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HEB > SEC Filings for HEB > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for HEMISPHERX BIOPHARMA INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for HEMISPHERX BIOPHARMA INC


18-Mar-2013

Annual Report


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

The following discussion and analysis is related to our financial condition and results of operations for the three years ended December 31, 2012. This information should be read in conjunction with ITEM 6 - "Selected Financial Data" and our consolidated financial statements and related notes thereto beginning on F-1 of this Form 10-K.

Statement of Forward-Looking Information

Certain statements in the section are "forward-looking statements". You should read the information before ITEM 1B above, "Special Note" Regarding Forward-Looking Statements" for more information about our presentation of information.

Background

We are a specialty pharmaceutical company based in Philadelphia, Pennsylvania and engaged in the clinical development of new drug therapies based on natural immune system enhancing technologies for the treatment of viral and immune based chronic disorders. Our flagship products include Alferon N InjectionŽ and the experimental therapeutic AmpligenŽ. Alferon N InjectionŽ is approved for a category of STD infection, and AmpligenŽ represents an experimental RNA nucleic acid being developed for globally important viral diseases and disorders of the immune system. Hemispherx' platform technology includes large and small agent components for potential treatment of various severely debilitating and life threatening diseases.

We have reported net income only from 1985 through 1987. Since 1987, we have incurred, as expected, substantial operating losses due to our conducting research and development programs.

Fair Value

In connection with equity financings on May 11 and 19, 2009, we issued warrants (the "Warrants") that are single compound derivatives containing both an embedded right to obtain stock upon exercise (a "Call") and a series of embedded rights to settle the Warrants for cash upon the occurrence of certain events (each, a "Put"). Generally, the Put provisions allow the Warrant Holders liquidity protection; the right to receive cash in certain situations where the Holders would not have a means of readily selling the shares issuable upon exercise of the Warrants (e.g., where there would no longer be a significant public market for our common stock). However because the contractual formula used to determine the cash settlement value of the embedded Put requires use of certain assumptions, the cash settlement value of the embedded Put can differ from the fair value of the unexercised embedded Call option at the time the embedded Put option is exercised. Specifically, the Put rights would be triggered upon the happening of a "Fundamental Transaction" (as defined below) that also is (1) an all cash transaction; (2) a "Rule 13e-3 transaction" under the Exchange Act (where the Company would be taken private); or (3) a transaction involving a person or entity not traded on a national securities exchange. "Fundamental Transactions" include (i) a merger or consolidation of the Company with or into another person or entity; (ii) a sale, lease, license, transfer or other disposition of all or substantially all of the Company's assets; (iii) any purchase offer, tender offer or exchange offer in which holders of Company Common Stock are permitted to sell, tender or exchange their shares for other securities, cash or property, which offer has been accepted by the holders of 50% or more of the Company's outstanding Common Stock; (iv) a reclassification, reorganization or recapitalization of the Common Stock pursuant to which the Common Stock is effectively converted into or exchanged for other securities, cash or property; or (v) a stock purchase or other business combination with another person or entity is effected pursuant to which such other person or entity acquires more than 50% of the outstanding shares of Common Stock. Pursuant to the Warrants, the Put rights enable the Warrant Holders to receive cash in the amount of the Black-Scholes-Merton value obtained from the "OV" function on Bloomberg, L.P. ("Bloomberg") determined as of the day of consummation of the applicable Fundamental Transaction for pricing purposes and reflecting (A) a risk-free interest rate corresponding to the U.S. Treasury rate for a period equal to the time between the date of the public announcement of the applicable Fundamental Transaction and the Warrant expiration date, (B) an expected volatility equal to the greater of 100% and the 100 day volatility obtained from the HVT function on Bloomberg as of the Trading Day immediately following the public announcement of the applicable Fundamental Transaction, (C) the underlying price per share used in such calculation shall be the sum of the price per share being offered in cash, if any, plus the value of any non-cash consideration, if any, being offered in such Fundamental Transaction and (D) a remaining option time equal to the time between the date of the public announcement of the applicable Fundamental Transaction and the Warrant expiration date.

The Company recomputes the fair value of the Warrants at the end of each quarterly reporting period. Such value computation includes subjective input assumptions that are consistently applied each period. If the Company were to alter its assumptions or the numbers input based on such assumptions, the resulting fair value could be materially different.

Fair value at measurement dates during the period from Warrants' issued May 10, 2009, May 18, 2009 and May 21, 2009 to December 31, 2010, 2011 and 2012, were estimated using the following assumptions:

                                     2010                   2011                   2012
Underlying price per share       $0.47-$0.74            $0.20-$0.46            $0.25-$0.80
Exercise price per share         $1.31-$1.65            $1.31-$1.65            $1.31-$1.65
Risk-free interest rate          0.83%-2.36%            0.29%-1.58%            0.19%-0.44%
Expected holding period        3.38-4.63 years        2.38-3.63 years        1.38-2.63 years
Expected volatility            112.16%-122.02%         74.55%-120.55%         69.21%-110.27%
Expected dividend yield              None                   None                   None

The significant assumptions using the Monte Carlo Simulation approach for valuation of the Warrants are:

(i) Risk-Free Interest Rate. The risk-free interest rates for the Warrants are based on U.S Treasury constant maturities for periods commensurate with the remaining expected holding periods of the warrants.

(ii) Expected Holding Period. The expected holding period represents the period of time that the Warrants are expected to be outstanding until they are exercised. The Company utilizes the remaining contractual term of the Warrants at each valuation date as the expected holding period.

(iii) Expected Volatility. Expected stock volatility is based on daily observations of the Company's historical stock values for a period commensurate with the remaining expected holding period on the last day of the period for which the computation is made.

(iv) Expected Dividend Yield. Expected dividend yield is based on the Company's anticipated dividend payments over the remaining expected holding period. As the Company has never issued dividends, the expected dividend yield is $-0- and this assumption will be continued in future calculations unless the Company changes its dividend policy.

(v) Expected Probability of a Fundamental Transaction. The possibility of the occurrence of a Fundamental Transaction triggering a Put right is extremely remote. As discussed above, a Put right would only arise if a Fundamental Transaction 1) is an all cash transaction; (2) results in the Company going private; or (3) is a transaction involving a person or entity not traded on a national securities exchange. The Company believes such an occurrence is highly unlikely because:

a. The Company only has one product that is FDA approved for sale, but such product will not be available for commercial sales any sooner than the second half of 2013;

b. The production of new Alferon N InjectionŽ API inventory will not commence until the capital improvement and validation phases are complete;

c. The Company is expected to be required to perform additional clinical trials for FDA approval of its flagship product as well as to diversify the applications of its FDA approved product;

d. Industry and market conditions continue to include a global market recession, adding risk to any transaction;

e. Available capital for a potential buyer in a cash transaction continues to be limited;

f. The nature of a life sciences company is heavily dependent on future funding and high fixed costs, including Research & Development;

g. The Company has minimal revenue streams which are insufficient to meet the funding needs for the cost of operations or construction at their manufacturing facility; and

h. The Company's Rights Plan and Executive Employment Agreements make it less attractive to a potential buyer.

With the above factors utilized in analysis of the likelihood of the Put's potential Liability, the Company estimated the range of probabilities related to a Put right being triggered as:

Range of Probability    Probability
        Low                      0.5 %
       Medium                    1.0 %
        High                     5.0 %

The Monte Carlo Simulation has incorporated a 5.0% probability of a Fundamental Transaction for the life to date for these securities.

(vi) Expected Timing of Announcement of a Fundamental Transaction. As the Company has no specific expectation of a Fundamental Transaction, for reasons elucidated above, the Company utilized a discrete uniform probability distribution over the Expected Holding Period to model in the potential announcement of a Fundamental Transaction occurring during the Expected Holding Period.

(vii) Expected 100 Day Volatility at Announcement of a Fundamental Transaction. An estimate of future volatility is necessary as there is no mechanism for directly measuring future stock price movements. Daily observations of the Company's historical stock values for the 100 days immediately prior to the Warrants' grant dates, with a floor of 100%, were utilized as a proxy for the future volatility.

(viii) Expected Risk-Free Interest Rate at Announcement of a Fundamental Transaction. The Company utilized a risk-free interest rate corresponding to the forward U.S. Treasury rate for the period equal to the time between the date forecast for the public announcement of a Fundamental Transaction and the Warrant expiration date for each simulation.

(ix) Expected Time Between Announcement and Consummation of a Fundamental Transaction. The expected time between the announcement and the consummation of a Fundamental Transaction is based on the Company's experience with the due diligence process performed by acquirers, and is estimated to be six months. The Monte Carlo Simulation approach incorporates this additional period to reflect the delay Warrant Holders would experience in receiving the proceeds of the Put.

RESULTS OF OPERATIONS

Year ended December 31, 2012 versus December 31, 2011

Net Loss

Our net loss of approximately $17,354,000 for the year ended December 31, 2012 was 93% higher when compared to the same period in 2011. This $8,339,000 increase in loss was primarily due to:

1) an increase in Research and Development costs in 2012 of approximately $2,786,000 or 41% as compared to the same period in 2011;

2) an increase in Production/Cost of Goods Sold in 2012 of approximately $946,000 or 91%;

3) an increase in General and Administrative expenses of approximately $2,365,000 or 35% as compared to the same period in 2011;

4) the revaluation of the Liability related to the Redeemable Warrants resulting in a non-cash gain of approximately $85,000 in 2012 as compared to non-cash gain of approximately $2,425,000 for the same period in 2011, resulting in an increased loss of $2,340,000;

5) sale in January 2012 of $16,000,000 of our New Jersey state Net Operating Loss carry-forwards (for the years 2009 and 2010) for approximately $1,328,000 as compared to February 2011, when we effectively sold $28,000,000 of our New Jersey state Net Operating Loss carry-forwards (for the years 2003 through 2008) for approximately $2,272,000, representing a decrease in income of $944,000 or 42%; offset by

6) an increase in interest and other income of approximately $973,000 from funds invested in marketable securities.

Net loss per share was $(0.12) for the current twelve month period versus $(0.07) per share for the same period in 2011. The weighted average number of shares of our common stock outstanding as of December 31, 2012 was 141,016,935 as compared to 135,432,395 as of December 31, 2011.

Revenues

Revenues from our AmpligenŽ Cost Recovery Treatment Program for the year ended December 31, 2012 were approximately $213,000 compared to revenues of $161,000 for the same period in 2011, an increase of $52,000 or 32%. The number of patients increased 25% in 2012. There were 45 patients in 2012 and 36 patients in 2011 participating in the program. Commercial sales of Alferon N InjectionŽ were halted in March 2008 when our Finished Goods Inventory expired. As a result, we had no Alferon N InjectionŽ product to commercially sell in 2012 or 2011 and all sales revenue in 2012 and 2011 has been generated from the AmpligenŽ Cost Recovery Treatment Program.

Production/Cost of Goods Sold

Production/Cost of Goods Sold was approximately $1,989,000 and $1,043,000, respectively, for the twelve months ended December 31, 2012 and 2011. This increase of $946,000 or 91% was primarily due to cost of fill, finish and packaging of Alferon N InjectionŽ Work-In-Process inventory along with a related valuation write-down reserve of approximately $1,024,000 to the lower of cost or market.

Research and Development Costs

Overall Research and Development ("R&D") costs for the year ended December 31, 2012 were approximately $9,508,000 as compared to $6,722,000 for the same period a year ago, reflecting an increase of approximately $2,786,000 or 41%. The increased R&D efforts during the year 2012 were primarily due to approximately $2,290,000 spent on our efforts regarding the AmpligenŽ NDA and preparedness for the FDA pre-approval inspections of the New Brunswick manufacturing facility along with approximately $1,159,000 of employment agreement incentive payment to Dr. William A. Carter, our Chief Executive Officer, President and Chief Scientific Officer, with these expenses offset by approximately $663,000 of cost savings achieved by suspending AlferonŽ related R&D projects.

General and Administrative Expenses

General and Administrative ("G&A") expenses for the year ended December 31, 2012 and 2011 were approximately $9,056,000 and $6,691,000, respectively, reflecting an increase of approximately $2,365,000 or 35%. The higher G&A expenses in 2012 consisted primarily of an increase of approximately $446,000 in legal fees due to the Cato Capital, LLC litigation and efforts to domesticate the judgment against JCI in South Africa, approximately $229,000 of prior year's Director's fees paid to Dr. Iraj E. Kiani, approximately $1,159,000 of employment agreement incentive payment to Thomas K. Equels, in his role as our General Counsel, and $250,000 bonus to The Sage Group for consulting fees. For detailed information on the sources of legal fees, see "Note 16 - Contingencies" under Notes to Consolidated Financial Statements.

Interest and Other Income

Interest and other income for the years ended December 31, 2012 and 2011 was approximately $1,597,000 and $624,000, respectively, representing an increase of $973,000 or 156%. The primary causes for the increase of investment income was a higher rate of return from our portfolio of short and long-term bond and fixed-income type investments during 2012, an increase in the size of our portfolio as proceeds were realized from sale of stock through the Maxim ATM in the latter part of 2012 and capital gain distributions of approximately $409,000 from the mutual funds investments. The interest income from the investments is recognized over the life of the instrument.

Interest Expense

In 2010 and 2011, we financed through capital leases some office equipment vital to our overall operations as well as manufacturing equipment utilized in the production of AlferonŽ. For the years ended December 31, 2012 and 2011, we had interest expense of approximately $24,000 and $41,000, respectively from these capital leases.

Sale of New Jersey Tax Net Operating Loss

In January 2012, we effectively sold $16,000,000 of our approximately $25,000,000 of New Jersey state Net Operating Loss carry-forwards (for the years 2009 and 2010) for approximately $1,328,000 as compared to February 2011, when we effectively sold $28,000,000 of our New Jersey state Net Operating Loss carry-forwards (for the years 2003 through 2008) for approximately $2,272,000, representing a decrease in gain of approximately $944,000 or 42% (see "Note 15:
Income Taxes (FASB ASC 740 Income Taxes) and Subsequent Event").

Redeemable Warrants Valuation Adjustment

The quarterly fiscal revaluations resulted in non-cash adjustments to the redeemable warrants liability for the twelve months ended December 31, 2012 and 2011 of approximately $85,000 gain and $2,425,000 gain, respectively, representing a decrease of $2,339,000 (see "Note 19: Fair Value").

RESULTS OF OPERATIONS

Year ended December 31, 2011 versus December 31, 2010

Net Loss

Our net loss of approximately $9,015,000 for the year ended December 31, 2011 was 31% lower when compared to the same period in 2010. This $4,121,000 decrease in loss was primarily due to:

1. a decrease in Research and Development costs in 2011 of approximately $891,000 or 12% as compared to the same period in 2010;

2. a decrease in Production/Cost of Goods Sold in 2011 of approximately $298,000 or 22%;

3. a decrease in General and Administrative expenses of approximately $877,000 or 12% as compared to the same period in 2010;

4. an adjustment at December 31, 2011 to record the change in fair value for a Liability related to certain redeemable warrants originally issued in May 2009. This Liability was recorded in May 2009, adjusted and revalued to $2,805,000 at December 31, 2010, resulting in a related non-cash gain of $879,000 in 2010. The value of this Liability at December 31, 2011 was $380,000. The cumulative quarterly adjustments needed during 2011 to revalue the liability resulted in a related non-cash gain of $2,425,000 for year ended December 31, 2011. This resulted in a decrease in loss of $1,545,000 in 2011 compared to 2010;

5. the 2011 receipt of funds from the sale of State New Jersey tax net operating losses for years 2003 to 2008 for $2,272,000; which were offset by

6. a decrease in interest and other income in 2011 of approximately $1,759,000 or 74% as compared to the same period in 2010.

Net loss per share for the year ended 2011 was approximately $(0.07) versus approximately $(0.10) for the same period in 2010. The weighted average number of shares of our common stock outstanding as of December 31, 2011 was 135,432,395 as compared to 134,081,243 as of December 31, 2010.

Revenues

Revenues from our AmpligenŽ cost recovery treatment program for the year ended December 31, 2011 were approximately $161,000 compared to revenues of $135,000 for the same period in 2010, an increase of $26,000 or 19% for 36 patients in 2011 and 21 patients in 2010 participating in the program. Commercial sales of Alferon N InjectionŽ were halted in March 2008 when our Finished Goods Inventory expired. As a result, we had no Alferon N InjectionŽ product to commercially sell in 2011 or 2010 and all sales revenue in 2011 and 2010 has been generated from AmpligenŽ cost recovery clinical treatment programs.

Production/Cost of Goods Sold

Production/Cost of Goods Sold was approximately $1,043,000 and $1,341,000, respectively, for the twelve months ended December 31, 2011 and 2010. This decrease of $298,000 or 22% was primarily due to the shrinkage of work-in-process due to restarting the manufacturing process and the resulting necessary additional testing of equipment, work-in-process and finished goods inventory for quality control. The additional costs related to addressing manufacturing issues were approximately $259,000 and the lower cost to maintain existing Alferon N InjectionŽ and AmpligenŽ inventory including storage, stability testing, transport and reporting costs due to our efforts to reduce the production costs of Alferon N InjectionŽ for potential future commercial sales. These savings achieved in 2011 were somewhat offset by comparison to 2010 due to last year's recognition of insurance proceeds of approximately $96,000 received for storm damages which occurred at the New Brunswick, NJ facility and September 2011 costs related to the transfer of existing Alferon N InjectionŽ and AmpligenŽ inventory to a new vendor (BioRidge) in coordination with the sales, marketing and education effort to be undertaken by Armada Healthcare for Alferon N InjectionŽ.

Research and Development Costs

Overall Research and Development costs for the year ended December 31, 2011 were approximately $6,722,000 as compared to $7,613,000 for the same period a year ago, reflecting a decrease of $891,000 or 12%. In 2011 we spent approximately $2,310,000 for the AmpligenŽ new drug treatment of Chronic Fatigue Syndrome, approximately $4,080,000 for AlferonŽ LDO for influenza and approximately $332,000 for other projects. The primary factors for the decrease in research and development costs were a suspension of some clinical, research and development costs related to AlferonŽ LDO as we work to select a vendor to conduct a confirmatory study, which will help us to further evaluate the potential effectiveness of this product and determine the cost/benefit of proceeding with the planned study of seasonal and pandemic influenza.

General and Administrative Expenses

General and Administrative expenses for the year ended December 31, 2011 and 2010 were approximately $6,691,000 and $7,568,000, respectively, reflecting a decrease of $877,000 or 12%. The primary reason for this decrease in expense in 2011 consisted primarily of a decrease in legal fees totaling approximately $941,000 due to settlement in 2010 of various legal proceedings.

Interest and Other Income

Interest and other income for the years ended December 31, 2011 and 2010 was approximately $625,000 and $2,383,000, respectively, representing a decrease of $1,759,000 or 74%. The primary causes for the decrease of interest income in 2011 were (1) the use of some of the proceeds from investments in operations, thereby diminishing the amounts available for investments and proportionately reducing the flow of interest income; and (2) the receipt of capital gain distributions in 2010 of approximately $1,079,000 which did not re-occur in 2011.

Interest Expense and Financing Costs

In 2011 and 2010 prior to the establishment of the Margin Account Loan, we financed through capital leases some office equipment vital to our overall operations as well as manufacturing equipment utilized in the production of AlferonŽ. For the year ended December 31, 2011 and 2010, we had interest expense of approximately $41,000 and $11,000, respectively.

Sale of New Jersey Tax Net Operating Loss

In February 2011, we received approximately $2,272,000 from the sale of the State of New Jersey tax net operating losses for years 2003 to 2008. No such sale occurred in 2010.

Redeemable Warrants Valuation Adjustment

The December 31, 2011 and 2010 revaluations resulted in non-cash adjustments to the Redeemable Warrants Liability as of December 31, 2011 and 2010 of approximately $2,425,000 and $879,000, respectively, representing an increase of $1,545,000.

Liquidity and Capital Resources

Cash used in operating activities for the twelve months ended December 31, 2012, was approximately $13,136,000 compared to $10,096,000 for the same period in 2011, an increase of $3,040,000 or 30%. Excluding the proceeds from the sale of New Jersey Net Operating Loss carry-forwards, cash used in operating activities for the twelve months ended December 31, 2012, was approximately $14,464,000 compared to $12,368,000. Cash used in operating activities increased by approximately $2,096,000 or 17% over the comparable period in 2011. This increase was primarily due to our efforts regarding the AmpligenŽ NDA and preparedness for the FDA pre-approval inspections of the New Brunswick manufacturing facility.

In January 2012, we effectively sold $16,000,000 of our New Jersey state Net Operating Loss carry-forwards (for the years 2009 and 2010) for approximately $1,328,000 as compared to February 2011, when we effectively sold $28,000,000 of our New Jersey state Net Operating Loss carry-forwards (for the years 2003 through 2008) for approximately $2,272,000. As of December 31, 2012, we had approximately $8,500,000 of New Jersey state net operating loss carry forwards (expiring in the years 2021 through 2022) available to offset future state taxable income or possibly sell though the State of New Jersey's Corporate Business Tax Transfer Program.

As of December 31, 2012, we had approximately $43,953,000 in Cash, Cash Equivalents and Marketable Securities (inclusive of $14,500,000 in Marketable Securities collateralizing certain debts), or an increase of approximately $9,562,000 from December 31, 2011. However, if we are unable to commercialize and sell AmpligenŽ or AlferonŽ LDO and/or recommence material sales of Alferon N InjectionŽ, our operations, financial position and liquidity may be adversely impacted, and additional financing may be required, however, there is no assurance that such financing will be available.

In its CRL, the FDA communicated that Hemispherx should conduct at least one additional clinical trial, complete various nonclinical studies and perform a number of data analysis. Until we undertake the end-of-review conference(s) with the FDA, we are unable to reasonably estimate the nature, costs, necessary efforts to obtain FDA clearance or anticipated completion dates of any additional clinical study or studies. Utilizing the industry norms for undertaking a Phase III clinical study, we estimate upon acceptance of the study's design that it would take approximately 18 months to three years to complete a new well-controlled AmpligenŽ clinical study for resubmission to the FDA. It can be reasonably anticipated that the time and cost to undertake clinical trial(s), studies and data analysis are beyond our current financial resources without gaining access to additional funding. The actual duration to complete the clinical study may be different based on the length of time it takes to design the study and obtain FDA's acceptance of the design, the final design of an acceptable Phase III clinical study design, availability of suitable participants and clinical sites along with other factors that could impact the implementation of the study, analysis of results or requirements of the FDA and/or other governmental organizations. Please see "Part I; ITEM 1A. Risk Factors; "We may require additional financing which may not be available. The limited number of shares of common stock available for financing without prior stockholder approval may hinder our ability to raise additional funding".

A "Margin Account" loan was established with Wells Fargo Advisors for which the proceeds of this flexible form of indebtedness effectively serves us as a line of credit to finance the capital improvement project underway at the New Brunswick, New Jersey Manufacturing facility. In order to maintain this Margin Account, established on July 26, 2011, we needed to pledge, restrict from sale and segregate to a Margin Account our Marketable Securities at an approximate ratio of two to one, based on the diversity of securities pledged as collateral, . . .

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