HEMISPHERX BIOPHARMA INC - 10-K Annual Report

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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File No. 1-13441

HEMISPHERX BIOPHARMA, INC.
(Exact name of registrant as specified in its charter)

Delaware 52-0845822 _
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)

1617 JFK Boulevard Philadelphia, Pennsylvania 19103 _
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (215) 988-0080

Securities registered pursuant to Section
12(b) of the Act:

Common Stock, $.001 par value

Securities registered pursuant to Section 12(g) of the Act:
(Title of Each Class)
NONE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ( ) No (X)

The aggregate market value of Common Stock held by non-affiliates at June 30,
2003, the last business day of the registrant's most recently completed second
fiscal quarter, was $71,603,879. For purposes of this calculation, it was
assumed that all Common Stock is valued at the closing price as of such date of
$1.88 per share.

The number of shares of the registrant's Common Stock outstanding as of February
27, 2004 was 40,835,199.

DOCUMENTS INCORPORATED BY REFERENCE

None.

TABLE OF CONTENTS
Page
PART I

Item 1. Business 1

Item 2. Properties 37

Item 3. Legal Proceedings 38

Item 4. Submission of Matters to a Vote of Security Holders 39

PART II

Item 5. Market for the Registrant's Common Equity and Related

Stockholder Matters 39

Item 6. Selected Financial Data 41

Item 7. Management's Discussion and Analysis of Financial

Condition and Results of Operations 42

Item 7A. Quantitative and Qualitative Disclosure About

Market Risk 60

Item 8. Financial Statements and Supplementary Data 60

Item 9. Changes In and Disagreements with Accountants on

Accounting and Financial Disclosure 61

Item 9A. Controls and Procedures 61

PART III

Item 10. Directors and Executive Officers of the Registrant 62

Item 11. Executive Compensation 65

Item 12. Security Ownership of Certain Beneficial Owners

and Management and Related Stockholder Matters 72

Item 13. Certain Relationships and Related Transactions 74

Item 14. Principal Accountant Fees and Services 75

PART IV

Item 15. Exhibits, Financial Statement Schedules,

and Reports on Form 8-K 76

1

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K (the "Form 10-K"),
including statements under "Item 1. Business," "Item 3. Legal Proceedings" and
"Item 7. Management's Discussion and Analysis of Financial Condition and Result
of Operations," constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, and the Private Securities
Litigation Reform Act of 1995 (collectively, the "Reform Act"). Certain, but not
necessarily all, of such forward-looking statements can be identified by the use
of forward-looking terminology such as "believes," "expects," "may," "will,"
"should," or "anticipates" or the negative thereof or other variations thereon
or comparable terminology, or by discussions of strategy that involve risks and
uncertainties. All statements other than statements of historical fact included
in this Form 10-K regarding our financial position, business strategy and plans
or objectives for future operations are forward-looking statements. Without
limiting the broader description of forward-looking statements above, we
specifically note that statements regarding potential drugs, their potential
therapeutic effect, the possibility of obtaining regulatory approval, our
ability to manufacture and sell any products, market acceptance or our ability
to earn a profit from sales or licenses of any drugs or our ability to discover
new drugs in the future are all forward-looking in nature.

Such forward-looking statements involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements of Hemispherx Biopharma, Inc. and its subsidiaries (collectively,
the "Company", "we or "us") to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements and other factors referenced in this Form 10-K. We do not undertake
and specifically declines any obligation to publicly release the results of any
revisions which may be made to any forward-looking statement to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.

PART I
ITEM 1. Business.
GENERAL
We were founded in the early 1970s as a contract researcher for the
National Institutes of Health (NIH). Dr. William A. Carter, M.D., joined us in
1976 and ultimately become our CEO in 1988. He has focused us on exploring,
understanding and mastering the mechanism of nucleic acid technology to produce
a promising new class of drugs for treating chronic viral diseases and disorders
of the immune system. In the course of almost three decades, we have established
a strong foundation of laboratory, pre-clinical and clinical data with respect
to the development of nucleic acids to enhance the natural antiviral defense
system of the human body and the development of therapeutic products for the
treatment of chronic diseases. Our strategy is to use our proprietary drug,
Ampligen(R), to treat diseases for which adequate treatment is not available. We
seek the required regulatory approvals which will allow the progressive
introduction of Ampligen(R) for Myalgic Encephalomyelitis/Chronic Fatigue
Syndrome ("ME/CFS"), HIV, Hepatitis C ("HCV") and Hepatitis B ("HBV") in the
U.S., Canada, Europe and Japan. Ampligen(R) is currently in the open label
2
portion of phase III clinical trials in the U.S. for use in treatment of ME/CFS
and is in Phase IIb clinical development in the U.S. for the treatment of
patients with HIV infection.

In March, 2003, we acquired from Interferon Sciences Inc. ("ISI"), all
of ISI's raw materials, work-in-progress and finished product of Alferon N
Injection(R), together with a limited license for the production, manufacture,
use, marketing and sale of the product. Alferon N Injection(R) [interferon alfa-
n3 (human derived)] is a natural alpha interferon that has been approved by the
U.S. Food and Drug Administration ("FDA") for commercial sale for the
intralesional treatment of refractory or recurring external genital warts in
patients 18 years of age or older. We intend to market this product in the
United States through sales facilitated via third party marketing agreements. In
the future, we expect to implement studies, beyond those conducted by ISI, for
testing the potential treatment of HIV, Hepatitis C and other indications,
including multiple sclerosis.

In March, 2003, we entered into an agreement with ISI subject to
certain events that would grant us global rights to sell Alferon N Injection(R)
as well as acquire certain other assets of ISI which include but are not limited
to real estate and property, plant and equipment.

We outsource certain components of our research and development,
manufacturing, marketing and distribution while maintaining control over the
entire process through our quality assurance group and our clinical monitoring
group.

3

AMPLIGEN(R)

Our proprietary drug technology includes Ampligen(R) and utilizes
specially configured ribonucleic acid ("RNA") and is protected by more than 300
patents worldwide with over 50 additional patent applications pending to provide
further proprietary protection in various international markets. Certain patents
apply to the use of Ampligen(R) alone and certain patents apply to the use of
Ampligen(R) in combination with certain other drugs. Some composition of matter
patents pertain to other new medications which have a similar mechanism of
action. The main U.S. ME/CFS treatment patent (#6130206) expires January 23,
2015. Our main patents covering HIV treatment (#4795744, #4820696, #5063209, and
#5091374) expire on August 26, 2006, September 30, 2008, August 10, 2010, and
May 6, 2011, respectively; Hepatitis treatment coverage is conveyed by U.S.
patent #5593973 which expires on October 5, 2014. The U.S. Ampligen(R) Trademark
(#1,515,099) expires on December 6, 2008 and can be renewed thereafter for an
additional 10 years. The U.S. FDA has granted us "orphan drug status" for our
nucleic acid-derived therapeutics for ME/CFS, HIV, and renal cell carcinoma and
malignant melanoma. Orphan drug status grants us protection against competition
for a period of seven years following FDA approval, as well as certain federal
tax incentives, and other regulatory benefits.

Nucleic acid compounds represent a potential new class of
pharmaceutical products that are designed to act at the molecular level for
treatment of human diseases. There are two forms of nucleic acids, DNA and RNA.
DNA is a group of naturally occurring molecules found in chromosomes, the cell's
genetic machinery. RNA is a group of naturally occurring informational molecules
which orchestrate a cell's behavior and which regulate the action of groups of
cells, including the cells, which comprise the body's immune system. RNA directs
the production of proteins and regulates certain cell activities including the
activation of an otherwise dormant cellular defense against virus and tumors.
Our drug technology utilizes specially configured RNA. Our double-stranded RNA
drug product, trademarked Ampligen(R), which is administered intravenously, is
(or has been) in human clinical development for various disease indications,
including treatment for ME/CFS, HIV, renal cell carcinoma and malignant
melanoma. Further studies are planned in cancer treatments but initiation dates
have not been set.

Based on the results of published, peer reviewed pre-clinical studies
and clinical trials, we believe that Ampligen(R) may have broad-spectrum
anti-viral and anti-cancer properties. Over 500 patients have received
Ampligen(R) in clinical trials authorized by the FDA at over twenty clinical
trial sites across the U.S., representing the administration of more than 45,000
doses of this drug.

Myalgic Encephalomyelitis/Chronic Fatigue Syndrome (ME/CFS)

ME/CFS is a debilitating disease that is difficult to diagnose and for
which, at present, there is no cure. People suffering from this illness
experience, among other symptoms, a constant tiredness, recurring dull
headaches, joint and muscle aches, a feeling of feverishness and chills, low
grade fever, depression, difficulty in concentrating on tasks, and tender lymph
glands. With progression of the disease they can become bed-ridden, lose their
jobs and become dependent upon the state for support and medical care.

ME/CFS has been given official recognition by the U.S. Social Security
Administration, and some European nations, rendering ME/CFS patients eligible
for disability benefits and heightening awareness of this debilitating disease
in the medical community. A further scientific publication by independent
4
academicians on the accurate laboratory diagnosis of ME/CFS appeared in a
peer-reviewed journal (American Journal of Medicine) in February 2000. The U.S.
Centers for Disease Control ("CDC") reconfirmed its research commitment to
ME/CFS following an audit by the U.S. Government Accounting Office ("GAO") which
was announced July 28, 1999.

Estimates of ME/CFS patient numbers in the Unites States range from a
low of 500,000 (1995-Centers for Disease Control, Atlanta, GA) to a high of
1,000,000 (1999-DePaul University study). Estimates of patient numbers in Europe
range from 600,000 to 2,200,000 as reported in the British Medical Journal in
January 2000. It is believed worldwide patient totals may be as high as ten
million.

In 1989, we received FDA authorization to conduct a Phase II study of
Ampligen(R) for ME/CFS. In 1991, we completed a 24-week, 92 patient, randomized,
placebo-controlled, double-blinded, multi-center trial of Ampligen(R) for
treating patients with ME/CFS. The results, published in a peer review journal
in 1994, suggested enhanced physical performance, greater cognitive functions
and improved ability to perform daily living activities. Patients required
reduced medications, while suffering little or no significant adverse side
effects. The FDA raised certain issues with respect to this clinical trial,
which required further study. These issues were reviewed and satisfactorily
resolved.

In February 1993, we presented results of our Phase II study of
Ampligen(R) for ME/CFS to a FDA Advisory Committee and these results were
published in early 1994 in Clinical Infectious Diseases, a peer reviewed medical
journal, which emphasizes the understanding and potential treatment of
infectious diseases. The results suggested that patients on Ampligen(R), in
contrast to those receiving a placebo, showed significant improvement in
physical capacity as determined by performance on treadmill testing. The
Ampligen(R) treated patient group also required less pain medication than did
the placebo group.

