symptoms of nerve agents, not their underlying
cause.  We believe available pre-and post-treatment options are
inadequate and that there is a need for more efficacious countermeasures,
especially as evidence mounts that modified, more toxic forms of organophospates
nerve agents may be used in future attacks.





9





Plague




The
Centers for Disease Control and Prevention classify Yersinia pestis (“Y. pestis”) as a Category A
bioterrorism agent, the highest threat category ranked by the
CDC.  Plague is a disease caused by the bacterium Y. pestis found endemically
in rodents and flea populations in certain parts of the world.  There
are two primary forms of the disease, bubonic and pneumonic.  If
bubonic plague is not treated, the bacteria can spread through the bloodstream
and infect the lungs, causing a secondary case of pneumonic
plague.  Pneumonic plague affects the lungs and can be transmitted
from person to person when an individual breathes in Y. pestis particles in
through the air.




Once
pneumonic disease is established in a human host, the bacteria can be readily
transmitted between individuals.  The extended time between exposure
to the bacteria and diagnosis increases the opportunity to transmit the bacteria
over a vast area, making containment a challenge.  Creating a
bioweapon carrying Y.
pestis is highly feasible as the bacterium occurs readily in nature and
could easily be isolated and grown in quantity in a laboratory.




To
prevent a high risk of death, particularly for pneumonic plague, antibiotics
must be given within 24 hours of the first symptoms.  However, given
the rapid onset of the disease and the difficulty diagnosing pneumonic plague,
it can rapidly prove fatal in untreated individuals or in a situation where
treatment is delayed.  Currently, no vaccine is commercially
available.




PharmAthene’s
Product Candidates




SparVaxTM:
Recombinant Protective Antigen (PA)-based Anthrax Vaccine




SparVaxTM
is a second generation, rPA anthrax vaccine designed to protect against
inhalation anthrax, the most lethal form of B. anthracis infection in
humans.  The vaccine has been shown to induce anti-Protective Antigen
(“PA”) antibodies in healthy human volunteers and in animal models of inhalation
anthrax.  These antibodies are believed to function by targeting PA, a
protein component necessary to initiate the toxic cascade and cell entry of
toxins produced by the bacterium.  SparVaxTM has been shown to be
protective in rabbit and non-human primate models when animals are vaccinated
and then exposed to lethal inhalation doses of anthrax spores.  One
Phase I and two Phase II clinical trials have been completed in over 700
individuals.  Data from these trials demonstrated that SparVaxTM is
well tolerated and immunogenic.




SparVaxTM
is being developed for two indications:  post-exposure prophylaxis
(“PEP”) in conjunction with antibiotics and general use prophylaxis
(“GUP”).  In a PEP setting, the vaccine would be used following a
suspected exposure to augment the natural immune response and provide protection
once antibiotics are discontinued.  In the GUP setting, the vaccine is
administered in advance of any exposure and is intended to induce an immune
response that will be protective should there be an exposure.




Pre-clinical
Studies




Prior to
an IND being filed with the FDA, SparVaxTM underwent safety testing in rodents
and non-human primates.  SparvaxTM was well tolerated with no deaths
and no behavioral or clinical signs observed in any species.  All of
the toxicology studies were compliant with Good Laboratory Practices (“GLP”) and
the data were used to support the IND and allow for the initiation of clinical
trials of SparVaxTM.





10





Non-clinical
Studies




SparVaxTM
is being developed utilizing the Animal Rule (21 CFR 609.1(a)(1-4)) which allows
for efficacy testing in appropriate animal models in lieu of clinical efficacy
trials.  To date, our animal model development and efficacy studies in
both rabbits and non-human primates for both GUP and PEP indications using
SparVaxTM have been sponsored by NIAID and conducted by a commercial research
organization.  Data from the studies conducted to date have shown that
SparVaxTM is immunogenic in both rabbits and non-human primates; protection has
been demonstrated in vaccinated animals subjected to aerosol challenge with Ames
strain spores.




Clinical
Studies




The Phase
I trial was a dose escalation study designed to evaluate a range of dose levels
administered in two different schedules.  There were no
vaccine-related serious adverse events or changes in blood chemistries, vital
signs or electrocardiograms (“ECGs”) reported.  The results
demonstrated that the vaccine was safe, well-tolerated and
immunogenic.




The Phase
II program was designed to include larger subject numbers and a three-dose
schedule at the two highest dose levels tested in Phase I.  Two Phase
II trials were conducted, both of which studied the effect of different dose
levels and different dosing schedules.




In the
Phase IIa trial, SparVaxTM was well tolerated with no vaccine-related serious
adverse events or changes in blood chemistries, vital signs or ECGs
reported.  Further, SparVaxTM was immunogenic in this
study.




The Phase
IIb trial compared a longer dosing regimen at two different dose levels with a
smaller control group who received the currently licensed anthrax vaccine,
BioThrax®.  Here, too, SparVaxTM was well-tolerated with no
vaccine-related serious adverse events or changes in blood chemistries, vital
signs or ECGs reported.  The immunogenicity data showed that a good
level of response was achieved with both vaccines and with both doses of
SparVaxTM.  While both vaccines were immunogenic following the 3-dose
series with response rates of approximately 90%, an increased proportion of
individuals experienced injection site pain in the BioThrax® group as compared
to the SparVaxTM groups.




Future
studies will seek to confirm the dose and schedule of SparVaxTM that induces
antibody levels in humans which are comparable to those shown to be protective
in the animal models, demonstrate the acceptability of using SparVaxTM in
conjunction with antibiotics, and confirm the safety of SparVaxTM in a sufficient
number of human subjects (as agreed to with FDA).




Funding




To date,
funding for the development of SparVaxTM has occurred under two contracts from
the NIH originally entered into in 2002 and 2003 which, not including the recent
modification discussed below, provided for aggregate funding of up to
approximately $117.7 million.




On
February 29, 2008, the DHHS issued a formal Request for Proposal
(RFP-BARDA-08-15) for an “Anthrax Recombinant Protective Antigen (rPA) Vaccine
for the Strategic National Stockpile.”  We submitted an initial
response to this solicitation in July 2008 and subsequently submitted four
proposal revisions.  In December 2009, BARDA canceled the RFP because
it did not believe vaccine developers submitting proposals could have product
ready for FDA licensure within 8 years, and encouraged existing anthrax vaccine
developers to submit product development plans under special instructions to
BAA-BARDA-09-34 that supports the advanced research and development of medical
countermeasures for chemical, biological, radiological and nuclear
threats.





11





In January 2010, we submitted a
proposal to BARDA to increase the funding  under our existing research
and development contract with BARDA for the development of SparVaxTM
(HHSO100200900103C) to cover remaining transfer and validation of the bulk drug
substance manufacturing process to final scale as well as work related to bulk
drug substance chemistry manufacturing and controls (CMC), development of
analytical methods, and generation of data to support target expiration dating
and non-clinical data in two animal species, all within the original contract
statement of work.




In
February, 2010, we entered into a contract modification to fund that
work.  During the base period of performance under the contract
modification, i.e., through December 31, 2012, we could receive payments of up
to approximately $61 million on a cost-reimbursement-plus-fixed-fee basis,
assuming that all milestones are achieved.  Under the contract
modification, the government, at its sole discretion, may exercise three
contract options during the base period of performance.  Assuming that
the government exercises all three options, we could receive up to an additional
$17 million. In March 2010, a third party filed a bid protest with the GAO,
challenging the decision by HHS to enter into the contract
modification.  On March 19, 2010 HHS suspended performance under the
modification pursuant to the automatic stay provisions of the FAR, pending a
decision by the GAO on the protest.  A ruling on the protest is
expected no later than June 11, 2010.




On
February 1, 2010, we furthermore submitted a white paper under BAA-BARDA-09-34
requesting additional funding to further support our development efforts on
SparVaxTM to cover development of an alternative formulation of the vaccine,
stability testing, and pre-pivotal non-clinical animal and human clinical
studies required to support a Biologics License Application (BLA) and potential
use under an Emergency Use Authorization (EUA).  If BARDA finds our
white paper submission acceptable, it will request a formal proposal, which we
believe could occur in the first half of 2010, with potential funding under the
BAA possible by the end of 2010.




Valortim®:
Anthrax Monoclonal Antibody




Valortim®
is a fully human monoclonal antibody designed to protect against and treat human
inhalational anthrax, as both post-exposure prophylaxis (i.e., before symptoms
manifest) and post-exposure therapy (i.e., once symptoms are
evident).




Valortim®
functions by targeting PA, a protein component of the bacterium that attaches to
and facilitates the entry of the destructive toxins Lethal Factor (LF) and Edema
Factor (EF) into healthy cells in the infected person.  Valortim® is
designed to bind to PA and protect the cells from damage by the anthrax
toxins.  In non-clinical studies, Valortim® protected animals against
infection when administered after exposure, facilitating recovery and survival
in animals exposed to lethal inhalation doses of anthrax spores.




Anthrax
spore challenge studies in animals have demonstrated protection by Valortim®
both when given early following challenge (post-exposure prophylaxis) as well as
when given at the point when animals demonstrate signs of infection after
challenge (therapeutic intervention).  Valortim® binds to a novel site
of PA, permitting protection after toxins have already attached to the
cell.  In addition, other data suggest that Valortim® may augment the
immune system’s ability to kill anthrax bacilli.  We believe potency
and a potentially unique mechanism of action of Valortim® differentiate it from
competing products.  In the initial Phase I clinical trial in healthy
human volunteers, Valortim® was well-tolerated with no drug-related serious
adverse events reported.  A second Phase I clinical trial of Valortim®
and the antibiotic, ciprofloxacin, which commenced in August 2009, was placed on
partial clinical hold pending the outcome of an investigation, after the
occurrence of two adverse reactions in the four subjects dosed, one of which was
characterized by clinical investigators as a serious adverse event, as further
described below.





12





Medarex Collaboration and
Development Timeline




We are
developing Valortim® in collaboration with Medarex, Inc. (a biopharmaceutical
company that specializes in developing fully human antibody-based therapeutic
products and that was acquired by Bristol Myers Squibb in 2009) pursuant to a
collaboration agreement entered into in November 2004.  Under the
terms of the collaboration agreement, we made an initial $2.0 million payment to
Medarex to fund planned development activities in 2004, and we are responsible
for funding all research and development and commercialization activities that
exceed current and future government funding.  The collaboration
agreement provides that Medarex and PharmAthene will share operating profits
according to a formula that establishes our share of the profits at between 20%
and 60%,  generally as follows: (i) upon execution of the
collaboration agreement and the $2.0 million initial payment, our profit share
was 20%; (ii) to maintain our 20% profit share we are required to contribute
funding in an amount equivalent to the funding provided by the U.S. government
to Medarex via grants awarded to fund Valortim® development work (approximately
$7.2 million); (iii) our share of operating profits will increase to 50% if a
contract for the procurement of Valortim® is entered into with the U.S.
government and we have satisfied our obligation to fund the additional $7.2
million (which condition we believe we have satisfied); and (iv) our share of
the operating profits can increase by 10% for every $5 million of funding we
provide over and above the initial payment of $2.0 million and the amount that
we provide as funding in excess of the $7.2 million in matching funds provided
to Medarex.  Our aggregate share of the operating profits is capped at
50% if the condition under clause (iii) is not satisfied and 60% if it is
satisfied.  Should the parties enter into a contract for the
procurement of Valortim® with the U.S. government prior to our satisfying our
obligation under clause (ii) above, we are required to make a milestone payment
to Medarex in an amount up to $1.5 million in order to achieve a 50% profit
share in the program.  Prior to distribution of operating profits,
each party is entitled to reimbursement of research and development expenses
incurred that were not otherwise covered by government funding.




Additional
animal model development and testing of Valortim® for therapeutic efficacy in
African green monkeys is being carried out under a Collaborative Research and
Development Agreement with the U.S. Army Medical Research Institute of
Infectious Diseases.  We had an end-of-Phase I meeting with the FDA in
October 2007 during which the FDA agreed that the African green monkey
model is acceptable as one of the two required species for licensure of
Valortim® under the Animal Rule.  In October 2008, we announced
results from a pilot study, funded by NIH, designed to attempt to refine a
rabbit model as a predictive therapeutic model for anthrax inhalation and which
showed that Valortim® enhanced survival as compared to a control group in this
animal model.  We presented additional confirmatory data in both the
African green monkey and New Zealand white rabbit models in 2009.




Valortim®
has received Fast Track designation from the FDA, which generally indicates that
the FDA will facilitate the development and expedite the regulatory review of
the product depending on the FDA’s resources.  However, we can provide
no assurance that the review will be successful.  In addition, the FDA
may withdraw its approval of a Fast-Track product on a number of grounds,
including the sponsor’s failure to conduct any required post-approval study with
due diligence and failure to continue to meet criteria for
designation.  Valortim® has also been granted orphan drug status, a
designation for drugs developed for diseases which affect less than 200,000
persons in the United States and provides for reduced fees to the FDA, market
exclusivity for seven years, and other FDA-related privileges.





13





Clinical and Non-clinical
Studies




Valortim®
is being developed for two indications: (i) as a post-exposure prophylaxis; and
(ii) as a post-exposure therapy.




Clinical Phase I
Studies




PharmAthene
and Medarex have completed dosing in a Phase I open-label, dose-escalation
clinical trial to evaluate the safety, tolerability, immunogenicity, and
pharmacokinetics (the study of absorption, metabolism and action of drugs) of a
single dose of Valortim® administered intravenously or intramuscularly in
healthy volunteers.  No drug-related serious adverse effects were
reported.




In August
2009 we began a second Phase I clinical trial of Valortim®.  This
trial involved the use of Valortim® in combination with the antibiotic
ciprofloxacin.  During the course of the study, there were two adverse
reactions in the four subjects dosed, one of which was characterized by the
clinical investigators as a serious adverse event.  While both adverse
reactions resolved after cessation of the administration of Valortim® and
appropriate medical treatment, and neither of the subjects appears to have
experienced any further or lasting adverse consequences, we temporarily halted
the trial in accordance with the requirements of the clinical trial protocol and
informed the FDA, NIAID and BARDA of these developments.  The FDA has
placed the Valortim®/ciprofloxacin study on partial clinical hold pending the
outcome of an investigation.  This clinical hold does not pertain to
other Valortim® related development efforts under the existing IND, and adverse
reactions like those seen in this trial have been observed before with the
administration of other marketed monoclonal antibodies.




Non-clinical Studies:
Post-exposure Prophylaxis Indication




We have
conducted studies in two animal models to evaluate the use of Valortim® as a
post-exposure prophylaxis, or, in other words, to protect exposed animals from
developing the signs and from dying of inhalation anthrax.  Treatment
in both animal models was initiated within one hour following exposure to the
anthrax spores.  Eighty-five percent (85%) of rabbits treated
intravenously with doses of Valortim® survived following inhalation exposure to
anthrax spores.  One hundred percent (100%) of cynomolgus monkeys
treated intramuscularly with doses of Valortim® were protected from death
following exposure to inhalation anthrax spores.




Non-clinical Studies:
Post-exposure Therapeutic Indication




We have
conducted studies in rabbits to evaluate the use of Valortim® as a therapeutic
intervention for inhalation anthrax. This indication for Valortim® would be
intended to treat patients who have already developed signs and/or symptoms of
inhalation anthrax.  In two studies, up to 100% of the animals
survived that were treated with Valortim® intravenously at the time they tested
positive for PA in the blood or had significant increases in body
temperature.




We have
also conducted two studies in African green monkeys treated with Valortim® at
the time they test positive for PA in the blood.  Up to 70% of animals
treated intravenously with Valortim®
survived.  In general, the mortality rate for control animals exposed
to inhalation anthrax is close to 100%.




In
addition to the animal efficacy and human safety studies to advance Valortim®
toward licensure under the Animal Rule, work is also ongoing to further explore
and define its mechanism of action.





14





Funding




In 2006
and 2008, we received DoD funding for the advancement of Valortim® in the
aggregate amount of $4.2 million.  On September 28, 2007, NIAID
awarded to PharmAthene a $13.9 million contract for the advanced development of
Valortim® as an anti-toxin therapeutic to treat inhalation anthrax infection. On
April 29, 2009, NIAID increased the value of this contract to $15.9 million,
which we expect will be funded incrementally through fiscal year
2011.




In
addition, in March 2009, BARDA issued BAA-BARDA-09-34, which included an
advanced development solicitation for proposals covering anthrax
anti-toxins.  We submitted a proposal in response to this BAA in the
second quarter 2009 for additional advanced development for
Valortim®.  BARDA has subsequently informed us that they will not make
an award with respect to our proposal until satisfactory resolution of the
investigation into the adverse reactions during our August 2009 Phase I clinical
trial and until the clinical hold is lifted, at which point we expect they will
promptly re-commence the negotiation process.  The clinical trial at
issue is not on the critical development path for FDA licensure for the
product.  However, it is unclear at this time how long it will take us
to complete our investigation, if and when we will be in a position to
recommence negotiations with BARDA with respect to a potential award under the
BAA, and what the effects of any delay in potential future funding of the
program will be on the overall Valortim® development timeline.




Protexia®:
Pegylated Recombinant Human Butyrylcholinesterase




Protexia®,
our nerve agent countermeasure, is a pegylated recombinant transgenic form of
human butyrylcholinesterase (“BChE”).  BChE is a naturally occurring
protein found in minute quantities in blood.  In its native form, BChE
functions as a natural bioscavenger, like a sponge, to absorb organophospate
poisons (e.g., nerve agents) and eliminate them from the circulation before they
cause neurological damage.  Recombinant BChE is first purified as the
unpegylated protein and then modified to arrive at its pegylated form, which
confers desirable attributes such as enhanced half life for a longer period of
protection and decreased potential for immunogenicity.  Preclinical
studies in animal models suggest that Protexia® may be effective
prophylactically and therapeutically for chemical nerve agent
poisoning.




We, in
collaboration with the Institute for Chemical Defense (ICD), a U.S. military
organization where the testing of compounds intended for use against traditional
and non-traditional nerve agents is performed, have screened recombinant BChE
(“rBChE”) and pegylated rBChE (“PEG-rBChE”) for activity against a number of
both traditional and non-traditional nerve agents.  Protexia® will
also be assessed against traditional agents as part of the work under the DoD
contract described below.  The DoD has also indicated that additional
testing of Protexia® against classified non-traditional agents may be performed;
the results of this testing, however, will be treated as classified national
security information and will not be available to us or to the
public.  In addition, newer, more potent, forms of rBChE will be
screened as second-generation rBChE molecules (having higher affinity binding
characteristics and enhanced catalytic activity) become available.




Proof of Concept Studies
Using rBChE or PEG-rBChE




Pre-exposure Prophylaxis
Indication




Pre-treatment
with PEG-rBChE provided 100% survival against multiple lethal doses of the nerve
agents VX and soman in pre-clinical animal models and the surviving animals
displayed no nerve agent side effects.





15





Post-Exposure Therapeutic
Indication




Based on
the demonstration of protection when PEG-rBChE was administered before nerve
agent exposure, a series of experiments were conducted to determine whether
rBChE was effective as a therapy when administered after exposure to nerve
agent.  Ninety percent (90%) of the animals exposed to VX on the skin
and then treated with rBChE survived as compared to no survivors among the group
that was not treated.




Additional
work for a post-exposure indication has been conducted under grant funding from
the NIH. Two studies have been completed to date. Data suggest that rBChE is
superior to the current standard of care; future work will further refine this
comparison.  Additional preclinical studies conducted in 2009 in
guinea pigs suggest that Protexia®has the
potential to  increase survival when administered therapeutically
(i.e., following nerve agent exposure). Specifically, animals treated with
Protexia®two
hours post exposure to multiple lethal doses of the nerve agent VX had lower
blood concentrations of VX than control animals that were not administered
Protexia®.
Additionally, all animals treated with Protexia®survived
while control animals died within 36 hours.




Development Timeline and
Phase I Clinical study




The
potential of rBChE and PEG-rBChE as medical countermeasures have been
demonstrated by their ability to protect animals from multiple lethal doses of
nerve agents and binding to a broad spectrum of agents, including sarin, soman,
tabun and VX.  Following proof-of-concept studies and award of the DoD
contract, we have developed a scalable manufacturing process for the final
product including selection of the PEG reagent.  The final product is
designated Protexia® to distinguish it from earlier versions of the recombinant
protein.




We
completed the manufacture of the first cGMP clinical lot of
Protexia®.  We filed an IND with the FDA in the third quarter of 2008
and began a Phase I clinical trial in humans in October
2008.   The primary and secondary endpoints of the study were an
evaluation of the safety, tolerability, pharmacokinetics and immunogenicity of
(i) escalating single doses of Protexia® given intramuscularly in healthy human
volunteers and (ii) a second dose of Protexia® administered to a subset cohort
approximately 2.5 months after the first dose, respectively.  The data
from the completed Phase I trial, which we initially announced in December 2009,
showed that Protexia® was safe and well-tolerated, with no serious adverse
events reported and with no apparent drug-induced immunogenicity
observed.




Funding




The DoD,
the department charged with purchasing biodefense countermeasurers for military
use, requested competitive bids in an RFP for a recombinant form of BChE drug
for the prophylaxis treatment of chemical nerve agent poisoning, which we
submitted in November 2005.  In 2006, NIH awarded us a grant for up to
$1.6 million to support work on Protexia®.  In September 2006, we were
awarded a multi-year contract by the DoD.  Under the contract, we have
recognized approximately $42.4 million of revenue  for the advanced
development of Protexia® through December 31, 2009.  The U.S.
government, at its sole discretion, has the right to elect to continue
development assistance with further funding of up to an additional $65
million.  We believe the remaining development costs required to
obtain FDA licensure for Protexia® in advance of government procurement will
exceed those used in our original proposal and provided for in the contract with
the DoD. It is unclear at this point when the DoD will make a decision regarding
funding for the next phase of the development work for Protexia®, although the
government has recently indicated that it may make a decision before the end of
the third quarter 2010.





16





Third
Generation rPA-based Anthrax Vaccine




In
addition to SparVaxTM, we are developing a third generation rPA-based anthrax
vaccine in response to the U.S. government’s desire to have a stable product
that does not require refrigeration and which can induce protective immunity in
fewer doses than the currently licensed vaccine, BioThrax® Anthrax Vaccine
Adsorbed (“AVA”), and the existing second generation vaccine
candidates.  This vaccine candidate utilizes the rPA already being
manufactured for the second generation product candidate (SparVaxTM), but it will
be freeze-dried and will contain an additional immune stimulant not present in
SparVaxTM, which we believe will allow for enhanced immunogenicity.




Pre-clinical
Studies




The data
generated to date have focused on proof-of-concept studies in animal models to
evaluate the immunogenicity of the candidate vaccine.  These studies
have shown that the vaccine induces a rapid and enhanced immune response that is
protective against infection with Bacillus anthracis in these
animal models.




There
have been no pre-clinical toxicology studies completed to date.  We
plan to initiate acute single dose toxicology studies in rodents in late
2011.




Clinical
Studies




This
vaccine candidate is in the early research and development stage.  We
do not anticipate filing an IND with the FDA before 2013, and we will not
commence any human clinical trials before an IND has been filed and accepted by
the FDA.




Manufacturing




Work in
2009 under the existing NIH funding (described below) focused on developing the
manufacturing process that combines the lyophilized (i.e., freeze-dried)
rPA-based anthrax vaccine with an immunostimulant for use in animal testing and
human clinical trials.  In 2010, the work will focus on refining the
formulation to re-constitute the lyophilized product, scaling up the process for
manufacturing, and establishing formal stability testing for the
product.




Funding




Two NIH
grants made in 2005 and 2007 in the aggregate amount of $6.9 million have funded
research activities to support the initial development of this vaccine
candidate.  On September 25, 2008, we were awarded a contract by NIAID
for up to approximately $13.2 million for additional development work over a
three-year base period.  Assuming all development milestones are met
and all contract options are exercised by NIAID at its sole discretion, we could
receive up to approximately $83.9 million over a nine year period (including the
base period and the $13.2 million disclosed above) under this contract, which
includes a cost reimbursement component and a fixed fee component payable upon
achievement of certain milestone events.  In February 2010, we
received notice from the NIAID raising concerns regarding performance under our
existing contract with them related to our third-generation anthrax vaccine
program, and directing us to explain how we plan to cure the
deficiencies.  In accordance with the timeline specified by NIAID, we
responded in March 2010 proposing, among other things, a revised development
program and timeline.





17





RypVaxTM:
Recombinant F1 (rF1) and V (rV) antigen-based Plague Vaccine




RypVaxTM
is a recombinant plague vaccine comprising separate recombinant F1 (rF1) and V
(rV) antigens produced in Escherichia
coli.  RypVaxTM has successfully completed three Phase I human
clinical trials.  The vaccine has been demonstrated to be immunogenic,
safe and well-tolerated.  In preclinical animal models of vaccination
with RypVaxTM, the vaccine has induced antibodies which provide protection
against a lethal aerosol challenge of bubonic and pneumonic
plague.  As described below, the government contract under which we
are currently receiving funding for this product is in its wind-down phase and
it is unlikely that additional funding from the U.S. government will be provided
for this product after expiration of the current contract.




Non-clinical
Studies




Three
acute dose toxicity studies have been conducted in the CD strain of rat, and one
study in the ICR-CD-1 mouse strain.  All data generated in these
studies to date demonstrated the safety of the vaccine for use in human clinical
trials.  Non-clinical efficacy studies completed in aerosol challenge
models of Y. pestis in
mice and cynomologus macaques have shown the vaccine to be immunogenic and
protective.




Clinical
Studies




Three
Phase I clinical trials have been conducted to evaluate the safety,
tolerability, and immunogenicity of RypVaxTM.  RypVaxTM has been shown
to be safe, well-tolerated, and immunogenic in all trials conducted to
date.




Funding




In 2004,
Avecia was awarded a multi-year contract from NIAID to support the advanced
development of the plague vaccine candidate for military
use.  PharmAthene acquired this contract as part of the Avecia
Acquisition.  We and the U.S. government have agreed to a reduction to
the scope of work under this contract; as a result, all activities under the
contract are winding down, with wind-down expected to be completed in the first
half of 2010.  We do not anticipate that the U.S. government will
provide additional funding in the future for or procure RypVaxTM.




U.S.
Government Regulatory Pathway




General




Regulation
by governmental authorities in the United States and other countries will have a
significant impact on our research, product development, manufacturing and
marketing of any biopharmaceutical products.  The nature and the
extent to which regulations apply to us will vary depending on the nature of any
such products.  Our potential biopharmaceutical products will require
regulatory approval by governmental agencies prior to
commercialization.  The products we are developing are subject to
federal regulation in the United States, principally by the FDA under the Public
Health Service Act and Federal Food, Drug, and Cosmetic Act (“FFDCA”) and by
state and local governments, as well as regulatory and other authorities in
foreign governments that include rigorous preclinical and clinical testing and
other approval procedures.  Such regulations govern or influence,
among other things, the research, development, testing, manufacture, safety and
efficacy requirements, labeling, storage, recordkeeping, licensing, advertising,
promotion, distribution and export of products, manufacturing and the
manufacturing process.  In many foreign countries, such regulations
also govern the prices charged for products under their respective national
social security systems and availability to consumers.





18





The
Public Health Service Act classifies our current drug candidates which are
produced using biological systems, as biological drug products, or biologics
(“Biologics”).  All drugs intended for human use, including Biologics,
are subject to rigorous regulation by the FDA in the United States and similar
regulatory bodies in other countries.  The steps ordinarily required
by the FDA before a biological drug product may be marketed in the United States
are similar to steps required in most other countries and include, but are not
limited to:




·
              completion
      of preclinical laboratory tests, preclinical animal testing and
      formulation studies;
  ·
              submission
      to the FDA of an IND, which must be in effect before clinical trials may
      commence;
  ·
              performance
      of adequate and well-controlled clinical trials to establish the safety,
      purity and potency (including efficacy) of the Biologic and to
      characterize how it behaves in the human
body;
  ·
              completion
      of comparability studies, if
necessary;
  ·
              submission
      to the FDA of a BLA that includes preclinical data, clinical trial data
      and manufacturing information;
  ·
              FDA
      review of the BLA;
  ·
              satisfactory
      completion of an FDA pre-approval inspection of the manufacturing
      facilities; and
  ·
              FDA
      approval of the BLA, including approval of all product
      labeling.




