SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

HYBRIDON, INC.

345 Vassar Street
Cambridge, Massachusetts 02139
(Address of principal executive offices)

(617) 679-5500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

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

HYBRIDON, INC.

FORM 10-Q

INDEX

Hybridon® and GEM® are our registered trademarks. Cyclicon™, IMO ™, Amplivax™ and IMOxine™ are also our trademarks. Other trademarks appearing in this quarterly report are the property of their respective owners.

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PART I — FINANCIAL STATEMENTS

ITEM 1 – UNAUDITED FINANCIAL STATEMENTS

HYBRIDON, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(UNAUDITED)

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

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HYBRIDON, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

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HYBRIDON, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

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HYBRIDON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

MARCH 31, 2004

(UNAUDITED)

(1)		Organization
		Hybridon, Inc. (the Company) was incorporated in the State of Delaware on May 25, 1989. The Company is engaged in the discovery and development of novel therapeutics and diagnostics using synthetic DNA. The Company’s activities are based on two technologies: immunomodulatory oligonucleotide (IMO) technology, which modulates responses of the immune system using synthetic DNA containing specific sequences that mimic bacterial DNA, and antisense technology, which uses synthetic DNA to block the production of disease causing proteins at the cellular level.
(2)		Unaudited Interim Financial Statements
		The accompanying consolidated condensed financial statements included herein have been prepared by the Company, without audit, in accordance with generally accepted accounting principals for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of interim period results have been included. The Company believes that its disclosures are adequate to make the information presented not misleading. Interim results for the three-month period ended March 31, 2004 are not necessarily indicative of results that may be expected for the year ended December 31, 2004. For further information, refer to the financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, which was filed with the Securities and Exchange Commission on March 23, 2004.
(3)		Pro Forma Balance Sheet
		In April 2004, the Company raised approximately $11.8 million in gross proceeds through a registered direct offering. In the offering, the Company sold 16,899,800 shares of common stock and warrants to purchase 3,041,964 shares of common stock to institutional and other investors. The warrants to purchase common stock have an exercise price of $1.14 per share and are exercisable at any time on or after October 21, 2004 and on or prior to April 20, 2009. The warrants may be exercised by cash payment only. On or after October 21, 2005, the Company may redeem the warrants if the closing sales price of the common stock for each day of any 20 consecutive trading day period ending within 30 days prior to providing notice of redemption is greater than or equal to $2.60 per share. The redemption price will be $0.01 per share of common stock underlying the warrants. The Company may exercise its right to redeem the warrants by providing 30 days prior written notice to the holders of the warrants. The net proceeds to the Company from the offering, excluding the proceeds of any future exercise of the warrants, will total approximately $10.8 million.
		On April 1, 2004, the Company’s 9% convertible subordinated notes matured. As a result, the Company paid $1,306,000 to the note holders in payment of the outstanding indebtedness plus accrued interest through the maturity date of $58,770. The Company has no additional notes outstanding.
		The unaudited pro forma balance sheet as of March 31, 2004 reflects the receipt of approximately $10.8 million of net proceeds from the common stock offering and the payment of amounts outstanding under the 9% convertible subordinated notes as if these transactions had occurred on March 31, 2004.
(4)		Net Loss per Common Share
		The following table sets forth the computation of basic and diluted loss per share:

Basic net loss per common share is computed using the weighted average number of shares of common stock outstanding during the period. For the three months ended March 31, 2004 and 2003, diluted net loss per share of common stock is the same as basic net loss per share of common stock, as the effects of the Company’s potential common stock equivalents are antidilutive. Total antidilutive securities were 24,983,929 and 34,261,704 for the three months ended March 31, 2004 and 2003, respectively. These antidilutive securities include stock options, warrants, convertible preferred stock and convertible debt instruments (on an as-converted basis) and are not included in the Company’s calculation of diluted net loss per common share.

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(5)		Cash Equivalents and Investments
		The Company considers all highly liquid investments with maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents at March 31, 2004 and December 31, 2003 consisted of cash and money market funds.
		The Company accounts for investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Management determines the appropriate classification of marketable securities at the time of purchase. In accordance with SFAS No. 115, investments that the Company does not have the positive intent to hold to maturity are classified as “available-for-sale” and reported at fair market value. Unrealized gains and losses associated with “available-for-sale” investments are recorded in “Accumulated other comprehensive gain (loss)” on the accompanying consolidated balance sheet. The amortization of premiums and accretion of discounts, and any realized gains and losses and declines in value judged to be other than temporary, and interest and dividends are included in “Investment income, net” on the accompanying consolidated statement of operations for all available-for-sale securities. The cost of securities sold is based on the specific identification method. The Company had no realized gains or losses for the three month period ended March 31, 2004. For the three month period ended March 31, 2003, the Company had $445 of realized gains included in “Investment income, net” on the accompanying consolidated statement of operations from available-for-sale securities sold in February 2003. There were no losses or permanent declines in value included in “investment income” for any securities in the three months ended March 31, 2004 and 2003.
		Available-for-sale securities are classified as short-term regardless of their maturity date if the Company has them available to fund operations within one year of the balance sheet date. Auction securities are highly liquid securities that have floating interest or dividend rates that reset periodically through an auctioning process that sets rates based on bids. Issuers include municipalities, closed-end bond funds and corporations. These securities can either be debt or preferred shares. The Company’s investments consisted of the following at March 31, 2004 and December 31, 2003:

(6)		Stock-Based Compensation Related to Repriced Options
		In September 1999, the Company’s Board of Directors authorized the repricing of options to purchase 5,251,827 shares of common stock to $0.50 per share, which represented the market value of the common stock on the date of the repricing. These options are subject to variable plan accounting which requires the Company to remeasure the intrinsic value of the repriced options, through the earlier of the date of exercise, cancellation or expiration, at each reporting date. For the three months ended March 31, 2004, the Company recognized a credit of approximately $317,000 as stock compensation from repriced options as a result of a decrease in the intrinsic value of these options between December 31, 2003 and March 31, 2004. For the three months ended March 31, 2003, the Company recognized approximately $6,000 as stock compensation expense for repriced options exercised at times when the market value per share of common stock was higher than its value at December 31, 2002. The Company did not have a charge or credit for the first quarter of 2003 for changes in intrinsic value on outstanding repriced options because the fair market value of its common stock at March 31, 2003 was the same as the fair market value of its common stock at December 31, 2002.
(7)		Series A Convertible Preferred Stock Dividend
		On December 4, 2003, the Company’s stockholders approved amendments to the Company’s Restated Certificate of Incorporation that:

•		reduced the liquidation preference of the Company’s Series A convertible preferred stock from $100 per share to $1 per share;
•		reduced the annual dividend on the Company’s Series A convertible preferred stock from 6.5% to 1%; and
•		increased the number of shares of the Company’s common stock issuable upon conversion of the Company’s Series A convertible preferred stock by 25% over the number of shares that would otherwise be issuable for a 60-day conversion

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period between December 4, 2003 and February 2, 2004 inclusive.

		As a result of these amendments, during the 60-day conversion period, the conversion ratio was increased so that the Series A convertible preferred stockholders could receive approximately 29.41 shares of common stock for each share of Series A convertible preferred stock converted instead of the stated conversion rate of 23.53 shares. The value of the additional shares issued during the 60-day conversion period was recorded as an addition to dividends in the statement of operations at the time of conversion. For the three months ended March 31, 2004 the Company recorded $3.2 million of preferred stock dividends related to the additional shares issued. During the 60-day conversion period, 99.9% of the Series A convertible preferred stock was converted to common stock.
		The combined effects of the amendments to the Company’s Restated Certificate of Incorporation and the Series A convertible preferred stock conversions are as follows:

		Dividends are payable semi-annually in arrears at the rate of 1% per annum to holders of Series A convertible preferred stock as of March 15 and September 15, at the election of the Company, either in cash or additional duly authorized, fully paid and nonassessable shares of Series A convertible preferred stock on April 1 and October 1 of each year. In the event of liquidation, dissolution or winding up of the Company, after payment of debts and other liabilities of the Company, the holders of the Series A convertible preferred stock then outstanding will be entitled to a distribution of $1 per share out of any assets available to stockholders. The Series A preferred stock is non-voting. All shares of Series A convertible preferred stock rank as to payment upon the occurrence of any liquidation event senior to the common stock. Shares of Series A preferred stock are convertible, in whole or in part, at the option of the holder into fully paid and nonassessable shares of common stock at $4.25 per share, subject to adjustment as defined.
		Through March 31, 2004, the Company has always elected to pay these dividends in stock. In calculating the number of shares to be paid with respect to each dividend, the Series A convertible preferred stock is valued at $100.00 per share. From January 1, 2004 through March 31, 2004, 488,570 shares of Series A convertible preferred stock were converted into 14,369,740 shares of the Company’s common stock at the adjusted conversion ratio. As a result of these conversions, $570,000 of dividends accreted during the year ended December 31, 2003 were reversed during the period ended March 31, 2004 because the former holders of these shares of Series A convertible preferred stock were no longer entitled to such dividends once their shares of series A convertible preferred stock were converted into common stock.
		As a result of the amendments to the Company’s Restated Certificate of Incorporation and the Series A convertible preferred stock conversions, the Series A convertible preferred stock liquidation preference was reduced from $73,055,654 at December 3, 2003 to $494,912 at December 31, 2003 and $643 at March 31, 2004.
(8)		Related Party Transactions
		In the three months ended March 31, 2003, the Company paid Pillar S.A., which is controlled by a director of the Company, $145,000 for consulting services relating to investor relations and the repurchase of the Company’s common stock from certain stockholders. Pillar has not provided consulting or any other services to the Company in the three months ended March 31, 2004.
(9)		Stock Repurchase
		On February 14, 2003, the Company repurchased 4,643,034 shares of its common stock at a price of $1.15 per share from two Middle Eastern stockholders and their affiliates. The fair market value of the common stock was $0.75 per share on the date of the transaction resulting in a premium of approximately $1,857,000 in the aggregate. The Company charged this premium to general and administrative expense in the three month period ended March 31, 2003. The repurchased stock was retired on March 13, 2003.
(10)		Stock-Based Compensation

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		The Company applies the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The Company continues to account for employee stock compensation at intrinsic value, in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations, with disclosure of the effects of fair value accounting on net income or net loss and related per share amounts on a pro forma basis.
		The pro forma effect of applying SFAS No. 123 for the three months ended March 31, 2004 and 2003 would be as follows:

The effects on the three months ended March 31, 2004 and 2003 pro forma net loss and net loss per share of expensing the estimated fair value of stock options are not necessarily representative of the effects on reported net income (loss) for the years ended December 31, 2004 and 2003 and future years because of the vesting periods of stock options and the potential for issuance of additional stock options in future periods.

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

GENERAL

     We are engaged in the discovery and development of novel therapeutics using synthetic DNA. Our activities are primarily based on two technologies:

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Our immunomodulatory oligonucleotide, or IMO, technology modulates responses of the immune system using synthetic DNA containing specific sequences that mimic bacterial DNA.

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•

Our antisense technology uses synthetic DNA to block the production of disease causing proteins at the cellular level.

     Since we began operations in February 1990, we have been involved primarily in research and development and manufacturing. To date, almost all of our revenues have been from collaborative and license agreements. In addition, we manufactured synthetic DNA and reagent products within our Hybridon Specialty Products Division, or HSP, prior to our selling HSP in September 2000.

     We have incurred total losses of $289.3 million through March 31, 2004 and expect to incur substantial operating losses in the future. In order to commercialize our therapeutic products, we need to address a number of technological challenges and to comply with comprehensive regulatory requirements. Now that we have strengthened our cash resources, we expect our research and development expenses will increase modestly for the remainder of 2004 if we move our drug candidates into Phase 2 clinical trials as we currently anticipate. We expect our general and administrative expenses for 2004 to remain at approximately the same level as in 2003, excluding for this purpose the $1.9 million charged to general and administrative expenses relating to the repurchase of shares of our common stock in February 2003.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

     This management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     Our significant accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2003. Not all of these significant accounting policies, however, require management to make difficult, complex or subjective judgments or estimates. We believe that our accounting policies relating to revenue recognition, as described under the caption “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2003, fit the definition of “critical accounting estimates and judgments.”

RESULTS OF OPERATIONS

Three Months Ended March 31, 2004 and 2003

  Alliance Revenues

     Total alliance revenues increased by $310,000, or 93%, from $335,000 for the three months ended March 31, 2003 to $645,000 for the three months ended March 31, 2004. Alliance revenue consists of revenue we receive under our collaboration and licensing agreements and in both three-month periods included research and development payments, milestone payments, license fees, sublicense fees, and royalty payments. The increase in the first quarter of 2004 was primarily attributable to increased research and development revenue associated with the supply to a collaborator of product for clinical trials.

  Research and Development Expenses

     Research and development expenses increased by $399,000, or 17%, from $2,406,000 to $2,805,000 for the three months ended March 31, 2004 compared to the same period in 2003. The increase in the first quarter of 2004 was primarily attributable to the cost of clinical supplies to be utilized under one of our collaboration and licensing agreements. Our other research and development costs in both periods relate primarily to the cost of advancing our basic IMO research and developing our IMO technology. These costs include salaries, allocated overhead, general lab supplies and patent preparation costs and related filing fees.

     Our two lead drug candidates are HYB2055 and GEM231:

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•		HYB2055 is the lead product candidate in our IMO program. We are developing HYB2055 for oncology applications under the name IMOxine. In the three months ended March 31, 2004 and 2003, we incurred approximately $0.6 million and $0.5 million, respectively, in direct external expenses to develop HYB2055. These direct expenses included costs of payments to clinical sites, independent contractors, and vendors for clinical studies and patent preparation costs and related filing fees and exclude internal costs such as payroll and overhead. IMOxine is in a phase 1 clinical trial in the United States in patients with refractory solid tumor cancers. If this trial is completed when anticipated and the results are favorable, we plan to commence a phase 2 clinical trial of IMOxine in the fall of 2004.
•		GEM231 is the lead product candidate in our antisense program. GEM231 is a 2nd generation antisense compound for the treatment of cancer. We incurred approximately $0.1 million in direct external expenses in connection with developing GEM231 in the three months ended March 31, 2004 and March 31, 2003. These direct expenses included patent preparation costs and related filing fees and costs of payments to independent contractors and vendors for clinical studies and exclude internal costs such as payroll and overhead. We are currently conducting a phase 1/2 clinical trial of GEM231 as a combination therapy with irinotecan. If the pharmacokinetic data and other findings from this phase 1/2 trial are favorable, we plan to commence a phase 2 trial using this drug combination in the second half of 2004.

     Because these projects are in early stage of development and given the technological and regulatory hurdles likely to be encountered in the development and commercialization of our products, the future timing and costs of our various research and development programs are uncertain.

  General and Administrative Expenses

     General and administrative expenses decreased by $2,327,000, or 72%, from $3,224,000 in the three months ended March 31, 2003 to $897,000 in the three months ended March 31, 2004. This decrease primarily reflects a one-time expense of $1,857,000 representing the premium over fair market value that we paid in repurchasing shares of our common stock in the first quarter of 2003 and other consulting and professional fees related to the repurchase of our common stock. The decrease also reflects higher legal fees in 2003 related to expenses incurred in our on-going patent interference proceedings. Although we are involved in these proceedings, we do not practice nor do we intend to practice the intellectual property involved in these proceedings (see “Risk Factors — Risk Relating to Intellectual Property” below). Other than the expenses incurred with respect to the stock repurchase and patent interference proceedings, general and administrative expenses in the first quarter of 2004 were relatively consistent with general and administrative expenses in the first quarter of 2003. These expenses consisted primarily of salary expense, professional legal fees associated with our regulatory filing requirements and business development.

  Stock-Based Compensation

     As a result of our repricing of our stock options in September 1999, some of our outstanding stock options are subject to variable plan accounting which requires us to measure the intrinsic value of the repriced options through the earlier of the date of exercise, cancellation or expiration at each reporting date. Operating results include a credit of approximately $317,000 for the three months ended March 31, 2004 as a result of a decrease in the intrinsic value of these options from December 31, 2003 to March 31, 2004. During the three months ended March 31, 2003, the intrinsic value of these options was unchanged, however, we recorded approximately $6,000 of expense for repriced options exercised at times when the market value per share of our common stock was higher than its value at December 31, 2002. Compensation charges and credits will likely occur in the future based upon changes in the market value of our common stock.

  Investment Income, net

     Investment income decreased by approximately $47,000, or 57%, from $83,000 in the three months ended March 31, 2003 to $36,000 in the three months ended March 31, 2004 as a result of lower interest income derived from lower cash and investment balances.

  Interest Expense

     Interest expense was constant for the three months ended March 31, 2004 and the three months ended March 31, 2003. Interest expense in both periods relates to the 9% notes which matured and were repaid in full on April 1, 2004.

  Preferred Stock Dividends

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     Accretion of preferred stock dividends increased by approximately $1,604,000, or 150%, from $1,071,000 for the three months ended March 31, 2003 to $2,675,000 for the three months ended March 31, 2004. This increase was primarily attributable to the amendment to our Restated Certificate of Incorporation approved by our stockholders on December 4, 2003 that increased the number of shares of our common stock issuable upon conversion of our series A convertible preferred stock by 25% over the number of shares that would otherwise have been issuable upon conversion during a 60-day conversion period. The value of the additional shares issued during the 60-day conversion period was recorded as an addition to dividends in the statement of operations at the time of conversion. For the three months ended March 31, 2004, we recorded $3.2 million of preferred stock dividends related to the additional shares issued. This additional $3.2 million dividend was partially offset by a reversal of $570,000 of dividends that were accreted in the fourth quarter of 2003 but will not be paid due to 2004 conversions. The amendments also reduced the liquidation preference on our series A convertible preferred stock from $100 per share to $1 per share. The liquidation preference was reduced from $73,055,654 at December 3, 2003 to $643 at March 31, 2004. All preferred stock dividends are payable, at our election, either in cash or shares of series A convertible preferred stock.

  Net Loss Applicable to Common Stockholders

     As a result of the factors discussed above, our net loss applicable to common stockholders amounted to $5,408,000 for the three months ended March 31, 2004 compared to $6,319,000 for the three months ended March 31, 2003.

LIQUIDITY AND CAPITAL RESOURCES

Sources of Liquidity

     We require cash to fund our operating expenses, to make capital expenditures and to pay debt service. Historically, we have funded our cash requirements primarily through the following:

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equity and debt financing;

•

license fees and research funding under collaborative and license agreements;

•

interest income; and

•

lease financings

We have also funded our cash requirements through the following:

•

manufacturing of synthetic DNA and reagent products by Hybridon Specialty Products, or HSP prior to its sale in 2000;

•

the sale of HSP for which we received a total of $15.0 million in 2000 and 2001; and

•

the sale of our shareholding in MethylGene Inc. for which we received a net of $6.9 million in 2001.

     In April 2004, we raised approximately $11.8 million in gross proceeds through a registered direct offering. In the offering, we sold 16,899,800 shares of common stock and warrants to purchase 3,041,964 shares of common stock to institutional and other investors. The warrants to purchase common stock have an exercise price of $1.14 per share and are exercisable at any time on or after October 21, 2004 and on or prior to April 20, 2009. The warrants may be exercised by cash payment only. On or after October 21, 2005, we may redeem the warrants if the closing sales price of the common stock for each day of any 20 consecutive trading day period ending within 30 days prior to providing notice of redemption is greater than or equal to $2.60 per share. The redemption price will be $0.01 per share of common stock underlying the warrants. We may exercise our right to redeem the warrants by providing 30 days prior written notice to the holders of the warrants. We expect that the net proceeds to us from the offering, excluding the proceeds of any future exercise of the warrants, will total approximately $10.8 million

Cash Flows

     As of March 31, 2004, we had approximately $10.3 million in cash, cash equivalents and investments, a decrease of approximately $3.4 million from December 31, 2003.

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     We used $3.4 million of cash for operating activities during the three months ended March 31, 2004, principally to fund our research and development expenses and our general and administrative expense