UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







Form 10-Q




(Mark
One)




x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended March 31, 2010Oro
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934







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)







Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes x  No o




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 o  No o







Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.




Large
      Accelerated Filer o
            
            Accelerated
      Filer oNon-Accelerated
      Filer o
            
            Smaller
      Reporting Company x(Do
      not check if a smaller reporting company)




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




Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date:    The number of shares
of the registrant’s Common Stock, par value $0.0001 per share, outstanding as of
May 4, 2010 was 30,086,019.









Table
of Contents




PHARMATHENE, INC.




TABLE
OF CONTENTS




PagePART I —FINANCIAL INFORMATIONItem 1. Financial Statements
            4Item 2. Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
            18Item 3. Quantitative and Qualitative Disclosures about
      Market Risk
            26Item 4. Controls and Procedures
            26PART II —OTHER INFORMATIONItem 1. Legal Proceedings
            28Item 1A. Risk Factors
            28Item 6. Exhibits
            35Certifications










PART I — FINANCIAL INFORMATION




Item 1.  Financial Statements





PHARMATHENE,
      INC.UNAUDITED
      CONSOLIDATED BALANCE SHEETSMarch
      31
                            
                            
                            December
      312010
                            
                            
                            2009ASSETSCurrent
      assets:Cash
      and cash equivalents
                            
                            $
                            735,119
                            
                            
                            $
                            2,673,567Restricted
      cash
                            
                            
                            100,000
                            
                            
                            
                            -Short-term
      investments
                            
                            
                            -
                            
                            
                            
                            3,137,071Accounts
      receivable
                            
                            
                            9,201,010
                            
                            
                            
                            8,866,346Other
      receivables (including unbilled receivables)
                            
                            
                            7,737,207
                            
                            
                            
                            8,566,425Prepaid
      expenses and other current assets
                            
                            
                            652,468
                            
                            
                            
                            973,214Total
      current assets
                            
                            
                            18,425,804
                            
                            
                            
                            24,216,623Property
      and equipment, net
                            
                            
                            6,481,457
                            
                            
                            
                            6,262,388Patents,
      net
                            
                            
                            918,368
                            
                            
                            
                            928,577Other
      long-term assets and deferred costs
                            
                            
                            308,348
                            
                            
                            
                            308,973Goodwill
                            
                            
                            2,348,453
                            
                            
                            
                            2,348,453Total
      assets
                            
                            $
                            28,482,430
                            
                            
                            $
                            34,065,014LIABILITIES AND STOCKHOLDERS' (DEFICIT)
      EQUITYCurrent
      liabilities:Accounts
      payable
                            
                            $
                            5,957,428
                            
                            
                            $
                            1,934,119Accrued
      expenses and other liabilities
                            
                            
                            8,422,656
                            
                            
                            
                            11,532,101Total
      current liabilities
                            
                            
                            14,380,084
                            
                            
                            
                            13,466,220Other
      long-term liabilities
                            
                            
                            458,846
                            
                            
                            
                            452,618Derivative
      instruments
                            
                            
                            567,803
                            
                            
                            
                            835,299Long-term
      debt
                            
                            
                            18,284,030
                            
                            
                            
                            17,426,513Total
      liabilities
                            
                            
                            33,690,763
                            
                            
                            
                            32,180,650Stockholders'
      (deficit) equity:Common
      stock, $0.0001 par value; 100,000,000 shares authorized; 28,188,288 and
      28,130,284 shares issued and outstanding at March 31, 2010 and December
      31, 2009, respectively
                            
                            
                            2,819
                            
                            
                            
                            2,813Additional
      paid-in-capital
                            
                            
                            157,673,857
                            
                            
                            
                            157,004,037Accumulated
      other comprehensive income
                            
                            
                            1,369,901
                            
                            
                            
                            1,188,156Accumulated
      deficit
                            
                            
                            (164,254,910
                            )
                            
                            
                            (156,310,642
                            )Total
      stockholders' (deficit) equity
                            
                            
                            (5,208,333
                            )
                            
                            
                            1,884,364Total
      liabilities and stockholders' (deficit) equity
                            
                            $
                            28,482,430
                            
                            
                            $
                            34,065,014


See the
accompanying notes to the consolidated financial statements.  4


PHARMATHENE,
      INC.UNAUDITED
      CONSOLIDATED STATEMENTS OF OPERATIONSThree
      months ended March 31,2010
                      
                      
                      2009Revenue
                      
                      $
                      3,116,553
                      
                      
                      $
                      5,521,903Operating
      expenses:Research
      and development
                      
                      
                      4,952,393
                      
                      
                      
                      5,695,326General
      and administrative
                      
                      
                      5,325,422
                      
                      
                      
                      5,145,999Depreciation
      and amortization
                      
                      
                      245,258
                      
                      
                      
                      192,478Total
      operating expenses
                      
                      
                      10,523,073
                      
                      
                      
                      11,033,803Loss
      from operations
                      
                      
                      (7,406,520
                      )
                      
                      
                      (5,511,900
                      )Other
      income (expense):Interest
      income
                      
                      
                      3,483
                      
                      
                      
                      104,245Interest
      expense
                      
                      
                      (948,150
                      )
                      
                      
                      (602,115
                      )Other
      income (expense)
                      
                      
                      139,422
                      
                      
                      
                      (123,841
                      )Change
      in market value of derivative instruments
                      
                      
                      267,496
                      
                      
                      
                      120,589Total
      other income (expense)
                      
                      
                      (537,749
                      )
                      
                      
                      (501,122
                      )Net
      loss
                      
                      $
                      (7,944,269
                      )
                      
                      $
                      (6,013,022
                      )Basic
      and diluted net loss per share
                      
                      $
                      (0.28
                      )
                      
                      $
                      (0.23
                      )Weighted
      average shares used in calculation of basic and diluted net loss per
      share
                      
                      
                      28,172,802
                      
                      
                      
                      26,009,387See
      the accompanying notes to the consolidated financial
      statements.





5




PHARMATHENE,
      INC.UNAUDITED
      CONSOLIDATED STATEMENTS OF CASH FLOWSThree
      months Ended March 312010
                  
                  
                  2009Operating
      activitiesNet
      loss
                  
                  $
                  (7,944,269
                  )
                  
                  $
                  (6,013,022
                  )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Change
      in market value of derivative instruments
                  
                  
                  (267,496
                  )
                  
                  
                  3,085Depreciation
      and amortization
                  
                  
                  245,258
                  
                  
                  
                  192,478Measurement
      period changes in purchase accounting estimates
                  
                  
                  -
                  
                  
                  
                  112,173Compensatory
      option expense
                  
                  
                  695,029
                  
                  
                  
                  951,560Non
      cash interest expense on debt
                  
                  
                  895,155
                  
                  
                  
                  468,047Changes
      in operating assets and liabilities:Accounts
      receivable
                  
                  
                  (306,422
                  )
                  
                  
                  (1,160,788
                  )Prepaid
      expenses and other current assets
                  
                  
                  1,093,149
                  
                  
                  
                  (168,509
                  )Accounts
      payable
                  
                  
                  4,180,024
                  
                  
                  
                  (414,221
                  )Accrued
      expenses and other liabilities
                  
                  
                  (2,972,554
                  )
                  
                  
                  (742,539
                  )Net
      cash used in operating activities
                  
                  
                  (4,382,126
                  )
                  
                  
                  (6,771,736
                  )Investing
      activitiesPurchases
      of property and equipment
                  
                  
                  (279,488
                  )
                  
                  
                  (151,979
                  )Purchases
      of short term investments
                  
                  
                  -
                  
                  
                  
                  (3,982,682
                  )Proceeds
      from sales or maturities of short term investments
                  
                  
                  3,130,588
                  
                  
                  
                  400,000Net
      cash provided by (used in) investing activities
                  
                  
                  2,851,100
                  
                  
                  
                  (3,734,661
                  )Financing
      activitiesPayments
      of debt obligations
                  
                  
                  -
                  
                  
                  
                  (1,000,000
                  )Change
      in restricted cash requirements
                  
                  
                  (100,000
                  )
                  
                  
                  4,250,000Net
      proceeds from issuance of common stock and warrants
                  
                  
                  (25,203
                  )
                  
                  
                  4,978,778Net
      cash provided by (used in) financing activities
                  
                  
                  (125,203
                  )
                  
                  
                  8,228,778Effects
      of exchange rates on cash
                  
                  
                  (282,219
                  )
                  
                  
                  (229,364
                  )Decreases
      in cash and cash equivalents
                  
                  
                  (1,938,448
                  )
                  
                  
                  (2,506,983
                  )Cash
      and cash equivalents, at beginning of period
                  
                  
                  2,673,567
                  
                  
                  
                  19,752,404Cash
      and cash equivalents, at end of period
                  
                  $
                  735,119
                  
                  
                  $
                  17,245,421Supplemental
      disclosure of cash flow informationCash
      paid for interest
                  
                  $
                  2,853
                  
                  
                  $
                  124,908Cash
      paid for income taxes
                  
                  $
                  0
                  
                  
                  $
                  184,226See
      the accompanying notes to the consolidated financial
      statements.




6




PHARMATHENE,
INC.


Notes
to Unaudited Consolidated Financial Statements


March
31, 2010







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”) in 2005, a special
purchase acquisition corporation formed solely to acquire a then unidentified
business.  In 2007  HAQ acquired a Delaware corporation
which at the time was known as “PharmAthene, Inc.” (the “Merger”); as a result
of the Merger, HAQ changed its name to “PharmAthene, Inc.”




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, and equity
issued subsequent to March 31, 2010) to sustain our operations.  Based
on the operating cash requirements and capital expenditures expected through the
end of 2010, and expected receipts from our government contracts and grants, we
currently do not anticipate requiring additional funding to continue our current
level of operations through the end of 2010.  We may elect to raise
additional capital in 2010 through the issuance of debt and/or equity to expand
our business and/or strengthen our financial position or, if our current
expectations and estimates about future operating costs prove to be incorrect,
we may need to raise additional capital in 2010.   Further, we
may need to raise additional capital to fund our operations beyond
2010.