Preclinical
testing includes laboratory evaluations to characterize the product’s
composition, impurities, stability, and mechanism of its biologic effect, as
well as animal studies to assess the potential safety, purity and potency of
each product.  Preclinical safety tests must be conducted by
laboratories that comply with FDA regulations regarding Good Laboratory
Practices (“GLP”) and the U.S. Department of Agriculture’s Animal Welfare
Act.  Violations of these laws and regulations can, in some cases,
lead to invalidation of the tests, requiring such tests to be
repeated.  The results of the preclinical tests, together with
manufacturing information and analytical data, are submitted to the FDA as part
of an IND and are reviewed by the FDA before the commencement of human clinical
trials.  Unless the FDA objects to an IND by placing the study on
clinical hold, the IND will go into effect 30 days following its receipt by the
FDA.  The FDA may authorize trials only on specified terms and may
suspend clinical trials at any time on various grounds, including a finding that
patients are being exposed to unacceptable health risks.  If the FDA
places a study on clinical hold, the sponsor must resolve all of the FDA’s
concerns before the study may proceed.  The IND application process
may become extremely costly and substantially delay development of
products.  Similar restrictive requirements also apply in other
countries.  Additionally, positive results of preclinical tests will
not necessarily indicate positive results in clinical trials.




Clinical
trials involve the administration of the investigational product to humans under
the supervision of qualified principal investigators.  Our clinical
trials must be conducted in accordance with Good Clinical Practice (“GCP”) under
protocols submitted to the FDA as part of an IND.  In addition, each
clinical trial is approved and conducted under the auspices of an institutional
review board (“IRB”) and with the patients’ informed consent.  The IRB
considers, among other things, ethical factors, the safety of human subjects,
and the possibility of liability of the institutions conducting the
trial.  The IRB at each institution at which a clinical trial is being
performed may suspend a clinical trial at any time for a variety of reasons,
including a belief that the test subjects are being exposed to an unacceptable
health risk.  Since our products are being developed using funding
from the U.S. government, additional review by either the NIH’s IRB or the DoD’s
IRB-equivalent will also be required.  These reviews take place
following approval by the independent IRB.  As the sponsor, we can
also suspend or terminate a clinical trial at any time.





19





Clinical
trials are typically conducted in three sequential phases, Phases I, II, and
III, involving an increasing number of human subjects.  Phase I trials
are safety studies performed in a small number of subjects.  Phase II
studies, which may involve hundreds of subjects, take an in-depth look at the
effectiveness of the drug and may include analysis of dose ranges and dose
regimens.  Finally, Phase III trials typically involve thousands of
individuals and provide the documentation of effectiveness and important
additional safety data required for licensing.




In 2002,
however, the FDA amended its requirements applicable to BLAs to permit the
approval of certain Biologics that are intended to reduce or prevent serious or
life-threatening conditions based on evidence of safety from trial in healthy
subjects and effectiveness from appropriate animal studies when human efficacy
studies are not ethical or feasible.  These regulations, also known as
the “Animal Rule”, and published in the Code of Federal Regulations (21 CFR 601
Subpart H) authorize the FDA to rely on evidence from animal studies to provide
substantial proof of a product’s effectiveness under circumstances where there
is a reasonably well-understood mechanism for the toxicity of the
agent.  Under these requirements, Biologics used to reduce or prevent
the toxicity of chemical, biological, radiological or nuclear substances may be
approved for use in humans based on evidence of effectiveness derived from
appropriate animal studies and any additional supporting
data.  Products evaluated for effectiveness under this rule are
evaluated for safety under preexisting requirements for establishing the safety
of new drug and biological products, including Phase I through Phase II clinical
trials.  Under certain circumstances a single animal species may be
acceptable if that animal model is sufficiently well-characterized for
predicting a response in humans.  The animal study endpoint must be
clearly related to the desired benefit in humans and the information obtained
from animal studies must allow for selection of an effective dose in
humans.  We intend to rely on the Animal Rule in seeking marketing
approval for our product candidates because we cannot ethically expose humans to
anthrax, nerve agents or plague.  Other countries do not, at this
time, have established criteria for review and approval of these types of
products outside their normal review process, i.e. there is no “Animal Rule”
equivalent in countries other than the United States.




Success
in early-stage animal studies and clinical trials does not necessarily assure
success in later-stage clinical trials.  Data obtained from animal
studies and clinical activities are not always conclusive and may be subject to
alternative interpretations that could delay, limit or even prevent regulatory
approval.




All data
obtained from the preclinical studies and clinical trials, in addition to
detailed information on the manufacture and composition of the product, would be
submitted in a BLA to the FDA for review and approval for the manufacture,
marketing and commercial shipments of any of our products.  FDA
approval of the BLA is required before commercial marketing or
non-investigational interstate shipment may begin in the United
States.  However, Project Bioshield gave authority to the FDA to grant
Emergency Use Authorization (“EUA”) for use of unlicensed/unapproved products
should there be an emergency declared by the appropriate authority within the
DHHS.  This legislation will also allow unlicensed products to be
procured for the SNS so that they are available at the time an emergency is
declared.  Our products will be eligible both for consideration for
procurement into the SNS and for use in the event of an emergency, although
there is no guarantee that our products will meet the criteria set forth by DHHS
or the FDA for procurement and EUA, respectively.





20





With
regard to a BLA, the FDA may deny or delay approval of an application that does
not meet applicable regulatory criteria, e.g. if the FDA determines that the
preclinical or clinical data or the manufacturing information does not
adequately establish the safety, purity and potency (including efficacy) of the
Biologic.  The FDA has substantial discretion in the approval process
and may disagree with an applicant’s interpretation of the data submitted in its
BLA.  The FDA can request additional information, seek clarification
regarding information already provided in the submission or ask that clinical
trials be conducted, all of which can delay approval.  The FDA also
may, at any time, require the submission of product samples and testing
protocols for lot-by-lot confirmatory review or testing, known as lot release,
by the FDA prior to commercial distribution.  This means a specific
lot of Biologic cannot be released for commercial distribution until the FDA has
authorized such release.  Similar types of regulatory processes will
be encountered as efforts are made to market any Biologic
internationally.  We will be required to assure product performance
and manufacturing processes from one country to another.




Once it
approves a BLA, the FDA may revoke or suspend the product approval if compliance
with post-market regulatory standards is not maintained or if problems occur
after the product reaches the marketplace.  In addition, the FDA may
require post-marketing studies to monitor the effect of approved products, and
may limit further marketing of the product based on the results of these
post-market studies.  The Animal Rule is clear that post-marketing
studies are required should the products be used in humans; the nature of these
studies will be discussed with FDA as part of the BLA process.  The
FDA has broad post-market regulatory and enforcement powers, including the
ability to levy civil and criminal penalties, suspend or delay issuance of
approvals, seize or recall products and revoke approvals.




Facilities
used to manufacture Biologics are subject to periodic inspection by the FDA and
other authorities, where applicable, and must comply with the FDA’s current Good
Manufacturing Practices (“cGMP”) regulations, the FDA’s general biological
product standards, and the product establishment standards set forth in the
approved BLA.  Failure to comply with the statutory and regulatory
requirements subjects the manufacturer to possible legal or regulatory action,
such as suspension of manufacturing, seizure of product or recall of a
product.  Adverse experiences with the product must be reported to the
FDA and could result in the imposition of market restriction through labeling
changes or in product removal.  Product approvals may be revoked if
compliance with regulatory requirements is not maintained or if problems
concerning safety or effectiveness of the product occur following
approval.  With respect to post-market product advertising and
promotion, the FDA imposes a number of complex regulations on entities that
advertise and promote Biologics, including, among others, standards and
regulations for direct-to-consumer advertising, off-label promotion,
industry-sponsored scientific and educational activities and promotional
activities involving the Internet.  The FDA has very broad enforcement
authority under the FFDCA, and failure to abide by these regulations can result
in administrative and judicial enforcement actions, including the issuance of a
Warning Letter directing correction of deviations from FDA standards, a
requirement that future advertising and promotional materials be pre-cleared by
the FDA, and state and federal civil and criminal investigations and
prosecutions.  Foreign regulatory bodies also strictly enforce these
and other regulatory requirements.





21





Orphan
Drug Act




The
Orphan Drug Act is intended to provide incentives to pharmaceutical companies to
develop and market drugs and Biologics for rare diseases or conditions affecting
fewer than 200,000 persons in the United States at the time of application for
orphan drug designation.  Orphan drug designation does not convey any
advantage in, or shorten the duration of, the regulatory review and approval
process.  Clinical testing requirements for orphan drugs are the same
as those for products that have not received orphan drug designation but
pharmaceutical companies may receive grants or tax credits for research, as well
as protocol assistance.  Further, if a drug or Biologic that receives
orphan drug designation and is the first product to receive FDA marketing
approval for the orphan designated indication, the product receives a seven-year
period of marketing exclusivity during which the FDA cannot approve any
application by another party to market the same drug for treatment of an
identical indication.  There are exceptions to this exclusivity,
however.  For example, the FDA is allowed to approve a second product
with the same active ingredient for the same indication if the sponsor of the
approved orphan product consents, grants a license to the second applicant or is
unable to assure an adequate supply of the drug, or if the second product has
been shown to be clinically superior to the approved orphan
drug.  Further, orphan drug exclusivity does not block approval of a
drug that, although proposed for the same indication, is considered by the FDA
(applying a regulatory standard) to be a different drug than the previously
approved orphan drug.  In addition, the holder of orphan drug status
must notify the FDA of any decision to discontinue active pursuit of drug
approval or, if such approval or license is in effect, notify the FDA at least
one year prior to any discontinuance of product production.  If the
holder of an orphan designation cannot assure the availability of sufficient
quantities of the product to meet the needs of affected patients, the FDA may
withdraw orphan drug status.




Fraud
and Abuse




We are
subject to various federal and state laws pertaining to health care fraud and
abuse, including anti-kickback laws, false claims laws and physician
self-referral laws.  Violations of these laws are punishable by
criminal, civil and/or administrative sanctions, including, in some instances,
imprisonment and exclusion from participation in federal and state health care
programs, including Medicare, Medicaid and veterans’ health
programs.  Because of the far-reaching nature of these laws, we cannot
assure you that the occurrence of one or more violations of these laws would not
result in a material adverse effect on our business, financial condition and
results of operations.




Anti-Kickback
Laws




Our
operations are subject to federal and state anti-kickback
laws.  Certain provisions of the Social Security Act prohibit entities
such as us from knowingly and willingly offering, paying, soliciting or
receiving any form of remuneration (including any kickbacks, bribes or rebates)
in return for the referral of items or services for which payment may be made
under a federal health care program, or in return for the recommendation,
arrangement, purchase, lease or order of items or services for which payment may
be made under a federal health care program.  Violation of the federal
anti-kickback law is a felony, punishable by criminal fines and imprisonment for
up to five years or both.  In addition, the DHHS may impose civil
penalties and exclude violators from participation in federal health care
programs such as Medicare and Medicaid.  Many states have adopted
similar prohibitions against payments intended to induce referrals of products
or services paid by Medicaid or other third party payors.




Other
Regulations




In
addition to the substantial regulations enforced by the FDA, we are also subject
to various federal, state and local laws, regulations and recommendations
relating to safe working conditions, laboratory and manufacturing practices, the
experimental use of animals, and the use and disposal of hazardous or
potentially hazardous substances, including radioactive compounds and infectious
disease agents, used in connection with our various activities.  We
cannot accurately predict the extent of government regulation that might result
from any future legislation or administrative action.





22





Process
and Analytical Development, and Manufacturing




While we
have no drug substance or drug product development, analytical or manufacturing
facilities of our own and limited manufacturing capabilities for the supply of
transgenic milk (as described below), we believe that acceptable alternatives
are available through third-party contract manufacturing organizations (“CMOs”)
and contract research organizations (“CROs”).  CMOs have experience in
developing biological manufacturing processes and operating under cGMPs
established by the Code of Federal Regulations and the Food, Drug and Cosmetic
Act (Biologics) regulated by the FDA, and we rely on them for clinical and
future commercial production of our product candidates.  CROs provide
cGLP/cGMP-compliant services for product analytical tests.




For
SparVaxTM and our third-generation anthrax vaccine, to date the rPA has been
produced in Escherichia
coli at the Avecia bacterial fermentation facilities.  At
Avecia, the bulk drug substance manufacturing process had been performed at
final commercial scale using standard purification unit operations yielding high
purity rPA.  We are in the process of moving rPA bulk drug substance
manufacturing from Avecia to a new CMO, Diosynth RTP, Inc.
(“Diosynth”).  Formulation and filling of the final drug product,
adjuvanted rPA, is performed at Baxter Pharmaceutical Solutions LLC, located in
the United States.  The final dosage presentation is in unit dose
syringes.




For
Protexia®, the starting material used to produce the purified rBChE comes from
the milk of transgenic goats raised on a farm we own and operate.  We
are producing rBChE at commercially feasible quantities.  For
commercial manufacturing, the bulk rBChE starting material is produced on our
farm and the final purification of the bulk drug substance will be performed at
a CMO.  Final formulation processes and product presentation are still
being developed.




For
Valortim®, the cell culture process was developed by Medarex, and results in a
commercially feasible and high purity product that is manufactured by a
CMO.  We have successfully manufactured bulk drug substance at large
scale following technology transfer to a CMO.  The final drug product
has been formulated and filled, tested and released for labeling.




For
RypVaxTM, the recombinant F1 (rF1) and V (rV) antigens have been independently
produced in Escherichia
coli in the Avecia facilities where they were being produced at large
scale in anticipation of future manufacturing.  The bulk drug
substance components are purified by precipitation, chromatographic and
filtration processes yielding the high purity recombinant
antigens.  The purified antigens are combined, formulated/adjuvanted
and filled as a liquid divalent recombinant plague vaccine.




Certain
raw materials used in producing our product candidates are available from only
one source or a limited number of sources.  We attempt to mitigate the
risk associated with such sole source raw materials by actively managing our
inventories.  We have not experienced any shortages in supplies of
such raw materials.  Unavailability of certain materials or the loss
of current sources of production could cause an interruption in production on a
temporary basis pending establishment of new sources or, in some cases,
implementation of alternative processes.




Intellectual
Property




Our
success depends in part on our ability to obtain patents, to protect trade
secrets, and to operate without infringing upon the proprietary rights of
others.  We seek to protect our proprietary position by, among other
methods, filing U.S. and foreign patent applications related to the proprietary
technology, inventions and improvements that are important to our
business.  We currently hold two issued U.S. patents relating to
Protexia® and four corresponding foreign patents.  These patents are
directed to direct gene transfer into the ruminant mammary gland and the method
for development of transgenic goats.  The issued patents have
expiration dates in 2015.  In accordance with ongoing research and
development efforts, we have six pending U.S. patent applications and 14
corresponding foreign applications covering relevant and newly-developed
portions of our transgenic technology.





23





The
following table identifies each of our issued and non-abandoned patents and
published pending applications:




Patent/Patent Application
                
                Patent Number/
                  Application
                  Number
                
                Country of
                  Issue/Filing
                
                Issue Date/File
                  Date
                
                Expiration DateDirect
      Gene Transfer Into the Ruminant Mammary Gland
                
                5,780,009
                
                U.S.
                
                Issued
                  July
      14, 1998
                
                July
      15, 2015Method
      for Development of Transgenic Goats
                
                5,907,080
                
                U.S.
                
                Issued
                  May
      25, 1999
                
                December
      1, 2015Method
      for Development of Transgenic Goats
                
                0871357
                
                Netherlands
                  Great Britain
                  France
                  Germany
                
                May
      2, 2003
                
                November
      27, 2016Production
      of Butyrylcholinesterase in Transgenic Mammals
                
                10/326,892
                
                U.S.
                
                Filed
                  December
      20, 2002
                
                December
      21, 2022Production
      of Butyrylcholinesterase in Transgenic Mammals
                
                051024531
                
                Hong
      Kong
                
                March
      22, 2005
                
                December
      19, 2022Production
      of Butyrylcholinesterase in Transgenic Mammals
                
                1458860
                
                Europe
                
                December
      19, 2002
                
                December
      19, 2022Long
      Half-Life Recombinant Butyrylcholinesterase
                
                US07/017279
                  12/309909
                  2009-523781
                  07811030.1
                  2659809
                  2007281998
                  196,871
                
                WO
                  U.S.
                  Japan
                  Europe
                  Canada
                  Australia
                  Israel
                
                Filed
                  August
      2, 2007
                  February
      2, 2009
                  February
      4, 2009
                  August
      27, 2007
                  February
      3, 2009
                  February
      10, 2009
                  February
      4, 2009
                
                August
      3, 2027
                  August
      3, 2027
                  August
      3, 2027
                  August
      3, 2027
                  August
      3, 2027
                  August
      3, 2027
                  August
      3, 2027Production
      of HSA-linked Butyrylcholinesterases
                
                11/401,390
                
                U.S.
                
                Filed
                  April
      10, 2006
                
                December
      21, 2022Method
      for Assaying Antigens
                
                GB07/001353
                  12/226101
                  2009-504819
                  2010914
                  2,648,850
                  2007242647
                  194459
                
                WO
                  U.S.
                  Japan
                  Europe
                  Canada
                  Australia
                  Israel
                
                April
      12, 2007
                  October
      7, 2008
                  October
      10, 2008
                  November
      10, 2008
                  October
      9, 2008
                  October
      24, 2008
                  October
      2, 2008
                
                April
      13, 2027
                  April
      13, 2027
                  April
      13, 2027
                  April
      13, 2027
                  April
      13, 2027
                  April
      13, 2027
                  April
      13, 2027Vaccine
      Composition
                
                GB2009/050050
                
                WO
                
                January
      22, 2009
                
                January
      22, 2029Anthrax
      Vaccine Formulation and Uses Thereof
                
                GB2009/051293
                
                WO
                
                October
      2, 2009
                
                October
      2, 2029Stable
      vaccine compositions and methods of use
                
                12/321564
                  GB2009/050051
                
                U.S.
                  WO
                
                January
      22, 2009
                  January
      22, 2009
                
                January
      23, 2029
                  January
      23, 2029Recombinant
      Butyrlcholinesterase & Truncates thereof
                
                61/284,444
                
                U.S.
                
                December
      21, 2009
                
                December
      21, 2029





24





In
addition, we are a party to various exclusive and non-exclusive licenses, which
provide access to intellectual property and know-how useful for our
products.  For the Protexia® program, we are party to licenses with
Exeter Life Sciences for intellectual property related to creating animal
clones, GTC Biotherapeutics, Inc. for intellectual property related to the
purification of proteins from milk and know-how related to the development of
protein drugs in the milk of transgenic animals, Nektar Therapeutics AL,
Corporation for intellectual property and know-how related to the pegylation of
proteins, Yissum Research Development Company for intellectual property related
to the production of proteins in the milk of transgenic animals.




Furthermore,
in connection with the Avecia Acquisition, we acquired license agreements with
The Defence Science and Technology Laboratory of the United Kingdom Ministry of
Defence (“DSTL”) originally executed May and December 2006, and amended in
February 2009.  These agreements allow for the licensing of certain
patents and technology useful in our rPA and plague vaccine
programs.  Upon commercialization of a product covered by a license,
the license agreements require that we make royalty payments equal to a
specified percentage of future sales of products for both government procurement
and commercial markets.  No royalty payments on these licenses have
been incurred.  Some of our licenses, which generally extend for the
life of any applicable patent, require us to pay royalties on sales of products
that may be derived from or produced using the licensed
technology.  We derive rights to the patents, patent applications and
know-how relating to Valortim® through our collaboration arrangement with
Medarex, which owns such rights.  For additional information on our
license agreements, please refer to Note 10--Commitments and
Contingencies--License Agreements in the Notes to our Consolidated Financial
Statements.




The
expiration dates for the licenses described above are as follows:




License
                
                Expiration DateExeter
      Life Sciences
                
                When
      sale of licensed product in a specific country or jurisdiction is no
      longer covered by a valid patent claimGTC
      Biotherapeutics, Inc.
                
                December
      31, 2026Nektar
      Therapeutics AL
                
                On
      a country-by-country basis upon the expiration of all royalty obligations
      in the applicable countryYissum
      Research Development Company
                
                When
      the last registered patent expiresDSTL
      Anthrax
                
                No
      expiration specifiedDSTL
      Plague
                
                No
      expiration specifiedMedarex
                
                Two
      years after the earlier of the date that (a) the collaboration product is
      no longer exploited under the agreement or (b) Unilateral Product (as
      defined in our collaboration agreement with Medarex) is no longer
      exploited under a unilateral development and commercialization
      agreement.





25





We rely
upon certain proprietary trade secrets, know-how and continuing technological
advances to develop a competitive position.  In efforts to maintain
confidentiality and ownership of trade secrets, proprietary information and
developments, all of our employees are required to execute agreements regarding
confidentiality and assigning to us all rights to any inventions and processes
they develop while they are employed by us.




We intend
to use license agreements to access external products and technologies, as well
as to convey our own intellectual property to others.  We will be able
to protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary rights are covered by valid and enforceable
patents or are effectively maintained as trade secrets.




Research
and Development Costs




During
the years ended December 31, 2009 and 2008, we incurred $30.2 million and $31.8
million, respectively, of development expenses related to our research and
development programs.




Competition




The
pharmaceutical industry is characterized by rapidly evolving technology and
intense competition.  A large number of companies of all sizes engage
in activities similar to our activities and many of our competitors have
substantially greater financial and other resources available to
them.




Anthrax
Product Competition




With
respect to the development of a PA-based vaccine, we are aware of two other
companies developing competing vaccines that are in the clinical stage of
development:  Emergent BioSolutions, Inc., which is the sole supplier
to the U.S. government of the only currently FDA-licensed anthrax vaccine -
BioThrax® Anthrax Vaccine Adsorbed, and Panacea Biotec Ltd.




Monoclonal
antibodies (“MAbs”) directed against PA are being developed for post-exposure
prophylaxis and as symptomatic therapy for anthrax infection.  There
are a limited number of companies we are aware of with anti-anthrax MAbs and/or
polyclonal antibodies in development, including: Cangene Corporation, Human
Genome Sciences, Inc., Elusys Therapeutics, Inc., Emergent BioSolutions, Inc.,
and IQ Corporation BV.




There are
a number of orally available small molecule and other drugs approved and/or
under development for the treatment of anthrax.  These include broad
spectrum antibiotics as well as anthrax specific products.  Bayer AG
produces ciprofloxacin, or Cipro®, which
has been approved for the post-exposure prophylaxis of inhalation
anthrax.  In late 2004, generic versions of Cipro® were
also approved by the FDA.  In addition, levofloxacin, an antibiotic
marketed in the United States by Ortho-McNeil Pharmaceuticals, and the generic
antibiotic, doxycycline, are both approved for post-exposure prophylaxis of
inhalation anthrax.





26





We also
believe that third generation anthrax vaccines, consisting of improved
formulations of the anthrax Protective Antigen are being developed by Bavarian
Nordic, Emergent BioSolutions, Inc., LigoCyte Pharmaceuticals, Inc., and
Intercell AG.




Nerve
Agent Product Competition




We are
aware of antidotes to nerve agents being developed by pharmaceutical companies,
including Countervaile Corporation, Meridian Medical Technologies, a subsidiary
of King Pharmaceuticals Inc., and Dynport Vaccine Company, LLC, in collaboration
with Baxter Healthcare Corporation.




Plague
Product Competition




Dynport
Vaccines Corporation has a recombinant F1/V fusion vaccine candidate under
development being funded by the DoD.




Employees




As of
December 31, 2009, we employed 147 persons on a full-time basis and 3 on a
part-time basis, including 110 individuals engaged in research and development
activities and 40 individuals engaged in general and administrative functions
such as human resources, finance, accounting, legal and investor
relations.  Our staff includes 23 employees with Ph.D. or M.D.
degrees.  None of our employees are party to any collective bargaining
agreement, and we believe that our relationship with our employees is
good.




Information
concerning our directors and executive officers can be found in Part III, Item
10 under the caption “Directors, Executive Officers and Corporate
Governance.”




Item
1A.     Risk Factors




Investing
in our securities involves risks.  In addition to the other
information in this annual report on Form 10-K, stockholders and potential
investors should carefully consider the risks described below relating to
investment in our common stock.  The risks and uncertainties described
below are not the only ones we face.  Additional risks and
uncertainties not presently known to us or that we currently consider immaterial
may also impair our business operations.  If any of the following
risks actually occur, our business, financial condition and/or results of
operations could be materially adversely affected, the trading price of our
common stock could decline and a stockholder could lose all or part of his or
her investment.




Risks
Related to Our Financial Condition




We
have a history of losses and negative cash flow, anticipate future losses and
negative cash flow, and cannot provide assurances that we will achieve
profitability.




We have
incurred significant losses since we commenced operations.  For the years
ended December 31, 2009, 2008 and 2007 we incurred net losses of approximately
$32.3 million, $36.4 million and $17.7 million respectively and had an
accumulated deficit of approximately $156.3 million at December 31, 2009. 
Our losses to date have resulted principally from research and development costs
related to the development of our product candidates, general and administrative
costs related to operations, and costs related to the Avecia
Acquisition.




Our
likelihood for achieving profitability will depend on numerous factors,
including success in:





27




·
              developing
      our existing products and developing and testing new product
      candidates;
  ·
              receiving
      regulatory approvals;
  ·
              carrying
      out our intellectual property
strategy;
  ·
              establishing
      our competitive position;
  ·
              pursuing
      third-party collaborations;
  ·
              acquiring
      or in-licensing products;
  ·
              manufacturing
      and marketing products; and
  ·
              continuing
      to receive government funding and identifying new government funding
      opportunities.




Many of
these factors will depend on circumstances beyond our control.  We cannot
guarantee that we will achieve sufficient revenues for profitability.  Even
if we do achieve profitability, we cannot guarantee that we can sustain or
increase profitability on a quarterly or annual basis in the future.  If
revenues grow more slowly than we anticipate, or if operating expenses exceed
our expectations or cannot be adjusted accordingly, then our business, results
of operations, financial condition and cash flows will be materially and
adversely affected.  Because our strategy includes potential acquisitions
of other businesses, acquisition expenses and any cash used to make these
acquisitions will reduce our available cash.  While we believe that our
existing cash resources, along with cash receipts from contract receivables
(some of which were unbilled at December 31, 2009) generated under our contracts
will be sufficient to enable us to fund our existing research and development
programs and support our currently anticipated general and administrative
activities through the end of 2010, there can be no assurance that unexpected
financial obligations or other activities that increase our use of cash will not
result in our depleting our cash resources quicker than presently
anticipated. For
example, to the extent that we are unable to collect our receivables on a timely
basis, we may be required to seek short term financing solutions, including
either short term indebtedness or through the sale of equity.




Furthermore,
under the terms of the sale and purchase agreement, as amended (the “Avecia
Purchase Agreement”) we entered into in connection with the Avecia Acquisition,
we are required to pay Avecia $5 million within 90 days of entering into a
multi-year funded development contract that was to be issued by BARDA under
solicitation number RFP-BARDA-08-15 (or any substitution or replacement thereof)
for the further development of SparVaxTM.  RFP-BARDA-08-15 was
cancelled by BARDA in December 2009.  Accordingly, our obligation to
pay Avecia the $5 million payment would mature only upon our receipt of a
substitution or replacement thereof.  We have received funds from
BARDA and other U.S. government agencies under various development agreements
between us and BARDA.  Any development contract deemed to be a
substitute or replacement of RFP-BARDA-08-15 could trigger our obligation to
make the $5 million payment under the Avecia Purchase Agreement.




