UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2005
Commission File Number: 0-27072
HEMISPHERx BIOPHARMA, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 52-0845822
------------------------------ -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1617 JFK Boulevard, Suite 660, Philadelphia, PA 19103
--------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(215) 988-0080
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).|X| Yes |_| No
62,299,252 shares of common stock were issued and outstanding as of July 12,
2006.
1
FORM 10-Q/A
EXPLANATORY NOTE
This amendment on Form 10-Q/A amends our Quarterly Report for the second quarter
of 2005 initially filed with the Securities and Exchange Commission ("SEC") on
August 9, 2005 (the "original Form 10-Q"). It is being filed to reflect the
restatement (the "Restatements") of our consolidated balance sheets and related
consolidated statements of operations, cash flows and stockholders' equity and
comprehensive loss as of and for the three and six months ended June 30, 2005
and 2004, as discussed in Note 2 to the consolidated financial statements.
No attempt has been made in this Form 10-Q/A to modify or update disclosures in
the original Form 10-Q except as required to address the Restatements. Except as
described below, this Form 10-Q/A does not reflect events occurring after the
filing of the original Form 10-Q or modify or update any related disclosures.
Information not affected by the amendment is unchanged and reflects the
disclosure made at the time of the filing of the original Form 10-Q with the
SEC. Accordingly, this Form 10-Q/A should be read in conjunction with the
original Form 10-Q and our filings made with the SEC subsequent to the filing of
the original Form 10-Q, including any amendments to those filings.
In accordance with Rule 12b-15 promulgated under the Securities and Exchange Act
of 1934, as amended, the complete texts of Part I, Items 1, 2 and 4 are set
forth herein, including those portions of the text that have not been amended
from that set forth in the original Form 10-Q. The only changes to the text in
Part I, Items 1, 2 and 4 of the original Form 10-Q are as follows:
Part I
Item 1.
o The financial statements, including the footnotes, have been
revised to reflect the changes required by the Restatements.
o A new footnote (Note 2) has been added to describe the
Restatements and the other footnotes have been revised to
conform with the footnote presentation and disclosure in our
Form 10-Q for the quarter ended March 31, 2006 (which was
filed with the SEC on June 30, 2006).
o Note 3: Stock Based Compensation was revised to include the
three month pro forma effect on the Company's net loss and
loss per share had compensation cost for the Company's option
plans been determined.
o The paragraphs concerning the August 2004 Private Placement
which were originally included in Note 8: Debenture Financing
have been moved to Note 9: Equity Financing to separate it
from the changes required by the restatements.
o The paragraph concerning the closing of the August 2004
Private Placement and its triggering of anti-dilution
provisions within Note 9: Equity Financing was removed to
reflect the changes required by the restatements.
Item 2.
o An additional critical accounting policy titled "Convertible
Debentures" has been added.
o The following subsections in both "Three months ended June 30,
2005 versus Three months ended June 30, 2004" and "Six months
ended June 30, 2005 versus Six months ended June 30, 2004"
have been revised as a result of the Restatements: "Net Loss,"
"General and Administrative Expenses" and "Interest Expense
and Financing Costs." In addition, a subsection titled "Deemed
Dividend" has been added in the three and six month
comparisons.
o An additional risk factor titled "We reported material
weaknesses in our internal control over financial reporting
that, if not remedied, could adversely affect our internal
controls" has been added.
2
o The risk factor "We may continue to incur substantial losses
and our future profitability is uncertain" has been revised to
correct the accumulated deficit as a result of the
Restatements.
Item 4.
o This Item has been revised in its entirety due to the
Restatements.
Summary of Restatements
In 2003 and 2004, we entered into convertible debenture arrangements which are
inherently complicated, which have been and continue to be the subject of
numerous intricate accounting pronouncements and interpretations and which are
not classified as normal recurring transactions. Our convertible debenture
transactions were reported within our previously filed financial statements for
the years ended December 31, 2003 and 2004. After an extensive review and
consultation with the our independent registered public accountants and our
audit committee, we determined that we must restate our historical financial
statements for the years ended December 31, 2003 and 2004 as well as the interim
financial statements for 2003, 2004, and 2005. We determined that, with respect
to the accounting for the convertible debentures, the interpretation and
application of EITF No. 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" was not correct at the time the convertible debentures
were initially recorded and upon conversion price resets related to the
convertible debentures. As a result of this determination, we restated our
annual financial statements and quarterly results of operations (unaudited)
included in our annual report on Form 10-K/A for the period ending December 31,
2005, which was filed on June 5, 2006 and further amended Footnote 19, Quarterly
Results of Operations (unaudited), to those financials in our Annual Report on
Form 10-K/A-2 for the fiscal year ended December 31, 2005, which was filed on
July 31, 2006.
In addition, we restated: (i) our condensed consolidated unaudited interim
financial statements for the quarter ended March 31, 2005 included in our
quarterly report on Form 10-Q for the quarter ended March 31, 2006, which was
filed on June 30, 2006; (ii) our condensed consolidated unaudited interim
financial statements for the quarter and six months ended June 30, 2005 and 2004
included in this quarterly report on Form 10-Q/A; and (iii) the condensed
consolidated unaudited interim financial statements for quarter and nine months
ended September 30, 2005 and 2004 contained in our September 30, 2005 quarterly
report on Form 10-Q/A filed on July 31, 2006. The modifications in the restated
financial statements relate to non-cash charges that do not affect our revenues,
cash flows from operations or liquidity.
3
PART I - FINANCIAL INFORMATION
ITEM 1: Financial Statements
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
(Restated) (Restated)
---------- ----------
December 31, June 30,
------------ --------
2004 2005
(Unaudited)
-----------
ASSETS
Current assets:
Cash and cash equivalents $ 8,813 $ 5,802
Short term investments 7,924 6,812
Inventory, net (Note 5) 2,148 1,815
Accounts and other receivables 139 72
Prepaid expenses and other current assets 266 225
-------------- --------------
Total current assets 19,290 14,726
-------------- --------------
Property and equipment, net 3,303 3,325
Patent and trademark rights, net 908 805
Investment (Note 4) 35 35
Construction in Progress -- 31
Deferred financing costs 440 233
Advance receivable (Note 8) 1,300 1,300
Other assets 17 17
-------------- --------------
Total assets $ 25,293 $ 20,472
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 526 $ 414
Accrued expenses 1,012 608
Current portion of long-term debt, net 3,818 5,033
-------------- --------------
Total current liabilities 5,356 6,055
-------------- --------------
Long-Term Debt-net of current portion (Note 8) 494 --
Commitments and contingencies
Stockholders' equity :
Preferred stock par value $0.01
per share Authorized 5,000,000;
issued and outstanding; none
Common stock, par value $0.01 per share, 50 51
authorized 100,000,000 shares; issued and
outstanding 49,631,766 and 50,509,429, respectively
Additional paid-in capital 154,609 155,992
Accumulated other comprehensive income (10) (95)
Accumulated deficit (135,206) (141,531)
-------------- --------------
Total stockholders' equity 19,443 14,417
-------------- --------------
Total liabilities and stockholders' equity $ 25,293 $ 20,472
============== ==============
See accompanying notes to consolidated financial statements.
4
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(in thousands, except share and per share data)
Three months ended June 30,
--------------------------------
2004 2005
(Restated) (Restated)
Revenues:
Sales of product net $ 289 $ 240
Clinical treatment programs 42 60
-------------- --------------
Total Revenues: 331 300
Costs and expenses:
Production/cost of goods sold 692 103
Research and development 758 1,158
General and administrative 1,076 1,523
-------------- --------------
Total costs and expenses 2,526 2,784
Interest and other income 13 63
Interest expense (105) (107)
Financing costs (Note 8) (497) (817)
-------------- --------------
Net loss $ (2,784) $ (3,345)
Deemed Dividend (2,355) --
-------------- --------------
Net loss applicable to common stockholders $ (5,139) $ (3,345)
============== ==============
Basic and diluted loss per share $ (.12) $ (.07)
============== ==============
Weighted average shares outstanding 43,871,350 50,299,176
============== ==============
See accompanying notes to consolidated financial statements.
5
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(in thousands, except share and per share data)
Six months ended June 30,
-------------- --------------
2004 2005
(Restated) (Restated)
Revenues:
Sales of product net $ 548 $ 469
Clinical treatment programs 91 89
-------------- --------------
Total Revenues: 639 558
Costs and expenses:
Production/cost of goods sold 1,293 201
Research and development 1,720 2,426
General and administrative 3,921 2,550
-------------- --------------
Total costs and expenses 6,934 5,177
Interest and other income 24 293
Interest expense (206) (213)
Financing costs (Note 8) (3,371) (1,786)
-------------- --------------
Net loss $ (9,848) $ (6,325)
Deemed Dividend (2,355) --
-------------- --------------
Net loss applicable to common stockholders
$ (12,203) $ (6,325)
============== ==============
Basic and diluted loss per share $ (.29) $ (.13)
============== ==============
Weighted average shares outstanding 42,040,412 50,033,623
============== ==============
See accompanying notes to consolidated financial statements.
6
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders'
Equity and Comprehensive Loss
For the Six Months Ended June 30, 2005 (Unaudited)
(in thousands, except share data)
Common stock Additional
------------ paid-in
Shares Amount capital
---------------- ---------------- ----------------
Balance as of December 31, 2004, Restated 49,631,766 $ 50 $ 154,609
Shares issued for:
Payment of accounts payable 222,310 192
Conversion of debt 514,107 1 778
Warrants converted 5,000 9
Interest on convertible debt 136,246 216
Options and warrants issued for services 107
Conversion price adjustment 81
Net comprehensive loss
---------------- ---------------- ----------------
Balance as of June 30, 2005, Restated 50,509,429 $ 51 $ 155,992
================
Accumulated
other Total
Comprehensive Accumulated stockholders'
Income (Loss) deficit equity
---------------- ---------------- ----------------
Balance as of December 31, 2004, Restated $ (10) $ (135,206) $ 19,443
Shares issued for:
Payment of accounts payable 192
Conversion of debt 779
Warrants converted 9
Interest on convertible debt 216
Options and warrants issued for services 107
Conversion price adjustment 81
Net comprehensive loss (85) (6,325) (6,410)
---------------- ---------------- ----------------
Balance as of June 30, 2005, Restated $ (95) $ (141,531) $ 14,417
================ ================ ================
See accompanying notes to financial statements
7
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2004 and 2005 (Unaudited)
(in thousands)
2004 2005
(Restated) (Restated)
---------- ----------
Cash flows from operating activities:
Net loss $ (9,848) $ (6,325)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation of property and
equipment 53 57
Amortization of patent and
trademark rights 160 174
Amortization of deferred
financing costs 2,841 1,786
Financing cost related to 530
redemption obligation --
Stock warrant compensation
expense 1,769 106
Interest expense 206 213
Changes in assets and liabilities:
Inventory 273 333
Accounts and other receivables 125 67
Deferred revenue 497 --
Prepaid expenses and other
current assets (76) 41
Accounts payable 365 80
Accrued expenses (781) (397)
Other Assets 14 --
---------- ----------
Net cash used in operating
Activities (3,872) (3,865)
---------- ----------
Cash flows from investing activities:
Purchase of land and building (143) --
Purchase of property, plant and
equipment -- (110)
Additions to patent and trademark
rights (121) (71)
Maturity of short term
investments 1,496 7,934
Purchase of short term
investments (4,969) (6,907)
---------- ----------
Net cash (used in) provided by
investing activities $ (3,737) $ 846
---------- ----------
8
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
For the Six Months Ended June 30, 2004 and 2005(Unaudited)
(in thousands)
2004 2005
(Restated) (Restated)
---------- ----------
Cash flows from financing activities:
Proceeds from long-term borrowing 5,808 --
Advance receivable (410) --
Proceeds from exercise of stock
Warrants 2,911 8
---------- ----------
Net cash provided by financing
Activities 8,309 8
---------- ----------
Net increase (decrease) in cash and cash equivalents
700 (3,011)
Cash and cash equivalents at beginning of period
3,764 8,813
---------- ----------
Cash and cash equivalents at end of period
$ 4,464 $ 5,802
========== ==========
Supplemental disclosures of cash flow information:
Issuance of common stock for
accounts payable and accrued
expenses $ 255 $ 192
========== ==========
Issuance of Common Stock for
Purchase of building $ 1,626 $ --
========== ==========
Issuance of Common Stock for
Debt Conversion and Interest
Payments on Convertible Debt $ 6,072 $ 994
========== ==========
See accompanying notes to consolidated financial statements.
9
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Hemispherx BioPharma, Inc., a Delaware corporation and its subsidiaries. All
significant intercompany accounts and transactions have been eliminated.
In the opinion of management, all adjustments necessary for a fair presentation
of such consolidated financial statements have been included. Such adjustments
consist of normal recurring items. Interim results are not necessarily
indicative of results for a full year.
The interim consolidated financial statements and notes thereto are presented as
permitted by the Securities and Exchange Commission (SEC), and do not contain
certain information which will be included in our annual consolidated financial
statements and notes thereto.
These consolidated financial statements should be read in conjunction with our
consolidated financial statements included in our annual report on Form 10-K/A-2
for the year ended December 31, 2005, as filed with the SEC on July 31, 2006.
Note 2: Restatements
In 2003 and 2004, the Company entered into convertible debenture arrangements
which are inherently complicated, which have been and continue to be the subject
of numerous intricate accounting pronouncements and interpretations and which
are not classified as normal recurring transactions. The Company's convertible
debenture transactions were reported within the Company's previously filed
financial statements for the years ended December 31, 2003 and 2004. After an
extensive review and consultation with the the Company's independent registered
public accountants and the Company's audit committee, it was determined that the
Company must restate its historical financial statements for the years ended
December 31, 2003 and 2004 as well as the interim financial statements for 2003,
2004, and 2005. The Company determined that, with respect to the accounting for
the convertible debentures, the interpretation and application of EITF No.
00-27: "Application of Issue No. 98-5 to Certain Convertible Instruments" was
not correct at the time the convertible debentures were initially recorded and
upon conversion price resets related to the convertible debentures. As a result
of this determination, the Company restated its annual financial statements and
quarterly results of operations (unaudited) included in its annual report on
Form 10-K/A for the period ending December 31, 2005, which was filed on June 5,
2006 and further amended Footnote 19, Quarterly Results of Operations
(unaudited), to those financials in its Annual Report on Form 10-K/A-2 for the
fiscal year ended December 31, 2005, which was filed on July 31, 2006.
In addition, the Company restated: (i) its condensed consolidated unaudited
interim financial statements for the quarter ended March 31, 2005 included in
its quarterly report on Form 10-Q for the quarter ended March 31, 2006, which
was filed on June 30, 2006; (ii) its condensed consolidated unaudited interim
financial statements for the quarter and six months ended June 30, 2005 and 2004
included in this quarterly report on Form 10-Q/A; and (iii) the condensed
consolidated unaudited interim financial statements for quarter and nine months
ended September 30, 2005 and 2004 contained in its September 30, 2005 quarterly
report on Form 10-Q/A filed on July 31, 2006. The modifications in the restated
financial statements relate to non-cash charges that do not affect its revenues,
cash flows from operations or liquidity.
10
(a) Based on SEC guidance presented at the 2005 annual AICPA National
Conference on current SEC and PCAOB developments, the Company
re-evaluated its accounting for its March 2003, July 2003, October
2003, January 2004 and July 2004 Debentures (collectively, "the
Debentures") to determine whether the embedded conversion options
required bifurcation and fair value accounting in accordance with
FASB Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities", and EITF 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in a
Company's Own Stock". The Company concluded that bifurcation was not
required and that EITF 00-27: "Application of Issue No. 98-5 to
Certain Convertible Instruments" ("EITF 00-27") should have been
applied. The Company did initially apply EITF 00-27, however as part
of performing an analysis on the guidelines set forth in EITF 00-27
it was determined that the initial accounting treatment for the
Debentures and conversion price resets that was originally applied
and reflected in the financial statements included in the Company's
Annual Reports on Form 10-K for the years ended December 31, 2004
and 2003, and in the Company's Quarterly Reports on Form 10-Q during
the quarterly periods in fiscal 2003, 2004 and 2005 were not
correctly applied and that, therefore, a restatement of the
Company's financial statements for the periods referenced above was
required. To properly account for the initial calculation of the
discount and the conversion price resets triggered upon the issuance
of the October 2003 Debenture and the August 2004 Private Placement
(See Notes 8 & 9 below for more details on these resets), it was
determined, under guidance from EITF 00-27 that the debt discount
should be restated for the Debentures. The total impact of this
restatement on the Company's statement of operations was to decrease
the net loss applicable to common stockholders for the three months
ended June 30, 2004 and 2005 by approximately $3,240,000 and
$628,000 or $0.07 and $0.01 per share, respectively, and decrease
the net loss applicable to common stockholders for the six months
ended June 30, 2004 and 2005 by approximately $4,334,000 and
$791,000, or $0.10 and $0.01 per share, respectively.
(b) The estimation of fair value ascribed to and the accounting
treatment of the investment banking fees paid to Cardinal Capital,
LLC ("Cardinal") in connection with the Debenture issuances, at
inception, was inaccurately reflected in the financial statements
included in the Company's Annual Report on Form 10-K for the years
ended December 31, 2004 and 2003, and the Company's Quarterly
reports on Form 10-Q during the quarterly periods in fiscal 2003,
2004 and 2005 and as a result a restatement of the Company's
financial statements for the periods referenced above was required.
In connection with the initial recording of the Debentures mentioned
above, it was determined that the fair value of the warrants issued
as investment banking fees paid to Cardinal, be accounted for as a
discount to the Debentures. These investment banking fees should
have been capitalized as deferred financing costs and amortized over
the life of the Debentures or charged to earnings on the earlier
conversion thereof. In addition, the initial calculation of the fair
value of the warrants issued to Cardinal as part of the Debenture
issuances was determined to be computed incorrectly at the time of
issuance. The total impact of this restatement on the Company's
statement of operations was to increase the net loss applicable to
common stockholders for the three months ended June 30, 2004 and
2005 by approximately $68,000 and $43,000 or $0.00 and $0.00 per
share respectively, and increase the net loss applicable to common
stockholders for the six months ended June 30, 2004 and 2005 by
approximately $185,000 and $86,000 or $0.00 and $0.00 per share,
respectively.
11
(c) The accounting treatment for certain warrants and options issued to
non-employees and our interpretationand application of FASB No. 123
was not correct in 2005. The total impact of this restatement on the
Company's settlement of operations was to increase the net loss for
the three months ended June 30, 2005, by approximately $114,000 or
$0.00 and an increase in the net loss applicable to common
stockholders for the six months ended June 30, 2005 by approximately
$159,000 or $0.00 per share.
