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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

Commission File Number: 001-32587

PHARMATHENE, INC.

(Exact name of registrant as specified in its charter)

(410) 269-2600

(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.  Yes x  No o

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.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

The number of shares of the registrant’s Common Stock, par value $0.0001 per share, outstanding as of November 13, 2008 was 25,886,977.

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PHARMATHENE, INC.

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Part I

Item 1.    Financial Statements

PHARMATHENE, INC.

CONSOLIDATED BALANCE SHEETS

See the accompanying notes to the consolidated financial statements.

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PHARMATHENE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See the accompanying notes to the consolidated financial statements.

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PHARMATHENE, INC.

CONSOLIDATED STATEMENTS OF CASHFLOWS

See the accompanying notes to the consolidated financial statements.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Note 1 - Organization and Business

PharmAthene, Inc. (“PharmAthene” or the “Company”) was incorporated under the laws of the State of Delaware as Healthcare Acquisition Corp. (“HAQ”) on April 25, 2005, a special purchase acquisition corporation formed to serve as a vehicle for the acquisition of a then unidentified business.  HAQ became a public company on August 3, 2005.  On August 3, 2007, HAQ consummated a merger (the “Merger”) with PharmAthene, Inc., a Delaware corporation (“Former PharmAthene”), pursuant to an Agreement and Plan of Merger, dated as of January 19, 2007, by and among HAQ, PAI Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of HAQ, and Former PharmAthene, whereby Former PharmAthene became a wholly-owned subsidiary of HAQ.  Effective upon the consummation of the Merger, HAQ changed its name from “Healthcare Acquisition Corp.” to “PharmAthene, Inc.” and Former PharmAthene changed its name to “PharmAthene US Corporation.”  Our operations are conducted by our wholly-owned subsidiary, PharmAthene US Corporation.

Upon completion of the Merger, approximately 12.2 million shares of common stock were issued to the stockholders of Former PharmAthene and the Company assumed all of Former PharmAthene’s stock options and warrants that were not cancelled as part of the Merger and 587,249 shares of common stock have been reserved for issuance upon the exercise of such options and warrants.  Also, Former PharmAthene’s $12.8 million of outstanding secured convertible notes (“Bridge Notes”), including interest, were exchanged for $12.3 million of new unsecured 8% convertible notes maturing on August 3, 2009 (the “Notes”). The Notes are convertible at the option of the holders into common stock at $10.00 per share and became redeemable by PharmAthene without penalty after August 3, 2008.  Immediately following the closing of the Merger, the Former PharmAthene stockholders, option holders and warrant holders held approximately 56% of the common stock of PharmAthene on a fully-diluted basis and former stockholders, option holders and warrant holders of HAQ prior to the Merger owned approximately 44% of PharmAthene’s common stock on a fully-diluted basis after the Merger.  Following completion of the Merger, the business conducted by PharmAthene became the one operated by Former PharmAthene prior to the completion of the Merger.

On March 20, 2008, PharmAthene, Inc. and certain of its affiliates (including a newly-formed UK subsidiary, “PharmAthene UK”) (collectively, “PharmAthene” or the “Company”) entered into a Sale and Purchase Agreement (the “Purchase Agreement”) with Avecia Biologics Limited and certain of its affiliates (collectively, “Avecia”) for the acquisition of substantially all of the assets and liabilities related to Avecia’s vaccines business which includes a second generation recombinant protective antigen (“rPA”) anthrax vaccine, which is now referred to as SparVaxTM, a recombinant dual antigen plague vaccine (“rYP”) which is now referred to as RypVaxTM, and a third generation rPA anthrax vaccine program (the “Avecia Acquisition”).  On April 2, 2008, the parties amended the Purchase Agreement and the Company completed the Avecia Acquisition acquiring substantially all of the assets and assuming the liabilities, in each case exclusively associated with Avecia’s biodefense vaccines business in accordance with the terms of the Purchase Agreement, as amended, including certain products, patents, trademarks, domain names and other intellectual property, license agreements, contracts, goodwill and other intangibles for approximately $18.6 million.  See Note 3 Avecia Acquisition for additional information.

PharmAthene is a biopharmaceutical company focused on developing biodefense countermeasure applications. The Company is subject to those risks associated with any biopharmaceutical company that has substantial expenditures for research and development. There can be no assurance that the Company’s research and development projects will be successful, that products developed will obtain necessary regulatory approval, or that any approved product will be commercially viable. In addition, the Company operates in an environment of rapid technological change and is largely dependent on the services and expertise of its employees, consultants and other third parties.

Note 2 - Summary of Significant Accounting Policies

Basis of Presentation

These financial statements reflect the historic results of Former PharmAthene prior to the Merger and that of the combined company following the Merger, and do not include the historic financial results of HAQ prior to the completion of the Merger.

Unless specifically noted otherwise, as used throughout these consolidated financial statements, “the Company”, “PharmAthene”, “we”, “us” or “our” refers to the business of the combined company after the Merger and the business of Former PharmAthene prior to the Merger. Unless specifically noted otherwise, as used throughout these consolidated financial statements, “HAQ” refers to the business of the Healthcare Acquisition Corp. prior to the completion of the Merger. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States.

Interim financial information

During the third quarter, we identified certain immaterial items in the interim financial statements that should have been recorded in the first and second quarters of 2008. We assessed the nature and magnitude of these items in accordance with SEC Staff Accounting Bulletin No. 99, Materiality in determining that these errors were not material. Accordingly, we have made adjustments to our accompanying financial statements for the third quarter to correct these items in the current period. The adjustments have no effect on our September 30, 2008 balance sheet or the statement of operations for the nine months ended September 30, 2008 as all items originated in prior 2008 interim periods and have been corrected.

During the quarter ended June 30, 2008, the Company did not record certain revenue earned under government contracts during the period.  However, the Company did reflect the related expenses during the quarter.  As a result, the net loss for the period included the expenses without the related revenue, and the reported net loss was greater than it should have been. In addition, certain development expenses under these and other government contracts were not recorded during the proper periods.  The adjustments described below also reflect the reclassification of certain expenses from general and administrative to research and development during the third quarter for employee related costs that were not properly classified.  Overall, net loss for the quarters ended March 31, 2008 and June 30, 2008 was overstated by $268,000 ($0.01 per share) and $267,000 ($0.01 per share) respectively. The effect of all of these adjustments during the third quarter had the following effect on the statement of operations for the three-month period ended September 30, 2008:

Selected Statement of Operations Data

(amounts in thousands)

Principles of Consolidation

The consolidated financial statements include the accounts of PharmAthene and its subsidiaries, PharmAthene U.S. Corporation, PharmAthene Canada, Inc., which was formed in March 2005, and PharmAthene UK Limited, which was formed in March 2008. All significant intercompany transactions and balances have been eliminated.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Segment Information

The Company currently operates in one material business segment.  The entire business is comprehensively managed by a single management team that reports to the Chief Executive Officer.  The Company does not operate any material separate lines of business or separate business entities with respect to products or product candidates.  Accordingly, the Company does not have separately reportable segments as defined by Statement of Financial Accounting Standards No. 131, Disclosures about Segments of a Enterprise and Related Information.

Comprehensive Loss

The Company reports comprehensive loss in accordance with the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income.  Comprehensive loss includes all changes in equity for cumulative translation adjustments resulting from the consolidation of foreign subsidiaries as the financial statements of the subsidiary located outside of the United States are measured using the local currency as the functional currency. Assets and liabilities of these subsidiaries are translated at the rates of exchange at the balance sheet date. The resultant translation adjustments are included in accumulated other comprehensive income (loss), a separate component of stockholders’ equity. Comprehensive loss for each of the three month periods ended September 30, 2008 and 2007 was approximately $4.5 million and $0.2 million, respectively.  For the nine months ended September 30, 2008 and 2007, comprehensive loss was approximately $31.6 million and $7.2 million, respectively.

Cash and Cash Equivalents

Cash and cash equivalents, which consist of short-term money market accounts, are stated at cost, which approximates market value.  The Company considers all highly-liquid investments with maturities of three months or less when purchased to be cash equivalents.  Interest income resulting from cash and cash equivalents and short-term investments was $0.2 million and $0.3 million for the three months ended September 30, 2008 and 2007, respectively.  For the nine months ended September 30, 2008 and 2007, interest income resulting from cash and cash equivalents and short-term investments was $1.0 million and $0.4 million, respectively.

Restricted Cash and Letter of Credit

In connection with the March 20, 2008 Consent and First Loan Agreement with Silicon Valley Bank and Oxford Finance Corporation, the Company maintains a segregated account at the Lenders in the amount of at least one and one-quarter times the principal amount of its obligations outstanding to the Lenders.  As of September 30, 2008, the Company recorded $5.0 million and $2.5 million in short-term and long-term restricted cash, respectively, under this agreement.

As further disclosed in Note 3, the Company agreed to provide a letter of credit in the amount of $7.0 million as security for the deferred consideration related to the acquisition of assets related to the Avecia Acquisition.  This letter of credit will be payable upon the earlier to occur of the completion of a financing transaction in the amount of $15.0 million or more or eighteen months following the closing of the acquisition. As of September 30, 2008, the letter of credit is shown on the balance sheet as long-term restricted cash and is included in other long term liabilities as it is due to Avecia.

Short-Term Investments

Short-term investments consist of investment grade government agency and corporate debt securities due within one year. All investments are classified as available-for-sale and are recorded at market value. Unrealized gains and losses are reflected in other comprehensive income. The estimated fair value of the available-for-sale securities is determined based on quoted market prices or rates for similar instruments. Management reviews the Company’s investment portfolio on a regular basis and seeks guidance from its professional portfolio manager related to US and global market conditions. We assess the risk of impairment related to securities held in our investment portfolio on a regular basis and noted no impairment during the nine months ended September 30, 2008.  Additionally, the Company’s Audit Committee reviews the investment portfolio and strategy on an annual basis.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Accounts Receivable

From inception to date, substantially all of PharmAthene’s accounts receivable have been associated with US Government contracts and grants. Amounts invoiced or recorded as billed under these programs but not yet collected are reported as outstanding accounts receivable.

While the Company has a policy to provide an allowance for any amount of accounts receivable which it determines to be uncollectible and to write off any uncollectible account when the likelihood of collection is determined to be not probable, the Company has not historically found it necessary to record any write-offs of accounts receivable or to record an allowance for uncollectible accounts. At September 30, 2008, the Company’s accounts receivable balance included approximately $10.9 million, including unbilled receivables of approximately $5.8 million, related to U.S Government contracts.

Property and Equipment

Property and equipment consists of land, building and leasehold improvements, laboratory, computer, farm and office equipment and furniture and are recorded at cost. Leasehold improvements are amortized over the economic life of the asset or the lease term, whichever is shorter.  Property and equipment are depreciated using the straight-line method over the estimated useful lives of the respective assets as follows:

Intangible Assets

Intangible assets consist of patents and are being amortized using the straight-line method over an eleven year period.

Impairment of Long-Lived Assets

Long-lived assets consist primarily of patents and property and equipment.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. Recoverability measurement and estimating of undiscounted cash flows is done at the lowest possible level for which there is identifiable assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Revenue Recognition

The Company generates its revenue from two different types of contractual arrangements: cost-plus-fee contracts and cost reimbursable grants.  Revenues on cost-plus-fee contracts are recognized to the extent of costs incurred plus an estimate of the applicable fees earned.  The Company considers fixed fees under cost-plus-fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract. The Company analyzes each cost reimbursable grant to ensure reporting of revenues gross versus net is appropriate based on the guidance in the AICPA Federal Government Contractors Guide or the Financial Accounting Standards Board’s Emerging Issues Task Force Issue 99-19, Gross Versus Net, whichever is most appropriate.  For the three and nine months ended September 30, 2008, the Company recorded approximately $0.9 million and $1.7 million of costs reimbursed from the government as a reduction to research and development expense as they are viewed as reduction of research and development costs under the guidance.

The Company’s contracts may include the provisions of more than one of its services.  Collaborative research and development agreements can provide for one or more of up-front license fees, research payments, and milestone payments. In these situations, the Company recognizes revenue in accordance with the Financial Accounting Standards Board’s Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables.  Accordingly, for applicable arrangements, revenue recognition includes the proper identification of separate units of accounting and the allocation of revenue across all elements based on relative fair values, with proper consideration given to the guidance provided by other authoritative literature.

Revenues from the achievement of research and development milestones, if deemed substantive, are recognized as revenue when the milestones are achieved and the milestone payments are due and collectible. If not deemed substantive, the Company recognizes such milestone as revenue on a straight-line basis over the remaining expected term of continued involvement in the research and development process. Milestones are considered substantive if all of the following conditions are met: (1) the milestone is non-refundable; (2) achievement of the milestone was not reasonably assured at the inception of the arrangement; (3) substantive effort is involved to achieve the milestone; and (4) the amount of the milestone appears reasonable in relation to the effort expended, the other milestones in the arrangement and the related risk associated with the achievement of the milestone and any ongoing research and development or other services are priced at fair value. Payments received in advance of work performed are recorded as deferred revenue.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Research and Development and Purchased In-Process Research and Development

Research and development costs include salaries, facilities expense, overhead expenses, material and supplies, pre-clinical expense, clinical trials and related clinical manufacturing expenses, stock-based compensation expense, contract services and other outside services.  On January 1, 2008, the Company adopted the Financial Accounting Standards Board’s Emerging Issues Task Force Issue 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.  As of September 30, 2008, the Company has recorded $0.3 million in prepaid development costs relating to non-refundable advance payments.  All other costs are charged to expense, as incurred.

The Company accounts for purchased in-process research and development in accordance with the SFAS No. 2, Accounting for Research and Development Costs (“SFAS No. 2”) along with Financial Accounting Standards Board (“FASB”) Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method — an interpretation of FASB Statement No. 2 (“FIN 4”). Under these standards, the Company is required to determine whether the technology relating to a particular research and development project acquired through an acquisition has an alternative future use. If the determination is that the technology has no alternative future use, the acquisition amount assigned to assets to be used in the particular research and development project is expensed. If the technology is determined to have an alternative future use, the Company capitalizes and amortizes the costs incurred over the estimated useful lives of the technology acquired.

Share-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment (“SFAS No. 123R”) which establishes accounting for share-based awards exchanged for employee services and requires companies to expense the estimated fair value of these awards over the requisite employee service period. Under SFAS No. 123R, share-based compensation cost is determined at the grant date using an option pricing model. The value of the award that is ultimately expected to vest is recognized as expense on a straight line basis over the employee’s requisite service period.

The Company has estimated the fair value of each award using the Black-Scholes option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and that are freely transferable. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price.

Employee share-based compensation expense recognized in the three and nine months ended September 30, 2008 and 2007 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures at a rate of either 7 percent or-16.3 percent, based on the Company’s historical option forfeitures.  SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Share-based compensation expense recognized under SFAS No. 123R for the three and nine month periods ended September 30, 2008 and 2007, respectively, was:

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Basic and Diluted Net Loss Per Share

The Company applies Statement of Financial Accounting Standards No. 128, Earnings per Share, which establishes standards for computing and presenting earnings per share.  Basic net loss per share of common stock excludes dilution for potential common stock issuances and is computed by dividing net loss by the weighted-average number of shares outstanding for the period. Diluted net loss per share reflects the potential dilution that could occur if securities were exercised into common stock. However, for all periods presented, diluted net loss per share is the same as basic net loss attributable to common shareholders per share as the inclusion of weighted average shares of common stock issuable upon the exercise of stock options and warrants would be anti-dilutive. Securities outstanding in the amount of 16,229,900 shares for both the three and nine months ended September 30, 2008, respectively, and 15,168,000 for the three and nine months ended September 30, 2007, respectively, were excluded from the calculation of diluted net loss per share since their inclusion would be anti-dilutive.

The following table provides a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share:

Income Taxes

The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of the deferred tax asset will not be realized. In evaluating the need for a valuation allowance, the Company takes into account various factors, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of the Company’s valuation allowance, the Company records a change in valuation allowance through income tax expense in the period such determination is made.

The Company adopted the provisions of Financials Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an Interpretation of FASB Statement No. 109 (“FIN 48”) on January 1, 2007.  The Company has analyzed tax positions in all jurisdictions where it is required to file an income tax return and has concluded that it does not have any material unrecognized tax benefits.  As a result, there were no material effects on our financials position or results of operations due to the implementation of FIN 48.  As of September 30, 2008, the Company has recognized a valuation allowance to the full extent of its deferred tax assets since the likelihood of realization of the benefit cannot be determined.  The Company believes that any of its uncertain tax positions would not result in adjustments to its effective income tax rate because likely corresponding adjustments to deferred tax assets would be offset by adjustments to recorded valuation allowances. We file a US federal income tax return as well as returns for various state and foreign jurisdictions. The Company’s income taxes have not been subject to examination in any tax jurisdiction since its inception.  Accordingly, all income tax returns filed by the Company are subject to examination in the relevant taxing jurisdictions.

The Company policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of tax expense.  As of the date of adoption of FIN 48, we did not have interest or penalties accrued for any unrecognized tax benefits and there was no interest expense recognized during the current year.

Fair Value of Financial Instruments

The Company’s financial instruments include primarily cash and cash equivalents, accounts receivable, short-term investments and other current assets, accounts payable, accrued and other liabilities, notes payable and long-term debt. Due to the short-term nature of the cash and cash equivalents, accounts receivable, short-term investments and other current assets, accounts payable

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

and accrued and other liabilities, the carrying amounts of these assets and liabilities approximate their fair value. The fair value of the Company’s notes payable and long term debt approximates fair value, based on current incremental borrowing rates of the Company.

Concentration of Credit Risk

 Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents, short-term investments and accounts receivable. The Company maintains its cash, cash equivalent and short-term investment balances in the form of money market accounts, debt and equity securities and overnight deposits with financial institutions that management believes are creditworthy. All of the Company’s accounts receivables are from either the U.S., Canadian or United Kingdom governments.

Reclassifications

Certain prior period amounts in the consolidated financial statements have been reclassified to conform to the current period presentation.

Recent Accounting Pronouncements

In December 2007, the EITF reached a consensus on Issue No. 07-1, Accounting for Collaborative Arrangements. In EITF 07-1, the EITF defined a collaborative arrangement as a contractual agreement involving a joint operating activity between two (or more) parties, each of which is both (1) an active participant in the activity and (2) exposed to significant risks and rewards that are dependent on the joint activity’s commercial success. Additionally, EITF 07-1 provides information to be disclosed on an annual basis by each collaborative arrangement participant for every significant collaborative arrangement, including the nature of the arrangement, the participant’s rights and obligations under the arrangement, the accounting policy followed for collaborative arrangements, and the income statement classification and amounts arising from the collaborative arrangement. EITF 07-01 is effective for financial statements issued for fiscal years beginning after December 15, 2008. This consensus is to be applied retrospectively for all periods presented. We are evaluating the potential impact of this consensus and do not expect it to have a material effect on our financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of the adoption of SFAS 141R on its consolidated financial position and results of operations.

Note 3 – Avecia Acquisition and Goodwill

On April 2, 2008, the Company completed the Avecia Acquisition, acquiring substantially all of the assets and assuming the liabilities exclusively associated with Avecia’s biodefense vaccines business in accordance with the terms of the Purchase Agreement, as amended, including certain products, patents, trademarks, domain names and other intellectual property, license agreements, contracts, goodwill and other intangibles. The transaction was valued at approximately $18.6 million, consisting of the initial consideration of $10.0 million in cash, deferred consideration of approximately $7.0 million, secured by a letter of credit, and transaction costs of approximately $1.6 million. The Purchase Agreement also provides for potential milestone considerations totaling $23.0 million and royalties of 1%-2.5% of net sales depending on product sales within the period of ten years from the consummation of the Avecia Acquisition.

The assets acquired were accounted for in accordance with the provisions of Statement of Financials Accounting Standards No. 141, Business Combinations (“SFAS No. 141”). All of the tangible and intangible assets acquired and liabilities assumed of Avecia Vaccines were recorded at their estimated fair market values on the acquisition date. The preliminary purchase price was allocated as follows:

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

In connection with the transaction, the Company recorded, in the second quarter 2008, a charge of $15.9 million for acquired research projects associated with products in development for which, at the acquisition date, technological feasibility had not been established and, for accounting purposes, no alternative future use existed.  An additional charge of $0.2 million to acquired in-process research and development was recorded in the third quarter of 2008 as the Company revised its purchase price allocation.

Pro Forma Financial Information

The unaudited financial information in the table below summarizes the combined results of operations of PharmAthene and Avecia Vaccines on a pro forma basis (as if the companies had been combined as of the beginning of each of the periods presented). The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition and the reverse merger with Healthcare Acquisition Corp had taken place at the beginning of each of the periods presented. The pro forma financial information for all periods presented includes adjustments to interest expense, interest income and related tax effects.

The unaudited pro forma financial information for the nine months ended September 30, 2008 and 2007 combines the historical results for PharmAthene for the nine months ended September 30, 2008 and 2007 and the historical results for Avecia for the same periods. The unaudited pro forma financial information for the three months ended September 30, 2007 combines the historical results for PharmAthene for the three months ended September 30, 2007 and the historical results for Avecia for the same period. The unaudited financial information for the three months ended September 30, 2008 reflects the operations of the consolidated company post acquisition.

Note 4 – Fair Value Measurements

Effective January 1, 2008, the Company adopted Statement of Financials Accounting Standards No. 157, Fair Value Measurements, (“SFAS No. 157”) which defines fair value 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 at the measurement date. SFAS No. 157 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

· Level 1 — Quoted prices in active markets for identical assets or liabilities.

· Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

· 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. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The Company’s adoption of SFAS No. 157 did not have a material impact on its consolidated financial statements. The Company has segregated all financial assets and liabilities that are measured at fair value on a recurring basis (at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. FSP FAS 157-2 delayed the effective date for all nonfinancial assets and liabilities until January 1, 2009, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.

As of September 30, 2008, financial assets and liabilities subject to fair value measurements were as follows:

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

The Company recognized gains of approximately $115,000 and approximately $505,000 on available-for sale securities investments for the three and nine months ended September 30, 2008, respectively.

Note 5 - Property and Equipment

Property and equipment consisted of the following:

Depreciation expense for the three months ended September 30, 2008 and 2007 was $164,547 and $157,164, respectively. Depreciation expense for the nine months ended September 30, 2008 and 2007 was $505,898 and $394,938, respectively.

Note 6 - Patents

In conjunction with the Company’s purchase of the assets of Nexia Biotechnologies Ltd. in March 2005 (the “Nexia Acquisition”), the Company recorded intangible assets related to patents of $1,407,000 with a useful life of eleven years. The gross carrying value and accumulated amortization, adjusted based on current foreign currency rates, was $1,665,984 and $537,762, respectively, at September 30, 2008. The gross carrying value and accumulated amortization, adjusted based on current foreign currency rates, was $1,761,329 and $448,338, respectively, at December 31, 2007. For the three months ended September 30, 2008 and 2007, the Company has recorded amortization expense of $40,862 and $52,256, respectively. For the nine months ended September 30, 2008 and 2007, the Company has recorded amortization expense of $135,527 and $123,775, respectively. Amortization expense related to the above intellectual property is expected to be approximately $127,910 per year for the next five years.

Note 7 – Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities consisted of the following:

Accrued expenses consist primarily of research and development activities and legal and professional services.

Note 8 - Long Term Debt

Convertible 8% Notes

The Convertible Notes accrue interest at an interest rate of 8% per annum, except in the event of a default in which instance the interest rate will increase to 12%.  The principal amount of the Notes and any accrued interest are convertible into shares of PharmAthene common stock at the option of the holder at any time based upon a conversion rate of $10.00 per share. The Notes have a maturity date of August 3, 2009.  The Company recognized interest expense of approximately $431,100 and $1.2 million on the Notes for the three and nine months ended September 30, 2008. For the three months ended September 30, 2007, the Company recognized interest expense of $243,100.  The Company recognized interest expense of approximately $84,600 and $558,000 for the three and nine months ended September 30, 2007 related to Former PharmAthene’s Bridge Notes.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

$10 Million Debt Financing

On March 30, 2007, the Company entered into a $10 million credit facility with Silicon Valley Bank and Oxford Finance Corporation (together, the “Lenders”). Under the credit facility the Company borrowed $10 million, which bears interest at the rate of 11.5%. Pursuant to the terms of the loan and security agreement evidencing the credit facility, the Company made monthly payments of interest only through September 30, 2007 and, thereafter, makes monthly payments of principal and interest over the remaining 30 months of the loan. The loan is secured by a security interest on all of the Company’s assets other than certain intellectual property. The Company may prepay the debt provided it pays certain prepayment fees. In connection with the credit facility, the Company issued to Silicon Valley Bank and Oxford Financial Corporation warrants, which expire on March 30, 2017 to purchase an aggregate of 100,778 shares of common stock with an exercise price of $4.06 per share.

The loan agreement (“Loan Agreement”) contains customary affirmative and negative covenants which, among other things, restricts the Company’s ability to undertake certain acquisitions, incur certain indebtedness or make certain investments.  Due to the then-anticipated merger with Avecia Biologics Limited, PharmAthene sought to obtain the consent of the Lenders to the Avecia Acquisition and entered into a Consent and First Loan Modification Agreement, dated as of March 20, 2008, with the Lenders (the “Loan Modification Agreement”) pursuant to which, among other things, the Lenders consented to the Avecia Acquisition provided that (i) PharmAthene (or its UK subsidiary involved in the acquisition) is the surviving entity in the acquisition, (ii) the total initial cash consideration upon the consummation of the acquisition does not exceed $11 million, (iii) the consummation of the acquisition will not otherwise result in an event of default as defined under the Loan Agreement, after giving effect to the acquisition and (iv) within 20 days following the consummation of the acquisition, PharmAthene causes its UK subsidiary to become a co-borrower or a secured guarantor under the Loan Agreement.

The Loan Modification Agreement also amends the Loan Agreement to provide (i) that PharmAthene shall maintain, at all times, at a segregated account, at either Silicon Valley Bank or Silicon Valley Bank Securities, unrestricted and unencumbered cash or cash equivalents in the amount of at least one and one-quarter times the outstanding obligations of PharmAthene to the Lenders, (ii) that if PharmAthene or any of its affiliates creates or acquires any subsidiary, PharmAthene shall notify the Lenders and take all such action as to cause each domestic subsidiary to guarantee the obligations of PharmAthene under the Loan Agreement granting a continuing pledge and security interest in and to the assets of such subsidiary, (iii) that PharmAthene shall deliver to the Lenders a control agreement with M&T Bank granting the lenders a first perfected security interest in the accounts of PharmAthene held at M&T Bank and (iv) amending the definition of “material adverse change” under the Loan Agreement to provide that a material adverse change shall be a determination of the Lenders based upon information available to them and in their reasonable judgment that there is a reasonable likelihood that PharmAthene shall fail to comply with one or more of the financial covenants contained in the Loan Agreement.  As discussed in Note 2, the Company has recorded $5.0 million and $2.5 million in short-term and long-term restricted cash, respectively, in connection with provision (i) above.

The Company has recognized interest expense on this credit facility of approximately $203,500 and $693,700 for the three and nine months ended September 30, 2008.  The Company has recognized interest expense on this credit facility of approximately $294,700 and $592,500 for the three and nine months ended September 30, 2007.

Note 9 - Commitments and Contingencies

Leases

The Company leases offices in the United States under a 10 year office lease, which commenced on May 1, 2007. Additionally, with the Avecia Acquisition, the Company leases offices in the United Kingdom under a lease expiring in 2010. Remaining annual minimum payments are as follows:

For the three months ended September 30, 2008 and 2007, total rent expense under operating lease agreements was approximately $197,700 and $231,200, respectively.  Total rent expense under operating lease agreements was approximately $598,600 and $410,600 for the nine months ended September 30, 2008 and 2007, respectively.

During September 2008, the Company entered into an agreement to lease additional office space at its headquarters in Annapolis, MD commencing in the first half of 2009.  The Company has the option to terminate this lease before December 31, 2008 but would be required to pay termination fees of either approximately $140,000 or $373,000 depending on when the Company elects to terminate the lease.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

License Agreements

In January 2006, the Company licensed certain patent rights from a research company. The license agreement required a $50,000 up-front payment. Additionally, the agreement provides for a sublicense fee of 20% and milestone payments of $25,000 upon the granting of a US patent, $200,000 upon the initiation of certain studies or trials, and $250,000 upon BLA approval. Upon commercialization, the license agreement requires royalty payments equal to a specified percentage of future sales of products for both government procurement and commercial market sales subject to the license through the expiration of the licensed patents. No sublicense fee or milestone payments have been incurred for the nine months ended September 30, 2008 and 2007, respectively.

In August 2006, the Company entered into a research and licensing agreement allowing for the licensing of certain patent rights from a research company. The agreement includes research expense reimbursement payments and certain development milestone payments. Upon commercialization, the license agreement requires royalty payments equal to a specified percentage of future sales of products for both government procurement and commercial market sales subject to the license through the expiration of the licensed patents. No research expense reimbursement payments or milestone payments have been incurred for the nine months ended September 30, 2008 and 2007, respectively.

In connection with the Nexia Acquisition, the Company acquired a license agreement originally executed in September 2004 for the rights to certain technologies. This agreement included an option to license product processing technology necessary to perform development of Protexia® as required under the Company’s government contract with the Department of Defense. The Company executed a new licensing agreement with a development company on March 12, 2007 which results in a license to all technology provided under the original agreement including the necessary purification technology previously included in an option and access to additional information and technology deemed to be essential for development of Protexia® and performance under the Department of Defense contract. Under the new agreement, the Company must pay initial license fees totaling $700,000 and royalty payments based on net sales, with $100,000 due in the first year. These expenses are eligible for reimbursement by the US Government under the contract with the Department of Defense. During 2007, the Company expensed $100,000 related to this agreement.  During the third quarter of 2008, the Company expensed an additional $200,000 related to this agreement.

In connection with the Avecia Acquisition, the Company acquired license agreements with The Defence Science and Technology Laboratory of the United Kingdom Ministry of Defence (“DSTL”) originally executed May and December 2006 for the rights to certain technologies. These agreements allow for the licensing of certain patents and technology necessary to perform development of the rPA and rYP programs as required under the Company’s government contracts with the NIAID. Upon commercialization, the license agreements require that PharmAthene make royalty payments equal to a specified percentage of future sales of products for both government procurement and commercial markets. No payments on these licenses have been incurred.

Note 10– Medarex Collaboration

In November 2004, the Company and Medarex, Inc. (“Medarex”) entered into a collaboration agreement under which the companies are working to develop and commercialize MDX-1303 (known as Valortim®), a fully human monoclonal antibody targeting the Bacillus anthracis protective antigen. MDX-1303 was developed by Medarex using its UltiMAb Human Antibody Development System®, and this antibody is currently in clinical development by PharmAthene for use against human anthrax infection.

Under the terms of the agreement, Medarex and PharmAthene have agreed jointly to continue to investigate the potential for MDX-1303 to be used as a therapeutic for individuals with active disease as well as for prophylactic treatment of individuals exposed to anthrax. For the three months ended September 30, 2008 and 2007, PharmAthene recorded research and development expenses of approximately $103,000 and $106,600 related to the development activities for MDX-1303. Research and development expenses under this agreement of approximately $315,000 and $526,100 were recorded for the nine months ended September 30, 2008 and 2007, respectively. PharmAthene is fully responsible for funding all future research and development activities that are not supported by government funds. The companies will share future profits, if any, according to a pre-agreed allocation percentage.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Note 11– Stockholders’ Equity

2002 Long-Term Incentive Plan

In connection with the Merger, the Company assumed awards that were granted by Former PharmAthene under Former PharmAthene’s 2002 Long-Term Incentive Plan (the “2002 Plan”) which provided for the grant of incentive stock options, restricted common stock and stock appreciation rights.  Under the 2002 Plan, option awards were granted to eligible employees, officers, directors and consultants. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model based on selected inputs. The board of directors of Former PharmAthene established the vesting schedule for the awards. Grants made to new employees upon commencement of employment, typically provided for annual vesting of 25% of shares on the first anniversary date of hire. For annual grants to existing employees, grants typically provided for monthly vesting over four years. These options had a maximum term of no more than 10 years.  As of September 30, 2008, an aggregate of 400,876 shares of common stock are reserved for issuance upon the exercise of outstanding assumed awards.  The 2002 Plan was not assumed by the Company in connection with the Merger. No further grants are being made under the 2002 Plan.

The following tables summarize the activity of the 2002 Plan:

2007 Long-Term Incentive Plan

On August 3, 2007, our stockholders approved the 2007 Long Term Incentive Plan (the “2007 Plan”) which provides for the granting of incentive and non-qualified stock options, stock appreciation rights, performance units, restricted common awards and performance bonuses (collectively “awards”)  to our officers and employees. Additionally, the 2007 Plan authorizes the granting of non-qualified stock options and restricted stock awards to our directors and to any independent consultants.  At that time, the Company reserved 3,500,000 shares of common stock for distribution of awards under the 2007 Plan.  At the 2008 annual meeting held on June 13, 2008, the Company’s shareholders approved proposed amendments to the 2007 Plan, increasing from 3,500,000 shares to 4,600,000 shares the maximum number of shares subject to the plan and adding an evergreen provision pursuant to which the number of shares subject to the plan will increase automatically in each year, beginning in 2009 and continuing through 2015, according to certain limits set forth in the 2007 Plan. The Board of Directors in conjunction with management determines who receives awards, the vesting conditions which are generally four years, and the exercise price.  Options may have a maximum term of no more than ten years.

On August 30, 2007, the Board of Directors of the Company granted to the Company’s Chief Executive Officer options to purchase 780,000 shares of common stock pursuant to the 2007 Plan at an exercise price of $5.36 per share, determined as the closing price of the Company’s common stock on such date, and granted him 100,000 restricted shares of common stock.  The options have a term of ten years and both the options and restricted stock award vest over a five year period with 25% vesting on the first anniversary of the grant, and the remainder vesting monthly on a pro rata basis over the succeeding 48 months following the first anniversary.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

The following tables summarize the activity of the 2007 Plan as related to option awards:

The following tables summarize the activity of the 2007 Plan as related to restricted stock awards:

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Valuation assumptions used to determine fair value of share-based compensation

The fair value for the 2008 and 2007 awards were estimated at the date of grant using the Black-Scholes option-pricing model using the following assumptions:

The valuation assumptions were determined as follows:

·                  Weighted average volatility:  We determine the expected volatility by using an average historical volatility from comparable public companies with an expected term consistent with ours.

·                  Risk-free interest rate:  The yield on zero-coupon US Treasury securities for a period that is commensurate with the expected term of the award.

·                  Expected annual dividend yield:  The estimate for annual dividends is zero because we have not historically paid a dividend and do not intend to do so in the foreseeable future.

·                  Expected life:  The expected term of the awards represents the period of time that the awards are expected to be outstanding.  We use historical data and expectations for the future to estimate employee exercise and post-vest termination behavior and do not stratify employees into multiple groups.

Unit Purchase Option

In connection with the initial public offering, the underwriters paid $100 for an option to purchase up to a total of 225,000 units.  The units issuable upon exercise of this option are identical to those offered in the initial public offering (i.e. each unit consists of one share of common stock and one warrant) except that the associated warrants have a different exercise price as further discussed in the warrant section below.  This option became exercisable at $10.00 per unit on August 3, 2007, and expires on July 28, 2010.  The exercise price and number of units issuable upon the exercise of the option may be adjusted in certain circumstances including in the event of a stock dividend, or recapitalization, reorganization, merger or consolidation.

Under an amendment to the unit purchase option agreement, the Company is not obligated to pay cash or other consideration to the holders of the unit purchase option or “net-cash settle” the obligation of HAQ under the unit purchase option.

Warrants

In connection HAQ’s initial public offering in 2005, HAQ sold 9.4 million warrants to acquire shares of common stock at an exercise price of $6.00  Each warrant entitles the holder to purchase from the Company one share of common stock and expires four years from the effective date of the offerings on July 28, 2009.  Furthermore, in connection with the initial public offering, HAQ issued to the representative of the underwriters an option to purchase up to a total of 225,000 units (as discussed above).  Underlying the units are 225,000 shares of common stock and 225,000 warrants to acquire shares of common stock at an exercise price of $7.50 per share.

Pursuant to the credit facility further discussed in Note 8, the Company issued 100,778 common stock warrants with an exercise price of $4.06 per share.

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PHARMATHENE, INC.

Notes to Consolidated Financial Statements

September 30, 2008

(unaudited)

Note 12 – Subsequent Events

On September 30, 2008 PharmAthene signed a securities purchase agreement with Kelisia Holdings Ltd., an indirect wholly-owned subsidiary of Panacea Biotec Limited, pursuant to which Kelisia acquired 3,733,334 shares of PharmAthene common stock at a negotiated price of $3.50 per share and a 12-month warrant to purchase up to 2,745,098 additional shares of PharmAthene common stock at an exercise price of $5.10 per share.  The Company received gross proceeds from this transaction, which closed on October 10, 2008, of approximately $13.1 million.

Upon the closing of the transaction, Panacea Biotec, through its subsidiary Kelisia, owns approximately 14.5% of PharmAthene’s issued and outstanding common stock.  While the warrant gives Kelisia the right to purchase up to an additional 2,745,098 shares, this right is subject to a stock ownership cap, following any warrant exercise, of 19.99% of PharmAthene’s issued and outstanding common stock as of such exercise date.

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  This information may involve known and unknown risks, uncertainties and other factors that are difficult to predict and may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements.  These risks, uncertainties and other factors include, but are not limited to, risk associated with the reliability of the results of the studies relating to human safety and possible adverse effects resulting from the administration of the Company’s product candidates, unexpected funding delays and/or reductions or elimination of U.S. government funding for one or more of the Company’s development programs, including without limitation our bid related to SparVax™ under the DHHS Request for Proposals for an Anthrax Recombinant Protective Antigen (rPA) Vaccine for the Strategic National Stockpile, the award of government contracts to our competitors, unforeseen safety issues, challenges related to the development, scale-up, and/or process validation of manufacturing processes for our product candidates, unexpected  determinations that these product candidates prove not to be effective and/or capable of being marketed as products, as well as risks detailed from time to time in PharmAthene’s Forms 10-K and 10-Q under the caption “Risk Factors” and in its other reports filed with the U.S. Securities and Exchange Commission (the “SEC”). Forward-looking statements describe management’s current expectations regarding our future plans, strategies and objectives and are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,”  “project,” “potential” or “plan”  or the negative of these words or other variations on these words or comparable terminology.  Such statements include, but are not limited to, statements about potential future government contract or grant awards, potential payments under government contracts or grants, potential regulatory approvals, future product advancements, anticipated financial or operational results and expected benefits from our acquisition of the biodefense vaccines business (“Avecia Acquisition”) from Avecia Biologics Limited and certain of its affiliates (“Avecia”).  Forward-looking statements are based on assumptions that may be incorrect, and we cannot assure you that the projections included in the forward-looking statements will come to pass.

We have based the forward-looking statements included in this Quarterly Report on Form 10-Q on information available to us on the date of this Quarterly Report, and we assume no obligation to update any such forward-looking statements.  Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we, in the future, may file with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

Unless specifically noted otherwise, as used throughout this Quarterly Report on Form 10-Q, “the Company”, “PharmAthene”, “we”, “us” or “our” refers to the business of the combined company after the merger with Former PharmAthene (the “Merger”) and to the business of Former PharmAthene prior to the Merger, and “HAQ” refers to the business of Healthcare Acquisition Corp. prior to the Merger.

The following discussion should be read in conjunction with the consolidated financial statements for the Company which present PharmAthene’s results of operations for the three and nine month periods ended September 30, 2008 and 2007 as well as its financial positions at September 30, 2008 and December 31, 2007, contained elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2007 filed on March 31, 2008, including the consolidated financial statements contained therein, and the Form 8-K/A filed on June 19, 2008 presenting the period historical financial statements for the vaccines business acquired from Avecia Biologics.

Overview

PharmAthene is a biodefense company engaged in the development and commercialization of medical countermeasures against biological and chemical weapons. In addition to our own efforts, we collaborate with pharmaceutical companies to support clinical development of product candidates.  We currently have five product candidates in various stages of development:

·                  SparVax™ - a second generation recombinant protective antigen (“rPA”) anthrax vaccine,

·                  Valortim®, a fully human monoclonal antibody (an identical population of highly specific antibodies produced from a single clone) for the prevention and treatment of anthrax infection,

·                  Protexia®, which mimics a natural bioscavenger for the treatment or prevention of nerve agent poisoning by organophosphate compounds, including nerve gases and pesticides,

·                  RypVax™ - a recombinant dual antigen vaccine for pneumonic and bubonic plague (“rYP”), and

·                  a third generation rPA anthrax vaccine.

Our lead product candidate, SparVax™, is a second generation recombinant (produced using genetic engineering technology) version of Protective Antigen for use against human anthrax infection.  It is intended to be used to protect individuals before and potentially after exposure to the Bacillus anthracis (the anthrax bacterium).  Phase I and Phase II clinical trials involving over 700 healthy adult human subjects have been completed with the clinical trials showing that SparVax™ is safe, well tolerated and induces

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an immune response in humans.  Earlier preclinical studies have demonstrated that SparVax™ can protect non-human primates against a lethal aerosol challenge of Ames strain anthrax spores.

On February 29, 2008, the U.S. Department of Health and Human Services issued a formal Request for Proposal (RFP-BARDA-08015) for an “Anthrax Recombinant Protective Antigen (rPA) Vaccine for the Strategic National Stockpile”, which includes a requisition for 25 million doses of an rPA anthrax vaccine.  We submitted a response to this solicitation on July 31, 2008.

Valortim®, our second most advanced product candidate, is a fully human monoclonal antibody designed to protect against and treat human inhalation anthrax, the most lethal form of infection caused by the Bacillus anthracis bacterium. The Company is co-developing Valortim® with Medarex, Inc., a biopharmaceutical company that specializes in developing fully human antibody-based therapeutic products, and will share with Medarex any profits derived from sales of Valortim®.  Preclinical studies in animal models have demonstrated Valortim® to be effective as both a prophylaxis and a therapeutic for inhalation anthrax infection. The Company and Medarex have completed dosing of healthy volunteers in a Phase I open-label, dose-escalation clinical trial to evaluate the safety, tolerability, immunogenicity (eliciting an undesired immune response), and pharmacokinetics (the study of absorption, metabolism and action of drugs) of a single dose of Valortim® administered intravenously or intramuscularly. No drug-related serious adverse events were reported. Final results from the Phase I trial were presented at the Infectious Disease Society of America meeting in October 2006. Valortim® was granted Fast Track Status by the U.S. Food and Drug Administration (the “FDA”), which may permit the Company to submit portions of a Biologics License Application (“BLA”) or efficacy supplement before the complete BLA is submitted. Fast Track Status can expedite the review process depending upon whether the FDA has sufficient resources to review the portions submitted. In addition, the FDA granted Valortim® orphan drug status for the treatment of inhalation anthrax. On September 28, 2007, the NIAID and the Biomedical Advanced Research and Development Authority (“BARDA”) awarded to PharmAthene a $13.9 million contract for the advanced development of Valortim® as an anti-toxin therapeutic to treat inhalation anthrax infection, of which $0.7 million have been received through September 30, 2008. The contract will continue to be funded in installments through fiscal year 2009.

Protexia®, our nerve agent countermeasure, is a recombinant form of human butyrylcholinesterase, a naturally occurring enzyme (“BChE”), for use in the prophylaxis and treatment of organophosphate chemical nerve agent poisoning. Preclinical studies in animal models suggest that Protexia® may be effective prophylactically and therapeutically for chemical nerve agent poisoning.  We filed an Investigational New Drug application, or IND, with the FDA in the third quarter of 2008 and began a Phase I clinical trial in humans in October 2008.

The procurement process for the scale-up development and sale of Protexia® is already underway with the U.S. Department of Defense (the “DoD”), the department charged with purchasing biodefense countermeasures for military use. The DoD requested competitive bids in a Request for Proposal for a recombinant form of BChE drug for the prophylaxis treatment of chemical nerve agent poisoning, which we submitted in November 2005.  In September 2006, the Company was awarded a multi-year contract by the DoD.  The contract provides an initial $41 million for the advanced development of Protexia® through March 2009 and, thereafter, the U.S. Government, at its sole discretion, may elect to continue development assistance with further funding of $65 million. Assuming development milestones are met and contract extensions are exercised by the U.S. Government, at its sole discretion, and that the U.S. Government elects to procure an initial 90,000 doses of Protexia® from PharmAthene, we could receive up to $219 million in total funding under this contract (including the $41 million and $65 million disclosed above for advanced development), of which $31.5 million has been received through September 30, 2008.

RypVax™ is a recombinant dual antigen plague vaccine intended to be used to protect individuals before exposure to Yersinia pestis (the bacterium that causes plague).  In the war fighter, vaccination is anticipated to take place before deployment, to be administered in two or three doses over several weeks, and to be sufficient to induce protective immunity.  This vaccine candidate has successfully completed three Phase I clinical trials in healthy adult human subjects.  The Phase I trials demonstrated that RypVax™ is safe, well tolerated and elicits an immune response. In preclinical animal models, RypVax™ demonstrated the ability to fully protect against a lethal aerosol challenge.

In 2004, Avecia Vaccines was awarded a multi-year contract, valued at up to approximately $50 million, from the NIAID to support the advanced development of the plague vaccine for military use. PharmAthene acquired this contract as part of the Avecia Acquisition.  As of September 30, 2008, $33.3 million has been received by Avecia Vaccines and PharmAthene under this contract. Future government funding for RypVax™ beyond our existing contract (which expires in the first half of 2010) remains uncertain at this time.

The main objective for our third generation rPA anthrax vaccine is to meet the U.S. government’s longer term primary goal to obtain an rPA-based anthrax vaccine that can be stored, transported and used without the need for a conventional “cold chain” — an important advantage for civilian biodefense deployment within the U.S. Strategic National Stockpile (“SNS”).  In particular, we

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intend to produce a vaccine that can maintain stability for three years at 35º C and induce protective immunity in two or fewer doses.  By way of comparison, the currently available first generation anthrax vaccine (BioThrax® Anthrax Vaccine Adsorbed), which was initially licensed by the FDA in 1970, requires six doses over a period of eighteen months to achieve protective immunity and is required to be stored at between 2º and 8º C.

Two grants from the NIH made in 2005 and 2007 in the aggregate amount of $6.9 million for funding of research activities through April 2009 have supported the development of our third generation anthrax vaccine candidate.  On September 25, 2008, we were awarded a contract by the National Institutes of Health, National Institute of Allergy and Infectious Diseases (“NIAID”) for additional development work on our third generation rPA anthrax vaccine.  We expect to receive funding of up to approximately $13.2 million during the initial three year base period of the contract.  Assuming all development milestones are met and all contract extensions are exercised by NIAID at its sole discretion, PharmAthene could receive up to approximately $83.9 million over a nine year period (including the base period) under this contract, which includes a cost reimbursement component and a fixed fee component payable upon achievement of certain milestone events.