The
continuing turmoil affecting the banking system and financial markets and the
possibility that financial institutions may consolidate or cease operations has
resulted in a tightening in the credit markets, a low level of liquidity in many
financial markets and extreme volatility in fixed income, credit, currency and
equity markets.  As a result, there can be no assurances that we will be
successful in obtaining sufficient financing on commercially reasonable terms or
at all.  Our requirements for additional capital may be substantial and
will be dependent on many factors, including the success of our research and
development efforts, our ability to commercialize and market products, our
ability to successfully pursue our licensing and collaboration strategy, the
receipt of continued government funding, competing technological and marketing
developments, costs associated with the protection of our intellectual property
and any future change in our business strategy.





28





To the
extent that we raise additional capital through the sale of securities, the
issuance of those securities or shares underlying such securities would result
in dilution that could be substantial to our stockholders.  In addition, if
we incur additional debt financing, a substantial portion of our operating cash
flow may be dedicated to the payment of principal and interest on such
indebtedness, thus limiting funds available for our business
activities.




If
adequate funds are not available, we may be required to curtail significantly
our development and commercialization activities.  This would have a
material adverse effect on our business, financial condition and/or results of
operations.




Risks
Related to Product Development and Commercialization




We
have not commercialized any products or recognized any revenues from
sales.  All of our product candidates are still under development, and
there can be no assurance of successful commercialization of any of our
products.




We have
not commercialized any products or recognized any revenues from product
sales.  In general, our research and development programs are at early
stages.  There can be no assurances that one or more of our future product
candidates will not fail to meet safety standards in human testing, even if
those product candidates are found to be effective in animal studies.  To
develop and commercialize biodefense treatment and prophylactic product
candidates, we must provide the FDA and foreign regulatory authorities with
human clinical and non-clinical animal data that demonstrate adequate safety and
effectiveness.  To generate these data, we will have to subject our product
candidates to significant additional research and development efforts, including
extensive non-clinical studies and clinical testing.  We cannot be sure
that our approach to drug discovery will be effective or will result in the
development of any drug.  Even if our product candidates are successful
when tested in animals, such success would not be a guarantee of the safety or
effectiveness of such product candidates in humans.




Research
and development efforts in the biodefense industry are time-consuming and
subject to delays.  Even if we initially receive positive early-stage
pre-clinical or clinical results, such results may not be indicative of results
that could be anticipated in the later stages of drug development.  Delays
in obtaining results in our non-clinical studies and clinical testing can occur
for a variety of reasons, such as slower than anticipated enrollment by
volunteers in the trials, adverse events related to the products, failure to
comply with Good Clinical Practices, unforeseen safety issues, unsatisfactory
results in trials, perceived defects in the design of clinical trials, changes
in regulatory policy as well as for reasons detailed in “Risk Factors—Necessary Reliance on
the Animal Rule in Conducting Trials is Time-Consuming and
Expensive.”




Any delay
or adverse clinical event arising during any of our clinical trials could force
us to conduct additional clinical trials in order to obtain approval from the
FDA and other regulatory bodies.  Our development costs will increase
substantially if we experience material delays in any clinical trials or if we
need to conduct more or larger trials than planned.




If delays
are significant, or if any of our products do not prove to be safe, pure, and
potent (including efficacy) or do not receive required regulatory approvals, we
may have to abandon the product altogether and will be unable to recognize
revenues from the sale of that product.  In addition, our collaborative
partners may not be able to conduct clinical testing or obtain necessary
approvals from the FDA or other regulatory authorities for any product
candidates jointly developed by us and our partners.  If we fail to obtain
required governmental approvals, we and our collaborative partners will
experience delays in, or be precluded from, marketing products developed through
them or, as applicable, their research.





29





Necessary
Reliance on the Animal Rule in Conducting Trials is Time-Consuming and
Expensive.




As
described in “Business—U.S.
Government Regulatory Pathway—General”, to obtain FDA approval for our
biological warfare defense products under current FDA regulations, we are
required to utilize animal model studies for efficacy and provide animal and
human safety data under the “Animal Rule.”  For many of the biological and
chemical threats, animal models are not yet available, and as such we are
developing, or will have to develop, appropriate animal models, which is a
time-consuming and expensive research effort.  Further, we may not be able
to sufficiently demonstrate the animal correlation to the satisfaction of the
FDA, as these corollaries are difficult to establish and are often
unclear.  The FDA may decide that our data are insufficient for approval
and require additional preclinical, clinical or other studies, refuse to approve
our products, or place restrictions on our ability to commercialize those
products.  Further, other countries do not, at this time, have established
criteria for review and approval of these types of products outside their normal
review process; i.e., there is no “Animal Rule” equivalent, and consequently
there can be no assurance that we will be able to make a submission for
marketing approval in foreign countries based on such animal data.




Additionally,
few facilities in the U.S. and internationally have the capability to test
animals with anthrax, plague, nerve agents, or other lethal biotoxins or
chemical agents or otherwise assist us in qualifying the requisite animal
models.  We have to compete with other biodefense companies for access to
this limited pool of highly specialized resources.  We therefore may not be
able to secure contracts to conduct the testing in a predictable timeframe or at
all.




Even
if we succeed in commercializing our product candidates, they may not become
profitable and manufacturing problems or side effects discovered at later stages
can further increase costs of commercialization.




We cannot
assure you that any drugs resulting from our research and development efforts
will become commercially available.  Even if we succeed in developing and
commercializing our product candidates, we may never generate sufficient or
sustainable revenues to enable us to be profitable.  Even if effective, a
product that reaches market may be subject to additional clinical trials,
changes to or re-approvals of our manufacturing facilities or a change in
labeling if we or others identify side effects or manufacturing problems after a
product is on the market.  This could harm sales of the affected products
and could increase the cost and expenses of commercializing and marketing
them.  It could also lead to the suspension or revocation of regulatory
approval for the products.




We and
our CMOs will also be required to comply with the applicable FDA current Good
Manufacturing Practice (“cGMP”) regulations.  These regulations include
requirements relating to quality control and quality assurance as well as the
corresponding maintenance of records and documentation.  Manufacturing
facilities are subject to inspection by the FDA.  These facilities must be
approved to supply licensed products to the commercial marketplace.  We and
our contract manufacturers may not be able to comply with the applicable cGMP
requirements and other FDA regulatory requirements.  Should we or our
contract manufacturers fail to comply, we could be subject to fines or other
sanctions or could be precluded from marketing our products.  In
particular, we have engaged a new contract manufacturer, Diosynth, to replace
Avecia to manufacture bulk drug substance for SparVaxTM and are engaged in a
technology transfer process to this new contract manufacturer. Diosynth has not
manufactured this bulk drug substance before.  There can be no assurance
that we will be successful in our technology transfer efforts or that this new
contract manufacturer will be able to manufacture sufficient amounts of cGMP
quality bulk drug substance necessary for us to meet our obligations to the U.S.
government.





30





We may
also fail to fully realize the potential of Valortim® and of
our co-development arrangement with Medarex (which was acquired by Bristol Myers
Squibb in 2009), our partner in the development of Valortim®, which
would have an adverse effect upon our business.  We have completed only one
Phase I clinical trial for Valortim® with our
development partner, Medarex, at this point.  As discussed in “--Risks Related to Our Dependence on
U.S. Government Contracts--Most of our immediately foreseeable future revenues
are contingent upon grants and contracts from the U.S. government and we may not
achieve sufficient revenues from these agreements to attain
profitability”, in the fourth quarter of 2009, the FDA placed our Phase I
clinical trial of Valortim® and
ciprofloxacin on clinical hold, pending the results of our investigation of the
potential causes for adverse reactions observed in two subjects dosed in the
trial.  BARDA has advised us that until satisfactory resolution of
this issue and the clinical hold is lifted it will not act on our request for
additional advanced development funding for Valortim® under
BAA-BARDA-09-34.  It is unclear at this time how long it will take us
to complete our investigation, if and when we will be in a position to
recommence negotiations with BARDA with respect to a potential award under the
BAA, and what the effects of any delay in potential future funding of the
program will be on the overall Valortim® development timeline.




Before we
may begin selling any doses of Valortim®, we will
need to conduct more comprehensive safety trials in a significantly larger group
of human subjects.  We will be required to expend a significant amount
to finalize manufacturing capability through a contract manufacturer to provide
material to conduct the pivotal safety and efficacy trials.  If our
contract manufacturer is unable to produce sufficient quantities at a reasonable
cost, or has any other obstacles to production, then we will be unable to
commence these required clinical trials and studies.  Even after we expend
sufficient funds to complete the development of Valortim® and if
and when we enter into an agreement to supply Valortim® to the
U.S. government, we will be required to share any and all profits from the sale
of products with our partner in accordance with a pre-determined
formula.




If
we cannot maintain successful licensing arrangements and collaborations, enter
into new licensing arrangements and collaborations, or effectively accomplish
strategic acquisitions, our ability to develop and commercialize a diverse
product portfolio could be limited and our ability to compete may be
harmed.




A key
component of our business strategy is the in-licensing of compounds and products
developed by other pharmaceutical and biotechnology companies or academic
research laboratories.




For
example, we have an agreement with Medarex to develop Valortim®, a fully
human monoclonal antibody product designed to protect against and treat
inhalation anthrax.  Under the agreement with Medarex, we will be entitled
to a variable percentage of profits derived from sales of Valortim®, if any,
depending, in part, on the amount of our investment.  In addition, we have
entered into licensing and research and development agreements with a number of
other parties and collaborators.  There can be no assurances that the
research and development conducted pursuant to these agreements will result in
revenue generating product candidates.  If our suppliers, vendors,
licensors, or other collaboration partners experience financial difficulties as
a result of the weak economy, or if they are acquired as part of the
current wave of consolidations in the pharmaceutical industry (such as, for
example, with the acquisitions of Medarex by Bristol Myers Squibb and Diosynth’s
parent company by Merck & Co., Inc. in 2009 and of Avecia’s CMO subsidiary
(Avecia Biologics) by Merck & Co., Inc. in 2010), their priorities or our
working relationship with them might change.  As a result,
they might shift resources away from the research, development and/or
manufacturing efforts intended to benefit our products, which could lead to
significant delays in our development programs and potential future
sales.  Finally, our current licensing, research and development, and
supply agreements may expire and may not be renewable or could be terminated if
we do not meet our obligations.  For example, our license agreement
from DSTL for certain technology related to RypVaxTM requires
that we diligently pursue development of this product candidate to maintain
exclusive rights to the technology.  Upon termination of our existing
contract with the U.S. government for the development of RypVaxTM, which
is on an accelerated wind-down schedule, we may decide not to continue with
development efforts at a level necessary to meet this requirement, since we do
not anticipate that the U.S. government will provide additional funding in the
future for or procure RypVaxTM.





31





If we are
not able to identify new licensing opportunities or enter into other licensing
arrangements on acceptable terms, we may be unable to develop a diverse
portfolio of products.  For our future collaboration efforts to be
successful, we must first identify partners whose capabilities complement and
integrate well with ours.  We face, and will continue to face, significant
competition in seeking appropriate collaborators.  Collaboration
arrangements are complex and time consuming to negotiate, document and
implement.  We may not be successful in our efforts to establish and
implement collaborations or other similar arrangements.  The terms of any
collaboration or other arrangements that we establish may not be favorable to
us.  Furthermore, technologies to which we gain access may prove
ineffective or unsafe or our partners may prove difficult to work with or less
skilled than we originally expected.  In addition, any past collaborative
successes are no indication of potential future success.




We may
also pursue strategic acquisitions to further our development and
commercialization efforts.  To achieve the anticipated benefits of an
acquisition, we must integrate the acquired company’s business, technology and
employees in an efficient and effective manner.  The successful combination
of companies in a rapidly changing biodefense industry may be more difficult to
accomplish than in other industries.  The combination of two companies
requires, among other things, integration of the companies’ respective
technologies and research and development efforts.  We cannot assure you
that any integration will be accomplished smoothly or successfully.  The
difficulties of integration are increased by the need to coordinate
geographically separated organizations and address possible differences in
corporate cultures and management philosophies.  The integration of certain
operations will require the dedication of management resources that may
temporarily distract attention from the day-to-day operations of the combined
companies.  The business of the combined companies may also be disrupted by
employee retention uncertainty and lack of focus during integration.  The
inability of management to integrate successfully the operations of the two
companies, in particular, to integrate and retain key scientific personnel, or
the inability to integrate successfully two technology platforms, could have a
material adverse effect on our business, results of operations and financial
condition.




We
may become subject to product liability claims, which could reduce demand for
our product candidates or result in damages that exceed our insurance
coverage.




We face
an inherent risk of exposure to product liability suits in connection with our
product candidates being tested in human clinical trials or sold
commercially.  We may become subject to a product liability suit if any
product we develop causes injury, or if treated individuals subsequently become
infected or suffer adverse effects from our products.  Regardless of merit
or eventual outcome, product liability claims may result in decreased demand for
a product, injury to our reputation, withdrawal of clinical trial volunteers,
and loss of revenues.





32





In
addition, if a product liability claim is brought against us, the cost of
defending the claim could be significant and any adverse determination may
result in liabilities in excess of our insurance coverage.  Although our
anthrax countermeasures are covered under the general immunity provisions of the
U.S. Public Readiness and Emergency Preparedness Act (the “Public Readiness
Act”), there can be no assurance that the U.S. Secretary of Health and Human
Services will make other declarations in the future that cover any of our other
product candidates or that the U.S. Congress will not act in the future to
reduce coverage under the Public Readiness Act or to repeal it altogether. 
For further discussion of that act, see “Risk Factors - Legislation limiting or restricting
liability for medical products used to fight bioterrorism is new, and we cannot
be certain that any such protection will apply to our products or if applied
what the scope of any such coverage will be” below.  Additionally,
we are considering applying for indemnification under the U.S. Support
Anti-terrorism by Fostering Effective Technologies (SAFETY) Act of 2002 which
preempts and modifies tort laws so as to limit the claims and damages
potentially faced by companies who provide certain “qualified” anti-terrorism
products.  However, we cannot be certain that we will be able to obtain or
maintain coverage under the SAFETY Act or adequate insurance coverage on
acceptable terms, if at all.




Risks
Related to Our Dependence on U.S. Government Contracts




Most
of our immediately foreseeable future revenues are contingent upon grants and
contracts from the U.S. government and we may not achieve sufficient revenues
from these agreements to attain profitability.




For the
foreseeable future, we believe our main customer will be national governments,
primarily the U.S. government.  Substantially all of our revenues to date
have been derived from grants and U.S. government contracts.  There can be
no assurances that existing government contracts will be renewed or that we can
enter into new contracts or receive new grants to supply the U.S. or other
governments with our products.  The process of obtaining government
contracts is lengthy and uncertain. In addition, the U.S. government is in the
process of reviewing the public health emergency countermeasure
enterprise.  It is anticipated that the review will include recommendations
for how the U.S government structures and oversees the research, development,
procurement, stockpiling and dispensing of countermeasures as well as how the
enterprise is funded.  The implications of the review are not known at this
time, however, it could impact existing and anticipated contract
opportunities.




If the
U.S. government makes significant contract awards to our competitors for the
supply to the U.S. emergency stockpile, our business will be harmed and it is
unlikely that we will ultimately be able to supply that particular treatment or
product to foreign governments or other third parties.  Further, changes in
government budgets and agendas, cost overruns in our programs, or advances by
our competitors, may result in a decreased and de-prioritized emphasis on, or
termination of, government contracts that support the development and/or
procurement of the biodefense products we are developing.  More
generally, due to the current economic downturn, the accompanying fall in tax
revenues and the U.S. government’s efforts to stabilize the economy, the U.S.
government may be forced or choose to reduce or delay spending in the biodefense
field or eliminate funding of certain programs altogether, which could decrease
the likelihood of future government contract awards or that the government would
procure products from us.




For
example, while RFP-BARDA-08-15 for an rPA vaccine for the SNS initially
indicated that the government would make an award by September 26, 2008,
the award was delayed multiple times and ultimately canceled in December
2009.  Furthermore, the U.S. government has selected a plague vaccine
product candidate from a competitor for advanced development funding, and we do
not anticipate that the U.S. government will provide additional funding in the
future for or procure RypVaxTM.  Given the limited future prospects for
RypVaxTM at this time, we and the U.S. government agreed to a reduction to the
scope of work that will result in early wind down of all activities under our
existing RypVaxTM contract, likely before the end of the first half of
2010.  Previously, the contract was expected to expire in the second half
of 2011.  In addition, we believe the remaining development costs
required to obtain FDA licensure for Protexia® in advance of government
procurement exceed those used in our original proposal and provided for in the
contract with the DoD, and it is unclear whether under the terms of our 2006
contract with the DoD the DoD will elect to continue to fund development of
Protexia® (as well
as the timing of any decision by the DoD in that regard, although the government
has recently indicated that it may make a decision before the end of the third
quarter 2010).  Further, even if the DoD does so elect to continue
funding and we meet all development milestones, the DoD may nevertheless choose
not to procure any doses of Protexia®.





33





In the
fourth quarter of 2009, the FDA placed our phase I clinical trial of Valortim®
and ciprofloxacin on clinical hold, pending the results of our investigation of
the potential causes for adverse reactions observed in two subjects dosed in the
trial.  BARDA has advised us that until satisfactory resolution of
this issue and the clinical hold is lifted it will not act on our request for
additional advanced development funding for Valortim® under
BAA-BARDA-09-34.  It is unclear at this time how long it will take us
to complete our investigation, if and when we will be in a position to
recommence negotiations with BARDA with respect to a potential award under the
BAA, and what the effects of any delay in potential future funding of the
program will be on the overall Valortim® development timeline.




U.S.
government agencies have special contracting requirements that give them the
ability to unilaterally control our contracts.




U.S.
government contracts typically contain unfavorable termination provisions and
are subject to audit and modification by the government at its sole discretion,
which will subject us to additional risks.  These risks include the ability
of the U.S. government unilaterally to:




·
              suspend
      or prevent us for a set period of time from receiving new contracts or
      extending existing contracts based on violations or suspected violations
      of laws or regulations;
  ·
              terminate
      our contracts, including if funds become unavailable or are not provided
      to the applicable governmental
agency;
  ·
              reduce
      the scope and value of our
contracts;
  ·
              audit
      and object to our contract-related costs and fees, including allocated
      indirect costs;
  ·
              control
      and potentially prohibit the export of our
  products;
  ·
              change
      certain terms and conditions in our contracts;
  and
  ·
              cancel
      outstanding RFP solicitations (as was the case with RFP-BARDA-08-15) or
      BAAs.




The U.S.
government will be able to terminate any of its contracts with us either for its
convenience or if we default by failing to perform in accordance with the
contract schedule and terms.  Termination-for-convenience provisions
generally enable us to recover only our costs incurred or committed, settlement
expenses, and profit on the work completed prior to termination. 
Termination-for-default provisions do not permit these recoveries and would make
us liable for excess costs incurred by the U.S. government in procuring
undelivered items from another source.




In
February 2010, we received notice from the NIAID raising concerns regarding
performance under our existing contract with them related to our
third-generation anthrax vaccine program, and directing us to explain how we
plan to cure the deficiencies.  In accordance with the timeline
specified by NIAID, we responded in March 2010 proposing, among other things, a
revised development program and timeline.  There can be no assurance
that the parties will come to agreement on a path forward or that the government
will not terminate the agreement.





34





Due to
the current economic downturn, the accompanying fall in tax revenues, and the
U.S. government’s efforts to stabilize the economy, the U.S. government may be
forced or choose to reduce or delay spending in the biodefense field or
eliminate funding of certain programs altogether, which could decrease the
likelihood of future government contract awards, the likelihood that the
government will exercise its right to extend any of its existing contracts with
us and/or the likelihood that the government would procure products from
us.




The
U.S. government’s determination to award any contracts may be challenged by an
interested party, such as another bidder, at the GAO or in federal court. 
If such a challenge is successful, a contract may be terminated.




The laws
and regulations governing the procurement of goods and services by the U.S.
government provide procedures by which other bidders and other interested
parties may challenge the award of a government contract.  If we are
awarded a government contract, such challenges or protests could be filed even
if there are not any valid legal grounds on which to base the protest.  If
any such protests are filed, the government agency may decide to suspend our
performance under the contract while such protests are being considered by the
GAO or the applicable federal court, thus potentially delaying delivery of goods
and services and payment.  In addition, we could be forced to expend
considerable funds to defend any potential award.  If a protest is
successful, the government may be ordered to terminate our contract and reselect
bids.  The government could even be directed to award a potential contract
to one of the other bidders.  For example, in March 2010 a third-party
filed a bid protest with the GAO challenging the February 2010 decision of the
HHS to modify its existing research and development contract with us for the
development of SparVaxTM.  On
March 19, 2010 HHS suspended performance under the modification pursuant to the
automatic stay provisions of the FAR, pending a decision by the GAO on the
protest.  A ruling on the protest is expected no later than June 11,
2010. We have intervened in the protest and  will likely
have  to expend considerable effort and funds to defend the contract
modification.  Further, there can be no assurances that the GAO will
not sustain the protest, which could then result in termination and re-bidding
of the modification and have a material adverse effect on our financial
condition and operations.




Our
business is subject to audit by the U.S. government and a negative audit could
adversely affect our business.




U.S.
government agencies such as the Defense Contract Audit Agency, or the DCAA,
routinely audit and investigate government contractors.  These agencies
review a contractor’s performance under its contracts, cost structure and
compliance with applicable laws, regulations and standards.




The DCAA
also reviews the adequacy of, and a contractor’s compliance with, its internal
control systems and policies, including the contractor’s purchasing, property,
estimating, compensation and management information systems.  Any costs
found to be improperly allocated to a specific contract will not be reimbursed,
while such costs already reimbursed must be refunded.  If an audit uncovers
improper or illegal activities, we may be subject to civil and criminal
penalties and administrative sanctions, including:




·
              termination
      of contracts;
  ·
              forfeiture
      of profits;
  ·
              suspension
      of payments;
  ·
              fines;
      and
  35
  ·
              suspension
      or prohibition from conducting business with the U.S.
      government.




In
addition, we could suffer serious reputational harm if allegations of
impropriety were made against us.




Laws
and regulations affecting government contracts make it more costly and difficult
for us to successfully conduct our business.




We must
comply with numerous laws and regulations relating to the formation,
administration and performance of government contracts, which can make it more
difficult for us to retain our rights under these contracts.  These laws
and regulations affect how we conduct business with government agencies. 
Among the most significant government contracting regulations that affect our
business are:




·
              the
      Federal Acquisition Regulations, or FAR, and agency-specific regulations
      supplemental to the Federal Acquisition Regulations, which comprehensively
      regulate the procurement, formation, administration and performance of
      government contracts;
  ·
              the
      business ethics and public integrity obligations, which govern conflicts
      of interest and the hiring of former government employees, restrict the
      granting of gratuities and funding of lobbying activities and incorporate
      other requirements such as the Anti-Kickback Act and Foreign Corrupt
      Practices Act;
  ·
              export
      and import control laws and regulations;
and
  ·
              laws,
      regulations and executive orders restricting the use and dissemination of
      information classified for national security purposes and the exportation
      of certain products and technical
data.




Foreign
governments typically also have laws and regulations governing contracts with
their respective agencies.  These foreign laws and regulations affect how
we and our customers conduct business and, in some instances, impose added costs
on our business.  Any changes in applicable laws and regulations could
restrict our ability to maintain our existing contracts and obtain new
contracts, which could limit our ability to conduct our business and materially
adversely affect our revenues and results of operations.




Risks
Related to Dependence on or Competition From Third Parties




Because we depend
on clinical research centers and other contractors for clinical and non-clinical
testing, including testing under the Animal Rule, and for certain research and
development activities, the results of our clinical trial, non-clinical animal
efficacy studies, and research and development activities are largely beyond our
control.




The
nature of clinical trials and our business strategy of outsourcing substantially
all of our research and development and manufacturing work require that we rely
on clinical research centers and other contractors to assist us with research
and development, clinical and non-clinical testing (including animal efficacy
studies under the Animal Rule), patient enrollment and other activities. 
As a result, our success depends largely on the success of these third parties
in performing their responsibilities.  Although we prequalify our
contractors and believe that they are fully capable of performing their
contractual obligations, we cannot directly control the adequacy and timeliness
of the resources and expertise that they apply to these activities. 
Furthermore, we have to compete with other biodefense companies for access to
this limited pool of highly specialized resources.  If our contractors do
not perform their obligations in an adequate and timely manner or we are unable
to enter into contracts with them because of prior commitments to our
competitors, the pace of clinical or non-clinical development, regulatory
approval and commercialization of our product candidates could be significantly
delayed and our prospects could be adversely affected.





36





We
depend on third parties to manufacture, package and distribute compounds for our
product candidates and key components for our product candidates.  The
failure of these third parties to perform successfully could harm our
business.




We do not
have any of our own manufacturing facilities.  We have therefore utilized,
and intend to continue utilizing, third parties to manufacture, package and
distribute our product candidates and key components of our product
candidates.  Any material disruption in manufacturing could cause a delay
in our development programs and potential future sales.  Furthermore,
certain compounds, media, or other raw materials used to manufacture our drug
candidates are available from any one or a limited number of sources.  Any
delays or difficulties in obtaining key components for our product candidates or
in manufacturing, packaging or distributing our product candidates could delay
clinical trials and further development of these potential products. 
Additionally, the third parties we rely on for manufacturing and packaging are
subject to regulatory review, and any regulatory compliance problems with these
third parties could significantly delay or disrupt our commercialization
activities.




We were
notified by the contract manufacturer who supplies the pegylation reagent for
our Protexia® product
candidate that it intends to cease its contract manufacturing operations to
focus exclusively on developing its own proprietary product candidates.  We
are now in the process of searching for an alternative supplier.  As part
of this process, we will need to negotiate and execute a license to certain
intellectual property from our current supplier related to the pegylation
process and to engage in a technology transfer process to a new supplier. 
If we are not successful in these endeavors, our Protexia®
development program will be adversely affected.




Finally,
third-party manufacturers, suppliers and distributors, like most companies, have
been adversely affected by the credit crisis and weakening of the global economy
and as such may be more susceptible to being acquired as part of the current
wave of consolidations in the pharmaceutical industry.  It has, for
example, become challenging for companies to secure debt capital to fund their
operations as financial institutions have significantly curtailed their lending
activities.  If our third-party suppliers continue to experience financial
difficulties as a result of weak demand for their products or for other reasons
and are unable to obtain the capital necessary to continue their present level
of operations or are acquired by others, they may have to reduce their
activities and/or their priorities or our working relationship with them
might change.  A material deterioration in their ability or
willingness to meet their obligations to us could cause a delay in our
development programs and potential future sales and jeopardize our ability to
meet our obligations under our contracts with the government or other third
parties.




We
face, and likely will continue to face, competition from companies with greater
financial, personnel and research and development resources.  Our
commercial opportunities will be reduced or eliminated if our competitors are
more successful in the development and marketing of their products.




The
biopharmaceutical industry is characterized by rapid and significant
technological change.  Our success will depend on our ability to develop
and apply our technologies in the design and development of our product
candidates and to establish and maintain a market for our product
candidates.  There are many organizations, both public and private,
including major pharmaceutical and chemical companies, specialized biotechnology
firms, universities and other research institutions engaged in developing
pharmaceutical and biotechnology products.  Many of these organizations
have substantially greater financial, technical, intellectual property, research
and development, and human resources than we have.  Competitors may develop
products or other technologies that are more effective than any that we are
developing or may obtain FDA approval for products more rapidly.  As noted
above in “- Most of our
immediately foreseeable future revenues are contingent upon grants and contracts
from the U.S. government and we may not achieve sufficient revenues from these
agreements to attain profitability,” the U.S. government has selected a
plague vaccine product candidate from a competitor for advanced development
funding.







