Emergent BioSolutions 10Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from___ to____

Commission file number: 001-33137

EMERGENT BIOSOLUTIONS INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		14-1902018
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

2273 Research Boulevard, Suite 400

Rockville, Maryland

20850

(Address of Principal Executive Offices)

(Zip Code)

(301) 795-1800

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X ] Yes o No

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

o Large Accelerated Filer

o Accelerated Filer

[ X ] Non-Accelerated Filer

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

As of April 30, 2007, the registrant had 28,172,392 shares of common stock outstanding.

Emergent BioSolutions Inc.

Index to Form 10-Q

Page

Part I.

Financial Information

Item 1.

Financial Statements

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial

Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures About

Market Risk

Item 4.

Controls and Procedures

Part II.

Other Information

Item 1.

Legal Proceedings

Item 1A.

Risk Factors

Item 2.

Unregistered Sales of Equity Securities

and Use of Proceeds

Item 3.

Defaults Upon Senior Securities

Item 4.

Submission of Matters to a Vote of

Security Holders

Item 5.

Other Information

Item 6.

Exhibits

Signatures

Exhibit Index

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

• our performance under existing sales contracts with the U.S. government for BioThrax (“BioThrax”) (Anthrax Vaccine Adsorbed), our FDA-approved anthrax vaccine, including the timing of deliveries under these contracts;

• our ability to obtain new BioThrax sales contracts with the U.S. government;

• our plans for future sales of BioThrax;

• our plans to pursue label expansions and improvements for BioThrax;

• our plans to expand our manufacturing facilities and capabilities;

• the rate and degree of market acceptance and clinical utility of our products;

• our ongoing and planned development programs, preclinical studies and clinical trials;

• our ability to identify and acquire or in-license products and product candidates that satisfy our selection criteria;

• the potential benefits of our existing collaboration agreements and our ability to enter into selective additional collaboration arrangements;

• the timing of and our ability to obtain and maintain regulatory approvals for our product candidates;

• our commercialization, marketing and manufacturing capabilities and strategy;

• our intellectual property portfolio; and

• our estimates regarding expenses, future revenues, capital requirements and needs for additional financing.

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

You should read this quarterly report, including the documents that we have incorporated by reference herein and filed as exhibits hereto, completely and with the understanding that our actual future results may be materially different from what we expect. We do not assume any obligation to update any forward-looking statements.

PART

FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

Emergent BioSolutions Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share and per share data)

		December 31,		March 31,
		2006		2007
				(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	76,418	$	67,645
Accounts receivable		43,331		3,935
Inventories		24,721		26,885
Income taxes receivable		869		3,255
Deferred tax assets		295		-
Prepaid expenses and other current assets		1,703		1,970
Total current assets		147,337		103,690

Property, plant and equipment, net		78,174		87,836
Deferred tax assets, net of current		11,477		11,074
Other assets		1,267		1,293

Total assets	$	238,255	$	203,893

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	27,366	$	19,003
Accrued expenses and other current liabilities		3,253		2,907
Accrued compensation		7,190		4,723
Indebtedness under lines of credit		8,930		-
Long-term indebtedness, current portion		2,456		2,638
Notes payable to employees		17		-
Income taxes payable		13,703		-
Deferred tax liability		-		104
Deferred revenue, current portion		1,432		1,090
Total current liabilities		64,347		30,465

Long-term indebtedness, net of current portion		31,368	��	30,746
Deferred revenue, net of current portion		2,997		2,859
Other liabilities		1,071		1,802
Total liabilities		99,783		65,872

Commitments and contingencies		-		-

Stockholders’ equity:
Preferred Stock $0.001 par value; 15,000,000 shares authorized, 0 shares issued and outstanding at December 31, 2006 and March 31, 2007		-		-
Common Stock, $0.001 par value; 100,000,000 shares authorized, 27,596,249 and 28,038,348 shares issued and outstanding at December 31, 2006 and March 31, 2007, respectively		28		28
Additional paid-in capital		90,920		93,936
Accumulated other comprehensive loss		(473)		(643)
Retained earnings		47,997		44,700
Total stockholders’ equity		138,472		138,021
Total liabilities and stockholders’ equity	$	238,255	$	203,893

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

Emergent BioSolutions Inc. and Subsidiaries
Consolidated Statements of Operations
(in thousands, except share and per share data)

	Three Months Ended
	March 31,
		2006		2007
	(Unaudited)
Revenues:
Product sales	$	12,196	$	25,446
Contracts and grants		27		1,002
Total revenues		12,223		26,448

Operating expense:
Cost of product sales		2,861		5,516
Research and development		8,995		15,570
Selling, general and administrative		9,765		11,193
Loss from operations		(9,398)		(5,831)

Other income (expense):
Interest income		203		874
Interest expense		(170)		(26)
Other income (expense), net		7		177
Total other income (expense)		40		1,025

Loss before benefit from income taxes		(9,358)		(4,806)
Benefit from income taxes		(4,722)		(2,116)
Net loss	$	(4,636)	$	(2,690)

Earnings (loss) per share - basic	$	(0.21)	$	(0.10)
Earnings (loss) per share - diluted	$	(0.21)	$	(0.10)

Weighted-average number of shares - basic		22,348,893		27,864,328
Weighted-average number of shares - diluted		22,348,893		27,864,328

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

Emergent BioSolutions Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
	Three Months Ended
	March 31,
		2006		2007
	(Unaudited)
Cash flows from operating activities:
Net loss	$	(4,636)	$	(2,690)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Stock-based compensation expense		96		529
Depreciation and amortization		968		1,198
Deferred income taxes		635		2,400
Loss on disposal of property and equipment		4		-
Changes in operating assets and liabilities:
Accounts receivable		59		39,396
Inventories		(4,661)		(2,163)
Income taxes		(6,615)		(17,686)
Prepaid expenses and other assets		(1,404)		(292)
Accounts payable		(2,294)		(2,735)
Accrued compensation		(472)		(2,467)
Accrued expenses and other liabilities		137		(223)
Deferred revenue		-		(481)
Net cash provided by (used in) operating activities		(18,183)		14,786
Cash flows from investing activities:
Purchases of property, plant and equipment		(2,853)		(16,490)
Net cash used in investing activities		(2,853)		(16,490)
Cash flows from financing activities:
Issuance of common stock subject to exercise of stock options		2		890
Redemption of Class B common stock		(200)		-
Principal payments on long term indebtedness, notes payable to employees, and lines of credits		(192)		(9,386)
Proceeds from excess tax benefits		-		1,597
Net cash used in financing activities		(390)		(6,899)

Effect of exchange rate changes on cash and cash equivalents		(94)		(170)

Net decrease in cash and cash equivalents		(21,520)		(8,773)
Cash and cash equivalents at beginning of period		36,294		76,418
Cash and cash equivalents at end of period	$	14,774	$	67,645

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	148	$	644
Cash paid during the period for income taxes	$	1,200	$	12,500
Supplemental information on non-cash investing and financing activities:
Purchases of property, plant and equipment unpaid at period end	$	11,140	$	5,511

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

EMERGENT BIOSOLUTIONS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(dollars in thousands, except per share data)

1.	Summary of significant accounting policies

Basis of presentation and consolidation

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

The unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission.

In the opinion of the Company’s management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, necessary to present fairly the financial position as of March 31, 2007, results of operations for the three month periods ended March 31, 2006 and 2007, and cash flows for the three month periods ended March 31, 2006 and 2007. Interim results are not necessarily indicative of results for the entire year.

Significant customers and accounts receivable

The Company’s primary customers are the U.S. Department of Defense (the “DoD”) and the U.S. Department of Health and Human Services (“HHS”). For the three months ended March 31, 2006 and 2007, sales of BioThrax to the DoD and HHS comprised 95% and 96% of total revenues, respectively. As of March 31, 2007, 98% of the Company’s receivable balance was comprised of amounts due from these customers. Unbilled accounts receivable, included in accounts receivable, totaling $1,690 and $172 as of March 31, 2006 and 2007, respectively, relate to various service contracts for which product has been delivered or work has been performed, though invoicing has not yet occurred. Accounts receivable are stated at invoice amounts and consist primarily of amounts due from the DoD and HHS as well as amounts due under reimbursement contracts with other government entities and non-government and philanthropic organizations.

Capitalized interest

The Company capitalizes interest expense based on the cost of major ongoing capital projects which have not yet been placed in service. For the three months ended March 31, 2006 and 2007, the Company capitalized $0 and $677 of interest, respectively.

Earnings per share

Basic net income per share of common stock excludes dilution for potential common stock issuances and is computed by dividing net income by the weighted average number of shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the three months ended March 31, 2006 and 2007, diluted net loss per share is equal to basic net loss per share, as the inclusion of outstanding stock options would be anti-dilutive.

Accounting for stock-based compensation

As of March 31, 2007, the Company has two stock-based employee compensation plans, the Emergent BioSolutions Inc. 2006 Stock Incentive Plan (the “2006 Plan”) and the Emergent BioSolutions Employee Stock Option Plan (the “2004 Plan”) (together, the “Emergent Plans”), described more fully in Note 4 — Stockholders’ Equity.

The Company accounts for equity instruments issued to non-employees in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation(“SFAS No. 123”) and Emerging Issues Task Force (“EITF”) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services, (“EITF No. 96-18”).

Effective January 1, 2006, the Company adopted the fair value provisions of SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), using the modified prospective method. Under the fair value recognition provisions of SFAS No. 123(R), the Company recognizes stock-based compensation net of an estimated forfeiture rate. Under the modified prospective method, compensation cost recognized in 2006 and 2007 includes: (1) compensation cost for all share-based payments granted prior to but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (2) compensation cost for all share-based payments granted and vested subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).

Based on options granted to employees as of March 31, 2007, total compensation expense not yet recognized related to unvested options is approximately $3,135, after tax. The Company expects to recognize that expense over a weighted average period of 3.0 years.

