Filed Pursuant to Rule 424(b)(3)
Registration Nos. 333-136187, 333-108645, 333-111135,
333-113796, 333-117178 and 333-130008
PROSPECTUS SUPPLEMENT
Number 1
to
Prospectus dated August 7, 2006
of
HEMISPHERX BIOPHARMA, INC.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
--------------------
This prospectus supplement no. 1 supplements the information provided in our
prospectus dated August 7, 2006. This prospectus supplement should be read in
conjunction with that Prospectus, which is to be delivered with this prospectus
supplement.
The date of this Prospectus Supplement is August 14, 2006.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2006
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
(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. |X| Yes |_| No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
|_| Large accelerated filer |X| Accelerated filer |_| Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). |_| Yes |X| No
62,581,122 shares of common stock were issued and outstanding as of August 8,
2006.
PART I - FINANCIAL INFORMATION
ITEM 1: Financial Statements
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)
December 31, June 30,
2005 2006
------------ -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,827 $ 2,555
Short term investments (Note 4) 12,377 18,963
Inventory, net 1,767 1,270
Accounts and other receivables, net of reserves
of $1 and $1, respectively 96 189
Prepaid expenses and other current assets 142 116
Total current assets 18,209 23,093
Property and equipment, net 3,364 4,803
Patent and trademark rights, net 795 775
Investment 35 35
Construction in Progress 821 546
Deferred financing costs 113 76
Advance receivable (Note 5) 1,300 1,300
Other assets 17 17
--------- ---------
Total assets $ 24,654 $ 30,645
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 991 $ 1,783
Accrued expenses 865 1,349
Current portion of long-term debt -- 3,640
--------- ---------
Total current liabilities 1,856 6,772
--------- ---------
Long-Term Debt (Note 5) 4,171 --
--------- ---------
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,
authorized 100,000,000 shares; issued and
outstanding 56,264,155 and 62,252,568
respectively 56 62
Additional paid-in capital 166,394 182,384
Accumulated other comprehensive (loss) income (171) 79
Accumulated deficit (147,652) (158,652)
--------- ---------
Total stockholders' equity 18,627 23,873
--------- ---------
Total liabilities and stockholders' equity $ 24,654 $ 30,645
========= =========
See accompanying notes to condensed consolidated financial statements.
2
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
(Unaudited)
Three months ended June 30,
---------------------------
2005 2006
------------ ------------
Revenues:
Sales of product net $ 240 $ 197
Clinical treatment programs 60 50
----------- -----------
Total revenues 300 247
Costs and expenses:
Production/cost of goods sold 103 398
Research and development 1,158 2,588
General and administrative 1,523 2,086
----------- -----------
Total costs and expenses 2,784 5,072
Interest and other income 63 205
Interest expense (107) (326)
Financing costs (Note 5) (817) (135)
----------- -----------
Net loss $ (3,345) $ (5,081)
=========== ===========
Basic and diluted loss per share (Note 2) $ (.07) $ (.08)
=========== ===========
Weighted average shares outstanding 50,299,176 64,033,333
=========== ===========
See accompanying notes to consolidated financial statements.
3
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
(Unaudited)
Six months ended June 30,
-------------------------
2005 2006
----------- -----------
Revenues:
Sales of product net $ 469 $ 380
Clinical treatment programs 89 103
----------- -----------
Total revenues 558 483
Costs and expenses:
Production/cost of goods sold 201 697
Research and development 2,426 5,018
General and administrative 2,550 5,178
----------- -----------
Total costs and expenses 5,177 10,893
Interest and other income 293 160
Interest expense (213) (410)
Financing costs (Note 5) (1,786) (340)
----------- -----------
Net loss $ (6,325) $ (11,000)
=========== ===========
Basic and diluted loss per share (Note 2) $ (.13) $ (.18)
=========== ===========
Weighted average shares outstanding 50,033,623 60,132,309
=========== ===========
See accompanying notes to consolidated financial statements.
4
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive loss
(in thousands except share data)
(Unaudited)
Common Accumulated
Stock other
Common $.001 Additional Comprehensive Total
Stock Par paid-in Income Accumulated stockholders'
Shares Value capital (loss) deficit equity
---------- ------ ---------- ------------- ----------- -------------
Balance at December 31, 2005 56,264,155 $56 $166,394 $(171) $(147,652) $ 18,627
Debt conversions 400,642 1 833 -- -- 834
Interest Payments 43,875 -- 101 -- -- 101
Warrants exercised 255,416 -- 672 -- -- 672
Private placement, net of issuance costs 5,235,420 5 11,975 -- -- 11,980
Stock issued for settlement of accounts
payable and accrued expenses 53,060 -- 146 -- -- 146
Stock warrant compensation expense -- -- 2,263 -- -- 2,263
Net comprehensive income (loss) -- -- -- 250 (11,000) (10,750)
---------- --- -------- ----- --------- --------
Balance at June 30, 2006 62,252,568 $62 $182,384 $ 79 $(158,652) $ 23,873
========== === ======== ===== ========= ========
See accompanying notes to consolidated financial statements.
5
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2005 and 2006
(in thousands)
(Unaudited)
2005 2006
------- --------
Cash flows from operating activities:
Net loss $(6,325) $(11,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation of property and equipment 57 70
Amortization of patent and trademark rights 174 56
Financing cost related to debt discounts 1,786 340
Stock compensation expense 106 2,263
Interest expense 213 101
Changes in assets and liabilities:
Inventory 333 497
Accounts and other receivables 67 (93)
Prepaid expenses and other current assets 41 26
Accounts payable 80 937
Accrued expenses (397) 484
------- --------
Net cash used in operating activities (3,865) (6,319)
------- --------
Cash flows from investing activities:
Purchase of property plant and
equipment, net (110) (1,508)
Additions to patent and trademark
rights (71) (36)
Maturity of short term
investments 7,934 12,548
Purchase of short term investments (6,907) (18,884)
Construction in progress -- 275
------- --------
Net cash provided by (used in) investing activities $ 846 $ (7,605)
------- --------
6
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
For the Six Months Ended June 30, 2005 and 2006
(in thousands)
(Unaudited)
2005 2006
------- -------
Cash flows from financing activities:
Proceeds from exercise of stock warrants 8 672
Proceeds from sale of stock, net of issuance costs -- 11,980
------- -------
Net cash provided by financing activities 8 12,652
------- -------
Net decrease in cash and cash equivalents (3,011) (1,272)
Cash and cash equivalents at beginning of period 8,813 3,827
------- -------
Cash and cash equivalents at end of period $ 5,802 $ 2,555
======= =======
Supplemental disclosures of non-cash investing and
financing cash flow information:
Issuance of common stock for accounts payable and
accrued expenses $ 192 $ 146
Issuance of common stock for debt conversion and
debt payments $ 994 $ 834
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ -- $ 73
======= =======
See accompanying notes to consolidated financial statements.
7
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The consolidated financial statements include the financial statements of
Hemispherx Biopharma, Inc. and its wholly-owned subsidiaries. The Company has
three domestic subsidiaries BioPro Corp., BioAegean Corp. and Core Biotech
Corp., all of which are incorporated in Delaware and are dormant. The Company's
foreign subsidiaries include Hemispherx Biopharma Europe N.V./S.A. established
in Belgium in 1998 and Hemispherx Biopharma Europe S.A. incorporated in
Luxemburg in 2002, which have limited or no activity. All significant
intercompany balances and transactions have been eliminated in consolidation.
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: NET LOSS PER SHARE
Basic and diluted net loss per share is computed using the weighted
average number of shares of common stock outstanding during the period.
Equivalent common shares, consisting of stock options and warrants including the
Company's convertible debentures, which amounted to 19,651,825 and 30,005,360
shares, are excluded from the calculation of diluted net loss per share for the
three and six months ended June 30, 2005 and 2006, respectively, since their
effect is antidilutive.
NOTE 3: STOCK BASED COMPENSATION
Prior to the adoption of Statement of Financial Accounting Standard No.
123R, "Share Based Payment", ("FAS 123R") the Company applied the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations including FASB Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation an interpretation of APB Opinion No.
25 issued in March 2000 ("FIN 44"), to account for its fixed plan stock options.
Under this method, compensation expense was recorded on the date of grant only
if the current market price of the underlying stock exceeded the exercise price.
SFAS No. 123, Accounting for Stock-Based Compensation, established accounting
and disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, an
amendment of FASB Statement No. 123. This Statement amended FAS 123, to provide
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based employee compensation.
The Equity Incentive Plan effective May 1, 2004, authorizes the grant of
non-qualified and incentive stock options, stock appreciation rights, restricted
stock and other stock awards. A maximum of 8,000,000 shares of common stock is
reserved for potential issuance pursuant to awards under the Equity Incentive
Plan. Unless sooner terminated, the Equity Incentive Plan will continue in
effect for a period of 10 years from its effective date.
8
The Equity Incentive Plan is administered by the Board of Directors. 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 may select.
Stock options awarded under the Equity Incentive Plan may be exercisable
at such times (not later than 10 years after the date of grant) and at such
exercise prices (not less than fair market value at the date of grant) as the
Board may determine. The Board may provide for options to become immediately
exercisable upon a "change in control," which is defined in the Equity Incentive
Plan to occur upon any of the following events: (a) the acquisition by any
person or group, as beneficial owner, of 20% or more of the outstanding shares
or the voting power of the outstanding securities of the Company; (b) either a
majority of the directors of the Company at the annual stockholders meeting has
been nominated other than by or at the direction of the incumbent directors of
the Board, or the incumbent directors cease to constitute a majority of the
Company's Board; (c) the Company's stockholders approve a merger or other
business combination pursuant to which the outstanding common stock of the
Company no longer represents more than 50% of the combined entity after the
transaction; (d) the Company's shareholders approve a plan of complete
liquidation or an agreement for the sale or disposition of all or substantially
all of the Company's assets; or (e) any other event or circumstance determined
by the Company's Board to affect control of the Company and designated by
resolution of the Board as a change of control.
Effective January 1, 2006, the Company adopted the FAS 123R. Under FAS
123R, share-based compensation cost is measured at the grant date, based on the
estimated fair value of the award, and is recognized as expense over the
requisite service period. The Company adopted the provisions of FAS 123R using a
modified prospective application. Under this method, compensation cost is
recognized for all share-based payments granted, modified or settled after the
date of adoption, as well as for any unvested awards that were granted prior to
the date of adoption. Prior periods are not revised for comparative purposes.
Because the Company previously adopted only the pro forma disclosure provisions
of FAS 123, it will recognize compensation cost relating to the unvested portion
of awards granted prior to the date of adoption, using the same estimate of the
grant-date fair value and the same attribution method used to determine the pro
forma disclosures under FAS 123, except that forfeitures rates will be estimated
for all options, as required by FAS 123R. The cumulative effect of applying the
forfeiture rates is not material.
The fair value of each option award is estimated on the date of grant
using a Black-Scholes option valuation model. Expected volatility is based on
the historical volatility of the price of the Company's stock. The risk-free
interest rate is based on U.S. Treasury issues with a term equal to the expected
life of the option. The Company uses historical data to estimate expected
dividend yield, expected life and forfeiture rates. The estimated per share
weighted average grant date fair values of stock options granted during the
three months ended June 30, 2005 and 2006, were $1.08 and $2.05, respectively.
The estimated per share weighted average grant date fair values of stock options
granted during the six months ended June 30, 2005 and 2006, were $1.07 and
$1.97, respectively. The fair values of the options granted, were estimated
based on the following weighted average assumptions:
9
Six months ended June 30,
-------------------------------
2005 2006
-------------- --------------
Expected volatility 58.78 - 60.67% 72.06% - 79.3%
Risk-free interest rate 4.81% 4.3% - 4.97%
Expected dividend yield -- --
Expected life 5 years 2.5 - 5 years
Stock option activity during the six months ended June 30, 2006, is as
follows:
Weighted
Weighted average
average remaining Aggregate
Number of exercise contracted intrinsic
Options price term (years) value
--------- -------- ------------ ---------
Outstanding at January 1, 2006 1,985,680 $2.15
Options granted 1,106,650 3.39
Options exercised -- --
Options forfeited (1,308) 1.90
========= =====
Options outstanding at June 30,
2006 3,091,022 $2.59 9.04 -0-
========= ===== ==== ===
Options exercisable at June 30,
2006 3,004,322 $2.70 8.56 -0-
========= ===== ==== ===
The impact on the Company's results of operations of recording share-based
compensation for the three and six months ended June 30, 2006 was to increase
general and administrative expenses by approximately $309,000 and $2,263,000,
respectively, and reduce earnings per share by $.00 and $.04 per basic and
diluted share, respectively.
As of June 30, 2006, there was no unrecognized stock-based compensation
cost related to options granted under the Equity Incentive Plan.
The following table illustrates the effect on the net loss and net loss
per share as if the Company had applied the fair value recognition provisions of
FAS 123 to stock based compensation prior to January 1, 2006:
Three months Six months
Ended June 30, Ended June 30,
2005 2005
(in thousands) (in thousands)
-------------- --------------
Net loss $ (3,345) $ (6,325)
Add stock-based employee compensation expense included in
reported net loss 106 106
Deduct total stock-based employee compensation expense
determined under fair value based method for all awards, net of tax (55) (82)
----------- -----------
Pro forma net loss $ (3,294) $ (6,301)
=========== ===========
Pro forma net loss per common share (Basic and diluted) $ (.07) $ (.13)
=========== ===========
Weighted average common shares outstanding: Basic and diluted 50,299,176 50,033,623
=========== ===========
Net loss per common share basic and diluted $ (.07) $ (.13)
=========== ===========
10
Note 4: SHORT TERM INVESTMENTS
Securities classified as available for sale consisted of (in thousands):
June 30, 2006
---------------------- Unrealized Maturity
Name of security Cost Market value gain date
---------------- ------- ------------ ---------- -------------
Prudential $ 783 $ 798 $15 7/11/06
Federal Home Loan 781 798 17 7/25/06
General Electric 775 790 15 9/22/06
AIG Discount Commercial Paper 946 963 17 9/22/06
General Electric 1,199 1,214 15 11/21/06
Certificate of Deposit 2,000 2,000 -- 11/27/06
Certificate of Deposit 2,000 2,000 -- 12/21/06
Certificate of Deposit 2,000 2,000 -- 12/27/06
Certificate of Deposit 2,000 2,000 -- 9/13/06
Certificate of Deposit 1,000 1,000 -- 9/23/06
Certificate of Deposit 2,000 2,000 -- 9/28/06
Certificate of Deposit 1,400 1,400 -- 9/29/06
Certificate of Deposit 2,000 2,000 -- 9/29/06
------- ------- ---
$18,884 $18,963 $79
======= ======= ===
No investment securities were pledged to secure public funds at June 30, 2006.
Comprehensive Income (loss)
The Company reports comprehensive income (loss), which includes net loss, as
well as certain other items, which result in a change to equity during the
period.
Three months Six months
ended June 30 ended June 30
(in thousands) (in thousands)
------------- --------------
2005 2006 2005 2006
------ ---- ----- ------
Unrealized gains (losses) during the period $(111) $33 $(95) 164
Realized loss (gains) during the period 29 (3) 10 86
----- --- ---- ----
Other comprehensive income(loss) $ (82) $30 $(85) $250
===== === ==== ====
There are no income tax effects allocated to comprehensive income (loss) as the
Company has no tax liabilities due to net operating losses.
The basis on which the Company computes gains and losses is based on the
specific identification method of accounting. For the six months ended June 30,
2006 total gains from sales of securities was $40,000 and total losses from the
sales of securities for the six months ended June 30, 2006 was $126,000.
Note 5: DEBENTURE FINANCING
Long term debt consists of the following:
(in thousands)
---------------------------------
December 31, 2005 June 30, 2006
----------------- -------------
October 2003 $ 2,071 $ 2,071
January 2004 1,365 1,031
July 2004 1,500 1,000
------- -------
Total 4,936 4,102
Less Discounts (765) (462)
------- -------
Total 4,171 3,640
=======
Less current portion -- 3,640
------- -------
Long term debt $ 4,171 $ --
======= =======
11
As of December 31, 2005, the Company made installment payments of
$2,389,000 and investors converted an aggregate $2,818,000 principal amount of
debt from the debentures as noted below (in thousands):
Common
Original Installment Remaining Shares Common Shares
Principal Debt Conversion payments in Principal issued for issued in
Debenture Amount to Common Shares Common Shares Amount Conversion installments
-------------------- --------- ---------------- ------------- --------- ---------- -------------
October 2003 $ 4,142 $2,071 $ -- $2,071 1,025,336 --
January 2004 4,000 747 1,889 1,365 347,000 1,094,149
July 2004 2,000 -- 500 1,500 -- 331,669
------- ------ ------ ------ --------- ---------
Totals $10,142 $2,818 $2,389 $4,936 1,372,336 1,425,818
======= ====== ====== ====== ========= =========
As of June 30, 2006, the Company made aggregate installment payments of
$2,388,000 and the investors converted an aggregate $3,652,000 principal amount
of debt from the debentures as noted below (in thousands):
Common
Original Installment Remaining Shares Common Shares
Principal Debt Conversion payments in Principal issued for issued in
Debenture Amount to Common Shares Common Shares Amount Conversion installments
-------------------- --------- ---------------- ------------- --------- ---------- -------------
October 2003 $ 4,142 $2,071 $ -- $2,071 1,025,336 --
January 2004 4,000 1,081 1,888 1,031 507,257 1,094,149
July 2004 2,000 500 500 1,000 240,385 331,669
------- ------ ------ ------ --------- ---------
Totals $10,142 $3,652 $2,388 $4,102 1,772,978 1,425,818
======= ====== ====== ====== ========= =========
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 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).
12
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.
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% (see "Debenture
Agreement Amendment" below for more details).
13
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 in 2004.
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, 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
June 30, 2006 have been accounted for as advances receivable and are reflected
as such on the accompanying balance sheet as of June 30, 2006. 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, 2006, 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 $2,071,178 is convertible into 1,025,336 shares of common stock.
The Company recorded financing costs for the three months ended June 30, 2005
and 2006, with regard to the October 2003 Debentures of $371,000 and $0,
respectively. Interest expense for the three months ended June 30, 2005 and
2006, with regard to the October 2003 Debentures was approximately $31,000 and
$36,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2005 and
2006, with regard to the October 2003 Debentures of $741,000 and $0
respectively. Interest expense for the six months ended June 30, 2005 and 2006,
with regard to the October 2003 Debentures was approximately $62,000 and
$72,000, respectively.
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).
14
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, the
conversion price was lowered to $2.08 per share. The Company recorded an
additional debt discount 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 January 31, 2006
to June 30, 2007, and increase the interest rate from 6% to 7% (see "Debenture
Agreement Amendment" below for more details).
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 the exercise price was lowered to $2.58 per share.
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.
15
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 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.
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.
16
As of June 30, 2006, the Company has made aggregate installment payments of
$1,888,000 and the investors have converted an aggregate of $1,081,000 of
principal amount of the January 2004 Debentures into 1,094,149 and 507,257
shares of common stock, respectively. During the quarter ended June 30, 2006,
the investors did not convert any of the principal amount of the January 2004
Debentures. The remaining principal on these Debentures was $1,031,268 as of
June 30, 2006.
The Company recorded financing costs for the three months ended June 30, 2005
and 2006 with regard to the January 2004 Debentures of $189,000 and $0,
respectively. Interest expense for the three months ended June 30, 2005 and
2006, with regard to the January 2004 Debentures was approximately $46,000 and
$29,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2005 and
2006 with regard to the January 2004 Debentures of $510,000 and $49,000,
respectively. Interest expense for the six months ended June 30, 2005 and 2006,
with regard to the January 2004 Debentures was approximately $92,000 and
$97,000, 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,
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.
In October 2005, the Company entered into an amendment agreement with the July
2004 Debenture holders to amend the maturity date from July 31, 2006 to June 30,
2007, and increase the interest rate from 6% to 7% (see "Debenture Agreement
Amendment" below for more details).
17
As of June 30, 2006, the Company has made aggregate installment payments of
$500,000 resulting in the issuance of 331,669 shares of the Company's common
stock. During the six months ended June 30, 2006, the Debenture holders
converted $500,000 principal amount of the July 2004 Debentures into 240,385
shares of common stock. The remaining principal amount on these debentures was
$1,000,000 as of June 30, 2006.
The Company recorded financing costs for the three months ended June 30, 2005
and 2006 with regard to the July 2004 Debentures of $124,000 and $116,000,
respectively. Interest expense for the three months ended June 30, 2005 and
2006, with regard to the January 2004 Debentures was approximately $30,000 and
$19,000, respectively.
The Company recorded financing costs for the six months ended June 30, 2005 and
2006 with regard to the July 2004 Debentures of $248,000 and $253,000,
respectively. Interest expense for the six months ended June 30, 2005 and 2006,
with regard to the January 2004 Debentures was approximately $60,000 and
$45,000, respectively.
Debenture Agreement Amendment
On October 6, 2005, the Company entered into a material definitive agreement
with the October 2003, January 2004 and July 2004 debenture holders to 1) amend
the remaining outstanding Debentures that were to mature on October 31, 2005 (as
amended, the "October 2003 Debenture") and the two traunches of outstanding
debentures due to mature on January 31, 2006 (as amended, respectively, the
"January 2004 and July 2004 Debentures"), to a maturity date of June 30, 2007,
2) to increase the interest rate from 6% per annum to 7% per annum. In
consideration for extending the maturity date of the outstanding debentures, the
Company issued an aggregate of 225,000 Warrants (the "October 2009 Warrants") to
the debenture holders to acquire common stock at a price of $2.50 per share at
any time from October 31, 2005 through October 31, 2009. The October 2009
Warrants contain provisions for adjustment of the exercised price in the event
of certain anti-dilution events. The Company agreed to register 135% of the
shares issuable as interest shares that might result due to the amendments to
the Debentures and issuable upon exercise of the October 2009 Warrants.
In accordance with EITF 96-19, "Debtor's Accounting for a Modification or
Exchange of Debt Instruments", the Company has treated the change in terms to
the original debentures as non-substantial in nature and have not accounted for
such modification as an extinguishment of debt, but rather a debt modification.
In addition, the 225,000 warrants issued to the debenture holders as
consideration for extending the maturity date were valued using the
Black-Scholes method and $189,000 of additional debt discount on the July 2004
Debenture was recorded. The discount will be amortized as interest expense over
the new term of the debt instrument in accordance with the effective interest of
accounting. Any costs incurred by third parties were expensed as incurred.
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 3,667,662 and 2,901,463 shares at December 31, 2005 and June 30,
2006, 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, 2006.
The cash collateral account provides partial security for repayment of the
outstanding Debentures in the event of default.
18
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. As of June 30, 2006, the Company was fully
compliant with its financial covenants.
The Company failed to timely file its 2005 Annual Report on Form 10-K and
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2006 with
the Securities and Exchange Commission ("SEC") pursuant to the 1934 Act, and
therefore, was in violation of its covenant to timely file within its debenture
agreements. The Company obtained a waiver letter from its debenture holders
regarding the failure to meet this covenant. In addition, due to the Company's
inability to timely file its annual report on Form 10-K for the year ended
December 31, 2005, the Company's registration statement, and the prospectus
contained therein, registering the shares issuable upon conversion of and
interest under the debentures and upon exercise of related warrants was no
longer current. As a result, the Company is subject to payment of liquidated
damages until such time as the foregoing shares are again registered for public
resale or eligible for resale pursuant to Rule 144(k) under the Securities Act.
Liquidated damages are based on the outstanding debt balance times the rate of
0.00067 per day or approximately $2,748 per day. The Company has recorded a
current liability for additional interest charges of $242,000 as of June 30,
2006 for these liquidated damages. As of June 30, 2006, the Company anticipated
liquidated damages not to exceed $350,000(See Note 7).
Note 6: EQUITY FINANCING
On July 8, 2005, the Company entered into a common stock purchase
agreement with Fusion Capital Fund II, LLC ("Fusion Capital"), 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, it 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 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 common
stock is less than $1.00.
Pursuant to the Company's agreement with Fusion Capital, the Company has
registered for public sale by Fusion Capital up to 10,795,597 shares of our
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. As of
June 30, 2006, Fusion Capital has purchased an aggregate 9,184,637 shares,
including commitment fee shares of 392,799 (as described below) amounting to
approximately $20,000,000, in gross proceeds to the Company.
In connection with entering into the above agreement with Fusion Capital,
the Company, in July 2005, issued to Fusion Capital 402,798 shares of its common
stock. 392,798 of these shares represented 50% of the commitment fee due Fusion
Capital with the remaining 10,000 shares issued as reimbursement for expenses.
An additional 392,799 shares, representing the remaining balance of the
commitment, are issuable in conjunction with daily purchases of common stock by
Fusion Capital. These additional commitment shares will be issued in an amount
equal to the product of (x) 392,799 and (y) the Purchase Amount Fraction. The
"Purchase Amount Fraction" means a fraction, the numerator of which is the
purchase price at which the shares are being purchased by Fusion Capital and the
denominator of which is $20,000,000.
19
In 2006, the Company issued 4,913,669 shares, including 235,287 commitment
fee shares, for proceeds of approximately $11,980,000 which completed the terms
of the July 8, 2005, Fusion Capital agreement.
On April 12, 2006, the Company entered into a Common Stock Purchase
Agreement ("Purchase Agreement") with Fusion Capital. Pursuant to the terms of
the Purchase Agreement, Fusion Capital has agreed to purchase from the Company
up to $50,000,000 of common stock over a period of approximately twenty-five
(25) months. Pursuant to the terms of the Registration Rights Agreement, dated
as of April 12, 2006, we agreed to file a registration statement (the
"Registration Statement") with the Securities and Exchange Commission on or
before June 30, 2006 covering the shares which are issued to or may be issued to
Fusion Capital under the Purchase Agreement. By agreement with Fusion Capital on
June 23, 2006, the deadline for filing of the Registration Statement was
extended to July 31, 2006 (see Note 7). Once the Registration Statement has been
declared effective, each trading day during the term of the Purchase Agreement
we have the right to sell to Fusion Capital up to $100,000 of the Company's
common stock on such date or the arithmetic average of the three lowest closing
trade prices of the common stock during the immediately proceeding 12 trading
day period. At our option under certain conditions, Fusion Capital can be
required to purchase greater amounts of common stock during a given period. In
connection with entering into the Purchase Agreement, the Company issued to
Fusion Capital 321,751 shares of our common stock. This offering was made
pursuant to an exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended.
The purchase price will be adjusted for any reorganization,
recapitalization, non-cash dividend, stock split, or other similar transaction.
Fusion Capital may not purchase shares of the Company's common stock under the
common stock purchase agreement if it, together with its affiliates, would
beneficially own more than 9.9% of our common stock outstanding at the time of
the purchase by Fusion Capital. Fusion Capital has the right at any time to sell
any shares purchased under the 2006 Purchase Agreement which would allow it to
avoid the 9.9% limitation. Due to AMEX guidelines, without prior stockholder
approval, we do not have the right or the obligation under the Agreement to sell
shares to Fusion Capital in excess of 12,386,723 shares (i.e. 19.99% of the
61,964,598 outstanding shares of our common stock on April 12, 2006, the date
the 2006 Purchase Agreement) inclusive of commitment shares issued to Fusion
Capital under the Agreement (see Note 7 below). In addition, Fusion Capital
cannot purchase more than 27,386,723 shares, inclusive of the commitment shares
under the Agreement. The Company would have to average a purchase price of
approximately $4.28 per share to receive the full $50.0 million under the common
stock purchase agreement if the Company does not receive stockholder approval.
Note 7 - SUBSEQUENT EVENTS
On July 31, 2006, the Company filed with the SEC its Form 10-K/A-2 for the
year ended December 31, 2005, its Forms 10-Q/A for the quarterly periods ended
June 30, 2005 and September 30, 2005, and, its registration statement on Form
S-1 to register the shares required to be registered under the Fusion Capital
Agreement and to update its stale registration statements previously filed on
Form S-3. Form S-1 was declared effective on August 7, 2006, which included the
shares issuable upon conversion and interest under the debenture securities and
upon exercise of certain warrants. As noted in Note 5, liquidated damages due to
the debenture holders are estimated not to exceed $350,000.
20
On July 26, 2006, the Company executed an agreement with Stem Cell
Innovations, Inc. (formerly Interferon Sciences, Inc.) whereby it acquired the
royalty interest previously granted Interferon Sciences with respect to the
Company's sale of products containing alpha interferon in exchange for 250,000
shares of common stock.
The Company is seeking stockholder approval of the issuance to Fusion
Capital of common stock in excess of limitations under AMEX guidelines at its
Annual Meeting of Stockholders scheduled for September 20, 2006.
NOTE 8: RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS 155, "Accounting for Certain Hybrid
Financial Instruments" ("SFAS No.155") - an amendment of FASB Statements No. 133
and 140. SFAS 155 amends FAS 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS No.133"), and SFAS 140 ("SFAS No.140"), "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", to permit fair value re-measurement of any hybrid financial
instrument that contains an embedded derivative that would otherwise require
bifurcation. Additionally, FAS 155 seeks to clarify which interest-only strips
and principal-only strips are not subject to the requirements of SFAS 133 and to
clarify that concentrations of credit risk in the form of subordination are not
embedded derivatives. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. Management does not believe the adoption of
this standard will have a material impact on the financial condition or the
results of operations of the Company.
On July 13, 2006, the Financial Accounting Standards Board issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").
The requirements are effective for fiscal years beginning after December 15,
2006. The purpose of FIN 48 is to clarify and set forth consistent rules for
accounting for uncertain tax positions in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative
effect of applying the provisions of this interpretation are required to be
reported separately as an adjustment to the opening balance of retained earnings
in the year of adoption. Management does not believe the adoption of this
standard will have a material impact on the financial condition or the results
of operations of the Company.
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.
21
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
General
We are a biopharmaceutical company engaged in the clinical development,
manufacture and marketing of new drug entities based on natural immune system
enhancing technologies for the treatment of viral and immune based acute and
chronic disorders. We were founded in the early 1970s, as a contract researcher
for the National Institutes of Health. Since that time, 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 acute and chronic diseases. We own a U.S. Food and Drug
Administration ("FDA") approved GMP (good manufacturing practice) manufacturing
facility in New Jersey.
Our flagship products include Ampligen(R) and Alferon N Injection(R).
Ampligen(R) is an experimental drug currently undergoing clinical development
for the treatment of: Myalgic Encephalomyelitis/Chronic Fatigue Syndrome
("ME/CFS" or "CFS") and HIV, and clinical testing for treatment of avian and
seasonal influenza viruses.
Alferon N Injection(R) 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 Injection(R) is also in clinical
development for treating Multiple Sclerosis and West Nile Virus ("WNV").
New Accounting Pronouncements
In February 2006, the FASB issued SFAS 155, "Accounting for Certain Hybrid
Financial Instruments" ("SFAS No.155") - an amendment of FASB Statements No. 133
and 140. SFAS 155 amends FAS 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS No.133"), and SFAS 140 ("SFAS No.140"), "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", to permit fair value re-measurement of any hybrid financial
instrument that contains an embedded derivative that would otherwise require
bifurcation. Additionally, FAS 155 seeks to clarify which interest-only strips
and principal-only strips are not subject to the requirements of SFAS 133 and to
clarify that concentrations of credit risk in the form of subordination are not
embedded derivatives. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. We do not believe the adoption of this standard
will have a material impact on our financial condition or the results of our
operations.
On July 13, 2006, the Financial Accounting Standards Board issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").
The requirements are effective for fiscal years beginning after December 15,
2006. The purpose of FIN 48 is to clarify and set forth consistent rules for
accounting for uncertain tax positions in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative
effect of applying the provisions of this interpretation are required to be
reported separately as an adjustment to the opening balance of retained earnings
in the year of adoption. Management does not believe the adoption of this
standard will have a material impact on the financial condition or the results
of operations on us.
22
Disclosure About Off-Balance Sheet Arrangements
None.
Critical Accounting Policies
There have been no material changes in our critical accounting policies and
estimates from those disclosed in Item 7 of our Annual Report on Form 10-K/A for
the year ended December 31, 2005.
RESULTS OF OPERATIONS
Three months ended June 30, 2005 versus Three months ended June 30, 2006
Net loss
Our net loss for the three months ended June 30, 2006 was approximately
$5,081,000 or an increase of $1,736,000 compared to the same period in 2005.
This 52% increase primarily consists of 1) an increase of $295,000 in production
(manufacturing), 2) a $1,430,000 increase in research and development due to the
continued development of our products and 3) a $563,000 increase in general and
administration expenses mainly due to stock compensation expense of $247,000
during the current quarter as a result of the implementation of FAS 123R and an
increase in accounting fees of $501,000 related to the restatement of our
financial statements. These increases in general and administrative expenses
were slightly offset by lower investment banking fees of $179,000 during the
current quarter. The overall increase in loss was partially offset by a decrease
of $463,000 in interest expense and financing costs.
Net loss per share was $(.08) for current period versus $(.07) in the same
period 2005.
Revenues
Revenues for the three months ended June 30, 2006 were $247,000 as
compared to revenues of $300,000 for the same period in 2005. Alferon N
Injection(R) sales were down $43,000 or 18% while Ampligen(R) sold under the
cost recovery clinical program was down $10,000 or 17%. The decline in Alferon N
Injection(R) sales can be attributed to increased competition from rival
products. Ampligen(R) sold under the cost recovery clinical program is a product
of physicians and ME/CFS patients applying to us to enroll in the program. 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(R) and 2) collection of clinical
data relating to the patients' treatment and results. We are changing our
marketing strategy for Alferon N Injection, (R). We are looking into conducting
a pilot program with a contract sales organization ("CSD"). As part of this
strategic change, we have eliminated our direct sales force. In the future, our
focus will be on using CSO's to sell Alferon N Injection(R) in the United States
and overseas markets.
23
Production costs/cost of goods sold
Our costs for production/cost of goods sold increased $295,000 for the
three months ended June 30, 2006 compared to the same period in 2005. This
increase was primarily due to higher production costs representing excess
production capacity during the current period amounting to $247,000. Cost of
goods sold for the three months ended June 30, 2005 and 2006 were $103,000 and
$151,000 respectively.
On February 8, 2006, we executed a Manufacturing and Safety Agreement with
Hyaluron, Inc. ("Hyaluron") of Burlington, Massachusetts, for the formulation,
packaging and labeling of Alferon N Injection(R). Pursuant to the Agreement, we
supplied work-in-progress inventory in sufficient quantity and provided
pertinent information to the project. During the second quarter 2006, Hyaluron
conducted three stability runs to test Alferon N Injection(R)'s new vial
material. We are continuing to work with Hyaluron in this validating process and
believe the testing will be concluded by year end 2006.
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.
Research and Development costs
Overall research and development costs for the three months ended June 30,
2006 were $2,588,000 as compared to $1,158,000 for the same period a year ago
representing an increase of $1,430,000 or 123%. The higher costs reflect an
increase in the direct costs associated with our effort to develop our lead
products, Ampligen(R), as a therapy in treating acute and chronic diseases,
cancers and on-going clinical trials involving patients with HIV and
pre-clinical and clinical testing for possible treatment for avian and seasonal
influenza viruses. We also incurred higher costs associated with our continued
stability studies for Ampligen(R) and Alferon N Injection(R) at our contractor
manufacturer's sites during the current quarter. These stability studies are
required before our new contract manufacturer can begin the commercial
formation, bottling and packaging of our technologies. Also, additional costs
were incurred during the current period due to proposals submitted to the
Department of Health and Human Services for funding for both Ampligen(R) and
Alferon N Injection(R).
On December 9, 2005, we executed a Supply Agreement with Hollister-Stier
Laboratories LLC of Spokane, Washington, for the contract manufacturing of
Ampligen(R) for a five year term. Pursuant to the agreement we will supply the
key raw materials and Hollister-Stier will formulate and bottle the Ampligen(R).
We paid $100,000 as a deposit in order to initiate the manufacturing project.
This deposit was expended as research and development in 2005. The achievement
of the initial objectives described in the agreement, in combination with our
polymer production facility under construction in New Brunswick, N.J., may
enable us to manufacture the raw materials for approximately 10,000 doses of
Ampligen(R) per week. We completed the transfer of our manufacturing technology
to Hollister-Stier and they have completed three pilot manufacturing runs of
Ampligen(R) for stability testing using raw material from the inventory of our
previous supplier. During the first half of 2006, we have paid Hollister-Stier
$921,000. As of July 31, 2006, we have paid an aggregate $1,108,000 pursuant to
this agreement.
The production of Ampligen(R) raw materials in our own facilities has
obvious advantages with respect to overall control of the manufacturing
procedure of Ampligen(R)'s raw materials, keeping costs down and controlling
regulatory compliance issues (other parts of our 43,000 sq. ft. wholly owned FDA
approved facility are already in compliance for Alferon N Injection(R)
manufacture). This allows us to obtain Ampligen(R) raw materials on a more
consistent and reliable basis. Poly I and Poly C12U make up the key ingredients
in Ampligen(R). Our new production line in New Brunswick has produced one lot of
Poly I and expects to have one lot of Poly C12U completed by mid-August 2006.
Our objective is to have sufficient raw material shipped to Hollister-Stier by
September 2006 in order to formulate and bottle three commercial lots for
additional validation and stability testing. We have also identified three
manufacturers to expand raw material manufacture, if necessary, and obtained
preliminary proposals from two. A third manufacturer has started feasibility
studies to determine its ability to produce Ampligen raw materials.
24
We have identified two other cGMP production facilities in the United
States capable of manufacturing Ampligen(R). Engagement of either of these
facilities would provide back-up to Hollister-Stier and/or provide additional
production capacity if needed. We are reviewing proposals from these production
facilities and expect to act upon one or the other at the appropriate time.
We continue our efforts with respect to preparing a New Drug Application
("NDA") for submission to the Food and Drug Administration ("FDA") for using
Ampligen(R) to treat patients afflicted with Chronic Fatigue Syndrome ("CFS").
CFS is a debilitating disease in which patients suffer complex symptoms such as
fatigue, flu-like ailments, headaches and muscle pain. At this time, there are
no approved treatment therapies. The Center for Disease Control ("CDC") has
added CFS to its priority list of emerging diseases. The preparation of the NDA
is a time consuming and laborious process and basically involves the preparation
of multiple technical documents including those covering 1) safety data results
from animal and humans exposed to Ampligen(R), 2) the data collection and
analysis of data from human clinical trials proving the efficacy of Ampligen(R)
and 3) the capacity and ability to produce Ampligen(R) on a consistent basis in
commercial quantities. We have experienced technical teams assigned to preparing
each of these three segments. When completed these three technical documents
will be consolidated into the common technical document for submitting to the
FDA. While the results of our AMP 516 Phase III clinical study is the basis for
filing the NDA we must also include the safety data collected on all patients
that ever received Ampligen(R) (some 800 patients from clinical trials for CFS,
HIV, Hepatitis, cancer, etc.) All of this is time consuming as our clinical
monitors and research assistants must visit and audit the records of clinical
investigators involved in our Ampligen clinical studies conducted over the last
15 years. Our pre-NDA meeting with the FDA on August 2, 2006 resulted in
constructive guidance with respect to the various data segments of our
anticipated NDA filing. We may request additional meetings in the near future to
complete our pre-NDA requests for guidance.
We have engaged an independent contractor to assist in filing the NDA
electronically to facilitate the review by the FDA. We can not yet provide
guidance as to the tentative date at which the compilation and filing of the NDA
will be complete, as significant factors are outside our control including,
without limitation, the ability and willingness of the independent clinical
investigators to complete the requisite reports at an acceptable regulatory
standard, the ability to collect overseas generated data, and the ability of
Hollister-Stier facilities to interface with our own New Brunswick
staff/facilities to meet the manufacturing regulatory standards. Also, the
timing of the FDA review process of the NDA is subject to the control of the FDA
and could 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 NDA application. Given these variables, we are unable
to project when material net cash inflows are expected to commence from the sale
of Ampligen(R).
25
Thirty-six HIV patients have participated in our AMP-720 HIV clinical
trial. This clinical trial is designed to study the affects of Ampligen with
respect to boosting the immune system of HIV patients while they are off of
their highly active anti-retroviral therapy ("HAART"). Some 18 anti-viral drugs
are currently approved by the FDA for the treatment of HIV infection. The use of
various combinations of three or more of these drugs is referred to as HAART.
HAART has provided dramatic decreases in morbidity and mortality of HIV
Infection. Often, HIV patients must go off of their HAART regiment due to
cumulative build up of toxicities. This off period is referred to strategic
therapeutic interruption ("STI"). We believe that the use of Ampligen(R) (an
anti-viral compound) during the STI period will aid in the suppression of HIV
allowing patients to remain off HAART for longer periods of time (longer STI
periods allow the HIV patients more time to rid their bodies of the toxicities).
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. The rate of enrollment in
this HIV trial depends on patient availability and on other products being in
clinical trials for the treatment of HIV, causing competition for the same
patient population. At present, more than 18 FDA approved drugs for HIV
treatment all competing 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 trial 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.
At the fourth annual Biodefense Research Meeting of the American Society
of Microbiology held in Washington, D.C., on February 16, 2006 we presented
results of laboratory testing that showed our two investigational
immunotherapeutics, Ampligen(R) and Alferon N Injection(R), are potentially
useful against H5N1, or avian flu virus. The pre-clinical research indicates
that Ampligen(R), a specifically configured double-stranded RNA, can provide
cross-protection against avian flu viral mutations as well as boost the activity
of Tamiflu and Relenza, the only two drugs formally recognized for combating
bird flu, up to 100 times. Other lab tests, in healthy human volunteers,
indicate that Alferon LDO (Low Dose Oral), a new delivery form of an anti-viral
with prior regulatory approval for a category of sexually transmitted diseases,
can stimulate genes that induce the key effects of interferon and other immune
compounds, key building blocks in the body's defense system and may be able to
block the "cytokine storm" which attributes to accelerated death especially in
avian influenza. The vaccine studies were conducted in conjunction with the
National Institute of Infectious Diseases of Japan.
Other Avian Flu Studies Include:
o The pre-clinical animal study being conducted by Defence R&D Canada,
Suffield (DROC Suffield), an agency of the Canadian department of
National Defence, to evaluate the antiviral efficacy of our
experimental drug, Ampligen(R) and for protection against human
respiratory influenza in validated animal models. This study is
ongoing and initial positive results are expected to be reported
shortly.
o The pre-clinical study being conducted by research affiliates of the
National Institute of Health at Utah State University to examine if
Ampligen(R) enhances the effectiveness of different drug
combinations on avian influenza. The ongoing research is comparing
the relative protection conveyed by Tamiflu (Oseltamiuir, Roche) and
Relenza (Zanamiuir, GlaxosmithKline) with Ampligen(R), alone and in
combination, against the avian flu virus. Early results indicate
that there is improved protection when Ampligen(R) is combined with
Tamiflu and Relenza, and also suggest the potential benefits of
Ampligen(R) given as monotherapy.
26
We also engaged the Sage Group, Inc., a health care, technology oriented,
strategy and transaction advisory firm, to assist us in obtaining a strategic
alliance in Japan for the use of Ampligen(R) in treating Chronic Fatigue
Syndrome or CFS. In the past year leaders in the Japanese medical community have
established the Japanese Society of the Fatigue Science and the Osaka City
University Hospital opened the Fatigue Clinical Center as the initial step in
their Fatigue Research Project. The Sage Group agreement has been expanded to
include obtaining an alliance in Japan for research in using Ampligen(R) to
treat avian influenza.
A clinical study conducted at the Princess Margaret Hospital in Hong Kong
evaluated the use of Alferon LDO (Low Dose Oral Interferon Alfa-N3, Human
Leukocyte Derived) in normal volunteers. This study completed the dosing of ten
patients during the fourth quarter 2005. We are 40% complete in analyzing the
results of this study and expect to be 100% complete by the end of August 2006.
A clinical study to evaluate the use of Alferon LDO in HIV infected
volunteers was initiated during the second quarter 2005 in Philadelphia, PA. The
study is currently being conducted at two sites, Drexel University and
Philadelphia FIGHT, a comprehensive AIDS service organization providing primary
care, consumer education, advocacy and research on potential treatments and
vaccines. The study is designed to determine whether Alferon LDO can resuscitate
the broad-spectrum antiviral and immunostimulatory genes. The initial patient
enrolled in this study in July 2005 and, as of July 2006, twelve patients have
enrolled and completed dosing. We are currently receiving data from this study
and we are in the process of analyzing the results. This 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 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.
General and Administrative Expenses
General and Administrative ("G&A") expenses for the three months ended
June 30, 2005 and 2006 were approximately $1,523,000 and $2,086,000,
respectively. The increase in G&A expenses of $563,000 or 37%, during this
period is primarily due to 1) an increase of $247,000 in stock compensation
expense mainly due to the adoption of FAS 123R in 2006; and 2) an increase in
professional fees of $501,000 related mainly to the restatement of our financial
statements. This was slightly offset by lower investment banking fees of
$179,000 during the current quarter.
Interest and Other Income and Expense
Interest and other income and expense for the three months ended June 30,
2005 and 2006 amounted to $63,000 and $205,000, respectively. The increase in
interest and other income and expense during the current quarter can primarily
be attributed to the timing of maturing marketable securities during the
comparable periods. All funds in excess of our immediate need are invested in
short-term high quality securities.
27
Interest Expense and Financing Costs
Interest expense and non-cash financing costs were approximately $461,000
for the three months ended June 30, 2006 versus $924,000 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. These charges are reflected in the
Consolidated Statements of Operations under the caption "Financing Costs." These
charges are amortized over the life of the debentures. The main reason for the
decrease in interest expense and financing costs of $463,000 can be attributed
to decreased amortization charges on the debt discounts as well as decreased
charges related to the conversion of the debentures amounting to $682,000. This
was slightly offset by an increase in interest expense of $242,000 due to
liquidated damages incurred during the current quarter. Please see Note 5 in the
consolidated financial statements contained herein for more details on these
transactions.
Six months ended June 30, 2005 versus Six months ended June 30, 2006
Net loss
Our net loss of $11,000,000 for the six months ended June 30, 2006 was up
$4,675,000 or 74% compared to the same period in 2005. This increase in loss was
primarily due to: 1) Higher G&A expense of $2,628,000 related primarily to the
adoption of FAS 123R amounting to $2,155,000 and higher accounting fees related
to the restatement of our financial statements of $507,000, and 2) Higher
research and development costs of $2,592,000 due to an increase in direct costs
associated with developing Ampligen(R) and Alferon N Injection(R) for new and
existing indications and costs associated with stability studies for Ampligen(R)
and Alferon N Injection(R) related to manufacturing at our new contract
manufacturers' sites, and 3) higher production costs of approximately $496,000
due to excess manufacturing capacity. Offsetting these increased expenditures,
was a decrease in our interest expense and financing costs of approximately
$1,249,000 as the amortization of the discounts on our convertible debentures
decreases as they near maturity. Net losses per share were $(.18) for current
period versus $(.13) in the same period 2005.
Revenues
Revenues for the six months ended June 30, 2006 were $483,000 as compared
to revenues of $558,000 for the same period in 2005. Ampligen(R) sold under the
cost recovery clinical program was up $14,000 (16%) and Alferon N Injection(R)
sales were down $89,000 (19%). The decline in Alferon N Injection(R) sales can
be attributed to increased competition from rival products. Ampligen(R) sold
under the cost recovery clinical program is a product of physicians and ME/CFS
patients applying to us to enroll in the program. 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(R) and 2) collection of clinical data relating
to the patients' treatment and results. We are changing our marketing strategy
for Alferon N Injection, (R). We are looking into conducting a pilot program
with a contract sales organization ("CSD"). As part of this strategic change, we
have eliminated our direct sales force. In the future, our focus will be on
using CSO's to sell Alferon N Injection(R) in the United States and overseas
markets.
Production costs/cost of goods sold
Production/cost of goods sold increased $496,000 for the six months ended
June 30, 2006 compared to the same period in 2005. This increase was primarily
due to higher production costs representing excess production capacity during
the six months ended June 30, 2006, amounting to $450,000. Cost of goods sold
for the six months ended June 30, 2005 and 2006 were $201,000 and $247,000,
respectively.
28
Research and Development costs
Overall research and development direct costs for the six months ended
June 30, 2005 and 2006 were $2,426,000 and $5,018,000, respectively,
representing an increase or $2,592,000 or 107%. 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, 2006 discussed above.
General and Administrative Expenses
General and Administrative ("G&A") expenses for the six months ended June
30, 2005 and 2006 were approximately $2,550,000 and $5,178,000, respectively,
representing an increase of a $2,628,000 or 103%. The increase in G&A expenses
relates primarily to the adoption of FAS 123R which has increased stock
compensation expense approximately $2,157,000 during the current period versus a
year ago. In addition, we have incurred higher accounting fees related to the
restatement of our financial statements which has increased these fees by
approximately $507,000 from the same period a year earlier.
Interest and Other Income
Interest and other income for the six months ended June 30, 2005 and 2006
totaled $293,000 and $160,000, respectively. The decrease in interest and other
income during the current quarter can primarily be attributed to the timing of
the maturities of our marketable securities during the 2006 period versus the
same period a year earlier. 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 $750,000
for the six months ended June 30, 2006 versus $1,999,000 for the same six months
a year ago. The main reason for the decrease in interest expense and financing
costs of $1,249,000 can be attributed to decreased amortization charges on debt
discounts as well as charges related to the conversion of the debentures.
(Please see Note 5 in the consolidated financial statements contained herein for
more details on these transactions.)
Liquidity And Capital Resources
Cash used in operating activities for the six months ended June 30, 2006
was $6,319,000 compared to $3,865,000 for the same period a year earlier. This
increase of $2,454,000 was primarily due to higher research and development
activity for our experimental products. Cash used in investing activities was
$7,605,000 for the six months ended June 30, 2006. This was mainly due to the
net effect of purchases and maturities within our short term investments as well
as capital additions to our New Jersey facility relating to our raw material
production line. Cash provided by financing activities for this period amounted
to $12,652,000, primarily from the sale of common stock. As of June 30, 2006, we
had approximately $21,500,000 in cash and cash equivalents and short-term
investments, an increase of $5,314,000 from December 31, 2005. These funds
should be sufficient to meet our operating cash requirements including debt
service for the next 18 months.
On February 27, 2006, the debenture holders converted $333,334 principal
amount of the January 2004 debenture into 160,257 shares of common stock. On
March 21, 2006, the debenture holders converted $500,000 of the July 2004
debenture into 240,385 shares of common stock.
29
Due to our inability to timely file our annual report on Form 10-K for the
year ended December 31, 2005, our registration statement, and the prospectus
contained therein, registering the shares issuable upon conversion of and
interest under the debentures and upon exercise of related warrants was no
longer current. As a result, we currently are subject to liquidated damages
until the time that such shares are again registered for public resale or
eligible for resale pursuant to Rule 144(k) under the Securities Act. We
anticipate the liquidated damages not to exceed $350,000 as the SEC declared our
registration statement (which included the debenture securities) effective on
August 7, 2006.
Pursuant to the terms of the July 8, 2005 common stock purchase agreement,
as of April 3, 2006, Fusion Capital has purchased an aggregate of 9,184,637
shares, including 392,799 commitment fee shares, for gross proceeds of
$20,000,000.
On April 12, 2006, we entered into a common stock purchase agreement (the
"2006 Purchase Agreement") with Fusion Capital, pursuant to which Fusion Capital
has agreed, under certain conditions, to purchase on each trading day $100,000
of our common stock up to an aggregate of $50.0 million over a period of
approximately 25 months as described below. We have the right to suspend such
purchases or terminate the agreement at any time. 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. Fusion Capital does not have the right or the
obligation to purchase shares of our common stock in the event that the price of
our common stock is less than $1.00.
The purchase price per share will be equal to the lesser of (i) the lowest
sale price of our common stock on the purchase date; or (ii) the average of the
three lowest closing sale prices of our common stock during the twelve
consecutive trading days prior to the date of a purchase by Fusion Capital.
The purchase price will be adjusted for any reorganization,
recapitalization, non-cash dividend, stock split, or other similar transaction.
Fusion Capital may not purchase shares of our common stock under the common
stock purchase agreement if it, together with its affiliates, would beneficially
own more than 9.9% of our common stock outstanding at the time of the purchase
by Fusion Capital. Fusion Capital has the right at any time to sell any shares
purchased under the 2006 Purchase Agreement which would allow it to avoid the
9.9% limitation. Due to American Stock Exchange requirements (the "AMEX Cap"),
without prior stockholder approval, we do not have the right or the obligation
under the Agreement to sell shares to Fusion Capital in excess of 12,386,723
shares (i.e. 19.99% of the 61,964,598 outstanding shares of our common stock on
April 12, 2006, the date of the 2006 Purchase Agreement) inclusive of the
commitment shares (discussed below). We are seeking stockholder approval of the
issuance to Fusion Capital of common stock in excess of the AMEX Cap at our
Annual Meeting of Stockholders scheduled for September 20, 2006. Notwithstanding
the foregoing, Fusion Capital cannot purchase more than 27,386,723 shares,
inclusive of the commitment shares under the common stock purchase agreement. We
would have to average a purchase price of approximately $4.28 per share to
receive the full $50.0 million under the common stock purchase agreement if we
do not receive stockholder approval.
We also have the right to increase the daily purchase amount at any time,
provided however, we may not increase the daily purchase amount above $100,000
unless our stock price is above $1.90 per share for five consecutive trading
days. Specifically, for every $0.10 increase in Threshold Price (as defined
below) above $1.90, we have the right to increase the daily purchase amount by
up to an additional $10,000. The "Threshold Price" is the lowest sale price of
our common stock during the five trading days immediately preceding our notice
to Fusion Capital to increase the daily purchase amount. If at any time during
any trading day the sale price of our common stock is below the Threshold Price,
the applicable increase in the daily purchase amount will be void.
30
In addition to the daily purchase amount, we may elect to require Fusion
Capital to purchase on any single trading day the following:
o $250,000 if our common stock trades at $1.50 or better for five
trading days.
o $500,000 if our common stock trades at $3.00 or better for five
trading days.
o $1,000,000 if our common stock trades at $5.00 or better for five
trading days.
o $2,000,000 if our common stock trades at $8.00 or better for five
trading days.
The price at which such shares would be purchased will be the lesser of
(i) the lowest Sale Price on the trading day that such purchase notice was
received Fusion Capital or (ii) the lowest purchase price (as defined above)
during the previous ten trading days prior to the date that such purchase notice
was received by Fusion Capital.
We filed a registration statement (the "Registration Statement") with the
Securities and Exchange Commission on July 31, 2006 covering the shares of our
common stock to be issued under the 2006 Purchase Agreement and are required to
keep it effective until the earlier of the date that all shares are sold or can
be sold pursuant to the provisions of Rule 144(k) under the Securities Act. If
the registration statement is not declared effective or, after the registration
statement is declared effective, we do not keep the registration statement
effective, Fusion Capital may terminate the agreement. Form S-1 was declared
effective on August 7, 2006, which included the shares issuable upon conversion
and interest under the debenture securities and upon exercise of certain
warrants.
Generally, Fusion Capital may terminate the common stock purchase
agreement without any liability or payment to us upon the occurrence of any of
the following events of default:
o our failure to timely file the registration statement or, once the
registration statement is declared effective, the effectiveness of
the registration statement lapses for any reason or is unavailable
to Fusion Capital for sale of our common stock and such lapse or
unavailability continues for a period of 10 consecutive trading days
or for more than an aggregate of 30 trading days in any 365-day
period;
o suspension by our principal market of our common stock from trading
for a period of three consecutive trading days;
o the de-listing of our common stock from the American Stock Exchange,
our principal market, provided our common stock is not immediately
thereafter trading on the Nasdaq National Market, the Nasdaq
SmallCap Market or the New York Stock Exchange or the OTC Bulleting
Board;
o the transfer agent's failure for five trading days to issue to
Fusion Capital shares of our common stock which Fusion Capital is
entitled to under the 2006 Purchase Agreement;
o any material breach of the representations or warranties or
covenants contained in the 2006 Purchase Agreement or any related
agreements which has or which could have a material adverse affect
on us subject to a cure period of 10 trading days;
o any participation or threatened participation in insolvency or
bankruptcy proceedings by or against us;
31
o a material adverse change in our business, properties, operations,
financial condition or results of operations; or
o the issuance of an aggregate of 12,386,733 shares to Fusion Capital
under our agreement and we fail to obtain the requisite stockholder
approval.
We have the unconditional right at any time for any reason to give notice
to Fusion Capital terminating the 2006 Purchase Agreement. Such notice shall be
effective one trading day after Fusion Capital receives such notice.
Under the terms of 2006 Purchase Agreement, Fusion Capital has received
321,751 shares of our common stock as a partial commitment fee and is entitled
to receive up to an additional 321,751 commitment shares (collectively, the
"Commitment Shares"). These additional commitment shares will be issued in an
amount equal to the product of (x) 321,751 and (y) the Purchase Amount Fraction.
The "Purchase Amount Fraction" means a fraction, the numerator of which is the
purchase price at which the shares are being purchased by Fusion Capital and the
denominator of which is $50,000,000. Unless an event of default occurs these
shares must be held by Fusion Capital until 25 months from the date of the 2006
Purchase Agreement or the date such agreement is terminated or in the event that
certain conditions precedent are not met.
We anticipate using the proceeds from this financing to extend our New
Brunswick facility for the production of Ampligen(R) and Alferon N Injection(R),
Research and Development to meet potential government procurement requirements
concerning avian influenza treatment and/or prevention and for general corporate
purposes.
Please see Note 5 "Debenture Financing" and Note 6 "Equity Financing" in
the consolidated financial statements contained herein for more details on
debenture and stock financings.
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 3: Quantitative and Qualitative Disclosures About Market Risk
We had approximately $21,500,000 in cash and cash equivalents and
short-term investments at June 30, 2006. To the extent that our cash and cash
equivalents and short term investments exceed our near term funding needs, we
generally invest the excess cash in three to twelve month high quality interest
bearing financial instruments. We employ established conservative policies and
procedures to manage any risks with respect to investment exposure.
Our financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and cash equivalents. We place our cash and cash
equivalents with what management believes to be high credit quality
institutions. At times such investments may be in excess of the FDIC insurance
limit.
32
We have not entered into, and do not expect to enter into, financial
instruments for trading or hedging purposes.
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 Financial 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 our management, the revised control processes
have been operating for a sufficient period of time to provide reasonable
assurance as to their effectiveness. We believe our management will be able to
make this assessment by December 31, 2006.
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 1. Legal Proceedings
On September 30, 1998, we filed a multi-count complaint against Manuel P.
Asensio, Asensio & Company, Inc. ("Asensio"). The action included claims of
defamation, disparagement, tortuous interference with existing and prospective
business relations and conspiracy, arising out of Asensio's false and defamatory
statements. The complaint further alleged that Asensio defamed and disparaged us
in furtherance of a manipulative, deceptive and unlawful short-selling scheme in
August and September, 1998. In 1999, Asensio filed an answer and counterclaim
alleging that in response to Asensio's strong sell recommendation and other
press releases, we made defamatory statements about Asensio. We denied the
material allegations of the counterclaim. In July 2000, following dismissal in
federal court for lack of subject matter jurisdiction, we transferred the action
to the Pennsylvania State Court. In March 2001, the defendants responded to the
complaints as amended and a trial commenced on January 30, 2002. A jury verdict
disallowed the claims against the defendants for defamation and disparagement
and the court granted us a directed verdict on the counterclaim. On July 2, 2002
the Court entered an order granting us a new trial against Asensio for
defamation and disparagement. Thereafter, Asensio appealed the granting of a new
trial to the Superior Court of Pennsylvania. The Superior Court of Pennsylvania
has denied Asensio's appeal. Asensio petitioned the Supreme Court of
Pennsylvania for allowance of an appeal, which was denied. We now anticipate the
scheduling of a new trial against Asensio for defamation and disparagement in
the Philadelphia Common Pleas Court.
33
In June 2002, a former ME/CFS clinical trial patient in Belgium filed a
claim in Belgium, against Hemispherx Biopharma Europe, NV/SA, our Belgian
subsidiary, and one of our clinical trial investigators alleging that she was
harmed in the Belgium ME/CFS clinical trial as a result of negligence and breach
of warranties. We believe the claim is without merit and we are defending the
claim against us through our product liability insurance carrier.
In December 2004, we filed a multicount complaint in federal court
(Southern District of Florida) against a conspiratorial group seeking to
illegally manipulate our stock for purposes of bringing about a hostile takeover
of Hemispherx. The lawsuit alleges that the conspiratorial group commenced with
a plan to seize control of our cash and proprietary assets by an illegal
campaign to drive down our stock price and publish disparaging reports on our
management and current fiduciaries. The lawsuit seeks monetary damages from each
member of the conspiratorial group as well as injunctions preventing further
recurrences of their misconduct. The conspiratorial group includes Bioclones, a
privately held South African Biopharmaceutical company that collaborated with
us, and Johannesburg Consolidated Investments, a South African corporation,
Cyril Donninger, R. B. Kebble, H. C. Buitendag, Bart Goemaere, and John Doe(s).
Bioclones, Johannesburg Consolidated Investments, Cyril Donninger, R. B. Kebble
and H.C. Buitendag filed a motion to dismiss the complaint, which was granted by
the court. We are in the process of appealing this decision to the 11th federal
circuit court of appeals.
On January 10, 2005, we initiated a multicount lawsuit in the United
States District Court for the Eastern District of Pennsylvania seeking
injunctive relief and damages against a conspiratorial group, many of whom are
foreign nationals or companies located outside the United States alleging that
the conspiratorial group has engaged in secret meetings, market manipulations,
fraudulent misrepresentations, utilization of foreign accounts and foreign
secrecy laws all in furtherance of an illegal scheme to take over Hemispherx and
enrich themselves at the expense of Hemispherx's public shareholders. On
February 18, 2005 we filed an amended complaint in the same lawsuit joining
Redlabs, USA, Inc. as a defendant with the existing defendants R.E.D.
Laboratories, N.V./S.A., Bart Goemaere, Jan Goemaere, Dr. Kenny De Meirleir,
Kenneth Schepmans, Johan Goossens, Lieven Vansacker and John Does. Pursuant to
an agreement in which R.E.D. Laboratories, N.V./S.A. and Dr. Kenny DeMeirleir
agreed not to participate in a hostile takeover of Hemispherx for a period of
five years, R.E.D. Laboratories, N.V./S.A. and Dr. Kenny DeMeirleir have been
dismissed as defendants in the litigation. We dismissed without prejudice the
litigation against the remaining defendants.
ITEM 1A: 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:
34
Risks Associated With Our Business
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.
We are in the process of preparing an NDA to be submitted to the FDA for
approval to use Ampligen in the treatment of Chronic Fatigue Syndrome. We can
provide no guidance as to the tentative data at which the compilation and filing
of the NDA will be complete, as significant factors are outside our control
including, without limitation, the ability and willingness of the independent
clinical investigators to complete the requisite reports at an acceptable
regulatory standard, the ability to collect overseas generated data, and the
ability of Hollister-Stier facilities to interface with our own New Brunswick
staff/facilities to meet the manufacturing regulatory standards. Also, the
timing of the FDA review process of the NDA is subject to the control of the FDA
and could 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 NDA application. Given these variables, we are unable
to project when material net cash inflows are expected to commence from the sale
of Ampligen(R).
Alferon N Injection(R). Although Alferon N Injection(R) is approved for
marketing in the United States for the intra-lesional 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 intra-lesional 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.
35
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 Agency for the Evaluation of Medicinal Products ("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.
Although preliminary in vitro testing indicates that Ampligen(R) enhances the
effectiveness of different drug combinations on avian influenza, preliminary
testing in the laboratory is not necessarily predictive of successful results in
clinical testing or human treatment.
Ampligen(R) is undergoing pre-clinical testing for possible treatment of
avian flu. Although preliminary in vitro testing indicates that Ampligen(R)
enhances the effectiveness of different drug combinations on avian flu,
preliminary testing in the laboratory is not necessarily predictive of
successful results in clinical testing or human treatment. No assurance can be
given that similar results will be observed in clinical trials. Use of
Ampligen(R) in the treatment of avian flu requires prior regulatory approval.
Only the FDA can determine whether a drug is safe, effective or promising for
treating a specific application. As discussed in the prior risk factor,
obtaining regulatory approvals is a rigorous and lengthy process.
In addition, Ampligen(R) is being tested on two strains of avian flu.
There are a number of strains and strains mutate. No assurance can be given that
Ampligen(R) will be effective on any strains that might infect humans.
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,
2006 our accumulated deficit was approximately $158,652,000. 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.
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, 2006, we had approximately $21,500,000 in cash and cash
equivalents and short-term investments. These funds should be sufficient to meet
our operating cash requirements, including debt service, for at least the next
12 months.
36
On April 12, 2006, we entered into a common stock purchase agreement with
Fusion Capital Fund II, LLC, pursuant to which Fusion Capital has agreed, under
certain conditions and with certain limitations, to purchase on each trading day
$100,000 of our common stock up to an aggregate of $50.0 million over a 25 month
period. See Part I, Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations; Liquidity And Capital Resources."
We only have the right to receive $100,000 per trading day under the
agreement with Fusion Capital unless our stock price exceeds $1.90 by at least
$0.10, in which case the daily amount may be increased under certain conditions
as the price of our common stock increases. 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 are in the process of registering 12,386,723 shares purchasable by Fusion
Capital pursuant to the common stock purchase agreement (inclusive of up to
643,502 additional Commitment Shares), the selling price of our common stock to
Fusion Capital will have to average at least about $4.26 per share for us to
receive the maximum proceeds of $50.0 million without registering additional
shares of common stock. Assuming a purchase price of $2.26 per share (the
closing sale price of the common stock on July 28, 2006) and the purchase by
Fusion Capital of the full 12,386,723 shares (inclusive of up to 643,502
additional Commitment Shares) under the common stock purchase agreement,
proceeds to us would only be $26,539,679 unless we choose to register more than
12,386,723 shares, which we have the right, but not the obligation, to do. In
the event we elect to issue additional shares to Fusion Capital, we will be
required to (i) file a new registration statement and have it declared effective
by the Securities and Exchange Commission and (2) seek stockholder approval in
order to be in compliance with the American Stock Exchange Market rules. In
addition, Fusion Capital cannot purchase more than 27,386,723 shares, inclusive
of Commitment Shares under the common stock purchase agreement. Accordingly,
depending upon the future market price of our common stock, we may realize less
than the maximum $50,000,000 proceeds from the sale of stock under the Purchase
Agreement.
The extent to which 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.
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 $50.0 million
under the common stock purchase agreement with Fusion Capital, 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.
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 and we have filed a patent application for
the use of Alferon LDO in treating viral diseases including avian influenza. 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.
37
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.
38
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
Biovail Corporation and Laboratorios Del Dr. Esteve S.A. may provide a sales
force in Canada, Spain and Portugal. We also had an agreement with Bioclones
(Proprietary), Ltd ("Bioclones") that covered South America, Africa, United
Kingdom, Australia and New Zealand. However, we deem this marketing arrangement
with Bioclones void due to the numerous and long standing failures of
performance by Bioclones. In addition, in December 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.
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(R) 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.
There are a limited number of manufacturers in the United States available
to provide the polymers for use in manufacturing Ampligen(R). At present, we do
not have any agreements with third parties for the supply of any of these
polymers. We are establishing relevant manufacturing operations within our New
Brunswick, New Jersey facility for the production of Ampligen(R) raw materials
in order to obtain polymers on a more consistent manufacturing basis. The
establishment of an Ampligen(R) raw materials production line within our own
facilities, while having obvious advantages with respect to regulatory
compliance (other parts of our 43,000 sq. ft. wholly owned FDA approved facility
are already in compliance for the manufacture of Alferon N Injection(R)), may
delay certain steps in the commercialization process, specifically a targeted
NDA filing.
39
If we are unable to obtain or manufacture 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, including commercial scale-up,
may affect the chemical structure of Ampligen(R) and other RNA drugs, as well as
their safety and efficacy, 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
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 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.
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.
40
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.
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 Smith
Kline, 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.
41
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.
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 intra-lesional (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),
Alferon N Injection(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(R) and/or Alferon N Injection(R) product
liability claims. A successful product liability claim against us in excess of
Ampligen(R)'s $1,000,000 in insurance coverage; $3,000,000 in aggregate, or in
excess of Alferon N Injection(R)'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.
42
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 December 31, 2010. 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.
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 assessed the effectiveness of our internal control over financial
reporting as of December 31, 2005. In making this assessment, our 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, our management 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.
43
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 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.
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 and 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.
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 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 July 31, 2006, the price of our common stock has
ranged from $1.45 to $3.99 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 shares are
sold in the public market.
45
We have registered 12,386,723 shares for sale by Fusion Capital and
333,658 shares by others, and may, in the future, register additional shares for
sale by Fusion under the common stock purchase agreement. As of August 8, 2006,
approximately 2,341,007 shares of our common stock, constituted "restricted
securities" as defined in Rule 144 under the Securities Act, 815,117 of which
have been registered in prior registration statements. Also, we have registered
10,084,996 shares issuable (i) upon conversion of approximately 135% of
Debentures that we issued in 2003 and 2004; (ii) as payment of 135% of the
interest on all of the Debentures; (iii) upon exercise of 135% of certain
Warrants; and (iv) 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.
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 and other shares
registered for selling stockholders could cause the price of our common stock to
decline.
The sale by Fusion Capital and other selling stockholders 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 and other selling stockholders as contemplated in this
prospectus could depress the market price for our common stock. The issuance of
shares to Fusion Capital under the common stock purchase agreement, 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 to be 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 offered by this
prospectus will be sold over a period of in excess of 25 months. 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 to Fusion Capital pursuant to
the purchase agreement, 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 9.3% 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
We have a limited number of authorized shares that are not issued or reserved
for issuance. If we do not increase our authorized shares, our ability to raise
capital may be hindered.
Our Certificate of Incorporation currently authorizes the issuance of
100,000,000 common shares and 5,000,000 Preferred Shares. As of August 8, 2006,
we had 62,581,122 common shares outstanding and 35,637,410 common shares
reserved for future issuance under our existing stock option plan and
outstanding options, warrants, convertible debentures, and the 2006 Purchase
Agreement with Fusion, leaving only 1,806,043 common shares available for future
use. In April 2006, our Board of Directors adopted a resolution proposing that
our Certificate of Incorporation be amended to increase the authorized number of
common shares to 200,000,000 subject to stockholder approval of such amendment.
If stockholders do not approve the amendment to our Certificate of Incorporation
at our next Annual Stockholders Meeting, it could harm our business by
preventing us from utilizing the daily purchase amounts available under the 2006
Purchase Agreement in full, raising capital from the issuance of our common
stock or delaying the payment of services via issuances of our common stock.
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.
47
ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds
During the quarter ended June 30, 2006, we issued 1) 798,239 shares issued
pursuant to the 2005 and 2006 Purchase Agreements with Fusion Capital, and 2)
and an aggregate of 17,360 shares for services performed.
All of the foregoing transactions were conducted pursuant to the exemption
from registration provided by Section 4(2) of the Securities Act of 1933.
We did not repurchase any of our securities during the quarter ended June 30,
2006.
On April 12, 2006, subsequent to the end of the first quarter of 2006, we
entered into a Common Stock Purchase Agreement ("Purchase Agreement") with
Fusion Capital. Pursuant to the terms of the Purchase Agreement, Fusion Capital
has agreed to purchase from us up to $50,000,000 of common stock over a period
of approximately twenty-five (25) months. This offering was made pursuant to an
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended. For more information about this transaction, please see Part
I, Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations; Liquidity And Capital Resources."
ITEM 3: Defaults upon Senior Securities
None.
ITEM 4: Submission of Matters to a Vote of Security Holders
None
ITEM 5: Other Information
None.
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
48
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: August 14, 2006
49