For the next several years, we believe our main customer will be national governments, primarily the U.S. Government.  Currently, the U.S. Government may, at its discretion, purchase critical biodefense products for the U.S. Strategic National Stockpile prior to FDA approval based on Emergency Use Authorization enabled under the Project Bioshield legislation.  On an ongoing basis we monitor notices for requests for proposal, grants and other potential sources of government funding that could potentially support the development and commercialization of our product candidates.  Nevertheless, changes in government budgets, priorities and agendas as well as political pressures could result in a reduction in overall government financial support for the biodefense sector in general and/or specifically the product candidates we are developing.  Our existing contracts with the government typically contain provisions that permit the government unilaterally to cancel or reduce the scope of these contracts. (For further information, see “Risk Factors — Risks Related to Our Business — U.S. government agencies have special contracting requirements which give them the ability to unilaterally control our contracts.”) As a result, further development of our product candidates and ultimate product sales to the government could be delayed or stopped altogether.

Recent Events

Strategic Financing with Panacea Biotec Subsidiary

On September 30, 2008 we signed a securities purchase agreement with Kelisia Holdings Ltd., an wholly-owned subsidiary of Panacea Biotec Limited, pursuant to which Kelisia acquired approximately 3.73 million shares of PharmAthene common stock at a negotiated price of $3.50 per share and a 12-month warrant to purchase up to approximately 2.75 million additional shares of PharmAthene common stock at an exercise price of $5.10 per share.  We received gross proceeds from this transaction, which closed on October 10, 2008, of approximately $13.1 million.

Upon the closing of the transaction, Panacea Biotec, through its subsidiary Kelisia, owned approximately 14.5% of PharmAthene’s issued and outstanding common stock.  While the warrant gives Kelisia the right to purchase up to an additional 2,745,098 shares, this right is subject to a stock ownership cap, following any warrant exercise, of 19.99% of PharmAthene’s issued and outstanding common stock as of such exercise date.

  PharmAthene and Kelisia also entered into an investor rights agreement in connection with the strategic financing, which provides Kelisia with registration rights in connection with the shares issued at closing and issuable upon exercise of the warrant.  In addition, the investor rights agreement grants rights to Kelisia to maintain its ownership percentage by purchasing shares of all common stock,

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preferred stock or securities convertible or exchangeable into common stock that we issue in private placements within three years of the closing (except issuances in connection with M&A transactions, employee benefit plans, commercial financing transactions, strategic alliances and in certain other circumstances).  Furthermore, for a three year period following the closing, Kelisia, Panacea Biotec and their affiliates are prohibited from purchasing, offering to purchase, entering into any agreement relating to the purchase of, or otherwise engaging in any transaction relating to, any of our securities.  Kelisia and its affiliates are also subject to certain restrictions on transferring the warrant, the shares issued at closing and issuable upon exercise of the warrant, and any rights in the warrant or such shares.

In a related agreement, (i) Panacea Biotec has agreed, among other things, to continue to have at least a majority ownership of Kelisia while Kelisia owns at least 500,000 of our shares, and (ii) both Panacea Biotec and PharmAthene have agreed to engage in discussions from time to time relating to, among other things, the manufacture and/or process development by Panacea Biotec of a portion of our proprietary biodefense medical countermeasures under development and Panacea Biotec has granted us a right of first negotiation with respect to the possible commercialization and marketing of certain of Panacea Biotec’s products.

Results of Operations

Revenue

The Company recognized revenues of $10.7 million and $3.4 million during the three months ended September 30, 2008 and 2007, respectively.  For the nine months ended September 30, 2008 and 2007, the Company recognized revenues of $27.4 million and $8.7 million, respectively. These revenues consisted primarily of contract funding from the U.S. Government for the development of Protexia®, SparVax™ and RypVax™.  As a result of the Avecia Acquisition in the second quarter of 2008, and particularly the acquired U.S. Government contracts supporting the development of the SparVax™, third generation rPA and RypVax™ product candidates, revenues for the three and nine month periods ended September 30, 2008 were further boosted by $5.5 million and $8.9 million, respectively.

During the three and nine months ended September 30, 2008 and 2007, PharmAthene recognized revenues related to U.S. Government awarded contracts and grants as follows:

·                  Under the Company’s September 2006 contract for the advanced development of Protexia®, the Company recognized $4.9 million and $3.4 million of revenue for the three months ended September 30, 2008 and 2007, respectively. For the nine months ended September 30, 2008 and 2007, revenue recognized under this contract was $17.6 million and $8.6 million, respectively.

·                  Under the September 2007 contract for the advanced development of Valortim®, the Company recognized $0.5 million and $1.0 million of revenue in the three and nine months ended September 30, 2008, respectively. No amounts were recognized during the corresponding periods in 2007.

·                  Under our contract for the development of SparVax™, which the Company acquired as part of the Avecia Acquisition, the Company recognized approximately $3.8 million and $6.0 million of revenue for the three and nine months ended September 30, 2008, respectively. Revenue for the three months ended September 30, 2008 includes approximately $0.6 million of revenue relating to research conducted during the quarter ended June 30, 2008 for the anthrax program.  The associated costs for this research were accrued during the quarter ended June 30, 2008.

·                  Under the contract for the advanced development of a plague vaccine RypVax™, which the Company acquired as part of the Avecia Acquisition, the Company recognized approximately $1.6 million and $2.9 million of revenue for the three and nine months ended September 30, 2008, respectively. Revenue for the three months ended September 30, 2008 includes approximately $0.2 million of revenue relating to research conducted during the quarter ended June 30, 2008 for the plague program.  The associated costs for this research were accrued during the quarter ended June 30, 2008.

Research and Development Expenses

The Company’s research and development expenses were $9.4 million and $3.6 million for the three months ended September 30, 2008 and 2007, respectively. For the nine months ended September 30, 2008 and 2007, expenses related to research and development activities were $26.5 million and $10.7 million, respectively.  These expenses resulted from research and development activities related to programs for Valortim® and for Protexia®, as well as expenses related to the SparVax™ and RypVax™ programs which

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were acquired in the second quarter of 2008. These research and development expenses are primarily funded through US Government contracts and grant awards.  The Company incurred both direct expenses, which included salaries and other costs of personnel, raw materials and supplies, and indirect expenses. We also incurred third-party costs, such as contract research, consulting and clinical development costs for individual projects.

Research and development expenses for the three months ended September 30, 2008 and 2007, respectively, were attributable to research programs as follows:

Research and development expenses for the nine months ended September 30, 2008 and 2007, respectively, were attributable to research programs as follows: