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PIP > SEC Filings for PIP > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Form 10-K for PHARMATHENE, INC


14-Mar-2013

Annual Report


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

The following discussion should be read in conjunction with our consolidated financial statements, which present our results of operations for the years ended December 31, 2012 and 2011 as well as our financial positions at December 31, 2011 and 2010, contained elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the "Special Note Regarding Forward Looking Statements" and "Risk Factors" sections of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We are a biodefense company engaged in the development and commercialization of next generation medical countermeasures against biological and chemical threats. Our current biodefense portfolio includes the following product candidates:

• SparVax®, a next generation recombinant protective antigen ("rPA") anthrax vaccine,

• rBChE (recombinant butyrylcholinesterase) bioscavanger, a medical countermeasure for nerve agent poisoning by organophosphorous compounds, including nerve gases and pesticides, and

• Valortim®, a fully human monoclonal antibody for the prevention and treatment of anthrax infection.

In addition, we were awarded by the Delaware Court of Chancery in September 2011 the right to receive 50% of all net profits (as defined in the court's final judgment) related to the sale of SIGA Technologies, Inc.'s ("SIGA") Arestvyr™ and related products for 10 years following initial commercial sale of the drug once SIGA earns $40 million in net profits from sales of Arestvyr™ and related products. In May 2012, the Court issued its final judgment. SIGA has appealed aspects of the decision to the Delaware Supreme Court. In response, we have cross-appealed other aspects of the decision. In January 2013, the Delaware Supreme Court heard oral argument in the case.

We can provide no assurances that SIGA will not prevail on its appeal, that we will be successful in our appeal, or that the Delaware Supreme Court will not overturn the trial court's decision. If the Delaware Supreme Court rules in favor of SIGA, our award can be modified, reduced or reversed completely. As a result, we may lose all of our rights, we may incur additional expense or our ability to recover any amounts could be delayed further.

Critical Accounting Policies

A summary of our critical accounting policies, including those that require the use of significant estimates and judgment, follows. A more comprehensive description of all of our significant accounting policies is contained in Note 2 to our consolidated financial statements.

Revenue Recognition

We generate our revenue from different types of contractual arrangements:
cost-plus-fee contracts, cost reimbursable grants and fixed price contracts.

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

When we use the milestone method of revenue recognition, milestone payments (including milestone payments for fees) contained in research and development arrangements are recognized as revenue when: (i) the milestones are achieved;
(ii) no further performance obligations with respect to the milestone exist;
(iii) collection is reasonably assured; and (iv) substantive effort was necessary to achieve the milestone.

Milestones are considered substantive if all of the following conditions are met:

· it is commensurate with either our performance to meet the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from our performance to achieve the milestone,

· it relates solely to past performance,

· the value of the milestone is reasonable relative to all the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

If a milestone is deemed not to be substantive, the Company recognizes the portion of the milestone payment as revenue that correlates to work already performed; the remaining portion of the milestone payment is deferred and recognized as revenue as the Company completes its performance obligations.

Revenue on fixed price contracts (without substantive milestones as described above) is recognized on the percentage-of-completion method. The percentage-of-completion method recognizes income as the contract progresses (generally related to the costs incurred in providing the services required under the contract). The use of the percentage-of-completion method depends on the ability to make reasonable dependable estimates and the fact that circumstances may necessitate frequent revision of estimates does not indicate that the estimates are unreliable for the purpose for which they are used.

As a result of our revenue recognition policies and the billing provisions contained in our contracts, the timing of customer billings may differ from the timing of recognizing revenue. Amounts invoiced to customers in excess of revenue recognized are reflected on the balance sheet as deferred revenue. We recorded approximately $1.4 million and $0.5 million as deferred revenue as of December 31, 2012 and 2011, respectively. Amounts recognized as revenue in excess of amounts billed to customers are reflected on the balance sheet as unbilled accounts receivable.

We analyze each cost reimbursable grant to determine whether we should report such reimbursements as revenue or as an offset to our expenses incurred. For the years ended December 31, 2012, 2011 and 2010, we recorded approximately $1.1 million, $0.7 million and $2.9 million, respectively, of costs reimbursed by the government as an offset to research and development expenses. Included in the 2010 grants was approximately $0.9 million in therapeutic discovery tax grants which was offset against research and development expense in 2010.

Research and Development Expenses

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

Share-Based Payments

We have a long-term incentive compensation plan (the "LTIP") under which options to purchase shares of our common stock may be granted to employees, consultants and directors at a price no less than the quoted market value on the date of grant. The LTIP also provides for awards in the form of stock appreciation rights, restricted or unrestricted stock awards, stock-equivalent units or performance-based stock awards.

We account for share-based awards to employees and non-employee directors at fair value. The amount of compensation expense recognized using the fair value method requires us to exercise judgment and make assumptions relating to the factors that determine the fair value of our stock option grants. We use the Black-Scholes model to estimate the fair value of our option grants. The fair value calculated by this model is a function of several factors, including grant price, the risk-free interest rate, the expected term of the option and the anticipated volatility of the option.

Intangible Assets and Goodwill

We continually assess the realizability and recoverability of our intangible assets and goodwill. These assessments contain substantial judgment in determining the fair value of such assets and with respect to future usage of the assets and potential cash flows associated with them.

Financial Instruments

Our financial instruments, and/or embedded features contained in those instruments, often are classified as derivative liabilities and are recorded at their fair values. The determination of fair value of these instrument and features requires estimates and judgments. Some of our stock purchase warrants are considered to be derivative liabilities due to the presence of net settlement features; the fair value of our warrants is determined based on the Black-Scholes option pricing model. Use of the Black-Scholes option-pricing model requires the use of unobservable inputs such as the expected term, anticipated volatility and expected dividends.

Results of Operations

Year Ended December 31, 2012 Compared to December 31, 2011

Revenue

We recognized revenue of $25.2 million and $24.3 million during the years ended December 31, 2012 and 2011, respectively. Our revenue in 2012 was derived from contracts with the U.S. government for the development of our product candidates.

                               Year ended December 31,
Revenue ($ in millions)       2012       2011     % Change
SparVax                   $   22.9     $ 19.3          18.7 %
rBChE - AES                    1.8        0.7         157.1 %
rBChE - Protexia                 -        0.6        -100.0 %
Valortim                       0.5        3.7         -86.5 %
Total Revenue             $   25.2     $ 24.3           3.7 %

Our revenue changed in 2012 from 2011 primarily due to the following:

Under our contract for the development of SparVax®, we recognized approximately $22.9 million of revenue in 2012, an increase of $3.6 million (or 18.7%) from 2011. During 2012, revenue for the Company's SparVax® program was primarily attributable to completion of Final Drug Product (FDP) manufacture, the initiation of Bulk Drug Substance (BDS) Process Characterization, progression in the development of bioanalytical and analytical assays, the execution of non-clinical activities and the achievement of several contract milestones. During 2011, revenue was primarily attributable to activities related to the manufacturing platform for SparVax® and additional work performed to develop and qualify analytical and stability-indicating assays for characterization of the product. Milestone revenue for the achievement of key technical milestones was approximately $2.2 million and $3.5 million for the years ended December 31, 2012 and 2011, respectively.

In August 2012, we received notification from the FDA that our SparVax® rPA anthrax vaccine program was placed on clinical hold. The FDA has requested additional stability data and information related to the stability indicating assays. We have provided some supporting data and information to the FDA and have commenced discussions with that agency as well as our customer, BARDA, regarding the clinical hold. We cannot be certain that the FDA will find our current data to be satisfactory and it is unclear at this point when or if we will be able to commence the planned Phase II human clinical trial with SparVax®. Consequently, revenues we recognize in future periods under our SparVax® contract will not include those related to this clinical trial until such time, if ever, as we are able to move forward with the clinical trial and overall SparVax® revenues until such time will be substantially less than they otherwise would have been had we commenced the clinical trial as planned. It is also unclear whether or to what extent the clinical hold will affect future government funding for our SparVax® program.

Under our contract with the Department of Defense (DoD) for the development of an advanced expression system (AES) for rBChE, our second generation rBChE bioscavanger, we recognized approximately $1.8 million, representing an increase of approximately $1.1 million (or 157.1%) from 2011. Significant technical progress was made in the development of our second generation rBChE bioscavanger in 2012, including the establishment of final clones, genetic stability and fed batch evaluation to establish the bioreactor conditions for manufacturing. On July 31, 2012, the DoD exercised a $2.5 million option to continue to fund work under this contract in 2013.

Under our NIAID contracts for the advanced development of Valortim®, we recognized $0.5 million of revenue in 2012, a substantial decrease of $3.2 million (or 86.5%) from 2011 levels as a result of our 2007 contract with NIAID for Valortim® ending (in accordance with its terms) in the first quarter 2012. Additional government funding has not been awarded for Valortim®. There can be no assurance we will be successful in obtaining additional financial support for this program.

Research and Development Expenses

Our research and development expenses were $19.5 million and $21.2 million for the years ended December 31, 2012 and 2011, respectively. These expenses resulted from research and development activities related to SparVax®, rBChE bioscavanger and Valortim®. Research and development expenses include direct expenses (salaries and other costs of personnel, raw materials and supplies, contract research, consulting and clinical development costs) and an allocation of indirect expenses.

Research and development expenses for the years ended December 31, 2012 and 2011 were attributable to research programs as follows:

                                                Year ended December 31,
($ in millions)                               2012        2011      % Change
Anthrax therapeutic and vaccines          $   18.3      $ 18.8           -2.7 %
Chemical nerve agent bioscavenger              1.1         0.6           83.3 %
Internal research and development              0.1         1.8          -94.4 %
Total research and development expenses   $   19.5      $ 21.2           -8.0 %

Research and development expenses for both 2012 and 2011 were net of cost reimbursements under certain of our government grants of $1.1 million and $0.7 million, respectively.

In 2012, research and development expenses decreased approximately $1.7 million from 2011, primarily due to a reduction in (i) indirect operating expenses including overhead and internal research and development, and (ii) direct costs related to our Valortim® program as a result of the completion in the first quarter of 2012 of work under our 2007 contract with NIAID, offset by higher direct SparVax® program expenses. As a result of the FDA clinical hold related to SparVax®, costs we recognize in future periods under our SparVax®contract related to the SparVax® clinical trial, may be substantially less than they otherwise would have been until such time, if ever, as we are able to move forward with the clinical trial.

General and Administrative Expenses

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

Expenses associated with general and administrative functions were $11.6 million for 2012 and $14.3 million for 2011, an approximate 19% decrease. The decrease in general and administrative expenses from 2011 to 2012 was largely due to (i) a $2.3 million reduction in legal and professional expenses primarily related to the SIGA litigation and trial activities and (ii) a planned reduction in headcount, offset in part by a $1.4 million insurance recovery that was received in 2011.

Depreciation Expense

Depreciation expenses were approximately $0.3 million and $0.5 million for the years ended December 31, 2012 and 2011, respectively. The decrease was related to previously purchased assets being fully depreciated during the year ended December 31, 2012.

Other Income (Expense)

Other income in 2012 was $1.5 million, compared to $7.9 million in 2011, a decrease of $6.4 million. The decrease was primarily the result of (i) a $6.5 million difference in gains related to the changes in fair value of our derivative instruments, (ii) a $0.8 million gain in 2011 from the sale of Canadian assets held for sale, and (iii) approximately $0.3 million of additional interest expense in 2012 generated from our loans with GE Capital, offset by $1.2 million of income related to the realization of the cumulative translation adjustment upon the substantial liquidation of PharmAthene Canada, Inc. in July 2012.

Income Taxes

The provision for income taxes was approximately $0.2 million for the year ended December 31, 2012, compared to no provision in 2011. The provision for income taxes in 2012 resulted from the difference between the treatment of goodwill for income tax purposes and for U.S. GAAP.

Year Ended December 31, 2011 Compared to December 31, 2010

Revenue

We recognized revenue of $24.3 million and $21.0 million during the years ended December 31, 2011 and 2010, respectively. Our revenue was derived primarily from contracts with the U.S. government for the development of our product candidates.

                               Year ended December 31,
Revenue ($ in millions)       2011       2010     % Change
SparVax                   $   19.3     $ 11.7          65.0 %
rBChE - AES                    0.7          -         100.0 %
rBChE - Protexia               0.6        5.8         -89.7 %
Valortim                       3.7        3.0          23.3 %
Other                            -        0.5        -100.0 %
Total Revenue             $   24.3     $ 21.0          15.7 %

Our revenue for the year ended December 31, 2011 changed from 2010 primarily due to the following:

Under our contract for the development of SparVax®, we recognized approximately $19.3 million in 2011, an increase of 65.0% from 2010 levels. The increase in revenue for the SparVax® program during 2011 is attributable to additional work in preparation and execution of the scale up campaign at our U.S.-based SparVax® bulk drug substance manufacturer as well as an increase in our billing rate under the contract. Additional activities related to the establishment of analytical and stability-indicating assays for characterization of the product. Of the revenue amounts set forth above, $3.5 million in 2011 and $1.8 million in 2010 represent substantive milestone payments that were tied to our successful achievement of certain technical activities.

Under the September 2007 contract for the advanced development of Valortim®, we recognized approximately $3.7 million in 2011 a 23.3% increase from 2011 levels. Revenue in 2011 reflects both clinical and non clinical work following the release of the FDA partial clinical hold in December 2010. Final patient dosing in clinical trial was completed in April 2011 and the in-life portion of the trial ended in the third quarter 2011. Revenue in 2010 was largely attributable to reimbursement of costs related to clinical and non-clinical studies, including work in connection with the investigation related to the partial clinical hold and certain manufacturing-related activities.

Under the September 2006 contract for the advanced development of Protexia®, we recognized approximately $5.8 million in the year ended December 31, 2010, of which $0.7 million in 2010 represent substantive milestone payments that were tied to our successful achievement of certain technical activities. The decline in revenue is attributed to completion of major development activities for this program in past years. In 2011, we generated additional revenue of $0.7 million under the fixed price contract with the DoD for the development of the AES for rBChE, our nerve agent medical countermeasure, which was awarded in August 2011.

Research and Development Expenses

Our research and development expenses were approximately $21.2 million and $20.9 million for the years ended December 31, 2011 and 2010, respectively. Research and development expenses for the years ended December 31, 2011 and 2010 were attributable to research programs as follows:

                                             Year ended December 31,        % Change
($ in millions)                              2011              2010
Anthrax therapeutic and vaccines          $      18.8       $      15.2          23.7 %
Chemical nerve agent protectants                  0.6               4.7         -87.2 %
Recombinant dual antigen plague vaccine             -               0.1        -100.0 %
Internal research and development                 1.8               0.9         100.0 %
Total research and development expenses   $      21.2       $      20.9           1.4 %

For the year ended December 31, 2011, research and development expenses increased $0.3 million from the prior year. This change was primarily due to the increased technical activity and the achievement of key technical milestones on our SparVax® program and the completion of the Phase I Valortim®dose escalation clinical trial partially offset by a decrease in development expenses related to the clinical nerve agent protectants program as a result of the December 31, 2010 shut down of the Protexia® program.

Research and development expenses for the years ended December 31, 2011 and 2010 were net of cost reimbursements under certain of our government grants of $0.7 million and $2.9 million, respectively. Included in the 2010 grants were $0.9 million in therapeutic discovery tax grants.

General and Administrative Expenses

General and administrative expenses were approximately $14.3 million and $18.0 million for the years ended December 31, 2011 and 2010, respectively. The decrease in 2011 primarily resulted from a $3.0 million reduction in bad debt expense and a property loss insurance recovery of $1.4 million in 2011, partially offset by an increase in non-cash stock compensation expenses as well as taxes and other expenses. The bad debt expenses in 2010 consisted primarily of provisions associated with an invoice to our U.S. government customer for the work at Avecia as well as the wind down of the third generation anthrax vaccine program.

Depreciation and Intangible Amortization (including impairment charges)

Depreciation and amortization expenses were approximately $0.5 million and $5.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in 2011 is primarily a result of the impairment charge taken in December 2010 of approximately $4.6 million with the closing of our Canadian operations.

Other Income (Expense)

Other income (expense) in 2011 was a net income of $7.9 million, compared to a net expense of $11.3 million in 2010. Most of the change was due to (i) a significant reduction in interest expense of $5.9 million resulting from the conversion of our convertible notes in the fourth quarter of 2010, (ii) a significant change in the fair value of our derivatives instruments (a $5.5 million loss in 2010 compared to a $7.1 million gain in 2011) primarily as a result of the change in our stock price, and (iii) a $0.8 million gain on the sale of Canadian assets held for sale in 2011.

Liquidity and Capital Resources

Overview

Our primary use of cash during 2012 was to fund our operations (including our research and development programs) and support our general and administrative activities. Our future capital requirements will depend on many factors, including, the progress of our research and development programs; the progress of pre-clinical and clinical testing; the time and cost involved in obtaining regulatory approval; the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; changes in our existing research relationships; competing technological and marketing developments; our ability to establish collaborative arrangements and to enter into licensing agreements and contractual arrangements with others; and any future change in our business strategy. These cash requirements could change materially as a result of shifts in our business and strategy. The need to raise additional capital will depend on many factors, including but not limited to, our future cash requirements, future contract funding, whether SIGA prevails in its appeal challenging the trial court ruling awarding us an interest in a portion of the net profits of Arestvyr™, the timing, amount, and profitability of sales of Arestvyr™, if any (including the timing of SIGA's recognition of revenue related thereto), and if the trial court ruling is upheld, our ability to collect our portion of net profits related to Arestvyr™.

Historically, we have not generated positive cash flows from operations. To bridge the gap between payments made to us under our government contracts and grants and our operating and capital needs, we have had to rely on a variety of financing sources, including the issuance of equity securities and equity-linked securities and proceeds from loans and other borrowings. For the foreseeable future, we will continue to need these types of financing vehicles and potentially others to help fund our future operating and capital requirements.

Global economic uncertainty continues to make capital markets more volatile and is threatening to once again tighten the credit markets. As a result, there can be no assurances that we would be successful in obtaining sufficient financing on commercially reasonable terms or at all. In addition, due to the U.S. government's continuing substantial efforts to stabilize the economy, the U.S. government may be forced or choose to reduce or delay spending in the biodefense field, which could decrease the likelihood of future government contract awards, the likelihood that the government will exercise its right to extend any of its existing contracts with us and/or the likelihood that the government would procure products from us.

We have $12.7 million of cash on hand at December 31, 2012. We also had approximately $1.6 million in additional funding available to borrow on our revolving line of credit with GE Capital. As a result of the clinical hold placed on our SparVax® program in 2012, it is unclear when or if we will be able to commence the planned Phase II human clinical trial. Consequently we expect SparVax®related revenues and corresponding research and development expenses until such time, if ever, as we are able to move forward with the clinical trial to be substantially less than they otherwise would have been had we commenced the clinical trial as planned. Nevertheless, we still currently anticipate that our cash on hand, amounts available under the line of credit, and cash to be collected from our various contracts currently in place, will be sufficient to meet the Company's ongoing expenses and capital requirements through at least December 31, 2013.

Cash Flows

The following table provides information regarding our cash flows for the years ended December 31, 2012, 2011 and 2010.

                                                    Year ended December 31,
                                            2012             2011             2010
. . .
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