The Company has utilized the Black-Scholes valuation model for estimating the fair value of all stock options granted. The fair value of each option is estimated on the date of grant. Set forth below are the weighted-average assumptions used in valuing the stock options granted and a discussion of the Company’s methodology for developing each of the assumptions used (no options were granted during the three months ended March 31, 2006):

	Three Months ended
	March 31, 2007
Expected dividend yield	0%
Expected volatility	50%
Risk-free interest rate	4.5%-4.8%
Expected average life of options	2.9 years

•

Expected dividend yield — The Company does not pay regular dividends on its common stock and does not anticipate paying any dividends in the foreseeable future;

•

Expected volatility — Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company analyzed the expected volatility used by similar companies at a similar stage of development to estimate expected volatility. The volatility used by these similar companies ranged from 33% to 79%, with an average estimated volatility of 53%;

•

Risk-free interest rate — This is the range of U.S. Treasury rates with a term that most closely resembles the expected life of the option as of the date the option was granted; and

•

Expected average life of options — This is the period of time that the options granted are expected to remain outstanding. This estimate is based primarily on the employee position profile of option holders and the trading lock out periods that result from employee access to stock price sensitive information.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the statement of cash flows. SFAS No. 123(R) requires the cash flows resulting from the tax benefits of deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

Comprehensive income (loss)

SFAS No. 130, Reporting Comprehensive Income (“SFAS No. 130”), requires the presentation of the comprehensive income (loss) and its components as part of the financial statements. Comprehensive income (loss) is comprised of net income and other changes in equity that are excluded from net income. The Company includes gains and losses on inter-company transactions with foreign subsidiaries that are considered to be long-term investments and translation gains and losses incurred when converting its subsidiaries’ financial statements from their functional currency to the U.S. dollar in accumulated other comprehensive income (loss). Comprehensive loss for the three months ended March 31, 2006 and 2007 was $4,730 and $2,860, respectively.

Reclassifications

Certain prior period balances have been reclassified to conform to current period presentation.

Recent accounting pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective for fiscal years beginning after November 15, 2007. The Company has not yet determined the impact of adoption of this statement on its financial statements.

2. Inventories

Inventories consist of the following:

		December 31,		March 31,
		2006		2007
Raw materials and supplies	$	2,133	$	2,222
Work-in-process		22,239		22,758
Finished goods		349		1,905
Total inventories	$	24,721	$	26,885

3. Property, plant and equipment

Property, plant and equipment consist of the following:

		December 31,		March 31,
		2006		2007
Land and improvements	$	5,173	$	5,173
Buildings and leasehold improvements		25,074		25,081
Furniture and equipment		15,401		15,464
Software		4,499		4,554
Construction-in-progress		41,563		52,145
		91,710		102,417
Less: Accumulated depreciation and amortization		(13,536)		(14,581)
Total property, plant and equipment, net	$	78,174	$	87,836

4. Stockholders’ equity

Preferred stock

The Company is authorized to issue up to 15,000,000 shares of preferred stock, $0.001 par value per share (“Preferred Stock”). Any Preferred Stock issued may have dividend rates, voting rights, conversion privileges, redemption characteristics, and sinking fund requirements as approved by the Company’s board of directors. As of March 31, 2007, no Preferred Stock has been issued.

Common stock

The Company currently has one class of common stock, $0.001 par value per share (“Common Stock”), authorized and outstanding. The Company is authorized to issue up to 100,000,000 shares of the Common Stock. Holders of Common Stock are entitled to one vote for each share of Common Stock held on all matters as may be provided by law.

On September 20, 2006, the Company’s board of directors recommended to the stockholders of the Company an amendment of the Company’s amended and restated certificate of incorporation, which the stockholders approved on October 27, 2006, that, among other things, reclassified the Company’s previously outstanding class A common stock, $0.01 par value per share, as Common Stock, increased the number of authorized shares of Common Stock to 100,000,000 shares and adjusted the par value of the Preferred Stock from $0.01 par value per share to $0.001 par value per share. The amendment became effective on October 27, 2006. On September 20, 2006, the Company’s board of directors also authorized the pricing committee of the board of directors to effect a stock split of the Common Stock, in the form of a dividend of shares of Common Stock, and the Company’s previously outstanding class B common stock, $0.01 par value per share (“Class B Common Stock”), in the form of a dividend of shares of Class B Common Stock. The pricing committee subsequently declared a 2.8771-for-one stock split of the Common Stock and the Class B Common Stock effective as of October 27, 2006.

Each share of Class B Common Stock automatically converted into one share of Common Stock immediately prior to the closing of the Company’s initial public offering on November 20, 2006. The par values, the number of authorized shares and all share and per share amounts in the consolidated financial statements have been retroactively adjusted to give effect to the filing of the certificate of amendment of the Company’s amended and restated certificate of incorporation, the stock split and the conversion of the Class B Common Stock into Common Stock.

Stock options

As of March 31, 2007, the Company has two stock-based employee compensation plans, the 2006 Plan and the 2004 Plan, under which the Company has granted options to purchase shares of Common Stock. The Emergent Plans have both incentive and non-qualified stock option features.

The Company established the 2006 Plan in connection with its initial public offering in November 2006. Under the 2006 Plan, the Company may grant options for a total of 503,500 shares of Common Stock, plus 585,961 shares of Common Stock reserved for issuance under the 2004 Plan that remained available for grant immediately prior to the initial public offering on November 14, 2006. Accordingly, the 2006 Plan initially authorized the issuance of up to 1,089,461 shares. In addition, the 2006 Plan contains an “evergreen provision” that allows for increases in the number of shares available for issuance under the 2006 Plan in the first and third quarter of each year from 2007 through 2009. The maximum number of options that may be granted per year under the 2006 Plan to a single participant is 287,700. The exercise price of each incentive option must be not less than 100% of the fair market value of the shares on the date of grant. Options granted under the 2006 Plan have a vesting period of no more than 5 years and contractual life of no more than 10 years. In conjunction with the establishment of the 2006 Plan, as noted above, the shares reserved for issuance under the 2004 Plan that remained available for grant became available for grant under the 2006 Plan.

Each option granted under the Emergent Plans becomes exercisable as specified in the relevant option agreement, and no option can be exercised after ten years from the date of grant. The following is a summary of stock option plan activity:

	2004 Plan			2006 Plan
	Number of Shares		Weighted-Average Exercise Price	Number of Shares		Weighted-Average Exercise Price		Aggregate Intrinsic Value
Outstanding at December 31, 2006	2,933,225	$	2.53	1,030,500	$	10.13
Granted	-		-	78,200		14.52
Exercised	(442,099)		2.02	-		-
Forfeited	(287)		2.74	-		-
Outstanding at March 31, 2007	2,490,839	$	2.62	1,108,700	$	10.44	$	30,204,987
Exercisable at March 31, 2007	1,990,708	$	1.43	-	$	-	$	23,868,589

The weighted average remaining contractual term of options outstanding as of December 31, 2006 and March 31, 2007 was 3.18 and 3.33 years, respectively. The weighted average remaining contractual term of options exercisable as of December 31, 2006 and March 31, 2007 was 1.06 and 0.98 years, respectively.

The weighted average grant date fair value of options granted during the three months ended March 31, 2007 was $5.46. The total intrinsic value of options exercised during the three months ended March 31, 2007 was $5,676. The total fair value of shares vested during the three months ended March 31, 2007 was $109.

Share-based compensation expense consists of the following:

	Three Months Ended
	March 31,
	2006			2007
Cost of sales	$	-	$	16
Research and development		-		85
General and administrative		96		428
Total share-based compensation expense	$	96	$	529

A summary of the status of the Company’s non-vested stock options at March 31, 2007 is presented below:

	2004 Plan			2006 Plan
	Number of Shares		Weighted-Average Price	Number of Shares		Weighted-Average Price
Non-vested at December 31, 2006	537,532	$	7.45	1,030,500	$	10.13
Granted	-		-	78,200		14.52
Exercised	-		-	-		-
Vested	(37,401)		8.41	-		-
Forfeited	-		-	-		-
Non-vested at March 31, 2007	500,131	$	7.38	1,108,700	$	10.44

During the three months ended March 31, 2007, the Company received a tax benefit from stock options exercised of approximately $1,522.

5. Income taxes

Significant components of the provision for income taxes attributable to operations consist of the following:

	Three months ended
	March 31,
		2006		2007
Current
Federal	$	(5,155)	$	(2,952)
State		100		34
Total current		(5,055)		(2,918)
Deferred
Federal		301		775
State		32		27
Total deferred		333		802
Total provision for income taxes	$	(4,722)	$	(2,116)

The estimated effective annual tax rate for the three months ended March 31, 2006 and 2007 was 50% and 44%, respectively. The estimated effective tax rate differs from statutory rates due primarily to the impact of foreign and state net operating losses and permanent differences, including incentive stock options.

In June 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, Accounting for Income Taxes (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not to be sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure.

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized, as a cumulative effect of change in accounting principle, a $607 increase in tax-related liabilities for unrecognized tax benefits and a $607 reduction to beginning retained earnings. The Company recognizes interest in interest expense and recognizes potential penalties related to unrecognized tax benefits in selling, general and administrative expense. The Company accrued approximately $154 for the payment of interest and penalties as of March 31, 2007. As of January 1, 2007, the Company recorded approximately $607 for unrecognized tax benefits, including accrued interest and penalties, related to prior years. During the three months ended March 31, 2007, the Company accrued $19 of interest expense related to unrecognized tax benefits of prior years. Substantially all of these reserves would impact the effective tax rate if released into income. Of the total unrecognized tax benefits recorded at March 31, 2007, $58 is classified as a current liability and $568 is classified as a non-current liability on the balance sheet. As of March 31, 2007, $415 of unrecognized tax benefits will reverse within the next twelve months.

The Company’s federal and state income tax returns for the tax years 2003, 2004, 2005 and 2006 remain open to examination. The Company’s tax returns in the United Kingdom remain open to examination for the tax years 2001, 2002, 2003, 2004, 2005 and 2006, and tax returns in Germany remain open indefinitely. The Company is the subject of an ongoing federal income tax audit for the tax years ended December 31, 2004 and 2005. The financial statement impact of the audit has been estimated at approximately $862, including $102 of interest. This amount has been accrued as of March 31, 2007.

6. Litigation

From time to time, the Company is involved in product liability claims and other litigation considered normal in the nature of its business. The Company does not believe that any such proceedings would have a material, adverse effect on the results of its operations. For claims filed against the Company for use of BioThrax by the DoD, the Company expects to rely on contractual indemnification provisions with the DoD and statutory protections to limit its potential liability resulting from the pending lawsuits.

7. Segment information

The Company operates in two business segments: biodefense and commercial. In the biodefense business, the Company develops, manufactures and commercializes immunobiotics, consisiting of vaccines and therapeutics, for use against biological agents that are potential weapons of bioterrorism and biowarfare. Revenues in this segment relate to the Company’s FDA-approved product, BioThrax. In the commercial business, the Company develops immunobiotics for use against infectious diseases that have resulted in significant unmet or underserved public health needs. Revenues in this segment consist predominantly of milestone payments and development and grant revenues received under collaboration and grant arrangements. The “All Other” segment relates to the general operating costs of the business and includes costs of the centralized services departments which are not allocated to the other segments. The assets in this segment consist primarily of cash and fixed assets.

		Reportable Segments
		Biodefense		Commercial		All Other		Total
Three Months Ended March 31, 2006
External revenues	$	12,196	$	27	$	-	$	12,223
Inter-segment revenues (expense)		-		-		-		-
Research and development		4,736		4,085		174		8,995
Interest income		-		-		203		203
Interest expense		-		-		(170)		(170)
Depreciation and amortization		763		174		31		968
Net income (loss)		138		(4,523)		(251)		(4,636)
Assets		48,667		10,067		31,839		90,573
Expenditures for long-lived assets		2,178		462		213		2,853
Three Months Ended March 31, 2007
External revenues	$	25,446	$	1,002	$	-	$	26,448
Inter-segment revenues		-		-		-		-
Research and development		10,091		4,986		493		15,570
Interest income		-		-		874		874
Interest expense		-		-		(26)		(26)
Depreciation and amortization		867		227		104		1,198
Net income (loss)		4,575		(5,697)		(1,568)		(2,690)
Assets		102,196		14,745		86,952		203,893
Expenditures for long-lived assets		15,170		445		875		16,490

The accounting policies of the segments are the same as those described in Note 1 — Summary of significant accounting policies. There are no inter-segment transactions.

8.	Subsequent event

On May 3, 2007, HHS issued a request for proposal (“RFP”) for the procurement of 10.4 million doses of BioThrax during a base contract period from July 2007 through September 2010, with the option for HHS to acquire up to an additional 8.35 million doses of BioThrax during the same period. On May 7, 2007, the DoD issued an RFP for the manufacture, storage and delivery of BioThrax during a base contract period from October 2007 through September 2008, with three one-year option periods through September 2011. The RFP seeks a minimum of 1.0 million doses and a maximum of 3.6 million doses of BioThrax during the base year with options to purchase a minimum of 1.0 million doses and a maximum of 3.6 million doses in each of the three option periods. The RFP also seeks up to an additional 70,000 doses of BioThrax in the base year and in each of the three option years for foreign military sales.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Overview

We are a biopharmaceutical company focused on the development, manufacture and commercialization of immunobiotics. We operate in two business segments: biodefense and commercial. We commenced operations as BioPort Corporation, or BioPort, in September 1998 through an acquisition from the Michigan Biologic Products Institute of rights to our marketed product, BioThrax, vaccine manufacturing facilities at a multi-building campus on approximately 12.5 acres in Lansing, Michigan and vaccine development and production know-how. Following this acquisition, we completed renovations at the Lansing facilities that had been initiated by the State of Michigan. In December 2001, the FDA approved a supplement to our manufacturing facility license for the manufacture of BioThrax at the renovated facilities.

In June 2004, we completed a corporate reorganization in which we:

• issued 18,666,479 shares of class A common stock in exchange for 18,017,994 shares of BioPort class A common stock and 648,485 shares of BioPort class B common stock;

• repurchased and retired all other issued and outstanding shares of BioPort class B common stock; and

• assumed all outstanding stock options to purchase BioPort class B common stock and granted option holders replacement stock options to purchase an equal number of shares of our class B common stock.

As a result of the reorganization, BioPort became a wholly owned subsidiary of Emergent. We subsequently renamed BioPort as Emergent BioDefense Operations Lansing Inc. We acquired our portfolio of commercial vaccine candidates through our acquisition of Microscience Limited, or Microscience, in a share exchange in June 2005 and our acquisitions for cash of substantially all of the assets of Antex Biologics, Inc., or Antex, in May 2003 and ViVacs GmbH, or ViVacs, in July 2006. We subsequently renamed Microscience as Emergent Product Development UK Limited, Antex as Emergent Product Development Gaithersburg Inc. and ViVacs as Emergent Product Development Germany GmbH. We expect to continue to seek to obtain marketed products and development stage product candidates through acquisitions and licensing arrangements with third parties.

Our biodefense business has generated net income for each of the last three fiscal years. However, in our commercial business, we have not received approval to market any of our product candidates and, to date, have received no product sales revenues. Our only sources of revenue in our commercial business are development grant funding and an upfront license fee and additional payments for development work under a collaboration agreement with Sanofi Pasteur. As a result, our commercial business has incurred a net loss for each of the last three fiscal years.

Biodefense

In our biodefense business, we develop, manufacture and commercialize immunobiotics for use against biological agents that are potential weapons of bioterrorism or biowarfare. Our marketed product, BioThrax, is the only vaccine approved by the U.S. Food and Drug Administration, or FDA, for the prevention of anthrax infection. The U.S. Department of Defense, or the DoD, and the U.S. Department of Health and Human Services, or HHS, have been the principal customers for BioThrax. In addition, we have supplied small amounts of BioThrax directly to several foreign governments.

Since 1998, we have been a party to two supply agreements for BioThrax with the DoD. Pursuant to these contracts, we have supplied over nine million doses of BioThrax through March 2007 for immunization of military personnel. Our most recent contract with the DoD, which was amended in October 2006, provided for the supply of a minimum of approximately 1.5 million doses of BioThrax to the DoD through September 2007. We delivered to the DoD approximately 630,000 of these doses through March 2007, and we expect to deliver the balance by September 2007. The DoD’s right to order additional doses of BioThrax under this contract expired in February 2007.

On May 7, 2007, the DoD issued an RFP for the manufacture, storage and delivery of BioThrax during a base contract period from October 2007 through September 2008, with three one-year option periods through September 2011. The RFP seeks a minimum of 1.0 million doses and a maximum of 3.6 million doses of BioThrax during the base year with options to purchase a minimum of 1.0 million doses and a maximum of 3.6 million doses in each of the three option periods. The RFP also seeks up to an additional 70,000 doses of BioThrax in the base year and in each of the three option years for foreign military sales.

Since May 2005, we have supplied 10.0 million doses of BioThrax to HHS for inclusion in the strategic national stockpile, or SNS, under a base contract for 5.0 million doses for a fixed price of $123.0 million and a modification for an additional 5.0 million doses for a fixed price of $120.0 million. We completed delivery of the first 5.0 million doses by February 2006, seven months earlier than required. We delivered approximately 4 million doses under the contract modification in 2006 and the balance in February 2007, more than two months earlier than required. On May 3, 2007, HHS issued an RFP for the procurement of another 10.4 million doses of BioThrax during a base contract period from July 2007 through September 2010, with the option for HHS to acquire up to an additional 8.35 million doses of BioThrax during the same period.

We have derived and expect for the foreseeable future to continue to derive substantially all of our revenues from sales of BioThrax. Our total revenues from BioThrax sales were $127.3 million in 2005, $148.0 million in 2006 and $25.4 million for the three months ended March 31, 2007. We are focused on increasing sales of BioThrax to U.S. government customers, expanding the market for BioThrax to other customers and pursuing label expansions and improvements for BioThrax.

In addition to BioThrax, our biodefense product portfolio includes three biodefense product candidates in preclinical development. We are independently developing an anthrax immune globulin candidate, in part with funding from the National Institute of Allergy and Infectious Diseases, or the NIAID. We are collaborating with the U.K. Health Protection Agency, or HPA, in the development of a recombinant bivalent botulinum vaccine candidate and a new botulinum toxoid vaccine that we plan to use as the basis for a botulinum immune globulin candidate. We are actively pursuing additional government sponsored development grants and working with various government agencies to encourage them to conduct studies relating to BioThrax and our other biodefense product candidates.

Commercial

In our commercial business, we develop a range of immunobiotic product candidates that are designed to address significant unmet or underserved public health needs caused by infectious diseases. Our commercial product portfolio includes a typhoid vaccine candidate and a hepatitis B therapeutic vaccine candidate, both of which are in Phase II clinical development, a group B streptococcus vaccine candidate in Phase I clinical development and a chlamydia vaccine candidate and a meningitis B vaccine candidate, both of which are in preclinical development. In May 2006, we entered into a license and co-development agreement with Sanofi Pasteur under which we granted Sanofi Pasteur an exclusive, worldwide license under our proprietary technology to develop and commercialize our meningitis B vaccine candidate.

We plan to encourage government entities and non-government and philanthropic organizations to provide development funding for, or to conduct clinical studies of, one or more of our commercial product candidates. For example, the Wellcome Trust provided funding for the Phase I clinical trial of our typhoid vaccine candidate in Vietnam and is providing funding for the Phase II clinical trial of this vaccine candidate in Vietnam. In addition, the NIAID agreed to sponsor the Phase I clinical development of our group B streptococcus vaccine candidate.