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 (which was merged
with and into PharmAthene, Inc. in the first quarter 2009), 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.  In the opinion of management, the accompanying
unaudited condensed consolidated financial statements include all adjustments,
consisting of normal recurring adjustments, which are necessary to present
fairly our financial position, results of operations and cash flows. The
condensed consolidated balance sheet at December 31, 2009 has been derived from
audited consolidated financial statements at that date. The interim results of
operations are not necessarily indicative of the results that may occur for the
full fiscal year. These statements should be read in conjunction with the
Consolidated Financial Statements and Notes included in our Annual Report on
Form 10-K for the year ended December 31, 2009 filed with the Securities and
Exchange Commission. We currently operate in one business segment.


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
whose financial statements are prepared for using the local currency as the
functional currency, and (ii) unrealized gains and losses on short term
available-for-sale investments. Comprehensive loss for the three month periods
ended March 31, 2010 and 2009 was approximately $7.8 million and $6.7 million,
respectively.  Comprehensive loss was not significantly different from net
loss.





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 $0.0
million and $0.1 million for the three months ended March 31, 2010 and 2009,
respectively.




Short-Term
Investments




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 for similar instruments.  Management
reviews the Company’s investment portfolio on a regular
basis and seeks guidance from its 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. At March 31, 2010 there were no short-term investments.




8


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 Institutes of
Health (“NIH”).




As of
March 31, 2010 and December 31, 2009, the Company’s trade receivable balances
were comprised solely of receivables from these customers.  Unbilled
accounts receivable totaling $7.1 million and $7.7 million as of March 31, 2010
and December 31, 2009, respectively, relate to the contracts with these same
customers.




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.




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 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 as of
March 31, 2010 or December 31, 2009.




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 and concluded that goodwill was not
impaired.  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.  In accordance with ASC Section 360-10-35, "Impairment or
Disposal of Long-Lived Assets"we
review assets for impairment. If impairment is indicated, we measure the amount
of such impairment by comparing the carrying value of the assets to the present
value of the expected future cash flows associated with the use of the asset.
During the three months ended March 31, 2010, no indicators of impairment came
to our attention.


9




Accrued Expenses




Management is required to estimate accrued expenses as
part of the process of preparing financial statements.  The estimation of
accrued expenses involves identifying services that have been performed on the
Company’s behalf, and estimating the level of
services performedand the associated costs incurred for
such services as of each balance sheet date in the financial statements. 
Accrued expenses include professional service fees, such as fees paid to lawyers
and accountants, contract service fees, such as those under contracts with clinical research
organizations and investigators in conjunction with clinical trials, and fees to
contract manufacturers in conjunction with the production of clinical
materials.  Pursuant to management’s assessment of the services that havebeen performed on clinical trials and
other contracts, the Company recognizes these expenses as the services are
provided.  Management assessments include, but are not limited to: 
(1) an evaluation by the project manager of the work that has been
completedduring the period, (2) measurement
of progress prepared internally and/or provided by the third-party service
provider, (3) analyses of data that justify the progress, and
(4) management’s judgment.





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 period by
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.  For the three months ended March 31, 2010 and 2009, we
recorded approximately $0.8 million and $0.3 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.





At March
31, 2010, “Other receivables (including unbilled receivables)” were
approximately $7.7 million.    As we progress through 2010,
we expect the amount of unbilled receivables to decline until all programs are
being invoiced on a current basis.


10





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; pre-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 award date and is  recognized
ratably as expense over the requisite service period.  Employee
share-based compensation expense recognized in the three months ended March 31,
2010 and 2009 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 the three months
ended March 31, 2010 and 2009, was:




Three
      months ended March 31,2010
                      
                      
                      2009Research
      and development
                      
                      $
                      183,427
                      
                      
                      $
                      259,320General
      and administrative
                      
                      
                      511,602
                      
                      
                      
                      692,240Total
      share-based compensation expense
                      
                      $
                      695,029
                      
                      
                      $
                      951,560




During
the three months ended March 31, 2010, we granted options to purchase an
aggregate of 110,000 shares of common stock to employees and non-employee
directors, and made no restricted stock grants.  At March 31, 2010, we had
total unrecognized stock based compensation expense related to unvested awards
of approximately $5.0 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 March 31, 2010, 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.


11




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
statements of operations.




Basic
and Diluted Net Loss Per Share




Basic
loss per share is computed by dividing consolidated net loss by the weighted
average number of shares of common stock 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 allocable to common
shareholders by the weighted average number of shares outstanding and the impact
of all dilutive potential shares of common stock,
consisting  primarily of stock options and the shares of common stock
underlying our convertible notes and stock purchase warrants.  The
dilutive impact of our dilutive potential shares of common stock resulting from
stock options and stock purchase warrants is determined by applying the treasury
stock method.  The dilutive impact of our dilutive potential shares of
common stock resulting from our convertible notes is determined by applying the
“if converted” method.




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 shares of common
stock is anti-dilutive due to the net losses.  A total of 16.5 million
and 20.1 million potential dilutive shares have been excluded in the calculation
of diluted net loss per share in the three months ended March 31, 2010 and 2009,
respectively, because their inclusion would be anti-dilutive.




Recent
Accounting Pronouncements




There are
several new accounting and disclosure requirements that we will be required to
adopt in the future, primarily with respect to revenue recognition practices. In
2011 we will be required to adopt ASU 2009-13 which deals with new revenue
recognition practices relating to revenue arrangements that include multiple
elements.  We will also be adopting ASU 2010-17 which deals with
revenue recognition for arrangements with milestones.  Our government
contracts and grants, and any future modifications to those contracts and
grants, may be affected by the new accounting and disclosure requirements. We
are currently evaluating any potential impact these new requirements may have on
our consolidated financial statements.





Note 3–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 third quarter
of 2009, we recorded a reserve for these exit activities, of which $1.0 million
remained in accrued expense at March 31, 2010.


12




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.




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 March 31, 2010 and 2009 we had level 3 derivative
liabilities of approximately $0.6 million and $1.5 million,
respectively




The
following table sets forth a summary of changes in the fair value of our Level 3
liabilities for the three months ended March 31, 2010:




Description
                      
                      Balance as of
                        December
                        31, 2009
                      
                      
                      Cumulative Effect
                        of Adoption of
                        New Accounting
                      
                      
                      New Liabilities
                      
                      
                      Unrealized Gains
                      
                      
                      Balance as of
                        March
      31,
                        2010Stock
      purchase warrants
                      
                      $
                      835,299
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      $
                      267,496
                      
                      
                      $
                      567,803




13


The following table sets
forth a summary of changes in the fair value of the Company’s Level 3 liabilities
for the three months ended March31, 2009:





Description
              
              Balance
      at
                December
                31,
      2008
              
              
              Cumulative
                Effect
      of the
                Adoption
      of
                EITF
      07-05
                (See
      Note 4)
              
              
              Realized
                Gains
      (Losses)
              
              
              Balance
      as
                of
      March
                31,
      2009Derivative
      liabilities related to Warrants
              
              $
              —
              
              
              $
              1,412,110
              
              
              $
              123,674
              
              
              $
              1,535,784




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





At March
31, 2010 we had no available-for-sale investments.





During
the three months ended March 31, 2010, we realized net gains of approximately
$4,640 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 - 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”).   The balance at March 31, 2010 was $18.3 million. 
In connection with the July 2009 Private Placement, among other things
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 shares of
common stock at a conversion price of approximately $2.54 per share (the “New
Convertible Notes”) and cancelled the corresponding Old Notes;
and




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




14




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 March 31, 2010, 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.





Note
7 - Commitments and Contingencies





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.




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, and subsequently we filed an answering brief and
SIGA filed its reply brief. While the specific timing for any hearing on SIGA’s
motion 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 motion 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.


15




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.




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
8 - Stockholders’ Equity




Common
Stock




In April
2010, we completed a public sale of 1,666,668 shares of common stock at $1.50
per share and warrants to purchase 500,000 shares of our common stock at an
exercise price of $1.89 per share, generating gross proceeds of $2.5 million.
The warrants become exercisable on October 13, 2010 and expire on October 13,
2015. Placement fees of $175,000 and legal fees of $92,772 were incurred in
connection with this transaction.




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.


16




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.




Warrants




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.  These warrants are 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
9 - Subsequent Events




In April
2010, we completed a public sale of 1,666,668 shares of common stock at $1.50
per share and warrants to purchase 500,000 shares of our common stock at an
exercise price of $1.89 per share, generating gross proceeds of $2.5
million.  The warrants become exercisable on October 13, 2010 and
expire on October 13, 2015. Placement fees of $175,000 and legal fees of $92,772
were incurred in connection with this transaction.





In April
2010 David P. Wright resigned as CEO.  In May 2010, Mr. Wright
resigned as member of our Board of Directors, and Mr. Eric Richman was appointed
interim CEO.





17




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




This
Quarterly Report on Form 10-Q 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.  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 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 the Company’s
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 from time to time in PharmAthene’s Forms 10-K and 10-Q under
the caption “Risk Factors” and in its other reports filed with the U.S.
Securities and Exchange Commission (the “SEC”).  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 Avecia’s biodefense vaccines business. 
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 Quarterly Report on
Form 10-Q on information available to us on the date of this Quarterly
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.




The
following discussion should be read in conjunction with the our condensed
consolidated financial statements which present our results of operations for
the three months ended March 31, 2010 and 2009 as well as our financial
positions at March 31, 2010 and December 31, 2009, contained elsewhere in
this Quarterly Report on Form 10-Q.  The following discussion should
also be read in conjunction with the Annual Report on Form 10-K for the
year ended December 31, 2009 filed on March 26, 2010 and as amended on
April 30, 2010, including the consolidated financial statements contained
therein.




Overview




We are a
biodefense company engaged in the development and commercialization of medical
countermeasures against biological and chemical weapons.  Our current lead
product candidates are:




·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, and


18




·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.





