The Company is required under U.S. Generally Accepted Accounting Principles (“GAAP”) to disclose information about the fair value of all the Company’s financial instruments, whether or not these instruments are measured at fair value on the Company’s consolidated balance sheet.

The Company estimates that the fair values of cash and cash equivalents, securities, other assets, accounts payable and accrued expenses approximate their carrying values due to the short-term maturities of these items.  The Company also has certain warrants with cash settlement or “Put” rights in the unlikely occurrence of a Fundamental Transaction (the “Warrants”).  For a discussion about how the Company values these Warrants, please see Note 11: Restatement below.

On January 1, 2008, the Company adopted new accounting guidance (codified at FASB ASC 820 and formerly Statement No. 157 Fair Value Measurements) that defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements.  The guidance does not impose any new requirements around which assets and liabilities are to be measured at fair value, and instead applies to asset and liability balances required or permitted to be measured at fair value under existing accounting pronouncements.  The Company measures its warrant liability at fair value.  As of March 31, 2010, except for the Warrants, the Company had no derivative assets or liabilities.

FASB ASC 820-10-35-37 (formerly SFAS No. 157) establishes a valuation hierarchy based on the transparency of inputs used in the valuation of an asset or liability.  Classification is based on the lowest level of inputs that is significant to the fair value measurement.  The valuation hierarchy contains three levels:

·

Level 1 – Quoted prices are available in active markets for identical assets or liabilities at the reporting date.

·

Level 2 – Observable inputs other than Level 1 prices such as quote prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or other valuation techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.  As of December 31, 2009, the Company has classified the Warrants(that contain embedded put and call features) as Level 3.  Management evaluates a variety of inputs and then estimates fair value based on those inputs.  As discussed below in Note 11: Restatement, the Company utilized the Monte Carlo Simulation approach in valuing these Warrants.

 

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The table below presents the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy as of March 31, 2010 (in thousands):

		Total				Level 1				Level 2				Level 3
Assets:
Marketable Securities		$	3,053			$	3,053			$	-			$	-
Liabilities:
Warrants			5,020				-				-				5,020
Total		$	8,073			$	3,053			$	-			$	5,020

For detailed information regarding the change to the fair value of assets recorded in Level 1 (See Note 5: Marketable Securities).

The changes in Level 3 Liabilities measured at fair value on a recurring basis are summarized as follows:

		Fair Value of Redeemable Warrants (in thousands)
		March 31,2009				March 31, 2010
Balance at beginning of quarter		$	-			$	3,684
Fair value adjustment at March 31, 2010			-				1,336
Balance at March 31, 2010		$	-			$	5,020

Note 11: Restatement

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

 

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Initially, the Company determined that these Warrants created a related Liability in accordance with ASC 480-10-55-29 & 30 due to the fact that the Warrants could be settled for cash as discussed above.  In their estimation of the value of this Liability, the Company interpreted and applied the concept of “Fair Value” from ASC 820 (formally SFAS 157).  After reviewing current accounting literature and the findings and opinion of an independent appraiser in determining proper accounting treatment, the Company took into account the extreme unlikelihood of the occurrence of a Fundamental Transaction triggering a right to cash settlement as a probability factor in applying a Black-Scholes-Merton valuation of the Warrants.  As a result, Management deemed the fair value of the Warrants to be immaterial and, therefore, stated the Warrants’ related Liability from May 31, 2009 through December 31, 2009 at zero.

 

On September 15, 2010, the Company received a comment letter from the Securities and Exchange Commission (“SEC”) concerning its review of the Company’s annual report on Form 10-K, as amended, for the year ended December 31, 2009.  During the process of resolving the SEC’s comments, the SEC Staff alerted Management that they did not agree with their method of computing the fair value of the Warrants as discussed above.

 

As a result, on December 22, 2010, after discussion with McGladrey & Pullen, LLP, the Company’s independent registered public accounting firm, the Company’s Audit Committee determined that the previously issued financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and in its Forms 10-Q for the periods ended March 31, 2010, June 30, 2010 and September 30, 2010 and in its Forms 10-Q for the periods ended June 30, 2009 and September 30, 2009, should not be relied upon.  Management has restated the financial statements for the year ended December 31, 2009 contained in the Company’s Form 10-K and in its Forms 10-Q for the periods ended March 31, 2010, June 30, 2010 and September 30, 2010 (including the comparable periods ended June 30, 2009 and September 30, 2009) to reflect the revised value of this Liability.

 

The restatements reflect the recalculation of the fair value of the Warrants using a Monte Carlo Simulation approach, applying critical assumptions provided by Management reflecting conditions at the valuation date.  The Monte Carlo Simulation approach incorporates the incremental value of the Put rights available to the Warrant Holders.  The fair value of Warrants ranged from $0.37 to $0.38 at December 31, 2009 and all valued at $0.51 at March 31, 2010.

 

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

Fair value at March 31, 2010, was estimated using the following assumptions:

Underlying price per share		$0.74
Exercise price per share		$1.31 – $1.65
Risk-free interest rate		2.12% - 2.36%
Expected holding period		4.13 - 4.63 years
Expected volatility		113.14% – 114.38%
Expected dividend yield		None

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

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

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

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

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

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

a.

The Company only has one product that is FDA approved;

b.

The Company will have to perform additional clinical trials for FDA approval of its flagship product;

c.

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

d.

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

e.

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

f.

According to Forbes.com, of approximately 17,000 public companies, fewer than 30 went private in 2008 and less than 100 were completed in 2007, representing 0.18% and 0.6%, respectively.  This would be further reduced based on the nature of a life sciences company and the potential lack of revenues, cash flows and the Company’s funding needs; and

g.

The Company's Rights Agreement makes it less attractive to a potential buyer.

 

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

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

The Monte Carlo Simulation incorporated a 5.0% probability of a Fundamental Transaction.

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

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

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

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

As a result of the corrections in the valuation of the Liabilities as described above, the Company has restated its consolidated financial statements in this amended report as follows:

 

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HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES

Consolidated Balance Sheet

March 31,2010

(in thousands)

		March 31,2010 As Previously Reported				Adjustments				March 31, 2010 As restated
ASSETS
Current Assets:
Cash and cash equivalents		$	50,723							$	50,723
Marketable securities maturing in less than one year			3,053								3,053
Prepaid expenses and other current assets			216								216
Total current assets			53,992								53,992
Property and equipment, net			4,738								4,738
Patent and trademark rights, net			838								838
Investment			35								35
Construction in progress			389								389
Other assets			892								892
Total assets		$	60,884							$	60,884
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts Payable		$	1,808							$	1,808
Accrued expenses			615								615
Current portion of capital lease			35								35
Total current liabilities			2,458								2,458
Long-term portion of capital lease			30								30
Redeemable warrants			-				3,684
							1,336				5,020
Total liabilities			2,488				5,020				7,508
Commitment and contingencies
Stockholders’ equity
Preferred stock			-								-
Common stock			133								133
Additional paid-in capital			273,174				(9,942	)			263,232
Accumulated other comprehensive loss			(20	)							(20	)
Accumulated deficit			(214,891	)			6,258				(209,969	)
							(1,336	)
Total stockholders' equity			58,396				(5,020	)			53,376
Total liabilities and stockholders’ equity		$	60,884							$	60,884

 

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HEMISPHERX BIOPHARMA, INC. AND SUBSIDIARIES

Consolidated Statement of Operations

Three months ended March 31,2010

(in thousands, except per share data)

		March 31,2010 As Previously Reported				Adjustments				March 31, 2010 As restated
Revenues:
Sales of product, net		$								$
Clinical treatment programs			32								32
Total revenues			32								32
Costs and expenses:
Production/cost of goods sold			140								140
Research and development			1,996								1,996
General and administrative			1,969								1,969
Total costs and expenses			4,105								4,105
Operating loss			(4,073	)							(4,073	)
Interest and other income			29								29
Redeemable warrants valuation adjustment							(1,336	)			(1,336	)
Net loss		$	(4,044	)			(1,336	)		$	(5,380	)
Basic and diluted loss per share		$	(.03	)			(.01	)		$	(.04	)
Weighted average shares outstanding Basic and Diluted			132,818,036								132,818,036

Note to above tables:  The estimated fair value of the Liability related to the Warrants was revalued at March 31, 2010.  Due to the increasing trading value of our stock during the relevant period, at March 31, 2010, the value of the Liability related to the remaining outstanding Warrants was $5,020,000, resulting in a related non-cash loss of $1,336,000.

None of the above issues from this non-cash adjustment affected the Company’s revenues, operating expenses, liquidity or cash flows from past, nor should they affect future operations, except in the highly unlikely event that a Put right is triggered under the Warrants.

NOTE 12: Cash And Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents.

 

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NOTE 13: Recent Accounting Pronouncements

The FASB has published FASB Accounting Standards Update 2010-01 through 2010-12.  The adoption of published FASB Accounting Standards Update 2010-01 through 2010-12 has no material effect on the Company’s financial statements for the three months ended March 31, 2010.

NOTE 14: Subsequent Events

The Company evaluated subsequent events through the date on which the financial statements were issued, and determined that there are no subsequent events that require adjustment or disclosure to the financial statements for the three months ended March 31, 2010.

ITEM 2:  Management's Discussion and Analysis of Financial Condition and Results of Operations.

Special Note Regarding Forward-Looking Statements

Certain statements in this document constitute "forwarding-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1995 (collectively, the "Reform Act").  Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "will", "should", or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties.  All statements other than statements of historical fact, included in this report regarding our financial position, business strategy and plans or objectives for future operations are forward-looking statements. Without limiting the broader description of forward-looking statements above, we specifically note that statements regarding potential drugs, their potential therapeutic effect, the possibility of obtaining regulatory approval, our ability to manufacture and sell any products, market acceptance or our ability to earn a profit from sales or licenses of any drugs or our ability to discover new drugs in the future are all forward-looking in nature.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to, the risk factors discussed below, which may cause the actual results, performance or achievements of Hemispherx and its subsidiaries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements and other factors referenced in this report.  We do not undertake and specifically decline any obligation to publicly release the results of any revisions which may be made to any forward-looking statement to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 

Overview

 

General

We are a specialty pharmaceutical company based in Philadelphia, Pennsylvania and engaged in the clinical development of new drug therapies based on natural immune system enhancing technologies for the treatment of viral and immune based chronic disorders.  We were founded in the early 1970s doing contract research for the National Institutes of Health.  Since that time, we have established a strong foundation of laboratory, pre-clinical and clinical data with respect to the development of natural interferon and nucleic acids to enhance the natural antiviral defense system of the human body and to aid the development of therapeutic products for the treatment of certain chronic diseases.  We have three domestic subsidiaries BioPro Corp., BioAegean Corp., and Core BioTech Corp., all of which are incorporated in Delaware and are dormant.  Our foreign subsidiary is Hemispherx Biopharma Europe N.V./S.A. established in Belgium in 1998, which has no activity.  All significant intercompany balances and transactions have been eliminated in consolidation.

 

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Our current strategic focus is derived from four applications of our two core pharmaceutical technology platforms Ampligen® and Alferon N Injection®.  The commercial focus for Ampligen® includes application as a treatment for Chronic Fatigue Syndrome (“CFS”) and as an influenza vaccine enhancer (adjuvant) for both therapeutic and preventative vaccine development.  Alferon N Injection® is a Food and Drug Administration (“FDA”) approved product with an indication for refractory or recurring genital warts.  Alferon® LDO (Low Dose Oral) is a formulation currently under development targeting influenza.

We have formed an independent Data Monitoring Committee (“DMC”) which will oversee our various drug development programs.  The principal role of an independent DMC is to perform, absent of serious conflict of interest, interim analyses of the clinical outcome data and to insure the safety of patients in clinical trials.  The DMC also plays a critical role in studies that may use “Adaptive Design” wherein trial design modifications can be made after patient enrollment has started.  Adaptive Design should enable us to respond to data collected during a trial to increase the likelihood of generating statistically and clinically significant results.

We own and operate a 43,000 sq. ft. FDA approved facility in New Brunswick, NJ that was primarily designed to produce Alferon®.  On September 16, 2009, our Board of Directors approved up to $4.4 million for full engineering studies, capital improvements, system upgrades and introduction of building management systems to enhance production of three products: Alferon N Injection®, Alferon® LDO and Ampligen®.  We outsource certain components of our research and development, manufacturing, marketing and distribution while maintaining control over the entire process through our quality assurance group and our clinical monitoring group.

 

Ampligen®

 

Ampligen® is an experimental drug currently undergoing clinical development for the treatment of Myalgic Encephalomyelitis/Chronic Fatigue Syndrome (“ME/CFS”).  Over its developmental history, Ampligen® has received various designations, including Orphan Drug Product Designation (FDA), Treatment IND (e.g., treatment investigational new drugs, or “Emergency” or “Compassionate” use authorization) with Cost Recovery Authorization (FDA) and “promising” clinical outcome recognition based on the evaluation of certain summary clinical reports (“AHRQ” or Agency for Healthcare Research and Quality).  Ampligen® represents the first drug in the class of large (macromolecular) RNA (nucleic acid) molecules to apply for New Drug Application (“NDA”) review.  Based on the results of published, peer reviewed pre-clinical studies and clinical trials, we believe that Ampligen® may have broad-spectrum anti-viral and anti-cancer properties.  Over 1,000 patients have participated in the Ampligen® clinical trials representing the administration of more than 90,000 doses of this drug.

On November 25, 2009, we received a Complete Response Letter (“CRL”) from the FDA which described specific additional recommendations related to the Ampligen® NDA.  In accordance with its 2008 Complete Response procedure, the FDA reviewers determined that they could not approve the application in its present form and provided specific recommendations to address the outstanding issues.

 

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We are carefully reviewing the CRL and will seek a meeting with the FDA to discuss its recommendations upon the compilation of necessary data to be used in our response.  We intend to take the appropriate steps to seek approval and commercialization of Ampligen®.  Most notably, the FDA stated that the two primary clinical studies submitted with the NDA did not provide credible evidence of efficacy of Ampligen® and recommended at least one additional clinical study which shows convincing effect and confirms safety in the target population.  The FDA indicated that the additional study should be of sufficient size and sufficient duration (six months) and include appropriate monitoring to rule out the generation of autoimmune disease.  In addition, patients in the study should be on more than one dose regimen, including at least 300 patients on dose regimens intended for marketing.  We are presently planning a confirmatory clinical study which will utilize the same primary endpoints as our earlier studies but with an enlarged number of subjects to potentially achieve a more representative statistical model.  Lastly, additional data including a well-controlled QT interval study (i.e., a measurement of time between the start of the Q wave and the end of the T wave in the heart’s electrical cycle) and pharmacokinetic evaluations of dual dosage regiments were requested.  Other items required by the FDA include certain aspects of Non-Clinical safety assessment and Product Quality.  In the Non-Clinical area, the FDA recommended among other things that we complete rodent carcinogenicity studies in two species.  As part of the NDA submission, we had requested that these studies be waived.  The waiver has not been granted as of May 5, 2010.

In the October 8, 2009 issue of Science Express, a consortium of researchers from the Whittemore Peterson Institute, the National Cancer Institute and the Cleveland Clinic reported a new retrovirus in the blood cells of 67% of Chronic Fatigue Syndrome (“CFS”) patients and 3.7% in healthy control subjects.  The infectious virus was also greater than 99% identical to that previously detected in prostate cancer.  Retrospective analyses of patient samples from the completed Phase III trial of Ampligen® in potential treatment of CFS continues in collaboration with the Whittemore Peterson Institute with these studies hoping to provide a new perspective on the design of a confirmatory Phase III study in this disorder.  The samples are being analyzed for the presence of XMRV, a novel retrovirus reported to be found in approximately two-thirds of CFS patients.

Alferon N Injection®

Alferon N Injection® is the registered trademark for our injectable formulation of natural alpha interferon, which is approved by the FDA in 1989 for the treatment of certain categories of genital warts.  Alferon® is the only natural-source, multi-species alpha interferon currently approved for sale in the U.S. for the intralesional (within lesions) treatment of refractory (resistant to other treatment) or recurring external genital warts in patients 18 years of age or older.

Alferon N Injection® [Interferon alfa-n3 (human leukocyte derived)] is a highly purified, natural-source, glycosylated, multi-species alpha interferon product.  There are essentially no antibodies observed against natural interferon to date and the product has a relatively low side-effect profile.

Commercial sales of Alferon N Injection® were halted in March 2008 as the current expiration date of our finished goods inventory expired.  We are undertaking a major capital improvement program to upgrade our manufacturing capability for Alferon N Injection® at our New Brunswick facility that will continue throughout 2010.  As a result, Alferon N Injection® could be available for commercial sales in mid to late 2011.

In April 2010, we began the process to undertake a clinical study with Max Neeman International, one of the leading and largest clinical research organizations (“CROs”) in India.  This collaborative clinical research effort is intended to utilize Alferon N Injection® for treatment of acute seriously ill patients hospitalized with either seasonal influenza or pandemic influenza.  The Indian site selection process has begun.  It is our goal to enroll subjects for the upcoming monsoon season of mid to late 2010.

 

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Alferon® Low Dose Oral (LDO)

Alferon® LDO [Low Dose Oral Interferon Alfa-n3 (Human Leukocyte Derived)] is an experimental low-dose, oral liquid formulation of Natural Alpha Interferon and like Alferon N Injection® should not cause antibody formation, which is a problem with recombinant interferon.  It is an experimental immunotherapeutic believed to work by stimulating an immune cascade response in the cells of the mouth and throat, enabling it to bolster systemic immune response through the entire body by absorption through the oral mucosa.  Oral interferon could be economically feasible for patients and logistically manageable in development programs in third-world countries primarily affected by HIV and other emerging viruses (e.g., SARS, Ebola, bird and swine flu).  Oral administration of Alferon® LDO, with its anticipated affordability, low toxicity, no production of antibodies, and broad range of potential bioactivity, could be a breakthrough treatment or prevention for viral diseases.

In October 2009, we submitted a protocol to the FDA proposing to conduct a Phase 2, well-controlled, clinical study using Alferon® LDO for the prophylaxis and treatment of seasonal and pandemic influenza of more than 200 subjects.  Following a teleconference with the FDA in November 2009, the FDA placed the proposed study on “Clinical Hold” because the protocol was deemed by the FDA to be deficient in design, and because of the need for additional information to be submitted in the area of chemistry, manufacturing and controls (“CMC”).  Thereafter in December 2009, we submitted additional information by Amendment with respect to both the clinical protocol design issues and the CMC items.  In January 2010, the FDA acknowledged that our responses to the clinical study design issues were acceptable; however, removal of the Clinical Hold was not warranted because the FDA believed that certain CMC issues had not been satisfactorily resolved.  In this regard, the FDA communicated concern regarding the extended storage of Alferon® LDO drug product clinical lots which had been manufactured from an active pharmaceutical ingredient (“API”) of Alferon N Injection® manufactured in year 2001.  While the biological (antiviral) potency of the product had remained intact, we learned through newly conducted physico-chemical tests (the “new tests” of temperature, pH, oxidation and light on the chemical stability of the active API), that certain changes in the drug over approximately nine storage years (combined storage of Alferon N Injection® plus storage of certain LDO sachets) had introduced changes in the drug which might adversely influence the human safety profile.  These “new tests” are part of recent FDA requirements for biological products, such as interferon, which did not exist at the time of the original FDA approval of Alferon N Injection® for commercialization and at the time of FDA approval of the “Establishment License” for Hemispherx’ manufacturing facility.  Based on the recent FDA request, we have now established and implemented the “new test” procedures.  As a result, we have found that certain Alferon N Injection® lots with extended storage (i.e., approximately eight to nine years) do appear to demonstrate some altered physico-chemical properties.  However we have also observed that more recent lots, including those manufactured beginning in the year 2006, are superior with respect to the enhanced scrutiny of these tests and, in our view, could be considered appropriate for clinical trials in the Alferon® LDO sachet format.  Upon their review, the FDA has been responsive to these new findings and requested additional stability data on the lots proposed for use in this clinical study utilizing the new test methods.  These data are expected to be compiled, analyzed and submitted to the FDA in mid to late 2010.  Once the FDA has received and reviewed the additional data, we believe that the full Clinical Hold could be thereafter lifted if the FDA concurs that the data address the outstanding CMC issues cited in the January 2010 FDA recommendations.

 

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401(k) Plan

In December 1995, we established a defined contribution plan, entitled the Hemispherx Biopharma Employees 401(K) Plan and Trust Agreement (the “401(k) Plan”).  Full time employees of the Company are eligible to participate in the 401(K) Plan following one year of employment.  Subject to certain limitations imposed by federal tax laws, participants are eligible to contribute up to 15% of their salary (including bonuses and/or commissions) per annum. Participants' contributions to the 401(K) Plan may be matched by the Company at a rate determined annually by the Board of Directors.

Each participant immediately vests in his or her deferred salary contributions, while Company contributions will vest over one year.  The 6% Company matching contribution was terminated as of March 15, 2008 and was reinstated effective January 1, 2010.  The Company provided matching contributions to each employee for up to 6% of annual pay aggregating $39,806 for the three months ended March 31, 2010.

Restatement

The Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to the restatement as discussed in Note 11: Restatement of the Notes to Consolidated Condensed Financial Statements.

New Accounting Pronouncements

Refer to “Note 13: Recent Accounting Pronouncements” under Notes To Unaudited Condensed Consolidated Financial Statements.

Disclosure About Off-Balance Sheet Arrangements

None.

Critical Accounting Policies

There have been no material changes in our critical accounting policies and estimates from those disclosed in Part I; Item 2: “Management's Discussion and Analysis of Financial Condition and Results of Operations; Critical Accounting Policies” contained in our amended and restated Annual Report on Form 10-K/A-2 for the year ended December 31, 2009.

 

RESULTS OF OPERATIONS

Three months ended March 31, 2010 versus three months ended March 31, 2009

Net Loss – restated

Our net loss as restated was approximately $5,380,000 for the three months ended March 31, 2010, which was an increase of $2,293,000 or 74% when compared to the same period in 2009.  This increase in loss for these three months was primarily due to the following expense elements:

1)

Research and Development costs increased approximately $401,000 or 25%;

2)

General and Administrative expenses increased approximately $803,000 or 69%;

3)

A decrease in Production/Cost of Goods Sold of approximately $19,000 or 16%;

 

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4)

A decrease in finance costs of $241,000 from a Standby Finance Agreement executed in February 2009; and

5)

A restatement adjustment of $1,336,000 of redeemable warrants. See Note 11.

Net loss per share as restated was $0.04 for the current period and for the same period in 2009.

 

Revenues

Revenues from our Ampligen® cost recovery program increased $3,000 or 10% for the quarter in 2010 with approximately the same number of patients participating in the program.  As previously stated, we have no Alferon N Injection® product to commercially sell at this time and all revenue was generated from the Ampligen® cost recovery clinical treatment programs.

Production/Cost of Goods Sold

Production/Cost of Goods Sold was approximately $121,000 and $140,000, respectively, for the three months ended March 31, 2010 and 2009.  This is a decrease of $19,000 or 16%.  These expenses basically represent the cost to maintain the Alferon N Injection® and Ampligen® inventory including storage, stability testing, transport and reporting costs.  The costs are essentially flat and the increase reflects price increases and charges for the movement of inventory between locations.

Research and Development Costs

Overall Research and Development (“R&D”) costs for the three months ended March 31, 2010 were approximately $1,996,000 as compared to $1,595,000 for the same period a year ago reflecting a increase of $401,000 or 25%.  The primary factor for the increase in expenses was related to our preparation of a response to the November 25, 2009 Complete Response Letter (“CRL”) from the FDA which described specific additional recommendations related to the Ampligen® NDA along with R&D costs associated with Alferon® LDO for potential clinical programs and preparations towards a launch of Alferon N Injection® Phase II clinical tests.

General and Administrative Expenses

General and Administrative (“G&A”) expenses for the three months ended March 31, 2010 and 2009 were approximately $1,969,000 and $1,166,000, respectively, reflecting an increase of $803,000 or 69%.  The primary cause of this increase in expense was an additional $769,000 in legal fees associated with our defense in three proceedings (See Part II – OTHER INFORMATION, ITEM 1. Legal Proceedings) plus minor increases in other expenses.

Interest and Other Income

Interest and other income for the three months ended March 31, 2010 and 2009 was approximately $29,000 and $7,000, respectively, representing an increase of $22,000.  The primary cause for the increase of interest income in 2010 was increased funds available for secure and highly liquid investments.

 

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Redeemable Warrants

Restatement for a non-cash valuation adjustment of $1,336,000 was made in 2010 due to a revaluation of redeemable warrants.  See Note 11.

Liquidity and Capital Resources

Cash used in operating activities for the three months ended March 31, 2010 was $3,925,000, compared to $1,424,000 for the same period in 2009, an increase of $2,501,000 or 176%.  This utilization of cash reflects the increased expenses in operations as explained in Management’s Discussion and Analysis section above in conjunction with the impact of 2009’s effort to conserve cash through implementation of the Employee Wage Or Hours Reduction Program (the “Program”) implemented January 1 through May 31, 2009 in which all active full-time employees reduced their base salary from 10% to 50% in return for our common stock issued six months after the shares were earned.  As of March 31, 2010, we had approximately $50,723,000 in Cash and Cash Equivalents or a decrease of approximately $7,349,000 from December 31, 2009, of which approximately $3,073,000 was used to purchase short-term investments.

We have been using the proceeds from 2009’s financings with the assistance of Rodman & Renshaw, LLC (“Rodman”) as placement agent and from Fusion Capital Fund II, LLC (“Fusion Capital”) equity financing to fund operating expenses and infrastructure growth including preparation for manufacturing, regulatory compliance and market development costs related to the FDA approval process for Ampligen®, Alferon N Injection® and Alferon® LDO development.  While as of September 2009, we had effectively exhausted the Fusion Capital Purchase Agreement through the purchase of the maximum number of shares that were registered under the Registration Statement, this agreement was formally terminated through notification on April 7, 2010.

Because of our long-term capital requirements, we may seek to access the public equity market whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time.  We are unable to estimate the amount, timing or nature of future sales of outstanding common stock or instruments convertible into or exercisable for our common stock.  Any additional funding may result in significant dilution and could involve the issuance of securities with rights, which are senior to those of existing stockholders.  We may also need additional funding earlier than anticipated, and our cash requirements, in general, may vary materially from those now planned, for reasons including, but not limited to, changes in our research and development programs, clinical trials, competitive and technological advances, the regulatory processes, including the commercializing of Ampligen® products.

 

There can be no assurances that, if needed, we will raise adequate funds from these or other sources, which may have a material adverse effect on our ability to develop our products.  Also, we have the ability to curtail discretionary spending, including some research and development activities, if required to conserve cash.

 

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

We had approximately $50,723,000 in Cash and Cash Equivalents at March 31, 2010.  In the past, we had invested the excess cash in three to twelve month interest bearing financial instruments.  However with the current state of the market and our funds well in excess of our short-term operational needs, our Board has reassessed our cash investment strategy consistent with the following objectives:

1.

to preserve, secure and control capital;

2.

to maintain liquidity to meet our operating cash flow requirements; and

 

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3.

to maximize return subject to policies and procedures that manage risks with respect to a conservative to moderate investment exposure at high credit quality institutions.

To accomplish these goals, in March 2010 we entrusted our investible funds through external investment managers with detailed investment and trading guidelines that are analyzed for compliance on an on-going basis.  We have not entered into, and do not expect to enter into, financial instruments for trading or hedging purposes.

Our financial instruments that are exposed to concentrations of credit risk consist primarily of Cash and Cash Equivalents.  We place our Cash and Cash Equivalents with what Management believes to be high credit quality institutions.  At times such investments may be in excess of the Federal Deposit Insurance Corporation insurance limit.

ITEM 4: Controls and Procedures

Our Chairman of the Board (serving as the principal executive officer) and the Chief Financial Officer performed an evaluation of the effectiveness of our disclosure controls and procedures, which have been designed to permit us to effectively identify and timely disclose important information.  In designing and evaluating the disclosure controls and procedures, Management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and Management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the controls and procedures were effective as of March 31, 2010 to ensure that material information was accumulated and communicated to our Management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

During the quarter ended March 31, 2010, we have made no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Part II – OTHER INFORMATION

ITEM 1. Legal Proceedings

(a)

Hemispherx Biopharma, Inc. v. Johannesburg Consolidated Investments, et al.,U.S. District Court for the Southern District of Florida, Case No. 04-10129-CIV.

In December, 2004, we filed a multi-count complaint in federal court (Southern District of Florida) for fraud and injunctive relief against Bioclones, Dr. Donniger, Bart Goemare, JCI, Brett Kebble and H.C. Buidentag.  However, a motion to dismiss the complaint, in part on grounds that the matter must be arbitrated in South Africa, was granted by the court.  We appealed this decision to the 11th Circuit Court of Appeals.  In July 2008, while the appeal was pending, we settled our disputes with both Bioclones and Cyril Donninger and dismissed them from the lawsuit.  In 2005 Buitendag and Kebble were indicted for using JCI to perpetrate the largest financial fraud in South African history.  The appeals court allowed the fraud action to go forward.  In 2008, we filed a second amended complaint for fraud against JCI, Goemare, the Estate of Kebble and Buidentag, the only remaining defendants.  In 2009, we settled our disputes with Goemare and dismissed him from the lawsuit.  In February of 2010, the Court began considering the remaining Defendants’(JCI, estate of Kebble, and Buidentag) motion to dismiss the complaint.  On April 7, 2010, the Court denied the motion to dismiss and we are awaiting Defendants’ Answer.  We continue to vigorously prosecute this case and the law firm of Colson Hicks Eidson is serving as our co-counsel.

 

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(b)

Hemispherx Biopharma, Inc. v. MidSouth Capital, Inc., Adam Cabibi, And Robert L. Rosenstein v. Hemispherx Biopharma, Inc. and The Sage Group, Inc., Civil Action No. 1:09-CV-03110-CAP.

On June 4, 2009, we filed suit in the United States District Court for the Southern District of Florida against MidSouth Capital, Inc. (“MidSouth”) and its principals seeking monetary and injunctive relief against MidSouth's tortuous interference with certain financing transactions in which we were engaged.  The case was transferred to the Northern District of Georgia, and we engaged Holland & Knight LLP on November 13, 2009 to serve as local counsel.  On November 19, 2009, MidSouth answered our Complaint and filed a Counterclaim against us and The Sage Group, Inc., seeking to recover between $3,900,000 and $4,800,000 for fees allegedly owed to it as a result of the same financing transactions, plus attorneys' fees and punitive damages.

On January 12, 2010, we filed a Motion for Judgment on the Pleadings with the Court.  By Order dated March 31, 2010, the Court granted that Motion in part and denied it in part.  The Court held that MidSouth's claim based upon an alleged breach of contract could not be sustained.  Additionally, the Court denied the Motion to dismiss insofar as it pertained to MidSouth's claims based upon promissory estoppel, quantum meruit, unjust enrichment, fraud, and MidSouth's request for attorney's fees and punitive damages.  The Court’s ruling merely held that MidSouth's pleadings were sufficient to state those claims; it does not constitute a ruling on the merits.  We are vigorously defending the remaining counterclaim and prosecuting our own claims against MidSouth.  Discovery is in a very preliminary stage.  Accordingly, we have no projection as to the likely outcome of the case.

(c)

Cato Capital, LLC v. Hemispherx Biopharma, Inc., U.S. District Court for the District of Delaware, Case No. 09-549-GMS.

On July 31, 2009, Cato Capital LLC (“Cato”) filed suit asserting that under a November 2008 agreement, we owe Cato a placement fee for certain investment transactions.  The Complaint seeks damages in the amount of $5,000,000 plus attorneys’ fees.  We filed our Answer on August 20, 2009.  On October 13, 2009, Cato filed a Motion seeking leave to file an Amended Complaint which proposes that Cato be permitted to add The Sage Group as an additional defendant and to bring additional causes of action against us arising from the defenses contained in our Answer and increase the total amount sought to $9,830,000, plus attorneys’ fees and punitive damages.  We filed a response objecting to the Motion with disposition of this Motion pending before the Court.  The law firm of Black and Gerngross is serving as our local counsel.  We believe we have meritorious defenses and are vigorously defending against this claim.

 

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(d)

In re Hemispherx Biopharma, Inc. Litigation, U. S. District Court for the Eastern District of Pennsylvania, Civil Action No. 09-5262.

Between November 10, 2009 and December 29, 2009, five putative class actions were filed against us and our Chief Executive Officer generally asserting that Defendants misrepresented the status of our New Drug Application (“NDA”) for Ampligen®.  Each action was purportedly brought on behalf of investors who purchased our publicly traded securities.  On February 12, 2010, the Court consolidated the five actions (“Securities Class Action Lawsuit”) and on February 26, 2010, a consolidated amended complaint was filed, adding our Medical Director as a Defendant.  On March 12, 2010, we filed a motion to dismiss the amended complaint, which the Court denied on April 20, 2010.  On April 27, 2010, the Court entered a Case Management Order directing the parties to begin the Discovery process.

Also in December 2009 and January 2010, three Shareholder Derivative Complaints were filed against us and some of our Officers and Directors (“Shareholder Derivative Lawsuits”).  These suits also allege that the named Defendants caused us to misrepresent the status of our NDA for Ampligen®.  On February 12, 2010, the Court consolidated the Securities Class Action Lawsuit with the Shareholder Derivative Lawsuits for purposes of Discovery and transferred the Shareholder Derivative Lawsuits to the civil suspense docket.

We intend to vigorously defend the Securities Class Action Lawsuit and the Shareholder Derivative Lawsuits.  Due to the preliminary state of the proceedings, the potential impact of these actions, which seek unspecified damages, attorneys’ fees and expenses, are uncertain.

(e)

Summation.

In reference to Contingencies identified above as (b), (c) and (d), there can be no assurance that an adverse result in these proceedings would not have a potentially material adverse effect on our business, results of operations, and financial condition.  With regards to Contingency (d), we maintain a Directors and Officers Insurance Policy that provides coverage for claims and retention of legal counsel.

We have not recorded any loss contingencies as a result of the above matters for the year ended December 31, 2009 or three months ended March 31, 2010.