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 September 30, 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 November 9, 2010 was 40,908,661.









PHARMATHENE, INC.




TABLE
OF CONTENTS





PagePART I
      —FINANCIAL INFORMATION
            
            
            3Item
      1. Financial Statements
            
            
            3Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            
            
            17Item
      3. Quantitative and Qualitative Disclosures about Market
    Risk
            
            
            28Item
      4. Controls and Procedures
            
            
            28PART II
      —OTHER INFORMATION
            
            
            29Item
      1. Legal Proceedings
            
            
            29Item
      1A. Risk Factors
            
            
            29Item
      6. Exhibits
            
            
            41Certifications




2




PART I — FINANCIAL INFORMATION




Item 1. 
Financial Statements




PHARMATHENE,
INC.


UnauditedSeptember
      30
              
              
              December
      312010
              
              
              2009ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              2,717,779
              
              
              $
              2,673,567Restricted
      cash
              
              
              100,000
              
              
              
              -Short-term
      investments
              
              
              -
              
              
              
              3,137,071Accounts
      receivable, net
              
              
              4,764,159
              
              
              
              8,866,346Other
      receivables (including unbilled receivables)
              
              
              3,898,062
              
              
              
              8,566,425Prepaid
      expenses and other current assets
              
              
              821,992
              
              
              
              973,214Total
      current assets
              
              $
              12,301,992
              
              
              $
              24,216,623Property
      and equipment, net
              
              
              6,042,375
              
              
              
              6,262,388Patents,
      net
              
              
              832,766
              
              
              
              928,577Other
      long-term assets and deferred costs
              
              
              89,071
              
              
              
              308,973Goodwill
              
              
              2,348,453
              
              
              
              2,348,453Total
      assets
              
              $
              21,614,657
              
              
              $
              34,065,014LIABILITIES AND
      STOCKHOLDERS' EQUITY (DEFICIT)Current
      liabilities:Accounts
      payable
              
              $
              6,731,715
              
              
              $
              1,934,119Accrued
      expenses and other liabilities
              
              
              3,242,922
              
              
              
              11,532,101Current
      portion of long-term debt
              
              
              20,057,953
              
              
              
              -Total
      current liabilities
              
              $
              30,032,590
              
              
              $
              13,466,220Other
      long-term liabilities
              
              
              460,854
              
              
              
              452,618Derivative
      instruments
              
              
              2,528,885
              
              
              
              835,299Long-term
      debt
              
              
              -
              
              
              
              17,426,513Total
      liabilities
              
              $
              33,022,329
              
              
              $
              32,180,650Stockholders'
      equity (deficit):Common
      stock, $0.0001 par value; 100,000,000 shares authorized; 32,643,252 and
      28,130,284 shares issued and outstanding at September 30, 2010 and
      December 31, 2009, respectively
              
              $
              3,264
              
              
              $
              2,813Additional
      paid-in-capital
              
              
              162,437,392
              
              
              
              157,004,037Accumulated
      other comprehensive income
              
              
              1,127,480
              
              
              
              1,188,156Accumulated
      deficit
              
              
              (174,975,808
              )
              
              
              (156,310,642
              )Total
      stockholders' equity (deficit)
              
              $
              (11,407,672
              )
              
              $
              1,884,364Total
      liabilities and stockholders' equity (deficit)
              
              $
              21,614,657
              
              
              $
              34,065,014


See the
accompanying notes to the consolidated financial statements.
  3


PHARMATHENE,
INC.


UNAUDITED
CONSOLIDATED STATEMENTS OF OPERATIONS


Three
      months endedSeptember 30,
                
                
                Nine
      months endedSeptember 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Contract
      revenue
                
                $
                6,243,567
                
                
                $
                6,830,399
                
                
                $
                14,139,711
                
                
                $
                20,423,5136,243,567
                
                
                
                6,830,399
                
                
                
                14,139,711
                
                
                
                20,423,513Operating
      expenses:Research
      and development
                
                
                6,172,147
                
                
                
                7,883,799
                
                
                
                17,064,900
                
                
                
                23,928,315General
      and administrative
                
                
                3,177,888
                
                
                
                6,224,868
                
                
                
                12,625,132
                
                
                
                15,787,115Depreciation
      and amortization
                
                
                258,231
                
                
                
                247,747
                
                
                
                757,929
                
                
                
                639,924Total
      operating expenses
                
                
                9,608,266
                
                
                
                14,356,414
                
                
                
                30,447,961
                
                
                
                40,355,354Loss
      from operations
                
                
                (3,364,699
                )
                
                
                (7,526,015
                )
                
                
                (16,308,250
                )
                
                
                (19,931,841
                )Other
      income (expenses):Interest
      income
                
                
                184
                
                
                
                61,743
                
                
                
                6,249
                
                
                
                258,841Interest
      expense
                
                
                (946,023
                )
                
                
                (748,892
                )
                
                
                (2,815,638
                )
                
                
                (1,949,402
                )Loss
      on early extinguishment of debt
                
                
                -
                
                
                
                (4,690,049
                )
                
                
                -
                
                
                
                (4,690,049
                )Other
      income (expense)
                
                
                (93,260
                )
                
                
                -
                
                
                
                75,914
                
                
                
                -Change
      in market value of derivative instruments
                
                
                75,594
                
                
                
                (1,059,509
                )
                
                
                376,560
                
                
                
                (295,218
                )Total
      other income (expenses)
                
                
                (963,505
                )
                
                
                (6,436,707
                )
                
                
                (2,356,915
                )
                
                
                (6,675,828
                )Net
      loss
                
                $
                (4,328,204
                )
                
                $
                (13,962,722
                )
                
                $
                (18,665,165
                )
                
                $
                (26,607,669
                )Basic
      and diluted net loss per share
                
                $
                (0.14
                )
                
                $
                (0.50
                )
                
                $
                (0.62
                )
                
                $
                (0.97
                )Weighted
      average shares used in calculation of basic and diluted net loss per
      share
                
                
                31,946,696
                
                
                
                28,077,348
                
                
                
                29,927,310
                
                
                
                27,388,761




See the
accompanying notes to the consolidated financial statements.
  4
  PHARMATHENE,
INC.


UNAUDITED
CONSOLIDATED STATEMENTS OF CASH FLOWS




Nine
      Months EndedSeptember 302010
            
            
            2009Operating
      activitiesNet
      loss
            
            $
            (18,665,165
            )
            
            $
            (26,607,669
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Bad
      Debt Expense
            
            
            1,924,601Change
      in market value of derivative instruments
            
            
            (376,560
            )
            
            
            295,218Loss
      on early extinguishment of debt
            
            
            -
            
            
            
            4,690,049Depreciation
      and amortization
            
            
            757,929
            
            
            
            639,924Change
      in Avecia purchase accounting
            
            
            -
            
            
            
            154,456Compensatory
      option expense
            
            
            1,821,684
            
            
            
            2,725,246Non
      cash interest expense on debt
            
            
            2,744,352
            
            
            
            605,265Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            2,189,982
            
            
            
            3,834,970Prepaid
      expenses and other current assets
            
            
            4,927,191
            
            
            
            (12,913,132
            )Accounts
      payable
            
            
            4,818,803
            
            
            
            (2,840,700
            )Accrued
      expenses and other liabilities
            
            
            (8,289,791
            )
            
            
            7,453,987Net
      cash used in operating activities
            
            
            (8,146,974
            )
            
            
            (21,962,386
            )Investing
      activitiesPurchases
      of property and equipment
            
            
            (324,579
            )
            
            
            (1,539,537
            )Purchases
      of short term investments
            
            
            -
            
            
            
            (8,800,640
            )Proceeds
      from sales of short term investments
            
            
            3,130,588
            
            
            
            4,600,000Payments
      for Avecia Acquisition
            
            
            -
            
            
            
            (7,000,000
            )Net
      cash provided by (used in) investing activities
            
            
            2,806,009
            
            
            
            (12,740,177
            )Financing
      activitiesProceeds
      from issuance of convertible debt
            
            
            -
            
            
            
            10,528,196Payments
      of debt obligations
            
            
            -
            
            
            
            (9,538,016
            )Change
      in restricted cash requirements
            
            
            (100,000
            )
            
            
            13,250,000Net
      proceeds from issuance of common stock and warrants
            
            
            5,682,268
            
            
            
            4,946,710Other
      financing costs
            
            
            -
            
            
            
            (551,090
            )Net
      cash provided by financing activities
            
            
            5,582,268
            
            
            
            18,635,800Effects
      of exchange rates on cash
            
            
            (197,091
            )
            
            
            502,631Increase
      (decrease) in cash and cash equivalents
            
            
            44,212
            
            
            
            (15,564,132
            )Cash
      and cash equivalents, at beginning of year
            
            
            2,673,567
            
            
            
            19,752,404Cash
      and cash equivalents, at end of quarter
            
            $
            2,717,779
            
            
            $
            4,188,272Supplemental
      disclosure of cash flow informationCash
      paid for interest
            
            $
            21,144
            
            
            $
            1,344,137Cash
      paid for income taxes
            
            
            0
            
            
            
            184,226




See
the accompanying notes to the consolidated financial statements.
  5




PHARMATHENE,
INC.