Recent
Events




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 Competition in Contracting Act, pending a decision by the GAO
on the protest, which is expected no later than June 11, 2010.




On
February 1, 2010, we submitted a white paper under BAA-BARDA-09-34 (which BAA
was originally issued in March 2009 and amended in December 2009) requesting
additional funding to further support our development efforts on
SparVaxTM.  Generally, if BARDA finds a white paper submission
acceptable, it will then request an interested party to submit a formal funding
proposal.  BARDA has provided feedback to us regarding certain
technical aspects of the program, in particular matters related to the proposed
alternative formulation, and notified us that they would not be requesting a
full proposal at this time based on the submitted white
paper.  However, in its written response and in debriefing meetings,
BARDA strongly encouraged us to resubmit a revised white paper focusing on areas
of interest to them that would support a BAA funding.




NIAID has
raised concerns regarding performance under our existing three year, $13.2
million contract with them related to our third-generation anthrax vaccine
program, with project delays and contract management noted as key areas of
concern.  Through March 31, 2010 we had recognized approximately $1.6
million in revenue under this contract. In April 2010, NIAID notified us that
the agency is considering terminating the contract, possibly for
default.  We have responded to address the agency’s specific
concerns.  At this point we believe it is likely that we will reach an
agreement with NIAID regarding termination of this contract.





We have been exploring alternative third
generation technologies for enhancing an rPA-based vaccine, which are directed
at meeting the government’s requirements for reducing the number
of doses to achieve
protective immunity, enhancing product stability, and possibly employing
alternative delivery mechanism.  We are a current rPA supplier to a
company that has been awarded a third generation contract and a past supplier to
other companies exploring thistechnology. We are developing a
lyophilized rPA-based vaccine candidate that has shown promise, and we are
continuing to evaluate its potential to fulfill these
requirements.


19





In April
2010, we completed a public sale (the “April 2010 Public Offering”) of 1,666,668
shares of common stock at $1.50 per share and warrants to purchase 500,000
shares of our common stock at an exercise price of $1.89 per share, generating
gross proceeds of $2.5 million.  The warrants become exercisable on
October 13, 2010 and expire on October 13, 2015.





I n April
2010 BARDA informed us of its belief that it is not practical at this point to
resume negotiations under our current proposal under BARDA- BAA-09-34 for the
advanced development of Valortim® and encouraged us to submit a new white paper
under Broad Agency Announcement,  BARDA-CBRN-BAA-10-100-SOL-00012, if
and when FDA agrees to permit us to reinitiate the Valortim® IV administration
clinical trial program. The program is continuing under our current contract
with NIAID/BARDA .





In April
2010, David P. Wright resigned as Chief Executive Officer.  In May
2010, Mr. Wright resigned as member of our Board of Directors, and Mr. Eric
Richman was appointed interim Chief Executive Officer.





In April
2010, our Board of Directors appointed Mitchel Sayare, Ph.D. to serve as a
director, and we hired Thomas R. Fuerst to serve as our Senior Vice President,
Chief Scientific Officer.





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.





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.  For the three months ended March 31, 2010 and 2009, we
recorded approximately $0.8 million and $0.3 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. At March
31, 2010, “Other receivables (including unbilled receivables)” were
approximately $7.7 million.    As we progress through 2010,
we expect the amount of unbilled receivables to decline until all programs are
being invoiced on a current basis.


20




Research
and Development Expenses




Research
and development costs are expensed as incurred; pre-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.





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.  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, in accordance with ASC Section 360-10-35,
"Impairment or Disposal of Long-Lived Assets."
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.   If impairment is indicated, we measure the amount of
such impairment by comparing the carrying value of the assets to the present
value of the expected future cash flows associated with the use of the
asset.




Results
of Operations




Revenue




We
recognized revenue of $3.1 million and $5.5 million during the three months
ended March 31, 2010 and 2009, 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 three months ended March 31,
2010 changed from the comparable period of 2009 primarily due to the
following:


21




·Under
the September 2006 contract with the DoD for the advanced development of
Protexia®, we
recognized $0.0 million and $2.4 million of revenue for the three months ended
March 31, 2010 and 2009, respectively.  The significant decline in revenue
in the 2010 period as compared to 2009 is primarily attributable to the fact
that activities related to the first phase of this contract were completed in
2009  and the Company is awaiting the decision of the DoD regarding
whether to fund the next phase of the program.  It is unclear at this point
when the DoD will make a decision regarding funding for the next phase (although
the government has indicated that it may make a decision before the end of the
third quarter 2010).  In addition, the Company has requested interim
funding from the DoD for certain activities under this program through the end
of 2010.  Until a funding decision is made either for the proposed
interim activities or for the longer term, we do not expect to recognize
significant additional revenues under this contract.




·Under
our contract for the development of SparVaxTM, we recognized approximately $2.1
million and $2.0 million of revenue for the three months ended March 31, 2010
and 2009, respectively.  The increase in revenue in 2010 as compared to
2009 was primarily attributable to the additional work performed under the
contract modification entered into in February 2010, performance under which was
subsequently suspended pending a decision on the protest  (as
described in “--Recent Events” above).




·Under
the September 2007 contract for the advanced development of Valortim®, we
recognized $0.8 million and $0.6 million of revenue for the three months ended
March 31, 2010 and 2009, respectively.  Revenue in both periods was largely
attributable to reimbursement of costs related to non-clinical
studies.  In addition, work in the three months ended March 31, 2009
included other development work as we prepared for human clinical trials, while
work in the three months ended March 31, 2010 included work in connection with
the on-going investigation related to the partial clinical hold and certain
manufacturing-related activities.





Research
and Development Expenses




Our
research and development expenses were $5.0 million and $5.7 million for the
three months ended March 31, 2010 and 2009, 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 three months ended March 31, 2010 and 2009 were net of cost
reimbursements under certain of our government grants of $0.8 million and $0.3
million, respectively.




Research
and development expenses for the three months ended March 31, 2010 and 2009 were
attributable to research programs as follows:





Three
      Months ended($ in millions)
                
                March 31,
                  2010
                
                
                March
      31,
                  2009Anthrax
      therapeutic and vaccines
                
                $
                4.0
                
                
                
                2.7Chemical
      nerve agent protectants
                
                
                1.0
                
                
                
                2.5Recombinant
      dual antigen plague vaccine
                
                
                —
                
                
                
                0.3Internal
      research and development
                
                
                
                
                
                
                0.2Total
      research and development expenses
                
                $
                5.0
                
                
                
                5.7




22


For the
three months ended March 31, 2010, research and development expenses decreased
$0.7 million from the prior year period, primarily due to a reduction in
pre-clinical development costs for our chemical nerve agent protectants program,
having finished activities for the initial phase of this program by the end of
2009 , 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.





The
decrease in development expenses related to the clinical nerve agent protectants
program resulted from reduced process development and manufacturing activities
as the program completed the development stage by the end of 2009.  As we
note above,we and
the U.S. government have agreed to a reduction to the scope of work related to
the development of our plague vaccine, and costs (and related revenue) under
that contract have declined during the wind down period.  Until such
time as the DoD decides, if ever, to continue to fund work, whether on an
interim basis during 2010 and/or over the longer term, costs incurred under our
chemical nerve agent protectants 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 $5.3 million and $5.1
million for the three months ended March 31, 2010 and 2009,
respectively.




General
and administrative expenses increased $0.2 million for the three months ended
March 31, 2010, as compared to the prior year period, primarily due to the
recording of an allowance for doubtful accounts in the amount of approximately
$588,000, established in conjunction with correspondence with NIAID regarding
the potential wind down of the third-generation anthrax vaccine program,
partially offset by reduced professional and consulting fees and travel and
entertainment expenses.




Depreciation
and Intangible Amortization




Depreciation
and amortization expenses were $0.2 million and $0.2 million for the three
months ended March 31, 2010 and 2009, 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
three months ended March 31, 2010 and 2009, we recognized interest income on our
investments of $0.0 million and $0.1 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.


23




We
incurred interest expense of $0.9 million and $0.6 million for the three months
ended March 31, 2010 and 2009, respectively.  Interest expense for both
periods relates primarily to interest on our outstanding convertible
notes.  For the three months ended March 31, 2010, interest expense
includes the amortization of the debt discount arising from
the  allocation of fair value to the stock purchase warrants issued in
connection with the July 2009 convertible debt, whereas interest expense for the
first quarter 2009 also includes amounts related to our outstanding secured
credit facility, which was repaid in full during the third quarter
2009.




The
change in the fair value of our derivative instruments was $0.3 million for the
three months ended March 31, 2010 compared to $0.1 million for the three months
ended March 31, 2009.  The fair value of these derivative instruments
is estimated using the Black-Scholes option pricing model.





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.  Based on the operating cash
requirements and capital expenditures expected through the end of 2010, and
expected receipts from our government contracts and grants, we currently do not
anticipate requiring additional funding to continue our current level of
operations through the end of 2010.  We may elect to raise additional
capital in 2010 through the issuance of debt and/or equity to expand our
business and/or strengthen our financial position or, if our current
expectations and estimates about future operating costs prove to be incorrect,
we may need to raise additional capital in 2010.   Further, we
may need to raise additional capital to fund our operations beyond
2010.





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.


24




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.





Sources
and Uses of Cash




Cash,
cash equivalents, restricted cash and short-term available-for-sale investments
were $0.8 million and $5.8 million at March 31, 2010 and December 31, 2009,
respectively.  The $5.0 million decrease at March 31, 2010 was primarily
attributable to the net impact of cash used to fund operations and the timing of
collections on our U.S. Government accounts receivable.  As of March
31, 2010 and December 31, 2009, total accounts receivables and other receivables
(including unbilled receivables) were $16.9 million and $17.4 million,
respectively.  As we progress through 2010, we expect the amount of
unbilled receivables to decline until all programs are being invoiced on a
current basis.
 
 As a
result of the April 2010 Public Offering, we sold 1,666,668 shares of common
stock at $1.50 per share and warrants to purchase 500,000 shares of our common
stock at an exercise price of $1.89 per share, generating gross proceeds of $2.5
million.  The warrants become exercisable on October 13, 2010 and
expire on October 13, 2015.




Operating
Activities




Net cash
used in operating activities was $4.4 million and $6.8 million for the three
months ended March 31, 2010 and 2009, respectively.  Net cash used in
operations during the three months ended March 31, 2010 primarily reflects the
$7.9 million net loss for the period and a decrease in accrued expenses and
other liabilities of $3.0 million due to reduced development activities,
partially offset by a $4.2 million increase in accounts payable due to enhanced
cash management activities and a $1.1 million increase in prepaid expenses and
other current assets.
  Cash used
in operations during the three months ended March 31, 2009 reflects a net loss,
after the effect of non-cash adjustments, of $4.3 million, an increase in
accounts receivable of $1.2 million, and a decrease in accrued expenses and
accounts payable totaling $1.2 million.  Non-cash adjustments for the
three months ended March 31, 2009 included non-cash stock compensation expense
of $1.0 million and non-cash interest expense of $0.5 million related to the Old
Notes.  Accounts receivable increased due to contract award
receivables due from NIAID related to the further development of SparVaxTM
and  RypVaxTM under contracts acquired in the second quarter of 2008 as
part of the Avecia Acquisition, and from NIAID related to increased activities
for the development of Valortim® and our third generation rPA anthrax
vaccine.


Investing
Activities




Net cash
provided by investing activities was $2.9 million for the three months ended
March 31, 2010, compared to $3.7 million used in investing activities for the
three months ended March 31, 2009.  Investing activities for the 2010
period related primarily to liquidating investments to meet working capital
requirements.




Net cash
used in investing activities for the first three months of 2009 related
primarily to the purchase, net of sales of available for sale securities, of
$3.6 million and approximately $0.2 million of capital
expenditures.


25





Financing
Activities




Net cash
used in financing activities was $0.1 million for the three months ended March
31, 2010 as compared to $8.2 million provided by financing activities for the
three months ended March 31, 2009.  Net cash used in financing
activities for the three months ended March 31, 2010 consisted of the issuance
of a $100,000 letter of credit in favor of American Express.





In March
2009, the Company raised net proceeds of approximately $5.0 million as a result
of the public sale of shares of its common stock and warrants. 
Additionally, in the first quarter 2009, the Company reduced its restricted cash
obligations under its outstanding secured credit facility by $4.3 million. 
The Company made principal repayments of $1.0 million under this credit facility
for the three months ended March 31, 2009, which it repaid in full during
the third quarter 2009.




Off-Balance
Sheet Arrangements




We do not
have any off-balance sheet arrangements.




Contractual
Obligations




The
following are contractual commitments at March 31, 2010 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
                
                $
                5,782,427
                
                
                
                853,794
                
                
                1,496,764
                
                
                
                2,401,392
                
                
                
                1,030,477Research
      and development agreements
                
                
                18,782,737
                
                
                
                16,797,737
                
                
                1,985,000
                
                
                
                -
                
                
                
                -Notes
      payable, including interest
                
                
                23,208,562
                
                
                
                -
                
                
                23,208,562
                
                
                
                -
                
                
                
                -Total
      contractual obligations
                
                $
                47,773,726
                
                
                
                17,651,531
                
                
                26,690,326
                
                
                
                2,401,392
                
                
                
                1,030,477







(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.




Item 3.  Quantitative and Qualitative Disclosures about
Market Risk.





Not
applicable.





Item 4.  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.


26




Changes
in Internal Control Over Financial Reporting




There
were no changes in our internal control over financial reporting, identified in
connection with the evaluation required by Rule 13a-15(d) under the Securities
Exchange Act of 1934, as amended, that occurred during the quarter ended March
31, 2010 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.




In April
2010, David P. Wright resigned as our Chief Executive Officer, and in May 2010
Eric I. Richman was appointed as our interim Chief Executive
Officer.




Inherent
Limitations on Disclosure Controls and Procedures




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.


27


PART II — OTHER INFORMATION




Item 1.  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 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, and subsequently we filed an answering brief and
SIGA filed its reply brief. While the specific timing for any hearing on SIGA’s
motion 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 motion 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.




Item 1A.  Risk Factors




Investing
in our securities involves risks.  In addition to the other information in
this quarterly report on Form 10-Q, stockholders and potential investors
should carefully consider the risks and uncertainties discussed in the
section "Item 1.A.  Risk Factors" in our annual report on Form 10-K for the
year ended December 31, 2009, as supplemented by the risks and uncertainties
discussed below.  If any of the risks and uncertainties set forth
below or in our annual report on Form 10-K actually materialize, 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. The risks and
uncertainties described below and in our annual report on Form 10-K 
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.





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 $164.3 million at March 31, 2010.  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.


28




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




·      developing our existing products and
developing and testing new product candidates;





·      continuing
to receive government funding and identifying new government funding
opportunities;





·      receiving
regulatory approvals;





·      carrying out our intellectual property
strategy;





·      establishing our competitive
position;





·      pursuing third-party
collaborations;





·      acquiring or in-licensing products;
and





·      manufacturing and marketing
products.





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, based
on the operating cash requirements and capital expenditures expected through the
end of 2010, and expected receipts from our government contracts and grants, we
currently do not anticipate requiring additional funding to continue our current
level of operations 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.


29




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




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 contract manufacturing organizations (“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 (now a subsidiary of Merck
& Co., Inc.), to replace Avecia (now a subsidiary of Merck & Co., Inc.)
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.




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 partial clinical hold, pending the
results of our investigation of the potential causes for adverse reactions
observed in two subjects dosed in the trial.  As a consequence, BARDA
advised us that until satisfactory resolution of this issue and the partial
clinical hold is lifted it would not act on our request for additional advanced
development funding for Valortim ® under BAA-BARDA-09-34.  In
April 2010 BARDA informed us of its belief that it is not practical at this
point to resume negotiations under the current proposal and encouraged us to
submit a new white paper for Valortim® under Board Agency Announcement,
BARDA-CBRN-BAA-10-100-SOL-00012, if and when FDA agrees to permit us to
reinitiate a Valortim® iv administration clinical trial program.  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 submit a new white paper and if in
response BARDA will request a formal proposal and provide additional funding for
this program, and what the effects of any delay in potential future funding of
the program will be on the overall Valortim® development timeline.


30




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.




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




All
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.


31




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 has resulted in early wind down of all activities under our
existing RypVaxTM contract.  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®.





In the
fourth quarter of 2009, the FDA placed our phase I clinical trial of Valortim®
and ciprofloxacin on partial clinical hold, pending the results of our
investigation of the potential causes for adverse reactions observed in two
subjects dosed in the trial.  As a consequence, BARDA advised us that
until satisfactory resolution of this issue and the partial clinical hold is
lifted it would not act on our request for additional advanced development
funding for Valortim® under BAA-BARDA-09-34.  In April 2010 BARDA
informed us of its belief that it is not practical at this point to resume
negotiations under the current proposal and encouraged us to submit a new white
paper for Valortim® under Board Agency Announcement,
BARDA-CBRN-BAA-10-100-SOL-00012, if and when FDA agrees to permit us to
reinitiate a Valortim® iv administration clinical trial program.  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 submit a new white paper and if in
response BARDA will request a formal proposal and provide additional funding for
this program, 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.





32


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.




NIAID has
raised concerns regarding performance under our existing three year, $13.2
million contract with them related to our third-generation anthrax vaccine
program, with project delays and contract management noted as key areas of
concern.  Through March 31, 2010 we had recognized approximately $1.6
million in revenue under this contract. In April 2010, NIAID notified us that
the agency is considering terminating the contract, possibly for
default.  We have responded to address the agency’s specific
concerns.  At this point we believe it is likely that we will reach an
agreement with NIAID regarding termination of this contract.





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.




Risks
Related to Dependence on or Competition From Third Parties




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, store, 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, including master and working
cell banks, 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, storage,
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, storage, 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, storage companies, 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.


33




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
aware of one granted U.S. patent directed to pegylated butyrylcholinesterase.
Protexia® includes a pegylated butyrylcholinesterase.  If a license is
required under such patent, we believe that the patent owner is willing to grant
such a license; however, we cannot provide any assurances that, if needed, such
a license will be granted or that the terms thereof will be
reasonable.  We are also aware of pending applications directed to
pegylated butyrylcholinesterase and if a patent is issued from such an
application, we may be required to obtain a license thereunder or obtain
alternative technology.  We cannot provide any assurances that
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 a license under any patent directed to pegylated butyrylcholinesterase
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.


34





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.




Risks
Related to our Common Stock and Warrants




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.  Even with the completion of the April
2010 Public Offering, 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 the April 2010 Public Offering and the offering we completed in
March 2009).  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.





In addition, as of March 31, 2010, we
had outstanding options to purchase approximately 5.0 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 March 31, 2010, the Company had issued and
outstanding additional warrants to purchase up to an additional approximately
0.8 million shares of common stock.  We issued additional warrants
(which become exercisable October 13, 2010) to purchase up to 500,000 shares at
$1.89 per share as part of the April 2010 Public Offering.  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.




Item 6.  Exhibits.




No.
            
            Description10.32
            
            Modification
      18 to Contract Number HHSO100200900203C*31.1
            
            Certification
      of Principal Executive Officer Pursuant to SEC
      Rule 13a-14(a)/15d-14(a)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 135032.2
            
            Certification
      of Principal Financial Officer Pursuant to 18 U.S.C.
      Section 1350





*  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.


35





SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized.




PHARMATHENE,
      INC.Dated:
      May 13, 2010
            By:
            /s/
      Eric I. RichmanEric
      I RichmanPresident
      and interim Chief Executive OfficerDated:
      May 13, 2010
            By:
            /s/
      Charles A. Reinhart IIICharles
      A. Reinhart IIIChief
      Financial Officer





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