form10-q.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended September 30, 2011
   
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from                                                      to

Commission file number: 001-33137

EMERGENT BIOSOLUTIONS INC.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
14-1902018
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
   
2273 Research Boulevard, Suite 400
 
Rockville, Maryland
20850
(Address of Principal Executive Offices)
(Zip Code)

(301) 795-1800
(Registrant’s Telephone Number, Including Area Code)

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.  þ Yes     o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes     o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

o Large accelerated filer              þ Accelerated filer                   o Non-accelerated filer                  o Smaller reporting company
                                                                                                                                                                 (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes      þ No

As of October 28, 2011, the registrant had 35,952,794 shares of common stock outstanding.


 
 

 

Emergent BioSolutions Inc.

Index to Form 10-Q

Part I. Financial Information
Item 1.
Financial Statements
 
Consolidated Balance Sheets
 
Consolidated Statements of Operations
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II. Other Information
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Removed and Reserved
Item 5.
Other Information
Item 6.
Exhibits
 
Signatures
 
Exhibit Index


 
 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. All statements, other than statements of historical fact, including statements regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans and objectives of management, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.

These forward-looking statements include, among other things, statements about:

§  
our ability to perform under our contracts with the U.S. government related to BioThrax® (Anthrax Vaccine Adsorbed), our FDA-approved anthrax vaccine, including the timing of deliveries;
§  
our plans for future sales of BioThrax, including our ability to obtain new contracts or modifications to existing contracts with the U.S. government;
§  
our plans to pursue label expansions and other improvements for BioThrax;
§  
our ability to perform under our development contract with the U.S. government for our product candidate PreviThraxTM (Recombinant Protective Antigen Anthrax Vaccine, Purified);
§  
our ability to perform under our contract with the U.S. government to develop and obtain regulatory approval for large-scale manufacturing of BioThrax in Building 55, our large-scale vaccine manufacturing facility in Lansing, Michigan;
§  
our plans to expand our manufacturing facilities and capabilities;
§  
the rate and degree of market acceptance of our products and product candidates;
§  
the success of preclinical studies and clinical trials of our product candidates and post-approval clinical utility of our products;
§  
our ongoing and planned development programs, preclinical studies and clinical trials;
§  
our ability to identify and acquire or in-license products and product candidates that satisfy our selection criteria;
§  
our ability to successfully integrate and develop the products or product candidates, programs, operations and personnel of any entities or businesses that we acquire;
§  
the potential benefits of our existing collaborations and our ability to selectively enter into additional collaborative arrangements;
§  
the timing of and our ability to obtain and maintain regulatory approvals for our products and product candidates;
§  
our commercialization, marketing and manufacturing capabilities and strategy;
§  
our intellectual property portfolio; and
§  
our estimates regarding expenses, future revenues, capital requirements and needs for additional financing.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this quarterly report, particularly in the “Risk Factors” section, that we believe could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.

You should read this quarterly report, including the documents that we have incorporated by reference herein or filed as exhibits hereto, completely and with the understanding that our actual future results may be materially different from what we expect. We disclaim any obligation to update any forward-looking statements.

 
 

 


PART I. FINANCIAL INFORMATION

ITEM 1.                        FINANCIAL STATEMENTS

Emergent BioSolutions Inc. and Subsidiaries
 
Consolidated Balance Sheets
 
(in thousands, except share and per share data)
 
             
   
September 30,
   
December 31,
 
   
2011
   
2010
 
ASSETS
 
(Unaudited)
       
Current assets:
           
Cash and cash equivalents
  $ 125,346     $ 169,019  
Investments
    3,499       2,029  
Accounts receivable
    48,994       39,326  
Inventories
    17,979       12,722  
Deferred tax assets, net
    7,209       2,638  
Income tax receivable, net
    24,488       8,728  
Restricted cash
    217       217  
Prepaid expenses and other current assets
    9,033       8,814  
Total current assets
    236,765       243,493  
                 
Property, plant and equipment, net
    188,245       152,701  
In-process research and development
    51,400       51,400  
Goodwill
    5,502       5,029  
Assets held for sale
    12,065       12,741  
Deferred tax assets, net
    18,278       33,757  
Other assets
    707       1,198  
                 
Total assets
  $ 512,962     $ 500,319  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 33,902     $ 25,409  
Accrued expenses and other current liabilities
    1,150       1,309  
Accrued compensation
    14,735       23,975  
Contingent value rights, current portion
    9,865       -  
Long-term indebtedness, current portion
    4,920       17,187  
Deferred revenue, current portion
    4,359       7,839  
Total current liabilities
    68,931       75,719  
                 
Contingent value rights, net of current portion
    5,992       14,532  
Long-term indebtedness, net of current portion
    48,873       30,239  
Deferred revenue, net of current portion
    2,781       4,386  
Other liabilities
    1,882       1,882  
Total liabilities
    128,459       126,758  
                 
Commitments and contingencies
    -       -  
                 
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 15,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively
    -       -  
Common stock, $0.001 par value; 100,000,000 shares authorized, 35,869,025 and 35,011,423 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively
    36       35  
Additional paid-in capital
    215,938       197,689  
Accumulated other comprehensive loss
    (2,894 )     (2,110 )
Retained earnings
    168,212       173,850  
    Total Emergent BioSolutions Inc. stockholders' equity
    381,292       369,464  
Noncontrolling interest in subsidiaries
    3,211       4,097  
Total stockholders’ equity
    384,503       373,561  
Total liabilities and stockholders’ equity
  $ 512,962     $ 500,319  

The accompanying notes are an integral part of these consolidated financial statements.

 
 

 


Emergent BioSolutions Inc. and Subsidiaries
 
Consolidated Statements of Operations
 
(in thousands, except share and per share data)
 
                         
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
Revenues:
                       
Product sales
  $ 43,663     $ 67,266     $ 120,739     $ 161,991  
Contracts and grants
    15,099       6,720       44,697       20,933  
Total revenues
    58,762       73,986       165,436       182,924  
                                 
Operating expenses:
                               
Cost of product sales
    10,706       11,532       27,843       30,116  
Research and development
    29,216       21,156       95,456       59,680  
Selling, general and administrative
    17,432       20,693       56,028       54,534  
Income (loss) from operations
    1,408       20,605       (13,891 )     38,594  
                                 
Other income (expense):
                               
Interest income
    22       38       81       802  
Interest expense
    -       -       -       -  
Other income (expense), net
    37       (1,003 )     (9 )     (1,012 )
Total other income (expense)
    59       (965 )     72       (210 )
                                 
Income (loss) before provision for (benefit from) income taxes
    1,467       19,640       (13,819 )     38,384  
Provision for (benefit from) income taxes
    1,604       7,696       (3,032 )     15,088  
Net income (loss)
    (137 )     11,944       (10,787 )     23,296  
    Net loss attributable to noncontrolling interests
    1,686       1,176       5,149       2,155  
Net income (loss) attributable to Emergent BioSolutions Inc.
  $ 1,549     $ 13,120     $ (5,638 )   $ 25,451  
                                 
Earnings (loss) per share - basic
  $ 0.04     $ 0.42     $ (0.16 )   $ 0.82  
Earnings (loss) per share - diluted
  $ 0.04     $ 0.41     $ (0.16 )   $ 0.80  
                                 
Weighted-average number of shares - basic
    35,855,217       31,301,796       35,552,900       31,094,616  
Weighted-average number of shares - diluted
    36,447,933       32,113,313       35,552,900       31,816,900  

The accompanying notes are an integral part of these consolidated financial statements.

 
 

 


Emergent BioSolutions Inc. and Subsidiaries
 
Consolidated Statements of Cash Flows
 
(in thousands)
 
   
Nine Months Ended
 
   
September 30,
 
   
2011
   
2010
 
   
(Unaudited)
 
Cash flows from operating activities:
           
Net income (loss)
  $ (10,787 )   $ 23,296  
Adjustments to reconcile to net cash provided by (used in) operating activities:
               
Stock-based compensation expense
    7,911       5,206  
Depreciation and amortization
    6,926       4,020  
Deferred income taxes
    11,937       4,516  
Non-cash development expenses from variable interest entities
    4,263       2,241  
Impairment of long-lived assets
    676       1,029  
Change in fair value of contingent value rights
    1,325       -  
Excess tax benefits from stock-based compensation
    (1,502 )     (1,077 )
Other
    60       (31 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (9,668 )     46,935  
Inventories
    (5,257 )     (3,799 )
Income taxes
    (15,760 )     (10,632 )
Prepaid expenses and other assets
    270       (794 )
Accounts payable
    119       5,990  
Accrued expenses and other liabilities
    (159 )     (1,177 )
Accrued compensation
    (9,240 )     (356 )
Deferred revenue
    (5,085 )     (2 )
Net cash (used in) provided by operating activities
    (23,971 )     75,365  
Cash flows from investing activities:
               
Purchases of property, plant and equipment
    (34,153 )     (14,042 )
Proceeds from maturity of investments
    3,750       -  
Purchase of investments
    (5,220 )     -  
Net cash used in investing activities
    (35,623 )     (14,042 )
Cash flows from financing activities:
               
Proceeds from borrowings on long-term indebtedness and line of credit
    21,298       15,000  
Issuance of common stock subject to exercise of stock options
    8,836       4,056  
Principal payments on long-term indebtedness and line of credit
    (14,931 )     (32,454 )
Excess tax benefits from stock-based compensation
    1,502       1,077  
Net cash provided by (used in) financing activities
    16,705       (12,321 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (784 )     (697 )
                 
Net increase (decrease) in cash and cash equivalents
    (43,673 )     48,305  
Cash and cash equivalents at beginning of period
    169,019       102,924  
Cash and cash equivalents at end of period
  $ 125,346     $ 151,229  

The accompanying notes are an integral part of these consolidated financial statements.

 
 

 

EMERGENT BIOSOLUTIONS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.     Basis of presentation and consolidation

The accompanying unaudited consolidated financial statements include the accounts of Emergent BioSolutions Inc. (the “Company” or “Emergent”) and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission.

In the opinion of the Company’s management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, and are necessary to present fairly the financial position of the Company as of September 30, 2011, results of operations for the three and nine month periods ended September 30, 2011 and 2010, and cash flows for the nine month periods ended September 30, 2011 and 2010.  Interim results are not necessarily indicative of results that may be expected for any other interim period or for an entire year.

2.     Fair value measurements  
 
The Company measures and records cash equivalents and investment securities considered available-for-sale at fair value in the accompanying financial statements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, an exit price, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value include: 

 
Level 1 — Observable inputs for identical assets or liabilities such as quoted prices in active markets;
 
Level 2 — Inputs other than quoted prices in active markets that are either directly or indirectly observable; and
 
Level 3 —Unobservable inputs in which little or no market data exists, which are therefore developed by the Company using estimates and assumptions that reflect those that a market participant would use.
 
The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis:

 
At September 30, 2011
 
(in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
Investment in money market funds (1)
  $ 85,893     $ -     $ -     $ 85,893  
U.S. Treasury securities (2)
    -       3,499       -       3,499  
Total assets
  $ 85,893     $ 3,499     $ -     $ 89,392  
                                 
Liabilities:
                               
Contingent value rights
  $ -     $ -     $ 15,857     $ 15,857  
Total liabilities
  $ -     $ -     $ 15,857     $ 15,857  
                                 
 
At December 31, 2010
 
(in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                               
Investment in money market funds (1)
  $ 102,360     $ -     $ -     $ 102,360  
U.S. Treasury securities (2)
    -       2,029       -       2,029  
Total assets
  $ 102,360     $ 2,029     $ -     $ 104,389  
                                 
Liabilities:
                               
Contingent value rights
  $ -     $ -     $ 14,532     $ 14,532  
Total liabilities
  $ -     $ -     $ 14,532     $ 14,532  

(1)                    Included in cash and cash equivalents in accompanying consolidated balance sheets.
(2)                    Included in investments in accompanying consolidated balance sheets.

The fair value of U.S. Treasury securities (Level 2) is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data.

The fair value of the Contingent Value Right (“CVR”) obligations is based on management’s assessment of certain development and collaboration milestones, which are inputs that have no observable market (Level 3).  The obligation is measured using a discounted cash flow model. For the three and nine months ended September 30, 2011, the changes in the fair value of the CVR obligations resulted from an adjustment to the discount rates along with an update to the probability and estimated timing of achievement for certain development milestones.  For the three months ended September 30, 2011, the Company recorded a reduction of $84,000 in the value for the CVRs. For the nine months ended September 30, 2011, the Company recorded a charge of $1.3 million to increase the CVRs to fair value. These adjustments to fair value are classified in the Company’s statement of operations as research and development expense within the Company’s biosciences segment.

The following table is a reconciliation of the beginning and ending balance of the liabilities measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2011. There were no Level 3 assets or liabilities at September 30, 2010.

(in thousands)
     
Balance at January 1, 2010
  $ -  
Fair value of CVRs issued
    14,532  
Expense (income) included in earnings
    -  
Purchases, sales, issuances and settlements
    -  
Transfers in/(out) of Level 3
    -  
Balance at December 31, 2010
  $ 14,532  
Expense (income) included in earnings
    1,325  
Purchases, sales, issuances and settlements
    -  
Transfers in/(out) of Level 3
    -  
Balance at September 30, 2011
  $ 15,857  

Separate disclosure is required for assets and liabilities measured at fair value on a recurring basis, as documented above, from those measured at fair value on a nonrecurring basis.  As of September 30, 2011 and December 31, 2010, the Company had no assets or liabilities that were measured at fair value on a nonrecurring basis.

The carrying amounts of the Company’s short-term financial instruments, which include cash, accounts receivable and accounts payable, approximate their fair values due to their short maturities. The fair value of the Company’s long-term indebtedness is estimated based on the quoted prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. Both the carrying value and fair value of long-term indebtedness at September 30, 2011 was $53.8 million.  The carrying value and fair value of long-term indebtedness was $48.3 million and $48.1 million, respectively, at September 30, 2010.

3.     Investments

The Company invests in a variety of highly liquid investment-grade securities.  The following is a summary of the Company’s available for sale securities:

 
At September 30, 2011
 
(in thousands)
 
Amortized Costs
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Market Value
 
U.S. Treasury securities
  $ 3,498     $ 1     $ -     $ 3,499  
 
At December 31, 2010
 
(in thousands)
 
Amortized Costs
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Market Value
 
U.S. Treasury securities
  $ 2,030     $ -     $ 1     $ 2,029  

4.     Inventories

Inventories consist of the following:

   
September 30,
   
December 31,
 
(in thousands)
 
2011
   
2010
 
Raw materials and supplies
  $ 2,118     $ 2,311  
Work-in-process
    13,663       7,917  
Finished goods
    2,198       2,494  
Total inventories
  $ 17,979     $ 12,722  

5.     Assets held for sale

The Company currently owns two buildings in Frederick, Maryland that it determined in 2009 would not be placed into service.  Accordingly, the Company committed to a plan to sell the buildings, along with associated improvements. These buildings are classified on the Company’s balance sheets as assets held for sale. Assets held for sale are recorded at the lower of the carrying amount or fair market value less costs to sell, and are no longer depreciated once classified as held for sale. The Company recorded the assets held for sale at fair market value, based on factors that include recent purchase offers, less estimated selling costs.  The Company recorded impairment charges of $483,000 and $676,000, respectively, for the three and nine months ended September 30, 2011. The Company recorded no impairment charge for the three months ended September 30, 2010 and recorded an impairment charge of $1.0 million for the nine months ended September 30, 2010. These charges were classified in the Company’s statement of operations as selling, general and administrative expense within the Company’s biosciences segment. The Company continues to actively seek to sell these buildings.

6.     Long-term indebtedness

The components of long-term indebtedness are as follows:

   
September 30,
   
December 31,
 
(in thousands)
 
2011
   
2010
 
Construction loan dated July 2011; one month LIBOR plus 3.0 %, due July 2017
  $ 21,298     $ -  
Term loan dated December 2009; three month LIBOR plus 3.25%, due December 2014
    20,096       21,233  
Term loan dated November 2009; three month LIBOR plus 3.25%, repaid in July 2011
    -       6,513  
Term loan dated November 2009; three month LIBOR plus 3.25%, due November 2014
    4,565       4,825  
Term loan dated April 2006; three month LIBOR plus 3.0%, repaid in April 2011
    -       6,686  
Loan dated October 2004; 3.0%, due March 2012
    2,500       2,500  
Term loan dated October 2004; 3.48%, due October 2013
    5,334       5,669  
Total long-term indebtedness
    53,793       47,426  
Less current portion of long-term indebtedness
    (4,920 )     (17,187 )
Noncurrent portion of long-term indebtedness
  $ 48,873     $ 30,239  

In August 2011, the Company entered into a loan agreement with PNC Bank (“PNC”) to provide the Company with an equipment loan of up to $12.0 million to fund equipment purchases at the Company’s Baltimore, Maryland product development and manufacturing facility. Under the equipment loan agreement, PNC agreed to make advances to the Company of up to $12.0 million through August 2012 based on periodic requests from the Company. The loan is collateralized by the equipment purchased. As of September 30, 2011, the Company has not drawn on this loan.

