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, 2005 Commission File Number: 0-27072 HEMISPHERx BIOPHARMA, INC. - ------------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 52-0845822 - ------------------------------ ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1617 JFK Boulevard, Suite 660, Philadelphia, PA 19103 - ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip Code) (215) 988-0080 - ------------------------------------------------------------------------------ (Registrant's telephone number, including area code) Not Applicable - ------------------------------------------------------------------------------ (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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). /X/ Yes // No 51,193,155 shares of common stock were issued and outstanding as of August 2, 2005.
PART I - FINANCIAL INFORMATION ITEM 1: Financial Statements HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands) December 31, June 30, ------------ -------- 2004 2005 ---- ---- ASSETS Current assets: Cash and cash equivalents $8,813 $5,802 Short term investments 7,924 6,812 Inventory, net (Note 4) 2,148 1,815 Accounts and other receivables (Note 5) 139 72 Prepaid expenses and other current assets 266 225 ---------------- ---------------- Total current assets 19,290 14,726 ---------------- ---------------- Property and equipment, net 3,303 3,325 Patent and trademark rights, net 908 805 Investment (Note 3) 35 35 Deferred financing costs 319 169 Advance receivable (Note 7) 1,300 1,300 Other assets 17 48 ---------------- ---------------- Total assets $ 25,172 $ 20,408 ================ ================ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 526 $ 414 Accrued expenses (Note 5) 1,012 608 Current portion of long-term debt, net 3,248 4,652 ---------------- --------------- Total current liabilities 4,786 5,674 ---------------- --------------- Long-Term Debt-net of current portion (Note 7) 305 - Commitments and contingencies (Notes 6, 7, 8 and 9) Stockholders' equity (Note 8): Common stock 50 51 Additional paid-in capital 158,024 159,632 Accumulated other comprehensive income (10) (95) Accumulated deficit (137,983) (144,854) ----------------- ---------------- Total stockholders' equity 20,081 14,734 ----------------- ---------------- Total liabilities and stockholders' equity $25,172 $20,408 ================= ================ See accompanying notes to condensed consolidated financial statements.
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Statements of Operations (in thousands, except share and per share data) Three months ended June 30, 2004 2005 ---- ---- Revenues: Sales of product net $ 289 $ 240 Clinical treatment programs 42 60 ----------------- -------------- Total Revenues: 331 300 Costs and expenses: Production/cost of goods sold 692 103 Research and development 758 1,158 General and administrative 1,076 1,409 ----------------- -------------- Total costs and expenses 2,526 2,670 Interest and other income 13 63 Interest expense (105) (107) Financing costs (Note 7) (3,669) (1,402) ----------------- -------------- Net loss $ (5,956) $ (3,816) ================= ============== Basic and diluted loss per share $ (.14) $ (.08) ================= ============== Weighted average shares outstanding 43,871,350 50,299,176 ================= ============== See accompanying notes to consolidated financial statements.
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Statements of Operations (in thousands, except share and per share data) Six months ended June 30, 2004 2005 ---- ---- Revenues: Sales of product net $ 548 $ 469 Clinical treatment programs 91 89 ----------------- -------------- Total Revenues: 639 558 Costs and expenses: Production/cost of goods sold 1,293 201 Research and development 1,720 2,426 General and administrative 3,921 2,391 ----------------- -------------- Total costs and expenses 6,934 5,018 Interest and other income 24 293 Interest expense (206) (213) Financing costs (Note 7) (7,520) (2,491) ----------------- -------------- Net loss $ (13,997) $ (6,871) ================= ============== Basic and diluted loss per share $ (.33) $ (.14) ================= ============== Weighted average shares outstanding 42,040,412 50,033,623 ================= ============== See accompanying notes to consolidated financial statements.
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholder Equity For the Six Months Ended June 30, 2005 (in thousands, except per share data) <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> <C> Additional Accumulated other Total Common stock paid-in Comprehensive Accumulated stockholders' Shares Amount capital Income (Loss) deficit equity ------------- --------- ----------- ------------ ----------- -------------- Balance as of December 31, 2004 49,631,766 $ 50 $ 158,024 $ (10) $ (137,983) $ 20,081 Warrants Converted 5,000 9 9 Shares issued in payment of accounts payable and private placement 222,310 33 33 Shares issued for debt payments 514,107 1 776 777 Shares issued for interest on convertible debt 136,246 218 218 Stock Compensation 106 106 Revaluation of May 2009 Warrants 466 466 Net Loss (85) ( 6,871) (6,956) 243: -------------- ---------- ----------- ----------- ------------ ------------- Balance as of June 30, 2005 50,509,429 $ 51 $ 159,632 $ (95) $ (144,854) $ 14,734 -------------- ---------- ----------- ---------- ------------ ------------- </TABLE> See accompanying notes to financial statements
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2004 and 2005 (in thousands) 2004 2005 ---- ---- Cash flows from operating activities: Net loss $ (13,997) $(6,871) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation of property and Equipment 53 57 Amortization of patent and Trademark rights 160 174 Amortization of deferred Financing costs 6,573 150 Financing cost related to redemption obligation 686 2,341 Stock warrant compensation Expense 1,769 106 Interest expense 206 213 Changes in assets and liabilities: Inventory 273 333 Accounts and other receivables 125 67 Deferred revenue 497 - Prepaid expenses and other Current assets (76) 41 Accounts payable 365 (79) Accrued expenses (520) (397) Other assets 14 - ------------- ------------ Net cash used in operating Activities (3,872) (3,865) ------------- ------------ Cash flows from investing activities: Purchase of land and building (143) - Purchase of property and Equipment, net - (110) Additions to patent and trademark Rights (121) (71) Maturity of short term Investments 1,496 7,934 Purchase of short term Investments (4,969) (6,907) ------------- ----------- Net cash (used) in provided by Investing Activities$ (3,737) $ 846 ------------- ----------- (CONTINUED)
HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Continued) For the Six Months Ended June 30, 2004 and 2005 (in thousands) 2004 2005 ---- ---- Cash flows from financing activities: Proceeds from long-term borrowing $ 5,808 $ - Deferred financing costs (410) - Proceeds from exercise of stock Warrants 2,911 8 -------------- ----------- Net cash provided by financing Activities 8,309 8 -------------- ----------- Net increase (decrease) in cash and cash equivalents 700 (3,011) Cash and cash equivalents at beginning of period 3,764 8,813 -------------- ----------- Cash and cash equivalents at end of period $4,464 $5,802 ============== =========== Supplemental disclosures of cash flow information: Issuance of common stock for accounts payable, accrued expenses and private placement $ 255 $ 33 ============== =========== Issuance of Common Stock for Purchase of building $ 1,626 $ - ============= =========== Issuance of Common Stock for Debt conversion debt $6,072 $ 994 payments and interest payments ============= =========== See accompanying notes to consolidated financial statements.
HEMISPHERx BIOPHARMA, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Hemispherx BioPharma, Inc., a Delaware corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments necessary for a fair presentation of such consolidated financial statements have been included. Such adjustments consist of normal recurring items. Interim results are not necessarily indicative of results for a full year. The interim consolidated financial statements and notes thereto are presented as permitted by the Securities and Exchange Commission (SEC), and do not contain certain information which will be included in our annual consolidated financial statements and notes thereto. These consolidated financial statements should be read in conjunction with our consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 16, 2005. NOTE 2: STOCK BASED COMPENSATION The Company follows Statement of Financial Accounting Standards(SFAS) No. 123, "Accounting for Stock-Based Compensation." We chose to apply Accounting Principal Board Opinion 25 and related interpretations in accounting for stock options granted to our employees. The Company provides pro forma disclosures of compensation expense under the fair value method of SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure." The weighted average assumptions used for the period presented are as follows: June 30, 2004 2005 Risk-free interest rate - 4.81% Expected lives - 5 years Expected volatility - 58.78%-60.67% Had compensation cost for the Company's option plans been determined, using the fair value method at the grant dates, the effect on the Company's net loss and loss per share for the six months ended June 30, 2004 and 2005 would have been as follows: (In Thousands) Six Months Ended June 30, --------- 2004 2005 ------- ------- Net (loss) as reported $(13,997) $(6,871) Add: Stock based employee compensation expense Included in reported net loss 1,769 106 Deduct: Total stock based employee compensation determined under fair value method for all awards - (82) ------- ------- Pro forma net loss $(12,228) $(6,847) ======== ======= Basic and diluted loss per share As reported $(.33) $(.14) Pro forma $(.29) $(.14) Note 3: INVESTMENT IN UNCONSOLIDATED AFFILIATES Investments include an equity investment of $35,000 in Chronix Biomedical ("Chronix"). Chronix focuses upon the development of diagnostics for chronic diseases. This initial investment was made in May 31, 2000 by the issuance of 50,000 shares of the Company's common stock from the treasury. On October 12, 2000, the Company issued an additional 50,000 shares of its common stock and on March 7, 2001 the Company issued 12,000 more shares of its common stock from the treasury to Chronix for an aggregate equity investment of $700,000. The percentage ownership in Chronix is approximately 5.4% and is accounted for under the cost method of accounting. During the quarter ended December 31, 2002, the Company recorded a non-cash charge of $292,000 with respect to the investment in Chronix. The Company recorded an additional non-cash charge of $373,000 during the quarter ended September 30, 2004, due to evidence of a further decline in Chronix's market value. This impairment reduces the carrying value to reflect a permanent decline in Chronix's market value based on its then proposed investment offerings. NOTE 4: INVENTORIES The Company uses the lower of first-in, first-out ("FIFO") cost or market method of accounting for inventory. Inventories consist of the following: December 31, 2004 June 30, 2005 ----------------- -------------- Raw materials-work in process $ 1,711,000 $1,711,000 Finished goods, net of $225,000 reserve 437,000 104,000 ----------------- -------------- $ 2,148,000 $1,815,000 ================= ============== The Company's reserve for R&D utilization as of June 30, 2005, totaled $225,000 for Alferon N finished goods that may not be sold prior to their 18 month shelf-life expiration. Also, the Company may consume some, or all of this, potentially stale inventory in its Research & Development efforts. The Company completed tests in 2004 to extend the product shelf life to 24 months. The Company filed its annual report with the FDA in December 2004 including documentation for the extension of shelf-life to 24 months. The Company received a response from the FDA at the end of June 2005 concerning the relabeling request of Alferon N Injection(R). After reviewing the information submitted, the FDA determined the submission as a "Prior Approval Supplement". Under this designation, the FDA has six months, as of May 2005, to approve the request to relabel Alferon N Injection(R) with the extended shelf-life. The Company now anticipates a response from the FDA by September 2005. NOTE 5: REVENUE AND LICENSING FEE INCOME The Company executed a Memorandum of Understanding (MOU) in January 2004 with Fujisawa Deutschland GmbH, ("Fuji") a major pharmaceutical corporation, granting them an exclusive option for a limited number of months to enter a Sales and Distribution Agreement with exclusive rights to market Ampligen(R) for ME/CFS in Germany, Austria and Switzerland. The Company received an initial fee of 400,000 Euros (approximately $497,000 US) in 2004. On November 9, 2004, the Company and Fuji terminated the MOU by mutual agreement. The Company did not agree on the process to be utilized in certain European Territories for obtaining commercial approval for the sale of Ampligen(R) in the treatment of patients suffering from Chronic Fatigue Syndrome (CFS). Instead of a centralized procedure, and in order to obtain an earlier commercial approval of Ampligen(R) in Europe, the Company has determined to follow a decentralized filing procedure which was not anticipated in the MOU. The Company believes that it now is in the best interest of our stockholders to potentially accelerate entry into selected European markets whereas the original MOU specified a centralized registration procedure. Pursuant to mutual agreement of the parties the Company refunded 200,000 Euros to Fuji. The Company has recorded the remaining 200,000 Euros as an accrued liability as of June 30, 2005. The Company is currently holding the 200,000 Euros pending further developments in accordance with the mutually agreed upon termination with Fuji. Fuji and Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") have reached a definitive agreement upon the terms of their merger, which took effect on April 1, 2005. Yamanouchi will be the surviving company and Fuji will be dissolved. The combined company name will be Astellas Pharma, Inc. Revenues for non-refundable license fees are recognized under the Performance Method-Expected Revenue. This method considers the total amount of expected revenue during the performance period, but limits the amount of revenue recognized in a period to total non-refundable cash received to date. This limitation is appropriate because future milestone payments are contingent on future events. Upon receipt, the upfront non-refundable payment is deferred. The non-refundable upfront payments plus non-refundable payments arising from the achievement of defined milestones are recognized as revenue over the performance period based on the lesser of (a) percentage of completion or (b)non-refundable cash earned (including the upfront payment). This method requires the computation of a ratio of cost incurred to date to total expected costs and then apply that ratio to total expected revenue. The amount of revenue recognized is limited to the total non-refundable cash received to date. During the period ended June 30, 2005, the Company did not receive any grant monies from local, state and or Federal Agencies. Revenue from the sale of Ampligen(R) under cost recovery clinical treatment protocols approved by the FDA is recognized when the treatment is provided to the patient. Revenues from the sale of product are recognized when the product is shipped, as title is transferred to the customer. The Company has no other obligation associated with its products once shipment has occurred. Note 6: ACQUISITION OF ASSETS OF INTERFERON SCIENCES, INC. ("ISI") On March 11, 2003, the Company acquired from ISI, ISI's inventory of ALFERON N Injection(R) and a limited license for the production, manufacture, use, marketing and sale of this product. As partial consideration, the Company issued 487,028 shares of its common stock to ISI Pursuant to their agreements with ISI, the Company registered these shares for public sale and ISI has reported that it has sold all of these shares. The Company also agreed to pay ISI 6% of the net sales of ALFERON N Injection(R). On March 11, 2003, the Company also entered into an agreement to purchase from ISI all of its rights to the product and other assets related to the product including, but not limited to, real estate and machinery. For these assets, the Company agreed to issue to ISI an additional 487,028 shares and to issue 314,465 shares and 267,296 shares, respectively to the American National Red Cross and GP Strategies Corporation, two creditors of ISI. The Company guaranteed the market value of all but 62,500 of these shares to be $1.59 per share on the termination date. As discussed below, the Company issued all of these shares and ISI, GP Strategies and the American National Red Cross have reported that they have sold all of their shares. The Company also agreed to satisfy other liabilities of ISI which were past due and secured by a lien on ISI's real estate and to pay ISI 6% of the net sales of products containing natural alpha interferon. On May 30, 2003, the Company issued the shares to GP Strategies and the American National Red Cross. Pursuant to the Company's agreements with ISI and these two creditors, the Company registered the foregoing shares for public sale. As a result at December 31, 2003 the guaranteed value of these shares ($491,000), which had not been sold by these two creditors, were reclassified to redeemable common stock. At December 31, 2004, all shares had been sold by these two creditors and the redeemable common stock was reclassed to equity. On November 6, 2003, the Company acquired and subsequently paid, the outstanding ISI property tax lien certificates in the aggregate amount of $457,000 from certain investors. These tax liens were issued for property taxes and utilities due for 2000, 2001 and 2002. In March 2004, the Company issued 487,028 shares to ISI to complete the acquisition of the balance of ISI's rights to market its product as well as its production facility in New Brunswick, New Jersey. ISI has sold all of its shares. The aggregated cost of the land and buildings was approximately $3,316,000. The cost of the land and buildings was allocated as follows: Land $ 423,000 Buildings 2,893,000 --------- Total cost $ 3,316,000 =========== The Company accounted for these transactions as a Business Combination under SFAS No. 141 Accounting for Business Combinations. Note 7: DEBENTURE FINANCING Long term debt consists of the following: (in thousands) December June 31, 2004 30, 2005 --------- -------- October 2003 Debenture $2,072 $2,072 January 2004 Debenture 3,083 2,305 July 2004 Debenture 2,000 2,000 Total 7,155 6,377 Less Discounts (3,602) (1,725) ------ ------ Balance 3,553 4,652 Less Current Portion of long-term debt (net of discounts of $3,239 and $1,725 respectively) (3,248) (4,652) ------- ------ Total long-term debt $ 305 $ - ======= ====== On July 10, 2003, the Company issued an aggregate of $5,426,000 in principal amount of 6% Senior Convertible Debentures due July 31, 2005 (the "July 2003 Debentures") and an aggregate of 507,102 Warrants (the "July 2008 Warrants") to the same investors who purchased the March Debentures, in a private placement for aggregate proceeds of $4,650,000. Pursuant to the terms of the July 2003 Debentures, $1,550,000 of the proceeds from the sale of the July 2003 Debentures were to have been held back and released to the Company if, and only if, the Company acquired ISI's facility with in a set timeframe. These funds were released to the Company in October 2003 although the Company had not acquired ISI's facility at that time. The July 2003 Debentures matured on July 31, 2005 and bore interest at 6% per annum, payable quarterly in cash or, subject to satisfaction of certain conditions, common stock. Any shares of common stock issued to the investors as payment of interest were valued at 95% of the average closing price of the common stock during the five consecutive business days ending on the third business day immediately preceding the applicable interest payment date. The July 2003 Debentures were convertible at the option of the investors at any time through July 31, 2005 into shares of the Company's common stock. The conversion price under the July 2003 Debentures was fixed at $2.14 per share; however, as part of the subsequent debenture placement closed on October 29, 2003 (see below), the conversion price under the July 2003 Debentures was lowered to $1.89 per share. The July 2008 Warrants received by the investors, as amended, were an aggregate of 507,102 shares of common stock at a price of $2.46 per share. The amended Warrants resulted in an additional debt discount of approximately $335,000 in 2004. These Warrants were exercised in July 2004 which produced gross proceeds in the amount of $1,247,470. On June 25, 2003, the Company issued to each of the March 12, 2003 Debenture holders warrants to acquire at any time through June 25, 2008 an aggregate of 1,000,000 shares of common stock at a price of $2.40 per share (the "June 2008 Warrants"). These warrants were issued as incentive for the debenture holders to exercise prior warrant issuances. This issuance resulted in an additional debt discount to the March debentures of $2,640,000. Pursuant to the Company's agreement with the Debenture holders, the Company registered the shares issuable upon exercise of these June 2008 Warrants for public sale. These warrants were exercised in May 2004 and the Company received gross proceeds of $2,400,000. As of December 31, 2004, the investors had converted the total $5,426,000 principal of the July Debentures into 2,870,900 shares of common stock. 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 provide a mortgage on the facility as further security for the October 2003 Debentures. In March 2004, the Company acquired the facility and the Company subsequently provided the mortgage of the facility to the Debenture holders. The October 2003 Debentures mature on October 31, 2005 and bear 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 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. Upon completing the sale of the October 2003 Debentures, the Company received $3,275,000 in net proceeds consisting of $1,725,000 from the October 2003 Debentures and $1,550,000 that had been withheld from the July 2003 Debentures. As noted above, pursuant to the terms of the October 2003 Debentures, $1,550,000 of the proceeds from the sale of the October 2003 Debentures had been held back. However, these proceeds were released to the Company in April 2004. As required by the Debentures, the Company has provided a mortgage on the ISI facility as further security for the Debentures. The October 2003 Debentures are convertible at the option of the investors at any time through October 31, 2005 into shares of our 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 our 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. The amended Warrants resulted in a reduction in debt discount of approximately $53,000 in 2004. These Warrants were exercised in July 2004 which produced gross proceeds in the amount of $951,510. As of June 30, 2005, the investors had converted $2,071,178 principal amount of the October 2003 Debenture into 1,025,336 shares of Common Stock. The remaining balance of $2,071,178 is covertible into 1,025,336 shares of common stock. 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 158,103 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 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. 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 our option, in shares of common stock. After one installment payment of $111,111 in our common stock, one debenture holder exercised its right to waive further installment payments on its note. 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. 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 our 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. As of June 30, 2005, the remaining principal on these debentures was $2,305,294. The investors converted $139,150 principal amount of the January 2004 Debenture into 55,000 shares of common stock. In addition, installment payments of $1,555,554 were made to the Company's investors amounting to 873,038 shares of the Company's common stock. 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, 2004, 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. In 2005, the Company recorded an additional charge to financing costs of $229,000 to account for the reset of the exercise price of the July 2009 warrants to $2.58 per share. The Company also issued to the investors Additional Investment Rights pursuant to which the investors have the right to acquire up to an additional $2,000,000 principal amount of January 2004 Debentures (the July 2004 Debentures") from us. The July 2004 Debentures are identical to the January 2004 Debentures except that the conversion price is $2.58. The investors exercised the Additional Investment Rights on July 13, 2004 and the Company received net proceeds of $1,860,000. Upon completion of the August 2004 Private Placement (see below), the conversion price was lowered to $2.08 per share. As of June 30, 2005, the Debenture holders had not converted any portion of this debenture. On May 14, 2004, in consideration for the Debenture holders' exercise of all of the June 2008 Warrants, the Company issued to the holders warrants (the "May 2009 Warrants") to purchase an aggregate of 1,300,000 shares of the Company's common stock. The Company issued 1,000,000 shares of common stock and received gross proceeds of $2,400,000 from the exercise of the June 2008 Warrants. The May 2009 Warrants are to acquire at any time commencing on November 14, 2004 through April 30, 2009 an aggregate of 1,300,000 shares of common stock at a price of $4.50 per share. This transaction generated a non-cash charge of about $2,355,000 in financing costs during the second quarter of 2004. Upon completion of the August 2004 Private Placement (see below), the exercise price was lowered to $4.008 per share. On May 14, 2005, the exercise price of these May 2009 Warrants was reset again to 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 May 15, 2004 and May 13, 2005. The exercise price (and the reset price) under the May 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 $4.008 per share. The financing associated with the second reset was not material. The Company entered into Registration Rights Agreements with the investors in connection with the issuance of (i) the Debentures; (ii) the June 2008, July 2008, October 2008, July 2009, and May 2009 Warrants (collectively, the "Warrants"); and (iii) the shares issued in January 2004. Pursuant to the Registration Rights Agreements the Company has registered on behalf of the investors the shares issued to them in January 2004 and 135% of the shares issuable upon conversion of the Debentures and upon exercise of all of the Warrants. If, subject to certain exceptions, sales of all shares so registered cannot be made pursuant to the registration statements, then the Company will be required to pay to the investors their pro rata share of $.00067 times the outstanding principal amount of the relevant Debentures for each day the above condition exists. As discussed below, 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 our outstanding common stock (the "Exchange Cap"). The Debentures (including the July 2004 Debentures) and Warrants have provisions that require us 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. As of June 30, 2005, the investors have converted $13,062,328 principal amount of debt from the Debentures issued in March, July and October 2003 and January 2004 into 7,667,674 shares of our common stock. $1,555,554 of principal was repaid with the issuance of 873,038 shares of stock. The March and July Debentures have been fully converted. The remaining principal balance on the outstanding Debentures is convertible into shares of our stock at the option of the investors at any time, through the maturity date. In addition, 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, 2005 have been accounted for as advances receivable and are reflected as such on the accompanying balance sheet as of June 30, 2005. The cash collateral account provides partial security for repayment of the outstanding Debentures in the event of default. By agreement with Cardinal Securities, LLC, for general financial advisory services and in conjunction with the private debenture placements in July and October 2003 and in January, May and July 2004, the Company paid Cardinal Securities, LLC an investment banking fee equal to 7% of the investments made by the two Debenture holders and issued to Cardinal the following warrants to purchase common stock: (i) 112,500 exercisable at $2.57 per share; (ii) 87,500 exercisable at $2.42 per share; and (iii) 100,000 exercisable at $3.04 per share. The $2.57 warrants expire on July 10, 2008, the $2.42 warrants expire on October 29, 2008 and the $3.04 warrants expire on January 5, 2009. With regard to the exercise of the June 2008 Warrants and issuance of the May 2009 Warrants, Cardinal received an investment banking fee of 7%, half in cash and half in shares. With regard to the exercise of the Additional Investment Rights, the July 2008 and October 2008 Warrants and issuance of the July 2009 Warrants, Cardinal received an investment banking fee of 7%, 146,980 in cash and 22,703 in shares as well as 50,000 warrants exercisable at $4.07 expiring on July 12, 2009. By agreement with Cardinal, the Company has registered all of the foregoing shares and shares issuable upon exercise of the above mentioned warrants for public sale and the Company has agreed to register the balance. As a result of all of the transactions discussed above, the Company recorded $1,430,000 as additional debt discounts. Section 713 of the 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 our outstanding common stock (the "Exchange Cap"). Taken separately, the July 2003, October 2003 and January 2004 Debenture transactions do not trigger Section 713. However, the AMEX took the position that the three 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 $1,244,000. This liability represented the fair market value of the warrants and beneficial conversion feature related to the 1,299,000 shares. In addition, in accordance with EITF 00-19, the Company revalued this redemption obligation associated with the beneficial conversion feature and warrants as of March 31, 2004. The Company recorded an additional redemption obligation and finance charge of $947,000 as a result of this revaluation. Upon stockholder approval, our redemption obligation was recorded as additional paid in capital as of the date approval was received. The requisite 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 beneficial conversion feature and warrants as of June 23, 2004. The Company recorded a reduction in the value of the redemption obligation and financing charge of $260,000 as a result of this revaluation. In addition, upon receiving the requisite stockholder approval, this redemption obligation was reclassified as additional paid in capital as of the date the approval was received or June 23, 2004. On July 13, 2004, the Debenture holders exercised all of the July 2003 and October 2003 Warrants and the Additional Investment Rights amounting to approximately $4,198,980 in gross proceeds to the Company. The Company issued to these holders warrants (the "June 2009 Warrants") to purchase an aggregate of 1,300,000 shares of common stock. The issuance of these warrants resulted in an additional debt discount to the note of $1,320,000 as explained below and a financing charge of $2,351,000. 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 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. Not withstanding the foregoing, the exercise price as reset or adjusted for anti-dilution, will in no event be less than $3.33 per share. Upon completion of the August 2004 Private Placement (see below), the exercise price was lowered to $3.33 per share. This transaction was subject to a non-cash financing charge of $1,320,000 to be amortized over the remaining life of the October 2003 Debentures. 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. On August 5, 2004, the Company closed a private placement with select institutional investors of approximately 3,617,300 shares of its Common Stock and warrants to purchase an aggregate of up to approximately 1,085,200 shares of its Common Stock. Jefferies & Company, Inc. acted as Placement Agent for which it received a fee and warrants to purchase Common Stock. The Company raised approximately $6,984,000 net proceeds from this private offering. The Warrant issued to each purchaser is exercisable for up to 30% of the number of shares of Common Stock purchased by such Purchaser, at an exercise price equal to $2.86 per share. Each Warrant has a term of five years and is fully exercisable from the date of issuance. Pursuant to the Registration Rights Agreement, made and entered into as of August 5, 2004 (the "Rights Agreement"), the Company has registered the resales of the shares issued to the Purchasers and shares issuable upon the exercise of the Warrants. By agreement with Cardinal Securities, LLC, for general financial advisory services and in conjunction with the August 2004 Private Placement with select institutional investors, the Company paid Cardinal Securities, LLC an investment banking fee of $140,000. The Company paid Cardinal one-half of the fee in cash with the remainder being paid with the issuance of 50,000 warrants to purchase common stock exercisable at $2.50 per share expiring on March 31, 2010. Closing of the August 2004 Private Placement triggered the anti-dilution provisions of the January 2004 Debentures and the July 2004 Debentures and the July 2009 Warrants and the June 2009 Warrants. The conversion price adjustment for the Debentures noted above resulted in an adjustment of $1,320,000 in the third quarter 2004 to the Debenture discount and additional paid-in-capital. Any adjustment to the Debenture discount will be amortized over the remaining life of the Debentures. The exercise price adjustment for the above warrants resulted in a non-cash financing adjustment in the third quarter 2004 upon revaluing the warrants at the new anti-dilution pricing using the Black-Scholes Method. The March, July, October, January 2004 and July 2004 issuances of 6% Senior Convertible Debentures in the principal amounts of $5,426,000, $5,426,000, $4,142,357 and $4,000,000 and $2,000,000 respectively and related embedded conversion features and warrants issuances were accounted for in accordance with EITF 98-5: Accounting for convertible securities with beneficial conversion features or contingency adjustable conversion and with EITF No. 00-27: Application of issue No. 98-5 to Certain convertible instruments. The Company determined the fair values to be ascribed to detachable warrants issued with the convertible debentures utilizing the Black-Scholes method. The Company recorded debt discounts of approximately $17.8 million which, in effect, reduced the carrying value of the debt to $3.2 million. 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, 2005, the Company was in compliance with debt covenants contained within its debenture agreements. In connection with the Debenture agreements, the Company has outstanding letters of credit of $1 million as additional collateral. Note 8: EXECUTIVE COMPENSATION In order to facilitate the Company's need to obtain financing and prior to our stockholders approving an amendment to our corporate charter to increase the number of authorized shares, Dr. Carter agreed to waive his right to exercise certain warrants and options unless and until our stockholders approved an increase in our authorized shares of Common Stock. In October 2003, in recognition of this action as well as Dr. Carter's prior and on-going efforts relating to product development securing critically needed financing and the acquisition of a new product line, the Compensation Committee determined that Dr. Carter be awarded bonus compensation in 2003 consisting of $196,636 and a grant of 1,450,000 stock warrants with an exercise price of $2.20 per share. This additional compensation was reviewed by an independent valuation firm and found to be fair and reasonable within the context of total compensation paid to chief executive officers of comparable biotechnology companies. In the quarter ended March 31, 2004, Dr. Carter was awarded an additional bonus of $99,481 by the Compensation Committee. In addition, The Company recorded a non-cash stock compensation charge of $1,769,000 during the first quarter 2004 resulting from warrants issued to Dr. Carter in 2003 that vested upon the execution of the second ISI asset closing on March 17, 2004. This was determined by subtracting the exercise price from the stock closing price on March 17, 2004 and multiplying the result by the number of warrants. Note 9 - EQUITY INCENTIVE PLAN The Equity Incentive Plan authorizes the grant of non-qualified and incentive stock options, stock appreciation rights, restricted stock and other stock awards. The Equity Incentive Plan provides for awards to be made to such officers, other key employees, non-employee directors, consultants and advisors of the Company and its subsidiaries as the board of directors may select. A maximum of 8,000,000 shares of common stock is reserved for potential issuance. Unless sooner terminated, the Equity Incentive Plan will continue in effect for a period of 10 years from its effective date. As of June 30, 2005, the Company has granted 1,163,080 options to directors, officers and employees pursuant to the terms of this plan. Note 10 - COMMITMENTS In May 2005, the Company committed to purchase lab equipment related to the manufacture of Ampligen raw material in the amount of approximately $628,000. The Company paid the initial deposit of approximately $31,400 in May 2005. Note 11 - SUSEQUENT EVENTS On July 8, 2005, the Company entered into a common stock purchase agreement with Fusion Capital Fund II, LLC, pursuant to which Fusion Capital has agreed, under certain conditions, to purchase on each trading day $40,000 of the Company's common stock up to an aggregate of $20.0 million over approximately a 25 month period, subject to earlier termination at the Company's discretion. In the Company's discretion, the Company may elect to sell less of the Company's common stock to Fusion Capital than the daily amount and the Company may increase the daily amount as the market price of the Company's stock increases. The purchase price of the shares of common stock will be equal to a price based upon the future market price of the common stock without any fixed discount to the market price. Fusion Capital does not have the right or the obligation to purchase shares of the Company's common stock in the event that the price of the Company's common stock is less than $1.00 Pursuant to the agreement with Fusion Capital, the Company has registered for public sale by Fusion Capital up to 10,795,597 shares of the Company's common stock. However, in the event that the Company decides to issue more than 10,113,278, i.e. greater than 19.99% of the outstanding shares of common stock as of the date of the agreement, the Company would first seek stockholder approval in order to be in compliance with American Stock Exchange rules. ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations. Special Note Regarding Forward-Looking Statements Certain statements in this document constitute "forwarding-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1995 (collectively, the "Reform Act"). Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward- looking terminology such as "believes," "expects," "may," "will," "should," or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. All statements other than statements of historical fact, included in this report regarding our financial position, business strategy and plans or objectives for future operations are forward-looking statements. Without limiting the broader description of forward-looking statements above, we specifically note that statements regarding potential drugs, their potential therapeutic effect, the possibility of obtaining regulatory approval, our ability to manufacture and sell any products, market acceptance or our ability to earn a profit from sales or licenses of any drugs or our ability to discover new drugs in the future are all forward-looking in nature. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to, the risk factors discussed below, which may cause the actual results, performance or achievements of Hemispherx and its subsidiaries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements and other factors referenced in this report. We do not undertake and specifically decline any obligation to publicly release the results of any revisions which may be made to any forward-looking statement to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Overview We are a biopharmaceutical company engaged in the clinical development, manufacture, marketing and distribution of new drug entities based on natural immune system enhancing technologies for the treatment of viral and immune based chronic disorders. We were founded in the early 1970s, as a contract researcher for the National Institutes of Health. After almost 30 years, we have established a strong foundation of laboratory, pre-clinical, and clinical data with respect to the development of nucleic acids to enhance the natural antiviral defense system of the human body and to aid the development of therapeutic products for the treatment of chronic diseases. We own a U.S. Food and Drug Administration ("FDA") approved GMP (good manufacturing practice) manufacturing facility in New Jersey, and our corporate offices are in Philadelphia, PA. Our flagship products include Ampligen and Alferon. Ampligen is an experimental drug undergoing clinical trials for the treatment of: Myalgic Encephalomyelitis/Chronic Fatigue Syndrome (ME/CFS), HIV, and HIV/Hepatitis C co-infection. In August 2004, we completed a Phase III clinical trial treating over 230 ME/CFS patients with Ampligen and are in the process of preparing a new drug application to be filed with the FDA. Alferon N Injection is the registered trademark for our injectable formulation of Natural Alpha Interferon, which is approved by the FDA for the treatment of genital warts. Alferon N is also in clinical development for treating Hepatitis C ("HEP-C"), Multiple Sclerosis, Human Immunodeficiency Virus (HIV), West Nile Virus ("WNV") and Severe Acute Respiratory Syndrome (SARS). We have over 140 patents worldwide with 10 additional patents pending comprising our intellectual property. We continually review our patents rights periodically to determine whether they have continuing value. Such review includes an analysis of the patent's ultimate revenue and profitability potential on an undiscounted cash basis to support the realizability of our respective capitalized cost. In addition, management's review addresses whether each patent continues to fit into our strategic business plans. We have a fully commercialized product (Alferon), and a GMP certified manufacturing facility. In March 2004, we completed the step-by-step acquisition from Interferon Sciences, Inc. ("ISI") of ISI's commercial assets, Alferon N inventory, a worldwide license for the production, manufacture, use, marketing and sale of Alferon N. As well as, a 43,000 square foot manufacturing facility in New Jersey and the acquisition of all intellectual property related to Alferon. Alferon N is a natural alpha interferon that has been approved by the FDA for commercial sale for the intra-lesional treatment of refractory or recurring external genital warts in patients 18 years of age or older. The acquisition was completed in Spring 2004 with the acquisition of all world wide commercial rights. We outsource certain components of our research and development, manufacturing, marketing and distribution while maintaining control over the entire process through our quality assurance group and our clinical monitoring group. Since the completion of our AMP 516 ME/CFS Phase III clinical trial for use of Ampligen(R) in the treatment of ME/CFS we have received inquiries from and, under confidentiality agreements, are having dialogue with other companies regarding marketing opportunities. No proposals or agreements have resulted from the dialogue, nor can we be assured that any proposals or agreements will result from these inquiries. RISK FACTORS The following cautionary statements identify important factors that could cause our actual result to differ materially from those projected in the forward-looking statements made in this report. Among the key factors that have a direct bearing on our results of operations are: No assurance of successful product development Ampligen(R) and related products. The development of Ampligen(R) and our other related products is subject to a number of significant risks. Ampligen(R) may be found to be ineffective or to have adverse side effects, fail to receive necessary regulatory clearances, be difficult to manufacture on a commercial scale, be uneconomical to market or be precluded from commercialization by proprietary right of third parties. Our products are in various stages of clinical and pre-clinical development and, require further clinical studies and appropriate regulatory approval processes before any such products can be marketed. We do not know when, if ever, Ampligen(R) or our other products will be generally available for commercial sale for any indication. Generally, only a small percentage of potential therapeutic products are eventually approved by the FDA for commercial sale. ALFERON N Injection(R). Although ALFERON N Injection(R) is approved for marketing in the United States for the intralesional treatment of refractory or recurring external genital warts in patients 18 years of age or older; to date it has not been approved for other indications. We face many of the risks discussed above, with regard to developing this product for use to treat other ailments such as multiple sclerosis and cancer. Our drug and related technologies are investigational and subject to regulatory approval. If we are unable to obtain regulatory approval, our operations will be significantly affected. All of our drugs and associated technologies other than ALFERON N Injection(R) are investigational and must receive prior regulatory approval by appropriate regulatory authorities for general use and are currently legally available only through clinical trials with specified disorders. At present, ALFERON N Injection(R) is only approved for the intralesional treatment of refractory or recurring external genital warts in patients 18 years of age or older. Use of ALFERON N Injection(R) for other indications will require regulatory approval. In this regard, ISI, the company from which we obtained our rights to ALFERON N Injection(R), conducted clinical trials related to use of ALFERON N Injection(R) for treatment of HIV and Hepatitis C. In both instances, the FDA determined that additional studies were necessary in order to fully evaluate the efficacy of ALFERON N Injection(R) in the treatment of HIV and Hepatitis C diseases. We have no immediate plans to conduct these additional studies at this time. Our products, including Ampligen(R), are subject to extensive regulation by numerous governmental authorities in the U.S. and other countries, including, but not limited to, the FDA in the U.S., the Health Protection Branch ("HPB") of Canada, and the European Medical Evaluation Agency ("EMEA") in Europe. Obtaining regulatory approvals is a rigorous and lengthy process and requires the expenditure of substantial resources. In order to obtain final regulatory approval of a new drug, we must demonstrate to the satisfaction of the regulatory agency that the product is safe and effective for its intended uses and that we are capable of manufacturing the product to the applicable regulatory standards. We require regulatory approval in order to market Ampligen(R) or any other proposed product and receive product revenues or royalties. We cannot assure you that Ampligen(R) will ultimately be demonstrated to be safe or efficacious. In addition, while Ampligen(R) is authorized for use in clinical trials in the United States, we cannot assure you that additional clinical trial approvals will be authorized in the United States or in other countries, in a timely fashion or at all, or that we will complete these clinical trials. If Ampligen(R) or one of our other products does not receive regulatory approval in the U.S. or elsewhere, our operations most likely will be materially adversely affected. We may continue to incur substantial losses and our future profitability is uncertain. We began operations in 1966 and last reported net profit from 1985 through 1987. Since 1987, we have incurred substantial operating losses, as we pursued our clinical trial effort and expanded our efforts in Europe. As of June 30, 2005 our accumulated deficit was approximately $144,854,000. 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, 2005, we had approximately $12,614,000 in cash and cash equivalents and short-term investments. These funds should be sufficient to meet our operating cash requirements including debt service for the near term. However, we may need to raise additional funds through additional equity or debt financing or from other sources in order to complete the necessary clinical trials and the regulatory approval processes including the commercializing of Ampligen(R) products. There can be no assurances that we will raise adequate funds which may have a material adverse effect on our ability to develop our products. Also, we have the ability to curtail discretionary spending, including some research and development activities, if required to conserve cash. Under the common stock purchase agreement signed with Fusion Capital on July 8, 2005, we only have the right to receive $40,000 per trading day unless our stock price equals or exceeds $2.00, in which case the daily amount may be increased under certain conditions as the price of our common stock increases (For a more detailed description of the terms of this agreement, see the agreement filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 11, 2005). Fusion Capital shall not have the right nor the obligation to purchase any shares of our common stock on any trading days that the market price of our common stock is less than $1.00. Since we initially registered 10,000,000 shares purchasable by Fusion Capital pursuant to the common stock purchase agreement, the selling price of our common stock to Fusion Capital will have to average at least $2.00 per share for us to receive the maximum proceeds of $20.0 million without registering additional shares of common stock. Assuming a purchase price of $1.56 per share (the closing sale price of the common stock on August 2, 2005) and the purchase by Fusion Capital of the full 10,000,000 shares under the common stock purchase agreement, proceeds to us would only be $15,600,000. Subject to approval by our board of directors, we have the right, but not the obligation, to issue more than 10,000,000 shares to Fusion Capital. In the event we elect to issue more than 10,000,000 shares, we will be required to file a new registration statement and have it declared effective by the Securities and Exchange Commission. In the event that we decide to issue more than 10,113,278 (19.99% of our outstanding shares of common stock as of the date of our agreement), we would first be required to seek stockholder approval in order to be in compliance with the American Stock Exchange Market rules. The extent we rely on Fusion Capital as a source of funding will depend on a number of factors including, the prevailing market price of our common stock and the extent to which we are able to secure working capital from other sources. Specifically, Fusion Capital shall not have the right nor the obligation to purchase any shares of our common stock on any trading days that the market price of our common stock is less than $1.00. If obtaining sufficient financing from Fusion Capital were to prove unavailable or prohibitively dilutive and if we are unable to commercialize and sell Ampligen(R) and/or increase sales of ALFERON N Injection(R) or our other products, we will need to secure another source of funding in order to satisfy our working capital needs. Even if we are able to access the full $20.0 million under the common stock purchase agreement with Fusion Capital, we may still need additional capital to fully implement our business, operating and development plans. Should the financing we require to sustain our working capital needs be unavailable or prohibitively expensive when we require it, the consequences would materially adversely affect our business, operating results, financial condition and prospects. We may not be profitable unless we can protect our patents and/or receive approval for additional pending patents. We need to preserve and acquire enforceable patents covering the use of Ampligen(R) for a particular disease in order to obtain exclusive rights for the commercial sale of Ampligen(R) for such disease. We obtained all rights to ALFERON N Injection(R), and we plan to preserve and acquire enforceable patents covering its use for existing and potentially new diseases. Our success depends, in large part, on our ability to preserve and obtain patent protection for our products and to obtain and preserve our trade secrets and expertise. Certain of our know-how and technology is not patentable, particularly the procedures for the manufacture of our drug product which are carried out according to standard operating procedure manuals. We have been issued certain patents including those on the use of Ampligen(R) and Ampligen(R) in combination with certain other drugs for the treatment of HIV. We also have been issued patents on the use of Ampligen(R) in combination with certain other drugs for the treatment of chronic Hepatitis B virus, chronic Hepatitis C virus, and a patent which affords protection on the use of Ampligen(R) in patients with Chronic Fatigue Syndrome. We have not yet been issued any patents in the United States for the use of Ampligen(R) as a sole treatment for any of the cancers, which we have sought to target. With regard to ALFERON N Injection(R), we have acquired from ISI its patents for natural alpha interferon produced from human peripheral blood leukocytes and its production process. We cannot assure that our competitors will not seek and obtain patents regarding the use of similar products in combination with various other agents, for a particular target indication prior to our doing such. If we cannot protect our patents covering the use of our products for a particular disease, or obtain additional patents, we may not be able to successfully market our products. The patent position of biotechnology and pharmaceutical firms is highly uncertain and involves complex legal and factual questions. To date, no consistent policy has emerged regarding the breadth of protection afforded by pharmaceutical and biotechnology patents. There can be no assurance that new patent applications relating to our products or technology will result in patents being issued or that, if issued, such patents will afford meaningful protection against competitors with similar technology. It is generally anticipated that there may be significant litigation in the industry regarding patent and intellectual property rights. Such litigation could require substantial resources from us and we may not have the financial resources necessary to enforce the patent rights that we hold. No assurance can be made that our patents will provide competitive advantages for our products or will not be successfully challenged by competitors. No assurance can be given that patents do not exist or could not be filed which would have a materially adverse effect on our ability to develop or market our products or to obtain or maintain any competitive position that we may achieve with respect to our products. Our patents also may not prevent others from developing competitive products using related technology. There can be no assurance that we will be able to obtain necessary licenses if we cannot enforce patent rights we may hold. In addition, the failure of third parties from whom we currently license certain proprietary information or from whom we may be required to obtain such licenses in the future, to adequately enforce their rights to such proprietary information, could adversely affect the value of such licenses to us. If we cannot enforce the patent rights we currently hold we may be required to obtain licenses from others to develop, manufacture or market our products. There can be no assurance that we would be able to obtain any such licenses on commercially reasonable terms, if at all. We currently license certain proprietary information from third parties, some of which may have been developed with government grants under circumstances where the government maintained certain rights with respect to the proprietary information developed. No assurances can be given that such third parties will adequately enforce any rights they may have or that the rights, if any, retained by the government will not adversely affect the value of our license. There is no guarantee that our trade secrets will not be disclosed or known by our competitors. To protect our rights, we require certain employees and consultants to enter into confidentiality agreements with us. There can be no assurance that these agreements will not be breached, that we would have adequate and enforceable remedies for any breach, or that any trade secrets of ours will not otherwise become known or be independently developed by competitors. If our distributors do not market our products successfully, we may not generate significant revenues or become profitable. We have limited marketing and sales capability. We are dependent upon existing and, possibly future, marketing agreements and third party distribution agreements for our products in order to generate significant revenues and become profitable. As a result, any revenues received by us will be dependent on the efforts of third parties, and there is no assurance that these efforts will be successful. Our agreement with Accredo offers the potential to provide some marketing and distribution capacity in the United States while agreements with Bioclones (Proprietary), Ltd, Biovail Corporation and Laboratorios Del Dr. Esteve S.A. may provide a sales force in South America, Africa, United Kingdom, Australia and New Zealand, Canada, Spain and Portugal. On December 27, 2004, we initiated a lawsuit in Federal Court identifying a conspiratorial group seeking to illegally manipulate our stock for purposes of bringing about the hostile takeover of Hemispherx. This conspiratorial group includes Bioclones and the potential legal action may adversely effect our agreement with Bioclones and the potential for marketing and distribution capacity in South America, Africa, United Kingdom, Australia and New Zealand. See Item 1: "Legal Proceedings" in Part II - Other Information below for more information. We cannot assure that our domestic or foreign marketing partners will be able to successfully distribute our products, or that we will be able to establish future marketing or third party distribution agreements on terms acceptable to us, or that the cost of establishing these arrangements will not exceed any product revenues. The failure to continue these arrangements or to achieve other such arrangements on satisfactory terms could have a materially adverse effect on us. There are no long-term agreements with suppliers of required materials. If we are unable to obtain the required raw materials, we may be required to scale back our operations or stop manufacturing ALFERON N Injection and/or Ampligen(R). A number of essential materials are used in the production of ALFERON N Injection(R), including human white blood cells. We do not have long-term agreements for the supply of any of such materials. There can be no assurance we can enter into long-term supply agreements covering essential materials on commercially reasonable terms, if at all. At present, we do not have any agreements with third parties for the supply of any polymers for use in manufacturing Ampligen. We have consolidated relevant manufacturing operations into our New Brunswick, New Jersey facility for the production of Ampligen raw materials. This consolidation and transfer of manufacturing operations has been implemented as an inspection of the Ribotech facility in South Africa, our previous supplier of Ampligen(R) raw materials, indicated that it did not, at present, meet the necessary GMP standards for a fully certified commercial process. The transfer of Ampligen(R) raw materials manufacture to our own facilities, while having obvious advantages with respect to regulatory compliance (other parts of the 43,000 sq. ft. wholly owned facility are already in compliance for Alferon N manufacture), may delay certain steps in the commercialization process, specifically a targeted NDA filing. If we are unable to obtain the required raw materials, we may be required to scale back our operations or stop manufacturing. The costs and availability of products and materials we need for the production of Ampligen(R) and the commercial production of ALFERON N Injection(R) and other products which we may commercially produce are subject to fluctuation depending on a variety of factors beyond our control, including competitive factors, changes in technology, and FDA and other governmental regulations and there can be no assurance that we will be able to obtain such products and materials on terms acceptable to us or at all. There is no assurance that successful manufacture of a drug on a limited scale basis for investigational use will lead to a successful transition to commercial, large-scale production. Small changes in methods of manufacturing may affect the chemical structure of Ampligen(R) and other RNA drugs, as well as their safety and efficacy. Changes in methods of manufacture, including commercial scale-up may affect the chemical structure of Ampligen(R) and can, among other things, require new clinical studies and affect orphan drug status, particularly, market exclusivity rights, if any, under the Orphan Drug Act. The transition from limited production of pre-clinical and clinical research quantities to production of commercial quantities of our products will involve distinct management and technical challenges and will require additional management and technical personnel and capital to the extent such manufacturing is not handled by third parties. There can be no assurance that our manufacturing will be successful or that any given product will be determined to be safe and effective, capable of being manufactured economically in commercial quantities or successfully marketed. We have limited manufacturing experience and capacity. Ampligen(R) has been only produced in limited quantities for use in our clinical trials and we are dependent upon third party suppliers for key components of our products and for substantially all of the production process. The failure to continue these arrangements or to achieve other such arrangements on satisfactory terms could have a material adverse affect on us. Also, to be successful, our products must be manufactured in commercial quantities in compliance with regulatory requirements and at acceptable costs. To the extent we are involved in the production process, our current facilities are not adequate for the production of our proposed products for large-scale commercialization, and we currently do not have adequate personnel to conduct commercial-scale manufacturing. We intend to utilize third-party facilities if and when the need arises or, if we are unable to do so, to build or acquire commercial-scale manufacturing facilities. We will need to comply with regulatory requirements for such facilities, including those of the FDA and HPB pertaining to current Good Manufacturing Practices ("cGMP") regulations. There can be no assurance that such facilities can be used, built, or acquired on commercially acceptable terms, or that such facilities, if used, built, or acquired, will be adequate for our long-term needs. In connection with settling various manufacturing infractions previously noted