In 1998, we were authorized by the FDA to initiate a Phase III
multicenter, placebo-controlled, randomized, double blind clinical trial to
treat 230 patients with ME/CFS in the U.S. The objective of this Phase III,
clinical study, denoted as Amp 516, is to evaluate the safety and efficacy of
Ampligen(R) as a treatment for ME/CFS. Over the course of the study, we engaged
the services of twelve (12) clinical investigators at Medical Centers in
California, New Jersey, Florida, North Carolina, Wisconsin, Pennsylvania,
Nevada, Illinois, Utah and Connecticut. These clinical investigators are medical
doctors with special knowledge of ME/CFS who have recruited, prescreened and
enrolled ME/CFS patients for inclusion in the Phase III Amp 516 ME/CFS clinical
trial. This clinical trial has enrolled and randomized over 230 ME/CFS patients
and is now fully enrolled. The patients complete a stage I, forty week,
double-blind, randomized, placebo-controlled portion of the clinical trial. This
stage I has now been completed with the final patients receiving their last
blinded dose in February 2004. Following Stage I, the 14 remaining patients then
move into the stage II or the open label treatment portion of the clinical
trial. We anticipate that this segment should be completed by June, 2004. To
date there have been no reported serious adverse events definitely related to
the study medication. The next stage in our program is the completion of Stage
II and the final data collection, quality assurance of data to insure its
accuracy and analysis of the data according to regulatory guidelines to
facilitate filing for commercial approval to sell.

5
Human Immunodeficiency Virus (HIV)

Over fifteen antiviral drugs are currently approved by the FDA for the
treatment of HIV infection. Most target the specific HIV enzymes, reverse
transcriptase ("RT") and protease. The use of various combinations of three or
more of these drugs is often referred to as Highly Active Anti-Retroviral
Therapy ("HAART"). HAART involves the utilization of several antiretrovirals
with different mechanisms of action to decrease viral loads in HIV-infected
patients. The goal of these combination treatments is to reduce the amount of
HIV in the body ("viral load") to as low as possible. Treatments include
different classes of drugs, but they all work by stopping parts of the virus so
the virus cannot reproduce. Experience has shown that using combinations of
drugs from different classes is a more effective strategy than using only one or
two drugs. HAART has provided dramatic decreases in morbidity and mortality of
HIV infection. Reduction of the viral load to undetectable levels in patients
with wild type virus (i.e., non-drug-resistant virus)is routinely possible with
the appropriate application of HAART. HIV mainly infects important immune system
cells called CD4 cells. After HIV has infected a CD4 cell, the CD4 cell becomes
damaged and is eventually destroyed. Fewer CD4 cells means more damage to the
immune system and, ultimately, results in AIDS. Originally, reduction of HIV
loads was seen as possibly allowing the reconstitution of the immune system and
led to early speculation that HIV might be eliminated by HAART.

Subsequent experience has provided a more realistic view of HAART and
the realization that chronic HIV suppression using HAART, as currently
practiced, would require treatment for life with resulting significant
cumulative toxicities. The various reverse transcriptase and protease inhibitor
drugs that go into HAART have significantly reduced the morbidity and mortality
connected with HIV; however there has been a significant cost due to drug
toxicity. It is estimated that 50% of HIV deaths are from the toxicity of the
drugs in HAART. Current estimates suggest that it would require as many as 60
years of HAART for elimination of HIV in the infected patient. Thus the toxicity
of HAART drugs and the enormous cost of treatment makes this goal impractical.

Although more potent second generation drugs are under development that
target the reverse transcriptase and protease genes as well as new HIV targets,
such as HIV integrase and HIV fusion inhibitors, the problem of drug toxicities,
the complex interactions between these drug classes, and the likelihood of
life-long therapy will remain a serious drawback to their usage.

Failure of antiretroviral therapies over time and the demonstration of
resistance have stimulated intensive searches for appropriate combinations of
agents, or sequential use of different agents, that act upon the same or
different viral targets. This situation has created interest in our drug
technology, which operates by a different mechanism.

We believe that the concept of Strategic Therapeutic Interruption
("STI") of HAART provides a unique opportunity to minimize the current
deficiencies of HAART while retaining the HIV suppression capacities of HAART.
STI is the cessation of HAART until HIV again becomes detectable (i.e.,
rebounds) followed by resumption of HAART with subsequent suppression of HIV. By
re-institution of HAART, HIV may be suppressed before it can inflict damage to
the immune system of the patient. Based on recent publications (AIDS 2001,15:
F19-27 and AIDS 2001, 15:1359-1368) in peer reviewed medical literature, it is
expected that in just 30 days after stopping HAART approximately 80% to 90%, of
the patients will suffer a relapse evidencing detectable levels of HIV. We
believe that Ampligen(R) combined with the STI approach may offer a unique
opportunity to retain HAART's superb ability to suppress HIV while potentially
minimizing its deficiencies. All present approved drugs block certain steps in
6
the life cycles of HIV. None of these drugs address the immune system, as
Ampligen(R) potentially does, although HIV is an immune-based disease.

By using Ampligen(R) in combination with STI of HAART, we will
undertake to boost the patients' own immune system's response to help them
control their HIV when they are off of HAART. Our minimum expectation is that
Ampligen(R) has potential to lengthen the HAART-free time interval with a
resultant decrease in HAART-induced toxicities. The ultimate potential, which of
course requires full clinical testing to accept or reject the hypothesis, is
that Ampligen(R) may potentiate STI of HAART to the point that the cell mediated
immune system will be sufficient to eliminate requirement for HAART. Clinical
results of using our technology has been presented at several International AIDS
Scientific Forums in 2003, including the XVI International Conference on
Antiviral Research in Savannah, Georgia in April 2003 and the 2nd IAS Conference
on HIV Pathogenesis and Treatment in Paris, France in July 2003.

Our AMP 720 HIV clinical trial is being conducted with individuals
infected with HIV who are responding well to HAART at the moment. Patients in
this study are required to meet minimum immune system requirements of CD4 cell
levels greater than 400, maximum HIV infection levels of less that 50 copies/ml,
and a HAART regimen containing at least one anti-viral drug showing therapeutic
synergy with Ampligen(R) based on a recently reported ex vivo study in a
peer-reviewed scientific journal (Reference: Robinson W, McDougall B and Essay
R. Mixed Dose Effect Analysis of a Biological Response Modifier (Ampligen) with
14 FDA-approved anti-HIV Agents. Antiviral Res, 46:A48, No. 46, 2000). All
patients are chronically HIV infected and will have been receiving the indicated
HAART regimen prior to starting the STI. The trial applies strategic treatment
interruption of HAART based on the hypothesis that careful management of HIV
rebound following STI may have potential to result in the development of
protective immune responses to HIV in order to achieve control of HIV
replication. We believe that the addition of Ampligen(R), with its potential
immunomodulatory properties, may reasonably achieve this outcome. Half of the
participants in the trial are given 400 mg of Ampligen(R) twice a week and once
they start the STI will remain off of HAART until such time as their HIV
rebounds. The other half of the participants (the control group) are on STI, but
they are given no Ampligen(R) during the "control" portion of the clinical test.

The targeted enrollment in the AMP 720 Clinical Trial is 120
HIV-infected persons who meet the criteria. We expect to have 60 people on STI
with Ampligen(R) and 60 people on STI without Ampligen(R). Presently, this study
is approximately 35% enrolled at approximately ten medical centers around the
U.S.

Other Diseases

We are evaluating potential novel clinical programs which would involve
using Ampligen(R) to treat both HCV and HIV when they coexist on the same
patient. We expect to commence these studies in collaboration with one or more
prospective corporate partners. A collaborative Clinical study in Europe, in
conjunction with Laboratorios Del Dr. Esteve S.A., is expected to commence in
2004.

We have acquired a series of patents on Oragen(TM), potentially a set
of oral broad spectrum antivirals, immunological enhancers through a licensing
agreement with Temple University in Philadelphia, PA. We were granted an
exclusive worldwide license from Temple for the Oragen(TM) products. Pursuant to
the arrangement, we are obligated to pay royalties of 2% on sales of Oragen(TM),
depending on how much technological assistance is required of Temple. We
7
currently pay minimum royalties of $30,000 per year to Temple. These compounds
have been evaluated in various academic laboratories for application to chronic
viral and immunological disorders. Research and development of Oragen(TM) may
start in 2004 dependent on the availability of funding provided by various
branches of the U.S. Government, including the Department of Defense where oral
forms of broad spectrum immunotherapeutics may have high value.

An FDA authorized Phase I/II study of Ampligen(R) in cancer, including
patients with renal cell carcinoma was completed in 1994. The results of this
study indicated that patients receiving high doses (200-500mg) twice weekly
experienced an increase in medium survival compared to the low dose group and as
compared to an historical control group. We received authorization from the FDA
to initiate a Phase II study using Ampligen(R) to treat patients with metastatic
renal cell carcinoma. Patients with metastatic melanoma were included in the
Phase I/II study of Ampligen(R) in cancer. The FDA has authorized us to conduct
a Phase II clinical trial using Ampligen(R) in melanoma. We do not expect to
devote any significant resources to funding these studies in the near future and
are seeking strategic partnerships to expand these promising studies.

ALFERON N INJECTION(R)

Interferons are a group of proteins produced and secreted by cells to
combat diseases. Researchers have identified four major classes of human
interferon: alpha, beta, gamma and omega. The ALFERON N Injection(R) product
contains a multi-species form of alpha interferon. The worldwide market for
injectable alpha interferon-based products has experienced rapid growth and
various alpha interferon injectable products are approved for many major medical
uses worldwide.

Alpha interferons are manufactured commercially in three ways: by
genetic engineering, by cell culture, and from human white blood cells. All
three of these types of alpha interferon are or were approved for commercial
sale in the U.S. Our natural alpha interferon is produced from human white blood
cells.

The potential advantages of natural alpha interferon over recombinant
interferon may be based upon their respective molecular compositions. Natural
alpha interferon is composed of a family of proteins containing many molecular
species of interferon. In contrast, recombinant alpha interferon each contain
only a single species. Researchers have reported that the various species of
interferons may have differing antiviral activity depending upon the type of
virus. Natural alpha interferon presents a broad complement of species, which we
believe may account for its higher activity in laboratory studies. Natural alpha
interferon is also glycosylated (partially covered with sugar molecules). Such
glycosylation is not present on the currently U.S. marketed recombinant alpha
interferons. We believe that the absence of glycosylation may be, in part,
responsible for the production of interferon-neutralizing antibodies seen in
patients treated with recombinant alpha interferon. Although cell
culture-derived interferon is also composed of multiple glycosylated alpha
interferon species, the types and relative quantity of these species are
different from our natural alpha interferon.

On October 10, 1989, the FDA approved ALFERON N Injection(R) for the
intralesional (within lesions) treatment of refractory (resistant to other
treatment) or recurring external genital warts in patients 18 years of age or
older. Certain types of human papillomaviruses ("HPV") cause genital warts, a
sexually transmitted disease ("STD"). A published report estimates that
8
approximately eight million new and recurrent causes of genital warts occur
annually in the United States alone.

Basically, our interest in acquiring Alferon N Injection(R)was driven
by two factors;

(1) Our belief that the use of Alferon N in combination with Ampligen(R) has
the potential to increase the positive therapeutic responses in chronic
life threatening viral diseases. Combinational therapy is evolving to the
standard of acceptable medical care based on a detailed examination of the
Biochemistry of the body's natural antiviral immune response; and

(2) New knowledge about the competitive products in the interferon arena that
we believe implies a large untapped market and potential new therapeutic
indication for Alferon N Injection(R)which could accelerate its revenues in
the near term. Specifically, the recombinant DNA derived alpha interferons
are now reported to have decreased effectiveness after one year, probably
due to antibody formation and other severe toxicities. These detrimental
effects have not been reported with Alferon N Injection, which could allow
this product to assume a much larger market share. These revenues would
provide operational capital to complete the Phase III clinical trials of
our experimental drug Ampligen(R)in a more cost effective, non-dilutive
manner on shareholder's equity.

Alferon N Injection(R) [Interferon alfa-n3 (human leukocyte derived)]
is a highly purified, natural-source, glycosylated, multispecies alpha
interferon product. There are essentially no antibodies observed against natural
interferon to date and the product has a relatively low side-effect profile.
Alferon is the only natural-source, multispecies alpha interferon currently sold
in the U.S.

The Alferon N Injection(R) targeted market consists of urologists,
proctologists, dermatologists, and Obstetricians/Gynecologists. These physicians
normally see patients with papilloma concondylomas (genital warts) in their
practice. For our marketing plans, see "Marketing/Distribution" below.

According to the NIH, there are one million new cases of venereal warts
every year.

Pipeline Products (Alpha Interferon)

The following products, together with other assets are to be acquired
upon the closing of the second ISI agreement, which is anticipated to occur in
March 2004.

ALFERON N Injection(R) -Other Applications

ALFERON N Injection(R) has been approved by the U.S. FDA for the
intralesional treatment of refractory or recurring external genital warts in
patients 18 years of age or older and has been studied for the potential
treatment of HIV, Hepatitis C and other indications. ISI, the company from which
we obtained our rights to ALFERON N Injection(R), has conducted clinical trials
with regard to the use of ALFERON N Injection(R) in the treatment of HIV and
Hepatitis C. While ISI found the results to be encouraging, in both instances,
9
the FDA determined that additional trials were necessary.

We anticipate initiating clinical trials to evaluate the use of Alferon
N Injection(R) to treat West Nile Virus infections and SARS that is dependent on
NIH providing the funds needed.

ALFERON LDO

ALFERON LDO is an experimental low-dose, oral liquid formulation of
Natural Alpha Interferon. Two Phase 2 clinical trials using ALFERON LDO for the
treatment of HIV-infected patients have been completed. We are entering an
active phase of Alferon LDO research. The FDA has recently authorized a new
Phase II clinical study designed to investigate the activity and safety of
Alferon LDO(R) in HIV positive subjects in early stage disease. The endpoints of
the study include an increase or upregulation of expression of genes known to be
mediators of the natural immune response using cutting edge gene chip
technology, as well as, absolute CD4 cell counts and plasma HIV RNA level.

There can be no assurance that any of these proposed products will be
cost-effective, safe, and effective or that we will be able to obtain FDA
approval for such use. Furthermore, even if such approval is obtained, there can
be no assurance that such products will be commercially successful or will
produce significant revenues or profits for us.

EUROPEAN OPERATIONS

Our European operations were set up to prepare for the introduction of
Hemispherx products and to accelerate market penetration into the European
market once full approval is obtained from the European Medicine Evaluation
Agency ("EMEA"). The EMEA is the equivalent of the United States FDA. From a
regulatory point of view the member countries of the European Economic Union
("EEU") represent a common market under the jurisdiction of the EMEA. However,
from a practical point of view, every country is different regarding developing
relations with the medical community, patient associations and obtaining
reimbursement for treatment from the equivalent of Social Security Agencies and
insurance carriers. This program will be integrated into our new commercial
asset, ALFERON N Injection(R), as well.

Our European operations have assisted the growth of a number of
patient/physician educational associations. The French Chronic Fatigue Syndrome
Association has grown from 10 members in the year 2000 to 800 currently. Every
major country now has an active educational association with substantial numbers
of members who regularly meet and "network". These programs have been modeled on
the successful experience in the U.S. of conducting twice a year meetings on
ME/CFS with Health and Human Services, FDA, NIH and Centers for Disease Control.

We maintain contact with the EMEA, keeping the agency aware of our
activities, as well as the health ministries in numerous countries in the
European Union. In early 2001, our application for "orphan" drug status for the
use of Ampligen(R) in ME/CFS was rejected because the Board found that the
prevalence of ME/CFS was significantly above the five person per 10,000 limit
required to grant orphan drug status in the European Union. Although no
applications are on file currently with the EEU, we are exploring various ways
to accelerate the commercial availability of our products in the various nations
of the EEU, including potential appreciation of the "foreign import" rule for
accepting products already approved in the U.S.

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Limited numbers of ME/CFS patients were treated during 2003 with
Ampligen(R) in the United Kingdom, Austria and Belgium under existing regulatory
procedures in these countries, which allow the therapeutic use of an
experimental drug under certain conditions. These procedures allowed us to
recover the cost of Ampligen(R) used as well as to collect additional clinical
data. Corresponding procedures are being considered in several other countries
at the request of locally based physicians.

Our European operations are considering implementing clinical trials in
Europe for the use of Ampligen(R) in the treatment of HIV/AIDS on the basis of
the new U.S. Protocols involving the use of the drug either in combination with
"cocktail" therapies or as part of a strategic interruption of the "cocktail"
therapies. We presented results of one these programs (AMP 720) at the LAS
Conference on HIV Pathogenesis and Treatment in Paris, France, in July 2003.

The efforts of our European operation have started to produce results.
In March 2002, our European subsidiary Hemispherx Biopharma Europe, S.A.
("Hemispherx, S.A.") entered into a Sales and Distribution Agreement with
Laboratorios Del Dr. Esteve S.A. ("Esteve"). Pursuant to the terms of the
Agreement, Esteve was granted the exclusive right to market Ampligen(R) in
Spain, Portugal and Andorra ("Territory") for the treatment of ME/CFS. In
addition to other terms and other projected payments, Esteve paid an initial and
non-refundable fee of 625,000 Euros (approximately $563,000) to Hemispherx, S.A.
on April 24, 2002. Esteve is to pay a fee of 1,000,000 Euros after U.S. FDA
approval of Ampligen(R) for the treatment of ME/CFS and a fee of 1,000,000 Euros
upon Spain's approval of the final marketing authorization for using Ampligen(R)
for the treatment of ME/CFS. The agreement runs for the longer of ten years from
the date of first arms-length sale in the Territory, the expiration of the last
Hemispherx patent exploited by Esteve or the period of regulatory data
protection for Ampligen(R) in the applicable territory. Pursuant to the terms of
the agreement Esteve is to conduct clinical trials using Ampligen(R) to treat
patients with both HCV and HIV and is required to purchase certain minimum
annual amounts of Ampligen(R) following regulatory approval. The agreement is
terminable by either party if Ampligen(R) is withdrawn from the territory for a
specified period due to serious adverse health or safety reasons, bankruptcy,
insolvency or related issues of one of the parties; or material breach of the
agreement. Hemispherx may transform the agreement into a non-exclusive agreement
or terminate the agreement in the event that Esteve does not meet specified
percentages of its annual minimum purchase requirements under the agreement.
Esteve may terminate the agreement in the event that Hemispherx fails to supply
Ampligen(R) to the territory for a specified period of time or certain clinical
trials being conducted by Hemispherx are not successful.

We executed a Memorandum of Understanding in January 2004 with Fujisawa
Deutschland GmbH, ("Fuji") a major pharmaceutical corporation, granting them an
exclusive option for a limited number of months to enter a Sales and
Distribution Agreement with exclusive rights to market Ampligen(R) for ME/CFS in
Germany, Austria and Switzerland. The option period ends 12 weeks after Fuji has
had a chance to review the report on the results of our Amp 516 clinical trial
and meet with the trial's principal investigators. We received an initial fee of
400,000 Euros (approximately $500,000US). If we do not provide Fuji with the
full report by May 31, 2004 we will be required to repay half of this fee and if
we do not provide them with the report by December 31, 2004, we will be required
to refund the entire fee. If Fuji exercises the option, Fuji would be required
to pay us an additional 1,600,000 Euros upon execution of the Sales and
Distribution agreement, purchase Ampligen(R) exclusively from us and meet
11
certain annual minimum purchase quotas. We would be required to file an
application with the EMEA for commercial sale of Ampligen(R) for ME/CFS on or
before December 31, 2005. Upon our filing of that application, we would receive
an additional 1,000,000 Euros and, upon approval by the EMEA, an additional
2,000,000 Euros. If we failed to meet the December 31, 2005 filing deadline, we
would be required to return 40% of all payments that we had received from Fuji.
We would be required to sell Ampligen(R) to Fuji at a 20% price discount until
the aggregate amount of the discount reached $1,000,000 Euros (representing 50%
of the initial 2,000,000 fee paid to us on and prior to execution of the
definitive agreement). The foregoing is a summary of the memorandum of
understanding. We cannot assure that we can prepare and issue the AMP 516 report
within the time frames noted or that Fuji will exercise the option or that the
proposed terms of the Sales and Distribution Agreement will not change
materially.

We continue negotiations with other prospective partners for the
marketing and distribution of Ampligen(R) in other European territories.

MANUFACTURING

Historically, we outsourced the manufacturing of Ampligen(R) to certain
contractor facilities in the United States and South Africa while maintaining
full quality control and supervision of the process. Nucleic Acid polymers
constitute the raw material used in the production of Ampligen(R). We acquired
our raw materials from Ribotech, Ltd. ("Ribotech") located in South Africa.
Ribotech, is jointly owned by us (24.9%) and Bioclones (Proprietary), Ltd.
(75.1%). Bioclones manages and operates Ribotech. There are a limited number of
manufacturers in the United States available to provide the polymers if Ribotech
is unable to supply our needs based on product specifications and pricing.
Sourcing our needs from U.S. suppliers could result in a cost increase for our
raw materials.

Until 1999, we distributed Ampligen(R) in the form of a freeze-dried
powder to be formulated by pharmacists at the site of use. We perfected a
production process to produce ready to use liquid Ampligen(R) in a dosage form,
which will mainly be used upon commercial approval of Ampligen(R). At the
present time, we have engaged the services of Schering-Plough Products to mass
produce ready-to-use Ampligen(R) doses. There are other pharmaceutical
processing companies that can supply our production needs.

Bioclones (PTY) Ltd. is headquartered in South Africa and is the
majority owner in Ribotech, Ltd. (we own 24.9%) which produces most of the
polymers used to date in manufacturing Ampligen(R). The licensing agreement with
Bioclones presently includes Africa, South America, Ireland, Australia, New
Zealand and the United Kingdom; the agreement imposes certain clinical trial
requirements on Ribotech, as well as, certain GMP standards on their facilities.
We plan to consult and work with Bioclones in 2004 to assure GMP compliance of a
new manufacturing facility. Bioclones has conducted limited clinical studies in
patients with ME/CFS in Australia and South Africa.

We currently occupy and use the New Brunswick, New Jersey laboratory
and production facility owned by ISI. We expect to acquire title to these
facilities pursuant to our second asset acquisition agreement with ISI by March
31, 2004 (see "Management's Discussion and Analysis of Financial Condition and
Results of Operations; Liquidity And Capital Resources" for more details). This
facility operates in compliance to Good Manufacturing Practices (GMP's)and is
12
approved by the FDA for the manufacture of Alferon N Injection(R).

GMP's require that a product be consistently manufactured to an
identical potency (strength) and purity with each lot, and that the
manufacturing facility itself and all the equipment therein, be certified to
operate within a strict set of performance standards. Our facilities in New
Jersey (Alferon) and Maryland (Ampligen) meet these performance standards.

MARKETING/DISTRIBUTION

Our marketing strategy for Ampligen(R) reflects the differing health
care systems around the world, and the different marketing and distribution
systems that are used to supply pharmaceutical products to those systems. In the
U.S., we expect that, subject to receipt of regulatory approval, Ampligen(R)
will be utilized in four medical arenas: physicians' offices, clinics, hospitals
and the home treatment setting. We currently plan to use a service provided in
the home infusion (non-hospital) segment of the U.S. market to execute direct
marketing activities, conduct physical distribution of the product and handle
billing and collections. Accordingly, we are developing marketing plans to
facilitate the product distribution and medical support for indication, if and
when they are approved, in each arena. We believe that this approach will
facilitate the generation of revenue without incurring the substantial costs
associated with a sales force. Furthermore, management believes that the
approach will enable us to retain many options for future marketing strategies.
In February 1998, we and Accredo Health Services, Inc. (formerly Gentiva Health
Services) entered into a Distribution/Specialty Agreement for the distribution
of Ampligen(R) for the treatment of ME/CFS patients under the U.S. treatment
protocols.

In Europe, we plan to adopt a country-by-country and, in certain cases,
an indication-by-indication marketing strategy due to the heterogeneity
regulation and alternative distribution systems in these areas. We also plan to
adopt an indication-by-indication strategy in Japan. Subject to receipt of
regulatory approval, we plan to seek strategic partnering arrangements with
pharmaceutical companies to facilitate introductions in these areas. The
relative prevalence of people from target indications for Ampligen(R) varies
significantly by geographic region, and we intend to adjust our clinical and
marketing planning to reflect the specialty of each area. We have a marketing
agreement with Bioclones pursuant to the Bioclones Agreement that covers South
America, the United Kingdom, Ireland, Africa, Australia, Tasmania, New Zealand,
and certain other countries and territories. In Spain, Portugal and Andorra we
have entered into a Sales and Distribution Agreement with Esteve, and in
Germany, Austria and Switzerland we have entered into a memorandum of
understanding with Fuji (see "European Operations" above).

Our marketing and distribution plan for Alferon N Injection(R) is
focused on increasing the sales of Alferon N Injection(R) for the intralesional
treatment of refractory and recurring external genital warts in adults. We will
reach out to a targeted audience of physicians consisting of OB/GYNs,
Urologists, Proctologists and Dermatologists and simultaneously create product
awareness in the patient population through several media and health
organizations. Different regional meetings and seminars are scheduled during
which guest speakers will explain the therapeutic benefits and safety profile of
Alferon. Additional exposure will be created by exhibiting at several STD
related conferences, expanded web presence, mailings and publications. We also
have engaged a contract sales organization in order to build up a nationwide
network of dedicated representatives in the U.S. Upon obtaining the foreign
marketing rights to Alferon N Injection(R) at the second asset closing now
13
expected to take place in March, 2004 we expect to amend the current
marketing/distribution agreements with Biovail, Esteve, Bioclones and Fujisawa
to include Alferon N Injection(R). For more information about our arrangements
with Accredo Health Services, Inc., Bioclones, Esteve and Biovails, see
"Research And Development/Collaborative Agreements" below.

In August 2003, we entered into a non exclusive Sales and Marketing
agreement with Engitech, a pharmaceutical contract sales organization, to launch
Alferon N Injection(R) on a nationwide scale in the United States. The agreement
stipulates that Engitech will deploy a sales force of 100 sales representatives
within one year in the U.S. domestic market and further expand the sales team up
to 250 sales representatives in the second year and after that as many as it
takes to continually drive market share. As of February 25, 2004 Engitech has 93
sales representatives on board, leading us to believe that Engitech will reach
the target of 100 sales representatives as stated in the agreement. Engitech
will also develop and implement a strategic and tactical marketing action plan
as well as organize a scientific and educational program towards a targeted
audience of physicians and consumers. Engitech has been in business since 1987.
This privately held company has several clients in the pharmaceutical industry.

COMPETITION

Our potential competitors are among the largest pharmaceutical
companies in the world, are well known to the public and the medical community,
and have substantially greater financial resources, product development, and
manufacturing and marketing capabilities than we have.

These companies and their competing products may be more effective and
less costly than our products. In addition, conventional drug therapy, surgery
and other more familiar treatments will offer competition to our products.
Furthermore, our competitors have significantly greater experience than we do in
pre-clinical testing and human clinical trials of pharmaceutical products and in
obtaining FDA, EMEA Health Protection Branch ("HPB") and other regulatory
approvals of products. Accordingly, our competitors may succeed in obtaining
FDA, EMEA and HPB product approvals more rapidly than us. If any of our products
receive regulatory approvals and we commence commercial sales of our products,
we will also be competing with respect to manufacturing efficiency and marketing
capabilities, areas in which we have no experience. Our competitors may possess
or obtain patent protection or other intellectual property rights that prevent,
limit or otherwise adversely affect our ability to develop or exploit our
products.

The major competitors with drugs to treat HIV diseases include Gilead
Pharmaceutical, Pfizer, Bristol-Myers, Abbott Labs, Glaxo Smithkline, Merck and
Schering-Plough Corp. ("Schering"). ALFERON N Injection(R) currently competes
with a product produced by Schering for treating genital warts. 3M
Pharmaceutical also has received FDA approval for its immune response modifier
product for the treatment of genital and perianal warts.

GOVERNMENT REGULATION
Regulation by governmental authorities in the U.S. and foreign
countries is and will be a significant factor in the manufacture and marketing
of ALFERON N products and our ongoing research and product development
activities. Ampligen(R) and the products developed from the ongoing research and
product development activities will require regulatory clearances prior to
commercialization. In particular, new human drug products for humans are subject
14
to rigorous preclinical and clinical testing as a condition for clearance by the
FDA and by similar authorities in foreign countries. The lengthy process of
seeking these approvals, and the ongoing process of compliance with applicable
statutes and regulations, has required, and will continue to require the
expenditure of substantial resources. Any failure by us or our collaborators or
licensees to obtain, or any delay in obtaining, regulatory approvals could
materially adversely affect the marketing of any products developed by us and
our ability to receive product or royalty revenue. We have received orphan drug
designation for certain therapeutic indications, which might, under certain
conditions, accelerate the process of drug commercialization. ALFERON N
Injection(R) is only approved for use in intralesional treatment of refractory
or recurring external genital warts in patients 18 years of age or older. Use of
Alferon N Injection(R) for other applications requires regulatory approval.

A "Fast-Track" designation by the FDA, while not affecting any clinical
development time per se, has the potential effect of reducing the regulatory
review time by fifty percent (50%) from the time that a commercial drug
application is actually submitted for final regulatory review. Regulatory
agencies may apply a "Fast Track" designation to a potential new drug to
accelerate the approval and commercialization process. Criteria for "Fast Track"
include: a) a devastating disease without adequate therapy and b) laboratory or
clinical evidence that the candidate drug may address the unmet medical need. As
of this date, we have not received a Fast-Track designation for any of our
potential therapeutic indications although we have received "Orphan Drug
Designation" for both ME/CFS and HIV/AIDS in the U.S. We will continue to
present data from time to time in support of obtaining accelerated review. We
have not yet submitted any New Drug Application (NDA) for Ampligen(R) or any
other drug to a North American regulatory authority. Assuming the results are
positive, we expect to finalize the data of our double-blind, placebo controlled
AMP 516 ME/CFS Phase III clinical trial and submit an NDA by year end 2004.
There are no assurances that such designation will be granted, or if granted,
there are no assurances that Fast Track designation will materially increase the
prospect of a successful commercial application. In 2000 we submitted an
emergency treatment protocol for clinically-resistant HIV patients, which was
withdrawn by us during the statutory 30 day regulatory review period in favor of
a set of individual physician-generated applications. There are no assurances
that authorizations to commence such treatments will be granted by any
regulatory authority or that the resultant treatments, if any, will support drug
efficacy and safety. In 2001, we did receive FDA authorization for two separate
Phase IIb HIV treatment protocols in which our drug is combined with certain
presently available antiretroviral agents. Interim results were presented in
2002 and 2003 at various international scientific meetings.

We are subject to various federal, state and local laws, regulations
and recommendations relating to such matters as safe working conditions,
laboratory and manufacturing practices, the experimental use of animals and the
use of and disposal of hazardous or potentially hazardous substances, including
radioactive compounds and infectious disease agents, used in connection with our
research work. We believe that our Rockville, Maryland manufacturing and quality
assurance/control facility is in substantial compliance with all material
regulations applicable to these activities as advanced by the European Union
Inspections team which conducted detailed audits in year 2000. The ISI
laboratory and production facility in New Brunswick, New Jersey, which we are
currently using and are in the process of acquiring title to, is approved for
the manufacture of Alferon N Injection(R) and we believe it is in substantial
compliance with all material regulations. However, we cannot give assurances
that facilities owned and operated by third parties, including those operated by
15
Bioclones Ltd., and Ribotech, Ltd., that are utilized in the manufacture of our
products, are in substantial compliance, or if presently in substantial
compliance, will remain so. These third party facilities include manufacturing
operations in San Juan, Puerto Rico; Cape Town, South Africa; Columbia,
Maryland, and Melbourne, Australia.

RESEARCH AND DEVELOPMENT/COLLABORATIVE AGREEMENTS

In 1994, we entered into a licensing agreement with Bioclones
(Proprietary) limited ("Bioclones") for manufacturing and international market
development in Africa, Australia, New Zealand, Tasmania, the United Kingdom,
Ireland and certain countries in South Africa, of Ampligen(R) and Oragen(TM).
Bioclones is to pursue regulatory approval in the areas of its franchise and is
required to conduct Hepatitis clinical trials, based on international GMP and
GLP standards. Thus far, these Hepatitis studies have not yet commenced to a
meaningful level. Bioclones has been given the first right of refusal, subject
to pricing, to manufacture that amount of polymers utilized in the production of
Ampligen(R) sufficient to satisfy at least one-third of the worldwide sales
requirement of Ampligen(R) and other nucleic acid-derived drugs. Pursuant to
this arrangement, we received: 1) access to worldwide markets, 2)
commercial-scale manufacturing resources, 3) a $3 million cash payment in 1995
from Bioclones, 4) a 24.9% ownership in Ribotech, Ltd., a company set up by
Bioclones to develop and manufacture RNA drug compounds, and 5) royalties of 8%
on Bioclones nucleic acid-derived drug sales in the licensed territories. The
agreement with Bioclones terminates three years after the expiration of the last
of the patents supporting the license granted to Bioclones, subject to earlier
termination by the parties for uncured defaults under the agreement, or
bankruptcy or insolvency of either party. The last patent expires on December
22, 2012.

In August, 1998, we entered into a strategic alliance with Accredo to
develop certain marketing and distribution capacity for Ampligen(R) in the
United States. Accredo is one of the nation's largest home health care companies
with over 400 offices and sixty thousand caregivers nationwide. Pursuant to the
agreement, Accredo assumed certain responsibilities for distribution of
Ampligen(R) for which they received a fee. Through this arrangement, Hemispherx
may mitigate the necessity of incurring certain up-front costs. Accredo has also
worked with us in connection with the Amp 511 ME/CFS cost recovery treatment
program, Amp 516 ME/CFS Phase III clinical trial and the Amp 719 (combining
Ampligen with other antiviral drugs in HIV-salvage therapy and Amp 720 HIV Phase
IIb clinical trials now under way). There can be no assurances that this
alliance will develop a significant commercial position in any of its targeted
chronic disease markets. The agreement had an initial one year term from
February 9, 1998 with successive additional one year terms unless either party
notifies the other not less than 180 days prior to the anniversary date of its
intent to terminate the agreement. Also, the agreement may be terminated for the
uncured defaults, or bankruptcy, or insolvency of either party and will
automatically terminate upon our receiving an NDA for Ampligen(R) from the FDA,
at which time, a new agreement will need to be negotiated with Accredo or
another major drug distributor. There were no initial fees and subsequent fees
paid under this agreement total approximately $15,000 for services performed in
2003.

We have acquired a series of patents on Oragen(TM), potentially an oral
broad spectrum antiviral, immunological enhancer through a licensing agreement
with Temple University. We were granted an exclusive worldwide license from
Temple for the Oragen(TM) products. Pursuant to the arrangement, we are
16
obligated to pay royalties of 2% to 4% on sales of Oragen(TM), depending on how
much technological assistance is required of Temple. There were no initial fees
and we currently pay minimum royalties of $30,000 per year to Temple. These
compounds have been evaluated in various academic laboratories for application
to chronic viral and immunological disorders. This agreement is to remain in
effect until the date that the last licensed patent expires unless terminated
sooner by mutual consent or default due to royalties not being paid. The last
Oragen(TM) patent expires on August 22, 2015.

In December, 1999, we entered into an agreement with Biovail
Corporation International ("Biovail"). Biovail is an international full service
pharmaceutical company engaged in the formulation, clinical testing,
registration and manufacture of drug products utilizing advanced drug delivery
systems. Biovail is headquartered in Toronto, Canada. The agreement grants
Biovail the exclusive distributorship of our product in the Canadian territories
subject to certain terms and conditions. In return, Biovail agrees to conduct
certain pre-marketing clinical studies and market development programs,
including without limitation, expansion of the Emergency Drug Release Program in
Canada with respect to our products. In addition, Biovail agrees to work with us
in preparing and filing a New Drug Submission with Canadian Regulatory
Authorities at the appropriate time. Biovail invested $2,250,000 in Hemispherx
equity at prices above the then current market price and agreed to make an
additional investment of $1,750,000 based on receiving approval to market
Ampligen(R) in Canada from the appropriate regulatory authorities in Canada. The
agreement requires Biovail to buy exclusively from us and penetrate certain
market segments at specific rates in order to maintain market exclusivity. The
agreement terminates on December 15, 2009, subject to successive two year
extensions by the parties and subject to earlier termination by the parties for
uncured defaults under the agreement, bankruptcy or insolvency of either party,
or withdrawal of our product from Canada for a period of more than ninety days
for serious adverse health or safety reasons.

In 1998, we invested $1,074,000 for a 3.3% equity interest in R.E.D.
Laboratory ("R.E.D."). R.E.D. is a privately held biotechnology company for the
development of diagnostic markers for Chronic Fatigue Syndrome and other chronic
immune diseases. Primarily, R.E.D.'s research and development is based on
certain technology owned by Temple University and licensed to R.E.D. We have an
informal collaboration arrangement with R.E.D. to assist in this development. We
have supplied scientific data with respect to ME/CFS and engaged R.E.D. to
conduct certain blood tests for our ME/CFS clinical trials. We have no other
obligations to R.E.D. R.E.D. is headquartered in Belgium. The investment was
recorded at cost in 1998. During the three months ended June 2002 and December
2002 respectively, we recorded a non-cash charge of $678,000 and $396,000,
respectively, to operations with respect to our investment in R.E.D. These
charges were the result of our determination that R.E.D.'s business and
financial position had deteriorated to the point that our investment had been
permanently impaired.

In May 2000, we acquired an interest in Chronix Biomedical Corp.
("CHRONIX"). Chronix focuses upon the development of diagnostics for chronic
diseases. We issued 100,000 shares of common stock to Chronix toward a total
equity investment of $700,000. Pursuant to a strategic alliance agreement, we
provided Chronix with $250,000 to conduct research in an effort to develop
intellectual property on potential new products for diagnosing and treating
various chronic illnesses such as ME/CFS. The strategic alliance agreement
provides us certain royalty rights with respect to certain diagnostic technology
developed from this research and a right of first refusal to license certain
17
therapeutic technology developed from this research. The strategic alliance
agreement provides us with a royalty payment of 10% of all net sales of
diagnostic technology developed by Chronix for diagnosing Chronic Fatigue
Syndrome, Gulf War Syndrome and Human Herpes Virus-6 associated diseases. The
royalty continues for the longer of 12 years from September 15, 2000 or the life
of any patent(s) issued with regard to the diagnostic technology. The strategic
alliance agreement also provides us with the right of first refusal to acquire
an exclusive worldwide license for any and all therapeutic technology developed
by Chronix on or before September 14, 2012 for treating Chronic Fatigue
Syndrome, Gulf War Syndrome and Human Herpes Virus-6 associated diseases. During
the quarter ended December 31, 2002, we recorded a noncash charge of $292,000
with respect to our investment in Chronix. This impairment reduces our carrying
value to reflect a permanent decline in Chronix's market value based on its then
proposed equity offerings.

In April, 1999 we acquired a 30% equity position in the California
Institute of Molecular Medicine ("CIMM") for $750,000. CIMM'S research is
focused on developing therapies for use in treating patients affected by
Hepatitis C ("HCV"). We use the equity method of accounting with respect to this
investment. During the fourth quarter of 2001 we recorded a non-cash charge of
$485,000 with respect to our investment in CIMM. This was a result of our
determination that CIMM's operations have not yet evolved to the point where the
full carrying value of our investment could be supported based on that company's
financial position and operating results. During 2002, CIMM continued to suffer
significant losses resulting in a deterioration of its financial condition. The
$485,000 written off during 2001 represented the unamortized balance of goodwill
included as part of our investment. Additionally, during 2001 we reduced our
investment in CIMM based on our percentage interest in CIMM's continued
operating losses. Our remaining investment at December 31, 2001 in CIMM,
representing our 30% interest in CIMM's equity at such date, was not deemed to
be permanently impaired, but was completely written off during 2002. Such amount
was not material. These charges are reflected in the Consolidated Statements of
Operations under the caption "Equity loss in unconsolidated affiliate". We still
believe CIMM will succeed in their efforts to advance therapeutic treatment of
HCV. We believe that CIMM's Hepatitis C diagnostic technology has great promise
and will fill a long-standing global void in the collective abilities to
diagnose and treat Hepatitis C infection at an early stage of the disorder.

In March 2002, our European subsidiary Hemispherx S.A. entered into a
Sales and Distribution agreement with Esteve. Pursuant to the terms of the
Agreement, Esteve was granted the exclusive right to market Ampligen(R) in
Spain, Portugal and Andorra for the treatment of ME/CFS. In addition to other
terms and other projected payments, Esteve agreed to conduct certain clinical
trials using Ampligen(R) in the patient population coinfected with hepatitis C
and HIV viruses. The Agreement runs for the longer of ten years from the date of
the first arms-length sale in the Territory, the expiration of the last
Hemispherx patent exploited by Esteve or the period of regulatory data
protection for Ampligen(R) in the applicable territory. Pursuant to the terms of
the agreement Esteve is to conduct clinical trials using Ampligen(R) to treat
patients with both HCV and HIV and is required to purchase certain minimum
annual amounts of Ampligen(R) following regulatory approval. We expect Esteve to
start HIV clinical trials in Spain in 2004. The agreement is terminable by
either party if Ampligen(R) is withdrawn from the territory for a specified
period due to serious adverse health or safety reasons; bankruptcy, insolvency
or related issues of one of the parties; or material breach of the agreement.
Hemispherx may transform the agreement into a non-exclusive agreement or
terminate the agreement in the event that Esteve does not meet specified
percentages of its annual minimum purchase requirements under the agreement.
18
Esteve may terminate the agreement in the event that Hemispherx fails to supply
Ampligen(R) to the territory for a specified period of time or certain clinical
trials being conducted by Hemispherx are not successful. The last patent with
respect to this agreement expires on June 5, 2012.

The development of our nucleic acid based products requires the
commitment of substantial resources to conduct the time-consuming research,
preclinical development, and clinical trials that are necessary to bring
pharmaceutical products to market and to establish commercial-scale production
and marketing capabilities. During our last three fiscal years, we have directly
spent approximately $13,876,000 in research and development, of which
approximately $3,150,000 was expended in the year ended December 31, 2003. These
direct costs do not include the overhead and administrative costs necessary to
support the research and development effort. Our European subsidiary has an
exclusive license on all the technology and support from us concerning
Ampligen(R) for the use of ME/CFS and other applications for all countries of
the European Union (excluding the UK where Bioclones has a marketing license)
and Norway, Switzerland, Hungary, Poland, the Balkans, Russia, Ukraine, Romania,
Bulgaria, Slovakia, Turkey, Iceland and Liechtenstein. As mentioned above,
Hemispherx S.A. entered into a Sales and Distribution Agreement with Esteve.
Pursuant to the terms of this agreement, Esteve has been granted the exclusive
right in Spain, Portugal and Andorra to market Ampligen(R) for the treatment of
ME/CFS. See "European Operations", above for more detailed information.

HUMAN RESOURCES

As of February 27, 2004, we had 38 personnel working on the development
of Ampligen(R) consisting of 19 full time employees, 6 regulatory/research
medical personnel on a part-time basis, and 13 clinical investigators. Part time
personnel are paid on a per diem or monthly basis. 22 personnel are engaged in
our research, development, clinical, and manufacturing effort. 5 of our
personnel perform regulatory, general administration, data processing, including
bio-statistics, financial and investor relations functions.

In addition to the foregoing personnel, pursuant to our agreement with
ISI, we added personnel from ISI to our payroll consisting of 5 part-time and 12
full-time employees.

We believe that the combination of Hemispherx and ISI Scientific
employees has 1) significantly strengthened our overall organization, 2) added
expertise to monitor and complete our ongoing clinical trials and 3) improved
our data management and system administration.

While we have been successful in attracting skilled and experienced
scientific personnel, there can be no assurance that we will be able to attract
or retain the necessary qualified employees and/or consultants in the future.

SCIENTIFIC ADVISORY BOARD

We reestablished a Scientific Advisory Board in October, 2003,
consisting of individuals who we believe have particular scientific and medical
expertise in Virology, Cancer, Immunology, Biochemistry and related fields.
These individuals will advise us about current and long term scientific planning
including research and development. The Scientific Advisory Board will hold
periodic meetings as needed by the clinical studies in progress by us. In
addition, individual Scientific Advisory Board Members sometimes will consult
19
with, and meet informally with our employees. All members of the Scientific
Advisory Board are employed by others and may have commitments to and/or
consulting agreements with other entities, including our potential competitors.
Members of the Scientific Advisory Board are compensated at the rate of $1,000
per meeting attended or per day devoted to our affairs.

In January 2004 a meeting was held in Philadelphia where Scientific
Advisory Board members from Cornell University, University of Virginia and the
Pasteur Institute gathered to review and make suggestions pertaining to our
clinical and research programs in 2004. A member of our Board of Directors, Dr.
William Mitchell of Vanderbilt University also attended the meeting.

RECENT FINANCING AND ASSET ACQUISITIONS

On March 12, 2003, we issued an aggregate of $5,426,000 in principal
amount of 6% Senior Convertible Debentures due January 2005 (the "March
Debentures") and an aggregate of 743,288 warrants to two investors in a private
placement for aggregate proceeds of $4,650,000. Pursuant to the terms of the
March Debentures, $1,550,000 of the proceeds from the sale of the March
Debentures were to have been held back and were to be released to us if, and
only if, we acquired ISI's facility within a set timeframe. Although we had not
acquired ISI's facility yet, these funds were released to us in June 2003. The
March Debentures were to mature on January 31, 2005 with interest at 6% per
annum, payable quarterly in cash or, subject to satisfaction of certain
conditions, common stock. Any shares of common stock issued to the investors as
payment of interest were valued at 95% of the average closing price of the
common stock during the five consecutive business days ending on the third
business day immediately preceding the applicable interest payment date.
Pursuant to the terms and conditions of the March Debentures, we pledged all of
our assets, other than our intellectual property, as collateral and are subject
to comply with certain financial and negative covenants, which included but were
not limited to the repayment of principal balances upon achieving certain
revenue milestones.

The March Debentures were convertible at the option of the investors at
any time through January 31, 2005 into shares of our common stock. The
conversion price under the March Debentures is fixed at $1.46 per share, subject
to adjustment for anti-dilution protection for issuance of common stock or
securities convertible or exchangeable into common stock at a price less than
the conversion price then in effect.

The investors also received Warrants to acquire at any time through
March 12, 2008 an aggregate of 743,288 shares of common stock at a price of
$1.68 per share. On March 12, 2004, the exercise price of the Warrants was to
reset to the lesser of the exercise price then in effect or a price equal to the
average of the daily price of the common stock between March 13, 2003 and March
11, 2004 (but in no event less than $1.176 per share). The exercise price (and
the reset price) under the Warrants also was subject to similar adjustments for
anti-dilution protection. All of these warrants have been exercised.

On June 25, 2003, we issued to each of the March 12, 2003 Debenture
holders a warrant to acquire at any time through June 25, 2008 an aggregate of
500,000 shares of common stock at a price of $2.40 per share. On June 25, 2004,
the exercise price of these June 2008 Warrants will reset to the lesser of the
exercise price then in effect or a price equal to the average of the daily price
of the common stock between June 26, 2003 and June 24, 2004 (but in no event
20
less than $1.68 per share). The exercise price (and the reset price) under the
June 2008 Warrants also is subject to adjustments for anti-dilution protection
similar to those in the July 2008 Warrants. Pursuant to our agreement with the
Debenture holders, we have registered the shares issuable upon exercise of these
June 2008 Warrants for public sale.

We entered into a Registration Rights Agreement with the investors in
connection with the issuance of the March Debentures and the Warrants. The
Registration Rights Agreement required that we register the shares of common
stock issuable upon conversion of the Debentures, as interest shares under the
Debentures and upon exercise of the Warrants. In accordance with this
agreement, we have registered these shares for public sale.

As of December 31, 2003, the investors had converted the total
$5,426,000 principal of the March Debentures into 3,716,438 shares of our common
stock. The total interest charges on the debentures were $111,711 of which
$17,290 was paid in cash and $94,421 was paid by the issuance of shares of our
common stock. The investors exercised the 743,288 warrants in July, 2003 which
produced proceeds in the amount of $1,248,724.

On July 10, 2003, we issued an aggregate of $5,426,000 in principal
amount of 6% Senior Convertible Debentures due July 31, 2005 (the "July
Debentures") and an aggregate of 507,102 Warrants (the "July 2008 Warrants") to
the same investors who purchased the March 12, 2003 Debentures, in a private
placement for aggregate anticipated gross proceeds of $4,650,000. Pursuant to
the terms of the July Debentures, $1,550,000 of the proceeds from the sale of
the July Debentures were to have been held back and were to be released to us
if, and only if, we acquired ISI's facility within a set timeframe. Although we
had not acquired ISI's facility yet, these funds were released to us in October
2003. The July Debentures mature on July 31, 2005 and bear interest at 6% per
annum, payable quarterly in cash or, subject to satisfaction of certain
conditions, common stock. Any shares of common stock issued to the investors as
payment of interest shall be valued at 95% of the average closing price of the
common stock during the five consecutive business days ending on the third
business day immediately preceding the applicable interest payment date.

The July Debentures are convertible at the option of the investors at
any time through July 31, 2005 into shares of our common stock. The conversion
price under the July Debentures was fixed at $2.14 per share; however, as part
of the new debenture placement closed on October 29, 2003 (see below), the
conversion price under the July Debentures was lowered to $1.89 per share. The
conversion price is subject to adjustment for anti-dilution protection for
issuance of common stock or securities convertible or exchangeable into common
stock at a price less than the conversion price then in effect.

The July 2008 Warrants received by the investors, as amended, are to
acquire at any time commencing on July 26, 2004 through January 31, 2009 an
aggregate of 507,102 shares of common stock at a price of $2.46 per share. On
July 10, 2004, the exercise price of these July 2008 Warrants will reset to the
lesser of the exercise price then in effect or a price equal to the average of
the daily price of the common stock between July 11, 2003 and July 9, 2004 (but
in no event less than $2.14 per share). The exercise price (and the reset price)
under the July 2008 Warrants is also subject to similar adjustments for
anti-dilution protection.

We entered into a Registration Rights Agreement with the investors in
connection with the issuance of the July Debentures and the July 2008 Warrants.
21
The Registration Rights Agreement requires that we register on behalf of the
holders the shares of common stock issuable upon conversion of the Debentures,
as interest shares under the Debentures and upon exercise of the July 2008
Warrants. These shares have been registered for public sale.

On October 29, 2003, we issued an aggregate of $4,142,357 in principal
amount of 6% Senior Convertible Debentures due October 31, 2005 (the "October
Debentures") and an aggregate of 410,134 Warrants (the "October 2008 Warrants")
in a private placement for aggregate anticipated gross proceeds of $3,550,000.
Pursuant to the terms of the October Debentures, $1,550,000 of the proceeds from
the sale of the October Debentures have been held back and will be released to
us if, and only if, we acquired ISI's facility within 90 days of October 29,
2003 and provide a mortgage on the facility as further security for the October
Debentures. The debenture holders have extended the deadline to 90 days after
January 26, 2004. The October Debentures mature on October 31, 2005 and bear
interest at 6% per annum, payable quarterly in cash or, subject to satisfaction
of certain conditions, common stock. Any shares of common stock issued to the
investors as payment of interest shall be valued at 95% of the average closing
price of the common stock during the five consecutive business days ending on
the third business day immediately preceding the applicable interest payment
date.

Upon completing the sale of the October Debentures, we received
$3,275,000 in net proceeds consisting of $1,725,000 from the October Debentures
and $1,550,000 that had been withheld from the July Debentures. As noted above,
$1,550,000 of the proceeds from the October Debentures have been held back
pending our completing the acquisition of the ISI facility.

The October Debentures are convertible at the option of the investors
at any time through October 31, 2005 into shares of our common stock. The
conversion price under the October Debentures is fixed at $2.02 per share,
subject to adjustment for anti-dilution protection for issuance of common stock
or securities convertible or exchangeable into common stock at a price less than
the conversion price then in effect.

The October 2008 Warrants, as amended, received by the investors are to
acquire at any time commencing on July 26, 2004 through April 30, 2009 an
aggregate of 410,134 shares of common stock at a price of $2.32 per share. On
October 29, 2004, the exercise price of these October 2008 Warrants will reset
to the lesser of the exercise price then in effect or a price equal to the
average of the daily price of the common stock between October 29, 2003 and
October 27, 2004 (but in no event less than $2.19 per share). The exercise price
(and the reset price) under the October 2008 Warrants is also subject to similar
adjustments for anti-dilution protection.

As of February 27, 2004, the investors had converted $,9,589,300 of
debt from the March and July Debentures into 5,894,137 shares of our common
stock. The March Debentures have been fully converted. The remaining principal
balance on the remaining debentures is convertible into shares of our stock at
the option of the investors at any time, through the maturity date. In addition,
we have paid $1,300,000 into the debenture cash collateral account as required
by the terms of the October Debentures. The amounts paid through December 31,
2003 have been accounted for as advances receivable and are reflected as such on
the accompanying balance sheet as of December 31, 2003. The cash collateral
22
account provides partial security for repayment of the July and October 2003 and
January 2004 Debentures in the event of default.

We entered into a Registration Rights Agreement with the investors in
connection with the issuance of the October Debentures and the October 2008
Warrants. The Registration Rights Agreement requires that we register on behalf
of the holders the shares of common stock issuable upon conversion of the
October Debentures, as interest shares under the October Debentures and upon
exercise of the 2008 Warrants. If, subject to certain exceptions, sales of all
shares required to be registered cannot be made pursuant to the registration
statement, then we will be required to pay to the investors their pro rata share
of $3,635 for each day such conditions exists.

On January 26, 2004, we issued an aggregate of $4,000,000 in principal
amount of 6% Senior Convertible Debentures due January 31, 2006 (the "January
2004 Debentures"), an aggregate of 790,514 warrants (the "2009 Warrants") and
158,103 shares of common stock, and Additional Investment Rights (to purchase up
to an additional $2,000,000 principal amount of January 2004 Debentures
commencing in six months) in a private placement for aggregate anticipated net
proceeds of $3,695,000. The January 2004 Debentures mature on January 31, 2006
and bear interest at 6% per annum, payable quarterly in cash or, subject to
satisfaction of certain conditions, common stock. Any shares of common stock
issued to the investors as payment of interest shall be valued at 95% of the
average closing price of the common stock during the five consecutive business
days ending on the third business day immediately preceding the applicable
interest payment date. Commencing six months after issuance, the Company is
required to start repaying the then outstanding principal amount under the
January 2004 Debentures in monthly installments amortized over 18 months in cash
or, at the Company's option, in shares of common stock. Any shares of common
stock issued to the investors as installment payments shall be valued at 95% of
the average closing price of the common stock during the 10-day trading period
commencing on and including the eleventh trading day immediately preceding the
date that the installment is due.

The January 2004 Debentures are convertible at the option of the
investors at any time through January 31, 2006 into shares of our common stock.
The conversion price under the January 2004 Debentures is fixed at $2.53 per
share, subject to adjustment for anti-dilution protection for issuance of common
stock or securities convertible or exchangeable into common stock at a price
less than the conversion price then in effect.

There are two classes of July 2009 warrants received by the Investors:
Class A and Class B. The Class A warrants are to acquire any time from July 26,
2004 through July 26, 2009 an aggregate of up to 395,257 shares of common stock
at a price of $3.29 per share. The Class B warrants are to acquire any time from
July 26, 2004 through July 26, 2009 an aggregate of up to 395,257 shares of
common stock at a price of $5.06 per share. On January 27, 2005, the exercise
price of these July 2009 Class A and Class B Warrants will reset to the lesser
of their respective exercise price then in effect or a price equal to the
average of the daily price of the common stock between January 27, 2004 and
January 26, 2005 (but in no event less than $2.58 per share with regard to the
Class A warrants and $3.54 per share with regard to the Class B warrants). The
exercise price (and the reset price) under the July 2009 Warrants also is
subject to similar adjustments for anti-dilution protection.

The Company also issued to the investors Additional Investment Rights
pursuant to which the investors have the right to acquire up to an additional
23
$2,000,000 principal amount of January 2004 Debentures from the Company. These
Debentures are identical to the January 2004 Debentures except that the
conversion price is $2.58. The Additional Investment Rights are exercisable
commencing on July 26, 2004 (the "Trigger" date) for a period of 90 days from
the Trigger Date or 90 days from the date which the registration statement
registering the shares issuable upon the conversion of the January 2004
Debentures to be issued pursuant to the Additional Investment Rights is declared
effective, whichever is longer.

The Company entered into a Registration Rights Agreement with the
investors in connection with the issuance of the January 2004 Debentures
(including any Debentures issued pursuant to the Additional Investment Rights),
the shares, and the January 2009 Warrants. The Registration Rights Agreement
requires that the Company register on behalf of the investors the shares issued
to the investors and 135% of the shares issuable upon conversion of the
Debentures (including payment of interest thereon) and upon exercise of the
January 2009 Warrants. If the Registration Statement covering these shares is
not filed within the time period required by the agreement, not declared
effective within the time period required by the agreement or, after it is
declared effective and subject to certain exceptions, sales of all shares
required to be registered thereon cannot be made pursuant thereto, then we will
be required to pay to the investors their pro rata share of $3,635 for each day
any of the above conditions exist with respect to this Registration Statement.

By agreement between the Company and the investors, the date upon which
all warrants previously issued to the investors may become exercisable is now
July 26, 2004 and the exercise periods of these warrants have been extended
accordingly.

By agreement with Cardinal Securities, LLC, ("Cardinal") for general
financial advisory services and in conjunction with the private debenture
placements in March, July and October 2003 and in January 2004, we paid Cardinal
an investment banking fee equal to 7% of the investments made by the two
Debenture holders and issued to Cardinal certain warrants. A portion of the
investment banking fee was paid with the issuance of 30,000 shares of our common
stock. Cardinal also received 612,500 warrants to purchase common stock, of
which 112,500 are exercisable at $1.74 per share, 112,500 are exercisable at
$2.57 per share, 200,000 are exercisable at $2.50 per share, 87,500 are
exercisable at $2.42 per share and 100,000 are exercisable at $3.04 per share.
The $1.74 warrants expire on July 10, 2008, the $2.57 and $2.50 warrants expire
on March 12, 2008, the $2.42 warrants expire on October 30, 2008 and the $3.04
warrants expire on January 25, 2009. By agreement with Cardinal, we have
registered 542,500 shares for public sale and have agreed to register the
balance.

On March 11, 2003, we acquired from Interferon Sciences, Inc. ("ISI"),
ISI's inventory of ALFERON N Injection(R), a pharmaceutical product used for
intralesional treatment of refractory or recurring external genital warts in
patients 18 years of age or older, and a limited license for the production,
manufacture, use, marketing and sale of this product. As partial consideration,
we issued 487,028 shares of our common stock to ISI Pursuant to our agreements
with ISI, we registered these shares for public sale and, as of December 17,
2003, ISI has reported that it has sold all of these shares. We also agreed to
pay ISI 6 % of the net sales of ALFERON N Injection(R).

On March 11, 2003, we also entered into an agreement to purchase from
ISI all of its rights to the product and other assets related to the product
24
including, but not limited to, real estate and machinery. For these assets, we
agreed to issue to ISI an additional 487,028 shares and to issue 314,465 shares
and 267,296 shares, respectively to The American National Red Cross and GP
Strategies Corporation, two creditors of ISI. We have guaranteed the market
value of all but 62,500 of these shares on terms substantially similar to those
for the initial acquisition of the ISI assets. The termination date for these
guarantees is 18 months after the date of issuance of the guaranteed shares to
GP Strategies, 24 months after the date of issuance and delivery of the
additional 487,028 guaranteed shares to ISI and 12 months after the date of
issuance of the guaranteed shares to the American National Red Cross. We also
agreed to satisfy other liabilities of ISI which are past due and secured by a
lien on ISI's real estate and to pay ISI 6% of the net sales of products
containing natural alpha interferon.

On May 30, 2003, we issued the shares to GP Strategies and the American
National Red Cross. Pursuant to our agreements with ISI and these two
creditors, we have registered the foregoing shares for public sale. As of
December 31, 2003, GP Strategies has indicated to us that it has sold all of
its Hemispherx shares.

In connection with the debenture agreements, we have outstanding
letters of credit of $1 million as additional collateral.

Prior to our annual meeting of stockholders in September 2003, we had a
limited number of shares of Common Stock authorized but not issued or reserved
for issuance upon conversion or exercise or outstanding convertible and
exercisable securities such as debentures, options and warrants. Prior to the
meeting, to permit consummation of the sale of the July 2005 Debentures and the
related warrants, Dr. Carter agreed that he would not exercise his warrants or
options unless and until our stockholders approve an increase in our authorized
shares of common stock. For Dr. Carter's waiver of his right to exercise certain
options and warrants prior to approval of the increase in our authorized shares,
and for Dr. Carter's entering into a $250,000 letter of credit benefiting the
Debenture holders in the event of a default, we agreed to compensate Dr. Carter.
See "Executive Compensation; Employment Agreements" for details related to how
Dr. Carter has been compensated with respect to these matters.

On November 6, 2003 we acquired some of the outstanding ISI property
tax lien certificates in the aggregate amount of $456,839 from certain
investors. These tax liens were issued for property taxes and utilities due for
2000, 2001 and 2002. For more information about our acquisition of these tax
liens and our suit against ISI in Delaware, see "Item 3. Legal Proceedings."

On March 13, 2003, we issued 347,445 shares of our common stock to
Provesan SA, an affiliate of Esteve, in exchange for 1,000,000 Euros of
convertible preferred equity certificates of Hemispherx Biopharma Europe, S.A.,
owned by Esteve, and all dividends earned and to be earned through September 30,
2003. We agreed to register the shares issued to Provesan SA, and we have
registered these shares for public sale.

As of December 31, 2003, we had approximately $5,260,000 in cash and
short term investments. We believe that these funds plus the net proceeds of
approximately $3.7 million from the recently placed January 2004 Debentures, 2)
the receipt of the $1.55 million of proceeds held back pending the acquisition
of the ISI facility, 3) potential licensing fee income, 4) the $2,000,000 in
proceeds we expect when the investors exercise their additional investment
rights in connection with the January 2004 Debenture, and 5) and the projected
25
revenue from the acquisition of the ALFERON N Injection(R) business should be
sufficient to meet our operating requirements for the 2004 fiscal year.

In addition, we may raise additional funds through additional equity or
debt financing, collaborative arrangements with corporate partners, lease
financing or from other sources in order to complete the necessary clinical
trials and the regulatory approval processes and begin commercializing our
products. If adequate funds are not available from operations and if we are not
able to secure additional sources of financing on acceptable terms, we would be
materially adversely affected in our commercialization process.

RISK FACTORS

The following cautionary statements identify important factors that could cause
our actual result to differ materially from those projected in the
forward-looking statements made in this Form 10-K. Among the key factors that
have a direct bearing on our results of operations are:

No assurance of successful product development

Ampligen(R) and related products. The development of Ampligen(R) and
our other related products is subject to a number of significant risks.
Ampligen(R) may be found to be ineffective or to have adverse side effects, fail
to receive necessary regulatory clearances, be difficult to manufacture on a
commercial scale, be uneconomical to market or be precluded from
commercialization by proprietary right of third parties. Our products are in
various stages of clinical and pre-clinical development and, require further
clinical studies and appropriate regulatory approval processes before any such
products can be marketed. We do not know when, if ever, Ampligen(R) or our other
products will be generally available for commercial sale for any indication.
Generally, only a small percentage of potential therapeutic products are
eventually approved by the U.S. Food and Drug Administration ("FDA") for
commercial sale.

ALFERON N Injection(R). Although ALFERON N Injection(R) is approved for
marketing in the United States for the intralesional treatment of refractory or
recurring external genital warts in patients 18 years of age or older, to date
it has not been approved for other indications. We face many of the risks
discussed above, with regard to developing this product for use to treat other
ailments such as multiple sclerosis and cancer.

Our drug and related technologies are investigational and subject to regulatory
approval. If we are unable to obtain regulatory approval, our operations will be
significantly affected.

All of our drugs and associated technologies other than ALFERON N
Injection(R) are investigational and must receive prior regulatory approval by
appropriate regulatory authorities for general use and are currently legally
available only through clinical trials with specified disorders. At present,
ALFERON N Injection(R) is only approved for the intralesional treatment of
refractory or recurring external genital warts in patients 18 years of age or
older. Use of ALFERON N Injection(R) for other indications will require
regulatory approval. In this regard, Interferon Sciences, Inc. ("ISI"), the
company from which we obtained our rights to ALFERON N Injection(R), conducted
clinical trials related to use of ALFERON N Injection(R) for treatment of HIV
and Hepatitis C. In both instances, the FDA determined that additional studies
26
were necessary in order to fully evaluate the efficacy of ALFERON N Injection(R)
in the treatment of HIV and Hepatitis C diseases. We have no obligation or
immediate plans to conduct these additional studies at this time.

Our products, including Ampligen(R), are subject to extensive
regulation by numerous governmental authorities in the U.S. and other countries,
including, but not limited to, the FDA in the U.S., the Health Protection Branch
("HPB") of Canada, and the European Medical Evaluation Agency ("EMEA") in
Europe. Obtaining regulatory approvals is a rigorous and lengthy process and
requires the expenditure of substantial resources. In order to obtain final
regulatory approval of a new drug, we must demonstrate to the satisfaction of
the regulatory agency that the product is safe and effective for its intended
uses and that we are capable of manufacturing the product to the applicable
regulatory standards. We require regulatory approval in order to market
Ampligen(R) or any other proposed product and receive product revenues or
royalties. We cannot assure you that Ampligen(R) will ultimately be demonstrated
to be safe or efficacious. In addition, while Ampligen(R) is authorized for use
in clinical trials in the United States and other countries, we cannot assure
you that additional clinical trial approvals will be authorized in the United
States or in other countries, in a timely fashion or at all, or that we will
complete these clinical trials. If Ampligen(R) or one of our other products does
not receive regulatory approval in the U.S. or elsewhere, our operations most
likely will be materially adversely affected.

We may continue to incur substantial losses and our future profitability is
uncertain.

We began operations in 1966 and last reported net profit from 1985
through 1987. Since 1987, we have incurred substantial operating losses, as we
pursued our clinical trial effort and expanded our efforts in Europe. As of
December 31, 2003, our accumulated deficit was $113,843,000. We have not yet
generated significant revenues from our products and may incur substantial and
increased losses in the future. We cannot assure that we will ever achieve
significant revenues from product sales or become profitable. We require, and
will continue to require, the commitment of substantial resources to develop our
products. We cannot assure that our product development efforts will be
successfully completed or that required regulatory approvals will be obtained or
that any products will be manufactured and marketed successfully, or be
profitable.

We may require additional financing which may not be available.

The development of our products will require the commitment of
substantial resources to conduct the time-consuming research, preclinical
development, and clinical trials that are necessary to bring pharmaceutical
products to market. As of December 31, 2003, we had approximately $5.3 million
in cash and short term investments. We believe that these funds plus 1) the
$3,695,000 in net proceeds from the January Debenture placement, 2) the
anticipated infusion of approximately $1.55 million in remaining net proceeds
from the October Debentures, 3) the projected net cash flow from the sale of
ALFERON N Injection(R), 4) the proceeds from licensing agreements and/or the
expected infusion of $2,000,000 in proceeds from our investors exercising their
additional investment rights should be sufficient to meet our operating cash
requirements including debt service during the 2004 fiscal year. We may need to
raise additional funds through additional equity or debt financing or from other
sources in order to complete the necessary clinical trials and the regulatory
approval processes and begin commercializing Ampligen(R) products. There can be
no assurances that we will raise adequate funds from these or other sources,
which may have a material adverse effect on our ability to develop our products.
27
In addition, if we do not timely complete the second ISI asset acquisition, our
financial condition could be materially and adversely affected (see the next
risk factor).

If we do not complete the second Interferon Sciences, Inc. asset acquisition,
our ability to generate revenues from the sale of ALFERON N Injection(R) and our
financial condition will be adversely affected.

In March, 2003 we executed two agreements with ISI to purchase certain
assets of ISI. In the first agreement we acquired ISI's inventory of ALFERON N
Injection(R) and a limited license for the production, manufacture, use,
marketing and sale of this product. Our ability to generate sustained revenues
from sales of this product is dependent, among other things, on our completing
the terms of the second agreement to acquire the balance of ISI's rights to its
product as well as ISI's production facility used to formulate and purify the
drug concentrate of ALFERON N Injection(R). If we are unable to generate
sustained revenues from the sale of this product, our financial condition could
be materially and adversely affected.

In addition, pursuant to terms of the October Debentures, we are
required to acquire ISI's facility within 90 days from January 26, 2004 and,
unless and until we acquire the facility, $1,550,000 of the proceeds from the
sale of the October Debentures will be held back. The same condition was in the
July Debentures and in the debentures issued in March 2003; however, the holders
waived this condition in both debentures. Consummation of the second agreement
requires, among other things, approval by ISI's stockholders. On March 9, 2004
ISI's stockholders approved the second asset acquisition.

Due to ongoing delays on the part of ISI, on September 23, 2003, we
commenced an action against ISI in Delaware seeking specific performance and
declaratory and injunctive relief related to the first and second asset
acquisition agreements. Our primary objectives are to compel ISI to complete the
second asset acquisition and to prevent ISI from terminating the second asset
acquisition agreement due to the passage of time. For more information on this
action, see "Item 3. Legal Proceedings." It is possible that that this lawsuit
could further delay the closing of the second asset acquisition.

Our failure to complete the acquisition within the 90 day period will
result in a technical default of the terms of the October Debentures and, absent
consent from the holders of these debentures for additional time, might result
in our having to redeem the securities. If we do not receive the additional
funds from the October Debentures as planned and, especially if we are required
to redeem these debentures, our financial condition would be materially and
adversely affected and we would probably have to reduce or possibly curtail
operational spending including some critical clinical effort. In addition,
although we have not yet completed the acquisition, we issued an aggregate of
581,761 shares to GP Strategies and the American National Red Cross, two
creditors of ISI, as partial consideration for the acquisition and we may be
required to repurchase some of the shares in the future at $1.59 per share (see
the risk factor "We have guaranteed the value of a number of shares issued and
to be issued as a result of our acquisition of assets from Interferon Sciences.
If our share price is not above $1.59 per share 12 or 24 months after the dates
of issuance of the guaranteed shares, our financial condition could be adversely
affected" below). If we do not complete the acquisition, we will look to ISI to
pay us the value of the shares that we issued to these two creditors. No
assurance can be given that we will be able to so recoup the value of these
shares.
28
We have guaranteed the value of a number of shares issued and to be issued as a
result of our acquisition of assets from Interferon Sciences. If our share price
is not above $1.59 per share 12 or 24 months after the dates of issuance of the
guaranteed shares, our financial condition could be adversely affected.

Upon the consummation of the second ISI asset acquisition, we will
issue an additional 487,028 shares to ISI. In May 2003 we issued an aggregate of
581,761 shares to two creditors of ISI. We anticipate, but cannot assure, that
we will close the second ISI asset acquisition sometime in March 2004. We have
guaranteed the value of all but 62,500 of these shares to be issued to ISI and
the creditors, to be $1.59 per share on the termination date. As of February 10,
2004, GP Strategies has sold all of its guaranteed shares. The termination dates
are 24 months after the dates of issuance and delivery of the guaranteed shares
to ISI, and 12 months after the date of issuance of the guaranteed shares to the
American National Red Cross. The guarantee relates only to those shares still
held by ISI and the American National Red Cross on the applicable termination
date. If, within 30 days after the relevant termination date, holders of the
guaranteed shares request that we honor the guarantees, we will reacquire the
holders' remaining guaranteed shares and pay the holders $1.59 per share. By way
of example, assuming that all remaining 738,993 shares are still held on the
relevant termination dates and the holders requested that we honor the
guarantees, we would be obligated to pay to ISI and the American National Red
Cross an aggregate of $1,174,999. The reported last sale price for our common
stock on the American Stock Exchange on February 18, 2004 was $4.05 per share.
If, during the 31 days commencing on the relevant termination dates, the market
price of our stock is not above $1.59 per share, we most likely would be
requested and obligated to pay the guaranteed amount on the guaranteed shares
outstanding on the relevant termination dates. We believe that the guaranteed
shares still outstanding on the relevant termination dates might be a factor of
the market price and sales volume of our common stock during the 24, and 12
month periods prior to the relevant termination date.

If the holders of the guaranteed shares do not sell a significant
amount of their guaranteed shares prior to the relevant termination dates and
the price of our common stock during the 31 day period commencing on the
relevant termination dates is not above $1.59 per share, we most likely will be
required to repurchase a significant number of guaranteed shares and our
financial condition could be materially and adversely affected.

We may not be profitable unless we can protect our patents and/or receive
approval for additional pending patents.

We need to preserve and acquire enforceable patents covering the use of
Ampligen(R) for a particular disease in order to obtain exclusive rights for the
commercial sale of Ampligen(R) for such disease. If and when we obtain all
rights to ALFERON N Injection(R), we will need to preserve and acquire
enforceable patents covering its use for a particular disease too. Our success
depends, in large part, on our ability to preserve and obtain patent protection
for our products and to obtain and preserve our trade secrets and expertise.
Certain of our know-how and technology is not patentable, particularly the
procedures for the manufacture of our drug product which are carried out
according to standard operating procedure manuals. We have been issued certain
patents including those on the use of Ampligen(R) and Ampligen(R) in combination
with certain other drugs for the treatment of HIV. We also have been issued
patents on the use of Ampligen(R) in combination with certain other drugs for
the treatment of chronic Hepatitis B virus, chronic Hepatitis C virus, and a
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patent which affords protection on the use of Ampligen(R) in patients with
Chronic Fatigue Syndrome. We have not yet been issued any patents in the United
States for the use of Ampligen(R) as a sole treatment for any of the cancers,
which we have sought to target. With regard to ALFERON N Injection(R), ISI has a
patent for natural alpha interferon produced from human peripheral blood
leukocytes and its production process and has additional patent applications
pending. We will acquire this patent and related patent applications, if and
when, we close on the second ISI asset acquisition. We cannot assure you that
any of these applications will be approved or that our competitors will not seek
and obtain patents regarding the use of our products in combination with various
other agents, for a particular target indication prior to us. If we cannot
protect our patents covering the use of our products for a particular disease,
or obtain additional pending patents, we may not be able to successfully market
our products.

The patent position of biotechnology and pharmaceutical firms is highly
uncertain and involves complex legal and factual questions.

To date, no consistent policy has emerged regarding the breadth of
protection afforded by pharmaceutical and biotechnology patents. There can be no
assurance that new patent applications relating to our products or technology
will result in patents being issued or that, if issued, such patents will afford
meaningful protection against competitors with similar technology. It is
generally anticipated that there may be significant litigation in the industry
regarding patent and intellectual property rights. Such litigation could require
substantial resources from us and we may not have the financial resources
necessary to enforce the patent rights that we hold. No assurance can be made
that our patents will provide competitive advantages for our products or will
not be successfully challenged by competitors. No assurance can be given that
patents do not exist or could not be filed which would have a materially adverse
effect on our ability to develop or market our products or to obtain or maintain
any competitive position that we may achieve with respect to our products. Our
patents also may not prevent others from developing competitive products using
related technology.

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There can be no assurance that we will be able to obtain necessary licenses if
we cannot enforce patent rights we may hold. In addition, the failure of third
parties from whom we currently license certain proprietary information or from
whom we may be required to obtain such licenses in the future, to adequately
enforce their rights to such proprietary information, could adversely affect the
value of such licenses to us.

If we cannot enforce the patent rights we currently hold we may be
required to obtain licenses from others to develop, manufacture or market our
products. There can be no assurance that we would be able to obtain any such
licenses on commercially reasonable terms, if at all. We currently license
certain proprietary information from third parties, some of which may have been
developed with government grants under circumstances where the government
maintained certain rights with respect to the proprietary information developed.
No assurances can be given that such third parties will adequately enforce any
rights they may have or that the rights, if any, retained by the government will
not adversely affect the value of our license.

There is no guarantee that our trade secrets will not be disclosed or known by
our competitors.

To protect our rights, we require certain employees and consultants to
enter into confidentiality agreements with us. There can be no assurance that
these agreements will not be breached, that we would have adequate and
enforceable remedies for any breach, or that any trade secrets of ours will not
otherwise become known or be independently developed by competitors.

If our distributors do not market our products successfully, we may not generate
significant revenues or become profitable.

We have limited marketing and sales capability. We are dependent upon
existing and, possibly future, marketing agreements and third party distribution
agreements for our products in order to generate significant revenues and become
profitable. As a result, any revenues received by us will be dependent on the
efforts of third parties, and there is no assurance that these efforts will be
successful. Our agreement with Accredo offers the potential to provide some
marketing and distribution capacity in the United States while agreements with
Bioclones (Proprietary), Ltd , Biovail Corporation and Laboratorios Del Dr.
Esteve S.A. should provide a sales force in South America, Africa, United
Kingdom, Australia and New Zealand, Canada, Spain and Portugal.

We cannot assure that our domestic or foreign marketing partners will
be able to successfully distribute our products, or that we will be able to
establish future marketing or third party distribution agreements on terms
acceptable to us, or that the cost of establishing these arrangements will not
exceed any product revenues. The failure to continue these arrangements or to
achieve other such arrangements on satisfactory terms could have a materially
adverse effect on us.

There are no long-term agreements with suppliers of required materials. If we
are unable to obtain the required raw materials, we may be required to scale
back our operations or stop manufacturing ALFERON N Injection.

A number of essential materials are used in the production of ALFERON N
Injection(R), including human white blood cells. We do not have long-term
agreements for the supply of any of such materials. There can be no assurance we
can enter into long-term supply agreements covering essential materials on
commercially reasonable terms, if at all. If we are unable to obtain the
required raw materials, we may be required to scale back our operations or stop
manufacturing ALFERON N Injection(R). The costs and availability of products and
materials we need for the commercial production of ALFERON N Injection(R) and
other products which we may commercially produce are subject to fluctuation
depending on a variety of factors beyond our control, including competitive
factors, changes in technology, and FDA and other governmental regulations and
there can be no assurance that we will be able to obtain such products and
materials on terms acceptable to us or at all.
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There is no assurance that successful manufacture of a drug on a limited scale
basis for investigational use will lead to a successful transition to
commercial, large-scale production.

Small changes in methods of manufacturing may affect the chemical
structure of Ampligen(R) and other RNA drugs, as well as their safety and
efficacy. Changes in methods of manufacture, including commercial scale-up may
affect the chemical structure of Ampligen(R) and can, among other things,
require new clinical studies and affect orphan drug status, particularly, market
exclusivity rights, if any, under the Orphan Drug Act. The transition from
limited production of pre-clinical and clinical research quantities to
production of commercial quantities of our products will involve distinct
management and technical challenges and will require additional management and
technical personnel and capital to the extent such manufacturing is not handled
by third parties. There can be no assurance that our manufacturing will b