In July 2011, the Company entered into a loan agreement and related agreements with PNC, under which PNC agreed to provide the Company with a construction loan of up to $30.0 million, primarily to fund the ongoing build-out of the Baltimore facility. A portion of the loan was also used to repay the Company’s loan with HSBC Bank, which the Company used to finance a portion of the purchase price of the facility. Under the Company’s loan agreement with PNC, PNC agreed to make advances to the Company of up to $30.0 million through July 2012. The Company is required to make interest only payments through July 2012. Beginning in July 2012, the Company will be required to make monthly payments of principal and interest based upon a 20-year amortization schedule with a balloon payment for the remaining unpaid principal and interest due in July 2017. Payment of the loan is secured by the Baltimore building along with Emergent BioDefense Operations Lansing LLC accounts receivable under the Company’s BioThrax supply contracts.  As of September 30, 2011, the Company has drawn $21.3 million under this loan.

Under the terms of the construction and equipment loans with PNC, the Company is required to maintain certain financial covenants including minimum cash and liquid investments balance of $50.0 million, a leverage ratio of less than 2.0 and a debt coverage ratio of not less than 1.25 to 1.

In October 2004, the Company entered into a Secured Conditional Loan with the Maryland Economic Development Assistance Fund for $2.5 million. In October 2011, the Company amended the agreement to extend the paid in full date to March 2012.

In connection with the 2004 purchase of the building in Frederick, Maryland, the Company entered into a loan agreement for $7.0 million with PNC to finance the remaining portion of the purchase price. The borrowing accrued interest at 6.625% per annum through October 2006. The Company was required to make interest only payments through that date. Beginning in November 2006, the Company began to make monthly payments of $62,000, based upon a 15 year amortization schedule. In November 2009 and thereafter, the annual interest rate was fixed at 4.075%.  In October 2011, the Company modified the agreement to extend the maturity date to October 2013, reduce the fixed annual interest rate to 3.48% and increase the monthly payment to $64,000.  All unpaid principal and interest is due in full in October 2013.  The Company has determined that the modified agreement is not a substantial modification of the original loan agreement.

7.     Accounting for stock-based compensation plans

As of September 30, 2011, the Company has two stock-based employee compensation plans, the Amended and Restated Emergent BioSolutions Inc. 2006 Stock Incentive Plan (the “2006 Plan”) and the Emergent BioSolutions Employee Stock Option Plan (the “2004 Plan” and together with the 2006 Plan, the “Emergent Plans”).  The Company has granted options to purchase shares of common stock under the Emergent Plans and has granted restricted stock units under the 2006 Plan. The Emergent Plans have both incentive and non-qualified stock option features. The Company no longer grants equity awards under the 2004 Plan.

The Company determines the fair value of restricted stock units using the closing market price of the Company’s common stock on the day prior to the date of grant.  The Company utilizes the Black-Scholes valuation model for estimating the fair value of all stock options granted. The fair value of each option is estimated on the date of grant. Set forth below are the assumptions used in valuing the stock options granted and a discussion of the Company’s methodology for developing each of the assumptions used:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Expected dividend yield
    0 %     0 %     0 %     0 %
Expected volatility
    60 %     55 %     60 %     55 %
Risk-free interest rate
    0.35 %     1.72 %    
0.35%-1.04
%     0.82%-1.46 %
Expected average life of options
 
3.0 years
   
3.0 years
   
3.4 years
   
3.4 years
 
 
§  
Expected dividend yield — the Company does not pay regular dividends on its common stock and does not anticipate paying any dividends in the foreseeable future.
§  
Expected volatility —  a measure of the amount by which a financial variable, such as share price, has fluctuated (historical volatility) or is expected to fluctuate (implied volatility) during a period. The Company analyzed its own historical volatility to estimate expected volatility over the same period as the expected average life of the options.
§  
Risk-free interest rate — the range of U.S. Treasury rates with a term that most closely resembles the expected life of the option as of the date on which the option is granted.
§  
Expected average life of options — the period of time that options granted are expected to remain outstanding, based primarily on the Company’s expectation of optionee exercise behavior subsequent to vesting of options.
 
As of September 30, 2011, an aggregate of 8,678,826 shares of common stock are authorized for issuance under the 2006 Plan, of which a total of 2,152,513 shares of common stock remain available for future awards to be made to plan participants. Awards of restricted stock units are counted against the maximum aggregate number of shares of common stock available for issuance under the 2006 Plan as one and one-half (1.5) shares of common stock for every one restricted stock unit granted. The maximum number of shares subject to awards that may be granted per year under the 2006 Plan to a single participant is 287,700. The exercise price of each option must be not less than 100% of the fair market value of the shares underlying such option on the date of grant. Awards granted under the 2006 Plan have a contractual life of no more than 10 years. The terms and conditions of equity awards (such as price, vesting schedule, term and number of shares) under the Emergent Plans are determined by the Company’s compensation committee, which administers the Emergent Plans.  Each equity award granted under the Emergent Plans vests as specified in the relevant agreement and no stock option can be exercised after ten years from the date of grant.

The following is a summary of option award activity under the Emergent Plans:

   
2006 Plan
   
2004 Plan
       
   
Number of Shares
   
Weighted-Average Exercise Price
   
Number of Shares
   
Weighted-Average Exercise Price
   
Aggregate Intrinsic Value
 
Outstanding at December 31, 2010
    3,397,915     $ 14.31       67,541     $ 9.80     $ 32,023,466  
Granted
    826,227       23.77       -       -          
Exercised
    (756,099 )     11.59       (14,385 )     13.26          
Forfeited
    (218,531 )     18.73       -       -          
Outstanding at September 30, 2011
    3,249,512     $ 17.08       53,156     $ 8.86     $ 5,413,569  
Exercisable at September 30, 2011
    1,583,683     $ 13.84       53,156     $ 8.86     $ 5,261,857  

The following is a summary of restricted stock unit award activity under the 2006 Plan:

   
Number of Shares
   
Weighted-Average Grant Price
   
Aggregate Intrinsic Value
 
Outstanding at December 31, 2010
    395,555     $ 16.09     $ 9,279,720  
Granted
    433,123       23.70          
Vested
    (124,863 )     16.02          
Forfeited
    (63,362 )     19.57          
Outstanding at September 30, 2011
    640,453     $ 20.91     $ 9,882,190  

8.     Variable interest entities

In July 2008, the Company entered into a collaboration with the University of Oxford (“Oxford”) and certain Oxford researchers to conduct clinical trials in the advancement of a vaccine product candidate for tuberculosis, resulting in the formation of the Oxford-Emergent Tuberculosis Consortium (“OETC”).  The Company has a 51% equity interest in OETC and controls the OETC Board of Directors. In addition, the Company has certain funding and service obligations related to its investment. The Company has evaluated its variable interests in OETC and has determined that it is the primary beneficiary as it has the ability to direct the activities of OETC and will absorb the majority of expected losses. Accordingly, the Company consolidates the entity. As of September 30, 2011 and 2010, respectively, assets of $408,000 and $229,000 and liabilities of $532,000 and $389,000 related to OETC are included within the Company’s consolidated balance sheet.  During the three and nine months ended September 30, 2011, OETC incurred net losses of $3.1 million and $9.9 million, respectively, of which $1.6 million and $5.0 million, respectively, is included in the Company’s consolidated statement of operations. During the three and nine months ended September 30, 2010, OETC incurred net losses of $2.4 million and $4.4 million, respectively, of which $1.2 million and $2.2 million, respectively, is included in the Company’s consolidated statement of operations.

In July 2011, the Company entered into an intercompany loan agreement with OETC, under which the Company would provide OETC with a loan of up to $14.0 million to fund future development costs for the tuberculosis vaccine product candidate. The loan value can be increased to up to $23.0 million at the sole discretion of the Company. The loan bears an interest rate of 8% per annum. Principal and interest on the outstanding balance shall be due and payable in December 2014 or upon occurrence of either an event of default or the closing of a debt or equity financing by OETC that results in net proceeds equal to or in excess of $30.0 million in a single transaction or a series of related transactions. Under the terms of the loan, OETC is required to comply with certain non-financial covenants.

In conjunction with the establishment of OETC, the Company granted a put option to Oxford and the Oxford researchers whereby the Company may be required to acquire all of the OETC shares held by Oxford and the Oxford researchers at fair market value of the underlying shares. This put option is contingent upon the satisfaction of a number of conditions that must exist or occur subsequent to the granting by the European Commission of marketing authorization for the OETC-sponsored vaccine product candidate for tuberculosis. The Company accounts for the put option in accordance with the accounting provisions related to derivatives and distinguishing liabilities from equity. In accordance with these provisions, the Company has determined that the put option has a de minimis fair value as of September 30, 2011.

In July 2010, the Company entered into a collaboration with Temasek Life Sciences Ventures Pte Limited to advance the development of monoclonal products for worldwide prophylaxis or treatment of infection caused by existing or anticipated future pandemic influenza strains via a hemagglutinin-based medical countermeasure, resulting in the formation of EPIC Bio Pte Limited (“EPIC”). The Company has a 60% equity interest in EPIC and controls the EPIC Board of Directors. The Company has evaluated its variable interests in EPIC and has determined that it is the primary beneficiary as it has the ability to direct the activities of EPIC and will absorb the majority of expected losses. Accordingly, the Company consolidates the entity. As of September 30, 2011, assets of $1.6 million and liabilities of $830,000 related to EPIC are included within the Company’s consolidated balance sheet. As of September 30, 2010, assets of $1.3 million are included within the Company’s consolidated balance sheet.  There were no liabilities at September 30, 2010.  During the three and nine months ended September 30, 2011, EPIC incurred net losses of $407,000 and $783,000, respectively, of which $244,000 and $470,000, respectively, is included in the Company’s consolidated statement of operations. For each of the three and nine months ended September 30, 2010, EPIC did not incur net income or losses.

The following is a summary of the stockholders’ equity attributable to the Company and the noncontrolling interests:

   
Emergent
   
Noncontrolling
       
(in thousands)
 
BioSolutions Inc.
   
Interests
   
Total
 
Stockholders' equity at December 31, 2010
  $ 369,464     $ 4,097     $ 373,561  
Non-cash development expenses from variable interest entities
    -       4,263       4,263  
Net loss
    (5,638 )     (5,149 )     (10,787 )
Other
    17,466       -       17,466  
Stockholders' equity at September 30, 2011
  $ 381,292     $ 3,211     $ 384,503  

9.    Comprehensive income (loss)

Comprehensive income (loss) is comprised of net income (loss) attributable to Emergent BioSolutions Inc. and other changes in equity that are excluded from net income (loss) attributable to Emergent BioSolutions Inc. The Company includes gains and losses on intercompany transactions with foreign subsidiaries that are considered to be long-term investments and translation gains and losses incurred when converting its subsidiaries’ financial statements from their functional currency to the U.S. dollar in accumulated other comprehensive income (loss). Comprehensive income for the three months ended September 30, 2011 was $1.4 million. Comprehensive loss for the nine months ended September 30, 2011 was $6.4 million. Comprehensive income for the three and nine months ended September 30, 2010 was $12.6 million and $24.8 million, respectively.

10.  Restructuring

In November 2010, the Company adopted a plan to restructure and reprioritize the operations of Emergent Product Development UK Limited (“EPDU”).  Severance and other related costs and asset-related charges are reflected within the Company’s consolidated statement of income as a component of selling, general and administrative expense within the Company’s biosciences segment.

The Company has completed this restructuring. The costs of the restructuring as of September 30, 2011 are detailed below:

   
Incurred in
   
Inception to Date
   
Total Expected
 
(in thousands)
 
2011
   
Costs Incurred
   
to be Incurred
 
Termination benefits
  $ 475     $ 2,893     $ 2,893  
Contract termination costs
    1,877       2,295       2,295  
Other costs
    136       396       396  
Total
  $ 2,488     $ 5,584     $ 5,584  

The following is a summary of the activity for the liabilities related to the EPDU restructuring:

         
Lease
       
   
Termination
   
Termination
       
(in thousands)
 
Benefits
   
Costs
   
Total
 
Balance at December 31, 2010
  $ 2,418     $ 650     $ 3,068  
Expenses incurred
    475       1,877       2,352  
Amount paid
    (2,893 )     (2,311 )     (5,204 )
Other adjustments
    -       (216 )     (216 )
Balance at September 30, 2011
  $ -     $ -     $ -  

11.  Earnings per share

Basic net income (loss) per share of common stock excludes dilution for potential common stock issuances and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
 
The following table presents the calculation of basic and diluted net income (loss) per share:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands, except share and per share data)
 
2011
   
2010
   
2011
   
2010
 
Numerator:
                       
Net income (loss)
  $ 1,549     $ 13,120     $ (5,638 )   $ 25,451  
                                 
Denominator:
                               
Weighted-average number of shares—basic
    35,855,217       31,301,796       35,552,900       31,094,616  
Dilutive securities—equity awards
    592,716       811,517       -       722,284  
Weighted-average number of shares—diluted
    36,447,933       32,113,313       35,552,900       31,816,900  
                                 
Earnings per share-basic
  $ 0.04     $ 0.42     $ (0.16 )   $ 0.82  
Earnings per share-diluted
  $ 0.04     $ 0.41     $ (0.16 )   $ 0.80  

Stock options with exercise prices in excess of the average per share closing price during the period are not considered in the calculation of fully diluted earnings per share. For the three month periods ended September 30, 2011 and 2010, approximately 1.7 million and 1.3 million stock options, respectively, and 1.8 million stock options for the nine month period ended September 30, 2010 were excluded from the calculation.  These stock options were excluded because the exercise prices were in excess of the average per share closing price.

For the nine month period ended September 30, 2011, approximately 3.9 million shares were excluded from the calculation of diluted earnings per share because the net loss attributable to Emergent BioSolutions Inc. would make these awards antidilutive.

12.  Litigation

Class-action litigation related to Trubion Pharmaceuticals acquisition.  On August 17, 2010, two class action lawsuits were filed in the Superior Court of Washington, King County (the “State Court”), against Trubion Pharmaceuticals, Inc. (“Trubion”), its board of directors, and the Company (collectively, the “Defendants”), alleging in summary that, in connection with the merger of Trubion with a subsidiary of the Company (the “Acquisition”),  members of the Trubion board of directors breached their fiduciary duties by conducting an unfair sale process and agreeing to an unfair price. Both complaints also claimed that Trubion and the Company aided and abetted the Trubion board of directors in its breach of fiduciary duties. On September 9, 2010, the actions were consolidated (the “State Action”).  On October 1, 2010, the plaintiffs in the State Action served on the Defendants a consolidated amended class action complaint (the “Amended Complaint”). The Amended Complaint alleged, among other things and in addition to the matters alleged in the initial complaints, that the Defendants omitted material information from the Proxy Statement/Prospectus relating to the Acquisition.

On October 4, 2010, a class action lawsuit was filed in the U.S. District Court for the Western District of Washington against the Defendants (the “Federal Action” and, collectively with the State Action, the “Actions”), which made allegations related to the Acquisition that were substantially similar to those matters alleged in the Amended Complaint and included additional allegations regarding purported violations of the federal securities laws and sought substantially similar relief.

On October 8, 2010, the Defendants reached agreement in principle with the plaintiffs in the Actions regarding the settlement of the Actions. The terms of the settlement contemplated by that agreement in principle required Trubion and the Company to make certain additional disclosures related to the Acquisition, as set forth in the Company’s Current Report on Form 8-K filed on October 8, 2010. The parties also agreed that the plaintiffs in the Actions could seek attorneys’ fees and costs in an aggregate amount up to $475,000, to be paid by Trubion if such fees and costs were approved by the State Court. There will be no other payment by Trubion, any of the members of the Trubion board of directors or the Company to the plaintiffs or their respective counsels in connection with the settlement and dismissal of the Actions. The agreement in principle further contemplated that the parties would enter into a stipulation of settlement, which would be subject to customary conditions, including State Court approval following notice to Trubion’s shareholders. The Actions were stayed pending approval of the settlement of the State Action by the State Court, after which the State Action and all claims asserted therein would be dismissed with prejudice and counsel for the plaintiff in the Federal Action would take all necessary steps to dismiss the Federal Action and all claims asserted therein with prejudice. On April 26, 2011, the State Court entered an order granting preliminary approval of the settlement and requiring that notice of the settlement and preliminary approval be mailed to class members by May 17, 2011.  The order also provided that all class members wishing to be excluded from the settlement of the Actions were required to give notice by June 21, 2011.  At a hearing on July 29, 2011, the State Court determined that the settlement was fair, reasonable and adequate to the class members and approved the settlement in all aspects.  On September 12, 2011 the Federal Action was dismissed and the Company has since made a payment in the amount of $475,000 for attorneys’ fees and costs.

Other.  From time to time, the Company is involved in product liability claims and other litigation considered normal in the nature of its business. The Company does not believe that any such proceedings would have a material adverse effect on the results of its operations.

13.  Related party transactions

The Company entered into an agreement in February 2009 with an entity controlled by family members of the Company’s Chief Executive Officer to market and sell BioThrax. The agreement was effective as of November 2008 and requires payment based on a percentage of net sales of biodefense products of 17.5% in Saudi Arabia and 15% in Qatar and United Arab Emirates, and reimbursement of certain expenses.  No expenses were incurred under this agreement during the nine months ended September 30, 2011.

The Company entered into a consulting agreement in September 2010 with an entity controlled by the Company’s former Senior Vice President Corporate Affairs, who is also a family member of the Company’s Chief Executive Officer.  The agreement, which terminated in August 2011, provided for consulting services in connection with special projects as assigned by the Company’s President.  During the nine months ended September 30, 2011 and 2010, the Company incurred approximately $40,000 and $5,000, respectively, for services rendered under this agreement, of which $5,000 remained in accounts payable at September 30, 2011.

The Company had a consulting agreement with a member of the Company’s Board of Directors. For each of the nine month periods ended September 30, 2011 and 2010, the Company incurred approximately $135,000 under this agreement for strategic consultation and project support for the Company’s marketing and communications group, of which no balance remained unpaid in accounts payable at September 30, 2011. In October 2011, this director resigned from the Company’s Board of Directors, and the consulting agreement was terminated in November 2011.
 
14.  Segment information

For financial reporting purposes, the Company reports financial information for two business segments: biodefense and biosciences. In the biodefense segment, the Company develops, manufactures and commercializes vaccines and antibody therapies for use against biological agents that are potential weapons of bioterrorism or biowarfare. Revenues in this segment relate primarily to the Company’s FDA-licensed product, BioThrax® (Anthrax Vaccine Absorbed). In the biosciences segment, the Company develops vaccines, protein therapeutics and technology platforms for use against infectious diseases, oncology, autoimmune and inflammatory disorders and other medical conditions that have resulted in significant unmet or underserved public health needs.  The “All Other” segment relates to the general operating costs of the Company and includes costs of the centralized services departments, which are not allocated to the other segments, as well as spending on product candidates or activities that are not classified as biodefense or biosciences. The assets in this segment consist primarily of cash. For the three and nine months ended September 30, 2010, the Company reclassified its business segments to conform with the current period presentation.

   
Reportable Segments
 
(in thousands)
 
Biodefense
   
Biosciences
   
All Other
   
Total
 
Three Months Ended September 30, 2011
                       
External revenue
  $ 56,679     $ 2,083     $ -     $ 58,762  
Net income (loss) attributable to Emergent BioSolutions Inc.
    18,304       (15,237 )     (1,518 )     1,549  
Assets
    229,351       134,381       149,230       512,962  
Three Months Ended September 30, 2010
                               
External revenue
  $ 73,986     $ -     $ -     $ 73,986  
Net income (loss) attributable to Emergent BioSolutions Inc.
    29,909       (14,421 )     (2,368 )     13,120  
Assets
    173,720       43,790       148,727       366,237  
                                 
   
Reportable Segments
 
(in thousands)
 
Biodefense
   
Biosciences
   
All Other
   
Total
 
Nine Months Ended September 30, 2011
                               
External revenue
  $ 155,864     $ 9,572     $ -     $ 165,436  
Net income (loss) attributable to Emergent BioSolutions Inc.
    49,114       (50,942 )     (3,810 )     (5,638 )
Assets
    229,351       134,381       149,230       512,962  
Nine Months Ended September 30, 2010
                               
External revenue
  $ 182,924     $ -     $ -     $ 182,924  
Net income (loss) attributable to Emergent BioSolutions Inc.
    65,818       (34,985 )     (5,382 )     25,451  
Assets
    173,720       43,790       148,727       366,237  

15.   Asset Purchase Agreement

In May 2011, the Company and TenX BioPharma, Inc. (“TenX”) entered into an asset purchase agreement in which the Company acquired all assets and rights related to the Zanolimumab product candidate and related technology from TenX. The Company paid approximately $3.1 million in conjunction with the closing of this acquisition and has recorded this amount in the Company’s statement of operations as research and development expense in the biosciences segment. The asset purchase agreement also contemplates additional payments by the Company for future milestones and specified percentages of future net sales.

16.   Subsequent events

The Company has evaluated subsequent events through the time of filing these financial statements.
 
ITEM 2.  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes and other financial information included elsewhere in this quarterly report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report on Form 10-Q, including information with respect to our plans and strategy for our business, include forward-looking statements that involve risks and uncertainties. You should review the “Special Note Regarding Forward-Looking Statements” and the “Risk Factors” sections of this quarterly report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

Product Portfolio

We are a biopharmaceutical company focused on protecting and enhancing life by developing and manufacturing vaccines and protein therapeutics that are supplied to healthcare providers and purchasers for use in preventing and treating disease. For financial reporting purposes, we operate in two business segments, biodefense and biosciences.

Our biodefense segment focuses on vaccines and antibody therapies for use against biological agents that are potential weapons of bioterrorism or biowarfare. Our products and product candidates in this segment are focused on anthrax. We manufacture and market BioThrax® (Anthrax Vaccine Adsorbed), the only vaccine licensed by the U.S. Food and Drug Administration, or FDA, for the prevention of anthrax infection. In addition to BioThrax, we are developing PreviThraxTM (Recombinant Protective Antigen Anthrax Vaccine, Purified), Anthrivig TM (Human Anthrax Immunoglobulin), Thravixa TM (Fully Human Anthrax Monoclonal Antibody) and NuThrax TM (Anthrax Vaccine Absorbed with CPG 7909 Adjuvant). Operations in this segment include biologics manufacturing, regulatory and quality affairs, marketing and sales in support of BioThrax and product development of our investigational product candidates.

Our biosciences segment is directed to commercial opportunities. Our programs in this segment target oncology, including B-cell malignancies of chronic lymphocytic leukemia, or CLL, and non-Hodgkin’s lymphoma, or NHL; autoimmune and inflammatory disorders, or AIID, including rheumatoid arthritis, or RA, and systemic lupus erythematosus, or SLE; as well as infectious diseases such as tuberculosis and influenza. Additionally, through our recent acquisition of certain assets of TenX BioPharma, Inc., or TenX, we acquired a clinical stage product candidate targeted at cutaneous T-cell lymphoma, or CTCL, and peripheral T-cell lymphoma, or PTCL. Our programs in this segment include clinical and preclinical stage investigational product candidates. Operations in this segment include product development in support of our investigational product candidates, and manufacturing and related infrastructure initiatives in support of our technology platforms.

Our biodefense segment has generated net income for each of the last five fiscal years. Over this timeframe, our biosciences segment has generated revenue through development contracts and collaborative funding, but none of our biosciences product candidates have received marketing approval and, therefore, our biosciences segment has not generated any product sales revenues. As a result, our biosciences segment has incurred a net loss for each of the last five fiscal years.

Product Sales

We have derived substantially all of our product sales revenues from BioThrax sales to the U.S. government.  We are currently a party to a contract with the U.S. Department of Health and Human Services, or HHS, to supply doses of BioThrax for placement into the Strategic National Stockpile, or SNS.  We expect for the foreseeable future to continue to derive substantially all of our product sales revenues from our sales of BioThrax to the U.S. government. Our total revenues from BioThrax sales were $120.7 million and $162.0 million, respectively, for the nine months ended September 30, 2011 and 2010. We are focused on increasing sales of BioThrax to U.S. government customers, expanding the market for BioThrax to other customers domestically and internationally and pursuing label expansions and improvements for BioThrax.

On September 30, 2011, we received a notice of award from the Centers for Disease Control and Prevention, or CDC, to supply up to 44.75 million doses of BioThrax to the CDC over a five-year period. We anticipate that delivery of doses under the award will commence in December 2011, immediately following the completion of deliveries under our current supply contract.

Contracts and Grants

We seek to advance development of our product candidates through external funding arrangements. We may slow down development programs or place them on hold during periods that are not covered by external funding. We have received funding for the following development programs:

§  
BioThrax post-exposure prophylaxis;
§  
NuThrax;
§  
Large-scale manufacturing for BioThrax;
§  
PreviThrax;
§  
Anthrivig;
§  
Thravixa;
§  
Double mutant recombinant protective antigen anthrax vaccine; and
§  
Recombinant botulinum vaccine.

Additionally, our tuberculosis vaccine product candidate is indirectly supported by grant funding provided to the University of Oxford by the Wellcome Trust and Aeras Global Tuberculosis Vaccine Foundation. Our TRU-016 product candidate is being funded via our collaboration with Abbott Laboratories, or Abbott, in which we and Abbott share all funding responsibilities equally. Our SBI-087 product candidate is substantially funded by Pfizer Inc., or Pfizer.

We continue to actively pursue additional government sponsored development contracts and grants and commercial collaborative relationships.  We also encourage both governmental and non-governmental agencies and philanthropic organizations to provide development funding or to conduct clinical studies of our product candidates.

Manufacturing Infrastructure

We conduct our primary vaccine manufacturing operations at a multi-building campus on approximately 12.5 acres in Lansing, Michigan. To augment our existing manufacturing capabilities, we have constructed Building 55, a 50,000 square foot large-scale manufacturing facility on our Lansing campus. In July 2010, we entered into an agreement with the Biomedical Advanced Research and Development Authority, or BARDA, to finalize development of and obtain regulatory approval for large-scale manufacturing of BioThrax in Building 55. This agreement provides for funding from BARDA of up to approximately $107 million over a five-year contract term, including a two-year base period of performance valued at approximately $55 million.

In November 2009, we purchased a building in Baltimore, Maryland for product development and manufacturing purposes, and have begun renovation, improvement and equipment acquisitions at this facility. We have entered into two loan agreements with PNC Bank totaling up to $42.0 million to fund these renovations, improvements and equipment acquisitions. Our specific plans for this facility will be contingent on the progress of our existing development programs and the outcome of our efforts to acquire new product candidates.

Critical Accounting Policies and Estimates

There have been no significant changes to our Critical Accounting Policies and Estimates during the nine months ended September 30, 2011. Refer to the Critical Accounting Policies and Estimates section in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission.

Financial Operations Overview

Revenues

On September 30, 2008, we entered into an agreement with HHS to supply up to 14.5 million doses of BioThrax for placement into the SNS. In April 2011, we entered into a modification to this contract to supply an additional 3.4 million doses at a value of up to $101 million.  The term of the modified agreement was from September 30, 2008 through September 30, 2011.  On September 28, 2011 we entered into a further modification of this contract that extends the period of performance of the contract at no additional cost, from September 30, 2011 to December 31, 2011.  The total purchase price of the modified contract for 17.9 million doses is approximately $500 million. Through September 30, 2011, we have delivered approximately 15.8 million doses under this agreement. We have agreed to provide all shipping services related to delivery of doses into the SNS over the term of the agreement, for which HHS has agreed to pay us approximately $2.3 million. We recognize revenue under the agreement upon acceptance of each delivery of BioThrax doses to the SNS.

On September 30, 2011, we received a notice of award from the CDC, to supply up to 44.75 million doses of BioThrax to the CDC over a five-year period. The maximum amount that could be paid to us under the award is up to $1.25 billion.  The period of performance under the award is from September 30, 2011 through September 29, 2016.  We anticipate delivery of doses under the award will commence in December 2011, immediately following the completion of deliveries under our current supply contract.

We have received contract and grant funding from the National Institute of Allergy and Infectious Diseases, or NIAID, and BARDA for the following development programs:

         
Amount
 
Product Candidate/Manufacturing
Funding Source
 
Award Date
 
(Up to)
Performance Period
Anthrivig
NIAID
    8/2006  
$3.7 million
  8/2006 — 12/2011
Anthrivig
NIAID
    9/2007  
$11.4 million
  9/2007 — 12/2011
Recombinant botulinum vaccine
NIAID
    6/2008  
$1.8 million
6/2008 — 5/2012
NuThrax
NIAID
    7/2008  
$2.8 million
7/2008 — 6/2013
Thravixa
NIAID/BARDA
    9/2008  
$16.7 million
9/2008 — 8/2012
NuThrax
NIAID/BARDA
    9/2008  
$24.4 million
9/2008 — 7/2012
Double mutant recombinant protective antigen anthrax vaccine
NIAID
    9/2009  
$4.9 million
9/2009 — 8/2012
Large-scale manufacturing for BioThrax
BARDA
    7/2010  
$107.5 million
7/2010 — 7/2015
NuThrax
NIAID
    7/2010  
$28.7 million
8/2010 — 8/2014
PreviThrax
BARDA
    9/2010  
$186.6 million
9/2010 — 9/2015

Our revenue, operating results and profitability have varied, and we expect that they will continue to vary on a quarterly basis, primarily due to the timing of our fulfilling orders for BioThrax and work done under new and existing grants and contracts, including collaborative relationships.

Cost of Product Sales

The primary expense that we incur to deliver BioThrax to our customers is manufacturing cost, which consist of primarily fixed costs. These fixed manufacturing costs consist of facilities, utilities and personnel-related expenses for indirect manufacturing support staff. Variable manufacturing costs for BioThrax consist primarily of costs for materials, direct labor and contract filling operations.

We determine the cost of product sales for doses sold during a reporting period based on the average manufacturing cost per dose in the period those doses were manufactured. We calculate the average manufacturing cost per dose in the period of manufacture by dividing the actual costs of manufacturing in such period by the number of units produced in that period. In addition to the fixed and variable manufacturing costs described above, the average manufacturing cost per dose depends on the efficiency of the manufacturing process, utilization of available manufacturing capacity and the production yield for the period of production.

Research and Development Expenses

We expense research and development costs as incurred. Our research and development expenses consist primarily of:

 
§
personnel-related expenses;
 
§
fees to professional service providers for, among other things, preclinical and analytical testing, independent monitoring or other administration of our clinical trials and acquiring and evaluating data from our clinical trials and non-clinical studies;
 
§
costs of contract manufacturing services for clinical trial material;
 
§
costs of materials used in clinical trials and research and development;
 
§
depreciation of capital assets used to develop our products; and
 
§
operating costs, such as the operating costs of facilities and the legal costs of pursuing patent protection of our intellectual property.

We believe that significant investment in product development is a competitive necessity and plan to continue these investments in order to be in a position to realize the potential of our product candidates. We expect that spending for our product pipeline will increase as our product development activities continue based on ongoing advancement of our product candidates, and as we prepare for regulatory submissions and other regulatory activities. We expect that the magnitude of any increase in our research and development spending will be dependent upon such factors as the results from our ongoing preclinical studies and clinical trials, continued participation of our third-party collaborators, number of product candidates under development, the size, structure and duration of any follow-on clinical programs that we may initiate, costs associated with manufacturing our product candidates on a large-scale basis for later-stage clinical trials, and our ability to use or rely on data generated by government agencies, such as studies with BioThrax conducted by the CDC.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel serving the executive, sales and marketing, business development, finance, accounting, information technology, legal and human resource functions. Other costs include facility costs not otherwise included in cost of product sales or research and development expense and professional fees for legal and accounting services. We currently market and sell BioThrax directly to the U.S. government with a small, targeted marketing and sales group. As we seek to broaden the market for BioThrax and if we receive marketing approval for additional products, we expect that we will increase our spending for marketing and sales activities.

Results of Operations

Quarter Ended September 30, 2011 Compared to Quarter Ended September 30, 2010

Revenues

Product sales revenues decreased by $23.6 million, or 35%, to $43.7 million for the three months ended September 30, 2011 from $67.3 million for the three months ended September 30, 2010. This decrease in product sales revenues was due to a 38% decrease in the number of doses of BioThrax delivered, due primarily to lower production yields in the period in which the doses were produced. Product sales revenues for the three months ended September 30, 2011 consisted of BioThrax sales to HHS of $43.6 million and aggregate international and other sales of $85,000.  Product sales revenues for the three months ended September 30, 2010 consisted of BioThrax sales to HHS of $67.2 million and aggregate other sales of $39,000.

Contracts and grants revenues increased by $8.4 million, or 125%, to $15.1 million for the three months ended September 30, 2011 from $6.7 million for the three months ended September 30, 2010. The increase in contracts and grants revenue was primarily due to increased revenue from our development contracts with BARDA for PreviThrax and large-scale manufacturing for BioThrax, along with our collaborations with Abbott and Pfizer.  Contracts and grants revenues for the three months ended September 30, 2011 consisted of $13.0 million in development contract and grant revenue from NIAID and BARDA and $2.1 million from Abbott and Pfizer. All contracts and grants revenues for the three months ended September 30, 2010 were from NIAID and BARDA.

Cost of Product Sales

Cost of product sales decreased by $826,000, or 7%, to $10.7 million for the three months ended September 30, 2011 from $11.5 million for the three months ended September 30, 2010. This decrease was attributable to the 38% decrease in the number of BioThrax doses sold, largely offset by an increase in the cost per dose sold associated with decreased production yield in the period in which the doses were produced.

Research and Development Expenses

Research and development expenses increased by $8.1 million, or 38%, to $29.2 million for the three months ended September 30, 2011 from $21.2 million for the three months ended September 30, 2010. This increase primarily reflects higher contract service and personnel-related costs, and includes increased expenses of $4.5 million for product candidates and technology platform development activities that are categorized in the biosciences segment, increased expenses of $2.0 million for product candidates that are categorized in the biodefense segment, and increased expenses of $1.5 million in other research and development, which are in support of central research and development activities. For the three months ended September 30, 2011 and 2010, we incurred research and development expenses net of development contract and grant reimbursements along with the net loss attributable to noncontrolling interests of $12.4 million and $13.3 million, respectively.

The spending on biodefense product candidates, detailed in the table below, was primarily attributable to the timing of development efforts on various programs as we completed various studies and prepared for subsequent studies and trials. The spending for NuThrax was due to process characterization and assay development along with the conduct of clinical trial activities. The increase in spending for our large-scale manufacturing for Biothrax program was primarily due to characterization assay development and validation activities. The decrease in spending for BioThrax related programs was related to the timing of clinical and non-clinical studies to support applications for marketing approval of these programs. The increase in spending for PreviThrax was primarily due to formulation development, stability studies and model optimization under the associated development contract awarded in September 2010. The decrease in spending for Anthrivig was primarily due to the timing of a clinical trial. The decrease in spending for Thravixa was primarily due to the timing of non-clinical studies. The decrease in spending for our other biodefense activities was primarily due to decreased spending associated with our double mutant recombinant protective antigen anthrax vaccine due primarily to reduced funding by the U.S. government for this product candidate. We expect that spending for our double mutant recombinant protective antigen anthrax vaccine will continue to decrease in the future.

The increase in spending on biosciences product candidates, detailed in the table below, was primarily attributable to the timing of development efforts and the acquisition of certain biosciences product candidates. The increase in spending for our tuberculosis vaccine product candidate is related to the costs incurred for the continued conduct of a Phase IIb clinical trial, along with process development and manufacturing activities. The increase in spending for our TRU-016, ES-301 (formerly DRACO) and XI product candidates, acquired as a result of our October 2010 acquisition of Trubion Pharmaceuticals, Inc. or Trubion, and its development programs for product candidates to treat certain autoimmune diseases and oncology, is primarily related to clinical trials, process development and manufacturing costs.  The spending for our Zanolimumab product candidate, which was acquired in the May 2011 acquisition of certain assets of TenX, was primarily due to ongoing analysis of clinical study data. The decrease in spending for our influenza vaccine product candidate was due to the timing of process and analytical development. The decrease in spending for Typhella was primarily due to the substantial completion of manufacturing and clinical studies. We have significantly reduced ongoing spending with regard to Typhella while we investigate options to sell or outlicense the related technology, and we expect that future spending will be reduced. The decrease in spending for our other biosciences activities was primarily due to reduced spending associated with development of platform technologies along with preclinical product candidates as a result of our acquisition of Trubion.

The spending for other research and development activities was primarily attributable to central research and development activities.

Our principal research and development expenses for the three months ended September 30, 2011 and 2010 are shown in the following table:

     
Three Months Ended
 
     
September 30,
 
(in thousands)
   
2011
   
2010
 
Biodefense:
             
NuThrax
    $ 2,596     $ 2,423  
Large-scale manufacturing for BioThrax
      3,637       2,607  
BioThrax related programs
      1,467       2,031  
PreviThrax
      4,496       840  
Anthrivig
      417       1,104  
Thravixa
      672       1,295  
Other biosdefense
      398       1,382  
Total biodefense
      13,683       11,682  
Biosciences:
                 
Tuberculosis vaccine
      4,287       3,836  
TRU-016
      2,395       -  
ES-301 (formerly DRACO)
      1,900       -  
X1         774       -  
Zanolimumab
      633       -  
Influenza vaccine
      682       999  
Typhella
      119       1,194  
Other biosciences
      2,266       2,503  
Total biosciences
      13,056       8,532  
Other
      2,477       942  
Total
    $ 29,216     $ 21,156  

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased by $3.3 million, or 16%, to $17.4 million for the three months ended September 30, 2011 from $20.7 million for the three months ended September 30, 2010. This decrease is primarily due to decreased professional services, including legal and other fees incurred in 2010 related to the Trubion acquisition. The majority of the expense is attributable to the biodefense segment, in which selling, general and administrative expenses decreased by $1.5 million, or 11%, to $12.0 million for the three months ended September 30, 2011 from $13.5 million for the three months ended September 30, 2010. Selling, general and administrative expenses related to our biosciences segment decreased by $1.7 million, or 24%, to $5.5 million for the three months ended September 30, 2011 from $7.2 million for the three months ended September 30, 2010.

Total Other Income (Expense)

Total other income (expense) increased by $1.0 million to net other income of $59,000 for the three months ended September 30, 2011 from net other expense of $965,000 for the three months ended September 30, 2010. The increase was due primarily to a charge to reduce previously recorded accrued interest income related to the settlement with Protein Sciences Corporation, or PSC, in October 2010.

Income Taxes

Provision for income taxes decreased by $6.1 million, or 79%, to $1.6 million for the three months ended September 30, 2011 from $7.7 million for the three months ended September 30, 2010.  The estimated effective tax rate before discrete items for the three months ended September 30, 2011 and 2010 was 34% and 37%, respectively. The decrease in the provision for income taxes was primarily due to the decrease in our income before provision for income taxes plus the loss attributable to noncontrolling interest of $17.7 million.

Net Loss Attributable to Noncontrolling Interests

Net loss attributable to noncontrolling interests increased by $510,000, or 43%, to $1.7 million for the three months ended September 30, 2011 from $1.2 million for the three months ended September 30, 2010. The loss was primarily a result of clinical and development activities and related expenses incurred by our joint ventures. These amounts primarily represent the portion of the losses incurred by the joint ventures for the three months ended September 30, 2011 and 2010, respectively, that is attributable to our joint venture partners.

Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010

Revenues

Product sales revenues decreased by $41.3 million, or 25%, to $120.7 million for the nine months ended September 30, 2010 from $162.0 million for the nine months ended September 30, 2010. This decrease in product sales revenues was primarily due to a 29% decrease in the number of doses of BioThrax delivered due to the redeployment of our potency testing capacity from BioThrax release testing to qualification of replacement reference standards and other development testing during the first quarter 2011 coupled with lower production yields in the period in which the doses were produced. Product sales revenues for the nine months ended September 30, 2011 consisted of BioThrax sales to HHS of $119.4 million and aggregate international and other sales of $1.4 million. Product sales revenues for the nine months ended September 30, 2010 consisted of BioThrax sales to HHS of $159.6 million and aggregate international and other sales of $2.4 million.

Contracts and grants revenues increased by $23.8 million, or 114%, to $44.7 million for the nine months ended September 30, 2011 from $20.9 million for the nine months ended September 30, 2010. The increase in contracts and grants revenues was primarily due to revenues from our contract with BARDA for large-scale manufacturing for BioThrax and our collaborations with Abbott and Pfizer, along with increased activity and associated revenue from our development contracts with NIAID and BARDA for NuThrax and PreviThrax. Contracts and grants revenues for the nine months ended September 30, 2011 consisted of $35.1 million in development contract and grant revenue from NIAID and BARDA and $9.6 million from Abbott and Pfizer. Contracts and grants revenues for the nine months ended September 30, 2010 consisted of $20.2 million in development contract and grant revenue from NIAID and BARDA and $750,000 from a milestone payment related to the 2008 sale of technology rights and related materials and documentation pertaining to our Pertussis technology.

Cost of Product Sales

Cost of product sales decreased by $2.3 million, or 8%, to $27.8 million for the nine months ended September 30, 2011 from $30.1 million for the nine months ended September 30, 2010. This decrease was attributable to a 29% decrease in the number of doses of BioThrax delivered, largely offset by an increase in the cost per dose sold associated with decreased production yield in the period in which the doses were produced.

Research and Development Expenses

Research and development expenses increased by $35.8 million, or 60%, to $95.5 million for the nine months ended September 30, 2011 from $59.7 million for the nine months ended September 30, 2010. This increase primarily reflects higher contract service and personnel-related costs, and includes increased expenses of $30.8 million for product candidates and technology platform development activities that are categorized in the biosciences segment, increased expenses of $3.1 million for product candidates categorized in the biodefense segment, and increased expenses of $1.9 million in other research and development, which are in support of central research and development activities. For the nine months ended September 30, 2011 and 2010, we incurred research and development expenses net of development contract and grant reimbursements along with the net loss attributable to noncontrolling interests of $45.6 million and $36.6 million, respectively.

The increase in spending on biodefense product candidates, detailed in the table below, was primarily attributable to the timing of development efforts on various programs as we completed various studies and prepared for subsequent studies and trials. The increase in spending for NuThrax was due to manufacturing, process characterization, assay validation and the conduct of clinical trial activities. The increase in spending for our large-scale manufacturing for Biothrax program was primarily due to characterization assay development, validation activities and manufacturing that increased subsequent to the associated development contract award in July 2010. The spending for BioThrax related programs was related to clinical and non-clinical studies to support applications for marketing approval of these programs. The increase in spending for PreviThrax was primarily due to formulation development, stability studies and model optimization subsequent to the associated development contract awarded in September 2010. The decrease in spending for Anthrivig was primarily due to the timing of a clinical trial and animal model development. The decrease in spending for Thravixa was primarily due to the timing of process development, non-clinical studies and animal model development. The decrease in spending for our other biodefense activities was primarily due to decreased spending associated with our double mutant recombinant protective antigen anthrax vaccine due primarily to reduced funding by the U.S. government for this product candidate. As such, we expect that spending for our double mutant recombinant protective antigen anthrax vaccine will decrease in the future.

The increase in spending on biosciences product candidates, detailed in the table below, was primarily attributable to the timing of development efforts and the acquisition of certain biosciences product candidates. The increase in spending for our tuberculosis vaccine product candidate is related to the costs incurred for the continued conduct of a Phase IIb clinical trial along with process development and manufacturing activities. The increase in spending for our TRU-016, ES-301 and XI product candidates, which is a result of our October 2010 acquisition of Trubion and its development programs for product candidates to treat certain autoimmune diseases and oncology, is primarily related to clinical trials, process development and manufacturing costs.  The spending for our Zanolimumab product candidate was primarily for upfront and milestone payments related to the May 2011 acquisition of certain assets of TenX. The decrease in spending for our influenza vaccine product candidate is related to the timing of process and analytical development. The decrease in spending for Typhella was primarily due to the substantial completion of manufacturing and clinical studies.  We have significantly reduced ongoing spending with regard to Typhella while we investigate options to sell or outlicense the related technology, and we expect that future spending will be reduced. The increase in spending for our other biosciences activities was primarily due to increased spending associated with development of platform technologies along with preclinical product candidates as a result of our acquisition of Trubion.

Our principal research and development expenses for the nine months ended September 30, 2011 and 2010 are shown in the following table:

     
Nine Months Ended
 
     
September 30,
 
(in thousands)
   
2011
   
2010
 
Biodefense:
             
NuThrax
    $ 9,317     $ 6,975  
Large-scale manufacturing for BioThrax
      9,738       6,022  
BioThrax related programs
      5,236       5,384  
PreviThrax
      10,420       2,290  
Anthrivig
      1,422       4,994  
Thravixa
      2,897       7,118  
Other biosdefense
      1,885       5,065  
Total biodefense
      40,915       37,848  
Biosciences:
                 
Tuberculosis vaccine
      14,123       8,158  
TRU-016
      10,871       -  
ES-301 (formerly DRACO)
      5,845       -  
X1          2,596       -  
Zanolimumab
      3,782       -  
Influenza vaccine
      2,144       2,588  
Typhella
      1,221       2,432  
Other biosciences
      8,868       5,469  
Total biosciences
      49,450       18,647  
Other
      5,091       3,185  
Total
    $ 95,456     $ 59,680  

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $1.5 million, or 3%, to $56.0 million for the nine months ended September 30, 2011 from $54.5 million for the nine months ended September 30, 2010. This increase is primarily due to approximately $2.2 million in restructuring charges related to our UK operations. The majority of the expense is attributable to the biodefense segment, in which selling, general and administrative expenses increased by $811,000, or 2%, to $39.1 million for the nine months ended September 30, 2011 from $38.3 million for the nine months ended September 30, 2010. Selling, general and administrative expenses related to our biosciences segment, increased by $683,000, or 4%, to $16.9 million for the nine months ended September 30, 2011 from $16.2 million for the nine months ended September 30, 2010.

Total Other Income (Expense)

Total other income increased by $282,000 to net other income of $72,000 for the nine months ended September 30, 2011 from net other expense of $210,000 for the nine months ended September 30, 2010. The increase was due primarily to a charge to reduce previously accrued interest income related to the settlement with PSC in October 2010.

Income Taxes

Provision for (benefit from) income taxes decreased by $18.1 million to a benefit from income taxes of $3.0 million for the nine months ended September 30, 2011 from a provision for income taxes of $15.1 million for the nine months ended September 30, 2010. The estimated annual effective tax rate before discrete items for the nine months ended September 30, 2011 and 2010 was 41% and 37%¸ respectively.  The decrease in income taxes is primarily due to a $49.2 million decrease in our income before provision for income taxes and the loss attributable to noncontrolling interests.

Net Loss Attributable to Noncontrolling Interest

Net loss attributable to noncontrolling interest increased by $3.0 million to $5.1 million for the nine months ended September 30, 2011 from $2.2 million for the nine months ended September 30, 2010. The increase resulted primarily from the timing of clinical and development activities and related expenses incurred by our joint ventures. These amounts represent the portion of the losses incurred by the joint ventures for the nine months ended September 30, 2011 and 2010, respectively, that is attributable to our joint venture partners.

Liquidity and Capital Resources

     Sources of Liquidity

We have funded our cash requirements from inception through September 30, 2011 principally with a combination of revenues from BioThrax product sales, debt financings and facilities and equipment leases, development funding from government entities and non-government and philanthropic organizations, the net proceeds from our initial public offering and from the sale of our common stock upon exercise of stock options. We have operated profitably for each of the five years ended December 31, 2010.

As of September 30, 2011, we had cash, cash equivalents and investments of $128.8 million. Additionally, as of September 30, 2011, our accounts receivable balance was $49.0 million.

Cash Flows

The following table provides information regarding our cash flows for the nine months ended September 30, 2011 and 2010:

   
Nine Months Ended
 
   
September 30,
 
(in thousands)
 
2011
   
2010
 
Net cash provided by (used in):
           
Operating activities(1)
  $ (24,755 )   $ 74,668  
Investing activities
    (35,623 )     (14,042 )
Financing activities
    16,705       (12,321 )
Total net cash provided by (used in)
  $ (43,673 )   $ 48,305  

(1)  
Includes the effect of exchange rates on cash and cash equivalents.

Net cash used in operating activities of $24.8 million for the nine months ended September 30, 2011 was principally due to our net loss attributable to Emergent BioSolutions Inc. of $5.6 million, a $5.3 million increase in inventory related to the timing of BioThrax shipments, a net decrease in income taxes of $3.8 million related to timing differences, a decrease in accrued compensation of $9.2 million primarily due to the payment of the 2010 bonuses and UK restructuring costs, an increase in accounts receivable of $9.7 million due to the timing of collection of amounts billed primarily to HHS, a decrease in deferred revenue of $5.1 million primarily due to our Abbott collaboration, partially offset by non-cash charges of $7.9 million for stock-based compensation, $6.9 million for depreciation and amortization, and $4.3 million for development expenses primarily from our joint venture with the University of Oxford.

Net cash provided by operating activities of $74.7 million for the nine months ended September 30, 2010 was due principally to net income attributable to Emergent BioSolutions Inc. of $25.5 million, a decrease in accounts receivable of $46.9 million due to the collection of amounts billed primarily to HHS, and non-cash charges of $5.2 million for stock-based compensation, $4.0 million for depreciation and amortization and $2.2 million for development expenses from our joint venture, partially offset by a decrease in income taxes of $10.6 million due to federal and state tax payments.

Net cash used in investing activities for the nine months ended September 30, 2011 was $35.6 million, primarily due to capital expenditures of $34.2 million related to the construction and related costs for our facility in Baltimore, Maryland, and infrastructure investments and other equipment, along with the purchase of U.S. Treasury securities of $5.2 million, partially offset by proceeds from the maturity of U.S. Treasury securities of $3.8 million.

Net cash used in investing activities for the nine months ended September 30, 2010 of $14.0 million, resulted principally from construction and related costs for Building 55, our large-scale manufacturing facility in Lansing, Michigan, and infrastructure investments and other equipment.

Net cash provided by financing activities of $16.7 million for the nine months ended September 30, 2011 resulted primarily from $21.3 million in advances under our construction loan with PNC Bank, or PNC, related to the renovation and improvement of our Baltimore facility, $8.8 million in proceeds from stock option exercises and $1.5 million related to excess tax benefits from the exercise of stock options, partially offset by $14.9 million in principal payments on indebtedness.

Net cash used in financing activities of $12.3 million for the nine months ended September 30, 2010 resulted primarily from $32.5 million in principal payments on indebtedness, including $30.0 million in payments on a revolving line of credit with Fifth Third Bank, partially offset by $15.0 million in proceeds from borrowings under the revolving line of credit with Fifth Third Bank, $4.1 million in proceeds from stock option exercises and $1.1 million related to excess tax benefits from the exercise of stock options.

Debt Financing

As of September 30, 2011, we had $53.8 million principal amount of debt outstanding, comprised primarily of the following:

 
§
$2.5 million outstanding under a loan from the Department of Business and Economic Development of the State of Maryland used to finance eligible costs incurred to purchase our first facility in Frederick, Maryland;
 
§
$5.3 million outstanding under a mortgage loan from PNC used to finance the remaining portion of the purchase price for our first Frederick facility;
 
§
$20.1 million outstanding under a term loan from HSBC Realty Credit Corporation used to finance a portion of the costs of our facility expansion in Lansing, Michigan;
 
§
$4.6 million outstanding under a mortgage loan from HSBC Realty Credit Corporation used to finance a portion of the purchase price of our facility in Gaithersburg, Maryland; and
 
§
$21.3 million outstanding under a construction loan from PNC used to fund the ongoing renovation of our Baltimore, Maryland facility.
 
        In April 2011, we repaid the remaining $6.5 million due under the mortgage loan from HSBC Realty Credit Corporation that was used to finance a portion of the purchase price for our second facility at the Frederick site.

In July 2011, we entered into a loan agreement and related agreements with PNC, under which PNC provided us with a construction loan of up to $30.0 million primarily to fund the ongoing renovation of the our Baltimore facility. A portion of the loan was also used to repay our loan with HSBC Bank, which we used to finance a portion of the purchase price of the facility. Under the loan agreement, PNC agreed to make advances to us of up to $30.0 million through July 2012 based on periodic requests from us.

In August 2011, we entered into a separate loan agreement with PNC to provide us with an equipment loan of up to $12.0 million to fund equipment purchases at the Baltimore facility. Under the equipment loan agreement, PNC agreed to make advances to us of up to $12.0 million through August 2012 based on periodic requests from us. As of September 30, 2011, we had not requested an advance on this loan.

In October 2011, we modified our agreement with PNC related to the first Frederick facility to extend the maturity date to October 2013, reduce the fixed annual interest rate to 3.48% and increase the monthly payment to $64,000. All unpaid principal and interest is due in full in October 2013.
 
Funding Requirements

We expect to continue to fund our anticipated operating expenses, capital expenditures and debt service requirements from existing cash and cash equivalents, revenues from BioThrax product sales, collaboration funding, development contract and grant funding, and any lines of credit we may establish from time to time. There are numerous risks and uncertainties associated with BioThrax product sales and with the development and commercialization of our product candidates.  We may seek additional external financing to provide additional financial flexibility. Our future capital requirements will depend on many factors, including:

§  
the level and timing of BioThrax product sales and cost of product sales;
§  
our ability to obtain funding from government entities and non-government and philanthropic organizations for our development programs; 
§  
the level of participation of collaborative partners in our development programs;
§  
the acquisition of new facilities and capital improvements to new or existing facilities;
§  
the timing of, and the costs involved in, completion of qualification and validation activities related to Building 55, our large-scale manufacturing facility in Lansing, Michigan, the build out of our new facility in Baltimore, Maryland, and any other new facilities;
§  
the scope, progress, results and costs of our preclinical and clinical development activities;
§  
the costs, timing and outcome of regulatory review of our product candidates;
§  
the number of, and development requirements for, other product candidates that we may pursue;
§  
the costs of commercialization activities, including product marketing, sales and distribution;
§  
the market acceptance and sales growth of any of our products and product candidates upon regulatory approval;
§  
the extent to which our growth generates increased administrative costs;
§  
the extent to which we lend money to, and are able to obtain repayment from, third parties;
§  
the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation costs and the results of such litigation;
§  
the extent to which we acquire or invest in companies, businesses, products and technologies;
§  
the effect of competing technological and market developments; and
§  
the extent to which we become obligated to make cash payments related to the contingent value rights issued to former holders of Trubion common stock in connection with our acquisition of Trubion that are not offset by corresponding cash inflows from our collaborative partners.
 
We may require additional sources of funds for future acquisitions that we may make or, depending on the size of the obligation, to meet balloon payments upon maturity of our current borrowings. To the extent our capital resources are insufficient to meet our future capital requirements, we will need to finance our cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. Current economic conditions may make it difficult to obtain financing on attractive terms or at all.  Lenders may be able to impose covenants on us that could be difficult to satisfy, which could put us at increased risk of defaulting on debt.  If financing is unavailable or lost, we could be forced to delay, reduce the scope of or eliminate our research and development programs or reduce our planned commercialization efforts.

Our ability to borrow amounts under any line of credit we may establish will likely be subject to our satisfaction of specified conditions.  Additional equity or debt financing, grants, or corporate collaboration and licensing arrangements may not be available on acceptable terms, if at all. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Any debt financing or additional equity that we raise may contain terms, such as liquidation and other preferences that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies or product candidates or grant licenses on terms that may not be favorable to us.

ITEM 3.                        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk is currently confined to our cash and cash equivalents and restricted cash that have maturities of less than three months, our investments, and our long-term indebtedness. We currently do not hedge interest rate exposure or foreign currency exchange exposure, and the movement of foreign currency exchange rates could have an adverse or positive impact on our results of operations. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cash and cash equivalents and the small amount of our non-cash investments of $3.5 million as of September 30, 2011, we do not believe that an increase in market rates would likely not have a significant impact on the realized value of our investments, but any increase in market rates would likely increase the interest expense associated with our debt.

ITEM 4.                        CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

No change in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, occurred during the quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.                        LEGAL PROCEEDINGS

Class-action litigation related to Trubion Pharmaceuticals acquisition.  On August 17, 2010, two class action lawsuits were filed in the Superior Court of Washington, King County, or State Court, against Trubion Pharmaceuticals, Inc., or Trubion, its board of directors, and us, or the Defendents, alleging in summary that, in connection with the merger of Trubion with our subsidiary, or the Acquisition, the members of the Trubion board of directors breached their fiduciary duties by conducting an unfair sale process and agreeing to an unfair price. Both complaints also claimed that Trubion and we aided and abetted the Trubion board of directors in its breach of fiduciary duties. On September 9, 2010, the actions were consolidated into one action, or the State Action.  On October 1, 2010, the plaintiffs in the State Action served on the Defendants a consolidated amended class action complaint, or the Amended Complaint. The Amended Complaint alleged, among other things and in addition to the matters alleged in the initial complaints, that the Defendants omitted material information from the Proxy Statement/Prospectus relating to the Acquisition.

On October 4, 2010, a class action lawsuit was filed in the U.S. District Court for the Western District of Washington against the Defendants, or the Federal Action, and, collectively with the State Action, the Actions, which made allegations related to the Acquisition that were substantially similar to those matters alleged in the Amended Complaint and included additional allegations regarding purported violations of the federal securities laws and sought substantially similar relief.

On October 8, 2010, the Defendants reached agreement in principle with the plaintiffs in the Actions regarding the settlement of the Actions. The terms of the settlement contemplated by that agreement in principle required that Trubion and we make certain additional disclosures related to the Acquisition, as set forth in our Current Report on Form 8-K filed on October 8, 2010. The parties also agreed that the plaintiffs in the Actions could seek attorneys’ fees and costs in an aggregate amount up to $475,000, to be paid by Trubion if such fees and costs are approved by the State Court. There would be no other payment by Trubion, any of the members of the Trubion board of directors or us to the plaintiffs or their respective counsels in connection with the settlement and dismissal of the Actions. The agreement in principle further contemplated that the parties would enter into a stipulation of settlement, which would be subject to customary conditions, including State Court approval following notice to Trubion’s shareholders. The Actions were stayed pending approval of the settlement of the State Action by the State Court, after which the State Action and all claims asserted therein would be dismissed with prejudice and counsel for the plaintiff in the Federal Action would take all necessary steps to dismiss the Federal Action and all claims asserted therein with prejudice. On April 26, 2011, the State Court entered an order granting preliminary approval of the settlement and requiring that notice of the settlement and preliminary approval be mailed to class members by May 17, 2011.  The order also provided that all class members wishing to be excluded from the settlement of the Actions were required to give notice by June 21, 2011.  At a hearing on July 29, 2011, the State Court determined that the settlement was fair, reasonable and adequate to the class members and approved the settlement in all aspects.  On September 12, 2011 the Federal Action was dismissed and we have since made a payment in the amount of $475,000 for attorneys’ fees and costs.

Other.  From time to time, we are involved in product liability claims and other litigation considered normal in the nature of our business. We do not believe that any such proceedings would have a material adverse effect on the results of our operations.

ITEM 1A.                    RISK FACTORS

Risks Related to Our Dependence on U.S. Government Contracts

We have derived substantially all of our revenue from sales of BioThrax under contracts with the U.S. government. If U.S. government demand for BioThrax is reduced, our business, financial condition and operating results could be materially harmed.

We have derived and expect for the foreseeable future to continue to derive substantially all of our revenue from sales to the U.S. government of BioThrax, our FDA-approved anthrax vaccine and only marketed product. We are currently party to a contract with the Centers for Disease Control and Prevention, or CDC, a U.S. federal agency under the U.S. Department of Health and Human Services, or HHS, to supply doses of BioThrax for placement into the Strategic National Stockpile, or SNS. If the SNS priorities change, or if the Department of Defense, or DoD, dose requirements from the SNS are reduced, our revenues could be substantially reduced.

Our existing contract expires in December 2011. In September 2011, we received an award from the CDC for the supply of 44.75 million doses of BioThrax for placement into the SNS over a five-year period, and we are currently working with CDC to finalize a related contract necessary to document the award.  The procurement of doses of BioThrax by the CDC is subject to availability of funding.  However, our existing and prior contracts with HHS and the DoD do not necessarily increase the likelihood that funding for the procurement of doses will be available. If we are unable to successfully come to an agreement with the CDC on the final terms of this contract, or if funding to procure doses of BioThrax is not available, our business, financial condition and operating results could be materially harmed, The success of our business and our operating results for the foreseeable future are substantially dependent on the terms of our BioThrax sales to the U.S. government, including price per dose, the number of doses and the timing of deliveries.

Our business may be harmed as a result of the government contracting process, which may be a competitive bidding process that involves risks and requirements not present in commercial contracting.

We expect that a significant portion of our near-term business will be under government contracts or subcontracts awarded through competitive bidding. Competitive bidding for government contracts presents a number of risks or requirements that are not typically present in the commercial contracting process, including:

 
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the commitment of substantial time and attention of management and key employees to the preparation of bids and proposals for contracts that may not be awarded to us;
 
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the need to accurately estimate the resources and cost structure that will be required to perform any contract that we might be awarded;
 
§
the possibility that we may be ineligible to respond to a request for proposal issued by the government;
 
§
the submission by third parties of protests to our responses to Requests For Proposal that could result in delays or withdrawals of those requests for proposal; and
 
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if our competitors protest or challenge contract awards made to us pursuant to competitive bidding, the potential that we may incur expenses or delays, and that any such protest or challenge would result in the resubmission of bids based on modified specifications, or in termination, reduction or modification of the awarded contract.
 
The U.S. government may choose not to award us future contracts for the development and supply of anthrax vaccines and other biodefense product candidates that we are developing, and may instead award such contracts to our competitors. If we are unable to win particular contracts, we may not be able to operate in the market for products that are provided under those contracts for a number of years.  Additionally, if we are unable to consistently win new contract awards over an extended period, or if we fail to anticipate all of the costs and resources that will be required to secure and, if applicable, perform such contract awards, our growth strategy and our business, financial condition and operating results could be materially and adversely affected.

Our U.S. government contracts require ongoing funding decisions by the U.S. government. Reduced or discontinued funding of these contracts could cause our financial condition and operating results to suffer materially.

Our principal customer for BioThrax is the U.S. government. We anticipate that the U.S. government will also be the principal customer for any other biodefense products that we successfully develop. Over its lifetime, a U.S. government program may be implemented through the award of many different individual contracts and subcontracts. The funding for government programs is subject to Congressional appropriations, often made on a fiscal year basis, even for programs designed to continue for several years. These appropriations can be subject to political considerations and stringent budgetary constraints. For example, sales of BioThrax supplied under our multi-year procurement contracts with HHS were, and any sales of BioThrax under the new award from the CDC will be, subject to available funding, mostly from annual appropriations.  Additionally, our government-funded development contracts typically give the U.S. government the right, exercisable in its sole discretion, to extend these contracts for successive option periods following a base period of performance.  The value of the services to be performed during these option periods may constitute the majority of the total value of the underlying contract.  For example, the development contract we were awarded in September 2010 for development of PreviThrax consists of a two-year base period of performance valued at approximately $51 million, three successive one-year option periods valued at approximately $126 million and funding for optional non-clinical studies valued at approximately $9 million. If levels of government expenditures and authorizations for biodefense decrease or shift to programs in areas where we do not offer products or are not developing product candidates, or if the U.S. government otherwise declines to exercise its options under our contracts with it, our business, revenues and operating results may suffer.
 
The success of our business with the U.S. government depends on our compliance with regulations and obligations under our U.S. government contracts and various federal statutes and regulations.

Our business with the U.S. government is subject to specific procurement regulations and a variety of other legal compliance obligations. These laws and rules include those related to:

 
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procurement integrity;
 
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export control;
 
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government security;
 
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employment practices;
 
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protection of the environment;
 
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accuracy of records and the recording of costs; and
 
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foreign corrupt practices.

In addition, before awarding us any future contracts, the U.S. government could require that we respond satisfactorily to a request to substantiate our commercial viability and industrial capabilities. Compliance with these obligations increases our performance and compliance costs. Failure to comply with these regulations and requirements could lead to suspension or debarment, for cause, from government contracting or subcontracting for a period of time. The termination of a government contract or relationship as a result of our failure to satisfy any of these obligations would have a negative impact on our operations and harm our reputation and ability to procure other government contracts in the future.

The pricing under our fixed price government contracts is based on estimates of the time, resources and expenses required to perform those contracts. If our estimates are not accurate, we may not be able to earn an adequate return or may incur a loss under these contracts.

Our existing and prior contracts for the supply of BioThrax with HHS and the DoD, as well as our current award for the procurement of 44.75 million doses of BioThrax from the CDC, are fixed price contracts. We expect that our future contracts with the U.S. government for BioThrax, as well as contracts for biodefense product candidates that we successfully develop, also may be fixed price contracts. Under a fixed price contract, we are required to deliver our products at a fixed price regardless of the actual costs we incur and to absorb any costs in excess of the fixed price. Estimating costs that are related to performance in accordance with contract specifications is difficult, particularly where the period of performance is over several years. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed price contract could reduce the profitability of a fixed price contract or cause a loss, which could in turn harm our operating results.

Unfavorable provisions in government contracts, some of which may be customary, may harm our business, financial condition and operating results.

Government contracts customarily contain provisions that give the government substantial rights and remedies, many of which are not typically found in commercial contracts, including provisions that allow the government to:

 
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terminate existing contracts, in whole or in part, for any reason or no reason;
 
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unilaterally reduce or modify contracts or subcontracts, including by imposing equitable price adjustments;
 
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cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;
 
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decline to exercise an option to renew a contract;
 
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exercise an option to purchase only the minimum amount, if any, specified in a contract;
 
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decline to exercise an option to purchase the maximum amount, if any, specified in a contract;
 
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claim rights to products, including intellectual property, developed under the contract;
 
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take actions that result in a longer development timeline than expected;
 
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direct the course of a development program in a manner not chosen by the government contractor;
 
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suspend or debar the contractor from doing business with the government or a specific government agency;
 
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pursue criminal or civil remedies under the False Claims Act and False Statements Act; and
 
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control or prohibit the export of products.

Generally, government contracts, including our HHS contracts for BioThrax, contain provisions permitting unilateral termination or modification, in whole or in part, at the government’s convenience. Under general principles of government contracting law, if the government terminates a contract for convenience, the other party to that contract may recover only its incurred or committed costs, settlement expenses and profit on work completed prior to the termination.

If the government terminates a contract for default, the defaulting company is entitled to recover costs incurred and associated profits on accepted items only and may be liable for excess costs incurred by the government in procuring undelivered items from another source.

One or more of our government contracts could be terminated under these circumstances. Some government contracts grant the government the right to use, for or on behalf of the U.S. government, any technologies developed by the contractor under the government contract. If we were to develop technology under a contract with such a provision, we might not be able to prohibit third parties, including our competitors, from using that technology in providing products and services to the government.

Legal proceedings challenging the U.S. government’s use of BioThrax may be costly to defend and could limit future purchases of BioThrax by the U.S. government.

Legal proceedings could be costly to defend, and the results could reduce demand for BioThrax by the U.S. government. For example, a group of unnamed military personnel filed a lawsuit in 2003 seeking to enjoin the DoD from administering BioThrax on a mandatory basis without informed consent of the recipient or a Presidential waiver, and a federal court issued the requested injunction in 2004. In 2005, the Food and Drug Administration, or FDA, issued an order affirming the BioThrax license and, as a result, an appellate court ruled in February 2006 that the injunction was dissolved.

In October 2006, the DoD announced that it was resuming a mandatory vaccination program for BioThrax for designated personnel and contractors. In December 2006, the same counsel who brought the prior lawsuit filed a new lawsuit contending that the FDA’s 2005 Final Order should be set aside and that BioThrax is not properly approved for use in the DoD’s vaccination program. In February 2008, the federal district court in which that case was pending dismissed the action, concluding that the FDA did not make a clear error of judgment in reaffirming the safety and efficacy of BioThrax. On September 29, 2009, the United States Court of Appeals for the District of Columbia Circuit issued its opinion in Rempfer v. Torti, affirming the February 29, 2008 finding of the District Court that the FDA did not violate the Administrative Procedure Act in connection with its December 19, 2005 Final Order classifying BioThrax as safe and effective.  The plaintiffs’ petition for writ of certiorari in the United States Supreme Court was denied on March 1, 2010.

Although we are not a party to any lawsuits challenging the DoD’s mandatory use of BioThrax, if a court were to again enjoin the DoD’s use of BioThrax on a mandatory basis, the amount of future purchases of BioThrax by the U.S. government could be affected. Furthermore, contractual indemnification provisions and statutory liability protections may not fully protect us from all related liabilities, and statutory liability protections could be revoked or amended to reduce the scope of liability protection. For example, we have invoiced the DoD for reimbursement of our costs incurred with respect to the lawsuits filed against us by current and former members of the U.S. military claiming damages as the result of personal injuries allegedly suffered from vaccination with BioThrax, and we are continuing our efforts to negotiate with the DoD for a satisfactory resolution of that claim. In addition, lawsuits brought directly against us by third parties, even if not successful, would require us to spend time and money defending the related litigation that may not be reimbursed by insurance carriers or covered by indemnification under existing contracts.
 
Risks Related to Our Financial Position and Need for Additional Financing

We may not maintain profitability in future periods or on a consistent basis.

Although we have been profitable for each of the last five fiscal years, we have not been profitable for every quarter during that time. For example, we incurred a net loss of $5.6 million for the period of 2011 covered by this quarterly report. Our profitability is substantially dependent on BioThrax product sales. BioThrax product sales have fluctuated significantly in recent quarters, and we expect that they will continue to fluctuate significantly from quarter to quarter based on several factors, including the timing of our fulfilling orders from the U.S. government. Additionally, our profitability may be adversely affected as we progress through various stages of ongoing or planned clinical trials for our product candidates. We may not be able to achieve consistent profitability on a quarterly basis or sustain or increase profitability on an annual basis.

Our indebtedness may limit cash flow available to invest in the ongoing needs of our business.

As of September 30, 2011, we had $53.8 million principal amount of debt outstanding. We may seek to raise substantial external debt financing to provide additional financial flexibility. The assumption of debt could have significant adverse consequences, including:

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requiring us to dedicate a substantial portion of any cash flow from operations to the payment of interest on, and principal of, our debt, which will reduce the amounts available to fund working capital, capital expenditures, product development efforts and other general corporate purposes;
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increasing the amount of interest that we have to pay on debt with variable interest rates if market rates of interest increase;
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increasing our vulnerability to general adverse economic and industry conditions;
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obligating us to restrictive covenant that may reduce our ability to obtain further debt or equity financing;
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limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and
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placing us at a competitive disadvantage compared to our competitors that have less debt or better debt servicing options.
 
We may not have sufficient funds or may be unable to arrange for additional financing to pay the amounts due under our existing debt. In addition, a failure to comply with the covenants under our existing debt instruments could result in an event of default under those instruments. In the event of an acceleration of amounts due under our debt instruments as a result of an event of default, we may not have sufficient funds or may be unable to arrange for additional financing to repay our indebtedness or to make any accelerated payments, and the lenders could seek to enforce security interests in the collateral securing such indebtedness. In addition, the covenants under our existing debt instruments and the pledge of our existing assets as collateral limit our ability to obtain additional debt financing.

We expect to require additional funding and may be unable to raise capital when needed, which would harm our business, financial condition and operating results.

We expect our development expenses to increase in connection with our ongoing activities, particularly as we conduct additional and later stage clinical trials for our product candidates. We also expect our commercialization expenses to increase in the future as we seek to broaden the market for BioThrax and if we receive marketing approval for additional products. We also may undertake additional facility projects in the future. In the event that our ability to sell BioThrax to the U.S. government is interrupted for an extended period of time, we will utilize our cash balances to help fund our ongoing operations.

As of September 30, 2011, we had $128.8 million of cash, cash equivalents and investments. Our future capital requirements will depend on many factors, including:

 
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the level and timing of BioThrax product sales and cost of product sales;
 
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our ability to obtain funding from government entities and non-government and philanthropic organizations for our development programs; 
 
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the level of participation of collaborative partners in our development programs, including Pfizer Inc., or Pfizer, with respect to SBI-087, and Abbott Laboratories, or Abbott, with respect to TRU-016;
 
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the acquisition of new facilities and capital improvements to new or existing facilities;
 
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the timing of, and the costs involved in, completion of qualification and validation activities related to Building 55, our large-scale manufacturing facility in Lansing, Michigan, the build out of our new facility in Baltimore, Maryland, and any other new facilities;
 
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the scope, progress, results and costs of our preclinical and clinical development activities;
 
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the costs, timing and outcome of regulatory review of our product candidates;
 
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the number of, and development requirements for, other product candidates that we may pursue;
 
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the costs of commercialization activities, including product marketing, sales and distribution;
 
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the market acceptance and sales growth of any of our products or product candidates upon regulatory approval;
 
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the extent to which our growth generates increased administrative costs;
 
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the extent to which we lend money to, and are able to obtain repayment from, third parties;
 
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the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation costs and the results of such litigation;
 
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the extent to which we acquire or invest in companies, businesses, products or technologies;
 
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the effect of competing technological and market developments; and
 
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the extent to which we become obligated to make cash payments related to the contingent value rights issued to former holders of common stock of Trubion Pharmaceuticals, Inc., or Trubion, in connection with our acquisition of Trubion that are not offset by corresponding cash inflows from our collaborative partners.

We may require additional sources of funds for future acquisitions that we may make or, depending on the size of the obligation, to meet balloon payments upon maturity of our current borrowings.  To the extent our capital resources are insufficient to meet our future capital requirements, we will need to finance our cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. Current economic conditions may make it difficult to obtain financing on attractive terms or at all. Lenders may be able to impose covenants on us that could be difficult to satisfy, which could put us at increased risk of defaulting on debt. If financing is unavailable or lost, we could be forced to delay, reduce the scope of or eliminate our research and development programs or reduce our planned commercialization efforts.

Our ability to borrow additional amounts under any line of credit we may establish will likely be subject to our satisfaction of specified conditions. Additional equity or debt financing, grants or corporate collaboration and licensing arrangements may not be available on acceptable terms, if at all. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

Any debt financing or additional equity that we raise may contain terms, such as liquidation and other preferences, that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies or product candidates or grant licenses on terms that may not be favorable to us.

Risks Related to Manufacturing and Manufacturing Facilities

We are in the process of expanding our manufacturing facilities and entering into arrangements with contract manufacturing organizations. Delays in completing facilities, or delays or failures in obtaining regulatory approvals for new manufacturing facility projects or new contract manufacturing partners, could limit our potential revenues and growth.

We continually evaluate alternatives for the manufacture of BioThrax and our various product candidates. We may seek to acquire one or more additional facilities or sign agreements with contract manufacturing organizations. We have constructed Building 55, a large-scale manufacturing facility on our Lansing, Michigan campus for which we received an award from the Biomedical Advanced Research and Development Authority, or BARDA, in July 2010 for scale-up, qualification and validation to manufacture BioThrax.  Additionally, in 2009, we acquired a facility in Baltimore, Maryland which we expect to utilize for certain product development or manufacturing projects.

Constructing, preparing and maintaining a facility for manufacturing purposes is a significant project. For example, the process for qualifying and validating Building 55 for FDA licensure will be costly and time consuming, may result in unanticipated delays and may cost more than expected due to a number of factors, including regulatory requirements. The costs and time required to comply with current good manufacturing practices, or cGMP, regulations or similar regulatory requirements for sales of our products outside the U.S. may be significant. We may also need to hire and train significant numbers of employees to staff our facility.  Start-up costs can be large and scale-up entails significant risks related to process development and manufacturing yields.  If our qualification and validation activities are delayed, we may not be able to meet our obligations to our customers, which may limit our opportunities for growth. Costs associated with constructing, qualifying and validating manufacturing facilities could require us to raise additional funds from external sources, and we may not be able to do so on favorable terms or at all.

BioThrax and our product candidates are complex to manufacture and ship, which could cause us to experience delays in revenues or shortages of products.

BioThrax and all our product candidates are biologics. Manufacturing biologic products, especially in large quantities, is complex. The products must be made consistently and in compliance with a clearly defined manufacturing process. Accordingly, it is essential to be able to validate and control the manufacturing process to assure that it is reproducible. Slight deviations anywhere in the manufacturing process, including maintaining master seed or cell banks and preventing drift, obtaining materials, seed or cell growth, fermentation, filtration, filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures or manufacturing shut-down, delays in the release of lots, product recalls, spoilage or regulatory action. Success rates can vary dramatically at different stages of the manufacturing process, which can reduce yields and increase costs.  From time to time we may experience deviations in the manufacturing process that may take significant time and resources to resolve and if unresolved may affect manufacturing output and could cause us to fail to satisfy customer orders or contractual commitments, lead to a termination of one or more of our contracts, lead to delays in our clinical trials, result in litigation or regulatory action against us or cause the FDA to cease releasing product until the deviations are explained and corrected, any of which could be costly to us and negatively impact our business.

FDA approval is required for the release of each lot of BioThrax. We will not be able to sell any lots that fail to satisfy the release testing specifications. We must provide the FDA with the results of potency testing before lots are released for sale. We have one mechanism for conducting this potency testing that is reliant on a unique animal strain for which we currently have no alternative. In developing alternatives, we may face significant regulatory hurdles. In the event of a problem with this strain, if we have not developed alternatives, we would not be able to provide the FDA with required potency testing data and not be able release product.

Additionally, potency testing of each lot of BioThrax is performed against a qualified reference lot that we maintain. We continually monitor the status of our reference lot and periodically produce and qualify a new reference lot to replace the existing reference lot.  For example, we prepared and qualified a new reference lot during the second quarter of 2011 to replace our prior, qualified reference lot. If we are not able to satisfy the FDA’s requirements for release of BioThrax, our ability to sell BioThrax would be impaired until such time as we become able to meet such requirements, which would significantly impact our revenues, require us to utilize our cash balances to help fund our ongoing operations and otherwise harm our business.

In addition, we are contractually required to ship BioThrax at a prescribed temperature range during shipping, and variations from that temperature range could result in loss of product and could adversely affect our profitability. Delays, lot failures, shipping deviations, spoilage or other loss during shipping could cause us to fail to satisfy customer orders or contractual commitments, lead to a termination of one or more of our contracts, lead to delays in our clinical trials or result in litigation or regulatory action against us, any of which could be costly to us and otherwise harm our business.

Disruption at, damage to or destruction of our manufacturing facilities could impede our ability to manufacture BioThrax, which would harm our business, financial condition and operating results.

We currently rely on our manufacturing facilities at a single location in Lansing, Michigan for the production of BioThrax. Any interruption in manufacturing operations at this location could result in our inability to satisfy the product demands of our customers. A number of factors could cause interruptions, including:

 
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equipment malfunctions or failures;
 
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technology malfunctions;
 
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work stoppages or slow-downs;
 
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protests, including by animal rights activists;
 
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damage to or destruction of the facility;
 
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regional power shortages; or
 
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product tampering.

As our equipment ages, it will need to be replaced. Replacement of equipment has the potential to introduce variations in the manufacturing process that may result in lot failures or manufacturing shut-down, delay in the release of lots, product recalls, spoilage or regulatory action.

In addition, providers of bioterrorism countermeasures could be subject to an increased risk of terrorist activities. For example, the U.S. government has designated our Lansing facility as a facility requiring additional security to protect against potential terrorist threats to the facility. Any disruption that impedes our ability to manufacture and ship BioThrax in a timely manner could reduce our revenues and materially harm our business, financial condition and operating results.

If the company on which we rely for filling BioThrax vials is unable to perform these services for us, our business may suffer.

We have outsourced the operation for filling BioThrax into vials to a single company. If this filler were unable to perform filling services for us, we would need to engage, qualify and license an alternative filling company or develop our own filling capabilities, all of which could involve significant time and cost. Any new contract filling company or filling capabilities that we acquire or develop will need to be approved by the FDA. We have identified and contracted with an additional provider that we believe can handle our filling needs. Before this additional provider can perform filling services for us, it must be qualified and licensed by the FDA.  Such qualification and licensure may be time consuming and costly, and may not result in FDA approval.

Our business may be harmed if we do not adequately forecast customer demand.

The timing and amount of customer demand is difficult to predict. We may not be able to scale-up our production quickly enough to fill any new customer orders on a timely basis. This could cause us to lose new business and possibly existing business. For example, we, or third party manufacturers with whom we may contract, may not be able to scale-up manufacturing processes for our product candidates to allow production of commercial quantities at a reasonable cost or at all. Furthermore, if we overestimate customer demand, or choose to commercialize products for which the market is smaller than we anticipate, we could incur significant unrecoverable costs from creating excess capacity. In addition, if we do not successfully develop and commercialize any of our product candidates, we may never utilize the production capacity that we expect to have available.

If third parties do not manufacture our product candidates or supplies for our manufacture of BioThrax in sufficient quantities and at an acceptable cost or in compliance with regulatory requirements and specifications, the development and commercialization of our product candidates could be delayed, prevented or impaired.

We currently rely, or plan to rely, on third parties to manufacture the supplies of some or all of our vaccine and therapeutic product candidates that we require for preclinical and clinical development. For example, we currently depend on contract manufacturers for certain biopharmaceutical development and manufacturing services for product candidates we acquired from Trubion. We also rely on third-party manufacturers for filling and finishing services for our product candidates. Any significant delay in obtaining adequate supplies of our product candidates could adversely affect our ability to develop or commercialize these product candidates. For example, in 2008, the initial manufacturer of Thravixa informed us it was discontinuing contract manufacturing operations and we were forced to secure alternative manufacturing resources to continue development of this product candidate.

In addition, we expect that we will rely on third parties for a portion of the manufacturing process for commercial supplies of product candidates that we successfully develop and that we will rely on those manufacturers to comply with a wide variety of rules and regulations. The manufacture and delivery of sufficient quantities of pharmaceutical products is a time-consuming and complex process.  If our contract manufacturers are unable to scale-up production to generate enough materials for commercial launch, if manufacturing is of insufficient quality or not compliant with applicable rules and regulations, or if the costs of manufacturing are prohibitively high, the success of those products may be jeopardized. Our current and anticipated future dependence upon others for the manufacture of our product candidates may adversely affect our ability to develop product candidates and commercialize any products that receive regulatory approval on a timely and competitive basis.

Reliance on contract manufacturers, other vendors and collaborators limits our control regarding many aspects of the manufacturing and delivery process and therefore exposes us to a variety of significant risks, including:

 
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limitations on our ability to schedule production with contract suppliers when needed to supply clinical trials;
 
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reliance on contract suppliers for legal and regulatory compliance and quality assurance;
 
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lack of obligation by a contract supplier to accept a purchase order;
 
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a contract supplier’s insistence on exclusivity, minimum or maximum levels of supply and related restrictions on our ability to increase or decrease supply, including provisions whereby we pay a penalty if we fail to order a minimum amount;
 
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breach of agreements by contract suppliers; and
 
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termination, price increases, or non-renewal of agreements by contract suppliers, based on other business priorities, at times that are costly or inconvenient for us.

We operate under short-term supply agreements with a number of third party manufacturers that are not obligated to accept any purchase orders we may submit. Third party manufacturers may also be unable or unwilling to accommodate our production scheduling requests, or may insist on exclusivity or minimum or maximum levels of supply, or may raise prices or decline to renew contracts.  If any third party terminates or declines to renew its agreement with us, or otherwise fails to fulfill our purchase orders on terms acceptable to us, we would need to rely on alternative sources or develop our own manufacturing capabilities to satisfy our requirements.

If alternative suppliers are not available or are delayed in fulfilling our requirements, or if we are unsuccessful in developing our own manufacturing capabilities, we may not be able to obtain adequate supplies of our product candidates on a timely basis. A change of manufacturers would require review and approval by the FDA and the applicable foreign regulatory agencies. This review and approval may be costly and time consuming. There are a limited number of manufacturers that operate under cGMP requirements and that are both capable of manufacturing for us and willing to do so.  We may not be able to reach agreement on reasonable terms, if at all, with these manufacturers.

We currently rely on third parties for regulatory compliance and quality assurance with respect to the supplies of our product candidates that they produce for us. We also will rely for these purposes on any third party that we use for production of commercial supplies of product candidates that we successfully develop. Manufacturers are subject to ongoing, periodic, unannounced inspection by the FDA and corresponding state and foreign agencies or their designees to ensure strict compliance with cGMP regulations and other governmental regulations and corresponding foreign standards.

We cannot be certain that our present or future manufacturers will be able to comply with cGMP regulations and other FDA regulatory requirements or similar regulatory requirements outside the U.S. We do not control compliance by manufacturers with these regulations and standards. If we or these third parties fail to comply with applicable regulations, sanctions could be imposed on us, which could significantly and adversely affect supplies of our product candidates. The sanctions that might be imposed include:

 
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fines, injunctions and civil penalties;
 
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refusal by regulatory authorities to grant marketing approval of our product candidates;
 
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delays, suspension or withdrawal of regulatory approvals, including license revocation;
 
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seizures or recalls of product candidates or products;
 
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operating restrictions; and
 
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criminal prosecutions.

If we or third parties are unable to manufacture our product candidates in compliance with regulatory requirements, in sufficient quantities, at an acceptable cost and according to applicable timelines, our clinical trials could be delayed, production costs could be significantly increased and the development prospects and commercial viability of our product candidates could be harmed.

We also depend on certain single-source suppliers for materials and services necessary for the manufacture of BioThrax and our product candidates. A disruption in the availability of such materials or services from these suppliers could require us to qualify and validate alternative suppliers. If we are unable to locate or establish alternative suppliers, our ability to manufacture our products could be adversely affected and also could cause us to fail to satisfy customer orders or contractual commitments, lead to a termination of one or more of our contracts, lead to delays in our clinical trials or result in litigation or regulatory action against us, any of which could be costly to us and otherwise harm our business.

Our use of hazardous materials, chemicals, bacteria and viruses requires us to comply with regulatory requirements and exposes us to significant potential liabilities.

Our research and development and manufacturing processes involve the use of hazardous materials, including chemicals, bacteria, viruses and radioactive materials, and produce waste products. Accordingly, we, the third parties that conduct clinical trials on our behalf, and the third parties that manufacture our product candidates are subject to federal, state, local and foreign laws and regulations governing the use, manufacture, distribution, storage, handling, disposal and recordkeeping of these materials. We are also subject to a variety of environmental laws in Michigan, including those regarding underground storage tanks. One such tank on our Lansing, Michigan campus has leaked in the past. The State of Michigan removed the tank, continues to monitor the situation and has agreed to indemnify us for any resulting liabilities. In the event that the State of Michigan does not indemnify us, or if our insurance does not cover the exposure of any remediation that may be necessary, we may be required to spend significant amounts on remediation efforts. In addition to complying with environmental and occupational health and safety laws, we must comply with special regulations relating to biosafety administered by the CDC, HHS and the DoD.

The Public Health Security and Bioterrorism Preparedness and Response Act and the Agricultural Protection Act require us to register with the CDC and U.S. Department of Agriculture our possession, use or transfer of select biological agents or toxins that could pose a threat to public health and safety, to animal or plant health or to animal or plant products. This legislation requires increased safeguards and security measures for these select agents and toxins, including controlled access and the screening of entities and personnel and establishes a comprehensive national database of registered entities.

We also are subject to export control regulations governing the export of BioThrax and technology and materials used to develop and manufacture BioThrax and our product candidates. These laws and regulations may limit the countries in which we may conduct development and manufacturing activities.

If we fail to comply with environmental, occupational health and safety, biosafety and export control laws, we could be held liable for fines, penalties and damages that result, and any such liability could exceed our assets and resources. In addition, we could be required to cease immediately all use of a select agent or toxin, and we could be prohibited from exporting our products, technology and materials or we could be suspended from the right to do business with the U.S. government.  In addition, we cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of hazardous materials. In the event of injury or a future contamination event, we could be held liable for resulting damages, and any liability could significantly impact our financial position.
 
Our insurance policies may not adequately compensate us for all liabilities that we may incur in the event of unanticipated costs, exposing us to potential expense and reduced profitability.

We hold a number of insurance policies in an effort to protect ourselves against extraordinary or unanticipated costs. Our general liability and excess insurance policies provide for coverage up to annual aggregate limits of $12 million, with coverage of $1 million per occurrence and $2 million in the aggregate for general liability and $10 million per occurrence and in the aggregate for excess liability. Both policies exclude coverage for liabilities relating to the release of pollutants. We do not currently hold insurance policies expressly providing for coverage relating to our use of hazardous materials other than storage tank liability insurance for our Lansing facility with coverage of $1 million per occurrence and $2 million annual aggregate limit and a $25,000 per claim deductible. We hold product liability and clinical trial liability insurance policies for our commercial products and each clinical trial we are conducting in amounts we deem appropriate.

These policies are subject to deductibles, exclusions and coverage limitations. We may be unable to maintain existing insurance or obtain new coverage or increase limits in the future on reasonable terms or at all.  Circumstances may arise where we face liabilities that are not covered by our insurance policies, or where our coverage is not adequate, which may expose us to significant liabilities and significantly and adversely affect our business or financial position.

Risks Related to Product Development

Our business depends significantly on our success in completing development and commercialization of our product candidates at acceptable costs. If we are unable to commercialize these product candidates, or experience significant delays or unanticipated costs in doing so, our business will be materially harmed.

We have invested a significant portion of our efforts and financial resources in the development of our vaccines and therapeutic product candidates and the acquisition of additional product candidates. In addition to BioThrax sales, our ability to generate near term revenue is dependent on the success of our development programs and collaboration programs, on the U.S. government’s interest in providing development funding for or procuring certain of our product candidates, on the interest of non-governmental organizations in providing grant funding for development of certain of our product candidates and on the commercial viability of our product candidates. The commercial success of our product candidates will depend on many factors, including accomplishing the following in an economical manner:

 
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successful development, formulation and cGMP scale-up of biological manufacturing that meets FDA requirements;
 
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successful development of animal models;
 
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successful completion of non-clinical development, including studies in approved animal models;
 
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the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;
 
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successful completion of clinical trials;
 
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receipt of marketing approvals from the FDA and equivalent foreign regulatory authorities;
 
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procurement of our biodefense product candidates prior to FDA approval;
 
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establishing commercial manufacturing processes of our own or arrangements with contract manufacturers;
 
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manufacturing stable commercial supplies of product candidates, including materials based on recombinant technology;
 
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launching commercial sales of the product candidate, whether alone or in collaboration with others; and
 
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acceptance of the product candidate by potential government customers, physicians, patients, healthcare payors and others in the medical community.

If we are prevented from developing and commercializing a product candidate in an economically acceptable manner, that product program may be adversely affected and the commercial success of the product candidate may be harmed.  For example, we recently agreed with one of our contract manufacturers to extend the commencement date of the commercial term for manufacture of Anthrivig.  We are currently in negotiations with that contract manufacturer for a longer-term resolution regarding commercial production; however, in the event that we are not able to negotiate a satisfactory resolution we may be required to explore other options for Anthrivig, which could result in less favorable commercial success for this product candidate, or no commercial success at all.
  
We depend on our collaborative relationships with Pfizer and Abbott to develop, manufacture and commercialize certain of our recently acquired product candidates.

We are party to collaboration agreements with each of Pfizer and Abbott.  Under the terms of our agreement with Pfizer, Pfizer is responsible for regulatory approval of and any subsequent commercialization of SBI-087.  Under the Abbott collaboration for the development and commercialization of TRU-016, we and Abbott must jointly agree to all development and commercialization plans and timelines for TRU-016.  If either Pfizer or Abbott were to terminate its agreement with us or otherwise curtail or fail to fulfill its obligations, we would need to obtain the capital necessary to fully fund the development and commercialization of the related product candidates or enter into alternative arrangements with a third party. We could also become involved in disputes with either of these partners, which could lead to delays in or termination of certain of our development and commercialization programs and time-consuming and expensive litigation or arbitration. If either Pfizer or Abbott terminates or breaches its agreement with us, or otherwise fails to complete its obligations in a timely manner, certain of our product development programs would be substantially delayed and the chances of successfully developing or commercializing the impacted product candidate(s) would be materially and adversely affected.
 
Our collaboration with Pfizer initially also included TRU-015, an investigational drug in Phase II evaluation for the treatment of Rheumatoid Arthritis, or RA.  In June 2010, Pfizer decided to discontinue development of TRU-015 based on preliminary results from the Phase II study, which, although consistent with previous studies and similar to other B-cell-depleting therapies, did not meet the internally predefined primary endpoint of the Phase II study. In April 2011, Pfizer also determined to not pursue development of certain other product candidates directed to targets other than CD20 that had been established pursuant to our agreement with Pfizer. Additionally, in May 2011, we and Pfizer agreed to remove certain exclusivity restrictions on Pfizer’s ability to develop and commercialize certain anti-CD20 product candidates that are part of our collaboration.  We cannot predict how or whether Pfizer will proceed with the development of the remaining product candidates covered by our agreement, including SBI-087 and other therapeutics directed to CD20. Our ability to receive any significant revenue from our product candidates covered by the agreement depends on the efforts of Pfizer and on our ability to collaborate effectively. Any future payments, including royalties to us, will depend on the extent to which Pfizer advances product candidates through development and commercialization. Pfizer may terminate our relationship with them, in whole or in part, without cause, by giving us 90 days’ written notice. Pfizer also has the right to terminate the agreement, on a target-by-target basis, upon 60 days’ written notice, if any safety or regulatory issue arises that would have a material adverse effect on Pfizer’s ability to develop, manufacture or commercialize one or more product candidates. With respect to control over decisions and responsibilities, our agreement with Pfizer provides for a CD20-directed therapy development committee consisting of representatives of Pfizer and us. Ultimate decision-making authority as to most matters within the collaboration, including development plans and timelines, however, is vested in Pfizer.
 
In August 2009, Trubion entered into a collaboration agreement with Facet Biotech Corporation, or Facet, for the joint worldwide development and commercialization of TRU-016, a product candidate in Phase I clinical development for chronic lymphocytic leukemia, or CLL, and other CD37-directed protein therapeutics. Facet became a wholly-owned subsidiary of Abbott in April 2010.  Under the terms of the collaboration agreement, neither we nor Abbott have the right to develop or commercialize protein therapeutics directed to CD37 outside of the collaboration, and development and commercialization expenses incurred by both companies in the development and commercialization of TRU-016 are shared equally.  Our ability to receive funding for TRU-016 under the collaboration depends on our ability to collaborate effectively with Abbott. Any future payments, including milestones payable to us, will depend on the extent to which we and Abbott advance TRU-016 through development and commercialization. With respect to control over decisions and responsibilities, the collaboration agreement provides for a joint steering committee that must make decisions by consensus. Failure to reach consensus on material aspects of the development or commercialization of TRU-016 would lead to dispute resolution by our respective designated officers, and potentially arbitration, any of which could delay the development of TRU-016, which may harm our business.  Additionally, Abbott may terminate the collaboration agreement without cause, and would not be obligated to pay us a termination fee. Abbott also has the right upon 90 days’ written notice to terminate the agreement for any uncured material breach by us. Under certain circumstances, the parties have the right to opt out of the collaboration or may be deemed to have opted out of the collaboration with respect to the product. If Abbott opts out of the collaboration with respect to a product, then we would become responsible for all development and commercialization costs for that product and be obligated to pay Abbott certain royalty payments upon the sale of that product. We are currently the lead manufacturing party for TRU-016. If we opt out of the collaboration and are the lead TRU-016 manufacturing party at that time, we would be obligated to continue to supply TRU-016 to Abbott for up to 18 months.

While SBI-087 or TRU-016 may never be successfully developed or commercialized, if either Pfizer or Abbott were to fail to perform its obligations in a timely manner or were to terminate or opt out of its collaboration with us, the development and commercialization of the affected product would be substantially delayed and may be otherwise adversely affected, which could have a material adverse effect on our results of operations.

We will not be able to commercialize our product candidates if our preclinical development efforts are not successful, our clinical trials do not demonstrate safety or our clinical trials or animal studies do not demonstrate efficacy.

Before obtaining regulatory approval for the sale of our product candidates, we and our collaborative partners must conduct extensive preclinical studies and clinical trials to establish proof of concept, safety and efficacy of our product candidates. Preclinical and clinical testing is expensive, difficult to design and implement, can take many years to complete and the outcome of such trials is uncertain. Success in preclinical testing and early clinical trials does not ensure that later clinical trials or animal efficacy studies will be successful, and interim results of a clinical trial or animal efficacy study do not necessarily predict final results.  For example, in December 2008, we and Sanofi Pasteur determined that the joint efforts of our collaboration related to our meningitis B product development program had not identified a viable product candidate, which effectively ended development activities under this collaboration.  A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials.

We expect to rely on FDA regulations known as the “animal rule” to obtain approval for certain of our product candidates. The animal rule permits the use of animal efficacy studies together with human clinical safety and immunogenicity trials to support an application for marketing approval. These regulations are relatively new, and we have limited experience in the application of these rules to the product candidates that we are developing. It is possible that results from these animal efficacy studies may not be predictive of the actual efficacy of our vaccine and therapeutic product candidates in humans. If we are not successful in completing the development and commercialization of our vaccine and therapeutic product candidates, or if we are significantly delayed in doing so, our business will be materially harmed.

A failure of one or more of our clinical trials or animal efficacy studies can occur at any stage of testing. We may experience numerous unforeseen events during, or as a result of, preclinical testing and the clinical trial or animal efficacy study process that could delay or prevent our ability to receive regulatory approval or commercialize our product candidates, including:

 
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regulators or institutional review boards may not authorize us, or our collaborators, to commence a clinical trial or conduct a clinical trial at a prospective trial site;
 
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we may decide, or regulators may require us, to conduct additional preclinical testing or clinical trials, or we may abandon projects that we expect to be promising, if our preclinical tests, clinical trials or animal efficacy studies produce negative or inconclusive results;
 
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we might have to suspend or terminate our clinical trials if the participants are being exposed to unacceptable health risks;
 
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regulators or institutional review boards may require that we hold, suspend or terminate clinical development for various reasons, including noncompliance with regulatory requirements;
 
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regulators may determine that service providers we use in the conduct of a clinical trial are precluded from providing such services;
 
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we or a collaborative partner may experience delay in beginning the clinical trial;
 
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we may experience competition in recruiting clinical investigators;
 
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the cost of our clinical trials could escalate and become cost prohibitive;
 
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any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable;
 
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regulatory requirements, policy and guidelines could change;
 
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we may experience limitations in our ability to manufacture or obtain from third parties materials sufficient for use in preclinical studies and clinical trials;
 
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we or our collaborators may fail to adequately manage the increasing number, size and complexity of our clinical trials;
 
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any or all of our collaborators, the FDA and foreign regulatory agencies may interpret data differently;
 
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third parties conducting and overseeing the operations of our clinical trials may fail to perform their contractual or regulatory obligations in a timely fashion;
 
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we may not be successful in recruiting a sufficient number of qualifying subjects for our clinical trials or may experience delays in patient enrollment and variability in the number and types of patients available for clinical trials; and
 
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the effects of our product candidates may not be the desired effects or may include undesirable side effects or the product candidates may have other unexpected characteristics.

In addition, because some of our current and future vaccine product candidates contain live attenuated viruses, our testing of these vaccine product candidates is subject to additional risk. For example, there have been reports of serious adverse events following administration of live vaccine products in clinical trials conducted by other vaccine developers. Also, for some of our current and future vaccine product candidates, we expect to conduct clinical trials in chronic carriers of the disease that our product candidate seeks to prevent. There have been reports of disease flares in chronic carriers following administration of live vaccine products.

If we are required to conduct additional clinical trials or other testing of our product candidates beyond those that we currently contemplate, if our clinical trials are not well designed, if we are unable to successfully complete our clinical trials or other testing, or if the results of these trials or tests are not positive, we may:

 
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be delayed in obtaining marketing approval for our product candidates;
 
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obtain approval for indications that are not as broad as intended; or
 
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not be able to obtain marketing approval.

Our product development costs will also increase if we experience delays in testing, are required to conduct additional testing, or experience delays in product approval. Significant clinical trial delays also could allow our competitors to bring products to market before we do and impair our ability to commercialize our products or product candidates.
 
Under the Project BioShield Act, the Secretary of HHS, or the Secretary, can contract to purchase countermeasures for the SNS prior to FDA approval of the countermeasure in specified circumstances. Project BioShield also allows the Secretary to authorize the emergency use of medical products that have not yet been approved by the FDA. However, our biodefense product candidates might not be selected by the Secretary under this authority. Moreover, this authority could result in increased competition for our products and product candidates.

If our drug discovery and development programs do not progress as anticipated, our revenue and stock price could be negatively impacted.
  
We estimate the timing of a variety of preclinical, clinical, regulatory and other milestones for planning purposes, including when a drug candidate is expected to enter clinical trials, when a clinical trial will be completed, when and if additional clinical trials will commence, or when an application for regulatory approval will be filed. We base our estimates on facts that are currently known to us and on a variety of assumptions that may prove not to be correct for a variety of reasons, many of which are beyond our control. For example, delays in the development of drugs by us or our collaborators may be caused by many factors, including regulatory or patent issues, negative or inconclusive interim or final results of on-going clinical trials, scheduling conflicts with participating clinics and the rate of patient enrollment in clinical trials and the development priorities of our collaborators. In addition, in preparing these estimates we rely on the timeliness and accuracy of information and estimates reported or provided to us by our collaborators concerning the timing, progress and results of clinical trials or other development activities they conduct under our collaborations with them. If we or our collaborators do not achieve milestones when anticipated, we may not achieve our planned revenue and our stock price could decline. In addition, any delays in obtaining approvals to market and sell drugs may result in the loss of competitive advantages in being on the market sooner than, or in advance of, competing products, which may reduce the value of these products and the potential revenue we receive from the eventual sale of these products, either directly or under agreements with our partners.

Our product development efforts could also result in large and immediate write-offs, significant milestone payments, incurrence of debt and contingent liabilities or amortization of expense related to intangible assets, any of which could negatively impact our financial results.  Additionally, if we were unable to develop any of our product candidates into viable commercial products, we will be reliant solely on sales of our currently approved product BioThrax for our revenues, thus limiting our growth opportunities and diversification.

Risks Related to Commercialization

If we fail to achieve significant sales of BioThrax to customers in addition to the U.S. government, our opportunities for growth could be harmed.

An element of our business strategy is to establish a market for sales of BioThrax to customers in addition to the U.S. government. These potential customers include foreign governments and state and local governments, which we expect will be interested in BioThrax to protect emergency responders such as police, fire and emergency medical personnel, multinational companies, non-governmental organizations and hospitals.

The market for sales of BioThrax to customers other than the U.S. government is undeveloped, and we may not be successful in generating meaningful sales of BioThrax to these potential customers.  For example, in June 2011 the Singapore Health Sciences Authority approved our product license application for the marketing and sale of BioThrax in Singapore.  Although our product license application has been approved, we have not secured a contract for the sale of BioThrax to the Singapore government. To date, we have supplied only small amounts of BioThrax directly to foreign governments and our sales of BioThrax to customers other than the U.S. government has represented a small portion of our revenue. If we fail to significantly increase our sales of BioThrax to these customers, our business and opportunities for growth could be materially harmed.

Government regulations may make it difficult for us to achieve significant sales of BioThrax to customers other than the U.S. government. For example, many foreign governments require licensure of BioThrax in their jurisdiction before they will consider procuring doses. Additionally, we are subject to export control laws imposed by the U.S. government. Although there are currently only limited restrictions on the export of BioThrax and related technology, the U.S. government may decide, particularly in the current environment of elevated concerns about global terrorism, to increase the scope of export prohibitions. These prohibitions could limit our sales of BioThrax to foreign governments and other foreign customers. In addition, U.S. government demand for an anthrax vaccine may limit supplies of BioThrax available for sale to non-U.S. government customers. For example, our efforts to develop domestic commercial and international sales may be impeded by the DoD’s right under the Defense Production Act to require us to deliver more doses than we currently anticipate. Furthermore, the DoD’s sale of BioThrax to foreign governments under the Foreign Military Sales program has had and may continue to have an adverse effect on our ability to sell BioThrax internationally.

Our ability to meet any future potential increased demand for sales of BioThrax to customers other than the U.S. government depends on our available production capacity. We use substantially all of our current production capacity at our FDA-approved manufacturing facility in Lansing, Michigan to manufacture BioThrax for current sales to U.S. government customers. We have constructed Building 55, a large-scale manufacturing facility at our Lansing campus that is available for large-scale production of BioThrax, subject to final qualification and validation activities.

Laws and regulations governing international operations may preclude us from developing, manufacturing and selling certain product candidates outside of the United States and require us to develop and implement costly compliance programs.

As we continue to expand our operations outside of the United States, we must comply with numerous laws and regulations relating to international business operations. The creation and implementation of international business practices compliance programs is costly and such programs are difficult to enforce, particularly where reliance on third parties is required.

The Foreign Corrupt Practices Act, or FCPA, prohibits any U.S. individual or business from paying, offering or authorizing payment or offering of anything of value, directly or indirectly, to any foreign official, political party or candidate for the purpose of influencing any act or decision of a foreign entity in order to assist the individual or business in obtaining or retaining business. The FCPA also obligates companies whose securities are listed in the United States to comply with certain accounting provisions requiring the company to maintain books and records that accurately and fairly reflect all transactions of the corporation, including international subsidiaries, and to devise and maintain an adequate system of internal accounting controls for international operations.

Compliance with the FCPA is expensive and difficult, particularly in countries in which corruption is a recognized problem. In addition, the FCPA presents particular challenges in the pharmaceutical industry because, in many countries, hospitals are operated by the government, and doctors and other hospital employees are considered foreign officials. Certain payments by third parties to hospitals in connection with clinical studies and other work have been deemed to be improper payments to government officials and have led to FCPA enforcement actions. Other international laws similar to the FCPA, such as the United Kingdom Bribery Act, may also result in similar penalties.

Various laws, regulations and executive orders also restrict the use and dissemination outside of the United States, or the sharing with certain non-U.S. nationals, of information classified for national security purposes, as well as certain products and technical data relating to those products. Our presence outside of the United States will require us to dedicate additional resources to comply with these laws, and these laws may preclude us from developing, manufacturing or selling certain products and product candidates outside of the United States, which could limit our growth potential and increase our development costs.

The failure to comply with laws governing international business practices may result in substantial penalties, including suspension or debarment from government contracting. Violation of the FCPA can result in significant civil and criminal penalties. Indictment alone under the FCPA can lead to suspension of the right to do business with the U.S. government until the pending claims are resolved. Conviction of a violation of the FCPA can result in long-term disqualification as a government contractor. The termination of a government contract or relationship as a result of our failure to satisfy any of our obligations under laws governing international business practices would have a negative impact on our operations and harm our reputation and ability to procure government contracts. The SEC also may suspend or bar issuers from listing their securities on United States securities exchanges for violations of the FCPA’s accounting provisions.

The commercial success of BioThrax and any additional products that we may develop will depend upon the degree of market acceptance by the government, physicians, patients, healthcare payors and others in the medical community.

Any products that we bring to the market may not gain or maintain market acceptance by potential government customers, physicians, patients, healthcare payors and others in the medical community.

In particular, our biodefense vaccine and therapeutic products and product candidates are subject to the product criteria that may be specified by potential U.S. government customers. The product specifications in any government procurement request may prohibit or preclude us from participating in the government program if our products or product candidates do not satisfy the stated criteria.

In addition, notwithstanding favorable findings regarding the safety and efficacy of BioThrax by the FDA in its final ruling in December 2005, the Government Accountability Office reiterated concerns regarding BioThrax in Congressional testimony in May 2006 that it had previously identified beginning in 1999. These concerns include the then-licensed six-dose regimen and annual booster doses, questions about the long-term and short-term safety of the vaccine, including how safety is affected by gender differences, and uncertainty about the vaccine’s efficacy against inhalational anthrax. Continued reiteration of these concerns could have a detrimental effect on the market’s acceptance of BioThrax.

The use of vaccines carries a risk of adverse health effects. The adverse reactions that have been associated with the administration of BioThrax include local reactions, such as redness, swelling and temporary limitation of motion in the inoculated arm, and systemic reactions, such as headache, fever, chills, nausea and general body aches. In addition, some serious adverse events have been reported to the vaccine adverse event reporting system database maintained by the CDC and the FDA with respect to BioThrax, including diabetes, heart attacks, autoimmune diseases, including Guillain-Barre syndrome, lupus, multiple sclerosis, lymphoma and death. None of these events have been causally linked to the administration of BioThrax.  The report of any adverse event to the vaccine adverse event reporting system database is not proof that the vaccine caused such event.

The commercial success of many of our product candidates, including our oncology and autoimmune therapeutic product candidates, will depend upon, among other things, their acceptance by physicians, patients, third-party payors and other members of the medical community as a therapeutic and cost-effective alternative to competing products and treatments.

If any products that we develop do not achieve an adequate level of acceptance, we may not generate material revenues from sales of these products. The degree of market acceptance of our product candidates, if approved for commercial sale, will depend on a number of factors, including:

 
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our ability to provide acceptable evidence of safety and efficacy;
 
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the prevalence and severity of any side effects;
 
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availability, relative cost and relative efficacy of alternative and competing treatments;
 
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the ability to offer our product candidates for sale at competitive prices;
 
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the relative convenience and ease of administration;
 
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the willingness of the target patient population to try new products and of physicians to prescribe these products;
 
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the strength of marketing and distribution support;
 
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publicity concerning our products or competing products and treatments; and
 
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the sufficiency of coverage or reimbursement by third parties.

If our products and product candidates do not become widely accepted by potential government customers, physicians, patients, third-party payors and other members of the medical community, our business, financial condition and operating results could be materially and adversely affected.

Political or social factors, including related litigation, may delay or impair our ability to market BioThrax and our biodefense product candidates and may require us to spend time and money to address these issues.
 
Products developed to treat diseases caused by or to combat the threat of bioterrorism are subject to changing political and social environments. The political and social responses to bioterrorism have been highly charged and unpredictable. We do not believe that recent changes in the leadership of prominent terrorist networks are likely to reduce the risk of bioterrorism, but they could result in a public perception that risk is reduced. Political or social pressures or changes in the perception of the risk that military personnel or civilians could be exposed to biological agents as weapons of bioterrorism may delay or cause resistance to bringing our products to market or limit pricing or purchases of our products, which would harm our business.
 
In addition, substantial delays or cancellations of purchases could result from protests or challenges from third parties. Furthermore, lawsuits brought against us by third parties or activists, even if not successful, require us to spend time and money defending the related litigation. The need to address political and social issues may divert our management’s time and attention from other business concerns. For example, between 2001 and 2006, members of the military and various activist groups who oppose mandatory inoculation with BioThrax petitioned the FDA and the federal courts to revoke the license for BioThrax and to terminate the DoD program for the mandatory administration of BioThrax to military personnel. Although the DoD has prevailed in those challenges to date, the actions of these groups have created negative publicity about BioThrax.  Additional lawsuits, publicity campaigns or other negative publicity may adversely affect the degree of market acceptance of, and thereby limit the demand for, BioThrax and our biodefense product candidates.  In such event, our ability to market and sell such products may be hindered and the commercial success of BioThrax and other products we develop will be harmed, thereby reducing our revenues.

We have a small sales and marketing group. If we are unable to expand our internal capabilities or enter into agreements with third parties, we may be unable to generate revenue from product sales to customers other than the U.S. government.

To achieve commercial success for any approved product, we must either develop our own sales and marketing capabilities, enter into collaborations with third parties able to perform these services or outsource these functions to third parties.

We currently market and sell BioThrax through a small, targeted sales and marketing group. We plan to continue to do so and expect that we will use a similar approach for sales to the U.S. government of any other biodefense product candidates that we successfully develop.

In addition, we are a party to a collaboration agreement with Pfizer to develop and commercialize therapeutics directed to CD20 and to a collaboration agreement with Abbott to develop and commercialize therapeutics directed to CD37.

To increase our sales of BioThrax to state and local governments and foreign governments and create an infrastructure for future sales of other biodefense products to these customers, we plan to expand our sales and marketing organization.  In addition, if we do not enter into collaborative agreements with respect to product candidates not covered by the Pfizer or Abbott collaborations, or if any of our product candidates are the subject of collaborative agreements with third parties that are not able to commercialize such product candidates, we may need to further expand our sales, marketing and distribution infrastructure to effectively commercialize these product candidates.

Our efforts to develop our sales, marketing and distribution infrastructure are subject to the following risks:

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potential difficulties in recruiting, training and retaining adequate numbers of effective sales and marketing personnel;
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the potential that the commercial launch of a product candidate for which we recruit a sales force and establish marketing capabilities could be delayed, resulting in us incurring related expenses too early relative to the product launch and causing personnel retention issues;
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our limited experience in the commercialization of pharmaceutical products other than BioThrax;
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difficulties in establishing an effective distribution network, including entering into marketing and distribution agreements with third parties on acceptable terms;
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the inability of sales personnel to obtain access to or persuade adequate numbers of potential government customers to purchase our products and physicians to prescribe our products;
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the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and
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unforeseen costs and expenses associated with creating a sales and marketing organization.

If we are not successful in our efforts to expand our sales and marketing capability, our ability to market and sell BioThrax and any other product candidates that we successfully develop will be impaired, which could negatively impact our business, financial condition and operating results.

We face substantial competition, which may result in others developing or commercializing products before or more successfully than we do.

The development and commercialization of new biopharmaceutical products is highly competitive and subject to rapid technological advances. We may face future competition with respect to BioThrax, our current product candidates and any products we may seek to develop or commercialize in the future from pharmaceutical companies and biotechnology companies worldwide. Potential competitors also include academic institutions, government agencies and other public and private research institutions that conduct research, seek patent protection and establish collaborative arrangements for research, development, manufacturing and commercialization.

Our competitors may develop products that are safer, more effective, have fewer side effects, are more convenient or are less costly than any products that we may develop. Our competitors may also obtain FDA or other regulatory approval for their products more rapidly than we may obtain approval for ours. They may also devote greater resources to market or sell their products, adapt more quickly to new technologies and scientific advances, initiate or withstand substantial price competition more successfully than we can, more effectively negotiate third-party licensing and collaborative arrangements and take advantage of acquisition or other opportunities more readily than we can. Any therapeutic product candidate that we successfully develop and commercialize is likely to compete with currently marketed products and with other product candidates that are in development for the same indications. In many cases, the currently marketed products have well-known brand names, are distributed by large pharmaceutical companies with substantial resources and have achieved widespread acceptance among physicians and patients. In particular, any new product candidate that competes with a generic market-leading product must demonstrate compelling advantages in efficacy, convenience, tolerability and safety in order to overcome severe price competition and be commercially successful.

We believe that our most significant competitors in the area of vaccine and therapeutics are a number of pharmaceutical companies that have vaccine programs, including Merck & Co., GlaxoSmithKline, Sanofi Pasteur, Pfizer, and Novartis, as well as smaller more focused companies engaged in vaccine and therapeutic development, such as Aeras, Crucell, Cangene, Human Genome Sciences, Soligenix, Dynport Vaccine Company, Elusys, Bavarian Nordic and PharmAthene.  Specifically with respect to oncology and autoimmune disease, our competitors include Amgen, Pfizer, Takeda, Centocor Ortho Biotech, Merck, Mitsubishi Tanabe, Abbott, Eisai, Celgene, Bristol-Myers Squibb, UCB, Otsuka, Roche, Chugai, Genentech, Biogen Idec, Spectrum Pharmaceuticals, Inc., Bayer Schering AG, GSK, Genzyme, Cephalon Oncology, Genmab, Allos Therapeutics, AstraZeneca, Boehringer Ingleheim and ImmunoGen, Inc.

We face competition for our biodefense product candidates. Although BioThrax is the only anthrax vaccine approved by the FDA for the prevention of anthrax infection, the U.S. government is funding the development of new products that could compete with BioThrax and could eventually procure those new products in addition to, or instead of, BioThrax, potentially reducing our BioThrax revenues. For example, HHS has awarded a development and SNS procurement contract to a competitor for an anthrax immune globulin therapeutic and is assisting this company in its production efforts by providing it with BioThrax doses that we delivered for placement into the SNS so that the competitor can immunize donors and obtain plasma for the competitor’s product candidate. HHS has awarded another development and SNS procurement contract to another competitor for an anthrax monoclonal antibody as a post-exposure therapeutic for anthrax infection.

Numerous companies have products or product candidates in development that would compete with the commercial product candidates for which we are seeking to obtain marketing approval.  If approved for the treatment of RA, we anticipate that some of our commercial product candidates would compete with other marketed protein therapeutics for the treatment of RA, including: Enbrel ® (Amgen, Pfizer and Takeda), Remicade ® (Centocor Ortho Biotech, Merck and Mitsubishi Tanabe), Humira ® (Abbott and Eisai), Orencia ® (BMS), Cimzia ® (UCB and Otsuka), Simponi ® (JNJ and Merck), Actemra ® (Roche and Chugai) and Rituxan ® (Genentech, Roche and Biogen Idec). If approved for the treatment of systemic lupus erythematosus, or SLE, our product candidates will compete with Benlysta (Human Genome Sciences and GSK) and other B cell depleting therapies, including CD20-directed therapeutics.

If approved for the treatment of CLL, non-Hodgkin’s lymphoma, or NHL, or other B cell malignancies, we anticipate that our product candidates would compete with other B cell depleting therapies and related therapeutics.  Non-CD37- directed therapeutics marketed for the treatment of NHL or CLL, or both, include Rituxan ® (Genentech), Zevalin ® (Spectrum Pharmaceuticals, Inc. and Bayer Schering AG), Bexxar ® (GlaxoSmithKline), Campath ® (Genzyme and Bayer Schering AG), Treanda ® (Cephalon Oncology) and Arzerra ® (GlaxoSmithKline and Genmab). In addition, Boehringer Ingelheim and ImmunoGen, Inc. are both developing antibody therapies directed to CD37.

If approved for the treatment of cutaneous T-cell lymphoma, or CTCL, and peripheral T-cell lymphoma, or PTCL, or other T-cell lymphomas, we anticipate that our product candidates would compete with other T-cell therapies and related therapeutics.  Therapeutics marketed for the treatment of CTCL or PTCL include Ontak and Targretin (Eisai), Istodax ® (Celgene), Zolinza ® (Merck), Folotin ® (Allos Therapeutics), Campath (Bayer Schering AG), and R788® (AstraZeneca). In addition, TaiMed Biologics, Biogen Idec, Roche, Adeona Pharmaceuticals, Bristol-Myers Squibb, Tolerx and Viral Genetics Inc. are developing therapies directed to CTCL or PTCL.

The Aeras Global Tuberculosis Vaccine Foundation is developing or supporting the development of five tuberculosis vaccine product candidates in addition to ours, any of which could present competitive risks.  

If we are not able to compete effectively against our current and future competitors, our business may not grow, and our financial condition and operating results may suffer.

Legislation and contractual provisions limiting or restricting liability of manufacturers or providing for indemnification may not be adequate to protect us from all liabilities associated with the manufacture, sale and use of our products.

Provisions of our BioThrax contracts with the U.S. government and federal legislation enacted to protect manufacturers of biodefense and anti-terrorism countermeasures may limit our potential liability related to the manufacture, sale and use of BioThrax and our biodefense product candidates. However, these contractual provisions and legislation may not fully protect us from all related liabilities.

The Public Readiness and Emergency Preparedness Act, or PREP Act, which was signed into law in December 2005, creates immunity for manufacturers of biodefense countermeasures when the Secretary of HHS issues a declaration for their manufacture, administration or use. A PREP Act declaration is meant to provide immunity from all claims under state or federal law for loss arising out of the administration or use of a covered countermeasure. Manufacturers are not entitled to protection under the PREP Act in cases of willful misconduct. Upon a declaration by the Secretary of HHS, a compensation fund is created to provide “timely, uniform, and adequate compensation to eligible individuals for covered injuries directly caused by the administration or use of a covered countermeasure.” The “covered injuries” to which the program applies are defined as serious physical injuries or death. Individuals are permitted to bring a willful misconduct action against a manufacturer only after they have exhausted their remedies under the compensation program. Therefore, a willful misconduct action could be brought against us if any individuals exhausted their remedies under the compensation program and thereby expose us to liability. In October 2008, the Secretary of HHS issued a PREP Act declaration identifying BioThrax and Anthrivig as covered countermeasures.

Under our prior BioThrax contracts with the DoD and HHS, the U.S. government agreed to indemnify us against claims by third parties for death, personal injury and other damages related to BioThrax, including reasonable litigation and settlement costs, to the extent that the claim or loss results from specified risks not covered by insurance or caused by our grossly negligent or criminal behavior. As required under our prior BioThrax contracts, we have notified the DoD of personal injury claims that have been filed against us as a result of the vaccination of U.S. military personnel with BioThrax and are seeking reimbursement from the DoD for uninsured costs incurred in defending these claims. The collection process can be lengthy and complicated, and there is no gua