(d) The accounting treatment set forth in FASB Statement No. 123,
"Accounting for Stock-Based Compensation", for the issuance of the
May 2009 Warrants that was originally interpreted and reflected in
the financial statements included in our Annual Report on Form 10-K
for the years ended December 31, 2003 and 2004, and in the Company's
Quarterly Reports on Form 10-Q during the quarterly periods in
fiscal 2003, 2004 and 2005 was not correctly applied and as a result
a restatement of our financial statements for the periods referenced
above was required. The Warrants issued as incentive to exercise
prior warrant issuances should be reflected as a deemed dividend at
the date of issuance where previously these warrants were either
recorded as additional debt discount or as a financing charge at
date of issuance. The total impact of this restatement on the
Company's statement of operations was to decrease the net loss
applicable to common stock holders for the three and six months
ended June 30, 2004 by $2,355,000 or $0.05 and $0.06 per share,
respectively.
As a result of the corrections of the errors described above, the Company has
restated its financial statements in this Quarterly Report on Form 10-Q/A as
follows:
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Three Months Ended June 30, 2005
June 30, June 30,
2005 Adjustments 2005
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 240 $ 240
Clinical treatment programs 60 60
--------------- ---------------
Total Revenues: 300 300
Costs and expenses:
Production/cost of goods sold 103 103
Research and development 1,158 1,158
General and administrative 1,409 $ (114) (c) 1,523
--------------- --------------- ---------------
Total costs and expenses 2,670 (114) 2,784
Interest and other income 63 63
Interest expense (107) (107)
Financing costs (1,402) 585 (a)(b) (817)
Net loss $ (3,816) $ 471 (a)(b) $ (3,345)
=============== =============== ===============
Basic and diluted loss per share $ (.08) $ 0.01 $ (.07)
=============== =============== ===============
Weighted average shares outstanding 50,299,176 50,299,176
=============== ===============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(c) Includes restatement adjustments for certain warrants and options issued
to non-employees and the Company's interpretation and application of FASB
No. 123 was not correct in 2005, as described above.
12
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Three Months Ended June 30, 2004
June 30, June 30,
2004 Adjustments 2004
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 289 $ 289
Clinical treatment programs 42 42
-------------- --------------
Total Revenues: 331 331
Costs and expenses:
Production/cost of goods sold 692 692
Research and development 758 758
General and administrative 1,076 1,076
-------------- --------------
Total costs and expenses 2,526 2,526
Interest and other income 13 13
Interest expense (105) (105)
Financing costs (3,669) $ 3,172 (a)(b) (497)
-------------- -------------- --------------
Net loss $ (5,956) 3,172 (a)(b) $ (2,784)
Deemed Dividend -- (2,355) (d) (2,355)
-------------- -------------- --------------
Net loss applicable to common
stockholders $ (5,956) $ 817 $ (5,139)
============== ============== ==============
Basic and diluted loss per share $ (.14) $ 0.02 $ (.12)
============== ============== ==============
Weighted average shares outstanding 43,871,350 43,871,350
============== ==============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(d) Includes restatement adjustment for the issuance of the May 2009 warrants
as incentive to exercise prior warrant issuances, as described above.
13
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Six Months Ended June 30, 2005
June 30, June 30,
2005 Adjustments 2005
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 469 $ 469
Clinical treatment programs 89 89
-------------- --------------
Total Revenues: 558 558
Costs and expenses:
Production/cost of goods sold 201 201
Research and development 2,426 2,426
General and administrative 2,391 $ (159) (c) 2,550
-------------- -------------- --------------
Total costs and expenses 5,018 (159) 5,177
Interest and other income 293 293
Interest expense (213) (213)
Financing costs (2,491) 705 (a)(b) (1,786)
-------------- -------------- --------------
Net loss $ (6,871) $ 546 (a)(b) $ (6,325)
============== ============== ==============
Basic and diluted loss per share $ (.14) $ 0.01 $ (.13)
============== ============== ==============
Weighted average shares outstanding 50,033,623 50,033,623
============== ==============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(c) Includes restatement adjustments for certain warrants and options issued
to non-employees and the Company's interpretation and application of FASB
No. 123 was not correct in 2005, as described above.
14
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Six Months Ended June 30, 2004
June 30, June 30,
2004 Adjustments 2004
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 548 $ 548
Clinical treatment programs 91 91
-------------- --------------
Total Revenues: 639 639
Costs and expenses:
Production/cost of goods sold 1,293 1,293
Research and development 1,720 1,720
General and administrative 3,921 3,921
-------------- --------------
Total costs and expenses 6,934 6,934
Interest and other income 24 24
Interest expense (206) (206)
Financing costs (7,520) $ 4,149 (a)(b) (3,371)
-------------- -------------- --------------
Net loss $ (13,997) 4,149 (a)(b) $ (9,848)
Deemed Dividend -- (2,355) (d) (2,355)
-------------- -------------- --------------
Net loss applicable to common
stockholders $ (13,997) $ 1,794 $ (12,203)
============== ============== ==============
Basic and diluted loss per share $ (.33) $ 0.04 $ (.29)
============== ============== ==============
Weighted average shares outstanding 42,040,412 42,040,412
============== ==============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(d) Includes restatement adjustment for the issuance of the May 2009 warrants
as incentive to exercise prior warrant issuances, as described above.
The Company and the Company's audit committee have discussed the above errors
and adjustments with the Company's current independent registered public
accounting firm and have determined that a restatement was necessary for the
period described above.
NOTE 3: STOCK BASED COMPENSATION
The Company follows Statement of Financial Accounting Standards(SFAS) No. 123,
"Accounting for Stock-Based Compensation." We chose to apply Accounting
Principal Board Opinion 25 and related interpretations in accounting for stock
options granted to our employees.
The Company provides pro forma disclosures of compensation expense under the
fair value method of SFAS No. 123, "Accounting for Stock-Based Compensation,"
and SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and
Disclosure."
15
The weighted average assumptions used for the period presented are as follows:
June 30,
--------
2004 2005
---- ----
Risk-free interest rate -- 4.81%
Expected lives -- 5 years
Expected volatility -- 58.78% - 60.67%
Had compensation cost for the Company's option plans been determined, using the
fair value method at the grant dates, the effect on the Company's net loss and
loss per share for the Three and Six months ended June 30, 2004 and 2005 would
have been as follows:
(In Thousands) (In Thousands)
-------------- --------------
Three Months Ended Six Months Ended
------------------------ ------------------------
June 30, June 30,
---------- ---------- ---------- ----------
2004 2005 2004 2005
---- ---- ---- ----
Net loss applicable to common
stockholders, as restated $ (5,139) $ (3,345) $ (12,203) $ (6,325)
Add: Stock based employee compensation
expenses; included in reported net loss -- 106 1,769 106
Deduct: Total stock based employee
compensation determined under fair
value method for all awards -- (55) -- (82)
---------- ---------- ---------- ----------
Pro forma net loss $ (5,139) $ (3,294) $ (10,434) $ (6,301)
========== ========== ========== ==========
Basic and diluted loss per share
As restated $ (.12) $ (.07) $ (.29) $ (.13)
Pro forma $ (.12) $ (.07) $ (.25) $ (.13)
Note 4: INVESTMENT IN UNCONSOLIDATED AFFILIATES
Investments include an equity investment of $35,000 in Chronix Biomedical
("Chronix"). Chronix focuses upon the development of diagnostics for chronic
diseases. This initial investment was made in May 31, 2000 by the issuance of
50,000 shares of the Company's common stock from the treasury. On October 12,
2000, the Company issued an additional 50,000 shares of its common stock and on
March 7, 2001 the Company issued 12,000 more shares of its common stock from the
treasury to Chronix for an aggregate equity investment of $700,000. The
percentage ownership in Chronix is approximately 5.4% and is accounted for under
the cost method of accounting. During the quarter ended December 31, 2002, the
Company recorded a non-cash charge of $292,000 with respect to the investment in
Chronix. The Company recorded an additional non-cash charge of $373,000 during
the quarter ended September 30, 2004, due to evidence of a further decline in
Chronix's market value. This impairment reduces the carrying value to reflect a
permanent decline in Chronix's market value based on its then proposed
investment offerings.
NOTE 5: INVENTORIES
The Company uses the lower of first-in, first-out ("FIFO") cost or market method
of accounting for inventory.
Inventories consist of the following:
December 31, 2004 June 30, 2005
----------------- -----------------
Raw materials-work in process $ 1,711,000 $1,711,000
Finished goods,
net of $225,000 reserve 437,000 104,000
----------------- -----------------
$ 2,148,000 $1,815,000
================= =================
16
The Company's reserve for R&D utilization as of June 30, 2005, totaled $225,000
for Alferon N finished goods that may not be sold prior to their 18 month
shelf-life expiration. Also, the Company may consume some, or all of this,
potentially stale inventory in its Research & Development efforts. The Company
completed tests in 2004 to extend the product shelf life to 24 months. The
Company filed its annual report with the FDA in December 2004 including
documentation for the extension of shelf-life to 24 months. The Company received
a response from the FDA at the end of June 2005 concerning the relabeling
request of Alferon N Injection(R). After reviewing the information submitted,
the FDA determined the submission as a "Prior Approval Supplement". Under this
designation, the FDA has six months, as of May 2005, to approve the request to
relabel Alferon N Injection(R) with the extended shelf-life. The Company now
anticipates a response from the FDA by September 2005.
NOTE 6: REVENUE AND LICENSING FEE INCOME
The company executed a Memorandum of Understanding (MOU) in January 2004 with
Astellas Pharma ("Astellas"), formally Fujisawa Deutschland GmbH (Fuji), a major
pharmaceutical corporation, granting them an exclusive option for a limited
number of months to enter a Sales and Distribution Agreement with exclusive
rights to market Ampligen(R) for ME/CFS in Germany, Austria and Switzerland. The
Company received an initial fee of 400,000 Euros (approximately $497,000 US) in
2004. On November 9, 2004, Astellas exercised their right to terminate the MOU.
The Company did not agree on the process to be utilized in certain European
Territories for obtaining commercial approval for the sale of Ampligen(R) in the
treatment of patients suffering from Chronic Fatigue Syndrome (CFS). Instead of
a centralized procedure, and in order to obtain an earlier commercial approval
of Ampligen(R) in Europe, the Company has determined to follow a decentralized
filing procedure which was not anticipated in the MOU. The Company believes that
it now is in the best interest of the Company's stockholders to potentially
accelerate entry into selected European markets whereas the original MOU
specified a centralized registration procedure. Pursuant to the agreement of the
parties the Company refunded 200,000 Euros to Fuji. The company has recorded the
remaining 200,000 Euros ($242,000 USD) as an accrued liability as of June 30,
2005. The Company is currently holding the 200,000 Euros pending further
developments in accordance with the mutually agreed upon termination with Fuji.
Fuji and Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") have reached a
definitive agreement upon the terms of their merger, which took effect on April
1, 2005. Yamanouchi will be the surviving company and Fuji will be dissolved.
The combined company name will be Astellas Pharma, Inc.
Revenues for non-refundable license fees are recognized under the Performance
Method-Expected Revenue. This method considers the total amount of expected
revenue during the performance period, but limits the amount of revenue
recognized in a period to total non-refundable cash received to date. This
limitation is appropriate because future milestone payments are contingent on
future events.
Upon receipt, the upfront non-refundable payment is deferred. The non-refundable
upfront payments plus non-refundable payments arising from the achievement of
defined milestones are recognized as revenue over the performance period based
on the lesser of (a) percentage of completion or (b)non-refundable cash earned
(including the upfront payment).
This method requires the computation of a ratio of cost incurred to date to
total expected costs and then apply that ratio to total expected revenue. The
amount of revenue recognized is limited to the total non-refundable cash
received to date.
During the period ended June 30, 2005, the Company did not receive any grant
monies from local, state and or Federal Agencies.
17
Revenue from the sale of Ampligen(R) under cost recovery clinical treatment
protocols approved by the FDA is recognized when the treatment is provided to
the patient.
Revenues from the sale of product are recognized when the product is shipped, as
title is transferred to the customer. The Company has no other obligation
associated with its products once shipment has occurred.
Note 7: ACQUISITION OF ASSETS OF INTERFERON SCIENCES, INC. ("ISI")
On March 11, 2003, the Company acquired from ISI, ISI's inventory of ALFERON N
Injection(R) and a limited license for the production, manufacture, use,
marketing and sale of this product. As partial consideration, the Company issued
487,028 shares of its common stock to ISI Pursuant to their agreements with ISI,
the Company registered these shares for public sale and ISI has reported that it
has sold all of these shares. The Company also agreed to pay ISI 6% of the net
sales of ALFERON N Injection(R).
On March 11, 2003, the Company also entered into an agreement to purchase from
ISI all of its rights to the product and other assets related to the product
including, but not limited to, real estate and machinery. For these assets, the
Company agreed to issue to ISI an additional 487,028 shares and to issue 314,465
shares and 267,296 shares, respectively to the American National Red Cross and
GP Strategies Corporation, two creditors of ISI. The Company guaranteed the
market value of all but 62,500 of these shares to be $1.59 per share on the
termination date. As discussed below, the Company issued all of these shares and
ISI, GP Strategies and the American National Red Cross have reported that they
have sold all of their shares.
The Company also agreed to satisfy other liabilities of ISI which were past due
and secured by a lien on ISI's real estate and to pay ISI 6% of the net sales of
products containing natural alpha interferon.
On May 30, 2003, the Company issued the shares to GP Strategies and the American
National Red Cross. Pursuant to the Company's agreements with ISI and these two
creditors, the Company registered the foregoing shares for public sale. As a
result at December 31, 2003 the guaranteed value of these shares ($491,000),
which had not been sold by these two creditors, were reclassified to redeemable
common stock. At December 31, 2004, all shares had been sold by these two
creditors and the redeemable common stock was reclassed to equity.
On November 6, 2003, the Company acquired and subsequently paid, the outstanding
ISI property tax lien certificates in the aggregate amount of $457,000 from
certain investors. These tax liens were issued for property taxes and utilities
due for 2000, 2001 and 2002.
In March 2004, the Company issued 487,028 shares to ISI to complete the
acquisition of the balance of ISI's rights to market its product as well as its
production facility in New Brunswick, New Jersey. ISI has sold all of its
shares. The aggregated cost of the land and buildings was approximately
$3,316,000. The cost of the land and buildings was allocated as follows:
Land $ 423,000
Buildings 2,893,000
----------
Total cost $3,316,000
The Company accounted for these transactions as a Business Combination under
SFAS No. 141 Accounting for Business Combinations.
18
Note 8: DEBENTURE FINANCING
Long term debt consists of the following:
(in thousands)
December June
31, 2004 30, 2005
--------------- ---------------
(As restated) (As restated)
October 2003 Debenture $ 2,071 $ 2,071
January 2004 Debenture 3,083 2,305
July 2004 Debenture 2,000 2,000
--------------- ---------------
Total 7,154 6,376
Less Discounts (2,842) (1,343)
--------------- ---------------
Balance 4,312 5,033
Less Current Portion of long-term debt
(3,818) (5,033)
--------------- ---------------
Total long-term debt (As Restated) $ 494 $ --
=============== ===============
As of June 30, 2005, the Company made aggregate installment payments of
$1,556,000 and the investors converted an aggregate $2,210,000 principal amount
of debt from the debentures as noted below (in thousands):
Common
Original Debt Installment Remaining Shares Common Shares
Principal Conversion to payments in Principal issued for issued in
Debenture Amount Common Shares Common Shares Amount Conversion installments
--------------- --------------- --------------- --------------- --------------- ---------------
October 2003 $ 4,142 $ 2,071 $ -- $ 2,071 1,025 --
January 2004 4,000 139 1,556 2,305 55 873
July 2004 2,000 -- -- 2,000 -- --
--------------- --------------- --------------- --------------- --------------- ---------------
Totals $ 10,142 $ 2,210 $ 1,556 $ 6,376 1,080 873
=============== =============== =============== =============== =============== ===============
As of December 31, 2004, the Company made installment payments of $778,000
and investors converted an aggregate $2,210,000 principal amount of debt from
the debentures as noted below (in thousands):
Common
Original Debt Installment Remaining Shares Common Shares
Principal Conversion to payments in Principal issued for issued in
Debenture Amount Common Shares Common Shares Amount Conversion installments
--------------- --------------- --------------- --------------- --------------- ---------------
October 2003 $ 4,142 $ 2,071 $ -- $ 2,071 1,025 --
January 2004 4,000 139 778 3,083 55 359
July 2004 2,000 -- -- 2,000 -- --
--------------- --------------- --------------- --------------- --------------- ---------------
Totals $ 10,142 $ 2,210 $ 778 $ 7,154 1,080 359
=============== =============== =============== =============== =============== ===============
July 2003 Debentures
On July 10, 2003, the Company issued an aggregate of $5,426,000 in principal
amount of 6% Senior Convertible Debentures due July 31, 2005 (the "July 2003
Debentures") and an aggregate of 507,102 Warrants (the "July 2008 Warrants") in
a private placement for aggregate proceeds of $4,650,000. At this time, the
$1,550,000 of proceeds from the March 2003 Debentures previously held back from
the Company was released to the Company. However, pursuant to the terms of the
July 2003 Debentures, $1,550,000 of the proceeds from the sale of the July 2003
Debentures was held back and to be released to the Company if, and only if, the
Company acquired ISI's facility with in a set timeframe. These funds were
released to the Company in October 2003 although the Company had not acquired
ISI's facility at that time. The Company recorded an additional debt discount of
$259,000 upon receiving the held back proceeds of $1,550,000 in October 2003.
The July 2003 Debentures were to mature on July 31, 2005 and bore interest at 6%
per annum, payable quarterly in cash or, subject to satisfaction of certain
conditions, common stock. Any shares of common stock issued to the investors as
payment of interest were valued at 95% of the average closing price of the
common stock during the five consecutive business days ending on the third
business day immediately preceding the applicable interest payment date.
Pursuant to the terms and conditions of the July 2003 Debentures, the Company
pledged all of the Company's assets, other than the Company's intellectual
property, as collateral and was subject to comply with certain financial and
negative covenants, which included but were not limited to the repayment of
principal balances upon achieving certain revenue milestones (see "Collateral
and Financial Covenants" below).
The July 2003 Debentures were convertible at the option of the investors at any
time through July 31, 2005 into shares of the Company's common stock. The
conversion price under the July 2003 Debentures was fixed at $2.14 per share;
however, as part of the subsequent debenture placement closed on October 29,
2003 (see below), the conversion price under the July 2003 Debentures was
lowered to $1.89 per share. The conversion price was subject to adjustment for
anti-dilution protection for issuance of common stock or securities convertible
or exchangeable into common stock at a price less than the conversion price then
in effect. In addition, in the event that the Company did pay the redemption
price at maturity, the Debenture holders, at their option, could have converted
the balance due at the lower of (a) the conversion price then in effect and (b)
95% of the lowest closing sale price of the Company's common stock during the
three trading days ending on and including the conversion date. In 2003, the
Company recorded a debt discount of approximately $741,000 upon the conversion
price reset to $1.89 per share. The additional debt discount is amortized over
the remaining life of these Debenture or, in the event of a conversion, written
off to financing costs on a pro-rata basis.
The July 2008 Warrants received by the investors, as amended, were exercisable
for an aggregate of 507,102 shares of common stock at a price of $2.46 per
share. These Warrants, as amended, did not result in any additional debt. These
Warrants were exercised in July 2004 which produced gross proceeds in the amount
of $1,247,000.
Pursuant to the Company's agreement with the holders, as discussed below in
"Registration Rights Agreements", the Company registered the shares issuable
upon conversion of the July 2003 Debentures and upon exercise of the July 2008
Warrants for public sale.
The July 2003 Debentures were recorded at a discount on issuance and with an
original issue discount of approximately $2,280,000 and $517,000, respectively,
due to ascribing value to the beneficial conversion feature and fair value of
warrants based on the relative fair value of the proceeds.
The conversion option and detachable warrant carry registration rights and a
feature that in certain circumstances, deemed in the control of the Company,
could require partial settlement of the conversion options to be in cash. In
addition, the July 2003 Debentures include other features including mandatory
conversion option and optional redemption rights if contingent transactions
occur. To determine whether the July 2003 Debentures had embedded derivatives,
including the conversion option, that required bifurcation and fair value
accounting, the Company analyzed the terms of the debentures in accordance with
FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"), and EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company's Own Stock" ("EITF
00-19"). The Company concluded that bifurcation was not required for the
conversion option and that EITF 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27") was the appropriate accounting to be
applied. The warrants were deemed to be permanent equity. The mandatory
conversion option and optional redemption rights were deemed to be derivatives
requiring bifurcation and thus the Company obtained a third party valuation for
the aggregate fair value of these derivatives that showed the fair value to be
immaterial at inception and for each subsequent reporting period.
During 2003, the investors had converted approximately $1,169,000 principal of
the July 2003 Debentures into 618,478 shares of the Company's Common Stock.
During 2004, the investors had converted $4,257,071 principal of the July 2003
Debentures into 2,252,417 shares of the Company's Common Stock. As of December
31, 2004, the investors had converted the total $5,426,000 principal of the July
2003 Debentures into 2,870,900 shares of common stock.
The Company recorded financing costs for the three months ended June 30, 2004
and 2005, with regard to the July 2003 Debentures of approximately $390,000 and
$0, respectively. Interest incurred for the three months ended June 30, 2004 and
2005 was $30,000 and $0, respectively.
The Company recorded financing costs for the six months ended June 30, 2004 and
2005, with regard to the July 2003 Debentures of approximately $1,366,000 and
$0, respectively. Interest incurred for the six months ended June 30, 2004 and
2005 was $64,000 and $0, respectively.
October 2003 Debentures
On October 29, 2003, the Company issued an aggregate of $4,142,357 in principal
amount of 6% Senior Convertible Debentures due October 31, 2005 (the "October
2003 Debentures") and an aggregate of 410,134 Warrants (the "October 2008
Warrants") in a private placement for aggregate gross proceeds of $3,550,000.
Pursuant to the terms of the October 2003 Debentures, $1,550,000 of the proceeds
from the sale of the October 2003 Debentures were held back and were to be
released to the Company if, and only if, the Company acquired ISI's facility
within 90 days of January 26, 2004 and provided a mortgage on the facility as
further security for the October 2003 Debentures. In April 2004, the Company
acquired the facility and the Company subsequently provided the mortgage of the
facility, as collateral, to the Debenture holders and the above funds were
released. The Company recorded an additional debt discount of $259,000 upon
receiving these held back proceeds. The October 2003 Debentures were to mature
on October 31, 2005 and bore interest at 6% per annum, payable quarterly in cash
or, subject to satisfaction of certain conditions, common stock. Any shares of
common stock issued to the investors as payment of interest are to be valued at
95% of the average closing price of the common stock during the five consecutive
business days ending on the third business day immediately preceding the
applicable interest payment date. Pursuant to the terms and conditions of the
October 2003 Debentures, the Company pledged all of the Company's assets, other
than the Company's intellectual property, as collateral and was subject to
comply with certain financial and negative covenants, which included but were
not limited to the repayment of principal balances upon achieving certain
revenue milestones (see "Collateral and Financial Covenants" below).
19
The October 2003 Debentures are convertible at the option of the investors at
any time through October 31, 2005 into shares of the Company's common stock. The
conversion price under the October 2003 Debentures is fixed at $2.02 per share,
subject to adjustment for anti-dilution protection for issuance of common stock
or securities convertible or exchangeable into common stock at a price less than
the conversion price then in effect. In addition, in the event that the Company
does not pay the redemption price at maturity, the Debenture holders, at their
option, may convert the balance due at the lower of (a) the conversion price
then in effect and (b) 95% of the lowest closing sale price of the Company's
common stock during the three trading days ending on and including the
conversion date.
The October 2008 Warrants, as amended, received by the investors were to acquire
an aggregate of 410,134 shares of common stock at a price of $2.32 per share.
These Warrants were exercised in July 2004 which produced gross proceeds in the
amount of approximately $952,000.
Pursuant to the Company's agreement with the holders, the Company registered the
shares issuable upon conversion of the October 2003 Debentures and upon exercise
of the October 2008 Warrants for public sale.
The October 2003 Debentures were recorded at a discount on issuance and with an
original issue discount of $2,000,000 and $333,000, respectively, due to
ascribing value to the beneficial conversion feature and fair value of warrants
based on the relative fair value of the proceeds.
The conversion option and detachable warrant carry registration rights and a
feature that in certain circumstances, deemed in the control of the Company,
could require partial settlement of the conversion options to be in cash. In
addition, the October 2003 Debentures include other features including mandatory
conversion option and optional redemption rights if contingent transactions
occur. To determine whether the October 2003 Debentures had embedded
derivatives, including the conversion option, that required bifurcation and fair
value accounting, the Company analyzed the terms of the debentures in accordance
with FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"), and EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company's Own Stock" ("EITF
00-19"). The Company concluded that bifurcation was not required for the
conversion option and that EITF 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27") was the appropriate accounting to be
applied. The warrants were deemed to be permanent equity. The mandatory
conversion option and optional redemption rights were deemed to be derivatives
requiring bifurcation and thus the Company obtained a third party valuation for
the aggregate fair value of these derivatives that showed the fair value to be
immaterial at inception and for each subsequent reporting period.
20
In October 2005, the Company entered into an amendment agreement with the
October 2003 Debenture holders to amend the maturity date from October 31, 2005
to June 30, 2007, and increase the interest rate from 6% to 7%.
On July 13, 2004, in consideration for the Debenture holders' exercise of all of
the July 2003 ("July 2008 Warrants") and October 2003("October 2008 Warrants")
Warrants amounting to approximately $2,199,000 in gross proceeds, the Company
issued to these holders warrants (the "June 2009 Warrants") to purchase an
aggregate of 1,300,000 shares of common stock. The Company recorded charges
associated with the issuance of these warrants, as restated, fair valued using
the Black-Scholes Method, at $1,676,000, which has been reflected as a deemed
dividend.
Pursuant to the Company's agreement with the holders, the Company registered the
shares issuable upon exercise of these Warrants for public sale.
The June 2009 Warrants are to acquire at any time commencing on January 13, 2005
through June 30, 2009 an aggregate of 1,300,000 shares of common stock at a
price of $3.75 per share. On July 13, 2005, the exercise price of these June
2009 Warrants was reset to $3.33, the lesser of the exercise price then in
effect or a price equal to the average of the daily price of the common stock
between July 14, 2004 and July 12, 2005. The exercise price (and the reset
price) under the June 2009 Warrants also is subject to adjustments for
anti-dilution protection similar to those in the other Warrants. Notwithstanding
the foregoing, the exercise price as reset or adjusted for anti-dilution, will
in no event be less than $3.33 per share. Upon completion of the August 2004
Private Placement (see below), the exercise price was lowered to $3.33 per
share. The Company agreed to register the shares issuable upon exercise of the
June 2009 Warrants pursuant to substantially the same terms as the registration
rights agreements between the Company and the holders. Pursuant to this
obligation, the Company has registered the shares.
The Company has paid $1,300,000 into the debenture cash collateral account as
required by the terms of the October 2003 Debentures. The amounts paid through
March 31, 2005 have been accounted for as advances receivable and are reflected
as such on the accompanying balance sheet as of March 31, 2005. The cash
collateral account provides partial security for repayment of the outstanding
principal and accrued interest on the Debentures in the event of default.
As of June 30, 2005, the investors had converted $2,071,178 principal amount of
the October 2003 Debenture into 1,025,336 shares of Common Stock. The remaining
balance of $2,071,179 is convertible into 1,025,336 shares of common stock.
The Company recorded financing costs for the three months ended June 30, 2004
and 2005, with regard to the October 2003 Debentures of $310,000 and $370,000,
respectively. Interest expense for the three months ended June 30, 2004 and
2005, with regard to the October 2003 Debentures was approximately $15,000 and
$30,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2004 and
2005, with regard to the October 2003 Debentures of $625,000 and $741,000,
respectively. Interest expense for the six months ended June 30, 2004 and 2005,
with regard to the October 2003 Debentures was approximately $39,000 and
$61,000, respectively.
21
January 2004 Debentures
On January 26, 2004, the Company issued an aggregate of $4,000,000 in principal
amount of 6% Senior Convertible Debentures due January 31, 2006 (the "January
2004 Debentures"), an aggregate of 790,514 warrants (the "July 2009 Warrants")
and 158,104 shares of common stock, and Additional Investment Rights (to
purchase up to an additional $2,000,000 principal amount of January 2004
Debentures commencing in six months) in a private placement for aggregate net
proceeds of $3,695,000. The January 2004 Debentures were to mature on January
31, 2006 and bear interest at 6% per annum, payable quarterly in cash or,
subject to satisfaction of certain conditions, common stock. As discussed below,
the maturity date and interest rate were amended. Any shares of common stock
issued to the investors as payment of interest shall be valued at 95% of the
average closing price of the common stock during the five consecutive business
days ending on the third business day immediately preceding the applicable
interest payment date. Pursuant to the terms of the January 2004 Debentures,
commencing July 26, 2004, the Company began to repay the then outstanding
principal amount under the Debentures in monthly installments amortized over 18
months in cash or, at the Company's option, in shares of common stock. Any
shares of common stock issued to the investors as installment payments shall be
valued at 95% of the average closing price of the common stock during the 10-day
trading period commencing on and including the eleventh trading day immediately
preceding the date that the installment is due. Pursuant to the terms and
conditions of the January 2004 Debentures, the Company pledged all of the
Company's assets, other than the Company's intellectual property, as collateral
and was subject to comply with certain financial and negative covenants, which
included but were not limited to the repayment of principal balances upon
achieving certain revenue milestones (see "Collateral and Financial Covenants"
below).
The January 2004 Debentures are convertible at the option of the investors at
any time through January 31, 2006 into shares of the Company's common stock. The
conversion price under the January 2004 Debentures was fixed at $2.53 per share,
subject to adjustment for anti-dilution protection for issuance of common stock
or securities convertible or exchangeable into common stock at a price less than
the conversion price then in effect. In addition, in the event that the Company
does not pay the redemption price at maturity, the Debenture holders, at their
option, may convert the balance due at the lower of (a) the conversion price
then in effect and (b) 95% of the lowest closing sale price of the Company's
common stock during the three trading days ending on and including the
conversion date. Upon completion of the August 2004 Private Placement (see Note
9), the conversion price was lowered to $2.08 per share. The Company recorded an
additional debt discount as restated (see Note 2), of approximately $915,000 due
to this conversion price reset.
In October 2005, the Company entered into an amendment agreement with the
January 2004 Debenture holders to amend the maturity date from October 31, 2005
to June 30, 2007, and increase the interest rate from 6% to 7%.
There are two classes of July 2009 Warrants received by the Investors: Class A
and Class B. The Class A warrants are to acquire any time from July 26, 2004
through July 26, 2009 an aggregate of up to 395,257 shares of common stock at a
price of $3.29 per share. The Class B warrants are to acquire any time from July
26, 2004 through July 26, 2009 an aggregate of up to 395,257 shares of common
stock at a price of $5.06 per share. On January 27, 2005, the exercise price of
these July 2009 Class A and Class B Warrants were reset to the lesser of their
respective exercise price then in effect or a price equal to the average of the
daily price of the common stock between January 27, 2004 and January 26, 2005.
The exercise price (and the reset price) under the July 2009 Warrants also is
subject to similar adjustments for anti-dilution protection. Notwithstanding the
foregoing, the exercise prices as reset or adjusted for anti-dilution, will in
no event be less than $2.58 per share. Upon completion of the August 2004
Private Placement (see Note 9), the exercise price was lowered to $2.58 per
share.
Pursuant to the Company's agreement with these investors, the Company registered
the shares issuable upon conversion of the January 2004 Debentures and upon
exercise of the July 2009 Warrants for public sale.
22
The January 2004 Debentures were recorded at a discount on issuance and with an
original issue discount of $306,000 and $465,000, respectively, due to ascribing
value to the beneficial conversion feature and fair value of warrants based on
the relative fair value of the proceeds.
The conversion option and detachable warrant carry registration rights and a
feature that in certain circumstances, deemed in the control of the Company,
could require partial settlement of the conversion options to be in cash. In
addition, the January 2004 Debentures include other features including mandatory
conversion option and optional redemption rights if contingent transactions
occur. To determine whether the January 2004 Debentures had embedded
derivatives, including the conversion option, that required bifurcation and fair
value accounting, the Company analyzed the terms of the debentures in accordance
with FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"), and EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company's Own Stock" (EITF
"00-19"). The Company concluded that bifurcation was not required for the
conversion option and that EITF 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27") was the appropriate accounting to be
applied. The warrants were deemed to be permanent equity. The mandatory
conversion option and optional redemption rights were deemed to be derivatives
requiring bifurcation and thus the Company obtained a third party valuation for
the aggregate fair value of these derivatives that showed the fair value to be
immaterial at inception and for each subsequent reporting period.
Section 713 of the American Stock Exchange Company Guide
--------------------------------------------------------
Section 713 of the American Stock Exchange ("AMEX") Company Guide provides that
the Company must obtain stockholder approval before issuance, at a price per
share below market value, of common stock, or securities convertible into common
stock, equal to 20% or more of the Company's outstanding common stock (the
"Exchange Cap"). The Debentures and Warrants have provisions that require the
Company to pay cash in lieu of issuing shares upon conversion of the Debentures
or exercise of the Warrants if the Company is prevented from issuing such shares
because of the Exchange Cap. In May 2004, the Debenture holders agreed to amend
the provisions of these Debentures and Warrants to limit the maximum amount of
funds that the holders could receive in lieu of shares upon conversion of the
Debentures and/or exercise of the Warrants in the event that the Exchange Cap
was reached to 119.9% of the conversion price of the relevant Debentures and
19.9% of the relevant Warrant exercise price. See below for the accounting
effect on this matter.
Taken separately, the March, July, October and January 2004 debenture
transactions do not trigger Section 713. However, the AMEX took the position
that these transactions should be aggregated and, as such, stockholder approval
was required for the issuance of common stock for a portion of the potential
exercise of the warrants and conversion of the Debentures in connection with the
January 2004 Debentures. The amount of potential shares that the Company could
exceed the Exchange Cap amounted to approximately 1,299,000. In accordance with
EITF 00-19, Accounting For Derivative Financial Instruments Indexed to and
Potentially Settled in a Company's Own Stock, the Company recorded on January
26, 2004, a redemption obligation of approximately $2,160,000, as restated, with
a corresponding increase to debt discount to be amortized over the life of the
debt or until the Company obtains shareholder approval. Any remaining discount
would be reclassed to additional paid in capital.
In addition, in accordance with EITF 00-19, the Company revalued this redemption
obligation as of March 31, 2004. The Company increased the redemption obligation
and recorded additional finance charge of $1,024,000 as a result of this
revaluation. The Company also incurred $104,000 in financing charges related to
the amortization of the related discount during the first quarter of 2004.
23
Stockholder approval was obtained at the Company's Annual Meeting of
Stockholders on June 23, 2004. In accordance with EITF 00-19, the Company
revalued this redemption obligation associated with the 1,299,000 shares as of
June 23, 2004 (date of shareholder approval). The Company recorded a reduction
in the value of the redemption obligation and financing charge of $839,000 as a
result of this revaluation and additional financing charge of $242,000 related
to the amortization of the debt discount in the second quarter 2004. In
addition, upon receiving the requisite stockholder approval on June 23, 2004,
the redemption obligation of $2,345,000 and the remaining unamortized debt
discount of $1,815,000 were reclassified as additional paid in capital.
As of June 30, 2005, the Company has made aggregate installment payments of
$1,555,554 and the investors have converted an aggregate of $139,150 of
principal amount of the January 2004 Debentures into 873,039 and 55,000 shares
of common stock, respectively. During the six months ended June 30, 2005, the
investors converted approximately $779,000_of principal amount of the January
2004 Debentures into 514,107 shares of common stock. The remaining principal on
these Debentures was $2,305,000 as of June 30, 2005.
The Company recorded financing costs for the three months ended June 30, 2004
and 2005 with regard to the January 2004 Debentures of $132,000 and $190,000,
respectively. Interest expense for the three months ended June 30, 2004 and
2005, with regard to the January 2004 Debentures was approximately $60,000 and
$46,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2004 and
2005 with regard to the January 2004 Debentures of $267,000 and $510,000,
respectively. Interest expense for the six months ended June 30, 2004 and 2005,
with regard to the January 2004 Debentures was approximately $103,000 and
$92,000, respectively.
July 2004 Debentures
Pursuant to the Additional Investment Rights issued in connection with the
January 2004 Debentures, the Company issued to the investors an additional
$2,000,000 principal amount of January 2004 Debentures (the "July 2004
Debentures"). The July 2004 Debentures are identical to the January 2004
Debentures except that the conversion price is $2.58. The investors exercised
the Additional Investment Rights on July 13, 2004 and the Company received net
proceeds of $1,860,000. Upon completion of the August 2004 Private Placement
(see Note 9), the conversion price of the July 2004 Debentures was lowered to
$2.08 per share. The Company recorded an additional debt discount of
approximately $632,000 upon the conversion price reset to $2.08 per share, which
is being amortized over the remaining life of the debenture in accordance with
the effective interest method of accounting.
The July 2004 Debentures were recorded at a discount on issuance of $628,000 due
to ascribing value to the beneficial conversion feature and fair value of
warrants based on the relative fair value of the proceeds.
The conversion option and detachable warrant carry registration rights and a
feature that in certain circumstances, deemed in the control of the Company,
could require partial settlement of the conversion options to be in cash. In
addition, the July 2004 Debentures include other features including mandatory
conversion option and optional redemption rights if contingent transactions
occur. To determine whether the July 2004 Debentures had embedded derivatives,
including the conversion option, that required bifurcation and fair value
accounting, the Company analyzed the terms of the debentures in accordance with
FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"), and EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company's Own Stock" (EITF
00-19"). The Company concluded that bifurcation was not required for the
conversion option and that EITF 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27") was the appropriate accounting to be
applied. The warrants were deemed to be permanent equity. The mandatory
conversion option and optional redemption rights were deemed to be derivatives
requiring bifurcation and thus the Company obtained a third party valuation for
the aggregate fair value of these derivatives that showed the fair value to be
immaterial at inception and for each subsequent reporting period.
24
In October 2005, the Company entered into an amendment agreement with the July
2004 Debenture holders to amend the maturity date from October 31, 2005 to June
30, 2007, and increase the interest rate from 6% to 7%.
The remaining principal amount on these debentures was $2,000,000 as of June 30,
2005.
The Company recorded financing costs for the three months ended June 30, 2004
and 2005 with regard to the July 2004 Debentures of $0 and $124,000,
respectively. Interest expense for the three months ended June 30, 2004 and
2005, with regard to the January 2004 Debentures was approximately $0 and
$30,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2004 and
2005 with regard to the July 2004 Debentures of $0 and $248,000, respectively.
Interest expense for the six months ended June 30, 2004 and 2005, with regard to
the January 2004 Debentures was approximately $0 and $60,000, respectively.
Conversion of Convertible Debt
The maximum number of shares issuable upon debt conversion, including interest
as well as 135% of the shares issuable upon conversion and interest payments
were 5,011,525 and 4,412,526 shares at December 31, 2004 and June 30, 2005,
respectively.
Collateral and Financial Covenants
The Company paid $1,300,000 in 2003 into the debenture cash collateral account
held by the debenture holders as required by the terms of the October 2003
Debentures. The amounts paid have been accounted for as advances receivable and
are reflected as such on the accompanying balance sheet as of June 30, 2005. The
cash collateral account provides partial security for repayment of the
outstanding Debentures in the event of default.
Pursuant to the terms and conditions of all of the outstanding Debentures, the
Company has pledged all of the Company's assets, other than the Company's
intellectual property, as collateral, and the Company is subject to comply with
certain financial covenants.
Note 9: EQUITY FINANCING
On August 5, 2004, the Company closed a private placement with select
institutional investors ("August 2004 Private Placement") for approximately
3,617,300 shares of its Common Stock and warrants to purchase an aggregate of up
to approximately 1,085,200 shares of its Common Stock. Jefferies & Company, Inc.
acted as Placement Agent for which it received a fee and warrants to purchase
Common Stock. The Company raised approximately $6,984,000 net proceeds from this
private offering.
The Warrant issued to each purchaser is exercisable for up to 30% of the number
of shares of Common Stock purchased by such Purchaser, at an exercise price
equal to $2.86 per share. Each Warrant has a term of five years and is fully
exercisable from the date of issuance. Pursuant to the Registration Rights
Agreement, made and entered into as of August 5, 2004 (the "Rights Agreement"),
the Company registered the resales of the shares issued to the Purchasers and
shares issuable upon the exercise of the Warrants.
By agreement with Cardinal Securities, LLC, for general financial advisory
services and in conjunction with the August 2004 Private Placement with select
institutional investors, the Company paid Cardinal Securities, LLC an investment
banking fee of $140,000. The Company paid Cardinal one-half of the fee in cash
with the remainder being paid with the issuance of 50,000 warrants to purchase
common stock exercisable at $2.50 per share expiring on March 31, 2010 and
46,667 shares of common stock. By agreement with Cardinal Securities, LLC, the
Company registered all of the foregoing shares and shares issuable upon exercise
of the above mentioned warrants for public resale.
25
Note 10: EXECUTIVE COMPENSATION
In order to facilitate the Company's need to obtain financing and prior to our
stockholders approving an amendment to our corporate charter to increase the
number of authorized shares, Dr. Carter agreed to waive his right to exercise
certain warrants and options unless and until our stockholders approved an
increase in our authorized shares of Common Stock.
In October 2003, in recognition of this action as well as Dr. Carter's prior and
on-going efforts relating to product development securing critically needed
financing and the acquisition of a new product line, the Compensation Committee
determined that Dr. Carter be awarded bonus compensation in 2003 consisting of
$196,636 and a grant of 1,450,000 stock warrants with an exercise price of $2.20
per share. This additional compensation was reviewed by an independent valuation
firm and found to be fair and reasonable within the context of total
compensation paid to chief executive officers of comparable biotechnology
companies.
In the quarter ended March 31, 2004, Dr. Carter was awarded an additional bonus
of $99,481 by the Compensation Committee. In addition, The Company recorded a
non-cash stock compensation charge of $1,769,000 during the first quarter 2004
resulting from warrants issued to Dr. Carter in 2003 that vested upon the
execution of the second ISI asset closing on March 17, 2004. This was determined
by subtracting the exercise price from the stock closing price on March 17, 2004
and multiplying the result by the number of warrants.
Note 11: EQUITY INCENTIVE PLAN
The Equity Incentive Plan authorizes the grant of non-qualified and incentive
stock options, stock appreciation rights, restricted stock and other stock
awards. The Equity Incentive Plan provides for awards to be made to such
officers, other key employees, non-employee directors, consultants and advisors
of the Company and its subsidiaries as the board of directors may select. A
maximum of 8,000,000 shares of common stock is reserved for potential issuance.
Unless sooner terminated, the Equity Incentive Plan will continue in effect for
a period of 10 years from its effective date. As of June 30, 2005, the Company
has granted 1,163,080 options to directors, officers and employees pursuant to
the terms of this plan.
Note 12: COMMITMENTS
In May 2005, the Company committed to purchase lab equipment related to the
manufacture of Ampligen raw material in the amount of approximately $628,000.
The Company paid the initial deposit of approximately $31,400 in May 2005.
Note 13: SUBSEQUENT EVENTS
On July 8, 2005, the Company entered into a common stock purchase agreement with
Fusion Capital Fund II, LLC, pursuant to which Fusion Capital has agreed, under
certain conditions, to purchase on each trading day $40,000 of the Company's
common stock up to an aggregate of $20.0 million over approximately a 25 month
period, subject to earlier termination at the Company's discretion. In the
Company's discretion, the Company may elect to sell less of the Company's common
stock to Fusion Capital than the daily amount and the Company may increase the
daily amount as the market price of the Company's stock increases. The purchase
price of the shares of common stock will be equal to a price based upon the
future market price of the common stock without any fixed discount to the market
price. Fusion Capital does not have the right or the obligation to purchase
shares of the Company's common stock in the event that the price of the
Company's common stock is less than $1.00 Pursuant to the agreement with Fusion
Capital, the Company has registered for public sale by Fusion Capital up to
10,795,597 shares of the Company's common stock. However, in the event that the
Company decides to issue more than 10,113,278, i.e. greater than 19.99% of the
outstanding shares of common stock as of the date of the agreement, the Company
would first seek stockholder approval in order to be in compliance with American
Stock Exchange rules.
26
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Special Note Regarding Forward-Looking Statements
Certain statements in this document constitute "forwarding-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1995 (collectively, the
"Reform Act"). Certain, but not necessarily all, of such forward-looking
statements can be identified by the use of forward- looking terminology such as
"believes," "expects," "may," "will," "should," or "anticipates" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. All statements other than
statements of historical fact, included in this report regarding our financial
position, business strategy and plans or objectives for future operations are
forward-looking statements. Without limiting the broader description of
forward-looking statements above, we specifically note that statements regarding
potential drugs, their potential therapeutic effect, the possibility of
obtaining regulatory approval, our ability to manufacture and sell any products,
market acceptance or our ability to earn a profit from sales or licenses of any
drugs or our ability to discover new drugs in the future are all forward-looking
in nature.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors, including but not limited to, the risk factors discussed
below, which may cause the actual results, performance or achievements of
Hemispherx and its subsidiaries to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements and other factors referenced in this report. We do
not undertake and specifically decline any obligation to publicly release the
results of any revisions which may be made to any forward-looking statement to
reflect events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events.
Overview
--------
We are a biopharmaceutical company engaged in the clinical development,
manufacture, marketing and distribution of new drug entities based on natural
immune system enhancing technologies for the treatment of viral and immune based
chronic disorders. We were founded in the early 1970s, as a contract researcher
for the National Institutes of Health. After almost 30 years, we have
established a strong foundation of laboratory, pre-clinical, and clinical data
with respect to the development of nucleic acids to enhance the natural
antiviral defense system of the human body and to aid the development of
therapeutic products for the treatment of chronic diseases. We own a U.S. Food
and Drug Administration ("FDA") approved GMP (good manufacturing practice)
manufacturing facility in New Jersey, and our corporate offices are in
Philadelphia, PA.
Our flagship products include Ampligen and Alferon. Ampligen is an experimental
drug undergoing clinical trials for the treatment of: Myalgic
Encephalomyelitis/Chronic Fatigue Syndrome (ME/CFS), HIV, and HIV/Hepatitis C
co-infection. In August 2004, we completed a Phase III clinical trial treating
over 230 ME/CFS patients with Ampligen and are in the process of preparing a new
drug application to be filed with the FDA. Alferon N Injection is the registered
trademark for our injectable formulation of Natural Alpha Interferon, which is
approved by the FDA for the treatment of genital warts. Alferon N is also in
clinical development for treating Hepatitis C ("HEP-C"), Multiple Sclerosis,
Human Immunodeficiency Virus (HIV), West Nile Virus ("WNV") and Severe Acute
Respiratory Syndrome (SARS).
27
We have over 140 patents worldwide with 10 additional patents pending comprising
our intellectual property. We continually review our patents rights periodically
to determine whether they have continuing value. Such review includes an
analysis of the patent's ultimate revenue and profitability potential on an
undiscounted cash basis to support the realizability of our respective
capitalized cost. In addition, management's review addresses whether each patent
continues to fit into our strategic business plans. We have a fully
commercialized product (Alferon), and a GMP certified manufacturing facility.
In March 2004, we completed the step-by-step acquisition from Interferon
Sciences, Inc. ("ISI") of ISI's commercial assets, Alferon N inventory, a
worldwide license for the production, manufacture, use, marketing and sale of
Alferon N. As well as, a 43,000 square foot manufacturing facility in New Jersey
and the acquisition of all intellectual property related to Alferon. Alferon N
is a natural alpha interferon that has been approved by the FDA for commercial
sale for the intra-lesional treatment of refractory or recurring external
genital warts in patients 18 years of age or older. The acquisition was
completed in Spring 2004 with the acquisition of all world wide commercial
rights.
We outsource certain components of our research and development, manufacturing,
marketing and distribution while maintaining control over the entire process
through our quality assurance group and our clinical monitoring group.
Since the completion of our AMP 516 ME/CFS Phase III clinical trial for use of
Ampligen(R) in the treatment of ME/CFS we have received inquiries from and,
under confidentiality agreements, are having dialogue with other companies
regarding marketing opportunities. No proposals or agreements have resulted from
the dialogue, nor can we be assured that any proposals or agreements will result
from these inquiries.
Restatements
In 2003 and 2004, we entered into convertible debenture arrangements which are
inherently complicated, which have been and continue to be the subject of
numerous intricate accounting pronouncements and interpretations and which are
not classified as normal recurring transactions. Our convertible debenture
transactions were reported within our previously filed financial statements for
the years ended December 31, 2003 and 2004. After an extensive review and
consultation with the our independent registered public accountants and our
audit committee, we determined that we must restate our historical financial
statements for the years ended December 31, 2003 and 2004 as well as the interim
financial statements for 2003, 2004, and 2005. We determined that, with respect
to the accounting for the convertible debentures, the interpretation and
application of EITF No. 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" was not correct at the time the convertible debentures
were initially recorded and upon conversion price resets related to the
convertible debentures. As a result of this determination, we restated our
annual financial statements and quarterly results of operations (unaudited)
included in our annual report on Form 10-K/A for the period ending December 31,
2005, which was filed on June 5, 2006 and further amended Footnote 19, Quarterly
Results of Operations (unaudited), to those financials in our Annual Report on
Form 10-K/A-2 for the fiscal year ended December 31, 2005, which was filed on
July 31, 2006.
28
In addition, we restated: (i) our condensed consolidated unaudited interim
financial statements for the quarter ended March 31, 2005 included in our
quarterly report on Form 10-Q for the quarter ended March 31, 2006, which was
filed on June 30, 2006; (ii) our condensed consolidated unaudited interim
financial statements for the quarter and six months ended June 30, 2005 and 2004
included in this quarterly report on Form 10-Q/A; and (iii) the condensed
consolidated unaudited interim financial statements for quarter and nine months
ended September 30, 2005 and 2004 contained in our September 30, 2005 quarterly
report on Form 10-Q/A filed on July 31, 2006. The modifications in the restated
financial statements relate to non-cash charges that do not affect our revenues,
cash flows from operations or liquidity.
(a) Based on SEC guidance presented at the 2005 annual AICPA National
Conference on current SEC and PCAOB developments, we re-evaluated
our accounting for our March 2003, July 2003, October 2003, January
2004 and July 2004 Debentures (collectively, "the Debentures") to
determine whether the embedded conversion options required
bifurcation and fair value accounting in accordance with FASB
Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities", and EITF 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in a
Company's Own Stock". We concluded that bifurcation was not required
and that EITF 00-27: "Application of Issue No. 98-5 to Certain
Convertible Instruments" ("EITF 00-27") should have been applied. We
did initially apply EITF 00-27, however as part of performing an
analysis on the guidelines set forth in EITF 00-27 it was determined
that the initial accounting treatment for the Debentures and
conversion price resets that was originally applied and reflected in
the financial statements included in our Annual Reports on Form 10-K
for the years ended December 31, 2004 and 2003, and in our Quarterly
Reports on Form 10-Q during the quarterly periods in fiscal 2003,
2004 and 2005 were not correctly applied and that, therefore, a
restatement of our financial statements for the periods referenced
above was required. To properly account for the initial calculation
of the discount and the conversion price resets triggered upon the
issuance of the October 2003 Debenture and the August 2004 Private
Placement, it was determined, under guidance from EITF 00-27 that
the debt discount should be restated for the Debentures. The total
impact of this restatement on our statement of operations was to
decrease the net loss applicable to common stockholders for the
three months ended June 30, 2004 and 2005 by approximately
$3,240,000 and $628,000, or $0.07 and $0.01 per share, respectively
and decrease the net loss applicable to common stockholders for the
six months ended June 30, 2004 and 2005 by approximately $4,334,000
and $791,000, or $0.10 and $0.01 per share, respectively.
(b) The estimation of fair value ascribed to and the accounting
treatment of the investment banking fees paid to Cardinal Capital,
LLC ("Cardinal") in connection with the Debenture issuances, at
inception, was inaccurately reflected in the financial statements
included in our Annual Report on Form 10-K for the years ended
December 31, 2004 and 2003, and our Quarterly reports on Form 10-Q
during the quarterly periods in fiscal 2003, 2004 and 2005 and as a
result a restatement of our financial statements for the periods
referenced above was required. In connection with the initial
recording of the Debentures mentioned above, it was determined that
the fair value of the warrants issued as investment banking fees
paid to Cardinal, be accounted for as a discount to the Debentures.
These investment banking fees should have been capitalized as
deferred financing costs and amortized over the life of the
Debentures or charged to earnings on the earlier conversion thereof.
In addition, the initial calculation of the fair value of the
warrants issued to Cardinal as part of the Debenture issuances was
determined to be computed incorrectly at the time of issuance. The
total impact of this restatement on our statement of operations was
to increase the net loss applicable to common stockholders for the
three months ended June 30, 2004 and 2005, by approximately $68,000
and $43,000 or $0.00 and $0.00 per share respectively, and increase
in the net loss applicable to common stockholders for the six months
ended June 30, 2004 and 2005 by approximately $185,000 and $86,000
or $0.00 and $0.00 per share, respectively.
29
(c) The accounting treatment for certain warrants and options issued to
non-employees and our interpretation and application of FASB No. 123
was not correct in 2005. The total impact of this restatement on our
settlement of operations was to increase the net loss for the three
months ended June 30, 2005, by approximately $114,000 or $0.00 per
share and an increase in the net loss applicable to common
stockholders for the six months ended June 30, 2005 by approximately
$159,000 or $0.00 per share.
(d) The accounting treatment set forth in FASB Statement No. 123,
"Accounting for Stock-Based Compensation", for the issuance of the
May 2009 Warrants that was originally interpreted and reflected in
the financial statements included in our Annual Report on Form 10-K
for the years ended December 31, 2003 and 2004, and in our Quarterly
Reports on Form 10-Q during the quarterly periods in fiscal 2003,
2004 and 2005 was not correctly applied and as a result a
restatement of our financial statements for the periods referenced
above was required. The Warrants issued as incentive to exercise
prior warrant issuances should be reflected as a deemed dividend at
the date of issuance where previously these warrants were either
recorded as additional debt discount or as a financing charge at
date of issuance. The total impact of this restatement on our
statement of operations was to decrease the net loss applicable to
common stockholders for the three and six months ended June 30, 2004
by $2,355,000, or $0.05 and $0.06 per share, respectively.
As a result of the corrections of the errors described above, we have restated
our financial statements included in this Quarterly Report on Form 10-Q/A as
follows:
30
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Three Months Ended June 30, 2005
June 30, June 30,
2005 Adjustments 2005
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 240 $ 240
Clinical treatment programs 60 60
--------------- ---------------
Total Revenues: 300 300
Costs and expenses:
Production/cost of goods sold 103 103
Research and development 1,158 1,158
General and administrative 1,409 $ (114) (c) 1,523
--------------- --------------- ---------------
Total costs and expenses 2,670 (114) 2,784
Interest and other income 63 63
Interest expense (107) (107)
Financing costs (1,402) 585 (a)(b) (817)
--------------- --------------- ---------------
Net loss $ (3,816) $ 471 (a)(b) $ (3,345)
=============== =============== ===============
Basic and diluted loss per share
$ (.08) $ 0.01 $ (.07)
=============== =============== ===============
Weighted average shares outstanding
50,299,176 50,299,176
=============== ===============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(c) Includes restatement adjustments for certain warrants and options issued
to non-employees and the Company's interpretation and application of FASB
No. 123 was not correct in 2005, as described above.
31
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Three Months Ended June 30, 2004
June 30, June 30,
2004 Adjustments 2004
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 289 $ 289
Clinical treatment programs 42 42
--------------- ---------------
Total Revenues: 331 331
Costs and expenses:
Production/cost of goods sold 692 692
Research and development 758 758
General and administrative 1,076 1,076
--------------- ---------------
Total costs and expenses 2,526 2,526
Interest and other income 13 13
Interest expense (105) (105)
Financing costs (3,669) $ 3,172 (a)(b) (497)
--------------- --------------- ---------------
Net loss $ (5,956) 3,172 (a)(b) $ (2,784)
Deemed Dividend -- (2,355) (d) (2,355)
--------------- --------------- ---------------
Net loss applicable to common
stockholders $ (5,956) $ 817 $ (5,139)
=============== =============== ===============
Basic and diluted loss per share $ (.14) $ 0.02 $ (.12)
=============== =============== ===============
Weighted average shares outstanding 43,871,350 43,871,350
=============== ===============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(d) Includes restatement adjustment for the issuance of the May 2009 warrants
as incentive to exercise prior warrant issuances, as described above.
32
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Six Months Ended June 30, 2005
June 30, June 30,
2005 Adjustments 2005
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 469 $ 469
Clinical treatment programs 89 89
--------------- ---------------
Total Revenues: 558 558
Costs and expenses:
Production/cost of goods sold 201 201
Research and development 2,426 2,426
General and administrative 2,391 $ (159) (c) 2,550
--------------- --------------- ---------------
Total costs and expenses 5,018 (159) 5,177
Interest and other income 293 293
Interest expense (213) (213)
Financing costs (2,491) 705 (a)(b) (1,786)
--------------- --------------- ---------------
Net loss $ (6,871) $ 546 (a)(b) $ (6,325)
=============== =============== ===============
Basic and diluted loss per share $ (.14) $ 0.01 $ (.13)
=============== =============== ===============
Weighted average shares outstanding 50,033,623 50,033,623
=============== ===============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(c) Includes restatement adjustments for certain warrants and options issued
to non-employees and our interpretation and application of FASB No. 123
was not correct in 2005, as described above.
33
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(in thousands, except share and per share data)
Six Months Ended June 30, 2004
June 30, June 30,
2004 Adjustments 2004
---- ----
As previously Restated
Reported
Revenues:
Sales of product net $ 548 $ 548
Clinical treatment programs 91 91
--------------- ---------------
Total Revenues: 639 639
Costs and expenses:
Production/cost of goods sold 1,293 1,293
Research and development 1,720 1,720
General and administrative 3,921 3,921
--------------- ---------------
Total costs and expenses 6,934 6,934
Interest and other income 24 24
Interest expense (206) (206)
Financing costs (7,520 $ 4,149 (a)(b) (3,371)
--------------- --------------- ---------------
Net loss $ (13,997) 4,149 (a)(b) $ (9,848)
Deemed Dividend -- (2,355) (d) (2,355)
--------------- --------------- ---------------
Net loss applicable to common
stockholders $ (13,997) $ 1,794 $ (12,203)
=============== =============== ===============
Basic and diluted loss per share $ (.33) $ 0.04 (.29)
=============== =============== ===============
Weighted average shares outstanding 42,040,412 42,040,412
=============== ===============
(a) Includes restatement adjustments for the Debentures relating to the
initial recording of and the effect of certain Conversion Price Resets on
the Debentures, as described above.
(b) Includes restatement adjustment for investment banking fees related to
Cardinal, as described above.
(d) Includes restatement adjustment for the issuance of the May 2009 warrants
as incentive to exercise prior warrant issuances, as described above.
We and our audit committee have discussed the above errors and adjustments with
our current independent registered public accounting firm and have determined
that a restatement was necessary for the periods described above.
RISK FACTORS
The following cautionary statements identify important factors that could
cause our actual result to differ materially from those projected in the
forward-looking statements made in this report. Among the key factors that have
a direct bearing on our results of operations are:
No assurance of successful product development
Ampligen(R) and related products. The development of Ampligen(R) and our
other related products is subject to a number of significant risks. Ampligen(R)
may be found to be ineffective or to have adverse side effects, fail to receive
necessary regulatory clearances, be difficult to manufacture on a commercial
scale, be uneconomical to market or be precluded from commercialization by
proprietary right of third parties. Our products are in various stages of
clinical and pre-clinical development and, require further clinical studies and
appropriate regulatory approval processes before any such products can be
marketed. We do not know when, if ever, Ampligen(R) or our other products will
be generally available for commercial sale for any indication. Generally, only a
small percentage of potential therapeutic products are eventually approved by
the FDA for commercial sale.
34
ALFERON N Injection(R). Although ALFERON N Injection(R) is approved for
marketing in the United States for the intralesional treatment of refractory or
recurring external genital warts in patients 18 years of age or older; to date
it has not been approved for other indications. We face many of the risks
discussed above, with regard to developing this product for use to treat other
ailments such as multiple sclerosis and cancer.
Our drug and related technologies are investigational and subject to regulatory
approval. If we are unable to obtain regulatory approval, our operations will be
significantly affected.
All of our drugs and associated technologies other than ALFERON N
Injection(R) are investigational and must receive prior regulatory approval by
appropriate regulatory authorities for general use and are currently legally
available only through clinical trials with specified disorders. At present,
ALFERON N Injection(R) is only approved for the intralesional treatment of
refractory or recurring external genital warts in patients 18 years of age or
older. Use of ALFERON N Injection(R) for other indications will require
regulatory approval. In this regard, ISI, the company from which we obtained our
rights to ALFERON N Injection(R), conducted clinical trials related to use of
ALFERON N Injection(R) for treatment of HIV and Hepatitis C. In both instances,
the FDA determined that additional studies were necessary in order to fully
evaluate the efficacy of ALFERON N Injection(R) in the treatment of HIV and
Hepatitis C diseases. We have no immediate plans to conduct these additional
studies at this time.
Our products, including Ampligen(R), are subject to extensive regulation
by numerous governmental authorities in the U.S. and other countries, including,
but not limited to, the FDA in the U.S., the Health Protection Branch ("HPB") of
Canada, and the European Medical Evaluation Agency ("EMEA") in Europe. Obtaining
regulatory approvals is a rigorous and lengthy process and requires the
expenditure of substantial resources. In order to obtain final regulatory
approval of a new drug, we must demonstrate to the satisfaction of the
regulatory agency that the product is safe and effective for its intended uses
and that we are capable of manufacturing the product to the applicable
regulatory standards. We require regulatory approval in order to market
Ampligen(R) or any other proposed product and receive product revenues or
royalties. We cannot assure you that Ampligen(R) will ultimately be demonstrated
to be safe or efficacious. In addition, while Ampligen(R) is authorized for use
in clinical trials in the United States, we cannot assure you that additional
clinical trial approvals will be authorized in the United States or in other
countries, in a timely fashion or at all, or that we will complete these
clinical trials. If Ampligen(R) or one of our other products does not receive
regulatory approval in the U.S. or elsewhere, our operations most likely will be
materially adversely affected.
We may continue to incur substantial losses and our future profitability is
uncertain.
We began operations in 1966 and last reported net profit from 1985 through
1987. Since 1987, we have incurred substantial operating losses, as we pursued
our clinical trial effort and expanded our efforts in Europe. As of June 30,
2005 our accumulated deficit, as restated, was approximately $141,500,000. We
have not yet generated significant revenues from our products and may incur
substantial and increased losses in the future. We cannot assure that we will
ever achieve significant revenues from product sales or become profitable. We
require, and will continue to require, the commitment of substantial resources
to develop our products. We cannot assure that our product development efforts
will be successfully completed or that required regulatory approvals will be
obtained or that any products will be manufactured and marketed successfully, or
be profitable.
35
We may require additional financing which may not be available.
The development of our products will require the commitment of substantial
resources to conduct the time-consuming research, preclinical development, and
clinical trials that are necessary to bring pharmaceutical products to market.
As of June 30, 2005, we had approximately $12,614,000 in cash and cash
equivalents and short-term investments. These funds should be sufficient to meet
our operating cash requirements including debt service for the near term.
However, we may need to raise additional funds through additional equity or debt
financing or from other sources in order to complete the necessary clinical
trials and the regulatory approval processes including the commercializing of
Ampligen(R) products. There can be no assurances that we will raise adequate
funds which may have a material adverse effect on our ability to develop our
products. Also, we have the ability to curtail discretionary spending, including
some research and development activities, if required to conserve cash.
Under the common stock purchase agreement signed with Fusion Capital on
July 8, 2005, we only have the right to receive $40,000 per trading day unless
our stock price equals or exceeds $2.00, in which case the daily amount may be
increased under certain conditions as the price of our common stock increases
(For a more detailed description of the terms of this agreement, see the
agreement filed as an exhibit to our Current Report on Form 8-K filed with the
SEC on July 11, 2005). Fusion Capital shall not have the right nor the
obligation to purchase any shares of our common stock on any trading days that
the market price of our common stock is less than $1.00. Since we initially
registered 10,000,000 shares purchasable by Fusion Capital pursuant to the
common stock purchase agreement, the selling price of our common stock to Fusion
Capital will have to average at least $2.00 per share for us to receive the
maximum proceeds of $20.0 million without registering additional shares of
common stock. Assuming a purchase price of $1.56 per share (the closing sale
price of the common stock on August 2, 2005) and the purchase by Fusion Capital
of the full 10,000,000 shares under the common stock purchase agreement,
proceeds to us would only be $15,600,000. Subject to approval by our board of
directors, we have the right, but not the obligation, to issue more than
10,000,000 shares to Fusion Capital. In the event we elect to issue more than
10,000,000 shares, we will be required to file a new registration statement and
have it declared effective by the Securities and Exchange Commission. In the
event that we decide to issue more than 10,113,278 (19.99% of our outstanding
shares of common stock as of the date of our agreement), we would first be
required to seek stockholder approval in order to be in compliance with the
American Stock Exchange Market rules.
The extent we rely on Fusion Capital as a source of funding will depend on
a number of factors including, the prevailing market price of our common stock
and the extent to which we are able to secure working capital from other
sources. Specifically, Fusion Capital shall not have the right nor the
obligation to purchase any shares of our common stock on any trading days that
the market price of our common stock is less than $1.00. If obtaining sufficient
financing from Fusion Capital were to prove unavailable or prohibitively
dilutive and if we are unable to commercialize and sell Ampligen(R) and/or
increase sales of ALFERON N Injection(R) or our other products, we will need to
secure another source of funding in order to satisfy our working capital needs.
Even if we are able to access the full $20.0 million under the common stock
purchase agreement with Fusion Capital, we may still need additional capital to
fully implement our business, operating and development plans. Should the
financing we require to sustain our working capital needs be unavailable or
prohibitively expensive when we require it, the consequences would materially
adversely affect our business, operating results, financial condition and
prospects.
36
We may not be profitable unless we can protect our patents and/or receive
approval for additional pending patents.
We need to preserve and acquire enforceable patents covering the use of
Ampligen(R) for a particular disease in order to obtain exclusive rights for the
commercial sale of Ampligen(R) for such disease. We obtained all rights to
ALFERON N Injection(R), and we plan to preserve and acquire enforceable patents
covering its use for existing and potentially new diseases. Our success depends,
in large part, on our ability to preserve and obtain patent protection for our
products and to obtain and preserve our trade secrets and expertise. Certain of
our know-how and technology is not patentable, particularly the procedures for
the manufacture of our drug product which are carried out according to standard
operating procedure manuals. We have been issued certain patents including those
on the use of Ampligen(R) and Ampligen(R) in combination with certain other
drugs for the treatment of HIV. We also have been issued patents on the use of
Ampligen(R) in combination with certain other drugs for the treatment of chronic
Hepatitis B virus, chronic Hepatitis C virus, and a patent which affords
protection on the use of Ampligen(R) in patients with Chronic Fatigue Syndrome.
We have not yet been issued any patents in the United States for the use of
Ampligen(R) as a sole treatment for any of the cancers, which we have sought to
target. With regard to ALFERON N Injection(R), we have acquired from ISI its
patents for natural alpha interferon produced from human peripheral blood
leukocytes and its production process. We cannot assure that our competitors
will not seek and obtain patents regarding the use of similar products in
combination with various other agents, for a particular target indication prior
to our doing such. If we cannot protect our patents covering the use of our
products for a particular disease, or obtain additional patents, we may not be
able to successfully market our products.
The patent position of biotechnology and pharmaceutical firms is highly
uncertain and involves complex legal and factual questions.
To date, no consistent policy has emerged regarding the breadth of
protection afforded by pharmaceutical and biotechnology patents. There can be no
assurance that new patent applications relating to our products or technology
will result in patents being issued or that, if issued, such patents will afford
meaningful protection against competitors with similar technology. It is
generally anticipated that there may be significant litigation in the industry
regarding patent and intellectual property rights. Such litigation could require
substantial resources from us and we may not have the financial resources
necessary to enforce the patent rights that we hold. No assurance can be made
that our patents will provide competitive advantages for our products or will
not be successfully challenged by competitors. No assurance can be given that
patents do not exist or could not be filed which would have a materially adverse
effect on our ability to develop or market our products or to obtain or maintain
any competitive position that we may achieve with respect to our products. Our
patents also may not prevent others from developing competitive products using
related technology.
There can be no assurance that we will be able to obtain necessary licenses if
we cannot enforce patent rights we may hold. In addition, the failure of third
parties from whom we currently license certain proprietary information or from
whom we may be required to obtain such licenses in the future, to adequately
enforce their rights to such proprietary information, could adversely affect the
value of such licenses to us.
If we cannot enforce the patent rights we currently hold we may be
required to obtain licenses from others to develop, manufacture or market our
products. There can be no assurance that we would be able to obtain any such
licenses on commercially reasonable terms, if at all. We currently license
certain proprietary information from third parties, some of which may have been
developed with government grants under circumstances where the government
maintained certain rights with respect to the proprietary information developed.
No assurances can be given that such third parties will adequately enforce any
rights they may have or that the rights, if any, retained by the government will
not adversely affect the value of our license.
37
There is no guarantee that our trade secrets will not be disclosed or known by
our competitors.
To protect our rights, we require certain employees and consultants to
enter into confidentiality agreements with us. There can be no assurance that
these agreements will not be breached, that we would have adequate and
enforceable remedies for any breach, or that any trade secrets of ours will not
otherwise become known or be independently developed by competitors.
If our distributors do not market our products successfully, we may not generate
significant revenues or become profitable.
We have limited marketing and sales capability. We are dependent upon
existing and, possibly future, marketing agreements and third party distribution
agreements for our products in order to generate significant revenues and become
profitable. As a result, any revenues received by us will be dependent on the
efforts of third parties, and there is no assurance that these efforts will be
successful. Our agreement with Accredo offers the potential to provide some
marketing and distribution capacity in the United States while agreements with
Bioclones (Proprietary), Ltd, Biovail Corporation and Laboratorios Del Dr.
Esteve S.A. may provide a sales force in South America, Africa, United Kingdom,
Australia and New Zealand, Canada, Spain and Portugal. On December 27, 2004, we
initiated a lawsuit in Federal Court identifying a conspiratorial group seeking
to illegally manipulate our stock for purposes of bringing about the hostile
takeover of Hemispherx. This conspiratorial group includes Bioclones and the
potential legal action may adversely effect our agreement with Bioclones and the
potential for marketing and distribution capacity in South America, Africa,
United Kingdom, Australia and New Zealand. See Item 1: "Legal Proceedings" in
Part II - Other Information below for more information.
We cannot assure that our domestic or foreign marketing partners will be
able to successfully distribute our products, or that we will be able to
establish future marketing or third party distribution agreements on terms
acceptable to us, or that the cost of establishing these arrangements will not
exceed any product revenues. The failure to continue these arrangements or to
achieve other such arrangements on satisfactory terms could have a materially
adverse effect on us.
There are no long-term agreements with suppliers of required materials. If we
are unable to obtain the required raw materials, we may be required to scale
back our operations or stop manufacturing ALFERON N Injection and/or
Ampligen(R).
A number of essential materials are used in the production of ALFERON N
Injection(R), including human white blood cells. We do not have long-term
agreements for the supply of any of such materials. There can be no assurance we
can enter into long-term supply agreements covering essential materials on
commercially reasonable terms, if at all.
At present, we do not have any agreements with third parties for the
supply of any polymers for use in manufacturing Ampligen. We have consolidated
relevant manufacturing operations into our New Brunswick, New Jersey facility
for the production of Ampligen raw materials. This consolidation and transfer of
manufacturing operations has been implemented as an inspection of the Ribotech
facility in South Africa, our previous supplier of Ampligen(R) raw materials,
indicated that it did not, at present, meet the necessary GMP standards for a
fully certified commercial process. The transfer of Ampligen(R) raw materials
manufacture to our own facilities, while having obvious advantages with respect
to regulatory compliance (other parts of the 43,000 sq. ft. wholly owned
facility are already in compliance for Alferon N manufacture), may delay certain
steps in the commercialization process, specifically a targeted NDA filing.
38
If we are unable to obtain the required raw materials, we may be required
to scale back our operations or stop manufacturing. The costs and availability
of products and materials we need for the production of Ampligen(R) and the
commercial production of ALFERON N Injection(R) and other products which we may
commercially produce are subject to fluctuation depending on a variety of
factors beyond our control, including competitive factors, changes in
technology, and FDA and other governmental regulations and there can be no
assurance that we will be able to obtain such products and materials on terms
acceptable to us or at all.
There is no assurance that successful manufacture of a drug on a limited scale
basis for investigational use will lead to a successful transition to
commercial, large-scale production.
Small changes in methods of manufacturing may affect the chemical
structure of Ampligen(R) and other RNA drugs, as well as their safety and
efficacy. Changes in methods of manufacture, including commercial scale-up may
affect the chemical structure of Ampligen(R) and can, among other things,
require new clinical studies and affect orphan drug status, particularly, market
exclusivity rights, if any, under the Orphan Drug Act. The transition from
limited production of pre-clinical and clinical research quantities to
production of commercial quantities of our products will involve distinct
management and technical challenges and will require additional management and
technical personnel and capital to the extent such manufacturing is not handled
by third parties. There can be no assurance that our manufacturing will be
successful or that any given product will be determined to be safe and
effective, capable of being manufactured economically in commercial quantities
or successfully marketed.
We have limited manufacturing experience and capacity.
Ampligen(R) has been only produced in limited quantities for use in our
clinical trials and we are dependent upon third party suppliers for key
components of our products and for substantially all of the production process.
The failure to continue these arrangements or to achieve other such arrangements
on satisfactory terms could have a material adverse affect on us. Also, to be
successful, our products must be manufactured in commercial quantities in
compliance with regulatory requirements and at acceptable costs. To the extent
we are involved in the production process, our current facilities are not
adequate for the production of our proposed products for large-scale
commercialization, and we currently do not have adequate personnel to conduct
commercial-scale manufacturing. We intend to utilize third-party facilities if
and when the need arises or, if we are unable to do so, to build or acquire
commercial-scale manufacturing facilities. We will need to comply with
regulatory requirements for such facilities, including those of the FDA and HPB
pertaining to current Good Manufacturing Practices ("cGMP") regulations. There
can be no assurance that such facilities can be used, built, or acquired on
commercially acceptable terms, or that such facilities, if used, built, or
acquired, will be adequate for our long-term needs.
In connection with settling various manufacturing infractions previously
noted by the FDA, Schering-Plough ("Schering") entered into a "Consent Decree"
with the FDA whereby, among other things, it agreed to discontinue various
contract (third party) manufacturing activities at various facilities including
its San Juan, Puerto Rico, plant. Ampligen(R) (which was not involved in any of
the cited infractions) was produced at this Puerto Rico plant from year
2000-2004. Operating under instructions from the Consent Decree, Schering has
advised us that it would no longer manufacture Ampligen(R) in this facility
beyond 2004 and would assist us in an orderly transfer of said activities to
other non Schering facilities. We had entered into a Confidentiality Agreement
with Mayne Pharma Pty, Ltd ("Mayne") to lead to reinitiation and expansion of
its Ampligen(R) manufacturing program. However, senior management at Mayne's
Mulgrave operations in Australia recently informed us that they are ceasing to
continue with all development activities associated with potential contract
customers and all other contract business will be progressively scaled down over
the next couple of years. Therefore, Mayne's Mulgrave facility in Australia will
no longer be a possibility for manufacturing. We have obtained two proposals
from manufacturers in the US and expect to obtain at least two more for the
manufacturing of Ampligen. We want to qualify at least two GMP facilities in
order to maintain a minimum of two independent production sites. We are in the
process of reviewing these proposals. If we are unable to engage a contract
manufacturer in a timely manner, our plans to file an NDA for Ampligen(R) and,
eventually, to market and sell Ampligen(R) will be delayed.
39
The purified drug concentrate utilized in the formulation of ALFERON N
Injection(R) is manufactured in our New Brunswick, New Jersey facility and
ALFERON N Injection(R) was formulated and packaged at a production facility
formerly owned and operated by Abbott Laboratories located in Kansas. Abbott
Labs has sold the facility to Hospira. We currently have 12,000 vials at Hospira
in purified drug concentrate form. Hospira will complete the labeling and
packaging of this lot. We have identified five new potential contract
manufacturers and obtained proposals for all five concerning the future
formulation and packaging of Alferon. If we are unable to secure a new facility
within a reasonable period of time to formulate and package ALFERON N
Injection(R) at an acceptable cost, our ability to sell ALFERON N Injection(R)
and to generate profits therefrom will be adversely affected.
We may not be profitable unless we can produce Ampligen(R) or other products in
commercial quantities at costs acceptable to us.
We have never produced Ampligen(R) or any other products in large
commercial quantities. We must manufacture our products in compliance with
regulatory requirements in large commercial quantities and at acceptable costs
in order for us to be profitable. We intend to utilize third-party manufacturers
and/or facilities if and when the need arises or, if we are unable to do so, to
build or acquire commercial-scale manufacturing facilities. If we cannot
manufacture commercial quantities of Ampligen(R) or enter into third party
agreements for its manufacture at costs acceptable to us, our operations will be
significantly affected. Also, each production lot of Alferon N Injection(R) is
subject to FDA review and approval prior to releasing the lots to be sold. This
review and approval process could take considerable time, which would delay our
having product in inventory to sell. Alferon N Injection(R) presently has a
shelf life of 18 months after having been bottled. Studies were completed in
2004 to possibly extend the shelf life to 24 months. We filed our annual report
with the FDA in December 2004 informing them of the extension of shelf-life for
Alferon N Injection(R). We filed the request with the FDA in May 2005 requesting
approval to relabel the first 2,000 vials with an extended shelf-life of 24
months. We received a response from the FDA at the end of June 2005 concerning
our relabeling request of Alferon N Injection(R). After reviewing the
information submitted, the FDA determined the submission as a "Prior Approval
Supplement". We have been informed by the FDA that we will receive a response to
the relabeling Prior Approval Supplement by September 22, 2005.
Rapid technological change may render our products obsolete or non-competitive.
The pharmaceutical and biotechnology industries are subject to rapid and
substantial technological change. Technological competition from pharmaceutical
and biotechnology companies, universities, governmental entities and others
diversifying into the field is intense and is expected to increase. Most of
these entities have significantly greater research and development capabilities
than us, as well as substantial marketing, financial and managerial resources,
and represent significant competition for us. There can be no assurance that
developments by others will not render our products or technologies obsolete or
noncompetitive or that we will be able to keep pace with technological
developments.
40
Our products may be subject to substantial competition.
Ampligen(R). Competitors may be developing technologies that are, or in
the future may be, the basis for competitive products. Some of these potential
products may have an entirely different approach or means of accomplishing
similar therapeutic effects to products being developed by us. These competing
products may be more effective and less costly than our products. In addition,
conventional drug therapy, surgery and other more familiar treatments may offer
competition to our products. Furthermore, many of our competitors have
significantly greater experience than us in pre-clinical testing and human
clinical trials of pharmaceutical products and in obtaining FDA, HPB and other
regulatory approvals of products. Accordingly, our competitors may succeed in
obtaining FDA, HPB or other regulatory product approvals more rapidly than us.
There are no drugs approved for commercial sale with respect to treating ME/CFS
in the United States. The dominant competitors with drugs to treat HIV diseases
include Gilead Pharmaceutical, Pfizer, Bristol-Myers, Abbott Labs, Glaxo
Smithkline, Merck and Schering-Plough Corp. These potential competitors are
among the largest pharmaceutical companies in the world, are well known to the
public and the medical community, and have substantially greater financial
resources, product development, and manufacturing and marketing capabilities
than we have. Although we believe our principal advantage is the unique
mechanism of action of Ampligen(R) on the immune system, we cannot assure that
we will be able to compete.
ALFERON N Injection(R). Many potential competitors are among the largest
pharmaceutical companies in the world, are well known to the public and the
medical community, and have substantially greater financial resources, product
development, and manufacturing and marketing capabilities than we have. ALFERON
N Injection(R) currently competes with Schering's injectable recombinant alpha
interferon product (INTRON(R) A) for the treatment of genital warts. 3M
Pharmaceuticals also received FDA approval for its immune-response modifier,
Aldara(R), a self-administered topical cream, for the treatment of external
genital and perianal warts. ALFERON N Injection(R) also competes with surgical,
chemical, and other methods of treating genital warts. We cannot assess the
impact products developed by our competitors, or advances in other methods of
the treatment of genital warts, will have on the commercial viability of ALFERON
N Injection(R). If and when we obtain additional approvals of uses of this
product, we expect to compete primarily on the basis of product performance. Our
potential competitors have developed or may develop products (containing either
alpha or beta interferon or other therapeutic compounds) or other treatment
modalities for those uses. In the United States, three recombinant forms of beta
interferon have been approved for the treatment of relapsing-remitting multiple
sclerosis. There can be no assurance that, if we are able to obtain regulatory
approval of ALFERON N Injection(R) for the treatment of new indications, we will
be able to achieve any significant penetration into those markets. In addition,
because certain competitive products are not dependent on a source of human
blood cells, such products may be able to be produced in greater volume and at a
lower cost than ALFERON N Injection(R). Currently, our wholesale price on a per
unit basis of ALFERON N Injection(R) is higher than that of the competitive
recombinant alpha and beta interferon products.
General. Other companies may succeed in developing products earlier than
we do, obtaining approvals for such products from the FDA more rapidly than we
do, or developing products that are more effective than those we may develop.
While we will attempt to expand our technological capabilities in order to
remain competitive, there can be no assurance that research and development by
others or other medical advances will not render our technology or products
obsolete or non-competitive or result in treatments or cures superior to any
therapy we develop.
41
Possible side effects from the use of Ampligen(R) or ALFERON N Injection(R)
could adversely affect potential revenues and physician/patient acceptability of
our product.
Ampligen(R). We believe that Ampligen(R) has been generally well tolerated
with a low incidence of clinical toxicity, particularly given the severely
debilitating or life threatening diseases that have been treated. A mild
flushing reaction has been observed in approximately 15% of patients treated in
our various studies. This reaction is occasionally accompanied by a rapid heart
beat, a tightness of the chest, urticaria (swelling of the skin), anxiety,
shortness of breath, subjective reports of "feeling hot," sweating and nausea.
The reaction is usually infusion-rate related and can generally be controlled by
slowing the infusion rate. Other adverse side effects include liver enzyme level
elevations, diarrhea, itching, asthma, low blood pressure, photophobia, rash,
transient visual disturbances, slow or irregular heart rate, decreases in
platelets and white blood cell counts, anemia, dizziness, confusion, elevation
of kidney function tests, occasional temporary hair loss and various flu-like
symptoms, including fever, chills, fatigue, muscular aches, joint pains,
headaches, nausea and vomiting. These flu-like side effects typically subside
within several months. One or more of the potential side effects might deter
usage of Ampligen(R) in certain clinical situations and therefore, could
adversely affect potential revenues and physician/patient acceptability of our
product.
ALFERON N Injection(R). At present, ALFERON N Injection(R) is only
approved for the intralesional (within the lesion) treatment of refractory or
recurring external genital warts in adults. In clinical trials conducted for the
treatment of genital warts with ALFERON N Injection(R), patients did not
experience serious side effects; however, there can be no assurance that
unexpected or unacceptable side effects will not be found in the future for this
use or other potential uses of ALFERON N Injection(R) which could threaten or
limit such product's usefulness.
We may be subject to product liability claims from the use of Ampligen(R) or
other of our products which could negatively affect our future operations.
We face an inherent business risk of exposure to product liability claims
in the event that the use of Ampligen(R) or other of our products results in
adverse effects. This liability might result from claims made directly by
patients, hospitals, clinics or other consumers, or by pharmaceutical companies
or others manufacturing these products on our behalf. Our future operations may
be negatively affected from the litigation costs, settlement expenses and lost
product sales inherent to these claims. While we will continue to attempt to
take appropriate precautions, we cannot assure that we will avoid significant
product liability exposure. Although we currently maintain product liability
insurance coverage, there can be no assurance that this insurance will provide
adequate coverage against Ampligen and/or Alferon N Injection product liability
claims. A successful product liability claim against us in excess of Ampligen's
$1,000,000 in insurance coverage; $3,000,000 in aggregate, or in excess of
Alferon's $5,000,000 in insurance coverage; $5,000,000 in aggregate; or for
which coverage is not provided could have a negative effect on our business and
financial condition.
The loss of Dr. William A. Carter's services could hurt our chances for success.
Our success is dependent on the continued efforts of Dr. William A. Carter
because of his position as a pioneer in the field of nucleic acid drugs, his
being the co-inventor of Ampligen(R), and his knowledge of our overall
activities, including patents and clinical trials. The loss of Dr. Carter's
services could have a material adverse effect on our operations and chances for
success. We have secured key man life insurance in the amount of $2,000,000 on
the life of Dr. Carter and we have an employment agreement with Dr. Carter that,
as amended, runs until May 8, 2008. However, Dr. Carter has the right to
terminate his employment upon not less than 30 days prior written notice. The
loss of Dr. Carter or other personnel, or the failure to recruit additional
personnel as needed could have a materially adverse effect on our ability to
achieve our objectives.
42
Uncertainty of health care reimbursement for our products.
Our ability to successfully commercialize our products will depend, in
part, on the extent to which reimbursement for the cost of such products and
related treatment will be available from government health administration
authorities, private health coverage insurers and other organizations.
Significant uncertainty exists as to the reimbursement status of newly approved
health care products, and from time to time legislation is proposed, which, if
adopted, could further restrict the prices charged by and/or amounts
reimbursable to manufacturers of pharmaceutical products. We cannot predict
what, if any, legislation will ultimately be adopted or the impact of such
legislation on us. There can be no assurance that third party insurance
companies will allow us to charge and receive payments for products sufficient
to realize an appropriate return on our investment in product development.
There are risks of liabilities associated with handling and disposing of
hazardous materials.
Our business involves the controlled use of hazardous materials,
carcinogenic chemicals, flammable solvents and various radioactive compounds.
Although we believe that our safety procedures for handling and disposing of
such materials comply in all material respects with the standards prescribed by
applicable regulations, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident or the failure to comply with applicable regulations, we could be held
liable for any damages that result, and any such liability could be significant.
We do not maintain insurance coverage against such liabilities.
Risks Associated With an Investment in Our Common Stock
We reported material weaknesses in our internal control over financial reporting
that, if not remedied, could adversely affect our internal controls.
We have assessed the effectiveness of our internal control over financial
reporting as of December 31, 2005. In making this assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission in Internal Control--Integrated Framework (COSO). Based on
this assessment, management has identified the following material weaknesses as
of December 31, 2005. A material weakness is a control deficiency, or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. The restatements made to the
financial statements for the three and six months ended June 30, 2004 and 2005
reflect weaknesses in disclosure controls and internal control over financial
reporting that existed as of the date of this report. Specifically,
1. Financial Statement Close and Reporting Process - We did not
maintain effective controls over the financial statement close and
reporting process because we lacked a complement of personnel able
to devote sufficient time and adequate financial reporting expertise
commensurate with 1 quarterly and year-end financial statement close
requirements, which include the financial statement preparation and
disclosures. Additionally, we had inadequate policies and procedures
providing for a detailed comprehensive review of the underlying
information supporting the amounts including in our annual and
interim consolidation financial statements and disclosures.
43
2. We did not maintain effective controls over the initial recording of
our convertible debentures that contained beneficial conversion
features (including incorrect recording of investment banking fees
incurred and subsequent conversion price resets) and the accounting
for warrants and options issued to non-employees. Our interpretation
and application of EITF No. 00-27, FASB Statement 133, EITF 98-5 and
EITF 00-19 was not correct at the time the convertible debentures
were initially recorded (2003 through July 2004), and our
interpretation and application of FASB statement No. 123 was not
correct in recording certain warrant and option issuances to
non-employees. These control deficiencies resulted in the
restatement of the 2004 and 2003 annual consolidated financial
statements as well as to the unaudited consolidated interim
financial statements for each of the three years in the period ended
December 31, 2005.
The result of applying the proper accounting treatment increased our net
loss applicable to common stockholders by $0.01, from $0.42 per share to $0.43
per share, for the year ended December 31, 2003, decreased our net loss
applicable to common stockholders by $0.07, from $0.53 per share to $0.46 per
share, for the year ended December 31, 2004, and decreased our net loss per
share applicable to common stockholders by $.00 and $.01 from $.08 per share to
$.07 per share for the first and second quarters of 2005, respectively.
Although the recording of the convertible debentures occurred during the
periods from March 2003 through July 2004, and we have not issued any debentures
since July 2004, we have taken and plan to take, during 2006, additional steps
to remediate these internal control weaknesses. We have subscribed to CCH's
"Accounting Research Manager," a recognized on-line service in order to maintain
up-to-date accounting guidance to enhance internal control over both financial
reporting and disclosure requirements. In addition, we have established policies
and procedures to include a detailed comprehensive review of the underlying
information supporting the amounts included within our consolidated financial
statements and disclosures including to assist in ensuring: 1) clerical accuracy
within our financial statements and disclosures, 2) financial statement
groupings within our financial statements are accurate, 3) support utilized in
preparation of the consolidated statement of cash flows is accurate, and 4)
equity transactions during the reporting period are complete and accurate. We
also engaged an additional accounting consultant in April 2006 to assist in
initiating the implementation of these policies and procedures on a going
forward basis. Notwithstanding the foregoing, and the measures we have taken and
any future measures we may take to remediate the reported internal control
weaknesses, we may not be able to maintain effective internal controls over
financial reporting in the future. In addition, deficiencies in our internal
controls may be discovered in the future. Any failure to remediate the reported
material weaknesses, or to implement new or improved controls, or difficulties
encountered in their implementation, could harm our operating results, cause us
to fail to meet our reporting obligations or result in material misstatements in
our financial statements. Any such failure also could affect the ability of our
management to certify in our 2006 Forms 10-K and 10-Q that our internal controls
are effective when it provides an assessment of our internal control over
financial reporting, and could affect the results of our independent registered
public accounting firm's related attestation report regarding our management's
assessment. Ineffective internal controls could also cause investors to lose
confidence in our reported financial information, which could have a negative
effect on the trading price of our securities.
44
The market price of our stock may be adversely affected by market volatility.
The market price of our common stock has been and is likely to be
volatile. In addition to general economic, political and market
conditions, the
price and trading volume of our stock could fluctuate widely in response to many
factors, including:
o announcements of the results of clinical trials by us or our
competitors;
o adverse reactions to products;
o governmental approvals, delays in expected governmental approvals or
withdrawals of any prior governmental approvals or public or
regulatory agency concerns regarding the safety or effectiveness of
our products;
o changes in U.S. or foreign regulatory policy during the period of
product development;
o developments in patent or other proprietary rights, including any
third party challenges of our intellectual property rights;
o announcements of technological innovations by us or our competitors;
o announcements of new products or new contracts by us or our
competitors;
o actual or anticipated variations in our operating results due to the
level of development expenses and other factors;
o changes in financial estimates by securities analysts and whether
our earnings meet or exceed the estimates;
o conditions and trends in the pharmaceutical and other industries;
new accounting standards; and
o the occurrence of any of the risks described in these "Risk
Factors."
Our common stock is listed for quotation on the American Stock Exchange.
For the 12-month period ended June 30, 2005, the price of our common stock has
ranged from $1.25 to $3.54 per share. We expect the price of our common stock to
remain volatile. The average daily trading volume of our common stock varies
significantly. Our relatively low average volume and low average number of
transactions per day may affect the ability of our stockholders to sell their
shares in the public market at prevailing prices and a more active market may
never develop.
In the past, following periods of volatility in the market price of the
securities of companies in our industry, securities class action litigation has
often been instituted against companies in our industry. If we face securities
litigation in the future, even if without merit or unsuccessful, it would result
in substantial costs and a diversion of management attention and resources,
which would negatively impact our business.
Our stock price may be adversely affected if a significant amount of sharesare
sold in the public market.
As of August 1, 2005, approximately 1,071,082 shares of our common stock,
constituted "restricted securities" as defined in Rule 144 under the Securities
Act of 1933, 402,798 of which are registered for public sale. Also, we have
registered 21,106,907 shares issuable (i) to Fusion Capital pursuant to the
common stock purchase agreement with Fusion Capital; (11) upon conversion of
approximately 135% of Debentures that we issued in 2003 and 2004; (iii) as
payment of 135% of the interest on all of the Debentures; (iv) upon exercise of
135% of the certain Warrants; and (v) upon exercise of certain other warrants.
Registration of the shares permits the sale of the shares in the open market or
in privately negotiated transactions without compliance with the requirements of
Rule 144. To the extent the exercise price of the warrants is less than the
market price of the common stock, the holders of the warrants are likely to
exercise them and sell the underlying shares of common stock and to the extent
that the conversion price and exercise price of these securities are adjusted
pursuant to anti-dilution protection, the securities could be exercisable or
convertible for even more shares of common stock. We also may issue shares to be
used to meet our capital requirements or use shares to compensate employees,
consultants and/or directors. We are unable to estimate the amount, timing or
nature of future sales of outstanding common stock. Sales of substantial amounts
of our common stock in the public market could cause the market price for our
common stock to decrease. Furthermore, a decline in the price of our common
stock would likely impede our ability to raise capital through the issuance of
additional shares of common stock or other equity securities.
45
The sale of our common stock to Fusion Capital may cause dilution and the sale
of the shares of common stock acquired by Fusion Capital could cause the price
of our common stock to decline.
The sale by Fusion Capital of our common stock will increase the number of
our publicly traded shares, which could depress the market price of our common
stock. Moreover, the mere prospect of resales by Fusion Capital could depress
the market price for our common stock. The issuance of shares to Fusion Capital
under the common stock purchase agreement dated July 8, 2005, will dilute the
equity interest of existing stockholders and could have an adverse effect on the
market price of our common stock.
The purchase price for the common stock to be sold to Fusion Capital
pursuant to the common stock purchase agreement will fluctuate based on the
price of our common stock. All shares sold to Fusion Capital are freely
tradable. Fusion Capital may sell none, some or all of the shares of common
stock purchased from us at any time. We expect that the shares will be sold over
a period of in excess of 25 months from the date theprospectus was filed.
Depending upon market liquidity at the time, a sale of shares under this
offering at any given time could cause the trading price of our common stock to
decline. The sale of a substantial number of shares of our common stock under
this offering, or anticipation of such sales, could make it more difficult for
us to sell equity or equity-related securities in the future at a time and at a
price that we might otherwise wish to effect sales.
Provisions of our Certificate of Incorporation and Delaware law could defer a
change of our management which could discourage or delay offers to acquire us.
Provisions of our Certificate of Incorporation and Delaware law may make
it more difficult for someone to acquire control of us or for our stockholders
to remove existing management, and might discourage a third party from offering
to acquire us, even if a change in control or in management would be beneficial
to our stockholders. For example, our Certificate of Incorporation allows us to
issue shares of preferred stock without any vote or further action by our
stockholders. Our Board of Directors has the authority to fix and determine the
relative rights and preferences of preferred stock. Our Board of Directors also
has the authority to issue preferred stock without further stockholder approval.
As a result, our Board of Directors could authorize the issuance of a series of
preferred stock that would grant to holders the preferred right to our assets
upon liquidation, the right to receive dividend payments before dividends are
distributed to the holders of common stock and the right to the redemption of
the shares, together with a premium, prior to the redemption of our common
stock. In this regard, in November 2002, we adopted a stockholder rights plan
and, under the Plan, our Board of Directors declared a dividend distribution of
one Right for each outstanding share of Common Stock to stockholders of record
at the close of business on November 29, 2002. Each Right initially entitles
holders to buy one unit of preferred stock for $30.00. The Rights generally are
not transferable apart from the common stock and will not be exercisable unless
and until a person or group acquires or commences a tender or exchange offer to
acquire, beneficial ownership of 15% or more of our common stock. However, for
Dr. Carter, our chief executive officer, who already beneficially owns 10.9% of
our common stock, the Plan's threshold will be 20%, instead of 15%. The Rights
will expire on November 19, 2012, and may be redeemed prior thereto at $.01 per
Right under certain circumstances.
46
Because the risk factors referred to above could cause actual results or
outcomes to differ materially from those expressed in any forward-looking
statements made by us, you should not place undue reliance on any such
forward-looking statements. Further, any forward-looking statement speaks only
as of the date on which it is made and we undertake no obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made or reflect the occurrence of
unanticipated events. New factors emerge from time to time, and it is not
possible for us to predict which will arise. In addition, we cannot assess the
impact of each factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements. Our research in clinical efforts
may continue for the next several years and we may continue to incur losses due
to clinical costs incurred in the development of Ampligen(R) for commercial
application. Possible losses may fluctuate from quarter to quarter as a result
of differences in the timing of significant expenses incurred and receipt of
licensing fees and/or cost recovery treatment revenues in Europe, Canada and in
the United States.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123 (revised 2004) (FASB 123R),
Shared-Based Payment. FASB 123R will require the Corporation to expense
share-based payments, including employee stock options, based on their fair
value. The Corporation is required to adopt the provisions of FASB 123R
effective as of the beginning of its next fiscal year that begins after June 15,
2005. FASB 123R provides alternative methods of adoption, which include
prospective application and a modified retroactive application. The Corporation
is currently evaluating the financial impact, including the available
alternative of adoption of FASB 123R.
Disclosure About Off-Balance Sheet Arrangements
Prior to our annual meeting of stockholders in September 2003, we had a
limited number of shares of Common Stock authorized but not issued or reserved
for issuance upon conversion or exercise of outstanding convertible and
exercisable securities such as debentures, options and warrants. Prior to the
meeting, to permit consummation of the sale of the July 2003 Debentures and the
related warrants, Dr. Carter agreed that he would not exercise his warrants or
options unless and until our stockholders approve an increase in our authorized
shares of common stock. For Dr. Carter's waiver of his right to exercise certain
options and warrants prior to approval of the increase in our authorized shares,
we have agreed to compensate Dr. Carter. See Note 8 in the accompanying
financial statements for more information concerning this transaction. In
connection with the Debenture agreements, we have outstanding letters of credit
of $1,000,000 as additional collateral.
Critical Accounting Policies
----------------------------
Financial Reporting Release No. 60 requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Our significant accounting policies are described in Notes
to the Consolidated Financial Statements. The significant accounting policies
that we believe are most critical to aid in fully understanding our reported
financial results are the following:
Revenue
-------
Revenues for non-refundable license fees are recognized under the
Performance Method-Expected Revenue. This method considers the total amount of
expected revenue during the performance period, but limits the amount of revenue
recognized in a period to total non-refundable cash received to date. This
limitation is appropriate because future milestone payments are contingent on
future events.
47
Upon receipt, the upfront non-refundable payment is deferred. The
non-refundable upfront payments plus non-refundable payments arising from the
achievement of defined milestones are recognized as revenue over the performance
period based on the lesser of (a) percentage of completion or (b) non-refundable
cash earned (including the upfront payment).
This method requires the computation of a ratio of cost incurred to date
to total expected costs and then apply that ratio to total expected revenue. The
amount of revenue recognized is limited to the total non-refundable cash
received to date.
Revenue from the sale of Ampligen(R) under cost recovery clinical
treatment protocols approved by the FDA is recognized when the treatment is
provided to the patient.
Revenues from the sale of product are recognized when the product is
shipped, as title is transferred to the customer. We have no other obligation
associated with our products once shipment has occurred.
Patents and Trademarks
----------------------
Patents and trademarks are stated at cost (primarily legal fees) and are
amortized using the straight-line method over the estimated useful life of 17
years. We review our patents and trademark rights periodically to determine
whether they have continuing value. Such review includes an analysis of the
patent and trademark's ultimate revenue and profitability potential on an
undiscounted cash basis to support the realizability of our respective
capitalized cost. In addition, management's review addresses whether each patent
continues to fit into our strategic business plans.
Concentration of Credit Risk
----------------------------
Financial instruments that potentially subject us to credit risks consist
of cash equivalents and accounts receivable.
Our policy is to limit the amount of credit exposure to any one financial
institution and place investments with financial institutions evaluated as being
credit worthy, or in short-term money markets, which are exposed to minimal
interest rate and credit risks. At times, we have bank deposits and overnight
repurchase agreements that exceed federally insured limits.
Concentration of credit risk, with respect to receivables, is limited
through our credit evaluation process. We do not require collateral on our
receivables. Our receivables consist principally of amounts due from wholesale
drug companies as of June 30, 2005.
Convertible Debentures
----------------------
The March 2003, July 2003, October 2003, January 2004 and July 2004
Debenture issuances and related embedded conversion features and warrants
issuances were accounted for in accordance with EITF 98-5: Accounting for
convertible securities with beneficial conversion features or contingently
adjustable conversion ratios and with EITF No. 00-27: Application of issue No.
98-5 to certain convertible instruments. We determined the fair values to be
ascribed to detachable warrants issued with the convertible debentures utilizing
the Black-Scholes method. Discounts derived from determining the beneficial
conversion feature and fair value of the warrants based on the relative fair
value of the proceeds are amortized to financing costs over the remaining life
of the debenture in accordance with the effective interest method of accounting.
The unamortized discount upon the conversion of the debentures is expensed to
financing cost on a pro-rata basis.
48
RESULTS OF OPERATIONS
Three months ended June 30, 2004 versus Three months ended June 30, 2005
------------------------------------------------------------------------
Net loss
--------
Our net loss applicable to common stockholders of $3,345,000 for the three
months ended June 30, 2005 was down $1,794,000 or 35% compared to the same
period in 2004. The reduction was primarily due to a deemed dividend of
$2,355,000 recorded upon the issuance of warrants to our debenture holders as
incentive to exercise prior warrant issuances. In addition, expenditures for
manufacturing/production were down $589,000 in 2005 reflecting the decrease in
non-recurring expenses associated with the ramping up of the New Brunswick
facility for further production of Alferon N Injection(R) in the second quarter
of 2004.
Our research and development, as well as, clinical expenses increased $401,000
over the same period in 2004 due to additional costs associated with preparing
the Ampligen NDA, expenses related to patents and research related to Alferon
LDO. Administrative expenses were higher than a year ago due to legal fees
associated with our ongoing lawsuit against a conspiracy group. The net loss
applicable to common stockholders was $(.07) per share for the current period
versus $(.12) per share for the same period in 2004.
Revenues
--------
Revenues for the three months ended June 30, 2005 were $300,000 as compared to
revenues of $331,000 for the same period in 2004. Alferon N Injection(R) sales
were down $49,000 or 17% while Ampligen sold under the cost recovery clinical
program was up $18,000 or 43%. Ampligen sold under the cost recovery clinical
program is a product of physicians and ME/CFS patients applying to us to enroll
in the program. After screening the patient's enrollment records, we ship
Ampligen to the physician. A typical six month treatment therapy costs the
patient about $7,200 for Ampligen. This program has been in effect for many
years and is offered as a treatment option to patients severely affected by
ME/CFS. As the name "cost recovery" implies, we have no gain or profit on these
sales. The benefits to us include 1) physicians and patients becoming familiar
with Ampligen and 2) collection of clinical data relating to the patients'
treatment and results.
We continue our efforts to establish an internal marketing and sales
infrastructure to support the sales of Alferon N Injection in the United States,
including marketing and sales support professionals based at our headquarters in
Philadelphia, Pennsylvania. We are hiring and training regional sales managers
and are looking to assure full sales coverage in all major US markets. Our sales
force will introduce Alferon and promote Alferon to OB GYN's, dermatologists,
and infectious disease physicians and particularly STD Clinics, who are involved
in the treatment of patients with refractory or recurring external genital
warts, as well as physicians about the growing problem and the risks of HPV. We
also intend to expand our marketing/sales programs on an international basis
with our primary focus on Europe. This program is being designed to engage
European pharmaceutical distributors to market and distribute Alferon N.
Human papillomavirus (HPV) is one of the most common causes of sexually
transmitted infection in the world. Experts estimate that there are more cases
of genital HPV infection than of any other sexually transmitted disease (STD) in
the United States. The Centers for Disease Control and the National Institute of
Health, report that approximately 20 million people are presently infected with
HPV. At least one half of sexually active men and women acquire genital HPV
infection at some point in their lives. By age 50, at least 80 percent of women
will have gotten a genital HPV infection. Roughly 6.2 million Americans get a
new genital HPV infection each year. While the market for drugs treating HPV is
extremely large, there are many competing drugs.
49
Production costs/cost of goods sold
-----------------------------------
Our costs for production/cost of goods sold were down $589,000 for the three
months ended June 30, 2005 compared to the same period in 2004. This decrease in
production costs is primarily due to expenses incurred in the second quarter of
2004 related to preparing the New Brunswick facility for the production of
Alferon. There were no such costs for Alferon N Injection in the current
quarter. We are now concentrating on the completion of the consolidation of all
manufacturing and research and development activities within our own Good
Manufacturing Practice (GMP) Facility in New Brunswick for Ampligen. This
consolidation will improve efficiency and compliance procedures and bring the
facility in line with worldwide drug manufacturing standards.
Cost of goods sold for the three months ended June 30, 2005 and 2004 were
$103,000 and $130,000, respectively. Since acquiring the right to manufacture
and market Alferon N on March 11, 2003, we have focused on converting the
work-in-progress inventory into finished goods. This work-in-progress inventory
included three production lots totaling the equivalent of approximately 55,000
vials (doses) at various stages of the manufacturing process. Approximately
34,000 vials have been produced. In August 2004, we released most of the second
lot of product to Hospira (formerly Abbott Laboratories) for bottling and
realized approximately 12,000 vials of Alferon N. Some 3,000 of the remaining
vials within this lot were held back to be utilized in the development of a more
compatible vial size for manufacturing of Alferon N Injection. Hospira has
informed us of their intention to complete the labeling and packaging of our
approximately 12,000 vials of Alferon N Injection(R) at their site. We plan to
convert these 12,000 vials to finish goods by the end of the third quarter 2005.
We have identified five new potential contract manufacturers to replace Hospira
and obtained proposals from all five concerning the future formulation and
packaging of Alferon. We are in the process of reviewing these proposals. If we
are unable to secure a new facility within a reasonable period of time to
formulate and package ALFERON N Injection(R) at an acceptable cost, our ability
to sell ALFERON N Injection(R) and to generate profits therefrom will be
adversely affected.
We plan on initiating the process of converting the third lot of approximately
13,000 vials of Alferon N Injection(R) from work-in-progress to finished goods
inventory in the first half of 2006. We have elected to delay the process of
converting the third lot of approximately 13,000 vials from work in process to
finished goods as a result of two factors: 1) we are concentrating on the
relevant manufacturing operations within our New Brunswick, New Jersey facility
for the production of Ampligen(R) raw materials and 2) Alferon N Injection(R)
inventory on hand is sufficient to meet current demand. Approximately 2,000
vials were abstracted from the third lot for research and development purposes
during the fourth quarter 2004. Our production and quality control personnel in
our New Brunswick, NJ facility are involved in the extensive process of
manufacturing and validation required by the FDA.
We have completed the consolidation of our Rockville Quality Assurance Lab and
equipment into our New Brunswick facility. This lab will service the quality
assurance needs of Ampligen and Alferon N Injection this consolidation provides
a more efficient operation. In May 2005, we committed to purchase lab equipment
related to the manufacture of Ampligen raw material in the amount of
approximately $628,000. We estimate the total cost of establishing this
production line to be some $1,800,000, including modifications to our New
Brunswick facility.
Research and Development costs
------------------------------
Overall research and development direct costs for the three months ended June
30, 2004 and 2005 were $758,000 and $1,158,000, respectively. These costs in
2005 reflect the direct costs associated with our effort to develop our lead
product, Ampligen(R), as a therapy in treating chronic diseases and cancers as
well as on-going clinical trials involving patients with HIV. In addition, these
costs reflect direct costs incurred relating to the development of Alferon LDO
(low dose oral). We have over approximately 160,000 doses on hand of Alferon LDO
which have been prepared for use in clinical trials treating patients affected
with the SARS, Avian Flu or other potentially emerging infectious diseases.
50
In the first six months of 2005, we increased our clinical staff by employing
several highly trained individuals to focus on the preparation of our Ampligen
NDA filing. The NDA filing is a very complex document and we are being
meticulous in the preparation of the document. Our clinical monitors and
research assistants are in the process of visiting the multiple clinical study
sites around the country and are collecting data generated at each of these
sites. All data must be reviewed and checked to clarify any inconsistencies or
inaccuracies that turn up. Due to the human factor, these types of problems
occur in all clinical trials. These gaps and inconsistencies in data must be
resolved with the respective clinical investigators, while maintaining a clear
record of events which allows the FDA to conduct a meaningful audit of these
records.
We had originally targeted a late 2004 filing date for this NDA for Ampligen(R).
In order to respond to recent changes in the regulatory environment that place a
greater emphasis on the safety and efficacy of all new experimental drug
candidates, we are now incorporating a larger sample of data from our previous
trials. The NDA filing will now include data accumulated from 40,000
administrations of the studied drug to approximately 700 CFS patients.
We believe that our recently completed AMP 516 ME/CFS Phase III clinical trial
for use of Ampligen(R) in the treatment of ME/CFS is the most comprehensive
study ever conducted in ME/CFS. This Phase III clinical trial, which was
conducted over a six year period, involved an enrollment of more than 230
severely debilitated CFS patients and was conducted at twelve medical centers
throughout the United States. The study is serving as the basis for us to file a
new drug application with the FDA. As discussed above, we have hired additional
personnel and are in the process of analyzing the clinical data and preparing
the NDA. The FDA review process of the NDA could take 18-24 months and result in
one of the following events; 1) approval to market Ampligen(R) for use in
treating ME/CFS patients, 2) require more research, development, and clinical
work, 3) approval to market as well as conduct more testing, or 4) reject our
application ("NDA"). Given these variables, we are unable to project when
material net cash inflows are expected to commence from the sale of Ampligen(R).
At the 18th International Conference on Antiviral Research on April 10, 2005, we
presented new peer-reviewed data entitled "Correlation of Increased Oxygen
Consumption with Enhanced Treadmill Performance in Patients with Chronic Fatigue
Syndrome (CFS) as a Function of Ampligen(R)". According to recent reports by the
Centers for Disease Control and Prevention (CDC), ME/CFS, a disease that affects
between 400,000 and 800,000 Americans, is more serious than multiple sclerosis
with respect to medical severity and overall economic impact on society. This
was reported in the ME/CFS Advisory Committee Report dated January 5, 2005.
Specifically, ME/CFS imparts a clinically significant, profound deficit in
oxygen utilization to patients, which impairs their ability to perform a range
of ambulatory functions necessary to maintain quality of life. Similar oxygen
consumption deficits have been observed in other chronic diseases such as
congestive heart failure/angina ("CHF") and chronic pulmonary conditions such as
pulmonary arterial hypertension ("PAH") both of which now have a range of
readily available, commercially approved, therapeutics for disease intervention.
The experimental Ampligen(R) treatment in ME/CFS improved exercise duration up
to two times more than approved (or approvable) drugs for their respective
chronic disease indications. Ampligen(R) increased the percentage improvement in
endurance by 15% over the placebo group. In the ME/CFS study, maximal oxygen
consumption (VO2max) increased with Ampligen vs. Placebo. There was a high
correlation between improvement in exercise duration and increase in VO2 max (p
is less than 0.0001). VO2max is a measure of oxygen consumption at maximum
exertion.
51
By comparison, analysis of seven recent clinical studies, which resulted in
commercial approvals (or "approvable" letters) for various drugs used in these
other allied disease categories (both CHF and PAH), showed much lower magnitudes
of physical performance improvements due to therapeutic interventions. For
example, in CHF: Fosinopril (6.7% improvement), Captopril (6.2%), Ranolazine
(6.5%) and Ranolazine (5.7%); in PAH, Tracleer (10.6% improvement), Remodulin
(8.0%), and Remodulin (4.1%). All therapeutic measurements in these seven other
studies were determined by exercise treadmill testing (or extent of walking),
similar or identical to the therapeutic endpoint used in the CFS study.
With respect to Ampligen(R) in the ME/CFS pivotal study, no significant
differences (p>0.05) were observed between the two groups (drug vs. placebo) for
treatment dropouts, the incidence of serious adverse events, or missed treatment
doses. With respect to relative safety of the experimental therapeutic, there
were also no significant differences in week forty blood chemistry, hematology,
or thyroid function parameters. These results are consistent with two prior open
label trials and a phase II, double-blind, placebo controlled, multi-center
clinical trial of Ampligen(R).
Ampligen is also currently in two Phase IIb studies for the treatment of HIV to
overcome multi-drug resistance, virus mutation and toxicity associated with
current HAART therapies. One study, the AMP-719, is a Salvage Therapy, conducted
in the U.S. and evaluating the potential synergistic efficacy of Ampligen in
multi-drug resistant HIV patients for immune enhancement. The second study, the
AMP-720, is a clinical trial designed to evaluate the effect of Ampligen under
Strategic Treatment Intervention and is also conducted in the U.S. Enrollment in
the AMP 719 study is presently on hold as we focus our efforts on ramping up the
AMP 720 study.
The Amp 720 HIV study is a treatment using a Strategic Treatment Interruption
(STI). The patients' antiviral HAART regimens are interrupted and Ampligen(R) is
substituted as mono-immunotherapy. Ampligen(R) is an experimental
immunotherapeutic designed to display both antiviral and immune enhancing
characteristics. Prolonged use of Highly Active Antiretroviral Therapy (HAART)
has been associated with long-term, potentially fatal, toxicities. The clinical
study AMP 720 is designed to address these issues by evaluating the
administration of our lead experimental agent, Ampligen(R), a double stranded
RNA drug acting potentially both as an immunomodulator and antiviral. Patients,
who have completed at least nine months of Ampligen(R) therapy, were able to
stay off HAART for a total STI duration with a mean time of 29.0 weeks whereas
the control group, which was also taken off HAART, but not given Ampligen(R),
had earlier HIV rebound with a mean duration of 18.7 weeks. Thus, on average,
Ampligen(R) therapy spared the patients excessive exposure to HAART, with its
inherent toxicities, for more than 11 weeks. In July 2005, we enrolled two new
patients in this study. 41 HIV patients have already participated in this 64
week study. It is difficult to estimate the duration or projected costs of this
clinical trial due to the many variables involved, i.e.: patient drop out rate,
recruitment of clinical investigators, etc. The length of the study and costs
related to our clinical trials cannot be determined at this time as such will be
materially influenced by (a) the number of clinical investigators needed to
recruit and treat the required number of patients, (b) the rate of accrual of
patients and (c) the retention of patients in the studies and their adherence to
the study protocol requirements. Under optimal conditions, the cost of
completing the studies could be approximately $2.5 to $3.0 million if the target
of 120 patients is achieved. The rate of enrollment depends on patient
availability and on other products being in clinical trials for the treatment of
HIV, as there is competition for the same patient population. At present, more
than 18 FDA approved drugs for HIV treatment may compete for available patients.
The length, and subsequently the expense of these studies, will also be
determined by an analysis of the interim data, which will determine when
completion of the ongoing Phase IIb is appropriate and whether a Phase III trial
will be conducted or not. In case a Phase III study is required; the FDA might
require a patient population exceeding the current one which will influence the
cost and time of the trial. Accordingly, the number of "unknowns" is
sufficiently great to be unable to predict when, or whether, we may obtain
revenues from our HIV treatment indications.
52
A clinical study has been approved by the Clinical Research Ethics Committee of
the Kowloon West Cluster at the Princess Margaret Hospital in Hong Kong to
evaluate the use of Alferon(R) LDO (Low Dose Oral Interferon Alfa-N3, Human
Leukocyte Derived) in normal volunteers and/or asymptomatic subjects with
exposure to a person known to have Severe Acute Respiratory Syndrome (SARS).
A clinical study to evaluate the use of Alferon(R) LDO in HIV infected
volunteers has been initiated in Philadelphia, PA at Drexel University. The
study is designed to determine whether Alferon(R) LDO can resuscitate the
broad-spectrum antiviral and immunostimulatory genes. The initial patient
enrolled in this study in July 2005. The trial methodology may have implications
for treating other emerging viruses such as avian influenza (bird flu). Present
production methods for vaccines involve the use of millions of chicken eggs and
would be slow to respond to an outbreak according to a recently convened World
Health Organization (WHO) expert panel in November 2004. Health officials are
also concerned that bird flu could mutate to cause the next pandemic and render
present vaccines under development ineffective. We have prepared more than
300,000 doses of Alferon LDO for appropriate clinical programs.
In September 2004, we commenced a clinical trial using Alferon N Injection to
treat patients infected with the West Nile Virus. The infectious Disease section
of New York Queens Hospital and the Weill Medical College of Cornell University
will be conducting this double-blinded, placebo controlled trial. This study
plans to enroll 60 patients as they become available. As of July 28, 2005, four
patients have entered this study. The CDC reports that 61 cases of West Nile
Virus have been reported in the US as of July 26, 2005.
In order to obtain Ampligen(R) raw materials on a more regular production basis,
we consolidated and transfered relevant manufacturing operations into our New
Brunswick, New Jersey facility during the first quarter 2005. This consolidation
and transfer of manufacturing operations was implemented as an inspection of the
Ribotech facility in South Africa, our previous supplier of Ampligen(R) raw
materials, indicated that it did not, at present, meet the necessary standards
for a fully certified commercial process. The transfer of Ampligen(R) raw
materials manufacture to our own facilities has obvious advantages with respect
to overall control of the manufacturing procedure of Ampligen's raw materials,
keeping costs down and controlling regulatory compliance issues (other parts of
the 43,000 sq. ft. wholly owned facility are FDA approved for Alferon N
manufacture). The cost of installing this production line including
modifications to our New Brunswick facility is estimated at $1,800,000. This may
delay certain steps in the commercialization process, specifically a targeted
NDA filing.
In connection with settling various manufacturing infractions previously noted
by the FDA, Schering-Plough ("Schering") entered into a "Consent Decree" with
the FDA whereby, among other things, it agreed to discontinue various contract
(third party) manufacturing activities at various facilities including its San
Juan, Puerto Rico, plant. Ampligen(R) (which was not involved in any of the
cited infractions) was produced at this Puerto Rico plant from year 2000-2004.
Operating under instructions from the Consent Decree, Schering has advised us
that it would no longer manufacture Ampligen(R) in this facility beyond 2004 and
would assist us in an orderly transfer of said activities to other non Schering
facilities. We had entered into a Confidentiality Agreement with Mayne Pharma
Pty, Ltd ("Mayne") to lead to reinitiation and expansion of its Ampligen(R)
manufacturing program. However, senior management at Mayne's Mulgrave operations
in Australia recently informed us that they are ceasing to continue with all
development activities associated with potential contract customers and all
other contract business will be progressively scaled down over the next couple
of years. Therefore, Mayne's Mulgrave facility in Australia will no longer be a
possibility for manufacturing. We have obtained two proposals from manufacturers
in the US and expect to obtain at least two more for the manufacturing of
Ampligen. We want to qualify at least two GMP facilities in order to maintain a
minimum of two independent production sites. If we are unable to engage a
contract manufacturer in a timely manner, our plans to file an NDA for
Ampligen(R) and, eventually, to market and sell Ampligen(R) will be delayed.
53
General and Administrative Expenses
-----------------------------------
General and Administrative ("G&A") expenses for the three months ended June 30,
2004 and 2005 were approximately $1,076,000 and $1,523,000, respectively. The
increase in G&A expenses of $446,000 during this period is primarily due to
higher professional fees, specifically legal costs associated with a lawsuit we
initiated seeking injunction relief and damages against a conspiratorial group
alleging that this conspiratorial group had engaged in illegal activities to
take over Hemispherx and enrich themselves at the expense of our shareholders.
See Item 1. "Legal Proceedings" in Part II - Other Information, below for more
information.
Interest and Other Income
-------------------------
Interest and other income for the three months ended June 30, 2004 and 2005
totaled $13,000 and $63,000, respectively. The increase in interest and other
income during the current quarter can primarily be attributed to the maturing of
marketable securities during the 2005 period. All funds in excess of our
immediate need are invested in short-term high quality securities.
Interest Expense and Financing Costs
------------------------------------
Interest expense and non-cash financing costs were approximately $924,000 for
the three months ended June 30, 2005 versus $602,000 in charges for the same
three months a year ago. Non-cash financing costs consist of the amortization of
Original Issue Discounts and the amortization of costs associated with
beneficial conversion features of our debentures and the relative fair value of
the warrants relating to the Debentures. Please see Note 8 in the consolidated
financial statements contained herein for more details on these transactions.
Deemed Dividend
---------------
Deemed dividend for the three months ended June 30, 2004 and 2005 was $2,355,000
and $0, respectively. This represents the fair value of the warrants issued to
our debenture holders as incentive to exercise prior warrant issuances.
Six months ended June 30, 2004 versus Six months ended June 30, 2005
--------------------------------------------------------------------
Net loss
--------
Our net loss applicable to common stockholders of $6,325,000 for the six months
ended June 30, 2005 was down $5,878,000 or 48% compared to the same period in
2004. This reduction was primarily due to: 1) lower costs associated with
non-cash financing charges related to convertible debentures, These lower
non-cash financing costs of $1,585,000 represented 27% of the change in net loss
from period to period, 2) production/costs of good sold expenditures were down
$1,092,000 due to expenditures during the first half of 2004 associated with
ramping up of the New Brunswick facility for further production of Alferon N
Injection(R), 3) lower non-cash stock compensation expenses, and 4) deemed
dividend of $2,355,000 recorded upon the issuance of warrants to our debenture
holders as incentive to exercise prior warrant issuances during second quarter
2004. Net losses per share were $(.13) for current period versus $(.29) in the
same period 2004.
54
Revenues
--------
Revenues for the six months ended June 30, 2005 were $558,000 as compared to
revenues of $639,000 for the same period in 2004. Ampligen sold under the cost
recovery clinical program was down $2,000 (2%) and Alferon N Injection sales
were down $79,000 (14%). For more information concerning revenue, see the
revenue section contained in the results of operations for the three months
ended June 30, 2005 versus three months ended June 30, 2004 discussed above.
Production costs/cost of goods sold
-----------------------------------
Production costs for the six months ended June 30, 2004 were $1,052,000. These
costs represented expenditures associated with preparing the New Brunswick
facility for further production of Alferon N Injection(R) in the first half of
2004. There were no production costs for Alferon N Injection during the first
six months of 2005 as we concentrated on the completion of the consolidation of
all manufacturing and research and development activities within our own Good
Manufacturing Practice (GMP) Facility in New Brunswick for Ampligen. This
consolidation will improve efficiency and compliance procedures and bring the
facility in line with worldwide drug manufacturing standards.
Cost of goods sold for the six months ended June 30, 2004 and 2005 were $241,000
and $201,000, respectively. For more information concerning production/cost of
goods sold, see the production/costs of goods sold section contained in the
results of operations for the three months ended June 30, 2005 versus three
months ended June 30, 2004 discussed above.
Research and Development costs
------------------------------
Overall research and development direct costs for the six months ended June 30,
2004 and 2005 were $1,720,000 and $2,426,000, respectively. For more information
on research and development activities, see the research and development section
contained within the results of operations for the three months ended June 30,
2005 versus three months ended June 30, 2004 discussed above.
General and Administrative Expenses
-----------------------------------
General and Administrative ("G&A") expenses for the six months ended June 30,
2004 and 2005 were approximately $3,921,000 and $2,550,000, respectively. The
decrease in G&A expenses of $1,371,000 during this period is primarily due to a
non-cash stock compensation charge of $1,769,000 resulting from the issuance of
1,450,000 warrants to purchase common stock at $2.20 per share to Dr. Carter in
2003 that vested in the first quarter 2004. The warrants vested upon the second
ISI asset closing which occurred on March 17, 2004. Please see "Item 11.
Executive Compensation." contained within our Form 10K filed with the Securities
and Exchange Commission on March 16, 2005, for more details on how Dr. Carter
was compensated. Higher professional fees, specifically legal costs, during the
first six months of 2005, slightly offset this decrease in G & A expenses, from
period to period. The costs were associated with a lawsuit we initiated seeking
injunction relief and damages against a conspiratorial group alleging that this
conspiratorial group had engaged in illegal activities to take over Hemispherx
and enrich themselves at the expense of our shareholders. See also Item 1.
"Legal Proceedings" in Part II - Other Information, below for more information.
Interest and Other Income
-------------------------
Interest and other income for the six months ended June 30, 2004 and 2005
totaled $24,000 and $293,000, respectively. The increase in interest and other
income during the current quarter can primarily be attributed to the maturing of
marketable securities during the 2005 period. All funds in excess of our
immediate need are invested in short-term high quality securities.
55
Interest Expense and Financing Costs
------------------------------------
Interest expense and non-cash financing costs were approximately $1,999,000 for
the six months ended June 30, 2005 versus $3,577,000 for the same three months a
year ago. Non-cash financing costs consist of the amortization of Original Issue
Discounts and the amortization of costs associated with beneficial conversion
features of our debentures and the relative fair value of the warrants relating
to the Debentures. These charges are reflected in the Consolidated Statements of
Operations under the caption "Financing Costs." The main reason for the decrease
in financing costs of $1,578,000 can be attributed to the aggregate total of
these charges being reduced since the first half of 2004 due to decreased
amortization charges associated with our debentures and additional financing
costs during the first half of 2004 with regard to our January 2004 debenture
and the impact of Section 713 of the American Stock Exchange Company Guide.
Please see Note 8 "Section 713 of The American Stock Exchange Company Guide"in
the consolidated financial statements contained herein for more details on these
transactions and for details on our debenture and stock financings.
Deemed Dividend
---------------
Deemed dividend for the six months ended June 30, 2004 and 2005 was $2,355,000
and $0 respectively. This represents the fair value of the warrants issued to
our debenture holders as incentive to exercise prior warrant issuances.
Liquidity and Capital Resources
-------------------------------
Cash used in operating activities for the six months ended June 30, 2005 was
$3,865,000. As of June 30, 2005, we had approximately $12,614,000 million in
cash and short-term investments. These funds should be sufficient to meet our
operating cash requirements including debt service for the near term. For
detailed information on our debenture and equity financings during this period,
please see Notes 8 and 9 in the consolidated financial statements contained
herein.
In May 2005, we committed to purchase lab equipment related to the manufacture
of Ampligen raw material ("polymers") in the amount of approximately $628,000.
The overall cost of establishing the polymer production line at the New
Brunswick facility is estimated at $1,800,000.
As of August 2, 2005, the outstanding principal of our convertible debentures
was $6,098,696 of which $2,071,178 matures on October 29, 2005 unless converted
into our common stock at $2.02 per share. The remaining principal on the January
2004 Debentures was $2,194,185. The investors converted $139,150 principal
amount of the January 2004 Debenture into 55,000 shares of common stock. In
addition, installment payments of $1,666,665 were made to our investors
amounting to 941,136 shares of our common stock. The remaining principal balance
on the July 2004 Debentures was $1,833,333. One installment payment of $166,667
was made in July 2005 to our investors amounting to 102,148 shares of our common
stock.
On July 8, 2005, we entered into a common stock purchase agreement with Fusion
Capital Fund II, LLC, pursuant to which Fusion Capital has agreed, under certain
conditions, to purchase on each trading day $40,000 of our common stock up to an
aggregate of $20.0 million over approximately a 25 month period, subject to
earlier termination at our discretion. In our discretion, we may elect to sell
less common stock to Fusion Capital than the daily amount and we may increase
the daily amount as the market price of our stock increases. The purchase price
of the shares of common stock will be equal to a price based upon the future
market price of the common stock without any fixed discount to the market price.
Fusion Capital does not have the right or the obligation to purchase shares of
our common stock in the event that the price of the common stock is less than
$1.00
56
Pursuant to our agreement with Fusion Capital, we have registered for public
sale by Fusion Capital up to 10,795,597 shares of our common stock. However, in
the event that we decide to issue more than 10,113,278, i.e. greater than 19.99%
of the outstanding shares of common stock as of the date of the agreement, we
would first seek stockholder approval in order to be in compliance with American
Stock Exchange rules.
This funding arrangement with Fusion Capital plus our current cash position
should be sufficient to meet our operating cash requirements for the next 30
months. However, we may need to raise additional funds through equity or debt
financing or from other sources to the extent that we do not receive adequate
funding from Fusion Capital (see "Risk Factors - We may require additional
financing that may not be available") and to complete the regulatory processes
including the commercialization of Ampligen products. There can be no assurances
that we will raise funds from these or other sources, which may have a material
adverse effect on our ability to develop our products.
Also, because of our long-term capital requirements, we may seek to access the
public equity market whenever conditions are favorable, even if we do not have
an immediate need for additional capital at that time. Any additional funding
may result in significant dilution and could involve the issuance of securities
with rights, which are senior to those of existing stockholders. We may also
need additional funding earlier than anticipated, and our cash requirements, in
general, may vary materially from those now planned, for reasons including, but
not limited to, changes in our research and development programs, clinical
trials, competitive and technological advances, the regulatory processes,
including the commercializing of Ampligen products.
There can be no assurances that we will raise adequate funds from these or other
sources, which may have a material adverse effect on our ability to develop our
products. Also, we have the ability to curtail discretionary spending, including
some research and development activities, if required to conserve cash.
Item 4: Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures (as 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 Quarterly Report on Form 10-Q was made under the
supervision and with the participation of management, including our Chief
Executive Officer and Chief Fincancial Officer. In connection with such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are not effective based on
the material weaknesses in internal control over financial reporting described
in our Annual Report on Form 10-K/A for the period ended December 31, 2005.
Remediation of Material Weaknesses
During the second quarter of 2006, to remedy the material weakness in our
internal control over financial reporting, we initiated the process of
establishing procedures to enhance controls over the "financial statement close
and disclosure" process which included subscribing to CCH's "Accounting Research
Manager", a recognized on-line service in order to maintain up-to-date
accounting and disclosure guidance. In addition, we have established policies
and procedures to include a detailed comprehensive review of the underlying
information supporting the amounts included within our consolidated financial
statements and disclosures including documented reviews to assist in ensuring:
1) clerical accuracy within our financial statements and disclosures, 2)
financial statement groupings within our financial statements are accurate, 3)
support utilized in preparation of the consolidated statement of cash flows is
accurate, and 4) equity transactions during the reporting period are completely
and accurately recorded. We engaged an additional accounting consultant in April
2006 to assist in initiating the implementation of these policies and procedures
during the second quarter 2006. The control deficiencies will be fully
remediated when in the opinion of the Company's management, the revised control
processes have been operating for a sufficient period of time to provide
reasonable assurance as to their effectiveness. The Company believes it will be
able to make this assessment by December 31, 2006.
57
Changes in Internal Controls
Other than as described above, there was no change in our internal
controls over financial reporting (as defined in Rule 13a-15(f) of the Exchange
Act) that occurred during the period covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
Part II - OTHER INFORMATION
ITEM 6: Exhibits
(a) Exhibits
31.1 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 from the Company's
Chief Executive Officer
31.2 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 from the Company's
Chief Financial Officer
32.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 from the Company's
Chief Executive Officer
32.2 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 from the Company's
Chief Financial Officer
58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEMISPHERx BIOPHARMA, INC.
/S/ William A. Carter
---------------------------
William A. Carter, M.D.
Chief Executive Officer & President
/S/ Robert E. Peterson
--------------------------
Robert E. Peterson
Chief Financial Officer
Date: July 31, 2006
59