37





If we
commence commercial sales of products, we still must compete in the
manufacturing and marketing of such products, areas in which we have limited
experience.  Many of these organizations also have manufacturing facilities
and established marketing capabilities that would enable such companies to
market competing products through existing channels of distribution.  Our
commercial opportunities will be reduced or eliminated if our competitors
develop and market products that:




·
              are
      more effective;
  ·
              have
      fewer or less severe adverse side
effects;
  ·
              are
      more adaptable to various modes of
dosing;
  ·
              obtain
      orphan drug exclusivity that blocks the approval of our application for
      seven years;
  ·
              are
      easier to administer; or
  ·
              are
      less expensive than the products or product candidates that we are, or in
      the future will be,
developing.




While the
regulatory climate for generic versions of biological products approved under a
Biologics License Application (or a BLA) in the United States remains uncertain,
and currently there is no formalized mechanism by which the FDA can approve a
generic version of an approved biological product, Federal legislation has been
introduced to establish a legal pathway for the approval of generic versions of
approved biological products.  If enacted, the legislation will impact the
revenue projections for our products.




Even if
we are successful in developing effective products, and obtain FDA and other
regulatory approvals necessary for commercializing them, our products may not
compete effectively with other successful products.  Our competitors may
succeed in developing and marketing products either that are more effective than
those that we may develop, alone or with our collaborators, making our products
obsolete, or that are marketed before any products that we develop are
marketed.




Risks
Related to Political and Social Factors




Political
or social factors may delay or impair our ability to market our products and our
business may be materially adversely affected.




Products
developed to treat diseases caused by, or to combat the threat of, bioterrorism
will be subject to changing political and social environments.  The
political and social responses to bioterrorism have been unpredictable. 
Political or social pressures may delay or cause resistance to bringing our
products to market or limit pricing of our products, which would harm our
business.





38





Risks
Related to Intellectual Property




Our
commercial success will be affected significantly by our ability (i) to
obtain and maintain protection for our proprietary technology and that of our
licensors and collaborators and (ii) not to infringe on patents and
proprietary rights of third parties.




The
patent position of biotechnology firms generally is highly uncertain and
involves complex legal and factual questions, and, therefore, validity and
enforceability cannot be predicted with certainty.  To date, no consistent
policy has emerged regarding the breadth of claims allowed in biotechnology
patents.  We currently hold two U.S. patents, have five pending U.S. patent
applications, and have a limited number of foreign patents and pending
international and foreign patents applications.  In addition, we have
rights under numerous other patents and patent applications pursuant to
exclusive and non-exclusive license arrangements with licensors and
collaborators.  However, there can be no assurance that patent applications
owned or licensed by us will result in patents being issued or that the patents,
whether existing or issued in the future, will afford protection against
competitors with similar technology.  Any conflicts resulting from
third-party patent applications and patents could significantly reduce the
coverage of the patents owned, optioned by or licensed to us or our
collaborators and limit our ability or that of our collaborators to obtain
meaningful patent protection.




Further,
our commercial success will depend significantly on our ability to operate
without infringing the patents and proprietary rights of third parties.  We
are aware of one U.S. patent covering recombinant production of an antibody and
a license may be required under such patent with respect to Valortim®, which
is a monoclonal antibody and uses recombinant reproduction of antibodies. 
Although the patent owner has granted licenses under such patent, we cannot
provide any assurances that we will be able to obtain such a license or that the
terms thereof will be reasonable.  If we do not obtain such a license and
if a legal action based on such patent was to be brought against us or our
distributors, licensees or collaborators, we cannot provide any assurances that
we or our distributors, licensees or collaborators would prevail or that we have
sufficient funds or resources to defend such claims.




We are
also aware of pending applications directed to pegylated
butyrylcholinesterase.  Protexia®
incorporates butyrylcholinesterase.  If patents are issued to third parties
that cover Protexia® or other
products, we may be required to obtain a license under such patents or obtain
alternative technology.  We cannot provide any assurances that such
licenses will be available or that the terms thereof will be reasonable or that
we will be able to develop alternative technologies.  If we do not obtain
such a license and if a legal action based on such patent was to be brought
against us or our distributors, licensees or collaborators, we cannot provide
any assurances that we or our distributors, licensees or collaborators would
prevail or that we have sufficient funds or resources to defend such
claims.




The costs
associated with establishing the validity of patents, of defending against
patent infringement claims of others and of asserting infringement claims
against others is expensive and time consuming, even if the ultimate outcome is
favorable.  An outcome of any patent prosecution or litigation that is
unfavorable to us or one of our licensors or collaborators may have a material
adverse effect on us.  The expense of a protracted infringement suit, even
if ultimately favorable, would also have a material adverse effect on
us.




We
furthermore rely upon trade secrets protection for our confidential and
proprietary information.  We have taken measures to protect our proprietary
information; however, these measures may not provide adequate protection to
us.  We have sought to protect our proprietary information by entering into
confidentiality agreements with employees, collaborators and consultants. 
Nevertheless, employees, collaborators or consultants may still disclose our
proprietary information, and we may not be able to meaningfully protect our
trade secrets.  In addition, others may independently develop substantially
equivalent proprietary information or techniques or otherwise gain access to our
trade secrets.





39





Risks
Related to Regulatory Approvals and Legislation




Our
use of hazardous materials and chemicals requires us to comply with regulatory
requirements which may result in significant costs and expose us to potential
liabilities.




Our
research and development involves the controlled use of hazardous materials and
chemicals.  We are subject to federal, state, local and foreign laws
governing the use, manufacture, storage, handling and disposal of such
materials.  We will not be able to eliminate the risk of accidental
contamination or injury from these materials.  In the event of such an
accident, we could be forced to pay significant damages or fines, and these
damages could exceed our resources and any applicable insurance coverage. 
In addition, we may be required to incur significant costs to comply with
regulatory requirements in the future.




Legislation
limiting or restricting liability for medical products used to fight
bioterrorism is new, and we cannot be certain that any such protection will
apply to our products or if applied what the scope of any such coverage will
be.




The U.S.
Public Readiness Act was signed into law in December 2005 and creates
general immunity for manufacturers of countermeasures, including security
countermeasures (as defined in Section 319F-2(c)(1)(B) of that act),
when the U.S. Secretary of Health and Human Services issues a declaration for
their manufacture, administration or use.  The declaration is meant to
provide general immunity from all claims under state or federal law for loss
arising out of the administration or use of a covered countermeasure. 
Manufacturers are excluded from this protection in cases of willful
misconduct.  Although our anthrax countermeasures have been covered under
the general immunity provisions of the Public Readiness Act since
October 1, 2008, there can be no assurance that the Secretary of Health and
Human Services will make other declarations in the future that would cover any
of our other product candidates or that the U.S. Congress will not act in the
future to reduce coverage under the Public Readiness Act or to repeal it
altogether.




Upon a
declaration by the Secretary of Health and Human Services, a compensation fund
would be created to provide “timely, uniform, and adequate compensation to
eligible individuals for covered injuries directly caused by the administration
or use of a covered countermeasure.”  The “covered injuries” to which the
program applies are defined as serious physical injuries or death. 
Individuals are permitted to bring a willful misconduct action against a
manufacturer only after they have exhausted their remedies under the
compensation program.  A willful misconduct action could be brought against
us if an individual(s) has exhausted their remedies under the compensation
program which thereby could expose us to liability.  Furthermore, there is
no assurance that the Secretary of Health and Human Services will issue under
this act a declaration to establish a compensation fund.  We may also
become subject to standard product liability suits and other third party claims
if products we develop which fall outside of the Public Readiness Act cause
injury or if treated individuals subsequently become infected or otherwise
suffer adverse effects from such products.





40





We
are required to comply with certain export control laws, which may limit our
ability to sell our products to non-U.S. persons and may subject us to
regulatory requirements that may delay or limit our ability to develop and
commercialize our products.




Our
product candidates are subject to the Export Administration Regulations (“EAR”)
administered by the U.S. Department of Commerce and are, in certain instances
(such as regarding aspects of our Protexia® product candidate) subject to the
International Traffic in Arms Regulations (“ITAR”) administered by the U.S.
Department of State.  EAR restricts the export of dual-use products and
technical data to certain countries, while ITAR restricts the export of defense
products, technical data and defense services.  The U.S. government
agencies responsible for administering EAR and ITAR have significant discretion
in the interpretation and enforcement of these regulations.  Failure to
comply with these regulations can result in criminal and civil penalties and may
harm our ability to enter into contracts with the U.S. government.  It is
also possible that these regulations could adversely affect our ability to sell
our products to non-U.S. customers.




Risks
Related to Personnel




We
depend on our key technical and management personnel, and the loss of these
personnel could impair the development of our products.




We rely,
and will continue to rely, on our key management and scientific staff, all of
whom are employed at-will.  The loss of key personnel or the failure to
recruit necessary additional qualified personnel could have a material adverse
effect on our business and results of operations.  There is intense
competition from other companies, research and academic institutions and other
organizations for qualified personnel.  We may not be able to continue to
attract and retain the qualified personnel necessary for the development of our
business.  If we do not succeed in retaining and recruiting necessary
personnel or developing this expertise, our business could suffer
significantly.




In
particular, as noted above in “Even if we succeed in
commercializing our product candidates, they may not become profitable and
manufacturing problems or side effects discovered at later stages can further
increase costs of commercialization,” we are transferring the
manufacturing process for the bulk rPA drug substance from Avecia in the United
Kingdom to Diosynth, a U.S.-based contract manufacturer.  In connection
with that transfer, we also anticipate moving our U.K.-based operations to the
United States by June 30, 2010.  There can be no assurance that we
will be able to recruit and hire the necessary staff in the U.S. to complete the
transfer of activities in a timely and cost effective manner.




Biotechnology
companies often become subject to claims that they or their employees wrongfully
used or disclosed alleged trade secrets of the employees’ former
employers.  Such litigation could result in substantial costs and be a
distraction to our management.




As is
commonplace in the biotechnology industry, we employ individuals who were
previously employed at other biotechnology or pharmaceutical companies,
including at competitors or potential competitors.  Although no claims
against us are currently pending, we may be subject to claims that we or our
employees have inadvertently or otherwise used or disclosed trade secrets or
other proprietary information of their former employers.  Litigation may be
necessary to defend against these claims.  Even if we are successful in
defending against these claims, litigation could result in substantial costs and
distract management.




Risks
Related to our Common Stock




Shares
that we may issue in the future in connection with certain capital-raising
transactions and shares available for future issuance upon conversion and
exercise of convertible notes, warrants and options could dilute our
shareholders and depress the market price of our common stock.




We will
likely seek to raise additional capital and may do so at any time through
various financing alternatives, including potentially selling shares of common
or preferred stock, notes and/or warrants convertible into, or exercisable for,
shares of common or preferred stock.  We could again rely upon the shelf
registration statement on Form S-3, which was declared effective on
February 12, 2009, in connection with a sale from time to time of common
stock, preferred stock or warrants or any combination of those securities,
either individually or in units, in one or more offerings for up to $50,000,000
(inclusive of the gross proceeds from our March 2009 public offering of $5.5
million and the $2.1 million we would receive if all of the warrants issued in
that offering were exercised).  Raising capital in this manner or any other
manner may depress the market price of our stock, and any such
financing(s) will dilute our existing shareholders.





41





In
addition, as of December 31, 2009, we had outstanding options to purchase
approximately 4.9 million shares of common stock.  Additional shares are
reserved for issuance under our 2007 Long-Term Incentive Compensation
Plan.  Our stock options are generally exercisable for ten years, with a
significant portion exercisable either immediately or beginning one year after
the date of the grant.  Furthermore, the senior unsecured convertible notes
in the aggregate principal amount of $19.3 million issued in July 2009 are
convertible at approximately $2.54 per share into approximately 7.6 million
shares of our common stock, and the accompanying warrants became exercisable on
January 28, 2010 for up to approximately 2.6 million shares of common stock at
$2.50 per share.  Finally, as of December 31, 2009, the Company had issued
and outstanding additional warrants to purchase up to an additional
approximately 0.8 million shares of common stock.  The issuance or even the
expected issuance of a large number of shares of our common stock upon
conversion or exercise of the securities described above could depress the
market price of our stock and the issuance of such shares will dilute the stock
ownership of our existing shareholders.




If
we are unable to continue to satisfy the listing requirements of NYSE Amex, our
securities could be delisted from trading which could limit investors’ ability
to make transactions in our securities and subject us to additional trading
restrictions.




Our
common stock and certain warrants are listed on the NYSE Amex (formerly the NYSE
Alternext US or American Stock Exchange), a national securities exchange, which
imposes continued listing requirements with respect to listed shares.  If
we fail to satisfy one or more of the requirements, such as the policy that
issuers that have had losses in their five most recent fiscal years have
stockholders’ equity of at least $6,000,000, that issuers have more than 300
public shareholders, or that the aggregate market value of shares publicly held
be more than $1,000,000, the NYSE Amex may decide to delist our common
stock.  If the NYSE Amex delists our securities from trading on its
exchange and we are not able to list our securities on another exchange or to
have them quoted on Nasdaq, our securities could be quoted on the OTC Bulletin
Board or on the “pink sheets”.  As a result, we could face significant
adverse consequences including:




·
              a
      limited availability of market quotations for our
    securities;
  ·
              a
      determination that our common stock is a “penny stock” which will require
      brokers trading in our common stock to adhere to more stringent
      rules and possibly result in a reduced level of trading activity in
      the secondary trading market for our
securities;
  ·
              a
      limited amount of news and analyst coverage for us;
  and
  ·
              a
      decreased ability to issue additional securities or obtain additional
      financing in the future.





42




We
can give no assurances that we will ever pay dividends.




We have
not paid any dividends on our common stock in 2009, 2008 or 2007 and do not
intend to declare any dividends in the foreseeable future.  While subject
to periodic review, our current policy is to retain all earnings, if any,
primarily to finance our future growth.  We make no assurances that we will
ever pay dividends, cash or otherwise.  Whether we pay any dividends in the
future will depend on our financial condition, results of operations, and other
factors that we will consider.




Item
1.B.    Unresolved Staff Comments.




Not
applicable.




Item
2.     Properties .




Our
principal executive offices are located at One Park Place, Suite 450, Annapolis,
MD 21401 and are comprised of approximately 21,900 square feet.  The
lease expires in 2017.  We sublease from Avecia approximately 12,700
square feet of office space in Haverton Hills, England which expires in October
2010.  We have also leased approximately 700 square feet of office
space in Cary, North Carolina on a month-to-month basis.




We own a
farm in Canada consisting of 180 acres of land where we raise transgenic
goats.




Management
believes that these facilities are suitable and adequate to meet our anticipated
needs.




Item
3.     Legal Proceedings .




Except as
noted below, we are not a defendant in any legal proceedings.




In
December 2006, we filed a complaint against Siga Technologies, Inc.
(“SIGA”) in the Delaware Chancery Court.  The complaint alleges, among
other things, that we have the right to license exclusively development and
marketing rights for SIGA’s drug candidate, SIGA-246, pursuant to a merger
agreement between the parties (the “Merger Agreement”) that was terminated in
October 2006.  The complaint also alleges that SIGA failed to
negotiate in good faith the terms of such a license pursuant to the terminated
merger agreement.




We are
seeking alternatively a judgment requiring SIGA to enter into an exclusive
license agreement with us for SIGA-246 in accordance with the terms of the term
sheet attached to the merger agreement or monetary damages.  In
January 2008, the Delaware Chancery Court issued a ruling denying a motion
by SIGA to dismiss the complaint.  SIGA has filed a counterclaim against us
alleging that we breached our duty to engage in good-faith negotiations by,
among other things, presenting SIGA with a bad-faith initial proposal for a
license agreement that did not contain all necessary terms, demanding SIGA
prepare a complete draft of a partnership agreement and then unreasonably
rejecting that agreement, and unreasonably refusing to consider economic terms
that differed from those set forth in the license agreement term sheet attached
to the Merger Agreement.  SIGA is seeking recovery of its reliance damages
from this alleged breach.




Discovery in the case closed in
February 2010.  In March 2010, SIGA filed a motion for summary
judgment. All reply briefs and any cross motions for summary judgment are due
by early May 2010. While the specific timing for any hearing on the motions
is within the court’s discretion, we anticipate that the court will schedule a
hearing in June or July 2010.  Thereafter, once the court rules on the
motions for summary judgment, and assuming open issues remain in the case, the
parties can ask the court to set a trial date for any time 45 days following the
ruling on summary judgment.  An actual trial date will be subject to
the court’s discretion and its schedule and docket at that
time.


43


Item
      4.
            Reserved.




Item
      5.
            Market
      for Registrant’s Common Equity and Related Stockholder
      Matters.




Market




Our
common stock trades on the NYSE Amex (formerly the NYSE Alternext US or American
Stock Exchange) under the symbol PIP.  The following table sets forth
the range of high and low trading prices of our common stock on the NYSE Amex
for the past two years during the fiscal periods shown.




Fiscal Year 2009
                  
                  High
                  
                  
                  Low4th
      Quarter Ended December 31
                  
                  $
                  4.24
                  
                  
                  $
                  1.213rd
      Quarter Ended September 30
                  
                  $
                  4.14
                  
                  
                  $
                  2.152nd
      Quarter Ended June 30
                  
                  $
                  3.00
                  
                  
                  $
                  2.001st
      Quarter Ended March 31
                  
                  $
                  3.25
                  
                  
                  $
                  1.48





Fiscal Year 2008
                  
                  High
                  
                  
                  Low4th
      Quarter Ended December 31
                  
                  $
                  2.46
                  
                  
                  $
                  0.053rd
      Quarter Ended September 30
                  
                  $
                  2.70
                  
                  
                  $
                  1.742nd
      Quarter Ended June 30
                  
                  $
                  3.17
                  
                  
                  $
                  2.271st
      Quarter Ended March 31
                  
                  $
                  3.99
                  
                  
                  $
                  2.37





Holders




As of
March 10, 2010, in accordance with our transfer agent records, we had 91 record
holders of our common stock.




Dividends




We have
not paid any dividends on our common stock in 2009 and 2008 and do not intend to
declare any dividends in the foreseeable future.  While subject to
periodic review, the current policy of our Board of Directors is to retain all
earnings, if any, primarily to finance our future growth.  We make no
assurances that we will ever pay dividends, cash or
otherwise.  Whether we pay any dividends in the future will depend on
our financial condition, results of operations, and other factors that the Board
of Directors will consider.




Item 6.
            Selected Financial
      Data.




Not applicable.


44


Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results
      of  Operations.




The
following discussion should be read in conjunction with (i) our consolidated
financial statements, which present our results of operations for the years
ended December 31, 2009 and 2008 as well as our financial positions at December
31, 2009 and 2008, contained elsewhere in this Annual Report on Form 10-K and
(ii) our Annual Report on Form 10-K for the year ended December 31, 2008 filed
on March 31, 2009, including the consolidated financial statements contained
therein, and the Form 8-K/A filed on June 19, 2008 presenting the historical
financial statements for the vaccines business acquired from
Avecia.  Some of the information contained in this discussion and
analysis or set forth elsewhere in this Annual Report on Form 10-K, including
information with respect to our plans and strategy for our business and related
financing, includes forward-looking statements that involve risks and
uncertainties.  You should review the “Special Note Regarding Forward
Looking Statements” and “Risk Factors” sections of this Annual Report for a
discussion of important factors that could cause actual results to differ
materially from the results described in or implied by the forward-looking
statements contained in the following discussion and analysis.




Overview




We are a
biodefense company engaged in the development and commercialization of medical
countermeasures against biological and chemical weapons.  We currently have
five product candidates in various stages of development:




·
            SparVaxTM,
      a second generation recombinant protective antigen (“rPA”) anthrax
      vaccine,




·
            Valortim®,
      a fully human monoclonal antibody (an identical population of highly
      specific antibodies produced from a single clone) for the prevention and
      treatment of anthrax infection,




·
            Protexia®,
      a recombinant enzyme (butyrylcholinesterase), which mimics a natural
      bioscavenger for the prevention or treatment of nerve agent poisoning by
      organophosphate compounds, including nerve gases and
      pesticides,




·
            a
      third generation rPA anthrax vaccine,
and




·
            RypVaxTM,
      a recombinant dual antigen vaccine for pneumonic and bubonic plague
      (“rYP”).




Critical
Accounting Policies




Estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles in the U.S. requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities, 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. 
We base our estimates and assumptions on historical experience and various other
factors that are believed to be reasonable under the circumstances.  Actual
results could differ from our estimates and assumptions.  We believe the
following are our critical accounting policies, i.e., they affect our more
significant estimates and assumptions and require the use of difficult,
subjective and complex judgment in their application.




Revenue
Recognition




We
generate our revenue from two different types of contractual arrangements:
cost-plus-fee contracts and cost reimbursable grants.  Costs consist
primarily of actual internal labor charges and external sub-contractor costs
incurred plus an allocation of applied fringe benefits, overhead and general and
administrative expenses as defined in the contract.


45


Revenues
on cost-plus-fee contracts are recognized in an amount equal to the costs
incurred during the period plus an estimate of the applicable fee
earned.  The estimate of the applicable fee earned is determined by
reference to the contract:  if the contract defines the fee in terms
of risk-based milestones and specifies the fees to be earned upon the completion
of each milestone, then the fee is recognized when the related milestones are
earned.  Otherwise, we compute fee income earned in a given
periodby using a
proportional performance method based on costs incurred during the period as
compared to total estimated project costs and application of the resulting
fraction to the total project fee specified in the contract.




We
analyze each cost reimbursable grant to determine whether we should report such
reimbursements as revenue or as an offset to our expenses
incurred.  In 2009 and 2008, we recorded approximately $2.4 million
and $2.2 million, respectively, of costs reimbursed by the government as an
offset to research and development expenses.




Our
revenue-generating contracts may include multiple elements, including one or
more of up-front license fees, research payments, and milestone
payments.  In these situations, we allocate the total contract price
to the multiple elements based on their relative fair values and recognize
revenue for each element according to its characteristics.  As revenue
is recognized in accordance with the terms of the contracts, related amounts are
recorded as unbilled receivables, the primary component of “Other receivables
(including unbilled receivables)” in our consolidated balance
sheets.  As specific contract invoices are generated and sent to our
customers, invoiced amounts are transferred out of unbilled receivables and into
billed accounts receivable.  Invoicing frequency and payment terms for
cost-plus-fee contracts with our customers are defined within each contract, but
are typically monthly invoicing with 30-60 day payment cycles.  During
2009, our development agreement for SparVaxTM, our second generation rPA anthrax
vaccine, was (i) transferred from NIH to BARDA, (ii) novated from our UK
subsidiary to the U.S. parent corporation, PharmAthene, Inc., and (iii) revised
with regard to the scope and timing of work under that
agreement.  During the period that this agreement was being
implemented, we agreed with our customer to delay invoicing under that contract,
which resulted in a significant increase in unbilled receivables.  We
believe that these unbilled receivables represent valid, chargeable program
expenses and we expect to invoice and collect them in 2010.




Research
and Development Expenses




Research
and development costs are expensed as incurred; advance payments are deferred
and expensed as performance occurs.  Research and development costs include
salaries, facilities expense, overhead expenses, material and supplies,
pre-clinical expense, clinical trials and related clinical manufacturing
expenses, stock-based compensation expense, contract services and other outside
services.




Share-Based
Payments




We
expense all share-based awards to employees, including grants of employee stock
options, based on their estimated fair value at date of grant.  Costs of
all share-based payments are recognized over the requisite service period that
an employee must provide to earn the award (i.e. usually the vesting period) and
charged to the functional operating expense associated with that
employee.


46


Intangible
Assets




Because
of the nature of pharmaceutical research, and particularly because of the
difficulties associated with efficacy studies in humans related to the
bioterrorist products with which we work and the government’s related funding
provisions, factors that affect the estimate of the life of an asset are often
more uncertain than with respect to other non-bioterrorist pharmaceutical
research.  On an annual basis, we assess recoverability of intangible
assets from future operations, using undiscounted future cash flows derived from
the intangible assets.  Any impairment would be recognized in operating
results to the extent the carrying value exceeds the fair value, which is
determined based on the net present value of estimated future cash flows; in
certain situations, where the carrying value is dependent upon the outcome of a
single study and that study is unsuccessful, that impairment may be significant
in amount and immediate in timing.




Results
of Operations




Revenue




We
recognized revenue of $27.5 million and $32.9 million during the years ended
December 31, 2009 and 2008, respectively.




Our
revenue consisted primarily of contract funding from the U.S. government for the
development of Protexia®,
SparVaxTM and Valortim®.
 Our revenue in the year ended December 31, 2009 changed from the
comparable period of 2008 due to the following:




·
            Under
      the September 2006 contract with the DoD for the advanced development
      of Protexia®,
      we recognized $6.9 million and $19.5 million of revenue for the years
      ended December 31, 2009 and 2008, respectively.  The significant
      decline in revenue in 2009 is primarily attributable to the shift of our
      Protexia®
      program from broad pre-clinical development efforts, including
      manufacturing, to a focus on clinical evaluation as well as the
      completion, during the third quarter of 2009, of all work and related
      funding under the initial phase of the contract with the
      DoD.  It is unclear at this point when the DoD will make a
      decision regarding funding for the next phase of the development work for
      Protexia® (although the government has recently indicated that it may make
      a decision before the end of the third quarter 2010).  Until a
      funding decision is made, we do not expect to recognize significant
      additional revenues under this
contract.




·
            Under
      our contract for the development of SparVaxTM, acquired as part of the
      Avecia Acquisition in April 2008, we recognized approximately $11.5
      million and $9.2 million of revenue for the years ended December 31, 2009
      and 2008, respectively.  Revenue for 2008 only includes revenue
      recognized from and after April 2, 2008, the closing date of the Avecia
      Acquisition.  The increase in revenue in 2009 as compared to
      2008 was primarily attributable to (i) the inclusion of a full year’s
      worth of activity in 2009 as compared to only nine months in 2008 (the
      period after the Avecia Acquisition in April 2008), and (ii) increased
      costs (and corresponding revenues) incurred in connection with our June
      2009 settlement agreement with Avecia, including $1.8 million related to
      past performance and raw materials under our agreement with them, offset
      in part by a decline in development activities in early 2009 as we stopped
      our development work at Avecia, revised our development plan, and
      commenced our efforts to transfer technology from Avecia to Diosynth, a
      US-based bulk drug substance
    manufacturer.




·
            Under
      the September 2007 contract for the advanced development of
      Valortim®,
      we recognized $6.2 million and $1.4 million of revenue for the years ended
      December 31, 2009 and 2008, respectively.  The increase in revenue is
      primarily attributable to the reimbursement of higher costs related to
      non-clinical studies as well other development work in 2009 as we prepared
      for and commenced human clinical trials.  The second Phase I
      clinical trial related to Valortim®,
      commenced in August 2009, was placed on partial clinical hold pending the
      outcome of an investigation, after the occurrence of two adverse reactions
      in the four subjects dosed, one of which was characterized by clinical
      investigators as a serious adverse event.  It is unclear at this
      time how long it will take us to complete our investigation, if and when
      we will be in a position to recommence negotiations with BARDA with
      respect to a potential award under BAA-BARDA-09-34 for additional advanced
      development of Valortim®, and what the effect of any delay in potential
      future funding of the program will be on the overall Valortim® development
      timeline.




47


·
            Under
      our September 2008 contract award for the additional development work
      on our third generation rPA anthrax vaccine, we recognized approximately
      $1.3 million and $0.1 million of revenue for the years ended December 31,
      2009 and 2008, respectively.  We began work under this contract
      in the fourth quarter 2008.In February 2010,
      we received notice from the NIAID raising concerns regarding performance
      under our existing contract with them related to our third-generation
      anthrax vaccine program, and directing us to explain how we plan to cure
      the deficiencies.  In accordance with the timeline specified by
      NIAID, we responded in March 2010 proposing, among other things, a revised
      development program and timeline.




·
            Under
      our contract for the advanced development of our plague vaccine, RypVaxTM,
      acquired as part of the Avecia Acquisition in April 2008, we
      recognized approximately $1.7 million and $2.7 million of revenue for the
      years ended December 31, 2009 and 2008, respectively.  We and the
      U.S. government have agreed to a reduction to the scope of work under this
      contract; as a result, all activities under the contract are winding down,
      with wind-down expected to be completed in the first half of
      2010.  We do not anticipate that the U.S. government will
      provide additional funding in the future for or procure
      RypVaxTM.