by the FDA, Schering-Plough ("Schering") entered into a "Consent Decree" with the FDA whereby, among other things, it agreed to discontinue various contract (third party) manufacturing activities at various facilities including its San Juan, Puerto Rico, plant. Ampligen(R) (which was not involved in any of the cited infractions) was produced at this Puerto Rico plant from year 2000-2004. Operating under instructions from the Consent Decree, Schering has advised us that it would no longer manufacture Ampligen(R) in this facility beyond 2004 and would assist us in an orderly transfer of said activities to other non Schering facilities. We had entered into a Confidentiality Agreement with Mayne Pharma Pty, Ltd ("Mayne") to lead to reinitiation and expansion of its Ampligen(R) manufacturing program. However, senior management at Mayne's Mulgrave operations in Australia recently informed us that they are ceasing to continue with all development activities associated with potential contract customers and all other contract business will be progressively scaled down over the next couple of years. Therefore, Mayne's Mulgrave facility in Australia will no longer be a possibility for manufacturing. We have obtained two proposals from manufacturers in the US and expect to obtain at least two more for the manufacturing of Ampligen. We want to qualify at least two GMP facilities in order to maintain a minimum of two independent production sites. We are in the process of reviewing these proposals. If we are unable to engage a contract manufacturer in a timely manner, our plans to file an NDA for Ampligen(R) and, eventually, to market and sell Ampligen(R) will be delayed. The purified drug concentrate utilized in the formulation of ALFERON N Injection(R) is manufactured in our New Brunswick, New Jersey facility and ALFERON N Injection(R) was formulated and packaged at a production facility formerly owned and operated by Abbott Laboratories located in Kansas. Abbott Labs has sold the facility to Hospira. We currently have 12,000 vials at Hospira in purified drug concentrate form. Hospira will complete the labeling and packaging of this lot. We have identified five new potential contract manufacturers and obtained proposals for all five concerning the future formulation and packaging of Alferon. If we are unable to secure a new facility within a reasonable period of time to formulate and package ALFERON N Injection(R) at an acceptable cost, our ability to sell ALFERON N Injection(R) and to generate profits therefrom will be adversely affected. We may not be profitable unless we can produce Ampligen(R) or other products in commercial quantities at costs acceptable to us. We have never produced Ampligen(R) or any other products in large commercial quantities. We must manufacture our products in compliance with regulatory requirements in large commercial quantities and at acceptable costs in order for us to be profitable. We intend to utilize third-party manufacturers and/or facilities if and when the need arises or, if we are unable to do so, to build or acquire commercial-scale manufacturing facilities. If we cannot manufacture commercial quantities of Ampligen(R) or enter into third party agreements for its manufacture at costs acceptable to us, our operations will be significantly affected. Also, each production lot of Alferon N Injection(R) is subject to FDA review and approval prior to releasing the lots to be sold. This review and approval process could take considerable time, which would delay our having product in inventory to sell. Alferon N Injection(R) presently has a shelf life of 18 months after having been bottled. Studies were completed in 2004 to possibly extend the shelf life to 24 months. We filed our annual report with the FDA in December 2004 informing them of the extension of shelf-life for Alferon N Injection(R). We filed the request with the FDA in May 2005 requesting approval to relabel the first 2,000 vials with an extended shelf-life of 24 months. We received a response from the FDA at the end of June 2005 concerning our relabeling request of Alferon N Injection(R). After reviewing the information submitted, the FDA determined the submission as a "Prior Approval Supplement". We have been informed by the FDA that we will receive a response to the relabeling Prior Approval Supplement by September 22, 2005. Rapid technological change may render our products obsolete or non-competitive. The pharmaceutical and biotechnology industries are subject to rapid and substantial technological change. Technological competition from pharmaceutical and biotechnology companies, universities, governmental entities and others diversifying into the field is intense and is expected to increase. Most of these entities have significantly greater research and development capabilities than us, as well as substantial marketing, financial and managerial resources, and represent significant competition for us. There can be no assurance that developments by others will not render our products or technologies obsolete or noncompetitive or that we will be able to keep pace with technological developments. Our products may be subject to substantial competition. Ampligen(R). Competitors may be developing technologies that are, or in the future may be, the basis for competitive products. Some of these potential products may have an entirely different approach or means of accomplishing similar therapeutic effects to products being developed by us. These competing products may be more effective and less costly than our products. In addition, conventional drug therapy, surgery and other more familiar treatments may offer competition to our products. Furthermore, many of our competitors have significantly greater experience than us in pre-clinical testing and human clinical trials of pharmaceutical products and in obtaining FDA, HPB and other regulatory approvals of products. Accordingly, our competitors may succeed in obtaining FDA, HPB or other regulatory product approvals more rapidly than us. There are no drugs approved for commercial sale with respect to treating ME/CFS in the United States. The dominant competitors with drugs to treat HIV diseases include Gilead Pharmaceutical, Pfizer, Bristol-Myers, Abbott Labs, Glaxo Smithkline, Merck and Schering-Plough Corp. These potential competitors are among the largest pharmaceutical companies in the world, are well known to the public and the medical community, and have substantially greater financial resources, product development, and manufacturing and marketing capabilities than we have. Although we believe our principal advantage is the unique mechanism of action of Ampligen(R) on the immune system, we cannot assure that we will be able to compete. ALFERON N Injection(R). Many potential competitors are among the largest pharmaceutical companies in the world, are well known to the public and the medical community, and have substantially greater financial resources, product development, and manufacturing and marketing capabilities than we have. ALFERON N Injection(R) currently competes with Schering's injectable recombinant alpha interferon product (INTRON(R) A) for the treatment of genital warts. 3M Pharmaceuticals also received FDA approval for its immune-response modifier, Aldara(R), a self-administered topical cream, for the treatment of external genital and perianal warts. ALFERON N Injection(R) also competes with surgical, chemical, and other methods of treating genital warts. We cannot assess the impact products developed by our competitors, or advances in other methods of the treatment of genital warts, will have on the commercial viability of ALFERON N Injection(R). If and when we obtain additional approvals of uses of this product, we expect to compete primarily on the basis of product performance. Our potential competitors have developed or may develop products (containing either alpha or beta interferon or other therapeutic compounds) or other treatment modalities for those uses. In the United States, three recombinant forms of beta interferon have been approved for the treatment of relapsing-remitting multiple sclerosis. There can be no assurance that, if we are able to obtain regulatory approval of ALFERON N Injection(R) for the treatment of new indications, we will be able to achieve any significant penetration into those markets. In addition, because certain competitive products are not dependent on a source of human blood cells, such products may be able to be produced in greater volume and at a lower cost than ALFERON N Injection(R). Currently, our wholesale price on a per unit basis of ALFERON N Injection(R) is higher than that of the competitive recombinant alpha and beta interferon products. General. Other companies may succeed in developing products earlier than we do, obtaining approvals for such products from the FDA more rapidly than we do, or developing products that are more effective than those we may develop. While we will attempt to expand our technological capabilities in order to remain competitive, there can be no assurance that research and development by others or other medical advances will not render our technology or products obsolete or non-competitive or result in treatments or cures superior to any therapy we develop. Possible side effects from the use of Ampligen(R) or ALFERON N Injection(R) could adversely affect potential revenues and physician/patient acceptability of our product. Ampligen(R). We believe that Ampligen(R) has been generally well tolerated with a low incidence of clinical toxicity, particularly given the severely debilitating or life threatening diseases that have been treated. A mild flushing reaction has been observed in approximately 15% of patients treated in our various studies. This reaction is occasionally accompanied by a rapid heart beat, a tightness of the chest, urticaria (swelling of the skin), anxiety, shortness of breath, subjective reports of "feeling hot," sweating and nausea. The reaction is usually infusion-rate related and can generally be controlled by slowing the infusion rate. Other adverse side effects include liver enzyme level elevations, diarrhea, itching, asthma, low blood pressure, photophobia, rash, transient visual disturbances, slow or irregular heart rate, decreases in platelets and white blood cell counts, anemia, dizziness, confusion, elevation of kidney function tests, occasional temporary hair loss and various flu-like symptoms, including fever, chills, fatigue, muscular aches, joint pains, headaches, nausea and vomiting. These flu-like side effects typically subside within several months. One or more of the potential side effects might deter usage of Ampligen(R) in certain clinical situations and therefore, could adversely affect potential revenues and physician/patient acceptability of our product. ALFERON N Injection(R). At present, ALFERON N Injection(R) is only approved for the intralesional (within the lesion) treatment of refractory or recurring external genital warts in adults. In clinical trials conducted for the treatment of genital warts with ALFERON N Injection(R), patients did not experience serious side effects; however, there can be no assurance that unexpected or unacceptable side effects will not be found in the future for this use or other potential uses of ALFERON N Injection(R) which could threaten or limit such product's usefulness. We may be subject to product liability claims from the use of Ampligen(R) or other of our products which could negatively affect our future operations. We face an inherent business risk of exposure to product liability claims in the event that the use of Ampligen(R) or other of our products results in adverse effects. This liability might result from claims made directly by patients, hospitals, clinics or other consumers, or by pharmaceutical companies or others manufacturing these products on our behalf. Our future operations may be negatively affected from the litigation costs, settlement expenses and lost product sales inherent to these claims. While we will continue to attempt to take appropriate precautions, we cannot assure that we will avoid significant product liability exposure. Although we currently maintain product liability insurance coverage, there can be no assurance that this insurance will provide adequate coverage against Ampligen and/or Alferon N Injection product liability claims. A successful product liability claim against us in excess of Ampligen's $1,000,000 in insurance coverage; $3,000,000 in aggregate, or in excess of Alferon's $5,000,000 in insurance coverage; $5,000,000 in aggregate; or for which coverage is not provided could have a negative effect on our business and financial condition. The loss of Dr. William A. Carter's services could hurt our chances for success. Our success is dependent on the continued efforts of Dr. William A. Carter because of his position as a pioneer in the field of nucleic acid drugs, his being the co-inventor of Ampligen(R), and his knowledge of our overall activities, including patents and clinical trials. The loss of Dr. Carter's services could have a material adverse effect on our operations and chances for success. We have secured key man life insurance in the amount of $2,000,000 on the life of Dr. Carter and we have an employment agreement with Dr. Carter that, as amended, runs until May 8, 2008. However, Dr. Carter has the right to terminate his employment upon not less than 30 days prior written notice. The loss of Dr. Carter or other personnel, or the failure to recruit additional personnel as needed could have a materially adverse effect on our ability to achieve our objectives. 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 and Investment in Our Common Stock The market price of our stock may be adversely affected by market volatility. The market price of our common stock has been and is likely to be volatile. In addition to general economic, political and market conditions, the price and trading volume of our stock could fluctuate widely in response to many factors, including: o announcements of the results of clinical trials by us or our competitors; o adverse reactions to products; o governmental approvals, delays in expected governmental approvals or withdrawals of any prior governmental approvals or public or regulatory agency concerns regarding the safety or effectiveness of our products; o changes in U.S. or foreign regulatory policy during the period of product development; o developments in patent or other proprietary rights, including any third party challenges of our intellectual property rights; o announcements of technological innovations by us or our competitors; o announcements of new products or new contracts by us or our competitors; o actual or anticipated variations in our operating results due to the level of development expenses and other factors; o changes in financial estimates by securities analysts and whether our earnings meet or exceed the estimates; o conditions and trends in the pharmaceutical and other industries; new accounting standards; and o the occurrence of any of the risks described in these "Risk Factors." Our common stock is listed for quotation on the American Stock Exchange. For the 12-month period ended June 30, 2005, the price of our common stock has ranged from $1.25 to $3.54 per share. We expect the price of our common stock to remain volatile. The average daily trading volume of our common stock varies significantly. Our relatively low average volume and low average number of transactions per day may affect the ability of our stockholders to sell their shares in the public market at prevailing prices and a more active market may never develop. In the past, following periods of volatility in the market price of the securities of companies in our industry, securities class action litigation has often been instituted against companies in our industry. If we face securities litigation in the future, even if without merit or unsuccessful, it would result in substantial costs and a diversion of management attention and resources, which would negatively impact our business. Our stock price may be adversely affected if a significant amount of sharesare sold in the public market. As of August 1, 2005, approximately 1,071,082 shares of our common stock, constituted "restricted securities" as defined in Rule 144 under the Securities Act of 1933, 402,798 of which are registered for public sale. Also, we have registered 21,106,907 shares issuable (i) to Fusion Capital pursuant to the common stock purchase agreement with Fusion Capital; (11) upon conversion of approximately 135% of Debentures that we issued in 2003 and 2004; (iii) as payment of 135% of the interest on all of the Debentures; (iv) upon exercise of 135% of the certain Warrants; and (v) upon exercise of certain other warrants. Registration of the shares permits the sale of the shares in the open market or in privately negotiated transactions without compliance with the requirements of Rule 144. To the extent the exercise price of the warrants is less than the market price of the common stock, the holders of the warrants are likely to exercise them and sell the underlying shares of common stock and to the extent that the conversion price and exercise price of these securities are adjusted pursuant to anti-dilution protection, the securities could be exercisable or convertible for even more shares of common stock. We also may issue shares to be used to meet our capital requirements or use shares to compensate employees, consultants and/or directors. We are unable to estimate the amount, timing or nature of future sales of outstanding common stock. Sales of substantial amounts of our common stock in the public market could cause the market price for our common stock to decrease. Furthermore, a decline in the price of our common stock would likely impede our ability to raise capital through the issuance of additional shares of common stock or other equity securities. The sale of our common stock to Fusion Capital may cause dilution and the sale of the shares of common stock acquired by Fusion Capital could cause the price of our common stock to decline. The sale by Fusion Capital of our common stock will increase the number of our publicly traded shares, which could depress the market price of our common stock. Moreover, the mere prospect of resales by Fusion Capital could depress the market price for our common stock. The issuance of shares to Fusion Capital under the common stock purchase agreement dated July 8, 2005, will dilute the equity interest of existing stockholders and could have an adverse effect on the market price of our common stock. The purchase price for the common stock to be sold to Fusion Capital pursuant to the common stock purchase agreement will fluctuate based on the price of our common stock. All shares sold to Fusion Capital are freely tradable. Fusion Capital may sell none, some or all of the shares of common stock purchased from us at any time. We expect that the shares will be sold over a period of in excess of 25 months from the date theprospectus was filed. Depending upon market liquidity at the time, a sale of shares under this offering at any given time could cause the trading price of our common stock to decline. The sale of a substantial number of shares of our common stock under this offering, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales. Provisions of our Certificate of Incorporation and Delaware law could defer a change of our management which could discourage or delay offers to acquire us. Provisions of our Certificate of Incorporation and Delaware law may make it more difficult for someone to acquire control of us or for our stockholders to remove existing management, and might discourage a third party from offering to acquire us, even if a change in control or in management would be beneficial to our stockholders. For example, our Certificate of Incorporation allows us to issue shares of preferred stock without any vote or further action by our stockholders. Our Board of Directors has the authority to fix and determine the relative rights and preferences of preferred stock. Our Board of Directors also has the authority to issue preferred stock without further stockholder approval. As a result, our Board of Directors could authorize the issuance of a series of preferred stock that would grant to holders the preferred right to our assets upon liquidation, the right to receive dividend payments before dividends are distributed to the holders of common stock and the right to the redemption of the shares, together with a premium, prior to the redemption of our common stock. In this regard, in November 2002, we adopted a stockholder rights plan and, under the Plan, our Board of Directors declared a dividend distribution of one Right for each outstanding share of Common Stock to stockholders of record at the close of business on November 29, 2002. Each Right initially entitles holders to buy one unit of preferred stock for $30.00. The Rights generally are not transferable apart from the common stock and will not be exercisable unless and until a person or group acquires or commences a tender or exchange offer to acquire, beneficial ownership of 15% or more of our common stock. However, for Dr. Carter, our chief executive officer, who already beneficially owns 10.9% of our common stock, the Plan's threshold will be 20%, instead of 15%. The Rights will expire on November 19, 2012, and may be redeemed prior thereto at $.01 per Right under certain circumstances. Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us, you should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Our research in clinical efforts may continue for the next several years and we may continue to incur losses due to clinical costs incurred in the development of Ampligen(R) for commercial application. Possible losses may fluctuate from quarter to quarter as a result of differences in the timing of significant expenses incurred and receipt of licensing fees and/or cost recovery treatment revenues in Europe, Canada and in the United States. NEW ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004) (FASB 123R), Shared-Based Payment. FASB 123R will require the Corporation to expense share-based payments, including employee stock options, based on their fair value. The Corporation is required to adopt the provisions of FASB 123R effective as of the beginning of its next fiscal year that begins after June 15, 2005. FASB 123R provides alternative methods of adoption, which include prospective application and a modified retroactive application. The Corporation is currently evaluating the financial impact, including the available alternative of adoption of FASB 123R. Disclosure About Off-Balance Sheet Arrangements Prior to our annual meeting of stockholders in September 2003, we had a limited number of shares of Common Stock authorized but not issued or reserved for issuance upon conversion or exercise of outstanding convertible and exercisable securities such as debentures, options and warrants. Prior to the meeting, to permit consummation of the sale of the July 2003 Debentures and the related warrants, Dr. Carter agreed that he would not exercise his warrants or options unless and until our stockholders approve an increase in our authorized shares of common stock. For Dr. Carter's waiver of his right to exercise certain options and warrants prior to approval of the increase in our authorized shares, we have agreed to compensate Dr. Carter. See Note 8 in the accompanying financial statements for more information concerning this transaction. In connection with the Debenture agreements, we have outstanding letters of credit of $1,000,000 as additional collateral. Critical Accounting Policies Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our significant accounting policies are described in Notes to the Consolidated Financial Statements. The significant accounting policies that we believe are most critical to aid in fully understanding our reported financial results are the following: Revenue Revenues for non-refundable license fees are recognized under the Performance Method-Expected Revenue. This method considers the total amount of expected revenue during the performance period, but limits the amount of revenue recognized in a period to total non-refundable cash received to date. This limitation is appropriate because future milestone payments are contingent on future events. Upon receipt, the upfront non-refundable payment is deferred. The non-refundable upfront payments plus non-refundable payments arising from the achievement of defined milestones are recognized as revenue over the performance period based on the lesser of (a) percentage of completion or (b) non-refundable cash earned (including the upfront payment). This method requires the computation of a ratio of cost incurred to date to total expected costs and then apply that ratio to total expected revenue. The amount of revenue recognized is limited to the total non-refundable cash received to date. Revenue from the sale of Ampligen(R) under cost recovery clinical treatment protocols approved by the FDA is recognized when the treatment is provided to the patient. Revenues from the sale of product are recognized when the product is shipped, as title is transferred to the customer. We have no other obligation associated with our products once shipment has occurred. Patents and Trademarks Patents and trademarks are stated at cost (primarily legal fees) and are amortized using the straight-line method over the estimated useful life of 17 years. We review our patents and trademark rights periodically to determine whether they have continuing value. Such review includes an analysis of the patent and trademark's ultimate revenue and profitability potential on an undiscounted cash basis to support the realizability of our respective capitalized cost. In addition, management's review addresses whether each patent continues to fit into our strategic business plans. Concentration of Credit Risk Financial instruments that potentially subject us to credit risks consist of cash equivalents and accounts receivable. Our policy is to limit the amount of credit exposure to any one financial institution and place investments with financial institutions evaluated as being credit worthy, or in short-term money markets, which are exposed to minimal interest rate and credit risks. At times, we have bank deposits and overnight repurchase agreements that exceed federally insured limits. Concentration of credit risk, with respect to receivables, is limited through our credit evaluation process. We do not require collateral on our receivables. Our receivables consist principally of amounts due from wholesale drug companies as of June 30, 2005. RESULTS OF OPERATIONS Three months ended June 30, 2005 versus Three months ended June 30, 2004 Net loss Our net loss of $3,816,000 for the three months ended June 30, 2005 was down $2,140,000 or 36% compared to the same period in 2004. The reduction was primarily due to $2,267,000 in lower costs associated with non-cash financing charges related to our convertible debentures and related warrants. In addition, expenditures for manufacturing/production were down $589,000 in 2005 reflecting the decrease in non-recurring expenses associated with the ramping up of the New Brunswick facility for further production of Alferon N Injection(R) in the second quarter of 2004. Our research and development, as well as, clinical expenses increased $400,000 over the same period in 2004 due to additional costs associated with preparing the Ampligen NDA, expenses related to patents and research related to Alferon LDO. Administrative expenses were higher than a year ago due to legal fees associated with our ongoing lawsuit against a conspiracy group. Net losses per share were $(.08) for current period versus $(.14) in the same period 2004. Revenues Revenues for the three months ended June 30, 2005 were $300,000 as compared to revenues of $331,000 for the same period in 2004. Alferon N Injection(R) sales were down $49,000 or 17% while Ampligen sold under the cost recovery clinical program was up $18,000 or 43%. Ampligen sold under the cost recovery clinical program is a product of physicians and ME/CFS patients applying to us to enroll in the program. After screening the patient's enrollment records, we ship Ampligen to the physician. A typical six month treatment therapy costs the patient about $7,200 for Ampligen. This program has been in effect for many years and is offered as a treatment option to patients severely affected by ME/CFS. As the name "cost recovery" implies, we have no gain or profit on these sales. The benefits to us include 1) physicians and patients becoming familiar with Ampligen and 2) collection of clinical data relating to the patients' treatment and results. We continue our efforts to establish an internal marketing and sales infrastructure to support the sales of Alferon N Injection in the United States, including marketing and sales support professionals based at our headquarters in Philadelphia, Pennsylvania. We are hiring and training regional sales managers and are looking to assure full sales coverage in all major US markets. Our sales force will introduce Alferon and promote Alferon to OB GYN's, dermatologists, and infectious disease physicians and particularly STD Clinics, who are involved in the treatment of patients with refractory or recurring external genital warts, as well as physicians about the growing problem and the risks of HPV. We also intend to expand our marketing/sales programs on an international basis with our primary focus on Europe. This program is being designed to engage European pharmaceutical distributors to market and distribute Alferon N. Human papillomavirus (HPV) is one of the most common causes of sexually transmitted infection in the world. Experts estimate that there are more cases of genital HPV infection than of any other sexually transmitted disease (STD) in the United States. The Centers for Disease Control and the National Institute of Health, report that approximately 20 million people are presently infected with HPV. At least one half of sexually active men and women acquire genital HPV infection at some point in their lives. By age 50, at least 80 percent of women will have gotten a genital HPV infection. Roughly 6.2 million Americans get a new genital HPV infection each year. While the market for drugs treating HPV is extremely large, there are many competing drugs. Production costs/cost of goods sold Our costs for production/cost of goods sold were down $589,000 for the three months ended June 30, 2005 compared to the same period in 2004. This decrease in production costs is primarily due to expenses incurred in the second quarter of 2004 related to preparing the New Brunswick facility for the production of Alferon. There were no such costs for Alferon N Injection in the current quarter. We are now concentrating on the completion of the consolidation of all manufacturing and research and development activities within our own Good Manufacturing Practice (GMP) Facility in New Brunswick for Ampligen. This consolidation will improve efficiency and compliance procedures and bring the facility in line with worldwide drug manufacturing standards. Cost of goods sold for the three months ended June 30, 2005 and 2004 were $103,000 and $130,000, respectively. Since acquiring the right to manufacture and market Alferon N on March 11, 2003, we have focused on converting the work-in-progress inventory into finished goods. This work-in-progress inventory included three production lots totaling the equivalent of approximately 55,000 vials (doses) at various stages of the manufacturing process. Approximately 34,000 vials have been produced. In August 2004, we released most of the second lot of product to Hospira (formerly Abbott Laboratories) for bottling and realized approximately 12,000 vials of Alferon N. Some 3,000 of the remaining vials within this lot were held back to be utilized in the development of a more compatible vial size for manufacturing of Alferon N Injection. Hospira has informed us of their intention to complete the labeling and packaging of our approximately 12,000 vials of Alferon N Injection(R) at their site. We plan to convert these 12,000 vials to finish goods by the end of the third quarter 2005. We have identified five new potential contract manufacturers to replace Hospira and obtained proposals from all five concerning the future formulation and packaging of Alferon. We are in the process of reviewing these proposals. If we are unable to secure a new facility within a reasonable period of time to formulate and package ALFERON N Injection(R) at an acceptable cost, our ability to sell ALFERON N Injection(R) and to generate profits therefrom will be adversely affected. We plan on initiating the process of converting the third lot of approximately 13,000 vials of Alferon N Injection(R) from work-in-progress to finished goods inventory in the first half of 2006. We have elected to delay the process of converting the third lot of approximately 13,000 vials from work in process to finished goods as a result of two factors: 1) we are concentrating on the relevant manufacturing operations within our New Brunswick, New Jersey facility for the production of Ampligen(R) raw materials and 2) Alferon N Injection(R) inventory on hand is sufficient to meet current demand. Approximately 2,000 vials were abstracted from the third lot for research and development purposes during the fourth quarter 2004. Our production and quality control personnel in our New Brunswick, NJ facility are involved in the extensive process of manufacturing and validation required by the FDA. We have completed the consolidation of our Rockville Quality Assurance Lab and equipment into our New Brunswick facility. This lab will service the quality assurance needs of Ampligen and Alferon N Injection this consolidation provides a more efficient operation. In May 2005, we committed to purchase lab equipment related to the manufacture of Ampligen raw material in the amount of approximately $628,000. We estimate the total cost of establishing this production line to be some $1,800,000, including modifications to our New Brunswick facility. Research and Development costs Overall research and development direct costs for the three months ended June 30, 2005 and 2004 were $1,158,000 and $758,000, respectively. These costs in 2005 reflect the direct costs associated with our effort to develop our lead product, Ampligen(R), as a therapy in treating chronic diseases and cancers as well as on-going clinical trials involving patients with HIV. In addition, these costs reflect direct costs incurred relating to the development of Alferon LDO (low dose oral). We have over approximately 160,000 doses on hand of Alferon LDO which have been prepared for use in clinical trials treating patients affected with the SARS, Avian Flu or other potentially emerging infectious diseases. In the first six months of 2005, we increased our clinical staff by employing several highly trained individuals to focus on the preparation of our Ampligen NDA filing. The NDA filing is a very complex document and we are being meticulous in the preparation of the document. Our clinical monitors and research assistants are in the process of visiting the multiple clinical study sites around the country and are collecting data generated at each of these sites. All data must be reviewed and checked to clarify any inconsistencies or inaccuracies that turn up. Due to the human factor, these types of problems occur in all clinical trials. These gaps and inconsistencies in data must be resolved with the respective clinical investigators, while maintaining a clear record of events which allows the FDA to conduct a meaningful audit of these records. We had originally targeted a late 2004 filing date for this NDA for Ampligen(R). In order to respond to recent changes in the regulatory environment that place a greater emphasis on the safety and efficacy of all new experimental drug candidates, we are now incorporating a larger sample of data from our previous trials. The NDA filing will now include data accumulated from 40,000 administrations of the studied drug to approximately 700 CFS patients. We believe that our recently completed AMP 516 ME/CFS Phase III clinical trial for use of Ampligen(R) in the treatment of ME/CFS is the most comprehensive study ever conducted in ME/CFS. This Phase III clinical trial, which was conducted over a six year period, involved an enrollment of more than 230 severely debilitated CFS patients and was conducted at twelve medical centers throughout the United States. The study is serving as the basis for us to file a new drug application with the FDA. As discussed above, we have hired additional personnel and are in the process of analyzing the clinical data and preparing the NDA. The FDA review process of the NDA could take 18-24 months and result in one of the following events; 1) approval to market Ampligen(R) for use in treating ME/CFS patients, 2) require more research, development, and clinical work, 3) approval to market as well as conduct more testing, or 4) reject our application ("NDA"). Given these variables, we are unable to project when material net cash inflows are expected to commence from the sale of Ampligen(R). At the 18th International Conference on Antiviral Research on April 10, 2005, we presented new peer-reviewed data entitled "Correlation of Increased Oxygen Consumption with Enhanced Treadmill Performance in Patients with Chronic Fatigue Syndrome (CFS) as a Function of Ampligen(R)". According to recent reports by the Centers for Disease Control and Prevention (CDC), ME/CFS, a disease that affects between 400,000 and 800,000 Americans, is more serious than multiple sclerosis with respect to medical severity and overall economic impact on society. This was reported in the ME/CFS Advisory Committee Report dated January 5, 2005. Specifically, ME/CFS imparts a clinically significant, profound deficit in oxygen utilization to patients, which impairs their ability to perform a range of ambulatory functions necessary to maintain quality of life. Similar oxygen consumption deficits have been observed in other chronic diseases such as congestive heart failure/angina ("CHF") and chronic pulmonary conditions such as pulmonary arterial hypertension ("PAH") both of which now have a range of readily available, commercially approved, therapeutics for disease intervention. The experimental Ampligen(R) treatment in ME/CFS improved exercise duration up to two times more than approved (or approvable) drugs for their respective chronic disease indications. Ampligen(R) increased the percentage improvement in endurance by 15% over the placebo group. In the ME/CFS study, maximal oxygen consumption (VO2max) increased with Ampligen vs. Placebo. There was a high correlation between improvement in exercise duration and increase in VO2 max (p is less than 0.0001). VO2max is a measure of oxygen consumption at maximum exertion. By comparison, analysis of seven recent clinical studies, which resulted in commercial approvals (or "approvable" letters) for various drugs used in these other allied disease categories (both CHF and PAH), showed much lower magnitudes of physical performance improvements due to therapeutic interventions. For example, in CHF: Fosinopril (6.7% improvement), Captopril (6.2%), Ranolazine (6.5%) and Ranolazine (5.7%); in PAH, Tracleer (10.6% improvement), Remodulin (8.0%), and Remodulin (4.1%). All therapeutic measurements in these seven other studies were determined by exercise treadmill testing (or extent of walking), similar or identical to the therapeutic endpoint used in the CFS study. With respect to Ampligen(R) in the ME/CFS pivotal study, no significant differences (p>0.05) were observed between the two groups (drug vs. placebo) for treatment dropouts, the incidence of serious adverse events, or missed treatment doses. With respect to relative safety of the experimental therapeutic, there were also no significant differences in week forty blood chemistry, hematology, or thyroid function parameters. These results are consistent with two prior open label trials and a phase II, double-blind, placebo controlled, multi-center clinical trial of Ampligen(R). Ampligen is also currently in two Phase IIb studies for the treatment of HIV to overcome multi-drug resistance, virus mutation and toxicity associated with current HAART therapies. One study, the AMP-719, is a Salvage Therapy, conducted in the U.S. and evaluating the potential synergistic efficacy of Ampligen in multi-drug resistant HIV patients for immune enhancement. The second study, the AMP-720, is a clinical trial designed to evaluate the effect of Ampligen under Strategic Treatment Intervention and is also conducted in the U.S. Enrollment in the AMP 719 study is presently on hold as we focus our efforts on ramping up the AMP 720 study. The Amp 720 HIV study is a treatment using a Strategic Treatment Interruption (STI). The patients' antiviral HAART regimens are interrupted and Ampligen(R) is substituted as mono-immunotherapy. Ampligen(R) is an experimental immunotherapeutic designed to display both antiviral and immune enhancing characteristics. Prolonged use of Highly Active Antiretroviral Therapy (HAART) has been associated with long-term, potentially fatal, toxicities. The clinical study AMP 720 is designed to address these issues by evaluating the administration of our lead experimental agent, Ampligen(R), a double stranded RNA drug acting potentially both as an immunomodulator and antiviral. Patients, who have completed at least nine months of Ampligen(R) therapy, were able to stay off HAART for a total STI duration with a mean time of 29.0 weeks whereas the control group, which was also taken off HAART, but not given Ampligen(R), had earlier HIV rebound with a mean duration of 18.7 weeks. Thus, on average, Ampligen(R) therapy spared the patients excessive exposure to HAART, with its inherent toxicities, for more than 11 weeks. In July 2005, we enrolled two new patients in this study. 41 HIV patients have already participated in this 64 week study. It is difficult to estimate the duration or projected costs of this clinical trial due to the many variables involved, i.e.: patient drop out rate, recruitment of clinical investigators, etc. The length of the study and costs related to our clinical trials cannot be determined at this time as such will be materially influenced by (a) the number of clinical investigators needed to recruit and treat the required number of patients, (b) the rate of accrual of patients and (c) the retention of patients in the studies and their adherence to the study protocol requirements. Under optimal conditions, the cost of completing the studies could be approximately $2.5 to $3.0 million if the target of 120 patients is achieved. The rate of enrollment depends on patient availability and on other products being in clinical trials for the treatment of HIV, as there is competition for the same patient population. At present, more than 18 FDA approved drugs for HIV treatment may compete for available patients. The length, and subsequently the expense of these studies, will also be determined by an analysis of the interim data, which will determine when completion of the ongoing Phase IIb is appropriate and whether a Phase III trial will be conducted or not. In case a Phase III study is required; the FDA might require a patient population exceeding the current one which will influence the cost and time of the trial. Accordingly, the number of "unknowns" is sufficiently great to be unable to predict when, or whether, we may obtain revenues from our HIV treatment indications. A clinical study has been approved by the Clinical Research Ethics Committee of the Kowloon West Cluster at the Princess Margaret Hospital in Hong Kong to evaluate the use of Alferon(R) LDO (Low Dose Oral Interferon Alfa-N3, Human Leukocyte Derived) in normal volunteers and/or asymptomatic subjects with exposure to a person known to have Severe Acute Respiratory Syndrome (SARS). A clinical study to evaluate the use of Alferon(R) LDO in HIV infected volunteers has been initiated in Philadelphia, PA at Drexel University. The study is designed to determine whether Alferon(R) LDO can resuscitate the broad-spectrum antiviral and immunostimulatory genes. The initial patient enrolled in this study in July 2005. The trial methodology may have implications for treating other emerging viruses such as avian influenza (bird flu). Present production methods for vaccines involve the use of millions of chicken eggs and would be slow to respond to an outbreak according to a recently convened World Health Organization (WHO) expert panel in November 2004. Health officials are also concerned that bird flu could mutate to cause the next pandemic and render present vaccines under development ineffective. We have prepared more than 300,000 doses of Alferon LDO for appropriate clinical programs. In September 2004, we commenced a clinical trial using Alferon N Injection to treat patients infected with the West Nile Virus. The infectious Disease section of New York Queens Hospital and the Weill Medical College of Cornell University will be conducting this double-blinded, placebo controlled trial. This study plans to enroll 60 patients as they become available. As of July 28, 2005, four patients have entered this study. The CDC reports that 61 cases of West Nile Virus have been reported in the US as of July 26, 2005. In order to obtain Ampligen(R) raw materials on a more regular production basis, we consolidated and transfered relevant manufacturing operations into our New Brunswick, New Jersey facility during the first quarter 2005. This consolidation and transfer of manufacturing operations was implemented as an inspection of the Ribotech facility in South Africa, our previous supplier of Ampligen(R) raw materials, indicated that it did not, at present, meet the necessary standards for a fully certified commercial process. The transfer of Ampligen(R) raw materials manufacture to our own facilities has obvious advantages with respect to overall control of the manufacturing procedure of Ampligen's raw materials, keeping costs down and controlling regulatory compliance issues (other parts of the 43,000 sq. ft. wholly owned facility are FDA approved for Alferon N manufacture). The cost of installing this production line including modifications to our New Brunswick facility is estimated at $1,800,000. This may delay certain steps in the commercialization process, specifically a targeted NDA filing. In connection with settling various manufacturing infractions previously noted by the FDA, Schering-Plough ("Schering") entered into a "Consent Decree" with the FDA whereby, among other things, it agreed to discontinue various contract (third party) manufacturing activities at various facilities including its San Juan, Puerto Rico, plant. Ampligen(R) (which was not involved in any of the cited infractions) was produced at this Puerto Rico plant from year 2000-2004. Operating under instructions from the Consent Decree, Schering has advised us that it would no longer manufacture Ampligen(R) in this facility beyond 2004 and would assist us in an orderly transfer of said activities to other non Schering facilities. We had entered into a Confidentiality Agreement with Mayne Pharma Pty, Ltd ("Mayne") to lead to reinitiation and expansion of its Ampligen(R) manufacturing program. However, senior management at Mayne's Mulgrave operations in Australia recently informed us that they are ceasing to continue with all development activities associated with potential contract customers and all other contract business will be progressively scaled down over the next couple of years. Therefore, Mayne's Mulgrave facility in Australia will no longer be a possibility for manufacturing. We have obtained two proposals from manufacturers in the US and expect to obtain at least two more for the manufacturing of Ampligen. We want to qualify at least two GMP facilities in order to maintain a minimum of two independent production sites. If we are unable to engage a contract manufacturer in a timely manner, our plans to file an NDA for Ampligen(R) and, eventually, to market and sell Ampligen(R) will be delayed. General and Administrative Expenses General and Administrative ("G&A") expenses for the three months ended June 30, 2005 and 2004 were approximately $1,409,000 and $1,076,000, respectively. The increase in G&A expenses of $333,000 during this period is primarily due to higher professional fees, specifically legal costs associated with a lawsuit we initiated seeking injunction relief and damages against a conspiratorial group alleging that this conspiratorial group had engaged in illegal activities to take over Hemispherx and enrich themselves at the expense of our shareholders. See Item 1. "Legal Proceedings" in Part II - Other Information, below for more information. Interest and Other Income Interest and other income for the three months ended June 30, 2005 and 2004 totaled $63,000 and $13,000, respectively. The increase in interest and other income during the current quarter can primarily be attributed to the maturing of marketable securities during the 2005 period. All funds in excess of our immediate need are invested in short-term high quality securities. Interest Expense and Financing Costs Non-cash financing costs were approximately $1,402,000 for the three months ended June 30, 2005 versus $3,669,000 in charges for the same three months a year ago. Non-cash financing costs consist of the amortization of debenture closing costs, the amortization of Original Issue Discounts and the amortization of costs associated with beneficial conversion features of our debentures and the 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 financing costs of $2,267,000 can be attributed to the aggregate total of these charges being reduced since the second quarter 2004 due to decreased amortization charges as well as charges related to the conversion of debentures. Please see Note 7 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, 2004 Net loss Our net loss of $6,871,000 for the six months ended June 30, 2005 was down $7,126,000 or 51% compared to the same period in 2004. This reduction was primarily due to: 1) lower costs associated with non-cash financing charges related to convertible debentures, These lower non-cash financing costs of $5,029,000 represented 71% of the change in net loss from period to period, 2) production/costs of good sold expenditures were down $1,092,000 due to expenditures during the first half of 2004 associated with ramping up of the New Brunswick facility for further production of Alferon N Injection(R), and 3) lower non-cash stock compensation expenses. Net losses per share were $(.14) for current period versus $(.33) in the same period 2004. Revenues Revenues for the six months ended June 30, 2005 were $558,000 as compared to revenues of $639,000 for the same period in 2004. Ampligen sold under the cost recovery clinical program was down $2,000 (2%) and Alferon N Injection sales were down $79,000 (14%). For more information concerning revenue, see the revenue section contained in the results of operations for the three months ended June 30, 2005 versus three months ended June 30, 2004 discussed above. Production costs/cost of goods sold Production costs for the six months ended June 30, 2004 were $1,052,000. These costs represented expenditures associated with preparing the New Brunswick facility for further production of Alferon N Injection(R) in the first half of 2004. There were no production costs for Alferon N Injection during the first six months of 2005 as we concentrated on the completion of the consolidation of all manufacturing and research and development activities within our own Good Manufacturing Practice (GMP) Facility in New Brunswick for Ampligen. This consolidation will improve efficiency and compliance procedures and bring the facility in line with worldwide drug manufacturing standards. Cost of goods sold for the six months ended June 30, 2005 and 2004 were $201,000 and $241,000, respectively. For more information concerning production/cost of goods sold, see the production/costs of goods sold section contained in the results of operations for the three months ended June 30, 2005 versus three months ended June 30, 2004 discussed above. Research and Development costs Overall research and development direct costs for the six months ended June 30, 2005 and 2004 were $2,426,000 and $1,720,000, respectively. For more information on research and development activities, see the research and development section contained within the results of operations for the three months ended June 30, 2005 versus three months ended June 30, 2004 discussed above. General and Administrative Expenses General and Administrative ("G&A") expenses for the six months ended June 30, 2005 and 2004 were approximately $2,391,000 and $3,921,000, respectively. The decrease in G&A expenses of $1,530,000 during this period is primarily due to a non-cash stock compensation charge of $1,769,000 resulting from the issuance of 1,450,000 warrants to purchase common stock at $2.20 per share to Dr. Carter in 2003 that vested in the first quarter 2004. The warrants vested upon the second ISI asset closing which occurred on March 17, 2004. Please see "Item 11. Executive Compensation." contained within our Form 10K filed with the Securities and Exchange Commission on March 16, 2005, for more details on how Dr. Carter was compensated. Higher professional fees, specifically legal costs, during the first six months of 2005, slightly offset this decrease in G & A expenses, from period to period. The costs were associated with a lawsuit we initiated seeking injunction relief and damages against a conspiratorial group alleging that this conspiratorial group had engaged in illegal activities to take over Hemispherx and enrich themselves at the expense of our shareholders. See also Item 1. "Legal Proceedings" in Part II - - Other Information, below for more information. Interest and Other Income Interest and other income for the six months ended June 30, 2005 and 2004 totaled $293,000 and $24,000, respectively. The increase in interest and other income during the current quarter can primarily be attributed to the maturing of marketable securities during the 2005 period. All funds in excess of our immediate need are invested in short-term high quality securities. Interest Expense and Financing Costs Non-cash financing costs were approximately $2,491,000 for the six months ended June 30, 2005 versus $7,520,000 for the same three months a year ago. Non-cash financing costs consist of the amortization of debenture closing costs, the amortization of Original Issue Discounts and the amortization of costs associated with beneficial conversion features of our debentures and the fair value of the warrants relating to the Debentures. These charges are reflected in the Consolidated Statements of Operations under the caption "Financing Costs." The main reason for the decrease in financing costs of $5,029,000 can be attributed to the aggregate total of these charges being reduced since the first half of 2004 due to decreased amortization charges. Also, in regard to connection with a redemption obligation with the January 2004 Debenture, we recorded additional financing costs of approximately $947,000 in the first quarter 2004. Please see Note 7 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, 2005 was $3,865,000. As of June 30, 2005, we had approximately $12,614,000 million in cash and short-term investments. These funds should be sufficient to meet our operating cash requirements including debt service for the near term. For detailed information on our debenture and equity financings during this period, please see Note 7 in the consolidated financial statements contained herein. In May 2005, we committed to purchase lab equipment related to the manufacture of Ampligen raw material ("polymers") in the amount of approximately $628,000. The overall cost of establishing the polymer production line at the New Brunswick facility is estimated at $1,800,000. As of August 2, 2005, the outstanding principal of our convertible debentures was $6,098,696 of which $2,071,178 matures on October 29, 2005 unless converted into our common stock at $2.02 per share. The remaining principal on the January 2004 Debentures was $2,194,185. The investors converted $139,150 principal amount of the January 2004 Debenture into 55,000 shares of common stock. In addition, installment payments of $1,666,665 were made to our investors amounting to 941,136 shares of our common stock. The remaining principal balance on the July 2004 Debentures was $1,833,333. One installment payment of $166,667 was made in July 2005 to our investors amounting to 102,148 shares of our common stock. On July 8, 2005, we entered into a common stock purchase agreement with Fusion Capital Fund II, LLC, pursuant to which Fusion Capital has agreed, under certain conditions, to purchase on each trading day $40,000 of our common stock up to an aggregate of $20.0 million over approximately a 25 month period, subject to earlier termination at our discretion. In our discretion, we may elect to sell less common stock to Fusion Capital than the daily amount and we may increase the daily amount as the market price of our stock increases. The purchase price of the shares of common stock will be equal to a price based upon the future market price of the common stock without any fixed discount to the market price. Fusion Capital does not have the right or the obligation to purchase shares of our common stock in the event that the price of the common stock is less than $1.00 Pursuant to our agreement with Fusion Capital, we have registered for public sale by Fusion Capital up to 10,795,597 shares of our common stock. However, in the event that we decide to issue more than 10,113,278, i.e. greater than 19.99% of the outstanding shares of common stock as of the date of the agreement, we would first seek stockholder approval in order to be in compliance with American Stock Exchange rules. This funding arrangement with Fusion Capital plus our current cash position should be sufficient to meet our operating cash requirements for the next 30 months. However, we may need to raise additional funds through equity or debt financing or from other sources to the extent that we do not receive adequate funding from Fusion Capital (see "Risk Factors - We may require additional financing that may not be available") and to complete the regulatory processes including the commercialization of Ampligen products. There can be no assurances that we will raise funds from these or other sources, which may have a material adverse effect on our ability to develop our products. Also, because of our long-term capital requirements, we may seek to access the public equity market whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Any additional funding may result in significant dilution and could involve the issuance of securities with rights, which are senior to those of existing stockholders. We may also need additional funding earlier than anticipated, and our cash requirements, in general, may vary materially from those now planned, for reasons including, but not limited to, changes in our research and development programs, clinical trials, competitive and technological advances, the regulatory processes, including the commercializing of Ampligen products. There can be no assurances that we will raise adequate funds from these or other sources, which may have a material adverse effect on our ability to develop our products. Also, we have the ability to curtail discretionary spending, including some research and development activities, if required to conserve cash. ITEM 3: Quantitative and Qualitative Disclosures About Market Risk We had approximately $12,614,000 in cash and cash equivalents and short-term investments at June 30, 2005. To the extent that our cash and cash equivalents exceed our near term funding needs, we invest the excess cash in three to six month high quality interest bearing financial instruments. We employ established conservative policies and procedures to manage any risks with respect to investment exposure. We have not entered into, and do not expect to enter into, financial instruments for trading or hedging purposes. Item 4: Controls and Procedures Our Chairman of the Board (serving as the principal executive officer) and the Chief Financial Officer performed an evaluation of our disclosure controls and procedures, which have been designed to permit us to effectively identify and timely disclose important information. They concluded that the controls and procedures were effective as of June 30, 2005 to ensure that material information was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. During the quarter ended June 30, 2005, we have made no change in our internal controls over financial reporting 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. In June 2002, a former ME/CFS clinical trial patient and her husband filed a claim in the Superior Court of New Jersey, Middlesex County, against us, one of our clinical trial investigators and others alleging that she was harmed in the ME/CFS clinical trial as a result of negligence and breach of warranties. On June 25, 2004 all claims against us were dismissed with prejudice. The former ME/CFS clinical trial patient and her husband have now appealed the dismissal of their claims to the New Jersey Superior Court, Apellate Division, where the matter is now pending. 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 June 2004, One Penn Associates, L.P. filed a claim in the Philadelphia Municipal Court for the Commonwealth of Pennsylvania seeking $44,242.68 for alleged unpaid rent and charges related to our offices in One Penn Center in Philadelphia. We believe this claim is without merit and are defending same pursuant to the terms of our lease as we were damaged and deprived of the use of a portion of the offices due to water from the landlord's faulty sprinkler system. 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. ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds During the quarter ended June 30, 2005, we issued 1) an aggregate of 33,332 shares to our Directors as part of their quarterly compensation and 2) an aggregate of 110,379 shares to three entities 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, 2005. ITEM 3: Defaults upon Senior Securities None. ITEM 4: Submission of Matters to a Vote of Security Holders We held our Annual Meeting of Stockholders on June 22, 2005. At that meeting, total shares voted were 37,170,441 shares out of 50,028,237 shares eligible to vote. At the meeting, stockholders approved the following: Election of Directors: For Withheld William A. Carter, M.D. 36,747,394 424,047 Richard C. Piani, Esq. 36,990,796 179,645 Ransom W. Etheridge, Esq. 37,005,756 164,685 William M. Mitchell. Ph.D., M.D. 37,015,756 154,685 Iraj-Eqhbal Kiani, Ph.D. 36,970,101 200,340 Steven D. Spence 37,018,453 151,988 Ratification of the selection of BDO Seidman, LLP, as our independent auditors for the year ending December 31, 2005. For: 37,016,810 Against: 148,231 Abstain: 5,400 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
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 9, 2005
EXHIBIT 31.1 CERTIFICATIONS PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, William A. Carter, Chief Executive Officer of Hemispherx Biopharma, Inc. (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: August 9, 2005 /s/ William A. Carter ----------------------- William A. Carter Chief Executive Officer
EXHIBIT 31.2 CERTIFICATIONS PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, Robert Peterson, Chief Financial Officer of Hemispherx Biopharma, Inc. (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: August 9, 2005 /s/ Robert E. Peterson ---------------------- Robert Peterson Chief Financial Officer
EXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Hemispherx Biopharma, Inc. (the "Company") on Form 10-Q for the fiscal quarter ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William A. Carter, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: August 9, 2005 /s/ William A. Carter -------------------------- William A. Carter Chief Executive Officer
EXHIBIT 32.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Hemispherx Biopharma, Inc. (the "Company") on Form 10-Q for the fiscal quarter ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert E. Peterson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: August 9, 2005 /s/ Robert E. Peterson ---------------------- Robert E. Peterson Chief Financial Officer