Notes
to Unaudited Consolidated Financial Statements


September
30, 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 in April, July and November 2010) to sustain our
operations.





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.  Certain prior year amounts in the consolidated financial
statements have been reclassified to conform to the current year
presentation.




6




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 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 September 30, 2010 and 2009 was approximately $4.2 million and $12.7
million, respectively.  Comprehensive loss for the nine month periods ended
September 30, 2010 and 2009 was approximately $18.7 million and $26.1 million,
respectively.





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.




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. There were no short-term
investments as of September 30, 2010.




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
September 30, 2010 and December 31, 2009, the Company’s trade receivable
balances were comprised solely of receivables from these
customers.  Unbilled accounts receivable, a component of “Other
receivables,” totaled approximated $3.1 and $8.1million as of September 30, 2010
and December 31, 2009, respectively, and also related to the contracts with
these same customers.




7




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 September 30, 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.  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.  As of the last
evaluation date, the Company determined that there was no impairment of
goodwill.





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 performed and 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 have been 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 completed during 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.




8




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 subcontractor 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 September 30, 2010 and 2009, we
recorded approximately $0.2 million for each period related to costs reimbursed
by the government as an offset to research and development
expenses.  For the nine months ended September 30, 2010 and 2009, we
recorded approximately $1.9 million and $1.4 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 accounts receivable, 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 accounts receivable
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
September 30, 2010, “Other receivables (including unbilled receivables)” were
approximately $3.9 million, of which approximately $3.1 million were unbilled
accounts receivable.





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.




9





Employee
share-based compensation expense recognized in the three and nine months ended
September 30, 2010 and 2009 was calculated based on awards ultimately expected
to vest and has been reduced for estimated forfeitures.  Forfeitures
were estimated at a rate of approximately 17% for both stock options and
restricted shares for 2009 and through the first quarter of 2010.  The
forfeiture rate was changed to a rate of approximately 12% for both stock
options and restricted shares during the second quarter of 2010, based on
historical forfeitures.





Share-based
compensation expense for the three months ended September 30, 2010 and 2009
was:




Three
      months ended
              September 30,2010
            
            
            2009Research
      and development
            
            $
            165,011
            
            
            
            179,559General
      and administrative
            
            
            256,315
            
            
            
            806,112Total
      share-based compensation expense
            
            $
            421,326
            
            
            
            985,671




Share-based
compensation expense for the nine months ended September 30, 2010 and 2009,
was:




Nine
      months ended
              September 30,2010
            
            
            2009Research
      and development
            
            $
            688,832
            
            
            
            646,028General
      and administrative
            
            
            1,132,852
            
            
            
            2,079,218Total
      share-based compensation expense
            
            $
            1,821,684
            
            
            
            2,725,246





During
the nine months ended September 30, 2010, we granted options to purchase an
aggregate of 1,434,750 shares of common stock to employees, non-employee
directors and consultants, and made no restricted stock grants.  At
September 30, 2010, we had total unrecognized share-based compensation expense
related to unvested awards of approximately $2.8 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 September 30, 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.




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.




10





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
approximately 18.1 million and 19.3 million potential dilutive shares have been
excluded in the calculation of diluted net loss per share at September 30, 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.  Effective January 1, 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 – 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 transitioned 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
completed the relocation of our UK operations, including terminating
substantially all of our UK workforce, by June 30, 2010.  In the third
quarter of 2009, we recorded a reserve for these exit activities, none of which
remains in accrued expense at September 30, 2010.





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.




11




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 September 30, 2010 and 2009 we had Level 3
derivative liabilities of approximately $2.5 million and $2.2 million,
respectively.




The
following table sets forth a summary of changes in the fair value of our Level 3
liabilities for the nine months ended September 30, 2010:




Description
            
            Balance as of
              December31, 2009
            
            
            New Liabilities
      in 2010
            
            
            Unrealized
              (Gains)
            
            
            Balance as of
              September
      30, 2010Stock
      purchase warrants
            
            $
            835,299
            
            
            $
            2,070,146
            
            
            $
            (376,560
            )
            
            $
            2,528,885





The
following table sets forth a summary of changes in the fair value of the
Company’s Level 3 liabilities for the nine months ended September 30,
2009:





Description
            
            Balance as of
              December31, 2008
            
            
            Cumulative
      Effect of Adoption of New Accounting
      Guidance
            
            
            New Liabilities
      in 2009
            
            
            Unrealized
              (Gains)Losses
            
            
            Balance as of
              September
      30, 2009Conversion
      option
            
            $
            6,405
            
            
            $
            -
            
            
            $
            -
            
            
            $
            (6,405
            )
            
            $Stock
      purchase warrants
            
            $
            -
            
            
            $
            636,609
            
            
            $
            1,236,067
            
            
            $
            301,623
            
            
            $
            2,174,299





The gains
and losses on the derivative instruments are classified in Other income
(expenses) as the change in market value of 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
September 30, 2010 we had no available-for-sale
investments.





During
the nine months ended September 30, 2010, we realized net gains of approximately
$5,000 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”).   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




12




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





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.





We have
determined that certain provisions contained in the notes are considered
embedded derivates that require bifurcation from the debt host contract. At the
date of issuance and as of September 30, 2010, we have determined that the value
of these derivatives is not significant. We evaluate the estimates and
assumptions used in determining such value each reporting period and make
revisions should facts and circumstances warrant a change.





The
Convertible Notes have been reclassified from long-term to current liabilities
as the notes mature on July 28, 2011.





Note
7 - Commitments and Contingencies





SIGA
Litigation




In
December 2006, we filed a complaint against Siga Technologies, Inc. (“SIGA”) in
the Delaware Court of Chancery.  The complaint alleges, among other
things, that we have the right to license exclusively development and marketing
rights for SIGA’s drug candidate, ST-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 ST-246 in accordance with the terms of
the term sheet attached to the merger agreement or monetary
damages.  In January 2008, the Delaware Court of Chancery 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 in
April 2010 and SIGA filed its reply brief.  Oral argument on SIGA’s motion
for summary judgment was held in the Delaware Court of Chancery in July
2010.  The court has reserved its final decision on SIGA’s motion but has
also set a date for trial to commence on January 3, 2011.





An
accrual for a loss contingency has not been made because the unfavorable
resolution of this 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.




13





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, 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 or 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 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 the initial day of a Maintenance Failure. Our total maximum obligation
under this provision would be approximately $193,000.




Following
a 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 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.





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.





Note
8 - Stockholders’ Equity (Deficit)




Common
Stock




In April
2010, we completed a public sale of 1,666,668 shares of our common stock at
$1.50 per share and warrants to purchase an aggregate of 500,000 shares of our
common stock at an exercise price of $1.89 per share, generating gross proceeds
of approximately $2.5 million. The warrants become exercisable on October 13,
2010 and expire on October 13, 2015. Placement fees of approximately $175,000
and legal and other fees of approximately $140,000 were incurred in connection
with this transaction.





In July
2010,we completed
a public sale of 2,785,714 shares of our common stock at $1.40 per share and
warrants to purchase an aggregate of 1,323,214 shares of our common stock at an
exercise price of $1.63 per share, generating gross proceeds of approximately
$3.9 million. The warrants become exercisable on January 23, 2011 and expire on
January 23, 2017. Placement fees of approximately $256,000 and legal and other
fees of approximately $130,000 were incurred in connection with this
transaction.





In July
2010, the NYSE Amex LLC (the “Exchange”) sent a letter to us advising that we
were not in compliance with continued listing standards, specifically
Sections 1003(a)(i), (ii) and (iii) of the Exchange’s Company Guide, because we
did not meet the following criteria: stockholders’ equity of at least (i) $2.0
million, (ii) $4.0 million or (iii) $6.0 million, with corresponding losses from
continuing operations and/or net losses in (i) two of our three most recent
fiscal years, (ii) three of our four most recent fiscal years, or (iii) our five
most recent fiscal years, respectively.  In August 2010, we submitted
a plan to the Exchange, stating how we intend to regain compliance with the
continued listing standards by January 26, 2012. In October 2010 the Exchange
accepted the plan, and as such we will be able to continue our listing during
such time, subject to continued periodic review by Exchange staff and other
conditions.  If we do not make progress consistent with the plan
during the plan period, or we do not meet the plan by the end of the plan
period, the Exchange could initiate delisting proceedings.  We may
appeal any delisting determination before a listing qualifications panel of the
Exchange and in turn request a review of the decision of such panel by the
Exchange’s Committee on Securities.




14





In
November 2010, we closed on a registered public offering of 4,300,000 shares of
our common stock at a price to the public of $3.50 per share, generating
estimated net proceeds of approximately $14.1 million (before expenses). We
incurred placement fees of approximately $903,000 and estimated legal and other
fees of approximately $250,000 in connection with this transaction.
Simultaneously with the closing, certain of our affiliates, officers and
directors, who own New Convertible Notes, converted their notes into an
aggregate of approximately 3.4 million shares of our common stock. These
converting noteholders have received cash payments from the proceeds of the
offering of approximately $0.6 million in the aggregate, corresponding to the
interest they would have accrued following conversion had they held the New
Convertible Notes to maturity.  We also granted the underwriter for
the offering a 30-day option to purchase up to an additional 645,000 shares to
cover over-allotments, if any.





Long-Term
Incentive Plan




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





At that
time, we reserved 3,500,000 shares of common stock in connection with awards to
be granted under the 2007 Plan, including those awards that had originally been
made under the 2002 Plan.  In 2008, our 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.





In April
2010, we completed a public sale of 1,666,668 shares of our common stock at
$1.50 per share and warrants to purchase an aggregate of 500,000 shares of our
common stock at an exercise price of $1.89 per share, generating gross proceeds
of approximately $2.5 million.  The warrants become exercisable on
October 13, 2010 and expire on October 13, 2015. Placement fees of approximately
$175,000 and legal and other fees of approximately $140,000 were incurred in
connection with this transaction. 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).




15





In July
2010,we completed
a public sale of 2,785,714 shares of our common stock at $1.40 per share and
warrants to purchase an aggregate of 1,323,214 shares of our common stock at an
exercise price of $1.63 per share, generating gross proceeds of approximately
$3.9 million. The warrants become exercisable on January 23, 2011 and expire on
January 23, 2017. Placement fees of approximately $256,000 and legal and other
fees of approximately $130,000 were incurred in connection with this
transaction. 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).





Note
9 - Subsequent Events




Public
offering of Common Stock and Conversion of Our Outstanding 10% Convertible
Notes





In
November 2010, we closed on a registered public offering of 4,300,000 shares of
our common stock at a price to the public of $3.50 per share, generating
estimated net proceeds of approximately $14.1 million (before expenses). We
incurred placement fees of approximately $903,000 and estimated legal and other
fees of approximately $250,000 in connection with this transaction.  We
also granted the underwriter for the offering a 30-day option to purchase up to
an additional 645,000 shares to cover over-allotments, if any.
 
 Under the
terms of our outstanding convertible notes, unless earlier converted, redeemed
or accelerated, the outstanding principal plus accrued interest is payable at
maturity on July 28, 2011.  We have the right to redeem all or a
portion of these convertible notes.  Upon a change in control or
default, as defined in the note, the note holders may require us to redeem their
notes. Under the terms of the notes, each holder converting notes is entitled to
receive a number of shares corresponding to principal and accrued interest
through the date of conversion (plus any accrued and unpaid late charges) at a
conversion price of approximately $2.54.  In addition, we have
recently agreed to pay each holder exercising his conversion right prior to
maturity an amount in cash corresponding to the interest foregone, i.e., the
interest the holder would have received between November 4, 2010 and the
maturity date had he held the note through maturity.  Simultaneously
with the closing of our November 2010 public offering, certain of our
affiliates, officers and directors who owned convertible notes converted their
notes into an aggregate of approximately 3.4 million shares of our common
stock.  These converting noteholders received cash payments of
approximately $0.6 million in the aggregate, corresponding to the interest
foregone.  As of November 11, 2010, holders of notes (including those
referenced above) in the aggregate principal amount (plus accrued interest) of
approximately $9.8 million have converted their notes, resulting in the issuance
of approximately 3.9 million shares of our common stock.  We may
redeem, either immediately or in the future, all of the remaining convertible
notes that have not been converted into shares of our common stock prior to
their maturity date.  Approximately $12.0 million would be required to
repay principal and interest on the remaining notes as of November 11,
2010.  If the holders of the remaining notes were to convert their
notes into shares of our common stock as of November 11, 2010, the holders of
those notes would receive approximately 4.7 million shares of common stock and
approximately $0.8 million in cash.


16





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,
challenges related to the implementation of our NYSE Amex compliance plan, 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 our condensed
consolidated financial statements which present our results of operations for
the three and nine months ended September 30, 2010 and 2009 as well as our
financial positions at September 30, 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




·
            rBChE
      - recombinant butyrylcholinesterase bioscavanger: Protexia®  and a
      second generation Advanced Expression System ("AES") countermeasures for
      nerve agent poisoning by organophosphate compounds, including nerve gases
      and pesticides




17


Recent
Events




Recent
Developments




Public
offering of Common Stock and Conversion of Our Outstanding 10% Convertible
Notes




In
November 2010, we closed on a registered public offering of 4,300,000 shares of
our common stock at a price to the public of $3.50 per share, generating
estimated net proceeds of approximately $14.1 million (before expenses). We
incurred placement fees of approximately $903,000 and estimated legal and other
fees of approximately $250,000 in connection with this transaction.
Simultaneously with the closing, certain of our affiliates, officers and
directors, who own 10% convertible senior notes of the Company due July 2011,
converted their notes into an aggregate of approximately 3.4 million shares of
our common stock. These converting noteholders have received cash payments from
the proceeds of the offering of approximately $0.6 million in the aggregate,
corresponding to the interest they would have accrued following conversion had
they held the notes to maturity.  As of November 11, 2010, holders of
notes (including those referenced above) in the aggregate principal amount (plus
accrued interest) of approximately $9.8 million have converted their notes,
resulting in the issuance of approximately 3.9 million shares of our common
stock.  For further details on these conversions, please refer to “-
Liquidity and Capital Resources - Overview.”   We also granted
the underwriter for the offering a 30-day option to purchase up to an additional
645,000 shares to cover over-allotments, if any.




Conditional
Listing on NYSE Amex




On July
26, 2010, we received a letter from the NYSE Amex, stating that we are not in
compliance with the exchange’s continued listing standards, specifically,
Sections 1003(a)(i), (ii) and (iii) of the NYSE Amex Company Guide, because we
have stockholders’ equity of less than $2.0 million, $4.0 million and $6.0
million and losses from continuing operations and net losses in two of our
three most recent fiscal years, three of our four most recent fiscal years and
our five most recent fiscal years, respectively.




On August
25, 2010, we submitted a plan to the NYSE Amex addressing how we intend to
regain compliance with the continued listing standards by January 26, 2012, the
end of the eighteen-month compliance period under NYSE Amex
rules.  Based on the information in our compliance plan and related
discussions with exchange staff, the NYSE Amex determined that we had made a
reasonable demonstration of our ability to regain compliance with Sections
1003(a)(i), (ii) and (iii) of the NYSE Amex Company Guide by January 26, 2012
and that it would continue the listing of our common stock subject to
conditions.  The conditions include (a) the requirement to provide
exchange staff with updates on the initiatives included in our compliance plan,
at least once each quarter concurrent with our corresponding periodic SEC
filing, (b) the periodic review of our compliance with the plan by exchange
staff, and (c) the approval of a NYSE Amex management committee prior to any
issuances of additional shares of common stock.  We currently believe
that we are in compliance with these conditions.   If we do not
show progress consistent with our compliance plan, or we do not meet the
continued listing standards by January 26, 2012, the NYSE Amex could initiate
delisting proceedings.  We may appeal any delisting determination
before a listing qualifications panel of the exchange and in turn request a
review of the decision of such panel by the exchange’s Committee on
Securities.




Update
on Nerve Agent Countermeasure Program




In 2006
we entered into a contract with the U.S. Department of Defense (“DoD”) to
develop a medical countermeasure for nerve agent exposure to protect the
warfighter.  This program utilizes the recombinant enzyme
butyrylcholinesterase, or “rBChE”, a naturally occurring bioscavenger, as its
active ingredient.  Our first generation program for producing rBChE,
which we refer to as Protexia®, utilizes transgenic goats to produce the enzyme
in their milk.  We have also been working on a second generation
approach, which we refer to as our Advanced Expression System, or “AES”, that
utilizes a mammalian-cell-based expression system for rBChE.




While the
AES technology is still at an early research stage, if our efforts are
successful, we believe this cell-based approach could have significant
advantages over the transgenic goat-based approach originally developed to
produce Protexia®.  Specifically, we believe these advantages could
include:




·
            An
      established manufacturing platform, consistent with those used for other
      biotechnology products and with the U.S. government’s recent advanced
      manufacturing system initiative.




·
            Final
      product with a pharmacokinetic (PK) profile that more closely resembles
      naturally occurring butyrylcholinesterase, or BChE, from human blood
      plasma.




·
            Higher
      production yields than a transgenic goat based
  approach.




18




·
            Substantially
      lower costs of production to yield significant savings to our DoD
      customer.




·
            A
      more traditional regulatory path to FDA
  licensure.




·
            Greater
      ability to scale up production if demand
  increases.




The DoD
has recently informed us that it is deferring a decision on whether to fund
advanced development of Protexia® for the time being, potentially for several
years, due to budget constraints and potential concerns about duration of
protection with the current route of Protexia® administration as compared to the
human blood plasma derived BChE product.  DoD has said they may need
more data regarding the duration of protection of Protexia® before making a
decision regarding future advanced development funding, and it is unclear at
this time how long and what the cost would be to address their concerns. While
the DoD has indicated it may fund the work to generate these data, no firm
commitment has been made to date and there can be no assurance DoD will
ultimately pay for this work. As such, our existing September 2006 contract
related to milk collection for Protexia® may not be extended past its current
term, which ends on December 31, 2010.




The
second generation AES approach is more consistent with the DoD
requirements.  We believe the AES could provide a potentially safe and
effective nerve agent countermeasure for the warfighter in a shorter timeframe
and at a more affordable cost than the transgenic goat-based product. We are
currently in discussions with the DoD regarding the path forward, and
whether to commence the work to generate the additional data regarding Protexia®
or to defer while we focus on the AES.




In
connection with the potential expiration of our current contract for milk
collection for Protexia®, we are reducing  our transgenic goat
operations and are in discussions with a third party to establish the capability
to initiate production of the transgenic goat-based product at an FDA-licensed
facility if the government decides to pursue development of this product again
in the future.  In the fourth quarter of 2010 and the first half of
2011, we expect to incur a modest amount of severance and other wind-down costs
related to the reduction of our Protexia®-related operations, but have not yet
determined whether we will need to write down the net book value of our
Protexia® related assets, and if required, how much that will be.  We
expect to complete this analysis in the fourth quarter 2010.




We are
in negotiations with the DoD regarding a new contract to fund on-going
research we have been conducting and self-funding related to the production of
rBChE using our AES. Based on those negotiations, we currently anticipate that
DoD will award a contract to us before the end of 2010 for up to $5.7 million to
support this initial work. We cannot assure you, however, that the contract will
be awarded in this time frame, or at all, of the specific terms of any such
contract, of even if this initial contract is awarded to us that DoD will
provide any other funding in the future.





Update
on BARDA performance evaluation




In
response to the performance evaluation for the period April 1, 2009 through
April 30, 2010 we received from BARDA under our current contract for the
advanced development of SparVaxTM, we have implemented key organizational changes
and information sharing enhancements.  We have received positive
feedback from BARDA personnel in recent months. BARDA has also solicited our
input regarding achievements since the last assessment by BARDA and agreed to
provide an interim assessment prior to the end of the year, which we anticipate
will recognize our improved execution.




Update
on Valortim® partial
clinical hold




As part
of our investigational plan regarding the partial clinical hold on Valortim®, we
conducted a subcutaneous skin testing study with five subjects, including the
two subjects who had adverse reactions as part of our Valortim®/Ciprofloxacin
study. There were no positive skin test reactions to Valortim® or it excipients,
suggesting that the adverse reactions previously observed were not likely to be
allergic reactions.




We
recently presented this information to the FDA and the Safety Monitoring
Committee (SMC) for Valortim®, which agreed with our plan to propose to FDA an
intravenous (IV) dose-escalation study of Valortim® with a slower infusion rate
than that used in the Valortim®/Ciprofloxacin study.  We plan to send
our final investigation plan report, IV dose escalation protocol, and SMC
recommendations to FDA in early November, and believe that we are
well-positioned for FDA to permit us to proceed with the dose escalation study,
with dosing of the first subject scheduled for January 2011.




19





We
updated BARDA during the course of our investigation, and the agency has
continued to express interest in Valortim®.  We plan to resubmit a
white paper to BARDA for advanced development funding for Valortim® of in excess
of $100 million before the end of 2010, if required, and subject to BARDA’s
agreement, submit a formal funding proposal as soon as possible
thereafter




Update
on Siga Litigation




Discovery
in our case against Siga Technologies 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.  Oral argument on
SIGA’s motion for summary judgment was held in the Delaware Court of Chancery in
July 2010.  The court has reserved it final decision on SIGA’s motion
but has also set a date for trial to commence on January 3, 2011.  We
can make no assurances that SIGA’s motion will not be granted, or that, if open
issues remain in the case, the trial will be successful.  In either
event, we will have spent significant resources on an unsuccessful
lawsuit.




Appointment
of Eric Richman




On
October 20, 2010, our Board appointed Eric I. Richman to the position of
President and Chief Executive Officer, effective immediately.  Mr.
Richman continues to serve as a member of the Board of Directors.  Mr.
Richman previously served as our President and interim Chief Executive Officer
since May 2010 and was our President and Chief Operating Officer between March
and May 2010.  Prior to being appointed President and Chief Operating
Officer, Mr. Richman served as our Senior Vice President, Business Development
and Strategic Planning since joining then-privately-held PharmAthene in
2003.




In
connection with his appointment, Mr. Richman received an option to purchase
125,000 shares of our common stock at an exercise price of $4.20 per share,
which was the closing price of our common stock on the NYSE Amex on the date of
grant.  Upon the consummation of the public offering of our common
stock referenced above, Mr. Richman received a second option grant on November
3, 2010 to purchase 125,000 shares of our common stock at an exercise price of
$3.34 per share, which was the closing price of our common stock on the NYSE
Amex on the date of grant.  Both options, granted under our 2007
Long-Term Incentive Compensation Plan, vest in installments of 25% per year,
with the first vesting to occur on the first anniversary of the respective date
of grant.





Critical
Accounting Policies




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 September 30, 2010 and 2009, we
recorded approximately $0.2 million for each period related to costs reimbursed
by the government as an offset to research and development
expenses.  For the nine months ended September 30, 2010 and 2009, we
recorded approximately $1.9 million and $1.4 million, respectively, of costs
reimbursed by the government as an offset to research and development
expenses.




20




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 accounts receivable, 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 accounts receivable
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
September 30, 2010, “Other receivables (including unbilled receivables)” were
approximately $3.9 million, of which approximately $3.1 million were unbilled
accounts receivables.





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 $6.2 million and $6.8 million during the three months
ended September 30, 2010 and 2009, respectively.  For the nine months
ended September 30, 2010 and 2009, we recognized revenue of $14.1 million and
$20.4 million, respectively.




21





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
and nine months ended September 30, 2010 changed from the comparable periods of
2009 primarily due to the following:





·
            Under
      the September 2006 contract with the DoD for the advanced development
      of Protexia®,
      we recognized $1.8 million and $1.5 million of revenue for the three
      months ended September 30, 2010 and 2009, respectively, and $3.6 million
      and $6.8 million for the nine months ended September 30, 2010 and 2009,
      respectively. Work under the first phase of this contract was
      substantially complete by September 30, 2009, and thus we recognized very
      little revenue under this contract from that time until the second quarter
      of 2010 when we entered into a modification to our contract under which
      the DoD reimbursed us for certain costs related to Protexia® during the
      second and third quarters of 2010.  Consequently, while revenue
      for the three month period ended September 30, 2010 did not change
      significantly from the prior year period, we experienced a significant
      decline in revenue in the nine month period ended September 30, 2010 as
      compared to the prior year period.  The DoD has recently informed us
      that it is deferring a decision on whether to fund advanced development of
      Protexia® for the time being, potentially for several
      years.   We are in negotiations with the DoD regarding
      a new contract to fund on-going research we have been conducting and
      self-funding related to the production of rBChE using our
      AES.  We expect the Protexia®contract may not be extended past the end of its term on
      December 31, 2010.




·
            Under
      our contract for the development of SparVaxTM, we recognized approximately
      $3.8 million and $2.4 million of revenue for the three months ended
      September 30, 2010 and 2009, respectively, and approximately $8.0 million
      and $7.3 million for the nine months ended September 30, 2010 and 2009,
      respectively. The increase in revenue in the 2010 periods as compared to
      2009 was primarily the result of the increase in program activities under
      the contract during the later
periods.




·
            Under
      the September 2007 contract for the advanced development of
      Valortim®,
      we recognized $0.6 million and $2.0 million of revenue for the three
      months ended September 30, 2010 and 2009, respectively.  We
      recognized $2.2 million and $4.2 million of revenue for the nine months
      ended September 30, 2010 and 2009, respectively.   Revenue
      in both the three and nine month period ended September 30, 2010 reflects
      decreased activity while we conducted our investigation into the adverse
      events observed during the Valortim®/Ciprofloxocin phase I clinical
trial.





Research
and Development Expenses





Our
research and development expenses were $6.2 million and $7.9 million for the
three months ended September 30, 2010 and 2009, respectively. Our research
and development expenses were $17.1 million and $23.9 million for the nine
months ended September 30, 2010 and 2009, respectively.  These
expenses primarily resulted from research and development activities related to
our SparVaxTM, Valortim® and
Protexia®
programs.  They include 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.  In the second quarter 2010 we completed the wind down of all
activities for our RypVaxTM plague vaccine program and entered into a
modification to our existing contract with the National Institute of Allergy and
Infectious Diseases (“NIAID”) for development work on the Company’s
third-generation anthrax vaccine candidate.  The modification closed
out this contract as part of a no-cost settlement between the Company and
NIAID.   Research and development expenses for the three months
ended September 30, 2010 and 2009 were net of cost reimbursements under certain
of our government grants of $0.2 million.  Research and development
expenses for the nine month period ended September 30, 2010 and 2009 were net of
cost reimbursements under certain of our government grants of $1.9 million and
$1.4 million, respectively.





Research
and development expenses for the three and nine months ended September 30, 2010
and 2009 were attributable to research programs as follows:





Three
      Months ended($ in millions)
            
            September
      30,
              2010
            
            
            September
      30,
              2009Anthrax
      therapeutic and vaccines
            
            $
            4.6
            
            
            $
            5.5Chemical
      nerve agent protectants
            
            
            1.4
            
            
            
            1.8Recombinant
      dual antigen plague vaccine
            
            
            0.1
            
            
            
            0.6Internal
      research and development
            
            
            0.1
            
            
            
            -Total
      research and development expenses
            
            $
            6.2
            
            
            $
            7.9




22





Nine
      Months ended($ in millions)
            
            September
      30,
              2010
            
            
            September
      30,
              2009Anthrax
      therapeutic and vaccines
            
            $
            12.8
            
            
            $
            15.7Chemical
      nerve agent protectants
            
            
            3.6
            
            
            
            6.4Recombinant
      dual antigen plague vaccine
            
            
            0.1
            
            
            
            1.6Internal
      research and development
            
            
            0.6
            
            
            
            0.2Total
      research and development expenses
            
            $
            17.1
            
            
            $
            23.9





For the
three and nine months ended September 30, 2010, research and development
expenses decreased $1.7 million and $6.8 million, respectively, from the prior
year periods.  Research and development expenses for the three month period
ended September 30, 2010 decreased compared to the prior year period because of
decreased activity in the Company’s Valortim anthrax anti-toxin and chemical
nerve agent bioscavenger programs as well as the completion of all activities in
the Company’s plague program, partially offset by increased activity under the
SparVaxTM anthrax vaccine program.  The expenses for the nine months
ended September 30, 2010 reflects a reclassification of costs to be consistent
with current allocations.  Research and development expenses for the nine
month period ended September 30, 2010 declined compared to the prior year period
because of decreased activity in the Company’s Valortim anthrax anti-toxin and
chemical nerve agent bioscavenger programs as well as the completion of all
activites in the Company’s plague program and to a $3.0 million one-time
termination fee to Avecia incurred in the second quarter of 2009.





The
decrease in development expenses related to the chemical nerve agents protectant
program resulted from reduced process development and manufacturing activities
as the program completed the first phase of work under the September 2006
contract by the end of 2009.  We expect to incur a lower level of costs
(and related revenues) over the next 12-24 months than we have historically
incurred under the chemical nerve agent protectants program as we transition to
the AES production platform for rBChE.  In addition, we expect to
incur certain wind down costs in the fourth quarter of 2010 and the first half
of 2011 related to our Protexia®program,
for which we do not anticipate reimbursement by the government. We have not
yet determined whether we will need to write down the net book value of our
Protexia® related assets, and if required, how much that will be.  We
expect to complete this analysis in the fourth quarter 2010.





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 $3.2 and $6.2 million
for both the three months ended September 30, 2010 and 2009,
respectively.  Expenses associated with general and administrative
functions were $12.6 million and $15.8 million for the nine months ended
September 30, 2010 and 2009, respectively.




General
and administrative expenses decreased approximately $3.0 million for the three
months ended September 30, 2010, as compared to the prior year period. During
the three months ended September 30, 2010, expenses related to personnel and
professional services declined.  Additionally, non-cash stock
compensation was approximately $0.5 million lower in the quarter ended September
30, 2010 as compared to the prior year period.  These reductions were
partially offset by the recording of bad debt expense in the quarter ended
September 30, 2010 of approximately $0.3 million, primarily associated with an
invoice to our government customer related to rPA anthrax vaccine development
work performed at Avecia prior to the transfer of development activities to a
U.S.-based manufacturer and the novation of the Company’s government contract
for the advanced development of its rPA anthrax vaccine candidate from NIH to
BARDA.




23





General
and administrative expenses decreased approximately $3.2 million for the nine
months ended September 30, 2010, as compared to the prior year period, due to
reduced expenses relating to personnel and professional services; additionally,
non-cash stock compensation was approximately $0.9 million lower in the nine
months ended September 30, 2010 as compared to the prior year
period.





Depreciation
and Intangible Amortization




Depreciation
and amortization expenses were $0.3 million and $0.2 million for the three
months ended September 30, 2010 and 2009, respectively.  Depreciation and
amortization expenses were $0.8 million and $0.6 million for the nine months
ended September 30, 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, and foreign currency transaction gains or
losses.




We
incurred interest expense of $0.9 million and $0.7 million for the three months
ended September 30, 2010 and 2009, respectively. We incurred interest expense of
$2.8 million and $1.9 million for the nine months ended September 30, 2010 and
2009, respectively.  Interest expense for all periods relates primarily to
interest on our outstanding convertible notes.  For the three and nine
months ended September 30, 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.  Interest expense for the three and nine months ended September
30, 2009 relates primarily to our old notes and our then outstanding
secured credit facility, which was repaid in full during the third quarter
2009.





The
change in the fair value of our derivative instruments (Common Stock Purchase
Warrants) was a gain of approximately $0.1 million for the three months ended
September 30, 2010 compared to an approximate $1.1 million loss for the three
months ended September 30, 2009.  The change in the fair value of our
derivative instruments was a gain of approximately $0.4 million for the nine
months ended September 30, 2010 compared to an approximate $0.3 million loss for
the three months ended September 30, 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.





At
September 30, 2010, accounts receivables and other receivables (including
unbilled receivables) totaled approximately $8.7 million.   The
bid protest filed by a third party with the GAO in March 2010, challenging the
decision by the HHS to enter into the modification to our research and
development contract with BARDA for the development of SparVaxTM, and resulting
“stop-work” order, caused delays in our work under that modification. The bid
protest was ultimately denied, and the related stop work-order canceled in June
2010.  Nevertheless, the protests, along with the accumulated billing
and collection delays, have reduced revenues and our available cash and cash
equivalents during the first nine months of 2010.   The
combination of these two developments reduced our operating cash flows, which
resulted in a need for additional financing to fund our working capital
needs.




24





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 an aggregate of 500,000 shares of our common
stock at an exercise price of $1.89 per share, generating net proceeds of $2.2
million.  The warrants became exercisable on October 13, 2010 and
expire on October 13, 2015.  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 July
2010, we completed a public sale of 2,785,714 shares of common stock at
$1.40 per share and warrants to purchase an aggregate of 1,323,214 shares of our
common stock at an exercise price of $1.63 per share, generating net proceeds of
$3.5 million.  The warrants become exercisable on January 23, 2011 and
expire on January 23, 2017.  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
November 2010, we closed on a registered public offering of 4,300,000 shares of
our common stock at a price to the public of $3.50 per share, generating
estimated net proceeds of approximately $14.1 million (before expenses). We
incurred placement fees of approximately $903,000 and estimated legal and other
fees of approximately $250,000 in connection with this transaction.   We
also granted the underwriter for the offering a 30-day option to purchase up to
an additional 645,000 shares to cover over-allotments, if any.




Under the
terms of our outstanding convertible notes, unless earlier converted, redeemed
or accelerated, the outstanding principal plus accrued interest is payable at
maturity on July 28, 2011.  We have the right to redeem all or a
portion of these convertible notes.  Upon a change in control or
default, as defined in the note, the note holders may require us to redeem their
notes. Under the terms of the notes, each holder converting notes is entitled to
receive a number of shares corresponding to principal and accrued interest
through the date of conversion (plus any accrued and unpaid late charges) at a
conversion price of approximately $2.54.  In addition, we have
recently agreed to pay each holder exercising his conversion right prior to
maturity an amount in cash corresponding to the interest foregone, i.e., the
interest the holder would have received between November 4, 2010 and the
maturity date had he held the note through maturity.  Simultaneously
with the closing of our November 2010 public offering, certain of our
affiliates, officers and directors who owned convertible notes converted their
notes into an aggregate of approximately 3.4 million shares of our common
stock.  These converting noteholders received cash payments of
approximately $0.6 million in the aggregate, corresponding to the interest
foregone.  As of November 11, 2010, holders of notes (including those
referenced above) in the aggregate principal amount (plus accrued interest) of
approximately $9.8 million have converted their notes, resulting in the issuance
of approximately 3.9 million shares of our common stock.  We may
redeem, either immediately or in the future, all of the remaining convertible
notes that have not been converted into shares of our common stock prior to
their maturity date.  Approximately $12.0 million would be required to
repay principal and interest on the remaining notes as of November 11,
2010.  If the holders of the remaining notes were to convert their
notes into shares of our common stock as of November 11, 2010, the holders of
those notes would receive approximately 4.7 million shares of common stock and
approximately $0.8 million in cash.





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.




25




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





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





Sources
and Uses of Cash





Cash,
cash equivalents, restricted cash and short-term available-for-sale investments
were $2.8 million and $5.8 million at September 30, 2010 and December 31, 2009,
respectively.  The $3.0 million decrease at September 30, 2010 was
primarily attributable to the combined reduction in accounts payable and accrued
expenses and other liabilities from the end of 2009. As of September 30, 2010
and December 31, 2009, total accounts receivables and other receivables
(including unbilled receivables) were $8.7 million and $17.4 million,
respectively.





We are
now current with the billing of our second generation anthrax vaccine
program. In addition, the bid protest (which was denied in June 2010) with
respect to the modification to our research and development contract with BARDA
for the development of SparVaxTM, and resulting “stop-work” order, along with the
accumulated billing and collection delays, reduced revenues and our available
cash and cash equivalents during the first nine months of 2010.





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 an aggregate of 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 and other fees
of approximately $140,000 were incurred in connection with this
transaction.





In July
2010, we completed a public sale of 2,785,714 shares of common stock at $1.40
per share and warrants to purchase an aggregate of 1,323,214 shares of our
common stock at an exercise price of $1.63 per share, generating gross proceeds
of $3.9 million. The warrants become exercisable on January 23, 2011 and expire
on January 23, 2017. Placement fees of $256,000 and legal and other fees of
approximately $130,000 were incurred in connection with this
transaction.





In
November 2010, we closed on a registered public offering of 4,300,000 shares of
our common stock at a price to the public of $3.50 per share, generating
estimated net proceeds of approximately $14.1 million (before expenses). We
incurred placement fees of approximately $903,000 and estimated legal and other
fees of approximately $250,000 in connection with this transaction.
Simultaneously with the closing, certain of our affiliates, officers and
directors, who own 10% convertible senior notes of the Company due July 2011,
converted their notes into an aggregate of approximately 3.4 million shares of
our common stock. These converting noteholders have received cash payments from
the proceeds of the offering of approximately $0.6 million in the aggregate,
corresponding to the interest they would have accrued following conversion had
they held the notes to maturity.  As of November 11, 2010, holders of
notes (including those referenced above) in the aggregate principal amount (plus
accrued interest) of approximately $9.8 million have converted their notes,
resulting in the issuance of approximately 3.9 million shares of our common
stock.  For further details on these conversions, please refer to “-
Overview” above. We also granted the underwriter for the offering a 30-day
option to purchase up to an additional 645,000 shares to cover over-allotments,
if any.





As part
of the wind down of activities related to the expiration of our September 2006
development contract with the DoD for Protexia®, we
anticipate disposing of certain related assets, including our production
facility in Canada in 2011.




26




Operating
Activities





Cash used
in operating activities was $8.1 million and $22.0 million for the nine months
ended September 30, 2010 and 2009, respectively. Cash used in operations
during the nine months ended September 30, 2010 reflects our net loss of $18.7
million, adjusted downward for non-cash interest of $2.7 million, bad debt
expense of $1.9 million, and non-cash share based compensation of $1.8 million,
decreases in prepaid expenses and other current assets of $4.9 million and
accounts receivable of $2.2 million, and an increase in accounts payable of $4.8
million, and adjusted upward by a decrease in accrued expenses and other
liabilities of $8.3 million.   The combined decrease in accounts
payable and accrued expenses and other liabilities of $3.5 million resulted from
the use of proceeds from the 2010 financings to partially pay down these
balances.




Net cash
used in operating activities during the nine months ended September 30,
2009 was $22.0 million.  Net cash used in operations during the nine
months ended September 30, 2009 reflects our net loss of $26.6 million, adjusted
for certain non-cash items, including share-based compensation of $2.7 million
and non-cash interest expense of $0.6 million,  a decrease in accounts
receivable of $3.8 million, an increase in other assets (the increase in other
assets of $12.9 million primarily relates to an increase  in unbilled
accounts receivable related to  government contracts) and an increase
in accrued expenses and accounts payable of $4.6 million.





Investing
Activities




Net cash
provided by investing activities was $2.8 million for the nine months ended
September 30, 2010, compared to $12.7 million used in investing activities for
the nine months ended September 30, 2009.  Investing activities for the
2010 period related primarily to liquidating investments to meet working capital
requirements.




Investing
activities for the first nine months of 2009 related primarily to the payment in
June of $7.0 million of deferred purchase consideration to Avecia,
purchases, net of sales, of available for sale securities of $4.2 million and
approximately $1.5 million of capital expenditures.





Financing
Activities




Net
cash provided by financing activities was $5.6 million for the nine months ended
September 30, 2010 as compared to $18.6 million provided by financing activities
for the nine months ended September 30, 2009.  Net cash provided from
financing activities for the nine months ended September 30, 2010 was the result
of the proceeds from the issuance of common stock and warrants in April and July
2010.





Net cash
provided by financing activities was $18.6 million for the nine months ended
September 30, 2009.  In March 2009, we raised net proceeds of
approximately $4.9 million from the sale of registered shares and
warrants.  We raised $10.5 million in the July 2009 private placement,
and used the proceeds from the sale of the convertible notes to repay $5.5
million of our old notes that were not exchanged for the new convertible notes
and related warrants and repaid all outstanding amounts and fees under our
existing credit facility.  Additionally, pursuant to the payment to
Avecia of the deferred purchase consideration and the repayment of all amounts
due under our credit facility, we eliminated all of our restricted cash
obligations of approximately $13.3 million.




27




Off-Balance
Sheet Arrangements




We do not
have any off-balance sheet arrangements.




Contractual
Obligations




The
following are contractual commitments at September 30, 2010 associated with
leases, research and development arrangements, collaborative development
obligations and long term debt:





Less
      than
            
            
            
            
            
            
            
            
            More
      thanTotal
            
            
            1
      Year
            
            
            1-3
      Years
            
            
            3-5
      Years
            
            
            5
      YearsOperating
      lease obligations
            
            $
            5,364,226
            
            
            $
            830,913
            
            
            $
            1,514,983
            
            
            $
            1,607,314
            
            
            $
            1,411,016Research
      and development collaboration agreements
            
            
            13,632,644
            
            
            
            12,222,974
            
            
            
            1,409,670
            
            
            
            -
            
            
            
            -Current
      and long term debt
            
            
            23,208,562
            
            
            
            23,208,562
            
            
            
            
            
            
            
            -
            
            
            
            -Total
            
            $
            42,205,432
            
            
            $
            36,262,449
            
            
            $
            2,924,653
            
            
            $
            1,607,314
            
            
            $
            1,411,016







(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.





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
September 30, 2010 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.





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.




28





PART II — OTHER INFORMATION




Item 1.  Legal Proceedings




In
December 2006, we filed a complaint against Siga Technologies, Inc. (“SIGA”) in
the Delaware Court of Chancery.  The complaint alleges, among other
things, that we have the right to license exclusively development and marketing
rights for SIGA’s drug candidate, ST-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 ST-246 in accordance with the terms of
the term sheet attached to the merger agreement or monetary
damages.  In January 2008, the Delaware Court of Chancery 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 in April 2010 and SIGA filed its reply brief.  Oral
argument on SIGA’s motion for summary judgment was held in the Delaware Court of
Chancery in July 2010.  The court has reserved it final decision on SIGA’s
motion but has also set a date for trial to commence on January 3, 2011.





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 in
our quarterly reports on Form 10-Q for the periods ended March 31 and June 30,
2010 and as discussed below.  If any of the risks
and uncertainties set forth below, in our 2009 annual report on Form
10-K or in our quarterly reports on Form 10-Q for the periods ended March
31and June 30, 2010 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 2009 annual report on Form 10-K and our quarterly reports on Form 10-Q
for the periods ended March 31 and June 30, 2010 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 $175.0 million at September 30,
2010. At September 30, 2010 we had a working capital of $(17.7) million and
a negative net worth of $(11.4) million. Our losses to date have resulted
principally from research and development costs related to the development of
our product candidates, general and administrative costs related to operations,
and costs related to the Avecia Acquisition.




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






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




29






·
            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.




At
September 30, 2010, accounts receivable and other receivables (including
unbilled receivables) totaled approximately $8.7million.  The bid
protest filed by a third party with the U.S. Government Accountability Office
(GAO) in March 2010, challenging the decision by the U.S. Department of Health
and Human Services (HHS) to enter into the modification to our research and
development contract with BARDA for the development of SparVax TM , and
resulting “stop-work” order, caused delays in our work under that
modification.  The bid protest was ultimately denied, and the related
stop work-order canceled in June 2010.  Nevertheless, the
protest  has reduced revenues and our available cash and cash
equivalents during the first nine months of 2010.





While we
received net proceeds (before expenses) of approximately $14.1 million in
connection with our November 2010 public offering of common stock, if we decide
to redeem, either immediately or in the future, all of our remaining convertible
notes that have not been converted into shares of our common stock prior to
their maturity date, we will need additional financing to fund our working
capital needs.  As of November 11, 2010, holders of notes in the
aggregate principal amount (plus accrued interest) of approximately $9.8 million
have converted their notes, resulting in the issuance of approximately 3.9
million shares of our common stock.  Approximately $12.0 million would
be required to repay principal and interest on the remaining notes as of
November 11, 2010.





Furthermore,
under the terms of the Avecia Purchase Agreement we entered into in connection
with the Avecia Acquisition, we are required to pay Avecia (now a subsidiary of
Merck & Co., Inc.) $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 SparVax TM.  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 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.




30




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.





Our
complaint against SIGA may not yield a favorable outcome.





In
December 2006, we filed a complaint against Siga Technologies, Inc., or 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 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  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.




In March
2010, SIGA filed a motion for summary judgment relating to our
lawsuit.  Oral argument was held in July 2010 and the court indicated
that it would render a decision by the end of October 2010.  If the
court rules in favor of SIGA, significant claims in our case could be dismissed,
drastically limiting our chances for a meaningful remedy.  We cannot
assure you that SIGA will not prevail on its motion for summary judgment or that
if the case eventually proceeds to trial, we will prevail or even recover any
costs or damages.





Risks Related to Product Development
and Commercialization





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




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




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




31




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




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





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





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





We and
our CMOs will also be required to comply with the applicable FDA current Good
Manufacturing Practice, or 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, a subsidiary of Merck & Co., Inc.
(Diosynth), to replace Avecia to manufacture bulk drug substance for SparVax TM
and are engaged in a technology transfer process to this new contract
manufacturer.  This manufacturer 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.




32





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.  BARDA has
advised us that until satisfactory resolution of this issue and the partial
clinical hold is lifted it will not act on our request for additional advanced
development funding for Valortim® under BAA-BARDA-09-34.  It is
unclear at this time if the FDA will agree with the recommendation of the SMC to
take Valortim® off partial clinical hold. Further, while we plan to submit a
white paper prior to the end of 2010 to BARDA for additional advanced
development funding for Valortim®, there can be no assurance that BARDA will ask
us to make a formal funding proposal or if the proposal is made, will award
additional funding.





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, rather
than to us, 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.  Funding is subject to Congressional
appropriations generally made on an annual basis even for multi-year contracts.
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.  Future funding levels for
two of our key government customers, BARDA and DoD, for the advanced development
and procurement of medical countermeasures are uncertain, and may be subject to
budget cuts as the U.S. Congress and the President look to reduce the nation’s
budget deficit.





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 RypVax TM .  Given the limited future prospects
for RypVax TM  at this time, we and the U.S. government agreed to a
reduction to the scope of work that resulted in early wind down of all
activities under our existing RypVax TM  contract.




33





Furthermore,
the DoD has recently informed us that it is deferring a decision on whether to
fund advanced development of Protexia® for the time being, potentially for
several years, due to budget constraints and potential concerns about duration
of protection with the current route of Protexia® administration as compared to
the human blood plasma derived BChE product.  DoD has said they may
need more data regarding the duration of protection of Protexia® before making a
decision regarding future advanced development funding, and it is unclear at
this time how long and what the cost would be to address their concerns. While
the DoD has indicated it may fund the work to generate these data, no firm
commitment has been made to date and there can be no assurance DoD will
ultimately pay for this work. As such, our existing September 2006 contract
related to milk collection for Protexia® may not be extended past its current
term, which ends on December 31, 2010.


We are
currently in discussions with the DoD regarding the path forward, and
whether to commence the work to generate the additional data regarding Protexia®
or to defer while we focus on the AES.  In connection with the
potential expiration of our current contract for milk collection for Protexia®,
we are reducing  our transgenic goat operations and are in discussions
with a third party to establish the capability to initiate production of the
transgenic goat-based product at an FDA-licensed facility.  In the
fourth quarter of 2010 and the first half of 2011, we expect to incur a modest
amount of severance and other wind-down costs related to the reduction of our
Protexia®-related operations, but have not yet determined whether we will need
to write down the net book value of our Protexia® related assets, and if
required, how much that will be.


We are
in negotiations with the DoD regarding a new contract to fund on-going
research we have been conducting and self-funding related to the production of
rBChE using our AES.  We cannot assure you, however, that the contract
will be awarded in the time frame we expect, or at all, of the specific terms of
any such contract, of even if this initial contract is awarded to us that DoD
will provide any other funding in the future.





Further,
BARDA has expressed concerns regarding our performance from April 1, 2009
through April 30, 2010 under our contract for the development of SparVax TM
..  If we are unable to perform adequately under this contract, we may
be at increased risk that BARDA will curtail our activities under, or terminate,
that contract.





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.  BARDA will request a formal proposal to 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 unilateral termination provisions for the
government 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;




34






·
            control
      and potentially prohibit the export of our
  products;





·
            claim
      rights to products, including intellectual property, developed under the
      contract;





·
            change
      certain terms and conditions in our contracts;
  and





·
            cancel
      outstanding RFP solicitations (as was the case with RFP-BARDA-08-15) or
      BAAs.





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





For
example, earlier this year, NIAID 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.  In June
2010, we entered into a modification to this contract with NIAID, which closed
out the contract as part of a no-cost settlement between us and
NIAID.





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





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





The laws
and regulations governing the procurement of goods and services by the U.S.
government provide procedures by which other bidders and other interested
parties may challenge the award of a government contract.  If we are
awarded a government contract, such challenges or protests could be filed even
if there are not any valid legal grounds on which to base the
protest.  If any such protests are filed, the government agency may
decide, and in certain circumstances will be statutorily required, to suspend
our performance under the contract while such protests are being considered by
the GAO or the applicable federal court, thus potentially delaying delivery of
goods and services and payment.  In addition, we could be forced to
expend considerable funds to defend any potential award.  If a protest
is successful, the government may be ordered to terminate our contract and
re-evaluate bids.  The government could even be directed to award a
potential contract to one of the other bidders.  For example, in March
2010, a third-party filed a bid protest with the GAO challenging the February
2010 decision of the HHS to modify its existing research and development
contract with us for the development of SparVax.  In March 2010 HHS
suspended performance under the modification pursuant to the automatic stay
provisions of the FAR, pending a decision by the GAO on the
protest.  While the bid protest was ultimately denied, and the related
HHS “stop work” order canceled in June 2010, the protest contributed to a
reduction in revenues and cash and cash equivalents over the period that work
could not be performed under the modification.  In addition, we
incurred unexpected general and administrative expenses to intervene in the
protest.





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





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




35





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





·
            termination
      of contracts;






·
            forfeiture
      of profits;






·
            suspension
      of payments;






·
            fines;
      and






·
            suspension
      or prohibition from conducting business with the U.S.
      government.






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





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





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





·
              the
      Federal Acquisition Regulation, or FAR, and agency-specific regulations
      supplemental to the Federal Acquisition Regulation, which comprehensively
      regulate the procurement, formation, administration and performance of
      government contracts;




·
              the
      business ethics and public integrity obligations, which govern conflicts
      of interest and the hiring of former government employees, restrict the
      granting of gratuities and funding of lobbying activities and incorporate
      other requirements such as the Anti-Kickback Act, the Procurement
      Integrity Act, the False Claims Act and Foreign Corrupt Practices
      Act;




·
              export
      and import control laws and regulations;
and




·
              laws,
      regulations and executive orders restricting the use and dissemination of
      information classified for national security purposes and the exportation
      of certain products and technical
data.




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





Risks Related to Dependence on or
Competition From Third Parties





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





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




36





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





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.





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.




37





Risks
Related to Regulatory Approvals and Legislation





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




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





Risks
Related to Personnel





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





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





In
particular, as noted above in “Even if we succeed in commercializing our product
candidates, they may not become profitable and manufacturing problems or side
effects discovered at later stages can further increase costs of
commercialization ,” we are transferring the manufacturing process for the bulk
rPA drug substance from Avecia in the United Kingdom to Diosynth, a U.S.-based
contract manufacturer, whose parent company has recently been acquired by Merck
& Co., Inc.  There can be no assurance that we will be able to
recruit and hire the necessary staff in the U.S. to complete the transfer of the
manufacturing process in a timely and cost effective manner.





Risks
Related to Our Common Stock





If
we are unable to make progress with respect to our plan to regain compliance
with the minimum stockholders’ equity requirements imposed by the NYSE Amex
within the required timeframes, our common stock could be delisted from trading,
which could limit investors’ ability to make transactions in our common stock
and subject us to additional trading restrictions.





Our
common stock is listed on the NYSE Amex, a national securities exchange, which
imposes continued listing requirements with respect to listed
shares.  In July 2010, we received a letter from the NYSE Amex,
stating that we are not in compliance with the exchange’s continued listing
standards, specifically, Sections 1003(a)(i), (ii) and (iii) of the NYSE Amex
Company Guide, because we have stockholders’ equity of less than $2.0 million,
$4.0 million and $6.0 million and losses from continuing operations and net
losses in two of our three most recent fiscal years, three of our four most
recent fiscal years and our five most recent fiscal years,
respectively.





On August
25, 2010, we submitted a plan to the NYSE Amex addressing how we intend to
regain compliance with the continued listing standards by January 26, 2012, the
end of the eighteen-month compliance period under NYSE Amex
rules.  Based on the information in our compliance plan and related
discussions with exchange staff, the NYSE Amex determined that we had made a
reasonable demonstration of our ability to regain compliance with Sections
1003(a)(i), (ii) and (iii) of the NYSE Amex Company Guide by January 26, 2012
and that it would continue the listing of our common stock subject to
conditions.  The conditions include (a) the requirement to provide
exchange staff with updates on the initiatives included in our compliance plan,
at least once each quarter concurrent with our corresponding periodic SEC
filing, (b) the periodic review of our compliance with the plan by exchange
staff, and (c) the approval of a NYSE Amex management committee prior to any
issuances of additional shares of common stock.  If we do not show
progress consistent with our compliance plan, or we do not meet the continued
listing standards by January 26, 2012, the NYSE Amex could initiate delisting
proceedings.




38





Furthermore,
if we fail to satisfy any other continued listing standard, such as the
requirement that issuers have more than 300 public shareholders, or that the
aggregate market value of shares publicly held be more than $1,000,000, the NYSE
Amex may also decide to initiate delisting proceedings.





If our
securities are delisted from trading on the NYSE Amex and we are not able to
list our securities on another exchange or to have them quoted on Nasdaq, our
securities could be quoted on the OTC Bulletin Board or on the “pink
sheets”.  As a result, we could face significant adverse consequences
including:




·
            a
      limited availability of market quotations for our
    securities;





·
            a
      determination that our common stock is a “penny stock” which will require
      brokers trading in our common stock to adhere to more stringent rules and
      possibly result in a reduced level of trading activity in the secondary
      trading market for our securities;





·
            a
      limited amount of news and analyst coverage for us;
  and





·
            a
      decreased ability to issue additional securities (including pursuant to
      our universal shelf registration statement on Form S-3) or obtain
      additional financing in the future.





Our
stock price is volatile.





The
market price of our common stock has been, and we expect will continue to be,
subject to significant volatility.  The value of our common stock may
decline regardless of our operating performance or prospects.  Factors
affecting our market price include:





·
              our perceived
      prospects;





·
              variations in our
      operating results and whether we have achieved key business
      targets;·
              changes in, or our
      failure to meet, revenue estimates;·
              changes in
      securities analysts’ buy/sell recommendations;·
              differences between
      our reported results and those expected by investors and securities
      analysts;·
              announcements of new
      contracts by us or our competitors;·
              reaction to any
      acquisitions, joint ventures or strategic investments announced by us or
      our competitors; and·
              general economic,
      political or stock market
conditions.





39


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 have
filed a 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.  We have sold securities under this shelf registration
statement in November 2010, July 2010, April 2010 and March 2009.  We
expect to file a new universal shelf registration statement in the
future.  Raising capital in this or other manners may depress the
market price of our stock, and any such financing(s) will dilute our existing
shareholders.




In
addition, as of September 30, 2010 we had outstanding options to purchase
approximately 4.3 million shares of common stock (not including unvested
restricted stock awards).  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.
 
 Under the
terms of our outstanding convertible notes, unless earlier converted, redeemed
or accelerated, the outstanding principal plus accrued interest is payable at
maturity on July 28, 2011.  Under the terms of the notes, each holder
converting notes is entitled to receive a number of shares corresponding to
principal and accrued interest through the date of conversion (plus any accrued
and unpaid late charges) at a conversion price of approximately
$2.54.  In addition, we have recently agreed to pay each holder
exercising his conversion right prior to maturity an amount in cash
corresponding to the interest foregone, i.e., the interest the holder would have
received between November 4, 2010 and the maturity date had he held the note
through maturity.  Simultaneously with the closing of our November
2010 public offering, certain of our affiliates, officers and directors who
owned convertible notes converted their notes into an aggregate of approximately
3.4 million shares of our common stock.  These converting noteholders
received cash payments of approximately $0.6 million in the aggregate,
corresponding to the interest foregone.  As of November 11, 2010,
holders of notes (including those referenced above) in the aggregate principal
amount (plus accrued interest) of approximately $9.8 million have converted
their notes, resulting in the issuance of approximately 3.9 million shares of
our common stock.  We may redeem, either immediately or in the future,
all of the remaining convertible notes that have not been converted into shares
of our common stock prior to their maturity date.  Approximately $12.0
million would be required to repay principal and interest on the remaining notes
as of November 11, 2010.  If the holders of the remaining notes were
to convert their notes into shares of our common stock as of November 11, 2010,
the holders of those notes would receive approximately 4.7 million shares of
common stock and approximately $0.8 million in cash.  These
conversions have diluted, and any further conversions will dilute, the equity
interest of our stockholders.  The convertible notes had accompanying
warrants which 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 September 30, 2010 the Company had issued and outstanding additional
warrants to purchase up to approximately 2.6 million shares of common stock (not
including the warrants to purchase approximately 2.6 million shares issued to
holders of the convertible notes, as discussed above).





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.  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.




40





Item
6.  Exhibits.





No.
            
            Description1.1
            
            Placement
      Agency Agreement dated as of July 20, 2010 by and among the Company and
      Roth Capital Partners, LLC*10.1
            
            Form
      of Securities Purchase Agreement dated as of July 20, 2010 between the
      Company and the Investor*10.2
            
            Form
      of Warrant*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







*
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed
on July 20, 2010.




41




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:
      November 15, 2010
            By:
            /s/
      Eric I. RichmanEric
      I. RichmanPresident
      and Chief Executive OfficerDated:
      November 15, 2010
            By:
            /s/
      Charles A. Reinhart IIICharles
      A. Reinhart IIIChief
      Financial Officer






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