Research
and Development Expenses




Our
research and development expenses were $30.2 million and $31.8 million for the
years ended December 31, 2009 and 2008, respectively.  These expenses
resulted from research and development activities related to our Valortim® and
Protexia® programs
as well as from activities related to the SparVaxTM, RypVaxTM and third
generation anthrax vaccine programs.  We incurred both direct expenses,
which included salaries and other costs of personnel, raw materials and
supplies, and an allocation of indirect expenses.  We also incurred
third-party costs, such as contract research, consulting and clinical
development costs for individual projects.  Research and development
expenses for the years ended December 31, 2009 and 2008 were net of cost
reimbursements under certain of our government grants of $2.4 million and $2.2
million, respectively.




Research
and development expenses for the years ended December 31, 2009 and 2008 were
attributable to research programs as follows:




Year ended($ in millions)
                
                December 31,
                  2009
                
                
                December 31,
                  2008Anthrax
      therapeutic and vaccines
                
                $
                21.4
                
                
                $
                14.9Chemical
      nerve agent protectants
                
                
                7.0
                
                
                
                11.8Recombinant
      dual antigen plague vaccine
                
                
                1.6
                
                
                
                4.1Internal
      research and development
                
                
                0.2
                
                
                
                1.0Total
      research and development expenses
                
                $
                30.2
                
                
                $
                31.8





For the
year ended December 31, 2009, research and development expenses decreased
$1.6 million from the prior year, primarily due to a reduction in
pre-clinical development costs for our chemical nerve agent protectants program
as we progressed in our clinical evaluation phase, and a reduction in
development costs for our plague vaccine program, partially offset by increased
pre-clinical development associated with our anthrax-related therapeutics and
vaccines programs.


48


The
decrease in development expenses related to the clinical nerve agent protectants
program resulted from reduced process development and manufacturing activities
as the program moved from the development stage to the Phase I clinical
trial.  Expenses in connection with the anthrax therapeutics and vaccines
programs increased primarily as a result of increased pre-clinical development
activity in 2009 as we prepared for and started Phase I human clinical trials,
along with increased costs incurred in connection with our June 2009
settlement agreement with Avecia.As we note above,we and the U.S.
government have agreed to a reduction to the scope of work related to the
development our plague vaccine, and expect the costs (and related revenue) under
that contract to decline over the wind down period.  Until such time
as the DoD decides, if ever, to continue to fund work under our chemical nerve
agent protectants program, costs incurred in this program in future periods will
not be covered, either in whole or in part, by corresponding revenues under our
contract with the DoD.  If the DoD does consent to further work under
this program, we anticipate that costs under our chemical nerve agent
protectants program will increase in future periods as that program progresses
through human clinical trials.




General
and Administrative Expenses




General
and administrative functions include executive management, finance and
administration, government affairs and regulations, corporate development, human
resources, legal, and compliance.  For each function, we may incur expenses
such as salaries, supplies and third-party consulting and other external costs
and non-cash expenditures such as expense related to stock option and restricted
share awards.  An allocation of indirect costs such as facilities,
utilities and other administrative overhead is also included in general and
administrative expenses.




Expenses
associated with general and administrative functions were $22.4 million and
$19.4 million for the years ended December 31, 2009 and 2008,
respectively.




General
and administrative expenses increased $3.0 million for the year ended December
31, 2009, as compared to the prior year, primarily due to the costs associated
with the transitioning of our development and manufacturing activities for our
SparVaxTM and third generation anthrax vaccine programs as well as other general
and administrative functions from the UK to the U.S., and with preparing and
submitting various bids and proposals, along with increased stock-based
compensation costs during the year.




Acquired
In-process Research and Development




During
the year ended December 31, 2008, we completed the Avecia
Acquisition.  The primary asset acquired in the Avecia Acquisition was
SparVaxTM, a second generation rPA anthrax vaccine.  The value of the
third generation anthrax vaccine acquired in the transaction was aggregated with
that of the second generation vaccine because success in developing the third
generation anthrax vaccine is contingent on the successful development of the
second generation vaccine.  At the acquisition date, the aggregate
fair value of the second and third generation vaccines was estimated at $16.1
million.  An income approach methodology was used to determine the
fair value of the acquired in-process research and development
asset.  This approach assessed the expected cash flows, net of
expected appropriate operating expenses, generated from the acquisition date in
April 2008 through the end of 2021 (the expected life of the vaccine) using a
risk adjusted discount rate of 51%, which we believe is commensurate with an
early stage biodefense product development opportunity of this
nature.  In connection with the transaction, in 2008 we recorded a
charge to expense for acquired in-process research and development of $16.1
million for these acquired research projects for which, at the acquisition date,
technological feasibility had not been established and no alternative future use
existed.  No such charge was recorded in 2009.


49




Both
vaccines are in their early stages of development and significant remaining
research and development is required to establish the technological feasibility
of these vaccines.  The cost and time required to complete the
development of these vaccines and earn FDA marketing approval is highly
uncertain and can vary significantly.  During 2009, we provided the
U.S. government with a series of development plans for SparVaxTM, in response to
their request for proposal, which estimated that it would cost in excess of $300
million over approximately five years to complete the development of
SparVaxTM.  No such estimates of the advanced development costs and
timeline for the third generation vaccine have been developed.





As with
all development efforts in the biodefense industry, the development of our
second and third generation anthrax vaccines is subject to delays, as described
in “Risk Factors—Necessary
Reliance on the Animal Rule in Conducting Trials is Time-Consuming and
Expensive” and “—We
have not commercialized any products or recognized any revenues from
sales.  All of our product candidates are still under development, and
there can be no assurance of successful commercialization of any of our
products.”  Our development costs will increase substantially if we
experience material delays in any clinical trials or if we need to conduct more
or larger trials than planned.





Depreciation
and Intangible Amortization




Depreciation
and amortization expenses were $0.9 million and $0.8 million for the years ended
December 31, 2009 and 2008, respectively.  These expenses relate primarily
to the depreciation and amortization of farm building improvements, leasehold
improvements and laboratory equipment, and patents acquired as part of a 2005
business combination.




Other
Income and Expenses




Other
income and expenses primarily consists of income on our investments, interest
expense on our debt and other financial obligations, changes in market value of
our derivative financial instruments, loss on early extinguishment of debt, and
foreign currency transaction gains or losses.




For the
years ended December 31, 2009 and 2008, we recognized interest income on our
investments of $0.3 million and $1.2 million, respectively.  The decrease
in interest income during the periods is primarily attributable to the reduced
average balances of our investments and cash balances as we continue to use cash
to support our operations, along with lower prevailing interest
rates.




We
incurred interest expense of $2.8 million and $2.6 million for the years ended
December 31, 2009 and 2008, respectively.  Interest expense relates
primarily to interest on our outstanding convertible notes (including the
amortization of the debt discount arising from the (i) allocation of fair value
to the stock purchase warrants issued in connection with the convertible debt
and (ii) beneficial conversion feature) and our senior secured credit facility,
which facility we repaid in full in July 2009.




The
change in the fair value of our derivative instruments was $1.0 million for the
year ended December 31, 2009 compared to $0.1 million for the year ended
December 31, 2008.  The increase from 2008 relates to the underlying
change in the estimated fair value of various stock purchase warrants issued in
2009 and 2008 and the embedded conversion option in the 8% convertible senior
notes that were exchanged or matured in 2009.  The fair value of these
derivative instruments is estimated using the Black-Scholes option pricing
model.   In connection with the July 2009 Private Placement, we
exchanged a portion of our Old Notes in the aggregate principal amount plus
accrued interest of $8.8 million, for New Convertible Notes, cancelled the
corresponding Old Notes, issued additional New Convertible Notes in the
aggregate principal amount of $10.5 million to new note investors, and issued to
the recipients of the New Convertible Notes certain stock purchase
warrants.  In connection with the exchange, we recognized a loss on
the early extinguishment of the Old Notes of approximately $4.7
million.


50


Liquidity
and Capital Resources




Overview




Our
primary cash requirements through the end of 2010 are to fund our operations
(including our research and development programs) and support our general and
administrative activities.  Our future capital requirements will depend on
many factors, including, but not limited to, the progress of our research and
development programs; the progress of pre-clinical and clinical testing; the
time and cost involved in obtaining regulatory approval; the cost of filing,
prosecuting, defending and enforcing any patent claims and other intellectual
property rights; changes in our existing research relationships, competing
technological and marketing developments; our ability to establish collaborative
arrangements and to enter into licensing agreements and contractual arrangements
with others; and any future change in our business strategy.  These cash
requirements could change materially as a result of shifts in our business and
strategy.




Since our
inception, we have not generated positive cash flows from operations.  To
bridge the gap between payments made to us under our government contracts and
grants and our operating and capital needs, we have had to rely on a variety of
financing sources, including the issuance of equity securities and convertible
notes, proceeds from loans and other borrowings, and the trust funds obtained in
the Merger.  For the foreseeable future, we will continue to need these
types of financing vehicles and potentially others to help fund our future
operating and capital requirements.  We believe that the funds obtained
from the July 2009 Private Placement, existing cash resources, along with cash
receipts from contract receivables (a substantial portion of which was unbilled
at December 31, 2009) generated under our contracts will be sufficient to enable
us to fund our existing research and development programs and support our
currently anticipated general and administrative activities through the end of
2010.  We have based this projection on our current and anticipated
operations, which do not take into account any potential future government
contracts that may be awarded to the Company, merger and acquisition or
corporate partnering activities, or unexpected financial obligations. However,
to the extent that we are unable to collect our receivables on a timely basis,
we may be required to seek short term financing solutions, including either
short term indebtedness or through the sale of equity.




The
turmoil affecting the banking system and financial markets and the possibility
that financial institutions may consolidate or cease operations has resulted in
a tightening in the credit markets, a low level of liquidity in many financial
markets, and extreme volatility in fixed income, credit, currency and equity
markets.  As a result, there can be no assurance that future funding will
be available to us on reasonably acceptable terms, or at all.  In addition,
due to the U.S. government’s substantial efforts to stabilize the economy, the
U.S. government may be forced or choose to reduce or delay spending in
the biodefense field, which could decrease the likelihood of future
government contract awards, the likelihood that the government will exercise its
right to extend any of its existing contracts with us and/or the likelihood that
the government would procure products from us.  Finally, the note and
warrant purchase agreement entered into in connection with the July 2009
Private Placement prevents us from incurring senior indebtedness (other than
trade payables) in excess of $10 million without the prior written approval of
no less than a majority of the aggregate principal amount of the debt then
outstanding.




We have
incurred cumulative net losses and expect to incur additional losses in
conducting further research and development activities.  We do not have
commercial products and, given the substantial costs relating to the development
of pharmaceutical products, have relatively limited existing capital
resources.  Our plans with regard to these matters include continued
development of our products as well as seeking additional funds to support our
research and development efforts.  Although we continue to pursue these
plans, there is no assurance that we will be successful in obtaining sufficient
future financing on commercially reasonable terms or at all or that we will be
able to secure additional funding through government contracts and
grants.  Our consolidated financial statements have been prepared on a
basis which assumes that we will continue as a going concern and which
contemplates the realization of assets and the satisfaction of liabilities and
commitments in the normal course of business and do not include any adjustments
that might result if the carrying amount of recorded assets and liabilities are
not realized.


51


Sources
and Uses of Cash




Cash,
cash equivalents and short-term available-for-sale investments were $5.8 million
and $22.9 million at December 31, 2009 and 2008, respectively.  The $17.1
million decrease in 2009 was primarily attributable to net cash used in our
operations (of approximately $28.1 million), capital expenditures (of
approximately $1.0 million), and payment of deferred consideration related to
the Avecia Acquisition (of $7 million), offset by net cash provided by financing
activities of approximately $18.8 million.  In addition, billings
under some of our contracts were delayed in 2009, resulting in a significant net
increase in our total unbilled receivables in 2009 of $3.1 million (as described
above under “Critical Accounting Policies – Revenue Recognition”).  As
of December 31, 2009 and 2008, total accounts receivables and other receivables
(including unbilled receivables) were $17.4 million and $10.3 million,
respectively.




In March
2009, we closed on the public sale of 2,116,055 newly issued shares of our
common stock at $2.60 per share and warrants to purchase 705,354 shares of our
common stock at an exercise price of $3.00 per share, resulting in net proceeds
of approximately $5.0 million.  The warrants became exercisable on
September 27, 2009 and will expire on September 27,
2014.




Upon the
closing of the Avecia Acquisition, in addition to certain initial consideration
paid at that time, we also provided a letter of credit in the amount of $7.0
million as security for deferred consideration in that same amount. 
Pursuant to the settlement agreement with Avecia entered into as of
June 17, 2009, we paid the $7.0 million deferred consideration to Avecia
during the second quarter 2009 (in connection with which the letter of credit
securing such amount was terminated and the required cash restrictions
eliminated).




In the
July 2009 Private Placement, we issued approximately $19.3 million of New
Convertible Notes, convertible immediately into common shares at a conversion
price of approximately $2.54 per share, and warrants to purchase 2,572,775
shares of common stock at $2.50 per share.  The warrants became
exercisable on January 28, 2010 and will expire on January 28,
2015.  As part of this transaction we exchanged a portion of our Old
Notes in the aggregate principal amount plus accrued interest of $8.8 million
for New Convertible Notes, cancelled the corresponding Old Notes, issued
additional New Convertible Notes in the aggregate principal amount of $10.5
million to new note investors, and issued to the recipients of the New
Convertible Notes the stock purchase warrants described above.  In
connection with the exchange, we recognized a loss on the early extinguishment
of the Old Notes of approximately $4.7 million.  We used the proceeds
from the sale of the New Convertible Notes to repay $5.5 million of our Old
Notes that were not exchanged for the New Convertible Notes and warrants and
repaid all outstanding amounts and fees under our existing senior secured credit
facility.




Potential
Future Amounts Payable under the Purchase Agreement with Avecia




In
connection with the Avecia Acquisition, certain amounts may become payable to
Avecia assuming certain milestones are achieved, including the
following:


52


(i)
            $5
      million within 90 days of entry by us into a multi-year funded development
      contract to be issued by BARDA (part of DHHS) under solicitation number
      RFP-BARDA-08-15 (or any substitution or replacement thereof) for the
      further development of SparVaxTM;
and




(ii)
            $5
      million within 90 days of entry by us into a contract or contracts for the
      supply of SparVaxTM into the SNS;
and




(iii)
            2.5%
      of PharmAthene net sales of SparVaxTM to the U.S. government within the
      period of ten years from the closing of the Avecia Acquisition after the
      first 25 million doses; and




(iv)
            1%
      of PharmAthene net sales of third generation anthrax vaccine to the U.S.
      government within the period of ten years from the closing of the Avecia
      Acquisition.




In
addition to the potential milestone payments described above, for a period of
ten years following our first purchase of bulk drug substance for the anthrax
and plague vaccines (“Drug Substance”) from a supplier other than Avecia, we may
be obligated to pay Avecia up to 7.5% of the amounts that would have been
payable to Avecia had Avecia produced the Drug Substance.




RFP-BARDA-08-15
was cancelled by BARDA in December 2009.  Accordingly, our obligation
to pay Avecia under clause (i) above would mature only upon our receipt of a
substitution or replacement thereof.  We have received funds from
BARDA and other U.S. government agencies under various development agreements
between us and BARDA.  Any development contract deemed to be a
substitute or replacement of RFP-BARDA-08-15 could trigger our obligation to
make the $5 million payment under (i) above.




Operating
Activities




Net cash
used in operating activities was $28.1 million and $13.2 million for the years
ended December 31, 2009 and 2008, respectively.  Net cash used in
operations during the year ended December 31, 2009 reflects our net loss of
$32.3 million, adjusted for certain non-cash items, including loss on
extinguishment of debt (of $4.7 million), share-based compensation (of $3.4
million), non-cash interest expense (of $1.5 million), an increase in billed
accounts receivable (of $4.9 million), an increase in unbilled accounts
receivable (of $3.1 million) and a net decrease in accrued expenses and accounts
payable (of $1.3 million).  During 2009, our development agreement for
SparVaxTM, our second generation rPA anthrax vaccine, was (i) transferred from
NIH to BARDA, (ii) novated from our UK subsidiary to the U.S. parent
corporation, PharmAthene, Inc., and (iii) revised with regard to the scope and
timing of work under that agreement.  During the period that the
changes to our second generation rPA anthrax vaccine contract were being
implemented, we agreed with the U.S. Government to delay invoicing under that
contract, which resulted in a significant increase in unbilled receivables. We
believe that these unbilled receivables represent valid, chargeable program
expenses and we expect to invoice and collect them during 2010.




Net cash
used in operations during the year ended December 30, 2008 reflects our net loss
of $36.4 million, adjusted for certain non-cash items, including acquired
in-process research and development related to the Avecia Acquisition (of $16.1
million), share-based compensation (of $3.0 million), non-cash interest expense
(of $1.8 million), an increase in accounts receivable (of $2.2 million), and an
increase in accrued expenses and accounts payable (of $4.1
million).


53


Investing
Activities




Net cash
used in investing activities was $8.0 million for the year ended December 31,
2009, compared to $10.1 million for the year ended December 31, 2008. 
Investing activities for 2009 related primarily to the payment in June of
$7.0 million of deferred purchase consideration to Avecia, and approximately
$1.0 million of capital expenditures.




In 2008
and in connection with the Avecia Acquisition, we paid $10.0 million to Avecia
and funded a $7.0 million letter of credit.  In order to fund the
transaction and the restricted cash obligations pursuant to the loan
modification agreement under our senior secured credit facility, approximately a
net $9.0 million of available-for-sale securities were
sold.  Additionally, during 2008, we incurred approximately $1.6
million related to transactions costs incurred as a result of the Avecia
Acquisition.




Financing
Activities




Net cash
provided by financing activities was $18.8 million for the year ended December
31, 2009 as compared to $2.4 million for the year ended December 31, 2008. 
In March 2009, we raised net proceeds of approximately $5.0 million as a
result of the public sale of shares of our common stock and
warrants.  We raised $10.5 million in the July 2009 Private Placement,
and used $9.5 million of those proceeds to repay our existing convertible notes
(including accrued interest) and all amounts outstanding under our credit
facility.We
exchanged and cancelled $8.8 million of our then-outstanding 8% convertible
notes for our newly issued 10% convertible notes and stock purchase
warrants.  Additionally, pursuant to the payment to Avecia of the
deferred purchase consideration and the repayment of all amounts due under our
credit facility, we eliminated all of our restricted cash obligations
(approximately $13.3 million).




Off-Balance
Sheet Arrangements




We do not
have any off-balance sheet arrangements.




Contractual
Obligations




The
following are contractual commitments at December 31, 2009 associated with
leases, research and development arrangements, collaborative development
obligations and long term debt:




Contractual Obligations(1)
                  
                  Total
                  
                  
                  Less than 1
                    Year
                  
                  
                  1-3 Years
                  
                  
                  3-5 Years
                  
                  
                  More than 5
                    yearsOperating
      facility leases
                  
                  $
                  6,078,400
                  
                  
                  $
                  958,200
                  
                  
                  $
                  1,498,100
                  
                  
                  $
                  2,383,700
                  
                  
                  $
                  1,238,400Research
      and development agreements
                  
                  
                  18,008,500
                  
                  
                  
                  16,023,500
                  
                  
                  
                  1,985,000
                  
                  
                  
                  -
                  
                  
                  
                  -Notes
      payable, including interest
                  
                  
                  23,208,600
                  
                  
                  
                  -
                  
                  
                  
                  23,208,600
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      contractual obligations
                  
                  $
                  47,295,500
                  
                  
                  $
                  16,981,700
                  
                  
                  $
                  26,691,700
                  
                  
                  $
                  2,383,700
                  
                  
                  $
                  1,238,400


(1)           This
table does not include any royalty payments of future sales of products subject
to license agreements the Company has entered into in relation to its
in-licensed technology, as the timing and likelihood of such payments are not
known.


54


Item
      7A.
            Quantitative
      and Qualitative Disclosures about Market
Risk.




Our
exposure to market risk is currently confined to our cash and cash equivalents
and short-term investments.  We believe that any interest rate change
related to our investment securities held as of December 31, 2009 is not
material to our consolidated financial statements.  We currently do
not hedge interest rate exposure or foreign currency exchange exposure, and the
movement of foreign currency exchange rates could have an adverse or positive
impact on our results of operations.  We have not used derivative
financial instruments for speculation or trading purposes.  Because of
the short-term maturities of our cash and cash equivalents, we do not believe
that an increase in market rates would have a significant impact on the realized
value of our investments.  Our debt is at rates fixed by the
lenders.




Item
      8.
            Financial
      Statements and Supplementary Data.




Our
financial statements and supplementary data required to be filed pursuant to
this Item 8 appear in a separate section of this report beginning on page
F-1.




Item
      9.
            Changes
      In and Disagreements with Accountants on Accounting and Financial
      Disclosure.




None.




Item
      9A.
            Controls
      and Procedures.




Evaluation
of Disclosure Controls and Procedures




Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”), as of the end of the period covered by this report. 
Based on this evaluation, our principal executive officer and our principal
financial officer concluded that our disclosure controls and procedures were
effective to provide reasonable assurance that information required to be
disclosed by us in reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and is accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosures.




Management’s
Annual Report on Internal Control Over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934.  Our internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles.  Our internal control over financial reporting
includes those policies and procedures that:




(i)
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;




(ii)
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company
      are being made only in accordance with authorizations of our management
      and directors; and




(iii)
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
statements.




55


Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.




Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009.  In making this assessment, management used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal
Control-Integrated Framework.  Based on this assessment,
management determined that we maintained effective internal control over
financial reporting as of December 31, 2009.




This
Annual Report on Form 10-K does not include an attestation report of our
independent registered public accounting firm, Ernst & Young LLP, regarding
internal control over financial reporting.  Management’s report was
not subject to attestation by our independent registered public accounting firm
pursuant to temporary rules of the SEC that permit us to provide only
management’s report in this Annual Report on Form 10-K.




Changes
in Internal Control Over Financial Reporting




Management
has identified several changes in our internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during
2009 that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting, including (i) changes to
our senior financial leadership, including the hiring of a new Chief Financial
Officer and the addition of an experienced controller, (ii) the utilization of
experienced external financial consultants to provide additional support to our
internal accounting and financial reporting functions; and (iii) our
implementation of a new financial accounting system.




Inherent
Limitations on Internal Control




In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives.  In addition, the design of disclosure controls and
procedures must reflect the fact that there are resource constraints and that
management is required to apply its judgment in evaluating the benefits of
possible controls and procedures relative to their costs.




Item
      9B.
            Other
      Information.




None.




Item
      10.
            Directors,
      Executive Officers and Corporate
Governance.




The
information required by this Item 10 will be incorporated by reference from our
definitive proxy statement or will be filed as an amendment to our Annual Report
on Form 10-K within 120 days of our fiscal year end.




Item
      11.
            Executive
      Compensation.




The
information required by this Item 11 will be incorporated by reference from our
definitive proxy statement or will be filed as an amendment to our Annual Report
on Form 10-K within 120 days of our fiscal year end.


56


Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.




The
information required by this Item 12 will be incorporated by reference from our
definitive proxy statement or will be filed as an amendment to our Annual Report
on Form 10-K within 120 days of our fiscal year end.




Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence.




The
information required by this Item 13 will be incorporated by reference from our
definitive proxy statement or will be filed as an amendment to our Annual Report
on Form 10-K within 120 days of our fiscal year end.




Item
      14.
            Principal
      Accountant Fees and Services.




The
information required by this Item 14 will be incorporated by reference from our
definitive proxy statement or will be filed as an amendment to our Annual Report
on Form 10-K within 120 days of our fiscal year end.




Item
      15.
            Exhibits
      and Financial Statement Schedules.




Financial
      Statements




Reference
      is made to the Index to the Consolidated Financial Statements beginning on
      page F-1 of this report.




Financial
      Statement Schedules




Required
      information is included in the footnotes to the financial
      statements.




Exhibit
      Index




Exhibit
                No.
              
              Description2.1
              
              
              Agreement and
      Plan of Merger, dated January 19, 2007, by and among Healthcare
      Acquisition Corp., PAI Acquisition Corp., and PharmAthene, Inc.
      (6)2.2
              
              
              Sale
      and Purchase Agreement, dated March 20, 2008, by and among the Registrant
      and Avecia Investments Limited, Avecia Biologics Limited and Avecia
      Biologics, Inc. (10)2.3
              
              
              Amendment
      Agreement, dated April 2, 2008, by and among, PharmAthene, Inc.,
      PharmAthene UK Limited and PharmAthene US Corporation and Avecia
      Investments Limited, Avecia Biologics Limited and Avecia Biologics, Inc.
      (12)3.1
              
              
              Amended
      and Restated Certificate of Incorporation of the Company, as amended.
      (25)3.2
              
              
              By-laws,
      as amended. (13)




57




4.1
              
              Specimen
      Unit Certificate. (1)


4.2
              
              Specimen
      Common Stock Certificate. (9)4.3
              
              Amendment
      to Unit Purchase Option by and between the Registrant and Maxim Partners,
      LLC dated January 28, 2007. (7)4.4
              
              Form
      of Warrant in connection with Securities Purchase Agreement dated as of
      March 23, 2009. (21)4.4
              
              Form
      of 10% Unsecured Senior Convertible Note. (22)4.10
              
              Form
      of Warrant in connection with Note and Warrant Purchase Agreement, as
      amended as of July 28, 2009. (22)10.1.1
              
              Letter
      Agreement among the Registrant, Maxim Group LLC and John Pappajohn dated
      May 6, 2005. (2)10.1.2
              
              Letter
      Agreement among the Registrant, Maxim Group LLC and Derace L. Schaffer,
      M.D. dated May 6, 2005. (2)10.1.3
              
              Letter
      Agreement among the Registrant, Maxim Group LLC and Matthew P. Kinley
      dated May 6, 2005. (2)10.1.4
              
              Restated
      Letter Agreement among the Registrant, Maxim Group LLC and Edward B.
      Berger dated June 8, 2005. (3)10.1.5
              
              Letter
      Agreement among the Registrant, Maxim Group LLC and Wayne A. Schellhammer
      dated June 8, 2005. (3)10.2
              
              Form of
      Investment Management Trust Agreement between Continental Stock
      Transfer & Trust Company and the Registrant.
  (3)10.2.1
              
              Amendment
      No. 1 to Investment Management Trust Agreement between Continental
      Stock Transfer & Trust Company and the Registrant.
      (5)10.4
              
              Form of
      Registration Rights Agreement among the Registrant and the Initial
      Stockholders. (1)10.6.1
              
              Promissory
      Note, dated April 28, 2005, issued to John Pappajohn, in the amount
      of $70,000. (1)10.6.2
              
              Promissory
      Note, dated April 28, 2005, issued to Derace L. Schaffer, M.D., in
      the amount of $70,000. (1)10.6.3
              
              Promissory
      Note, dated April 28, 2005, issued to Matthew P. Kinley, in the
      amount of $35,000. (1)10.6.4
              
              Promissory
      Note, dated July 26, 2005, issued to John Pappajohn, in the amount of
      $30,000. (4)




58




10.6.5
                
                Promissory
      Note, dated July 26, 2005, issued to Derace L. Schaffer, M.D., in the
      amount of $30,000. (4)10.6.6
                
                Promissory
      Note, dated July 26, 2005, issued to Matthew P. Kinley, in the amount
      of $15,000. (4)10.7
                
                Form of
      Unit Option Purchase Agreement between the Registrant and Maxim Group LLC.
      (3)10.9
                
                Form of
      Registration Rights Agreement by and among Healthcare Acquisition Corp.
      and the former stockholders and note holders of PharmAthene, Inc.
      (6)10.11
                
                Advisory
      Agreement by and among Maxim Group LLC and the Registrant, dated
      January 8, 2007. (7)10.12
                
                Amended
      and Restated 2007 Long-Term Incentive Compensation Plan.
    (15)10.13
                
                Employment
      Agreement, dated August 3, 2007, between the Registrant and David P.
      Wright. (8) ++10.13.1
                
                Form
      of 1st Amendment, dated January 21, 2009, to Employment Agreement by and
      between the Company and David P. Wright. (21) ++10.19.1
                
                Loan
      and Security Agreement, dated March 30, 2007, by and among the
      Registrant, Silicon Valley Bank, Oxford Finance Corporation, and other
      lenders listed on Schedule 1.1 thereof. (9)10.19.2
                
                Consent
      and First Loan Modification Agreement, dated March 20, 2008, by and
      among the Registrant, Silicon Valley Bank and Oxford Finance Corporation
      (10).10.19.3
                
                Consent,
      Assumption and Second Loan Modification Agreement, dated as of March 31,
      2009, by and among Silicon Valley Bank, Oxford Finance Corporation and
      PharmAthene, Inc. (21)10.20
                
                U.S.
      Army Space & Missile Defense Command—“Development and Licensure
      of Bioscavanger Increment II (Recombinant Drug Candidate)” Award/Contract
      No. W9113M-06-C-0189, dated September 22, 2006, by and between
      the Company and the U.S. Army Space & Missile Defense Command.
      (9)+10.21
                
                Cooperative
      Research and Development Agreement, dated September 12, 2006, by and
      between the Company and the U.S. Army Medical Research Institute of
      Infectious Diseases. (9)+10.22
                
                Center
      for Scientific Review, National Institute of Health, Research Project
      Cooperative Agreement, Notice of Grant Award No. 1 U01 NS058207-01,
      dated September 30, 2006, awarded to the Company.
  (9)+10.23
                
                Collaboration
      Agreement, dated November 29, 2004, by and between the Company and
      Medarex, Inc. (9)+10.24
                
                Research
      and License Agreement, dated August 8, 2006, by and between the
      Company and Nektar Therapeutics AL, Corporation.
  (9)+




59





10.25
              
              License
      Agreement, dated March 12, 2007, by and between the Company and GTC
      Biotherapeutics, Inc. (9)+10.26.1
              
              Office
      Lease, dated September 14, 2006, by and between the Company and Park
      Place Trust, as amended by First Amendment to Office Lease, dated
      January 22, 2007. (9)10.26.2
              
              Second
      Amendment to Office Lease, by and between the Company and Park Place
      Trust, dated September 16, 2008. (28)10.27
              
              Biopharmaceutical
      Development and Manufacturing Services Agreement, dated June 15,
      2007, by and between the Company and Laureate Pharma, Inc.
      (9)+10.28
              
              Services
      Agreement, dated March 2, 2007, by and between the Company and GTC
      Biotherapeutics, Inc. (9)+10.29
              
              Transitional
      Services Agreement, dated April 2, 2008, between Avecia Biologics
      Limited and PharmAthene UK. (16)10.30
              
              Form of
      PharmAthene Inc. Executive Employment Agreement. (17)
++10.30.1
              
              Employment
      Agreement, dated April 18, 2008, by and between Eric Richman and
      PharmAthene, Inc.*10.30.2
              
              Employment
      Agreement, dated April 18, 2008, by and between Wayne Morges and
      PharmAthene, Inc.*10.31
              
              Form of
      PharmAthene Inc. Confidentiality and Non-Solicitation Agreement.
      (17)10.32
              
              Master
      Services Agreement, dated April 2, 2008, between PharmAthene UK
      Limited and Avecia Biologics Limited. (17) +10.33
              
              Master
      Service Agreement, dated December 15, 2004, between Avecia Limited
      and the Secretary of State for Defence, acting through the Defence Science
      and Technology Laboratory (DSTL). (18)+10.34
              
              Master
      Service Agreement, dated August 18, 2005, between Avecia Limited and
      DSTL. (18) +10.35
              
              Manufacturing
      Licence Agreement, dated June 20, 2006, between Avecia Limited and
      DSTL. (18) +10.36
              
              Manufacturing
      and Marketing Licence Agreement, dated December 4, 2006, between
      Avecia Limited and DSTL. (18) +10.36.1
              
              Amended
      and Restated Manufacturing and Marketing Licence Agreement between the
      Secretary of State for Defence as represented by the Defence Science and
      Technology Laboratory (Dstl) and PharmAthene UK Ltd. in respect of
      Recombinant [***] Vaccine, dated February 11, 2009. (21)
  +10.37
              
              Letter
      Agreement, dated March 20, 2008, between Avecia Biologics Limited and
      DSTL. (18)+10.37.1
              
              Amended
      and Restated Licence Agreement between the Secretary of State for Defence
      as represented by the Defence Science and Technology Laboratory (Dstl) and
      PharmAthene UK Ltd. in respect of Recombinant [***] Vaccine, dated
      February 5, 2009. (21) +10.38
              
              Contract
      Award by the National Institute of Allergy and Infectious Diseases
      (NIAID), dated September 25, 2008. (19)+10.39
              
              Securities
      Purchase Agreement, dated September 30, 2008, between
      PharmAthene, Inc. and Kelisia Holdings Ltd.
  (19)




60





10.40
              
              Letter
      Agreement, dated September 30, 2008, between PharmAthene, Inc.
      and Panacea Biotec, Ltd. (19)10.41
              
              Investor
      Rights Agreement, dated October 10, 2008, between PharmAthene Inc.
      and Kelisia Holdings Ltd. (19)10.43
              
              Deed
      of Confidentiality between PharmAthene UK Limited, and its employees.
      (19)10.44
              
              Contract
      with the National Institutes of Health for the Production and Testing of
      Anthrax Recombinant Protective Antigen (rPA) Vaccine (#N01-AI-30052) (“NIH
      Prime Contract-Anthrax”), dated September 29, 2003. (27)
      +10.45
              
              Amendments
      1 through 13 to the NIH Prime Contract-Anthrax. (27) **,
  +10.45.1
              
              Modification
      (Amendment) 16 to the Contract with the National Institutes of Health for
      the Production and Testing of Anthrax Recombinant Protective Antigen (rPA)
      Vaccine (#N01-AI-30052). (26) +10.46
              
              Contract
      with the National Institutes of Health for the Development, Testing and
      Evaluation of Candidate Vaccines Against Plague (#HSSN266200400034C) (“NIH
      Prime Contract-Plague”), dated September 30, 2004. (27)
    +10.47
              
              Amendments
      1 through 10 to the NIH Prime Contract-Plague. (27) **,
  +10.48
              
              Form
      of Indemnification Agreement (20)10.49
              
              Form
      of Securities Purchase Agreement dated as of March 23, 2009 between the
      Company and the Purchasers party thereto. (23)10.51
              
              Form
      of Note and Warrant Purchase Agreement, dated as of July 24, 2009, by and
      among PharmAthene, Inc. and the investors signatories thereto, as amended
      by Amendment No. 1 to Note and Warrant Purchase Agreement, dated as of
      July 26, 2009 and Amendment No. 2 to Note and Warrant Purchase Agreement,
      dated as of July 28, 2009. (22)10.52
              
              Form
      of Registration Rights Agreement, dated as of July 28, 2009 by and among
      PharmAthene, Inc. and the investors signatories thereto.
    (22)10.53
              
              Technology
      Transfer and Development Services Subcontract, dated as of September 17,
      2009, by and between Diosynth RTP Inc. and PharmAthene, Inc. (26)
      +10.54
              
              Variation
      and Settlement Agreement, dated as of June 17, 2009, by and among
      PharmAthene, Inc., PharmAthene UK Limited and Avecia Biologics
      Limited and affiliates. (24) +14
              
              Code
      of Ethics. (3)21
              
              Subsidiaries.
      *23
              
              Consent
      of Ernst & Young LLP Independent Registered Public Accounting
      Firm *31.1
              
              Certification
      of Principal Executive Officer Pursuant to SEC
      Rule 13a-14(a)/15d-14(a).*




61




31.2
                
                Certification
      of Principal Financial Officer Pursuant to SEC
      Rule 13a-14(a)/15d-14(a).*32.1
                
                Certification
      of Principal Executive Officer Pursuant to 18 U.S.C.
      Section 1350.*32.2
                
                Certification
      of Principal Financial Officer Pursuant to 18 U.S.C.
      Section 1350.*(1)
                
                Incorporated
      by reference to the Registration Statement on Form S-1 of the
      Registrant filed on May 6, 2005.(2)
                
                Incorporated
      by reference to the Registration Statement on Form S-1/A of the
      Registrant filed on June 10, 2005.(3)
                
                Incorporated
      by reference to the Registration Statement on Form S-1/A of the
      Registrant filed on July 12, 2005.(4)
                
                Incorporated
      by reference to the Registration Statement on Form S-1/A of the
      Registrant filed on July 27, 2005.(5)
                
                Incorporated
      by reference to the Quarterly Report on Form 10-Q filed by the
      Registrant on November 14, 2005.(6)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on January 22, 2007.(7)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on January 25, 2007.(8)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on August 9, 2007.(9)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on September 24, 2007.(10)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on March 26, 2008.(11)
                
                Reserved.(12)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on April 8, 2008.(13)
                
                Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on May 2, 2008.(14)
                
                Reserved.




62




(15)
              
              Incorporated
      by reference to Appendix B to the Proxy Statement on Schedule 14A filed by
      the Registrant on May 15, 2008.(16)
              
              Incorporated
      by reference to the Current Report on Form 8-K/A filed by the
      Registrant on June 18, 2008.(17)
              
              Incorporated
      by reference to the corresponding exhibit to the Quarterly Report on
      Form 10-Q filed by the Registrant on August 14,
      2008.(18)
              
              Incorporated
      by reference to the corresponding exhibit to the Amendment to the
      Quarterly Report on Form 10-Q/A filed by the Registrant on
      August 19, 2008.(19)
              
              Incorporated
      by reference to the corresponding exhibit to the Quarterly Report on
      Form 10-Q filed by the Registrant on November 14,
      2008.(20)
              
              Incorporated
      by reference to the Current Report on Form 8-K filed by the
      Registrant on January 27, 2009.(21)
              
              Incorporated
      by reference to the corresponding exhibit to the Quarterly Report on
      Form 10-Q filed by the Registrant on May 15,
    2009.(22)
              
              Incorporated
      by reference to Amendment No. 1 to the Company’s current report on Form
      8-K filed on August 3, 2009.(23)
              
              Incorporated
      by reference to Exhibits 10.1 and 10.2, respectively, to the Current
      Report on Form 8-K filed by the Registrant on  March 27, 2009
      (File No. 001-32587).(24)
              
              Incorporated
      by reference to the corresponding exhibit to the Company’s quarterly
      report on Form 10-Q filed on August 13, 2009.(25)
              
              Incorporated
      by reference to the Company’s current report on Form 8-K filed on November
      4, 2009.(26)
              
              Incorporated
      by reference to the corresponding exhibit to the Company’s current report
      on Form 10-Q filed on November 13, 2009.(27)
              
              Incorporated
      by reference to the corresponding exhibit to the Company’s annual report
      on Form 10-K for the year ended December 31, 2008.(28)
              
              Incorporated
      by reference to Exhibit 10.44 to the Quarterly Report on Form 10-Q
      filed by the Registrant on November 14, 2008.*
              
              Filed
      herewith.**
              
              Amendments
      No. 2 and 5 to the NIH Prime Contract-Anthrax have been superseded in
      full by subsequent amendments filed herewith and are therefore omitted.
      Amendment No. 12 to the NIH Prime Contract-Anthrax and Amendment
      No. 8 to the NIH Prime Contract-Plague were never executed and are
      therefore omitted.




63





+
              
              Certain
      confidential portions of this exhibit have been omitted and filed
      separately with the Securities and Exchange Commission pursuant to a
      request for confidential treatment under Rule 24b-2 of the Securities
      Exchange Act of 1934.++
              
              Management
      Compensation Arrangement.




Financial
Statements and Schedules of Subsidiaries and Affiliates




None.


64


SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized, in the city of Annapolis, State of
Maryland, on the 26th day of March, 2010.




PHARMATHENE,
      INC.By:
            /s/ David P. WrightDavid
      P. WrightChief
      Executive Officer




POWER
OF ATTORNEY




BY THESE
PRESENTS, each person whose signature appears below constitutes and appoints
David P. Wright, Charles A. Reinhart III, and Jordan P. Karp his true and lawful
attorney-in-fact and agents, with full power of substitution and resubstitution
for him and in his name, place and stead, in any and all capacities to sign any
and all amendments to this Annual Report on Form 10-K, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in-fact or his substitute, each acting alone, may lawfully do or
cause to be done by virtue thereof.




In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.




Signature
            
            Title
            
            Date/s/ David P. Wright
            
            Chief
      Executive Officer and Director
              (Principal
      Executive Officer)
            
            March
      26, 2010David
      P. Wright/s/ Charles A. Reinhart III
            
            Chief
      Financial Officer
              (Principal
      Financial Officer and Principal
              Accounting
      Officer)
            
            March
      26, 2010Charles
      A. Reinhart III/s/
      John Pappajohn
            
            Chairman
      of the Board
            
            March
      26, 2010John
      Pappajohn/s/ John Gill
            
            
            
            March
      26, 2010John
      Gill
            
            Director/s/ James H. Cavanaugh
            
            
            
            March
      26, 2010James
      H. Cavanaugh
            
            Director


65





/s/ Steven St. Peter
            
            
            
            March
      26, 2010Steven
      St. Peter
            
            Director/s/ Derace Schaffer, MD
            
            
            
            March
      26, 2010Derace
      Schaffer, MD
            
            Director/s/ Joel McCleary
            
            
            
            March
      26, 2010Joel
      McCleary
            
            Director/s/ Jeffrey W. Runge, MD
            
            
            
            March
      26, 2010Jeffrey
      W. Runge, MD
            
            Director




66


PHARMATHENE,
INC.




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport
      of Independent Registered Public Accounting Firm
              F-2Consolidated
      Balance Sheets
              F-3Consolidated
      Statements of Operations
              F-4Consolidated
      Statements of Stockholders’ Equity
              F-5Consolidated
      Statements of Cash Flows
              F-6Notes
      to Consolidated Financial Statements
              F-7




F-1




Report
of Independent Registered Public Accounting Firm
  The Board
of Directors and Shareholders of PharmAthene, Inc.
  We have
audited the accompanying consolidated balance sheets of PharmAthene,
Inc   as of December 31, 2009 and 2008, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. 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. We were not engaged to perform an
audit of the Company’s 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, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
  In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of PharmAthene, Inc. at
December 31, 2009 and 2008, and the consolidated results of its operations and
its cash flows for the years then ended, in conformity with U.S. generally
accepted accounting principles.
 
  /s/
      Ernst & Young LLP
  McLean,
Virginia
  March 26,
2010


F-2


PHARMATHENE,
INC.





CONSOLIDATED
BALANCE SHEETS





December31,2009
                      
                      
                      2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      2,673,567
                      
                      
                      $
                      19,752,404Restricted
      cash
                      
                      
                      -
                      
                      
                      
                      12,000,000Short-term
      investments
                      
                      
                      3,137,071
                      
                      
                      
                      3,190,912Accounts
      receivable
                      
                      
                      8,866,346
                      
                      
                      
                      3,800,840Other
      receivables (including unbilled receivables)
                      
                      
                      8,566,425
                      
                      
                      
                      6,480,749Prepaid
      expenses and other current assets
                      
                      
                      973,214
                      
                      
                      
                      917,125Total
      current assets
                      
                      
                      24,216,623
                      
                      
                      
                      46,142,030Long-term
      restricted cash
                      
                      
                      -
                      
                      
                      
                      1,250,000Property
      and equipment, net
                      
                      
                      6,262,388
                      
                      
                      
                      5,313,219Patents,
      net
                      
                      
                      928,577
                      
                      
                      
                      925,489Other
      long-term assets and deferred costs
                      
                      
                      308,973
                      
                      
                      
                      257,623Goodwill
                      
                      
                      2,348,453
                      
                      
                      
                      2,502,909Total
      assets
                      
                      $
                      34,065,014
                      
                      
                      $
                      56,391,270LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      liabilities:Accounts
      payable
                      
                      $
                      1,934,119
                      
                      
                      $
                      3,870,871Accrued
      expenses and other current liabilities
                      
                      
                      11,532,101
                      
                      
                      
                      14,624,757Convertible
      notes
                      
                      
                      -
                      
                      
                      
                      13,377,505Current
      portion of long-term debt
                      
                      
                      -
                      
                      
                      
                      4,000,000Total
      current liabilities
                      
                      
                      13,466,220
                      
                      
                      
                      35,873,133Other
      long-term liabilities
                      
                      
                      452,618
                      
                      
                      
                      626,581Derivative
      instruments
                      
                      
                      835,299
                      
                      
                      
                      -Convertible
      notes and other debt, net of discount of $2,705,440 in
2009
                      
                      
                      17,426,513
                      
                      
                      
                      928,117Total
      liabilities
                      
                      
                      32,180,650
                      
                      
                      
                      37,427,831Stockholders'
      equity:Common
      stock, $0.0001 par value; 100,000,000 shares authorized; 28,130,284 and
      25,890,143 shares issued and outstanding at December 31, 2009 and
      2008
                      
                      
                      2,813
                      
                      
                      
                      2,589Additional
      paid-in-capital
                      
                      
                      157,004,037
                      
                      
                      
                      142,392,163Accumulated
      other comprehensive income
                      
                      
                      1,188,156
                      
                      
                      
                      386,351Accumulated
      deficit
                      
                      
                      (156,310,642
                      )
                      
                      
                      (123,817,664
                      )Total
      stockholders' equity
                      
                      
                      1,884,364
                      
                      
                      
                      18,963,439Total
      liabilities and stockholders' equity
                      
                      $
                      34,065,014
                      
                      
                      $
                      56,391,270





See the
accompanying notes to the consolidated financial statements.


F-3


PHARMATHENE,
INC.





CONSOLIDATED
STATEMENTS OF OPERATIONS





Year ended December 31,2009
                  
                  
                  2008Contract
      revenue
                  
                  $
                  27,549,978
                  
                  
                  $
                  32,821,526Other
      revenue
                  
                  
                  -
                  
                  
                  
                  89,80227,549,978
                  
                  
                  
                  32,911,328Operating
      expenses:Research
      and development
                  
                  
                  30,219,758
                  
                  
                  
                  31,812,431General
      and administrative
                  
                  
                  22,432,585
                  
                  
                  
                  19,397,532Acquired
      in-process research and development
                  
                  
                  -
                  
                  
                  
                  16,131,002Depreciation
      and amortization
                  
                  
                  872,304
                  
                  
                  
                  813,891Total
      operating expenses
                  
                  
                  53,524,647
                  
                  
                  
                  68,154,856Loss
      from operations
                  
                  
                  (25,974,669
                  )
                  
                  
                  (35,243,528
                  )Other
      income (expenses):Interest
      income
                  
                  
                  269,133
                  
                  
                  
                  1,225,471Loss
      on early extinguishment of debt
                  
                  
                  (4,690,049
                  )
                  
                  
                  -Interest
      expense
                  
                  
                  (2,837,302
                  )
                  
                  
                  (2,573,406
                  )Other
      income (expense)
                  
                  
                  (90,655
                  )
                  
                  
                  58,106Change
      in market value of derivative instruments
                  
                  
                  1,043,782
                  
                  
                  
                  118,244Total
      other income (expenses)
                  
                  
                  (6,305,091
                  )
                  
                  
                  (1,171,585
                  )Net
      loss
                  
                  $
                  (32,279,760
                  )
                  
                  $
                  (36,415,113
                  )Basic
      and diluted net loss per share
                  
                  $
                  (1.17
                  )
                  
                  $
                  (1.59
                  )Weighted
      average shares used in calculation of basic and diluted net loss per
      share
                  
                  
                  27,575,332
                  
                  
                  
                  22,944,066





See the
accompanying notes to the consolidated financial statements.


F-4


PHARMATHENE,
INC.




CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY





Common StockShares
                  
                  
                  Amount
                  
                  
                  Additional Paid-In
                    Capital
                  
                  
                  Accumulated
                    Other
                    Comprehensive
                    Income
                  
                  
                  Accumulated
                    Deficit
                  
                  
                  Stockholders' EquityBalance
      as of 12/31/2007
                  
                  
                  22,087,121
                  
                  
                  $
                  2,209
                  
                  
                  $
                  126,490,647
                  
                  
                  $
                  1,481,779
                  
                  
                  $
                  (87,402,551
                  )
                  
                  $
                  40,572,084Net
      Loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (36,415,113
                  )
                  
                  
                  (36,415,113
                  )Net
      unrealized gains on short term investments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  82,567
                  
                  
                  
                  -
                  
                  
                  
                  82,567Foreign
      currency translation adjustments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,177,995
                  )
                  
                  
                  -
                  
                  
                  
                  (1,177,995
                  )Comprehensive
      income (loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,095,428
                  )
                  
                  
                  -
                  
                  
                  
                  (37,510,541
                  )Vesting
      of restricted shares
                  
                  
                  69,688
                  
                  
                  
                  7
                  
                  
                  
                  (7
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Issuance
      of common stock, net issuance costs
                  
                  
                  3,733,334
                  
                  
                  
                  373
                  
                  
                  
                  12,660,069
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  12,660,442Merger
      costs
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  200,308
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  200,308Share-based
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,041,146
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,041,146Balance
      as of 12/31/2008
                  
                  
                  25,890,143
                  
                  
                  $
                  2,589
                  
                  
                  $
                  142,392,163
                  
                  
                  $
                  386,351
                  
                  
                  $
                  (123,817,664
                  )
                  
                  $
                  18,963,439Cumulative
      impact of adoption of new accounting guidance
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (423,391
                  )
                  
                  
                  -
                  
                  
                  
                  (213,218
                  )
                  
                  
                  (636,609
                  )Adjusted
      balance as of 12/31/2008
                  
                  
                  25,890,143
                  
                  
                  $
                  2,589
                  
                  
                  $
                  141,968,772
                  
                  
                  $
                  386,351
                  
                  
                  $
                  (124,030,882
                  )
                  
                  $
                  18,326,830Net
      Loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (32,279,760
                  )
                  
                  
                  (32,279,760
                  )Net
      unrealized (losses) on short term investments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (10,199
                  )
                  
                  
                  -
                  
                  
                  
                  (10,199
                  )Foreign
      currency translation adjustments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  812,004
                  
                  
                  
                  -
                  
                  
                  
                  812,004Comprehensive
      income (loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  801,805
                  
                  
                  
                  -
                  
                  
                  
                  (31,477,955
                  )Vesting
      of restricted shares
                  
                  
                  114,336
                  
                  
                  
                  11
                  
                  
                  
                  (11
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Issuance
      of common stock, net issuance costs
                  
                  
                  2,116,055
                  
                  
                  
                  212
                  
                  
                  
                  4,924,058
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,924,270Sale
      of stock purchase warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,236,067
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,236,067
                  )Share-based
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,444,275
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,444,275Issuance
      of common stock pursuant to share-based awards
                  
                  
                  9,750
                  
                  
                  
                  1
                  
                  
                  
                  27,447
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  27,448Equity
      component of convertible debt
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  7,875,563
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  7,875,563Balance
      as of 12/31/2009
                  
                  
                  28,130,284
                  
                  
                  $
                  2,813
                  
                  
                  $
                  157,004,037
                  
                  
                  $
                  1,188,156
                  
                  
                  $
                  (156,310,642
                  )
                  
                  $
                  1,884,364





See the
accompanying notes to the consolidated financial
statements.


F-5


PHARMATHENE,
INC.





CONSOLIDATED
STATEMENTS OF CASH FLOWS





Year ended December 31,2009
                
                
                2008Operating
      activitiesNet
      loss
                
                $
                (32,279,760
                )
                
                $
                (36,415,113
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Acquired
      in-process research and development
                
                
                -
                
                
                
                16,131,002Change
      in market value of derivative instruments
                
                
                (1,043,782
                )
                
                
                (118,244
                )Loss
      on extinguishment of debt
                
                
                4,690,049
                
                
                
                -Depreciation
      and amortization
                
                
                872,304
                
                
                
                813,891Measurement
      period changes in purchase accounting estimates
                
                
                154,456
                
                
                
                -Shared-based
      compensation
                
                
                3,444,275
                
                
                
                3,041,146Non
      cash interest expense
                
                
                1,480,284
                
                
                
                1,755,408Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                (4,897,917
                )
                
                
                (2,195,580
                )Prepaid
      expenses and other current assets
                
                
                (1,915,837
                )
                
                
                (287,564
                )Accounts
      payable
                
                
                (1,939,185
                )
                
                
                (60,704
                )Accrued
      expenses and other liabilities
                
                
                3,289,463
                
                
                
                4,137,184Net
      cash used in operating activities
                
                
                (28,145,650
                )
                
                
                (13,198,574
                )Investing
      activitiesPurchases
      of property and equipment
                
                
                (1,029,428
                )
                
                
                (509,315
                )Payment
      for business combination, net of cash acquired
                
                
                (7,000,000
                )
                
                
                (11,556,117
                )Purchase
      of letter of credit
                
                
                -
                
                
                
                (7,000,000
                )Purchases
      of short term investments
                
                
                (8,406,697
                )
                
                
                (17,169,388
                )Proceeds
      from sales and maturities of short term investments
                
                
                8,450,339
                
                
                
                26,132,421Net
      cash used in investing activities
                
                
                (7,985,786
                )
                
                
                (10,102,399
                )Financing
      activitiesProceeds
      from issuance of long-term debt
                
                
                10,528,196
                
                
                
                -Principal
      payments on debt
                
                
                (9,538,016
                )
                
                
                (4,000,000
                )Change
      in restricted cash requirements
                
                
                13,250,000
                
                
                
                (6,250,000
                )Net
      proceeds from issuance of common stock and warrants
                
                
                4,951,718
                
                
                
                12,660,442Financing
      costs
                
                
                (402,430
                )
                
                
                -Net
      cash provided by financing activities
                
                
                18,789,468
                
                
                
                2,410,442Effects
      of exchange rates on cash
                
                
                263,131
                
                
                
                60,292Decreases
      in cash and cash equivalents
                
                
                (17,078,837
                )
                
                
                (20,830,239
                )Cash
      and cash equivalents, at beginning of year
                
                
                19,752,404
                
                
                
                40,582,643Cash
      and cash equivalents, at end of year
                
                $
                2,673,567
                
                
                $
                19,752,404Supplemental
      disclosure of cash flow informationCash
      paid for interest
                
                $
                1,357,018
                
                
                $
                800,481





See the
accompanying notes to the consolidated financial
statements.


F-6


PharmAthene,
Inc.


Notes
to Consolidated Financial Statements


As
of and For the Year Ended December 31, 2009





Note
1 - Organization and Business




PharmAthene,
Inc. (“PharmAthene” or the “Company”) was incorporated under the laws of the
State of Delaware as Healthcare Acquisition Corp. (“HAQ”) on April 25, 2005, a
special purchase acquisition corporation formed solely to acquire a then
unidentified business.  HAQ became a public company on August 3,
2005.  On August 3, 2007, HAQ acquired a Delaware corporation which at
the time was known as “PharmAthene, Inc.” (the “Merger”); effective upon the
consummation of the Merger, HAQ changed its name from “Healthcare Acquisition
Corp.” to “PharmAthene, Inc.” and former PharmAthene changed its name to
“PharmAthene US Corporation.”  Through February 27, 2009, our
operations were conducted by PharmAthene US Corporation.  Effective
February 27, 2009, PharmAthene US Corporation was merged with and into
PharmAthene, Inc., with PharmAthene, Inc. being the surviving
corporation.




In March
2008, PharmAthene Inc., through its wholly-owned subsidiary PharmAthene UK
Limited, acquired substantially all the assets and liabilities related to the
biodefense vaccines business (the “Avecia Acquisition”) of Avecia Biologics
Limited (along with its affiliates, “Avecia”).




We are a
biopharmaceutical company focused on developing biodefense countermeasure
applications.  We are subject to those risks associated with any
biopharmaceutical company that has substantial expenditures for research and
development.  There can be no assurance that our research and
development projects will be successful, that products developed will obtain
necessary regulatory approval, or that any approved product will be commercially
viable.  In addition, we operate in an environment of rapid
technological change and are largely dependent on the services and expertise of
our employees, consultants and other third parties.




Historically,
we have performed under government contracts and grants and raised funds from
investors (including additional debt and equity issued in 2009) to sustain our
operations.  Based on the operating cash requirements and capital
expenditures expected for 2010, we will not require additional funding to
continue our current level of operations to the end of 2010. Our sources of
funds include existing government grants and contracts. We may also elect to
raise additional capital through debt and or equity to strengthen our financial
position.




Note
2 - Summary of Significant Accounting Policies




Basis
of Presentation




Our
consolidated financial statements include the accounts of PharmAthene, Inc. and
its wholly-owned subsidiaries, PharmAthene U.S. Corporation, PharmAthene Canada,
Inc., and PharmAthene UK Limited, collectively referred to herein as
“PharmAthene”, “we”, “us”, “our” or the “Company”.  All significant
intercompany transactions and balances have been eliminated in
consolidation.  Our consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States.  We currently operate in one business segment. Unbilled
accounts receivable in the prior year have been reclassified out of accounts
receivable line item on the consolidated balance sheet into other receivables to
conform with current year presentation.




F-7


Use
of Estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
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.




Foreign
Currency Translation




The
functional currency of our wholly owned foreign subsidiaries located in Canada
and the United Kingdom is their local currency.  Assets and
liabilities of our foreign subsidiaries are translated into United States
dollars based on exchange rates at the end of the reporting
period.  Income and expense items are translated at the weighted
average exchange rates prevailing during the reporting
period.  Translation adjustments are accumulated in a separate
component of stockholders’ equity.  Transaction gains or losses are
included in the determination of net loss.




Comprehensive
Loss




Comprehensive
loss includes the total of our net loss and all other changes in equity other
than transactions with owners, including (i) changes in equity for cumulative
translation adjustments resulting from the consolidation of foreign subsidiaries
as the financial statements of the subsidiaries located outside of the United
States are accounted for using the local currency as the functional currency,
and (ii) unrealized gains and losses on short term available-for-sale
investments.




Unrealized
                
                
                AccumulatedForeign Currency
                
                
                Gains (Losses)
                
                
                Other ComprehensiveTranslation
                
                
                on Investments
                
                
                IncomeBalance
      as of December 31, 2007
                
                $
                1,581,029
                
                
                $
                (99,250
                )
                
                $
                1,481,7792008
      other comprehensive income (loss)
                
                
                (1,177,995
                )
                
                
                82,567
                
                
                
                (1,095,428
                )Balance
      as of December 31, 2008
                
                
                403,034
                
                
                
                (16,683
                )
                
                
                386,3512009
      other comprehensive income
                
                
                812,004
                
                
                
                (10,199
                )
                
                
                801,805Balance
      as of December 31, 2009
                
                $
                1,215,038
                
                
                $
                (26,882
                )
                
                $
                1,188,156





Cash
and Cash Equivalents




Cash and
cash equivalents, are stated at cost which approximates market
value.  We consider all highly liquid investments with original
maturities of three months or less to be cash equivalents.  Interest
income earned on cash and cash equivalents and short-term investments was $0.3
million and $1.2 million in 2009 and 2008, respectively.




F-8


Restricted
Cash and Letter of Credit




Prior to
the repayment in full of all outstanding amounts and its termination in July
2009, we were required to maintain restricted cash pursuant to a bank credit
facility.  Prior to payment in June 2009 of the remaining deferred
consideration existing from the Avecia Acquisition, we had agreed to provide a
letter of credit as security for the deferred consideration.  As of
December 31, 2009 we no longer have either the  restricted cash or
letter of credit requirements.




Significant
Customers and Accounts Receivable




Our
primary customers are the U.S. Department of Defense (the “DoD”), the National
Institute of Allergy and Infectious Diseases (“NIAID”), the Biomedical Advanced
Research and Development Authority (“BARDA”), and the National Institute of
Health (“NIH”).




As
of December 31, 2009 and 2008, the Company’s trade receivable balances were
comprised solely of receivables from these customers.  Unbilled
accounts receivable totaling $8.1 million and $5.0 million as of December 31,
2009 and 2008, respectively, relate to the contracts with these same
customers.




Property
and Equipment




Property
and equipment consist of land, building and leasehold improvements, laboratory,
computer, farm and office equipment and furniture and are recorded at
cost.  Leasehold improvements are amortized over the economic life of
the asset or the lease term, whichever is shorter.  Property and
equipment are depreciated using the straight-line method over the estimated
useful lives of the respective assets as follows:




Asset Category
                    
                    Estimated Useful Life
                      (in Years)Building
      and leasehold improvements
                    
                    4 -
      20Laboratory
      equipment
                    
                    7Furniture,
      farm and office equipment
                    
                    5 -
      7Computer
      equipment
                    
                    3





Impairment
of Long-Lived Assets




Long-lived
assets consist primarily of patents and property and equipment.  We
review long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.  Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to future undiscounted net
cash flows expected to be generated by the asset.  Recoverability
measurement and estimating of undiscounted cash flows is done at the lowest
possible level for which we can identify assets.  If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of assets exceeds the fair value of the
assets.




Concentration
of Credit Risk




Financial
instruments that potentially subject us to concentrations of credit risk are
primarily cash and cash equivalents, investments and billed and unbilled
accounts receivable.  We maintain our cash and cash equivalents and
investment balances in the form of money market accounts, corporate and
government debt securities and overnight deposits with financial institutions
that we believe are creditworthy.




F-9


Fair
Value of Financial Instruments




Our
financial instruments primarily include cash and cash equivalents, accounts
receivable, short-term investments and other current assets, accounts payable,
accrued and other liabilities, convertible notes and long-term
debt.  Due to the short-term nature of the cash and cash equivalents,
accounts receivable, short-term investments and other current assets, accounts
payable and accrued and other liabilities (including derivative instruments),
the carrying amounts of these assets and liabilities approximate their fair
value.  The carrying values of our convertible notes and other long
term debt approximate their fair values, based on our current incremental
borrowing rates.




Short-term
investments consist of investment grade government agency and corporate debt
securities due within one year.  All investments are classified as
available-for-sale and are recorded at market value.  Unrealized gains
and losses are reflected in other comprehensive income (loss).  The
estimated fair value of the available-for-sale securities is determined based on
quoted market prices or rates.  The estimated fair value of our
available-for-sale securities is determined based on quoted market prices or
rates for similar instruments.  We review our investment portfolio on
a regular basis and seek guidance from our professional portfolio manager
related to U.S. and global market conditions.  We assess the risk of
impairment related to securities held in our investment portfolio on a regular
basis and identified no permanent or “other-than-temporary” impairment during
the year ended December 31, 2009 and 2008.




Intangible
Assets




Patents
are carried at cost less accumulated amortization which is calculated on a
straight line basis over the estimated useful lives of the patents, currently
estimated to be 11 years.  Goodwill represents the excess of purchase
price over the fair value of net identifiable assets associated with the Avecia
Acquisition.  We review the carrying value of our intangible assets
for impairment annually during the fourth quarter of every year, or more
frequently if impairment indicators exist.  Evaluating for impairment
requires judgment, including the estimation of future cash flows, future growth
rates and profitability and the expected life over which cash flows will
occur.  Changes in the Company’s business strategy or adverse changes
in market conditions could impact impairment analyses and require the
recognition of an impairment charge equal to the excess of the carrying value of
the intangible asset over its estimated fair value.  For the year
ended December 31, 2009, we determined that there was no impairment of our
intangible assets.




Revenue
Recognition




We
generate our revenue from two different types of contractual arrangements:
cost-plus-fee contracts and cost reimbursable grants.  Costs consist
primarily of actual internal labor charges and external sub-contractor costs
incurred plus an allocation of applied fringe benefits, overhead and general and
administrative expenses as defined in the contract.




Revenues
on cost-plus-fee contracts are recognized in an amount equal to the costs
incurred during the period plus an estimate of the applicable fee
earned.  The estimate of the applicable fee earned is determined by
reference to the contract:  if the contract defines the fee in terms
of risk-based milestones and specifies the fees to be earned upon the completion
of each milestone, then the fee is recognized when the related milestones are
earned.  Otherwise, we compute fee income earned in a given
periodby using a
proportional performance method based on costs incurred during the period as
compared to total estimated project costs and application of the resulting
fraction to the total project fee specified in the contract.




F-10


We
analyze each cost reimbursable grant to determine whether we should report
payments under such grant as revenue or as an offset to our expenses
incurred.  In 2009 and 2008, we recorded approximately $2.4 million
and $2.2 million, respectively, of costs reimbursed by the government as an
offset to research and development expenses.




As
revenue is recognized in accordance with the terms of the contracts, related
amounts are recorded as unbilled receivables, the primary component of “Other
receivables (including unbilled receivables)” in our consolidated balance
sheets.  As specific contract invoices are generated and sent to our
customers (i.e., the relevant government entity), invoiced amounts are
transferred out of unbilled receivables and into billed accounts
receivable.  Invoicing frequency and payment terms for cost-plus-fee
contracts with our customers are defined within each contract, but are typically
monthly invoicing with 30-60 day payment cycles.  During 2009, our
development agreement for SparVaxTM, our second generation rPA anthrax vaccine,
was (i) transferred from NIH to BARDA, (ii) novated from our UK subsidiary to
the U.S. parent corporation, PharmAthene, Inc., and (iii) revised with regard to
the scope and timing of work under that agreement.  During the period
that these changes were being implemented, we agreed with our customer to delay
invoicing under that contract, which resulted in a significant increase in
unbilled receivables.




Collaborative
Arrangements




Even
though most of our products are being developed in conjunction with support by
the U.S. Government, we are an active participant in that development, with
exposure to significant risks and rewards of commercialization relating to the
development of these pipeline products.  In collaborations where we
are deemed to be the principal participant of the collaboration, we recognize
costs and revenues generated from third parties using the gross basis of
accounting; otherwise, we use the net basis of accounting.




Research
and Development




Research
and development costs are expensed as incurred; advance payments are deferred
and expensed as performance occurs.  Research and development costs
include salaries, facilities expense, overhead expenses, material and supplies,
pre-clinical expense, clinical trials and related clinical manufacturing
expenses, stock-based compensation expense, contract services and other outside
services.




Share-Based
Compensation




We
expense the estimated fair value of share-based awards granted to employees
under our stock compensation plans.  The fair value of restricted
stock grants is determined based on the quoted market price of our common
stock.  Share-based compensation cost for stock options is determined
at the grant date using an option pricing model.  We have estimated
the fair value of each award using the Black-Scholes option pricing
model.  The Black-Scholes model considers, among other factors, the
expected life of the award and the expected volatility of the Company’s stock
price. The value of the award that is ultimately expected to vest is recognized
as expense on a straight line basis over the employee’s requisite service
period.




The fair
value of restricted stock grants are determined based on the closing price of
our common stock on the NYSE Amex on the award date and is ratably recognized as
expense over the requisite service period.  Employee share-based
compensation expense recognized in 2009 and 2008 was calculated based on awards
ultimately expected to vest and has been reduced for estimated forfeitures at a
rate of approximately 17% for both stock options and restricted shares, based on
historical forfeitures.  Share-based compensation expense for 2009 and
2008, respectively, was:




F-11





Year ended December 31,2009
                  
                  
                  2008Research
      and development
                  
                  $
                  773,109
                  
                  
                  $
                  587,957General
      and administrative
                  
                  
                  2,671,166
                  
                  
                  
                  2,453,189Total
      share-based compensation expense
                  
                  $
                  3,444,275
                  
                  
                  $
                  3,041,146





During
2009, we granted 1,592,850 options to employees and non-employee directors, and
made restricted stock grants of 258,633.  At December 31, 2009, we had
total unrecognized stock based compensation expense related to unvested awards
of approximately $5.7 million that we expect to recognize as expense over the
next three years.




Income
Taxes




We
account for income taxes using the asset and liability method.  Under
this method, deferred tax assets and liabilities are recorded for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective tax
bases.  Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.  The
effect of a tax rate change on deferred tax assets and liabilities is recognized
in income in the period that includes the enactment date.  We record
valuation allowances to reduce net deferred tax assets to the amount considered
more likely than not to be realized.  Changes in estimates of future
taxable income can materially change the amount of such valuation
allowances.  As of December 31, 2009, we had recognized a valuation
allowance to the full extent of our net deferred tax assets since the likelihood
of realization of the benefit does not meet the more likely than not
threshold.




We file a
U.S. federal income tax return as well as returns for various state and foreign
jurisdictions.  Our income taxes have not been examined by any tax
jurisdiction since our inception.  Uncertain tax positions taken on
our tax returns are accounted for as liabilities for unrecognized tax
benefits.  We recognize interest and penalties, if any, related to
unrecognized tax benefits in other income (expense) in the consolidated
statement of operations.




Basic
and Diluted Net Loss Per Share




Income (loss) per
share:  Basic income (loss) per share is computed by dividing
consolidated net income (loss) by the weighted average number of common shares
outstanding during the year, excluding unvested restricted stock.




For
periods of net income when the effects are not anti-dilutive, diluted earnings
per share is computed by dividing our net income by the weighted average number
of shares outstanding and the impact of all dilutive potential common shares,
consisting  primarily of stock options, unvested restricted stock and
the common shares underlying our convertible notes and stock purchase
warrants.  The dilutive impact of our dilutive potential common shares
resulting from stock options and stock purchase warrants is determined by
applying the treasury stock method.  The dilutive impact of our
dilutive potential common shares resulting from our convertible notes is
determined by applying the “if converted” method.




F-12


For the
periods of net loss, diluted loss per share is calculated similarly to basic
loss per share because the impact of all dilutive potential common shares is
anti-dilutive due to the net losses.  A total of 16.5 million and 19.0
million potential dilutive shares have been excluded in the calculation of
diluted net loss per share in 2009 and 2008, respectively, because their
inclusion would be anti-dilutive.




Recent
Accounting Pronouncements




In August
2009, the Financial Accounting Standards Board issued Accounting Standards
Update 2009-05, “Fair Value Measurements and Disclosures (Topic 820) Measuring
Liabilities at Fair Value (“ASU 2009-05”).  ASU 2009-05 clarifies that
in circumstances in which a quoted market price in an active market for the
identical liability is not available, a reporting entity is required to measure
fair value using one of several acceptable valuation techniques.  ASU
2009-05 also clarifies (i) that when estimating the fair value of a liability, a
reporting entity is not required to include a separate input or adjustments to
other inputs relating the existence of a restriction that prevents the transfer
of the liability, and (ii) that both a “quoted price in an active market for the
identical liability at the measurement date” and the “quoted price for the
identical liability when traded as an asset in a active market when no
adjustments to the quoted price of the asset are required” are Level 1 fair
value measurements.  We adopted ASU 2009-05 in the fourth quarter of
2009; the adoption did not have a material impact on our consolidated financial
statements.




In
October 2009, the Financial Accounting Standards Board issued Accounting
Standards Update 2009-13, “Revenue Recognition (Topic 605) Multiple-Deliverable
Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force (“ASU
2009-13”).  ASU 2009-13 amends existing accounting guidance for
separating consideration in multiple-deliverable arrangements.  ASU
2009-13 establishes a selling price hierarchy for determining the selling price
of a deliverable.  The selling price used for each deliverable will be
based on vendor-specific objective evidence if available, third-party evidence
if vendor-specific evidence is not available, or estimated selling price if
neither vendor-specific evidence nor third-party evidence is
available.  ASU 2009-13 eliminates residual method of allocation and
requires that arrangement consideration be allocated at the inception of the
arrangement to all deliverables using the “relative selling price
method.”  The relative selling price method allocates any discount in
the arrangement proportionately to each deliverable on the basis of each
deliverable’s selling price.  ASU 2009-13 requires that a vendor
determine its best estimate of selling price in a manner that is consistent with
that used to determine the price to sell the deliverable on a stand-alone
basis.  ASU 2009-13 is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after June 15, 2010, with earlier adoption permitted.  We have not yet
determined the impact of the adoption of ASU 2009-13 on our consolidated
financial statements.




In
January 2010, the FASB issued accounting standards update (ASU) No. 2010-06,
Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures about
Fair Value Measurements (ASU No. 2010-06). ASU No. 2010-06 requires: (1) fair
value disclosures of assets and liabilities by class; (2) disclosures about
significant transfers in and out of Levels 1 and 2 on the fair value hierarchy,
in addition to Level 3; (3) purchases, sales, issuances and settlements be
disclosed on gross basis on the reconciliation of beginning and ending balances
of Level 3 assets and liabilities; and (4) disclosures about valuation methods
and inputs used to measure the fair value of Level 2 assets and liabilities. ASU
No. 2010-06 becomes effective for the first financial reporting period beginning
after December 15, 2009, except for disclosures about purchases, sales,
issuances and settlements of Level 3 assets and liabilities which will be
effective for fiscal years beginning after December 15, 2010. We are currently
assessing what impact, if any, ASU No. 2010-06 will have on our fair value
disclosures; however, we do not expect the adoption of the guidance provided in
this codification update to have any material impact on our consolidated
financial statements.




F-13


Note
3 - Avecia Acquisition




In April
2008, we completed the Avecia Acquisition, acquiring substantially all of the
assets and assuming the liabilities exclusively associated with Avecia’s
biodefense vaccines business, including certain products, patents, trademarks,
domain names and other intellectual property, license agreements, contracts,
goodwill and other intangibles.  The transaction was valued at
approximately $18.6 million, consisting of the initial consideration of $10.0
million in cash, deferred consideration of approximately $7.0 million, secured
by a letter of credit, and transaction costs of approximately $1.6
million.  They are also entitled to certain potential milestone
consideration totaling $23.0 million (of which an aggregate of $13.0 million are
milestones related to RypVaxTM and thus are highly unlikely ever to be paid out)
and royalties of 1%-2.5% of net sales depending on product sales within the
period of ten years from the consummation of the Avecia
Acquisition.




The
assets acquired were accounted for as purchase business combination. All of the
tangible and intangible assets acquired and liabilities assumed of Avecia
Vaccines were recorded at their estimated fair market values on the acquisition
date. The purchase price was allocated as follows:




(in thousands)Current
      assets
                    
                    $
                    5,340Current
      liabilities
                    
                    $
                    (5,418
                    )Goodwill
                    
                    $
                    2,503In-process
      research and development
                    
                    $
                    16,131Total
      purchase consideration
                    
                    $
                    18,556




The
primary asset acquired in the Avecia Acquisition was SparVaxTM, a second
generation rPA anthrax vaccine.  The value of the third generation
anthrax vaccine acquired in the transaction was aggregated with that of the
second generation vaccine because success in developing the third generation
anthrax vaccine is contingent on the successful development of the second
generation vaccine.  At the acquisition date, the aggregate fair value
of the second and third generation vaccines was estimated at $16.1
million.  An income approach methodology was used to determine the
fair value of the acquired in-process research and development
asset.  This approach assessed the expected cash flows, net of
expected appropriate operating expenses, generated from the acquisition date in
April 2008 through the end of 2021 (the expected life of the vaccine) using a
risk adjusted discount rate of 51%, which the Company believes is commensurate
with an early stage biodefense product development opportunity of this
nature.  In connection with the transaction, the Company in 2008
recorded a charge to expense for acquired in-process research and development of
$16.1 million for these acquired research projects for which, at the acquisition
date, technological feasibility had not been established and no alternative
future use existed.  No such charge was recorded in 2009.




F-14


Both
vaccines are in their early stages of development and significant remaining
research and development is required to establish the technological feasibility
of these vaccines.  The cost and time required to complete the
development of these vaccines and earn FDA marketing approval is highly
uncertain and can vary significantly.  During 2009, the Company
provided the U.S. Government with a series of development plans for SparVaxTM, in
response to their request for proposal, which estimated that it would cost in
excess of $300 million over approximately five years to complete the development
of SparVaxTM.  No such estimates of the advanced development costs and
timeline for the third generation vaccine have been developed.




As with
all development efforts in the biodefense industry, the development of the
Company’s second and third generation anthrax vaccines is subject to
delays.  The Company’s development costs will increase substantially
if it experiences material delays in any clinical trials or if it needs to
conduct more or larger trials than planned.




The
results of operations of Avecia are included in our statement of operations
starting on the acquisition date in April 2008.  The unaudited
financial information in the table below summarizes the combined results of
operations of PharmAthene and Avecia Vaccines on a pro forma basis (as if the
companies had been combined as of January 1, 2008). The pro forma financial
information is presented for informational purposes only and is not indicative
of the results of operations that would have been achieved if the business
combination had taken place at January 1, 2008. The pro forma financial
information for the year ended December 31, 2008 includes adjustments to
interest expense, interest income and related tax effects.




(in thousands, except share data)Total
      revenue
                    
                    $
                    32,911Net
      loss attributable to common shareholders
                    
                    $
                    (36,415
                    )Basic
      and dilutednet loss per share
                    
                    $
                    (1.59
                    )




In June
2009, PharmAthene and Avecia entered into a settlement agreement (i) to resolve
certain issues related to the wind down and cancellation of work related to the
Company’s rPA vaccine program being conducted at Avecia pursuant to a master
services agreement (“MSA”) between the two organizations, and (ii) to accelerate
the payment of certain deferred consideration related to the Avecia
Acquisition.  Under the settlement agreement:




·
              we
      paid Avecia $7.0 million of the remaining deferred purchase price
      consideration under the Avecia Acquisition, and as a result the existing
      letter of credit that had supported the deferred consideration (and the
      related requirement to maintain restricted cash as collateral for the
      letter of credit) was terminated in June
2009;




·
              we
      agreed to pay Avecia approximately $1.8 million related to past
      performance and raw materials under the MSA subject to certain remaining
      performance obligations by Avecia related to, among other things, the
      technology transfer effort to a new U.S.-based bulk drug substance
      manufacturer; and




·
              we
      agreed to pay Avecia approximately $3.0 million in cancellation
      fees.




In June
2009, we expensed as allowable costs under our government contract the $1.8
million payment for past contract performance and recognized related contract
revenues.  We also expensed the $3.0 million cancellation fee in June
2009.




F-15


In the
second quarter 2009, our existing research and development contract for SparVaxTM
was transferred from NIAID to BARDA.  In the third quarter 2009 BARDA
and PharmAthene modified the existing statement of work to include, among other
things, the completion of on-going stability studies and development of potency
assays along with certain manufacturing scale-up and technology transfer
activities to a U.S.-based manufacturer for the bulk drug substance for
SparVaxTM.  We then entered into a corresponding subcontract with our
U.S.-based manufacturer.  As a result of the transfer of the contract
and modification of the statement of work, we have been transitioning
development and manufacturing activities as well as other general and
administrative functions from the UK to the U.S.  In connection with
this transition, we anticipate relocating our UK operations, including
terminating our UK workforce, by June 30, 2010.  In  2009,
we expensed approximately $2.1 million of costs associated with these exit
activities.  Of this amount approximately $1.8 and $0.3 is presented
as research and development expenses and general and administrative expenses,
respectively.  As of December 31, 2009, $1.1 remains in accrued
expenses.




In
connection with the Avecia Acquisition, we acquired license agreements with The
Defence Science and Technology Laboratory of the United Kingdom Ministry of
Defence (“DSTL”) for the rights to certain technologies.  These
agreements allow for the licensing of specified patents and technology necessary
to perform development of the rPA and rYP programs as required under our
contracts with NIAID and BARDA.  Upon commercialization, the license
agreements require us to make royalty payments equal to a specified percentage
of future sales of products for both government procurement and commercial
markets.  No payments on these licenses have been
incurred.  In February 2009, both of these licenses were amended and
restated to broaden the scope of exclusivity and address other general business
issues.




Note
4 - Fair Value Measurements




We define
fair value as the exchange price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants at the measurement date.  We report assets and
liabilities that are measured at fair value using a three-level fair value
hierarchy that prioritizes the inputs used to measure fair
value.  This hierarchy maximizes the use of observable inputs and
minimizes the use of unobservable inputs.  The three levels of inputs
used to measure fair value are as follows:




·
              Level
      1 — Quoted prices in active markets for identical assets or
      liabilities.




·
              Level
      2 — Observable inputs other than quoted prices included in Level 1, such
      as quoted prices for similar assets and liabilities in active markets;
      quoted prices for identical or similar assets and liabilities in markets
      that are not active; or other inputs that are observable or can be
      corroborated by observable market
data.




·
              Level
      3 — Unobservable inputs that are supported by little or no market activity
      and that are significant to the fair value of the assets or
      liabilities.  This includes certain pricing models, discounted
      cash flow methodologies and similar techniques that use significant
      unobservable inputs.




An
asset’s or liability’s level within the fair value hierarchy is based on the
lowest level of any input that is significant to the fair value
measurement.  At each reporting period, we perform a detailed analysis
of our assets and liabilities that are measured at fair value.  All
assets and liabilities for which the fair value measurement is based on
significant unobservable inputs or instruments which trade infrequently and
therefore have little or no price transparency are classified as Level
3.




F-16


We have
segregated our financial assets and liabilities that are measured at fair value
into the most appropriate level within the fair value hierarchy based on the
inputs used to determine the fair value at the measurement date in the table
below.  We have no non-financial assets and liabilities that are
measured at fair value.




As of December 31, 2009Level 1
                
                
                Level 2
                
                
                Level 3
                
                
                BalanceAssetsAvailable-for-sale
      securities
                
                $
                3,137,071
                
                
                $
                -
                
                
                $
                -
                
                
                $
                3,137,071LiabilitiesDerivatives
                
                $
                -
                
                
                $
                -
                
                
                $
                835,299
                
                
                $
                835,299





As of December 31, 2008Level 1
                
                
                Level 2
                
                
                Level 3
                
                
                BalanceAssetsAvailable-for-sale
      securities
                
                $
                3,190,912
                
                
                $
                -
                
                
                $
                -
                
                
                $
                3,190,912LiabilitiesDerivatives
                
                $
                -
                
                
                $
                -
                
                
                $
                6,405
                
                
                $
                6,405




The
following table sets forth a summary of changes in the fair value of our Level 3
liabilities for the years ended December 31, 2009 and 2008:




F-17





Description
                
                Balance as of
                  December
                  31, 2008
                
                
                Cumulative Effect
                  of Adoption of
                  New Accounting
                
                
                New Liabilities
                
                
                Unrealized Gains
                
                
                Balance as of
                  December 31,
                  2009Embedded
      conversion option
                
                $
                6,405
                
                
                $
                -
                
                
                $
                -
                
                
                $
                (6,405
                )
                
                $
                -Stock
      purchase warrants
                
                $
                -
                
                
                $
                636,609
                
                
                $
                1,236,067
                
                
                $
                (1,037,377
                )
                
                $
                835,299





Description
                  
                  Balance as of
                    December
                    31, 2007
                  
                  
                  New Liabilities
                  
                  
                  Unrealized Gains
                  
                  
                  Balance as of
                    December 31,
                    2008Embedded
      conversion option
                  
                  $
                  124,650
                  
                  
                  $
                  -
                  
                  
                  $
                  (118,245
                  )
                  
                  $
                  6,405





The gains
on the derivative instruments are classified in other expenses as the change in
derivative instruments in our consolidated statements of
operations.  The fair value of our stock purchase warrants and
conversion option is determined based on the Black-Scholes option pricing
model.  Use of the Black-Scholes option-pricing model requires the use
of unobservable inputs such as the expected term, anticipated volatility and
expected dividends.




Note
5 - Short-Term Investments – Available for Sale Securities




The
amortized cost, gross unrealized gains, gross unrealized losses and fair value
of available-for-sale investments by security classification, all of which are
short term, at December 31, 2009 and 2008 were as follows:




December 31, 2009
                                  
                                  Amortized Cost
                                  
                                  
                                  Gross Unrealized
                                    Gain
                                  
                                  
                                  Gross Unrealized
                                    Loss
                                  
                                  
                                  Estimated Fair
                                    ValueCorporate
      debt securities
                                  
                                  $
                                  3,130,588
                                  
                                  
                                  $
                                  6,491
                                  
                                  
                                  $
                                  (8
                                  )
                                  
                                  $
                                  3,137,071Total
      Securities
                                  
                                  $
                                  3,130,588
                                  
                                  
                                  $
                                  6,491
                                  
                                  
                                  $
                                  (8
                                  )
                                  
                                  $
                                  3,137,071December 31, 2008Corporate
      debt securities
                                  
                                  $
                                  3,183,461
                                  
                                  
                                  $
                                  7,451
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  3,190,912Total
      Securities
                                  
                                  $
                                  3,183,461
                                  
                                  
                                  $
                                  7,451
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  3,190,912




F-18


During
the years ended December 31, 2009 and 2008, we realized net gains of
approximately $3,300 and net losses of $8,700, respectively, on sales of
available-for-sale securities.  The gains and losses on
available-for-sale securities are based on the specific identification
method.




Note
6 - Property and Equipment




Property
and equipment consisted of the following:




December 31,2009
                
                
                2008Land
                
                $
                524,109
                
                
                $
                449,787Building
      and leasehold improvements
                
                
                5,940,009
                
                
                
                4,841,800Furniture,
      farm and office equipment
                
                
                446,897
                
                
                
                222,892Laboratory
      equipments
                
                
                713,533
                
                
                
                643,332Computer
      and other equipment
                
                
                1,224,927
                
                
                
                841,1858,849,475
                
                
                
                6,998,996Less
      accumulated depreciation
                
                
                (2,587,087
                )
                
                
                (1,685,777
                )Property
      and equipment, net
                
                $
                6,262,388
                
                
                $
                5,313,219





Depreciation
expense for the years ended December 31, 2009 and 2008 was $0.8 million and $0.6
million, respectively.




Note
7 - Patents




In
conjunction with our purchase of the assets of Nexia Biotechnologies Ltd. in
March 2005 (the “Nexia Acquisition”), we recorded an intangible asset for
acquired patents of $1.4 million with an estimated useful life of 11
years.  Accumulated amortization at December 31, 2009 and 2008 related
to these patents was $0.8 million and $0.5 million, respectively.  For
the years ended December 31, 2009 and 2008, we recognized amortization expense
related to the patents of $0.1 million and $0.2 million,
respectively.  Anticipated future amortization expense will
approximate $0.2 million per year until the patents are fully amortized in
2016.




F-19


Note
8 - Accrued Expenses and Other Liabilities




Accrued
expenses and other liabilities consisted of the following:




December 31,2009
                
                
                2008Accrued
      development expenses
                
                $
                6,582,470
                
                
                $
                4,140,072Accrued
      professional services
                
                
                1,849,045
                
                
                
                1,149,622Accrued
      employee expenses
                
                
                1,330,471
                
                
                
                936,282Deferred
      consideration - Avecia acquisition
                
                
                -
                
                
                
                7,000,000Other
                
                
                1,770,115
                
                
                
                1,398,781Accrued
      expenses and other liabilities
                
                $
                11,532,101
                
                
                $
                14,624,757





Note
9 - Debt




Convertible
Notes




Our 8%
senior unsecured convertible notes accrued interest at a rate of 8% per annum
and were to mature on August 3, 2009 (the “Old Notes”).  The principal
amount of the Old Notes and any accrued interest were convertible into shares of
PharmAthene common stock at the option of the holder at any time based upon a
conversion rate of $10.00 per share.  In July 2009, we cancelled a
portion of the Old Notes, and issued new convertible notes and stock purchase
warrants to certain holders of the Old Notes as well as to certain new note
investors in a private placement (the “July 2009 Private
Placement”).  Specifically, in connection with the July 2009 Private
Placement, we:




·
              exchanged
      a portion of the Old Notes in the aggregate principal amount plus accrued
      interest totaling $8.8 million for new two-year 10% unsecured senior
      convertible notes, convertible into common shares at a conversion price of
      approximately $2.54 per share (the “New Convertible Notes”) and cancelled
      the corresponding Old Notes;
  ·
              issued
      additional New Convertible Notes in the aggregate principal amount of
      $10.5 million to new note
investors;
  ·
              issued
      to the recipients of the New Convertible Notes stock purchase warrants to
      purchase up to 2,572,775 shares of common stock at $2.50 per share, which
      warrants are exercisable from January 28, 2010 through January 28, 2015;
      and
  ·
              used
      the proceeds from the sale of the New Convertible Notes to repay $5.5
      million of the Old Notes that were not exchanged for the New Convertible
      Notes and warrants and repaid all outstanding amounts and fees under the
      Company’s then-existing credit
facility.


The New
Convertible Notes accrue interest at 10% per annum and mature on July 28,
2011.  The note holders may convert their principal and related
accrued interest into shares of the Company’s common stock at a conversion price
of $2.54 per share.  The conversion price is subject to adjustment for
specified dilutive events, as defined in the note.  Starting on July
28, 2010, the Company has the right to redeem all or a portion of the New
Convertible Notes.  Upon a change in control or default, as defined in
the note, the note holders may require the Company to redeem their
notes.  These two provisions of the note are considered embedded
derivatives that require bifurcation from the debt host contract.  At
the date of issuance and as of December 31, 2009, we have determined the
probability of change in control or default to be remote; accordingly the
resulting value of these derivatives is not significant.  We evaluate
these estimates and assumptions each reporting period and make revisions should
facts and circumstances warrant a change.




F-20


The New
Convertible Notes and related stock purchase warrants issued in exchange for the
Old Notes were accounted for as an early extinguishment of debt, resulting in a
loss on extinguishment of the Old Notes of approximately $4.7
million.  This portion of the New Convertible Notes and the related
stock purchase warrants were recorded at their fair values, resulting in an
increase to additional paid-in capital for the premium associated with the New
Convertible Notes and the value attributed to the warrants.




The New
Convertible Notes and related stock purchase warrants issued to new note
investors were recorded at their relative fair values.  As a result of
this relative fair value allocation, the total value allocated to the New
Convertible Notes issued to new note investors was $7.3 million.  In
combination with the $8.8 million of New Convertible Notes issued to the Old
Note holders, the total initial value ascribed to the New Convertible Notes was
approximately $16.1 million.  This initial value of $16.1 million will
be accreted up to the total aggregate principal face amount of $19.3 million
over the life of the notes by the recognition of additional interest
expense.  Financing costs incurred in connection with the July 2009
Private Placement were allocated to the various components of consideration
(liabilities and equity) based on the respective component’s relative fair
value.  The financing costs allocated to the liability component are
amortized to interest expense over the term of the New Convertible
Notes.




Credit
Facility




In March
2007, we entered into a $10 million credit facility with Silicon Valley Bank and
Oxford Finance Corporation (together, the “Lenders”).  In July 2009,
we repaid all outstanding amounts due under the credit facility along with
certain prepayment fees.  In connection with establishing the credit
facility, in 2007 we issued to the Lenders certain stock purchase warrants,
which expire on March 30, 2017, to purchase an aggregate of 100,778 shares of
the Company’s common stock at $3.97 per share.




Note
10 - Commitments and Contingencies




Leases




We lease
our offices in the United States under a 10 year operating lease, which
commenced on May 1, 2007.  Additionally, with the Avecia Acquisition,
we assumed an operating lease for office space in the United Kingdom which
expires in October, 2010.  Remaining annual minimum payments are as
follows:




2010
                  
                  $
                  958,2002011
                  
                  
                  750,4002012
                  
                  
                  747,7002013
                  
                  
                  773,4002014
                  
                  
                  793,3002015
      and thereafter
                  
                  
                  2,055,400




F-21


For the
years ended December  31, 2009 and 2008, total rent expense under
operating lease agreements approximated $1.0 million and $0.8 million,
respectively.




License
Agreements




In 2006
we licensed certain patent rights from a research company.  The
license agreement required a $50,000 up-front payment, provides for a sublicense
fee of 20% and provides for milestone payments of $25,000 upon the granting of a
U.S. patent, $200,000 upon the initiation of certain studies or trials, and
$250,000 upon Biologic License Application approval.  Upon
commercialization, the license agreement requires royalty payments equal to a
specified percentage of future sales of products for both government procurement
and commercial market sales subject to the license through the expiration of the
licensed patents.  No sublicense fee or milestone payments were
incurred in 2009 or 2008.




In 2006
we entered into a research and licensing agreement allowing for the licensing of
certain patent rights from a research company.  The agreement includes
research expense reimbursement payments and certain development milestone
payments.  Upon commercialization, the license agreement requires
royalty payments equal to a specified percentage of future sales of products for
both government procurement and commercial market sales subject to the license
through the expiration of the licensed patents.  No research expense
reimbursement payments or milestone payments were incurred in 2009 or
2008.




In
connection with the Nexia Acquisition, we acquired a license agreement for the
rights to certain technologies.  This agreement included an option to
license product processing technology necessary to perform development of
Protexia® as required under our government contract with the DoD.  We
executed a new licensing agreement with a development company in 2007 which
results in a license to all technology provided under the original agreement
including the necessary purification technology previously included in an option
and access to additional information and technology deemed to be essential for
development of Protexia® and performance under the DoD
contract.  Under the new agreement, we are required to pay initial
license fees totaling $700,000 and royalty payments based on net sales, with
$100,000 due in the first year.




In
connection with the Avecia Acquisition, we acquired license agreements with The
Defence Science and Technology Laboratory of the United Kingdom Ministry of
Defence (“DSTL”) for the rights to certain technologies.  These
agreements allow for the licensing of certain patents and technology necessary
to perform development of the rPA and plague vaccine programs as required under
the Company’s government contracts with the NIAID.  Upon
commercialization, the license agreements require that PharmAthene make royalty
payments equal to a specified percentage of future sales of products for both
government procurement and commercial markets.  No royalty payments on
these licenses have been incurred.




SIGA
Litigation




In
December 2006, we filed a complaint against Siga Technologies, Inc. (“SIGA”) in
the Delaware Chancery Court.  The complaint alleges, among other
things, that we have the right to license exclusively development and marketing
rights for SIGA’s drug candidate, SIGA-246, pursuant to a merger agreement
between the parties (the “Merger Agreement”) that was terminated in October
2006.  The complaint also alleges that SIGA failed to negotiate in
good faith the terms of such a license pursuant to the terminated merger
agreement.




F-22


We are
seeking alternatively a judgment requiring SIGA to enter into an exclusive
license agreement with the Company for SIGA-246 in accordance with the terms of
the term sheet attached to the merger agreement or monetary
damages.  In January 2008, the Delaware Chancery Court issued a ruling
denying a motion by SIGA to dismiss the complaint.  SIGA has filed a
counterclaim against the Company alleging that we breached our duty to engage in
good-faith negotiations by, among other things, presenting SIGA with a bad-faith
initial proposal for a license agreement that did not contain all necessary
terms, demanding SIGA prepare a complete draft of a partnership agreement and
then unreasonably rejecting that agreement, and unreasonably refusing to
consider economic terms that differed from those set forth in the license
agreement term sheet attached to the Merger Agreement.  SIGA is
seeking recovery of its reliance damages from this alleged breach.




Discovery
in the case closed in February 2010.  In March 2010 SIGA filed a
motion for summary judgment. All reply briefs and any cross motions for summary
judgment are due by early May 2010. While the specific timing for any
hearing on the motions is within the court’s discretion, we anticipate that the
court will schedule a hearing in June or July 2010.  Thereafter, once
the court rules on the motions for summary judgment, and assuming open issues
remain in the case, the parties can ask the court to set a trial date for any
time 45 days following the ruling on summary judgment.  An actual
trial date will be subject to the court’s discretion and its schedule and docket
at that time.




An
accrual for a loss contingency has not been made because the contingency is not
probable.




Government
Contracting




Payments
to the Company on cost-plus-fee contracts are provisional and are subject to
adjustment upon audit by the Defense Contract Audit Agency. In our opinion,
adjustments that may result from audits are not expected to have a material
effect on the Company’s financial position, results of operations, or cash
flows.




Registration
Rights Agreements




We
entered into a Registration Rights Agreement with the investors who participated
in the July 2009 Private Placement.  We subsequently filed a
registration statement on Form S-3 with the Securities and Exchange Commission
to register a portion of the shares underlying the New Convertible Notes and
related warrants, which registration statement was declared effective in the
fourth quarter 2009.  We are obligated to maintain the registration
statement effective until the date when all shares underlying the New
Convertible Notes and related warrants (and any other securities issued or
issuable with respect to in exchange for such shares) have been
sold.




We have
separate registration rights agreements with investors that we executed in
connection with the initial public offering, the Merger and a subsequent equity
financing, under which we have obligations to keep the corresponding
registration statements effective until the registrable securities (as defined
in each such agreement) have been sold, and under which we may have separate
obligations to file registration statements in the future on either a demand or
“piggy-back” basis or both.




Under the
terms of the New Convertible Notes, if the registration statement is not
declared effective as specified in such notes (“Effectiveness Failure”), or
after the effective date of the registration statement, after the 2nd
consecutive business day (other than during an allowable blackout period) on
which sales of all of the securities required to be included on the registration
statement cannot be made pursuant to the registration statement (a “Maintenance
Failure”), we will be required to pay to each selling stockholder a one-time
payment of 1.0% of the aggregate principal amount of the New Convertible Notes
relating to the affected shares on: (i) the day of an Effectiveness Failure and
(ii) the initial day of a Maintenance Failure. Our total maximum obligation
under this provision would be approximately $193,000.




F-23


Following
an Effectiveness Failure or Maintenance Failure, we will also be required to
make to each selling stockholder monthly payments of 1.0% of the aggregate
principal amount of the New Convertible Notes relating to the affected shares on
each of the following dates:  (i) on every 30th day after the initial
day of an Effectiveness Failure and (ii) on every 30th day after the initial day
of a Maintenance Failure, in each case prorated for shorter periods and until
the failure is cured. Our total maximum obligation under this provision would
approximate $193,000 for each month until the failure is cured.  The
payments above assume that we otherwise comply with the terms of the New
Convertible Notes.




Note
11 - Related Party Transactions




Several
directors and officers of the Company invested in the New Convertible Notes and
warrants as part of the July 2009 Private Placement.




Note
12 - Medarex Collaboration




In 2004,
the Company and Medarex, Inc. (“Medarex”) entered into a collaboration agreement
under which the companies are working to develop and commercialize MDX-1303
(known as Valortim®), a fully human monoclonal antibody targeting the Bacillus anthracis protective
antigen.  MDX-1303 was developed by Medarex using its UltiMAb Human
Antibody Development System®, and this antibody is currently in clinical
development by PharmAthene for use against human anthrax infection.




Under the
terms of the agreement, Medarex and PharmAthene have agreed jointly to continue
to investigate the potential for Valortim® to be used as a therapeutic for
individuals with active disease as well as for prophylactic treatment of
individuals exposed to anthrax.  For the years ended December 31, 2009
and 2008, we recognized research and development expenses of approximately $0.1
million and $0.4 million related to the development activities for
Valortim®.  PharmAthene is fully responsible for funding all future
research and development activities that are not supported by government
funds.  The companies will share future profits, if any, according to
a pre-agreed allocation percentage.




Note
13 - Stockholders’ Equity




Common
Stock




In March
2009, we completed a public sale of 2,116,055 shares of common stock at $2.60
per share and warrants to purchase 705,354 shares of our common stock at an
exercise price of $3.00 per share, generating gross proceeds of $5.5
million.  The warrants expire on September 27, 2014.




F-24


Long-Term
Incentive Plan




Prior to
2007, share-based awards were granted pursuant to our 2002 Long-Term Incentive
Plan (the “2002 Plan”).  In connection with the Merger, we assumed all
outstanding awards that had been initially granted under the 2002
Plan.  No further grants are being made under the 2002
Plan.  On August 3, 2007, the Company’s stockholders approved the 2007
Long Term Incentive Plan (the “2007 Plan”) which provides for the granting of
incentive and non-qualified stock options, stock appreciation rights,
performance units, restricted common awards and performance bonuses
(collectively “awards”)  to Company officers and
employees.  Additionally, the 2007 Plan authorizes the granting of
non-qualified stock options and restricted stock awards to Company directors and
to independent consultants.




At that
time, we reserved 3,500,000 shares of common stock in connection with awards to
be granted under the 2007 Plan, including those awards that had originally been
made under the 2002 Plan.  In 2008, the Company’s shareholders
approved amendments to the 2007 Plan, increasing from 3,500,000 shares to
4,600,000 shares the maximum number of shares authorized for issuance under the
plan and adding an evergreen provision pursuant to which the number of shares
authorized for issuance under the plan will increase automatically in each year,
beginning in 2009 and continuing through 2015, according to certain limits set
forth in the 2007 Plan.  The Board of Directors in conjunction with
management determines who receives awards, the vesting conditions, which are
generally four years, and the exercise price.  Options  may
have a maximum term of ten years.




The
following tables summarize the activity of the 2007 Plan for
options:




Shares
                
                
                Weighted-
                  Average
                  Exercise
                  Price
                
                
                Weighted-
                  Average
                  Remaining
                  Contractual
                  TermOptionsOutstanding
      January 1, 2009
                
                
                3,962,623
                
                
                $
                4.23Granted
                
                
                1,592,850
                
                
                $
                2.58Exercised
                
                
                (9,750
                )
                
                $
                2.72Forfeited
                
                
                (632,357
                )
                
                $
                2.85Outstanding,
      December 31, 2009
                
                
                4,913,366
                
                
                $
                3.88
                
                
                8.1 yearsExercisable,
      December 31, 2009
                
                
                2,253,547
                
                
                $
                4.30
                
                
                7.6 yearsVested
      and expected to vest, December 31, 2009
                
                
                4,473,487
                
                
                $
                3.91





The
aggregate intrinsic value is calculated as the difference between (i) the
closing price of the common stock at December 31, 2009 and (ii) the exercise
price of the underlying awards, multiplied by the number of options that had an
exercise price less than the closing price on the last trading
day.  The aggregate intrinsic value of options outstanding
and  exercisable was approximately $14,000  as of December
31, 2009.




Valuation
assumptions used to determine fair value of share-based
compensation




The fair
value for the 2009 and 2008 awards were estimated at the date of grant using the
Black-Scholes option-pricing model using the following assumptions:




F-25





December 31,2009
                  
                  
                  2008Weighted-average
      volatility
                  
                  
                  86
                  %
                  
                  
                  66
                  %Risk-free
      rate
                  
                  
                  1.8%-3.6
                  %
                  
                  
                  2.2-3.9
                  %Expected
      annual dividend yield
                  
                  
                  -
                  
                  
                  
                  -Expected
      weighted-average life, in years
                  
                  
                  6.0
                  
                  
                  
                  7.0





The
valuation assumptions were determined as follows:




·
              Weighted
      average volatility:  We determine expected volatility by using
      our historical volatility weighted 50% and the average historical
      volatility from comparable public companies with an expected term
      consistent with ours weighted 50%.
  ·
              Risk-free
      interest rate:  The yield on zero-coupon U.S. Treasury
      securities for a period that is commensurate with the expected term of the
      award.
  ·
              Expected
      annual dividend yield:  The estimate for annual dividends is
      zero because we have not historically paid a dividend and do not intend to
      do so in the foreseeable future.
  ·
              Expected
      life:  The expected term of the awards represents the period of
      time that the awards are expected to be outstanding.  We use
      historical data and expectations for the future to estimate employee
      exercise and post-vest termination behavior and therefore do not stratify
      employees into multiple
groups.




The
following tables summarize the activity of the 2007 plan for restricted
shares:


F-26





Shares
                  
                  
                  Weighted-
                    Average
                    Grant Date
                    Fair Value
                  
                  
                  Weighted-
                    Average
                    Remaining
                    TermRestricted
      SharesOutstanding
      January 1, 2009
                  
                  
                  163,121
                  
                  
                  $
                  5.05Granted
                  
                  
                  258,633
                  
                  
                  $
                  2.46Vested
                  
                  
                  (114,336
                  )
                  
                  $
                  3.71Forfeited
      or expired
                  
                  
                  (2,102
                  )
                  
                  $
                  5.17Outstanding,
      December 31, 2009
                  
                  
                  305,316
                  
                  
                  $
                  3.36
                  
                  
                  8.6
      yearsVested
      and expected to vest, December 31, 2009
                  
                  
                  254,821
                  
                  
                  $
                  3.36
                  
                  
                  8.6
      years





Unit
Purchase Option




In
connection with our initial public offering in 2005, the underwriters paid $100
for an option to purchase up to a total of 225,000 units.  The units
issuable upon exercise of this option are identical to those offered in the
initial public offering (i.e. each unit consists of one share of common stock
and one warrant) except that the associated warrants have a higher exercise
price (see below).  The unit purchase option became exercisable at
$10.00 per unit on August 3, 2007, and expires on July 27, 2010 (except that the
warrant included in such option expired unexercised on July 27,
2009).  The exercise price and number of units issuable upon the
exercise of the option may be adjusted in certain circumstances including in the
event of a stock dividend, or recapitalization, reorganization, merger or
consolidation.  We are not obligated to pay cash or other
consideration to the holders of the unit purchase option or “net-cash settle”
the obligation under the unit purchase option.




Warrants




In
connection with our initial public offering in 2005, we sold warrants to acquire
approximately 9.4 million shares of common stock at an exercise price of $6.00
per share; the warrants expired unexercised on July 27, 2009.  We also
issued to the representative of the underwriters an option to purchase up to a
total of 225,000 units (as discussed above).  Underlying the units are
225,000 shares of common stock and warrants to acquire 225,000 shares of common
stock at an exercise price of $7.50 per share.  All warrants expired
unexercised on July 27, 2009.




Pursuant
to the terms of our credit facility at the time (all outstanding amounts under
which were repaid in full in July 2009), we issued to the Lenders 100,778 common
stock warrants with an exercise price of $3.97 per share.  The
warrants expire in 2017, and are classified in equity.




In
connection with a stock purchase by Kelisia Holdings Ltd. in 2008, we issued a
warrant to purchase up to 2,745,098 additional shares of the Company’s common
stock at an exercise price of $5.10 per share.  This warrant expired
unexercised on October 10, 2009.




F-27


Prior to
our adoption on January 1, 2009 of new accounting guidance related to the
determination of derivative liabilities, we classified stock purchase warrants
as equity in our consolidated balance sheets.  As a result of the
adoption of the new accounting guidance, we considered the warrant issued to
Kelisia Holdings Ltd. to be a derivative liability and reclassified the warrant
to reflect it as a liability in the consolidated balance sheets.  The
impact of adopting this new guidance resulted in an increase to our retained
deficit and a decrease to additional paid in capital at January 1, 2009 of
approximately $0.2 million and $0.4 million, respectively, along with an
increase in reported liabilities of approximately $0.6 million.




In
connection with the March 27, 2009 public offering of approximately 2.1 million
shares, we issued warrants to purchase an aggregate of 705,354 shares of our
common stock at an exercise price of $3.00 per share.  The warrants
became exercisable on September 27, 2009 and will expire on September 27,
2014.  We consider these warrants to be a derivative liability and as
such reflect the liability at fair value in the consolidated balance
sheets.  The fair value of this derivative liability will be
re-measured at the end of every reporting period and the change in fair value
will be reported in the consolidated statement of operations as other income
(expense).




In
connection with the July 2009 Private Placement, we issued warrants to purchase
an aggregate of 2,572,775 shares of the Company’s common stock at an exercise
price of $2.50 per share.  The warrants will expire on January 28,
2015, and are classified in equity.




Note 14 - Income
Taxes




The
actual income tax provision (benefit) differs from the expected income tax
provision (benefit) computed at the federal statutory rate as
follows:




December 31,2009
                
                
                2008Statutory
      federal tax benefit
                
                $
                (10,975,118
                )
                
                $
                (12,375,599
                )State
      income tax, net of federal benefit
                
                $
                (1,166,452
                )
                
                
                (812,065
                )Other
      permanent differences
                
                
                1,041,007
                
                
                
                (349,219
                )Foreign
      rate differential
                
                
                571,788
                
                
                
                1,616,669Jurisdictional
      difference in book income
                
                
                
                
                
                
                4,105,939Increase
      in valuation allowance
                
                
                10,528,775
                
                
                
                7,814,275Income
      tax expense
                
                $
                -
                
                
                $
                -





Our net
deferred tax assets consisted of the following:




F-28





December 31,2009
                
                
                2008Deferred
      tax assets:Net
      operating loss carryforwards
                
                $
                33,865,625
                
                
                $
                26,045,695Fixed
      assets/intangibles
                
                
                7,834,521
                
                
                
                7,131,555Research
      and development credits/loss carryforwards
                
                
                2,207,081
                
                
                
                1,022,090Accrued
      expenses and other
                
                
                3,732,459
                
                
                
                1,858,109Total
      deferred tax assets
                
                
                47,639,686
                
                
                
                36,057,449Deferred
      tax liabilities:Convertible
      notes
                
                
                689,734
                
                
                
                -Bridge
      note revaluation
                
                
                -
                
                
                
                (166,766
                )Total
      deferred tax liabilities
                
                
                689,734
                
                
                
                (166,766
                )Net
      deferred tax assets
                
                
                48,329,420
                
                
                
                35,890,683Less:
      valuation allowance
                
                
                (48,329,420
                )
                
                
                (35,890,683
                )Net
      deferred tax assets
                
                $
                -
                
                
                $
                -





In
assessing the realizability of deferred tax assets, we consider whether it is
more likely than not that some or all of the deferred tax asset will not be
realized.  The ultimate realization of the deferred tax asset is
dependent upon the generation of future taxable income during the periods in
which the net operating loss carryforwards are available.  We consider
projected future taxable income, the scheduled reversal of deferred tax
liabilities and available tax planning strategies that can be implemented by us
in making this assessment on a jurisdiction-by-jurisdiction
basis.  Based upon the level of historical taxable income and
projections for future taxable income over the periods in which the net
operating loss carryforwards are available to reduce income taxes payable, we
have established a full valuation allowance against the net deferred tax asset
in 2009, consistent with 2008.




The U.S.
federal net operating loss carryforwards of approximately $67.9 million will
begin to expire in various years beginning in 2021.  Under Section 382
of the U.S. Internal Revenue Code, the Company’s net operating loss
carryforwards may be limited due to underlying ownership of its common
stock.  The Canadian federal net operating loss carryforwards of
approximately $10.9  million will begin to expire in
2014.  Certain Canadian federal net operating losses may have an
unlimited life.  The UK net operating loss carryforwards of
approximately $4.3 million has an unlimited life.




We have
analyzed tax positions in all jurisdictions where the Company is required to
file an income tax return and have concluded that we do not have any material
unrecognized tax benefits.  As such, we believe that any of its
uncertain tax positions would not result in adjustments to our effective income
tax rate.




F-29


Note
15 - Subsequent Events







On
February 22, 2010, our existing research and development contract with BARDA for
the development of SparVaxTM (HHSO100200900103C) was modified to provide for
additional advanced development funding for SparVaxTM.  During the base
period of performance under the contract modification, i.e., through December
31, 2012, we could receive payments of up to approximately $61 million on a
cost-reimbursement-plus-fixed-fee basis, assuming that all milestones are
achieved.  Under the contract modification, the government, at its
sole discretion, may exercise three contract options during the base period of
performance.  Assuming that the government exercises all three
options, we could receive up to an additional $17 million. On February 1, 2010,
we furthermore submitted a white paper under BAA-BARDA-09-34 requesting
additional funding to further support our development efforts on
SparVaxTM.   In March 2010, a third party filed a bid protest with
the U.S. Government Accountability Office (GAO), challenging the decision by
U.S. Department of Health and Human Services (HHS) to enter into the contract
modification.  On March 19, 2010 HHS suspended performance under the
modification pursuant to the automatic stay provisions of the Federal
Acquisition Regulations (or FAR), pending a decision by the GAO on the
protest.  A ruling on the protest is expected no later than June 11,
2010.




F-30