Manufacturing Infrastructure

To augment our existing manufacturing capabilities, we are constructing a new 50,000 square foot manufacturing facility on our Lansing, Michigan campus. We expect the construction of the facility to cost approximately $75 million, including approximately $55 million for the building and associated capital equipment, with the balance related to validation and qualification activities required for regulatory approval and initiation of manufacturing. We incurred costs of approximately $46 million for these purposes through March 2007.

We substantially completed construction of this facility in 2006, and expect to conduct installation, validation and qualification activities required for regulatory approval during 2007 and 2008. We are constructing this new facility as a large scale manufacturing plant that we can use to produce multiple vaccine products, subject to complying with appropriate change-over procedures.

We anticipate that we will initiate large scale manufacturing of BioThrax for commercial sale at the new facility in 2008. Our plans assume that the FDA will not require us to complete a human bridging trial demonstrating that BioThrax manufactured at our new facility is bioequivalent to BioThrax manufactured at our existing facility. We currently expect to rely on non-clinical studies for these purposes. However, the FDA has not approved our plan to rely on non-clinical studies without conducting a human bridging trial and may not do so. If the FDA requires us to conduct a human bridging trial, the initiation of large scale manufacturing of BioThrax for commercial sale at our new facility will be delayed and we will incur additional unanticipated costs.

We also own two buildings in Frederick, Maryland that are available to support our future manufacturing requirements. We incurred costs of approximately $1.5 million related to initial engineering design and preliminary utility build out of these facilities through March 2007. Because we are in the preliminary planning stages of our Frederick build out, we cannot reasonably estimate the timing and costs that will be necessary to complete this project. If we proceed with this project, we expect the costs to be substantial and to likely require external sources of funds to finance the project. We may elect to lease all or a substantial portion of one of these facilities to third parties.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses, fair valuation of stock related to stock-based compensation and income taxes. We based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the reported amounts of revenues and expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenues from product sales in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, or SAB 104. SAB 104 requires recognition of revenues from product sales that require no continuing performance on our part if four basic criteria have been met:

•

there is persuasive evidence of an arrangement;

•

delivery has occurred or title has passed to our customer based on contract terms;

•

the fee is fixed and determinable and no further obligation exists; and

•

collectibility is reasonably assured.

We cannot sell BioThrax to our customers without written FDA approval for each lot that we manufacture. As part of the FDA review process, we submit a detailed lot protocol for each BioThrax lot that we produce for sale. We also are required to submit product samples to the FDA for testing. Although we generally submit lot protocols and product samples promptly following the satisfactory completion of internal testing, we are permitted to submit product samples in advance of the lot protocols. The length of the FDA review process is approximately four to six weeks. However, individual lots may be released sooner or later depending on factors such as reviewer questions, license supplement approval, reviewer availability and whether our internal testing of product samples is completed before or concurrently with FDA testing. During the period covered by our financial statements included in this quarterly report, the FDA has not denied the sale of any BioThrax lots that we have submitted for approval.

We have generated BioThrax sales revenues under U.S. government contracts with the DoD and HHS. Under the DoD contract, we invoice the DoD for progress payments upon reaching contractually specified stages in the manufacture of BioThrax. We record as deferred revenue the full amount of each progress payment invoice that we submit to the DoD. Title to the product passes to the DoD upon submission of the first invoice. The earnings process is complete upon FDA release of the product for sale and distribution.

Following FDA release of the product, we segregate the product for later shipment and recognize as period revenue all deferred revenue related to the released product in accordance with the “bill and hold” sale requirements under SAB 104. At that time, we also invoice the DoD for the final progress payment and recognize the amount of that invoice as period revenue.

Our contract with HHS does not provide for progress payments. We invoice HHS and recognize the related revenues upon delivery of the product to the government carrier, at which time title to the product passes to HHS. We do not record allowances for sales returns, rebates or special promotional programs for sales of BioThrax or provisions for sales made in prior periods.

Under the collaboration agreement that we entered into with Sanofi Pasteur in May 2006 for our meningitis B vaccine candidate, we received an upfront license fee and are entitled to additional payments for development work under the collaboration and upon achieving contractually defined development and commercialization milestones. We evaluate the various components of a collaboration in accordance with Emerging Issues Task Force, or EITF, Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, or EITF No. 00-21, which addresses whether, for revenue recognition purposes, there is one or several elements in an arrangement. We concluded that under EITF No. 00- 21, the upfront license fee, the development work and the milestone payments under our agreement with Sanofi Pasteur should be accounted for as a single unit of accounting.

We recognize amounts received under this agreement over the estimated development period as we perform services. We recorded the amount of the upfront license fee as deferred revenue. We are recognizing this revenue over the estimated development period under the contract, currently estimated at seven years, as adjusted from time to time for any delays or acceleration in the development of the product candidate. Under the collaboration agreement, we are entitled to payments up to specified levels for development work we perform for Sanofi Pasteur. We invoice Sanofi Pasteur in advance of each quarter for the estimated work to occur in the upcoming quarter. We record the invoice amount as deferred revenue. As services are completed, we recognize the amount of the related deferred revenue as period revenues. Under the collaboration agreement, we also will be entitled to royalty payments on any future net sales of this product candidate.

From time to time, we are awarded reimbursement contracts for services and development grant contracts with government entities and non-government and philanthropic organizations. Under these contracts, we typically are reimbursed for our costs in connection with specific development activities and may also be entitled to additional fees. We record the reimbursement of our costs and any associated fees as contract and grant revenues and the associated costs as research and development expense. We issue invoices under these contracts after we incur the reimbursable costs. We recognize revenue upon invoicing the sponsoring organization.

Accounts Receivable

Accounts receivable are stated at invoice amounts and consist primarily of amounts due from the DoD and HHS as well as amounts due under reimbursement contracts with other government entities and non-government and philanthropic organizations. Because the prior collection history for receivables from these entities indicate that collection is likely, we do not currently record an allowance for doubtful accounts.

Inventories

Inventories are stated at the lower of cost or market, with cost being determined using a standard cost method, which approximates average cost. Average cost consists primarily of material, labor and manufacturing overhead expenses and includes the services and products of third party suppliers. We analyze our inventory levels quarterly and write down in the applicable period inventory that has become obsolete, inventory that has a cost basis in excess of its expected net realizable value and inventory in excess of expected customer demand. We also write off in the applicable period the costs related to expired inventory. We capitalize the costs associated with the manufacture of BioThrax as inventory from the initiation of the manufacturing process through the completion of manufacturing, labeling and packaging.

Accrued Expenses

As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves identifying services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for such service where we have not yet been invoiced or otherwise notified of actual cost. We make these estimates as of each balance sheet date in our financial statements. Examples of estimated accrued expenses include:

•

fees payable to contract research organizations in conjunction with clinical trials;

•

fees payable to third party manufacturers in conjunction with the production of clinical trial materials; and

•

professional service fees.

In accruing service fees, we estimate the time period over which services were provided and the level of effort in each period. If the actual timing of the provision of services or the level of effort varies from the estimate, we will adjust the accrual accordingly. The majority of our service providers invoice us monthly in arrears for services performed. In the event that we do not identify costs that have begun to be incurred or we underestimate or overestimate the level of services performed or the costs of such services, our actual expenses could differ from such estimates. The date on which some services commence, the level of services performed on or before a given date and the cost of such services are often subjective determinations. We make judgments based upon the facts and circumstances known to us.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, or SFAS No. 109. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the tax rates and laws that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A net deferred tax asset or liability is reported in the balance sheet. Our deferred tax assets include the unamortized portion of in-process research and development expenses, the anticipated future benefit of the net operating losses that we have incurred and other timing differences between the financial reporting basis of assets and liabilities. We have historically incurred net operating losses for income tax purposes in some states and in some foreign jurisdictions, primarily the United Kingdom. The amount of the deferred tax assets on our balance sheet reflects our expectations regarding our ability to use our net operating losses to offset future taxable income. The applicable tax rules in particular jurisdictions limit our ability to use net operating losses as a result of ownership changes. In particular, we believe that these rules will significantly limit our ability to use net operating losses generated by Microscience and Antex prior to our acquisition of Microscience in June 2005 and our acquisition of substantially all of the assets of Antex in May 2003.

We review our deferred tax assets on a quarterly basis to assess our ability to realize the benefit from these deferred tax assets. If we determine that it is more likely than not that the amount of our expected future taxable income will not be sufficient to allow us to fully utilize our deferred tax assets, we increase our valuation allowance against deferred tax assets by recording a provision for income taxes on our income statement, which reduces net income, or increases net loss, for that period and reduces our deferred tax assets on our balance sheet. If we determine that the amount of our expected future taxable income will allow us to utilize net operating losses in excess of our net deferred tax assets, we reduce our valuation allowance by recording a benefit from income taxes on our income statement, which increases net income, or reduces net loss, for that period and increases our deferred tax assets on our balance sheet.

We account for uncertainty in income taxes in accordance with Financial Accounting Standards Board, or FASB, Interpretation 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, Accounting for Income Taxes, or FIN 48. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under FIN 48, the Company recognizes in its financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure.

Stock-based Compensation

We adopted Statement of Financial Accounting Standards No. 123, or SFAS No. 123, Share-Based Payment, or SFAS No. 123(R), on January 1, 2006 using the modified prospective method. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. Pro forma disclosure is no longer an alternative.

We value our share-based payment transactions using the Black-Scholes valuation model. Under the modified prospective method, we recognize compensation cost in our financial statements for all awards granted after January 1, 2006 and for all awards outstanding as of January 1, 2006 for which the requisite service had not been rendered as of the date of adoption. Prior period operating results have not been restated. We measure the amount of compensation cost based on the fair value of the underlying common stock on the date of grant. We recognize compensation cost over the period that an employee provides service in exchange for the award.

As a result of our adoption of SFAS No. 123(R) effective January 1, 2006, we recorded stock-based compensation expense of $96,000 and $94,000 in the three months ended March 31, 2006 and 2007, respectively, related to stock options that were outstanding and had not completely vested as of January 1, 2006. During 2006 and the first quarter of 2007, we granted a total of 1,367,633 stock options. We recorded additional stock-based compensation expense of $435,000 related to these options in the three months ended March 31, 2007.

The effect of adopting SFAS No. 123(R) on net loss and net loss per share is not necessarily representative of the effects in future years due to, among other things, the vesting period of the stock options and the fair value of additional stock option grants in future years. Based on options granted to employees as of March 31, 2007, total compensation expense not yet recognized related to unvested options is approximately $3.1 million, after tax. We expect to recognize that expense over a weighted average period of 3.0 years. Based on options granted to employees as of March 31, 2007, we expect to recognize amortization of stock-based compensation, after tax, of approximately $1.1 million during the remainder of 2007, $1.1 million in 2008, $0.9 million in 2009, and $3,000 in 2010.

Financial Operations Overview

Revenues

We have generated substantially all of our revenues from sales of BioThrax. We delivered approximately 1.1 million total doses of BioThrax during the first quarter of 2007, representing 96% of our total revenues for the quarter. The DoD and HHS have been the principal customers for BioThrax. We also have had limited sales of BioThrax to foreign governments and private industry. In addition, we periodically realize revenues from grants from government entities and non-government and philanthropic organizations and from licensing fees, milestone payments and development reimbursement payments. These items accounted for 4% of our total revenues during the three months ended March 31, 2007. If our ongoing development efforts are successful, we would expect to generate revenues from sales of additional products and milestone payments, development payments and royalties on sales of products that we license to third parties.

In January 2004, we entered into a contract with the DoD for the delivery of a minimum number of doses of BioThrax over one base contract year plus two option periods for a minimum fixed price of approximately $91 million. Under the original terms of this contract, we were required to deliver a minimum of approximately 3.8 million total doses through September 2006. We delivered approximately 4.9 million total doses under this contract from 2004 through September 30, 2006 pursuant to the DoD purchase orders. Our most recent contract with the DoD was amended to provide for the supply of a minimum of approximately 1.5 million additional doses of BioThrax to the DoD through September 2007. We delivered to the DoD approximately 630,000 of those doses through March 2007, and we expect to deliver the balance by September 2007. We have invoiced the DoD, as contemplated under this contract, for progress payments as doses of BioThrax are manufactured for sale to the DoD. In accordance with our revenue recognition policy, we record deferred revenue for invoiced amounts until the FDA releases the product for sale and delivery. As of December 31, 2006 and March 31, 2007, we had no deferred revenue for the DoD sales. On May 7, 2007, the DoD issued an RFP for the manufacture, storage and delivery of BioThrax during a base contract period from October 2007 through September 2008, with three one-year option periods through September 2011. The RFP seeks a minimum of 1.0 million doses and a maximum of 3.6 million doses of BioThrax during the base year with options to purchase a minimum of 1.0 million doses and a maximum of 3.6 million doses in each of the three option periods. The RFP also seeks up to an additional 70,000 doses of BioThrax in the base year and in each of the three option years for foreign military sales.

In May 2005, we entered into an agreement to supply 5.0 million doses of BioThrax to HHS for the SNS for a fixed price of $123 million. We completed delivery of all 5.0 million doses by February 2006, seven months earlier than required. In May 2006, we entered into a contract modification with HHS for the delivery of an additional 5.0 million doses of BioThrax for the SNS by May 2007 for a fixed price of $120 million. We delivered approximately 4.0 million of these doses in December 2006 and the balance in February 2007, more than two months earlier than required. On May 3, 2007, HHS issued an RFP for the procurement of 10.4 million doses of BioThrax during a base contract period from July 2007 through September 2010, with the option for HHS to acquire up to an additional 8.35 million doses of BioThrax during the same period.

In May 2006, we entered into a collaboration agreement with Sanofi Pasteur relating to the development and commercialization of our meningitis B vaccine candidate and received a $3.8 million upfront license fee. This agreement also provides for a series of milestone payments upon the achievement of specified development and commercialization objectives, payments for development work under the collaboration and royalties on net sales of this product. We deferred the upfront license fee, milestone payments and development reimbursement payments under this agreement, and will record revenue in accordance with our revenue recognition policies.

Our revenue, operating results and profitability have varied, and we expect that they will continue to vary, on a quarterly basis, primarily because of the timing of our fulfilling orders for BioThrax. We expect contracts and grant revenues to increase in 2007 compared to 2006 as we receive reimbursement for development expenses under our meningitis B collaboration with Sanofi Pasteur, funding from the Wellcome Trust for costs associated with our completed Phase I clinical trial and initiated Phase II clinical trial of our typhoid vaccine candidate in Vietnam and funding from the NIAID for costs associated with our animal efficacy studies for our anthrax immune globulin candidate.

Cost of Product Sales

The primary expense that we incur to deliver BioThrax to our customers is manufacturing costs, which are primarily fixed costs. These fixed manufacturing costs consist of attributable facilities, utilities and salaries and personnel-related expenses for indirect manufacturing support staff. Variable manufacturing costs for BioThrax consist primarily of costs for materials, direct labor and contract filling operations. We expect our manufacturing costs to remain relatively stable during 2007.

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

Research and Development Expenses

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

• salaries and related expenses for personnel;

• fees to professional service providers for, among other things, preclinical and analytical testing, independently monitoring our clinical trials and acquiring and evaluating data from our clinical trials;

• costs of contract manufacturing services;

• costs of materials used in clinical trials and research and development;

• depreciation of capital assets used to develop our products; and

• operating costs, such as the operating cost of facilities and the legal costs of pursuing patent protection of our intellectual property.

The successful development of our product candidates is highly uncertain. We believe that significant investment in product development is a competitive necessity and plan to continue these investments in order to be in a position to realize the potential of our product candidates. We cannot reasonably estimate or know the nature, timing and projected costs of the efforts that will be necessary to complete the remainder of the development for our product candidates, or the period, if any, in which material net cash inflows may commence from any of our product candidates. This is due to the numerous risks and uncertainties associated with developing biological products, including the uncertainty of:

• the scope, rate of progress and expense of our clinical trials and other research and development activities;

• our ability to obtain adequate supplies of our product candidates required for later stage clinical trials, including from third party manufacturers;

• the potential benefits of our product candidates over other products;

• our ability to market, commercialize and achieve market acceptance for any of our product candidates that we are developing or may develop in the future;

• future clinical trial results;

• the terms and timing of regulatory approvals; and

• the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.

A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate.

We expect that development spending will increase for all of our biodefense product candidates as our product development activities continue and we prepare for regulatory submissions and other regulatory activities. We expect our development expenses in our commercial business to increase in connection with our ongoing activities, particularly as we conduct additional and later stage clinical trials for our product candidates.

We expect that the magnitude of any increase in our research and development spending will be dependent upon such factors as the results from our ongoing preclinical studies and clinical trials, the size, structure and duration of any follow on clinical program that we may initiate, cost associated with manufacturing our product candidates on a large scale basis for later stage clinical trials, our ability to use data generated by government agencies, such as the ongoing studies by the Centers for Disease Control and Prevention, or the CDC, with BioThrax, and our ability to rely upon and utilize clinical and non-clinical data, such as the data generated by the CDC from use of the pentavalent botulinum toxoid vaccine previously manufactured by the State of Michigan. Furthermore, if the FDA or other regulatory authority were to require us to conduct clinical trials beyond those which we currently anticipate will be required for the completion of clinical development of a product candidate or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development.

Selling, General and Administrative Expenses

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

Total Other Income (Expense)

Total other income (expense) consists principally of interest income and interest expense. We earn interest on our cash, cash equivalents and short-term investments, and we incur interest expense on our indebtedness. We capitalize interest expense based on the cost of major ongoing projects which have not yet been placed in service, such as our new manufacturing facility. Our interest income may increase in future periods as a result of the investment of the net proceeds from our initial public offering. Our total interest cost will increase in future periods as compared to prior periods as a result of the mortgage loan that we entered into in April 2006 and the term loan that we entered into in August 2006, as well as any borrowings under our revolving lines of credit. In addition, some of our existing debt arrangements provide for increasing amortization of principal payments in future periods.

Results of Operations

Quarter Ended March 31, 2007 Compared to Quarter Ended March 31, 2006

Revenues

Product sales revenues in our biodefense segment increased by $13.3 million to $25.4 million for the three months ended March 31, 2007 from $12.2 million for the three months ended March 31, 2006. This increase in product sales revenues was primarily due to a 125% increase in the number of doses of BioThrax delivered, partially offset by a 7% decrease in average sales price per dose. Product sales revenues for the three months ended March 31, 2007 consisted of BioThrax sales to HHS of $21.7 million and sales to the DoD of $3.7 million. Product sales revenues for the three months ended March 31, 2006 consisted of BioThrax sales to HHS of $11.6 million and aggregate international and other sales of $630,000.

Contracts and grant revenues in our commercial segment increased by $975,000 to $1.0 million for the three months ended March 31, 2007 from $27,000 for the three months ended March 31, 2006. Contracts and grant revenues for the three months ended March 31, 2007 consisted of $1.0 million in amortization of the upfront payment received in 2006 and development program revenue from the Sanofi Pasteur collaboration.

Cost of Product Sales

Cost of product sales increased by $2.7 million, or 93%, to $5.5 million for the three months ended March 31, 2007 from $2.9 million for the three months ended March 31, 2006. This increase was attributable to a 125% increase in the number of doses sold, partially offset by improved utilization of our manufacturing capacity for BioThrax. The increase in the number of doses delivered resulted in an increase in costs of approximately $3.1 million. Manufacturing efficiencies resulted in a cost savings of approximately $400,000.

Research and Development Expense

Research and development expenses increased by $6.6 million to $15.6 million for the three months ended March 31, 2007 from $9.0 million for the three months ended March 31, 2006. This increase reflects increased expenses of $5.4 million in the biodefense segment, $900,000 in the commercial segment, and approximately $300,000 in other research and development expense.

The increase in biodefense spending, detailed in the table below, was attributable to increased efforts on all our biodefense programs as we completed various studies and began subsequent studies and trials. This increase primarily reflects additional personnel and contract service costs. The increase in spending for BioThrax enhancements is related to preparing for animal efficacy studies to support applications for marketing approval of these enhancements, which we expect to submit to the FDA in late 2008 or early 2009. The increase in spending for our immune globulin candidate development related primarily to costs associated with our plasma collection program for our anthrax immune globulin. The increase in spending for the recombinant botulinum vaccine program, which is in preclinical development, resulted from advancing this program to the process development stage and the manufacture of clinical trial material. The increase in spending for the next generation anthrax vaccine program, which has product candidates in preclinical and Phase I clinical development, resulted from feasibility studies and formulation development of product candidates.

The increase in commercial spending, detailed in the table below, primarily reflects additional personnel and contract service costs. The spending for our typhoid vaccine candidate resulted from ongoing work for the Phase I clinical trial in Vietnam that we recently completed and preparing for our Phase II clinical trial in Vietnam that we initiated in the fourth quarter of 2006. The spending in 2007 for our hepatitis B therapeutic vaccine candidate resulted from preparing for our Phase II clinical trial, which we received regulatory clearance to commence in the fourth quarter of 2006. The spending in 2007 for our group B streptococcus vaccine candidate resulted from costs associated with our analysis of results from the Phase I clinical trial that we recently completed for one of the protein components of the vaccine candidate and preparation for Phase I clinical trials for two of the protein components of the vaccine candidate. In December 2006, we signed an agreement with the NIAID under which the NIAID has agreed to sponsor a Phase I clinical trial of each of the two components separately and the two-proteins in combination in healthy human volunteers. Both our chlamydia vaccine and meningitis B vaccine candidates are in preclinical development.

The increase in other research and development expenses was primarily attributable to spending associated with preclinical programs that we acquired from ViVacs in July 2006.

Our principal research and development expenses for the three months ended March 31, 2007 and 2006 are shown in the following table:

	Three Months Ended
		March 31,
(in thousands)		2006		2007

Biodefense:
BioThrax enhancements	$	1,745	$	2,029
Immune globulin		2,531		5,955
Recombinant bivalent botulinum vaccine		460		1,397
Next generation anthrax vaccine		-		710
Total biodefense		4,736		10,091
Commercial:
Typhoid vaccine		1,486		1,785
Hepatitis B therapeutic vaccine		1,049		1,141
Group B streptococcus vaccine		527		1,149
Chlamydia vaccine		409		455
Meningitis B vaccine		614		456
Total commercial		4,085		4,986
Other		174		493
Total	$	8,995	$	15,570

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $1.4 million, or 15%, to $11.2 million for the three months ended March 31, 2007 from $9.8 million for the three months ended March 31, 2006. Selling, general and administrative expenses related to our biodefense segment increased by $423,000, or 5%, to $8.9 million for the three months ended March 31, 2007 from $8.4 million for the three months ended March 31, 2006.

Selling, general and administrative expenses related to our commercial segment increased by $1.0 million, or 75%, to $2.3 million for the three months ended March 31, 2007 from $1.3 million for the three months ended March 31, 2006. The increase in both segments was primarily attributable to an increase in general and administrative expenses of approximately $1.2 million resulting from the addition of personnel related to our transition to a publicly traded company and increased legal and other professional services for our headquarters organization.

Total Other Income (Expense)

Total other income increased by $985,000 to $1.0 million for the three months ended March 31, 2007 from $40,000 for the three months ended March 31, 2006. This increase resulted primarily from an increase in interest income of $671,000 as a result of higher investment return on increased average cash balances, including the net proceeds of our initial public offering, a decrease in interest expense of $144,000 related primarily to the capitalization of interest based on the cost of major ongoing capital projects which have not yet been placed in service, and an increase in other income of $170,000.

Income Taxes

Benefit from income taxes decreased by $2.6 million to $2.1 million for the three months ended March 31, 2007 from $4.7 million for the three months ended March 31, 2006. Our effective tax rate was 44% for the three months ended March 31, 2007 and 50% for the three months ended March 31, 2006. The effective estimated annual tax rate differs from statutory rates due primarily to the impact of foreign and state net operating losses and permanent differences, including incentive stock options. The benefit from income taxes also reflects research and development tax credits of $226,000 for the three months ended March 31, 2007 and $0 for the three months ended March 31, 2006.

Liquidity and Capital Resources

Sources of Liquidity

We require cash to meet our operating expenses and for capital expenditures, acquisitions and principal and interest payments on our debt. We have funded our cash requirements from inception through March 31, 2007 principally with a combination of revenues from BioThrax product sales, debt financings and facilities and equipment leases, revenues under our collaboration agreement with Sanofi Pasteur, development funding from government entities and non-government and philanthropic organizations and, to a lesser extent, from the sale of our common stock upon exercise of stock options. We have operated profitably for each of the years in the three year period ended December 31, 2006.

As of March 31, 2007, we had cash and cash equivalents of $67.6 million. On November 20, 2006, we completed our initial public offering, in which we raised $54.2 million, net of issuance costs.

Cash Flows

The following table provides information regarding our cash flows for the three months ended March 31, 2006 and 2007:

	Three Months Ended
(in thousands)	March 31,
		2006		2007
Net cash provided by (used in):
Operating activities(1)	$	(18,277)	$	14,616
Investing activities		(2,853)		(16,490)
Financing activities		(390)		(6,899)
Total net cash used	$	(21,520)	$	(8,773)

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

Net cash provided by operating activities of $14.6 million for the three months ended March 31, 2007 resulted principally from $39.4 million received from the DoD and HHS relating to amounts billed in December 2006, partially offset by a decrease in income taxes payable of $17.7 million due to the timing of payment of our 2006 income tax liability, a decrease in accounts payable of $2.7 million related to timing of payments of construction and research and development costs recorded but unpaid at December 31, 2006 and our net loss of $2.7 million for the three months ended March 31, 2007.

Net cash used in operating activities of $18.3 million for the three months ended March 31, 2006 resulted principally from our net loss of $4.6 million, a non-cash benefit from income taxes of $6.6 million, reflecting our net loss before provision for income taxes for the period, and an increase in inventories of $4.7 million, reflecting the value of work in process for BioThrax lots being manufactured or awaiting delivery.

Net cash used in investing activities for the three months ended March 31, 2007 and 2006 resulted principally from the purchase of property, plant and equipment. Capital expenditures of $16.5 million for the three months ended March 31, 2007 relate primarily to construction of our new building in Lansing, Michigan. Capital expenditures of $2.9 million for the three months ended March 31, 2006 related primarily to $1.0 million for construction of our new building in Lansing, Michigan and approximately $1.9 million in infrastructure investments and other equipment.

Net cash used in financing activities of $6.9 million for the three months ended March 31, 2007 resulted primarily from the repayment of $8.9 million from our revolving line of credit with Fifth Third Bank, partially offset by $890,000 in proceeds from the exercise of stock options and $1.6 million related to excess tax benefits from the exercise of stock options.

Net cash used in financing activities of $390,000 for the three months ended March 31, 2006 resulted primarily from the redemption of Class B common stock of $200,000 and $192,000 related to the repayment of long-term debt.

Debt Financing

As of March 31, 2007, we had $33.4 million principal amount of debt outstanding, comprised primarily of the following:

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$2.5 million outstanding under a forgivable loan from the Department of Business and Economic Development of the State of Maryland used to finance eligible costs incurred to purchase the first facility in Frederick, Maryland;

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$6.9 million outstanding under a mortgage loan from Mercantile Potomac Bank used to finance the remaining portion of the purchase price for the Frederick facility;

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$8.3 million outstanding under a mortgage loan from HSBC Realty Credit Corporation used to finance the purchase price for the second facility on the Frederick site;

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$0.7 million outstanding under a term loan from Fifth Third Bank used to finance the purchase of an enterprise resource planning system;

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$10.0 million outstanding under a term loan from HSBC Realty Credit Corporation used to finance a portion of the costs of our facility expansion in Lansing, Michigan; and

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$5.0 million outstanding under a $5.0 million revolving line of credit with HSBC Realty Credit Corporation.

We also have a revolving line of credit for up to $10.0 million with Fifth Third Bank. We can borrow under this line of credit through May 2007.

Tax Benefits

In connection with our facility expansion in Lansing, the State of Michigan and the City of Lansing have provided us a variety of tax credits and abatements. We estimate that the total value of these tax benefits may be up to $18.5 million over a period of up to 15 years, beginning in 2006. These tax benefits are based on our $75 million planned investment in our Lansing facility. In addition, we must maintain a specified number of employees in Lansing to continue to qualify for these tax benefits.

Funding Requirements

We expect to continue to fund our anticipated operating expenses, capital expenditures and debt service requirements from existing cash and cash equivalents, revenues from BioThrax product sales and other committed sources of funding. There are numerous risks and uncertainties associated with BioThrax product sales and with the development and commercialization of our product candidates. We may seek to raise additional external debt financing to fund our facility expansion in Lansing, Michigan and to provide additional financial flexibility. In addition to purchase obligations and orders under our contract with the DoD for BioThrax sales, our only committed external sources of funds are remaining borrowing availability under our revolving line of credit with Fifth Third Bank, development funding under our collaboration agreement with Sanofi Pasteur, funding from the NIAID, including for animal efficacy studies of our anthrax immune globulin candidate, and funding from the Wellcome Trust for our Phase II clinical trial of our typhoid vaccine candidate in Vietnam. Our ability to borrow additional amounts under our loan agreements is subject to our satisfaction of specified conditions. Our future capital requirements will depend on many factors, including:

• the level and timing of BioThrax product sales and cost of product sales;

• the timing of, and the costs involved in, constructing our new manufacturing facility in Lansing, Michigan and the build out of our manufacturing facility in Frederick, Maryland;

• the scope, progress, results and costs of our preclinical and clinical development activities;

• the costs, timing and outcome of regulatory review of our product candidates;

• the number of, and development requirements for, other product candidates that we may pursue;

• the costs of commercialization activities, including product marketing, sales and distribution;

• the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation costs and the results of such litigation;

• the extent to which we acquire or invest in businesses, products and technologies;

• our ability to obtain development funding from government entities and non-government and philanthropic organizations; and

• our ability to establish and maintain collaborations, such as our collaboration with Sanofi Pasteur.

We may require additional sources of funds for future acquisitions that we may make or, depending on the size of the obligation, to meet balloon payments upon maturity of our current borrowings. To the extent our capital resources are insufficient to meet our future capital requirements, we will need to finance our cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements.

Additional equity or debt financing, grants, or corporate collaboration and licensing arrangements, may not be available on acceptable terms, if at all. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate our research and development programs or reduce our planned commercialization efforts. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Any debt financing or additional equity that we raise may contain terms, such as liquidation and other preferences, that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies or product candidates or grant licenses on terms that may not be favorable to us.

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board, or FASB, issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115, or SFAS No. 159. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective for fiscal years beginning after November 15, 2007. We have not yet determined the impact of the adoption of this statement on our financial statements.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk is currently confined to our cash and cash equivalents and restricted cash that have maturities of less than three months. We currently do not hedge interest rate exposure or foreign currency exchange exposure. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have a significant impact on the realized value of our investments, but would likely increase the interest expense associated with our debt.

ITEM 4.

CONTROLS AND PROCEDURES

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2007. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Management recognizes that any controls or procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2007, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

BioThrax product liability litigation. On October 14, 2005, January 9, 2006 and January 17, 2006, we were named as a defendant in three federal lawsuits filed on behalf of three individuals who alleged that they were vaccinated with BioThrax by the DoD and claimed damages resulting from personal injuries allegedly suffered because of the vaccinations. The plaintiffs in each of these three lawsuits claimed different injuries and sought varying amounts of damages. The first plaintiff alleged that the vaccine caused erosive rheumatoid arthritis and requested damages in excess of $1 million. The second plaintiff alleged that the vaccine caused Bell’s palsy and other related conditions and requested damages in excess of $75,000. The third plaintiff alleged that the vaccine caused a condition that originally was diagnosed as encephalitis related to a gastrointestinal infection and caused him to fall into a coma for many weeks and requested damages in excess of $10 million.

We moved to dismiss these three lawsuits for lack of personal jurisdiction, or in the alternative, to transfer the lawsuits to federal court in Michigan. On October 27, 2006, one of these lawsuits was transferred to the U.S. District Court for the Western District of Michigan. On October 31, 2006, another of these lawsuits was dismissed for lack of personal jurisdiction. The plaintiff in this lawsuit appealed that decision to the U.S. Court of Appeals for the Ninth Circuit. The appeal has not yet been fully briefed and oral argument is not scheduled. The court denied our motion in the third lawsuit. These lawsuits are in the preliminary stages of litigation, and we believe that we are entitled to indemnification under our contract with the DoD for legal fees and any damages that may result from these claims.

In April 2006, the U.S. District Court for the Western District of Michigan entered summary judgment in our favor in four other consolidated lawsuits asserting similar claims brought by approximately 120 individuals. The District Court’s ruling in the four cases was based on two grounds. First, the District Court found that we were entitled to protection under a Michigan state statute that provides immunity for drug manufacturers if the drug was approved by the FDA and its labeling is in compliance with FDA approval, unless the plaintiffs establish that the manufacturer intentionally withheld or misrepresented information to the FDA and the drug would not have been approved, or the FDA would have withdrawn approval, if the information had been accurately submitted. Second, the District Court found that we were entitled to the immunity afforded by the government contractor defense, which, under specified circumstances, extends the sovereign immunity of the United States to government contractors who manufacture a product for the government. Specifically, the government contractor defense applies when the government approves reasonably precise specifications, the product conforms to those specifications and the supplier warns the government about known dangers arising from the use of the product. The District Court found that we established each of those factors. We intend to rely on similar defenses with respect to the substantive claims asserted in our pending lawsuits. We also expect to rely on contractual indemnification provisions with the DoD and statutory protections to limit our potential liability resulting from the pending lawsuits.

Insurance coverage litigation. On December 26, 2006, we were named as a defendant in a lawsuit brought by Evanston Insurance Company in the U.S. District Court for the Western District of Michigan captioned Evanston Insurance Company v. BioPort Corporation and Robert C. Myers. Evanston issued a general liability policy to us in 2000, and we made a claim for coverage under that policy for defense and indemnity costs incurred as a result of the claims asserted in the BioThrax product liability litigation discussed above and the thimerosal litigation discussed below. In its complaint, Evanston asserts a number of purported bases for the court to void or reduce its obligation to defend or indemnify us, including a claim that we failed to disclose on our insurance application our alleged knowledge of “incidents, conditions, circumstances, effects or suspected defects which may result in claims.” Evanston seeks rescission or reformation of the policy to exclude a duty to defend or indemnify us for the claims asserted in the BioThrax product liability litigation and the thimerosal litigation. Evanston also seeks a refund of the approximately $331,000 that it has reimbursed us for defense costs.

MilVax litigation. In 2003, six unidentified plaintiffs filed suit in the U.S. District Court for the District of Columbia against the U.S. government seeking to enjoin the Anthrax Vaccine Immunization Program administered under MilVax under which all military personnel were required to be vaccinated with BioThrax. On October 27, 2004, the District Court enjoined the DoD from administering BioThrax to military personnel on a mandatory basis without their informed consent or a Presidential waiver. This ruling was based in part on the District Court’s finding that the FDA, as part of its review of all biological products approved prior to 1972, had not properly issued a final order determining that BioThrax is safe and effective and not misbranded.

In December 2005, the FDA issued a final order determining that BioThrax is safe and effective and not misbranded. On February 9, 2006, the U.S. Court of Appeals for the District of Columbia, on appeal of the injunction by the government, ruled that the injunction had dissolved by its own terms as a result of the FDA’s final order. The matter remains pending in the District Court, where subsequent proceedings have focused on whether the plaintiffs are entitled to recover attorneys’ fees from the government.

In October 2006, the DoD announced that it was resuming a mandatory vaccination program for BioThrax for designated military personnel and emergency DoD civilian personnel and contractors. On December 14, 2006, the same counsel who represented the plaintiffs in the 2003 litigation filed a new lawsuit against the government in the same federal court, on behalf of unnamed service members and the DoD civilian employees or contractors and purportedly on behalf of a class of similarly situated individuals. The suit contends on various grounds that the FDA's 2005 final order should be set aside as substantively and procedurally flawed and that BioThrax is not properly approved for use in the DoD’s vaccination program. The plaintiffs seek a declaration that BioThrax is improperly licensed and is not approved for use against inhalation anthrax, an order vacating the FDA’s 2005 final order, and an injunction prohibiting the DoD from using BioThrax in a mandatory vaccination program. On February 26, 2007, the government moved to dismiss the case. Although we are not a party to either of the Milvax lawsuits, if the District Court were to grant all or part of the requested relief, the amount of future purchases of BioThrax could be affected.

Other. We are, and may in the future become, subject to other legal proceedings, claims and litigation arising in the ordinary course of our business in connection with the manufacture, distribution and use of our products and product candidates. For example, Emergent BioDefense Operations is a defendant, along with many other vaccine manufacturers, in a series of lawsuits that have been filed in various state and federal courts in the United States alleging that thimerosal, a mercury-containing preservative used in the manufacture of some vaccines, caused personal injuries, including brain damage, central nervous system damage and autism. No specific dollar amount of damages has been claimed. Emergent BioDefense Operations is currently a named defendant in 41 lawsuits pending in two jurisdictions: four in California and 37 in Illinois. The products at issue in these lawsuits are pediatric vaccines and immune globulins. Because we are not currently and have not historically been in the business of manufacturing or selling pediatric vaccines, we do not believe that we manufactured the pediatric vaccines at issue in the lawsuits.

Under a contractual obligation to the State of Michigan, we manufactured one batch of vaccine suitable for pediatric use. However, the contract required the State to use the vaccine solely for Michigan public health purposes. One plaintiff in a thimerosal lawsuit alleges that he was injured by immune globulin containing thimerosal. We previously manufactured human immune globulin that contained thimerosal. We no longer manufacture any products that contain thimerosal. We have submitted a request for coverage of the defense and indemnity costs incurred as a result of these thimerosal claims to our insurance carriers. The insurance carrier that issued our general liability policies during the relevant years is disputing coverage.

ITEM 1A.

RISK FACTORS

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

We have derived substantially all of our revenue from sales of our BioThrax anthrax vaccine, our only marketed product, under contracts with the U.S. Department of Defense and the U.S. Department of Health and Human Services. If we are unable to obtain new contracts with, and deliver BioThrax to, these customers, our business, financial condition and operating results could be materially harmed.

We have derived and expect for the foreseeable future to continue to derive substantially all of our revenue from sales of BioThrax, our FDA-approved anthrax vaccine and our only marketed product. In 2006 and for the three months ended March 31, 2007, we derived substantially all of our revenue from our BioThrax contracts with the DoD and HHS. Although the DoD has issued an RFP for the manufacture, storage and delivery of up to an additional 14.68 million doses of BioThrax through September 2011 and HHS has issued an RFP for the procurement of up to an additional 18.35 million doses of BioThrax through September 2010, neither the DoD nor HHS has awarded a new contract to us.

We may not be awarded a follow-on contract by either the DoD or HHS, or we may be awarded a contract on less favorable terms than our prior contracts with the DoD and HHS.

Our prior contracts with the DoD and HHS do not necessarily increase the likelihood that we will secure future comparable contracts with the U.S. government. The success of our business and our operating results for the foreseeable future are substantially dependent on the price per dose, the number of doses and the timing of deliveries for BioThrax sales to the U.S. government.

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

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

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the need to devote substantial time and attention of management and key employees to the preparation of bids and proposals for contracts that may not be awarded to us;

•

the need to accurately estimate the resources and cost structure that will be required to perform any contract that we might be awarded; and

•

the expenses that we might incur and the delays that we might suffer if our competitors protest or challenge contract awards made to us pursuant to competitive bidding, and the risk that any such protest or challenge could result in the resubmission of bids based on modified specifications, or in termination, reduction or modification of the awarded contract.

The U.S. government may choose to award future contracts for the supply of anthrax vaccines and other biodefense product candidates that we are developing to our competitors instead of to us. If we are unable to win particular contracts, we may not be able to operate in the market for products that are provided under those contracts for a number of years. For example, if any other company is successful in developing a next generation anthrax vaccine, U.S. government customers may purchase only the next generation vaccine and not BioThrax.

If we are unable to consistently win new contract awards over an extended period, or if we fail to anticipate all of the costs and resources that will be required to secure such contract awards, our growth strategy and our business, financial condition, and operating results could be materially adversely affected.

Our U.S. government contracts for BioThrax require ongoing funding decisions by the government. The failure to fund one or more of these contracts could cause our financial condition and operating results to suffer materially.

Our principal customer for BioThrax, our only marketed product, is the U.S. government. We have sold BioThrax to the U.S. government under contracts with the DoD and HHS. In addition, we anticipate that the U.S. government will be the principal customer for any other biodefense products that we successfully develop. Accordingly, we are subject to a range of risks arising out of being a contractor to the U.S. government under U.S. government programs.

Over its lifetime, a U.S. government program may be implemented through the award of many different individual contracts and subcontracts. The funding of government programs is subject to Congressional appropriations. Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years. For example, the DoD contracts for BioThrax have been structured with one base year during which the DoD agrees to purchase a minimum number of doses of BioThrax with options for the DoD to purchase further quantities in future years. Any future contract that we enter into with the DoD may be structured in a similar manner.

Government programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations. The termination of a program or failure to commit funds to a program would result in a loss of anticipated future revenues attributable to that program, which could materially harm our business. Our government customers are subject to stringent budgetary constraints and political considerations. If levels of government expenditures and authorizations for biodefense decrease or shift to programs in areas where we do not offer products or are not developing product candidates, our business, revenues and operating results may suffer.

The success of our business with the U.S. government depends on our compliance with additional regulations and obligations under our U.S. government contracts.

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

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procurement integrity;

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export control;

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government security regulations;

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employment practices;

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protection of the environment;

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accuracy of records and the recording of costs; and

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foreign corrupt practices.

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

The pricing under our fixed price government contracts is based on estimates of the time, resources and expenses required to deliver the specified doses of BioThrax. If our estimates are not accurate, we may not be able to earn an adequate return under these contracts.

Historically, our contracts for the supply of BioThrax with the DoD and HHS were fixed price contracts. We expect that our future contracts with the U.S. government for biodefense product candidates that we successfully develop also may be fixed price contracts. Under a fixed price contract, we are required to deliver our products at a fixed price regardless of the actual costs we incur and absorb any costs in excess of the fixed price. Estimating costs that are related to performance in accordance with contract specifications is difficult. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed price contract could reduce the profitability of a fixed price contract or cause a loss.

Unfavorable provisions in government contracts may harm our business, financial condition and operating results.

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

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terminate existing contracts, in whole or in part, for any reason or no reason;

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unilaterally reduce or modify contracts or subcontracts;

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cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;

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decline to exercise an option to renew a contract;

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exercise an option to purchase only the minimum amount specified in a contract;

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decline to exercise an option to purchase the maximum amount specified in a contract;

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claim rights in products, including intellectual property, developed under the contract;

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take actions that result in a longer development timeline than expected;

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direct the course of a development program in a manner not chosen by the government contractor;

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suspend or debar the contractor from doing business with the government or a specific government agency;

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pursue criminal or civil remedies under the False Claims Act and False Statements Act; and

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control or prohibit the export of products.

Generally, government contracts, including our U.S. government contracts for BioThrax, contain provisions permitting unilateral termination or modification, in whole or in part, at the government’s convenience. Under general principles of government contracting law, if the government terminates a contract for convenience, the terminated company may recover only its incurred or committed costs, settlement expenses and profit on work completed prior to the termination. If the government terminates a contract for default, the defaulting company is entitled to recover costs incurred and associated profits on accepted items only and may be liable for excess costs incurred by the government in procuring undelivered items from another source.

One or more of our government contracts could be terminated under these circumstances. In addition, if the U.S. government decides to withdraw military personnel from high threat areas, including Iraq, or otherwise determines that it will decrease the number of military personnel to be immunized with BioThrax, the DoD’s demand for BioThrax may be reduced substantially. In addition, any follow-on contract with the DoD may not provide sufficient indemnification, and the DoD may require us to accept a greater risk of loss for the product manufacture, storage and delivery. Some government contracts grant the government the right to use, for or on behalf of the U.S. government, any technologies developed by the contractor under the government contract. If we were to develop technology under a contract with such a provision, we might not be able to prohibit third parties, including our competitors, from using that technology in providing products and services to the government.

Ongoing legal proceedings or any future similar lawsuits could limit future purchases of BioThrax by the U.S. government.

The results of ongoing or future legal proceedings could reduce demand for BioThrax by the U.S. government. For example, in 2003, a group of unnamed military personnel filed a lawsuit seeking to enjoin the DoD from administering BioThrax on a mandatory basis without informed consent of the recipient or a Presidential waiver, and, in October 2004, a federal court issued the requested injunction. In December 2005, the FDA issued an order affirming the BioThrax license, and, as a result, an appellate court ruled in February 2006 that the injunction was dissolved. In October 2006, the DoD announced that it was resuming a mandatory vaccination program for BioThrax for designated military personnel and emergency DoD civilian personnel and contractors. In December 2006, the same counsel who brought the prior lawsuit filed a new lawsuit contending that the FDA's 2005 final order should be set aside and that BioThrax is not properly approved for use in the DoD’s vaccination program. In February 2007, the government moved to dismiss the case. Although we are not a party to either of these lawsuits, if a court were to again enjoin the DoD's use of BioThrax on a mandatory basis, the amount of future purchases of BioThrax could be affected. Lawsuits brought against us by third parties, even if not successful, require us to spend time and money defending the related litigation. Furthermore, contractual indemnification provisions and statutory liability protections may not fully protect us from all related liabilities, and statutory liability protections could be revoked or amended to reduce the scope of liability protection.

Risks Related to Our Financial Position and Need for Additional Financing

We have a limited operating history and may not maintain profitability in future periods or on a consistent basis.

We have a limited operating history. We commenced operations in 1998, and the FDA approved the manufacture of BioThrax at our renovated facilities in Lansing, Michigan in December 2001. Although we were profitable for each of the last five fiscal years, we have not been profitable for every quarter during that time. We may not be able to achieve consistent profitability on a quarterly basis or sustain or increase profitability on an annual basis. Our profitability is substantially dependent on revenues from BioThrax product sales. Revenues from BioThrax product sales have fluctuated significantly in recent quarters, and we expect that they will continue to fluctuate significantly from quarter to quarter based on the timing of our fulfilling orders from the U.S. government. If we are unable to maintain profitability on a consistent basis, the market price of our common stock may decline, and you could lose part or all of your investment.

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

As of March 31, 2007, we had $33.4 million principal amount of debt outstanding and remaining borrowing availability of $10.0 million under our revolving lines of credit. We may seek to raise substantial external debt financing to fund our facility expansion in Lansing, Michigan and to provide additional financial flexibility. Our leverage could have significant adverse consequences, including:

• requiring us to dedicate a substantial portion of any cash flow from operations to the payment of interest on, and principal of, our debt, which will reduce the amounts available to fund working capital, capital expenditures, product development efforts and other general corporate purposes;

• increasing the amount of interest that we have to pay on debt with variable interest rates if market rates of interest increase;

• increasing our vulnerability to general adverse economic and industry conditions;

• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and

• placing us at a competitive disadvantage compared to our competitors that have less debt.

We may not have sufficient funds or may be unable to arrange for additional financing to pay the amounts due under our existing debt. In addition, a failure to comply with the covenants under our existing debt instruments could result in an event of default under those instruments. In the event of an acceleration of amounts due under our debt instruments as a result of an event of default, we may not have sufficient funds or may be unable to arrange for additional financing to repay our indebtedness or to make any accelerated payments, and the lenders could seek to enforce security interests in the collateral securing such indebtedness. The covenants under our existing debt instruments and the pledge of our existing assets as collateral limit our ability to obtain additional debt financing.

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

We expect our development expenses to increase in connection with our ongoing activities, particularly as we conduct additional and later stage clinical trials for our product candidates. In addition, we incur significant commercialization expenses for BioThrax product sales, marketing and manufacturing. We expect these commercialization expenses to increase in the future as we seek to broaden the market for BioThrax and if we receive marketing approval for additional products. We also are committed to substantial capital expenditures in connection with our facility expansion in Lansing, Michigan. We expect the construction of the facility to cost approximately $75 million, including approximately $55 million for the building and associated capital equipment, with the balance related to validation and qualification activities required for regulatory approval and initiation of manufacturing. We incurred approximately $46 million for these purposes through March 31, 2007. We also own two buildings in Frederick, Maryland that are available to support our future manufacturing requirements. We incurred approximately $1.5 million related to initial engineering design and preliminary utility build out for these facilities through March 31, 2007. Because we are in the preliminary planning stages of our Frederick build out, we cannot reasonably estimate the timing and costs that will be necessary to complete this project.

We expect to continue to fund a significant portion of our development and commercialization costs for our product candidates with internally generated funds from sales of BioThrax. If we do not obtain future contracts with, and deliver BioThrax to, the DoD and HHS on terms consistent with our current expectations, we will be forced to find additional sources of funding. We will not be able to obtain this funding or otherwise be able to raise capital when needed or on attractive terms, which would force us to delay, reduce the scope of or eliminate our research and development programs or reduce our planned commercialization efforts.

As of March 31, 2007, we had $67.6 million of cash and cash equivalents. Our future capital requirements will depend on many factors, including: