Emergent BioSolutions Inc. - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file number: 001-33137

EMERGENT BIOSOLUTIONS INC.

(Exact Name of Registrant as Specified in Its Charter)

(240) 631-3200

(Registrant's Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  No

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

 Large accelerated filer  Accelerated filer  Non-accelerated filer  Smaller reporting company

(Do not check if a smaller reporting company)

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

As of October 31, 2016, the registrant had 40,498,025 shares of common stock outstanding.

Emergent BioSolutions Inc.

Index to Form 10-Q

BioThrax® (Anthrax Vaccine Adsorbed), RSDL® (Reactive Skin Decontamination Lotion Kit), BAT™ [Botulism Antitoxin Heptavalent (A,B,C,D,E,F,G)-(Equine)], Anthrasil™ (Anthrax Immune Globulin Intravenous [human]), NuThrax™ (anthrax vaccine adsorbed with CPG 7909 adjuvant), PreviThrax™ (recombinant protective antigen anthrax vaccine, purified), VIGIV [Vaccinia Immune Globulin Intravenous (Human)], Emergard™ and any and all Emergent BioSolutions Inc. brands, products, services and feature names, logos and slogans are trademarks or registered trademarks of Emergent BioSolutions Inc. or its subsidiaries in the United States or other countries. All other brands, products, services and feature names or trademarks are the property of their respective owners.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements regarding the future earnings and performance of Emergent or any of its businesses, our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans and objectives of management, are forward-looking statements. We generally identify forward-looking statements by using words like "believes," "expects," "anticipates," "intends," "plans," "forecasts," "estimates" and similar expressions in conjunction with, among other things, discussions of financial performance or financial condition, growth strategy, product sales, manufacturing capabilities, product development, regulatory approvals or expenditures. These forward-looking statements are based on our current intentions, beliefs and expectations regarding future events. We cannot guarantee that any forward-looking statement will be accurate. You should realize that if underlying assumptions prove inaccurate or unknown risks or uncertainties materialize, actual results could differ materially from our expectations. You are, therefore, cautioned not to place undue reliance on any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we do not undertake to update any forward-looking statement to reflect new information, events or circumstances.

There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements, including, among others:



appropriations for the procurement of BioThrax® (Anthrax Vaccine Adsorbed) and our other countermeasure products;

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our ability to perform under our contracts with the U.S. government related to BioThrax, including the timing of deliveries;

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our ability to obtain a new procurement contract for BioThrax on favorable terms;

§

our ability to obtain Emergency Use Authorization pre-approval for NuThrax from the FDA;

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the availability of funding for our U.S. government grants and contracts;

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our ability to successfully execute our growth strategy and achieve our financial and operational goals;

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our ability to successfully integrate and develop the products or product candidates, programs, operations and personnel of any entities or businesses that we acquire;

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our ability to utilize the full manufacturing capacity of Building 55, our large-scale vaccine manufacturing facility in Lansing, Michigan;

§

whether the operational, marketing and strategic benefits of the spin-off of our biosciences business can be achieved and the timing of any such benefits;

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

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our ability to realize synergies and benefits from acquisitions or in-licenses within expected time periods or at all;

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our ability to successfully identify and respond to new development contracts with the U.S. government, as well as successfully maintain, through achievement of development milestones, current development contracts with the U.S. government;

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our ability to obtain and maintain intellectual property protection for our products and product candidates;

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our ability and plans to expand our manufacturing facilities and capabilities;

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our ability and the ability of our contractors and suppliers to maintain compliance with cGMP and other regulatory obligations;

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the results of regulatory inspections;

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the operating and financial restrictions placed on us and our subsidiaries under our senior secured credit facility;

§

the outcome of the purported class action lawsuit filed against us and possible other future material legal proceedings;

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

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the success of our ongoing and planned development programs, non-clinical activities and clinical trials of our product candidates;

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

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the success of our commercialization, marketing and manufacturing capabilities and strategy; and

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the accuracy of our estimates regarding future revenues, expenses, capital requirements and needs for additional financing.

The foregoing sets forth many, but not all, of the factors that could cause actual results to differ from our expectations in any forward-looking statement. New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. You should consider this cautionary statement, the risk factors identified in the section entitled "Risk Factors" in this quarterly report on Form 10-Q and the risk factors identified in our other periodic reports filed with the Securities and Exchange Commission when evaluating our forward-looking statements.

PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

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

(1) See Note 10 "Earnings per share" for details on calculation.

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

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

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

EMERGENT BIOSOLUTIONS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Basis of presentation and consolidation

On August 6, 2015, Emergent BioSolutions Inc. (the "Company" or "Emergent"), announced its plan to separate into two independent publicly-traded companies. On August 1, 2016, the Company accomplished this plan through the completion of the spin-off of Aptevo Therapeutics Inc. ("Aptevo"), a biotechnology company focused on novel oncology and hematology therapeutics to meaningfully improve patients' lives. Emergent remains as a global specialty life sciences company focused on providing specialty products for civilian and military populations that address intentional and naturally emerging public health threats.

In anticipation of the spin-off, the Company realigned certain components of its biosciences business to the new Aptevo segment to be consistent with how the Company's chief operating decision maker ("CODM") allocates resources and makes decisions about the operations of the Company. Effective January 1, 2016, the Company changed its segment presentation to reflect this new structure, and recast all prior periods presented to conform to the new presentation. On August 1, 2016, the Company completed the spin-off of Aptevo. Aptevo is now an independent public company trading under the symbol "APVO" on the NASDAQ Global Select Market ("NASDAQ"). The results of operations and financial position of Aptevo are reflected as discontinued operations for all periods presented through the date of the spin-off. The historical financial statements and footnotes have been revised accordingly. See Note 2. "Discontinued operations" for further details regarding the spin-off. For periods following the spin-off, the Company reports financial results under one business segment.

The accompanying unaudited consolidated financial statements include the accounts of Emergent and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC.

During the nine months ended September 30, 2016 there have been no significant changes to the Company's summary of significant accounting policies contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC. In the opinion of the Company's management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, except for the adjustments associated with the spin-off of Aptevo, and are necessary to present fairly the financial position of the Company as of September 30, 2016, specifically: the results of operations and comprehensive income for the three and nine months ended September 30, 2016 and 2015; and cash flows for the nine months ended September 30, 2016 and 2015. Interim results are not necessarily indicative of results that may be expected for any other interim period or for an entire year.

We analyze our multiple element revenue-generating arrangements to determine whether the elements can be separated and accounted for individually as separate units of accounting. An item can generally be considered a separate unit of accounting if both of the following criteria are met: (1) the delivered item(s) has value to the customer on a stand-alone basis and (2) if the arrangement includes a general right of return and delivery or performance of the undelivered item(s) is considered probable and substantially in our control. Items that cannot be divided into separate units are combined with other units of accounting, as appropriate. Consideration received is allocated among the separate units based on the unit's relative selling price and is recognized in full when the appropriate revenue recognition criteria are met. We deem services to be rendered if no continuing obligation exists on our part. As of September 30, 2016, the Company has determined that its US Government contracts for Anthrasil™ (Anthrax Immune Globulin Intravenous (Human), BAT™ (Botulism Antitoxin Heptavalent (A,B,C,D,E,F,G)-Equine and VIGIV (Vaccinia Immune Globulin Intravenous (Human)) are multiple element arrangements.

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU No. 2014-08"). ASU No. 2014-08 limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity's operations and financial results. ASU No. 2014-08 also requires expanded disclosures for discontinued operations and disposals of individually significant components of an entity that do not qualify for discontinued operations reporting. ASU No. 2014-08 was effective for disposals and components classified as held-for-sale that occurred within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption was permitted. The new guidance is effective for the Company prospectively for all disposals of components of an entity that occurred after January 1, 2015. The spin-off of Aptevo by the Company on August 1, 2016 meets the definition of a discontinued operation under the new guidance and, as a result, the Company reflected the provisions of the new guidance in the third quarter of 2016.

In May 2014, the FASB issued ASU No. 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40). ASU No. 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, as well as most industry-specific guidance, and significantly enhances comparability of revenue recognition practices across entities and industries by providing a principles-based, comprehensive framework for addressing revenue recognition issues. In order for a provider of promised goods or services to recognize as revenue the consideration that it expects to receive in exchange for the promised goods or services, the provider should apply the following five steps: (1) identify the contract with a customer(s); (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU No. 2014-09 also specifies the accounting for some costs to obtain or fulfill a contract with a customer and provides enhanced disclosure requirements. The FASB has deferred ASU No. 2014-09 for one year, and with that deferral, the standard will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, which for the Company will be its 2018 first quarter. The Company is permitted to use either the retrospective or the modified retrospective method when adopting ASU No. 2014-09. The Company is still assessing the potential impact that ASU No. 2014-09 will have on its financial statements and disclosures, but believes that there could be changes to the revenue recognition for government contracts.

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30), which simplifies the presentation of debt issuance costs. ASU No. 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as an asset on the balance sheet. ASU No. 2015-03 is effective for interim and annual periods beginning after December 15, 2015. The Company has adopted the guidance and has applied the guidance on a retrospective basis.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718). ASU No. 2016-09 simplifies several aspects of the accounting for share-based payment award transactions, including: (1) the income tax consequences, (2) classification of awards as either equity or liabilities, and (3) classification on the statement of cash flows. ASU No. 2016-09 is effective for the annual reporting period beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU No. 2016-09 will have on the consolidated financial statements and related disclosures.

2. Discontinued operations

On August 1, 2016, the Company completed the spin-off of Aptevo through the distribution of 100% of the outstanding shares of common stock of Aptevo to the Company's shareholders (the "Distribution"). The Distribution was made to the Company's shareholders of record as of the close of business on July 22, 2016 (the "Record Date"), who received one share of Aptevo common stock for every two shares of Emergent common stock held as of the Record Date. The Distribution was intended to qualify as a tax-free distribution for federal income tax purposes in the United States. In the aggregate, approximately 20.2 million shares of Aptevo common stock were distributed to the Company's shareholders of record as of the Record Date in the Distribution. After the Distribution, the Company no longer holds shares of Aptevo's common stock. In addition, on August 1, 2016, the Company entered into a non-negotiable, unsecured promissory note with Aptevo to provide an additional $20 million in funding within six to twelve months following the Distribution.

The historical balance sheet and statements of operations of Aptevo have been presented as discontinued operations in the consolidated financial statements and prior periods have been restated. Discontinued operations include results of Aptevo's business except for certain allocated corporate overhead costs and certain costs associated with transition services provided by the Company to Aptevo. These allocated costs remain part of continuing operations. Due to differences between the basis of presentation for discontinued operations and the basis of presentation as a stand-alone company, the financial results of Aptevo included within discontinued operations for the Company may not be indicative of actual financial results of Aptevo.

In conjunction with the spin-off, the Company entered into a Separation and Distribution Agreement with Aptevo to effect the separation of Aptevo from the Company (the "Separation"). The Company also entered into various other agreements to provide a framework for its relationship with Aptevo after the Separation, including a manufacturing services agreement, transition services agreement, a tax matters agreement and an employee matters agreement.

The Separation and Distribution Agreement with Aptevo sets forth, among other things, the assets that were transferred, the liabilities assumed, and the contracts that were assigned to each of Aptevo and the Company as part of the Separation of the Company into two companies, and provided for when and how these transfers, assumptions and assignments were to occur.

Under the terms of the manufacturing services agreement, the Company agreed to provide contract manufacturing services for certain of Aptevo's products commencing on the date of the Distribution. The contract has a term of ten years. For the three and nine months ended September 30, 2016, there has been no revenue under this agreement.

Under the terms of the transition services agreement, the Company agreed to provide on an interim, transitional basis, various services, including, but not limited to, accounts payable administration, information technology services, regulatory and clinical support, general administrative services and other support services commencing on the date of the Distribution and terminating up to two years following the date of the Distribution. During the three and nine months ended September 30, 2016, approximately $0.5 million of transition services revenue associated with the provision of services to Aptevo.

The tax matters agreement governs the respective rights, responsibilities and obligations of Aptevo and the Company with respect to taxes (including taxes arising in the ordinary course of business and taxes, if any, incurred as a result of any failure of the Distribution and certain related transactions to qualify as tax-free for U.S. federal income tax purposes), tax attributes, tax returns, tax proceedings and certain other tax matters.

The employee matters agreement governs certain compensation and employee benefit obligations and allocates liabilities and responsibilities relating to employment matters, employee compensation and benefit plans and programs and other related matters, including the transfer or assignment of employees from the Company to Aptevo.

The following table represents the carrying value of Aptevo's assets and liabilities distributed as part of the Separation on August 1, 2016:

The following table represents Aptevo's assets and liabilities presented as discontinued operations and classified as held-for-disposition as of December 31, 2015:

The following table summarizes results from discontinued operations of Aptevo included in the consolidated statements of operations:

The following table summarizes the cash flows of Aptevo included in the September 30, 2016 and 2015 consolidated statements of cash flows:

The following table represents the Company's fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis:

(1) Included in cash and cash equivalents in the accompanying consolidated balance sheets.

During the nine months ended September 30, 2016, the Company did not have any transfers between Level 1 and Level 2 assets or liabilities.

For the three months ended September 30, 2016, the contingent consideration obligation associated with the EV-035 series of molecules increased by $0.1 million. For the nine months ended September 30, 2016, the contingent consideration obligation associated with the EV-035 series of molecules decreased by $0.3 million. For the three and nine months ended September 30, 2015, the contingent consideration obligation decreased by $9.9 million and $9.5 million, respectively. These changes are primarily due to the estimated timing and probability of success for certain development and regulatory milestones and the estimated timing and volume of potential future sales of the EV-035 series of molecules and the broad spectrum antiviral platform, which are inputs that have no observable market (Level 3), along with the novation of the Defense Threat Reduction Agency ("DTRA") contract for the EV-035 series of molecules. These decreases and increases in the contingent consideration were classified in the Company's statement of operations as both selling, general and administrative expense and research and development expense. During the nine months ended September 30, 2015, the Company received novation of the DTRA contract and paid the $4.0 million milestone to Evolva in the second quarter of 2015.

 For the three and nine months ended September 30, 2016, the contingent purchase consideration obligations associated with RSDL decreased by $2.3 million and $1.0 million, respectively. For the three and nine months ended September 30, 2015, the contingent consideration obligations associated with RSDL decreased by $1.9 million and $1.8 million, respectively. The fair value of the RSDL contingent consideration obligations decreased as a result of management's assessment of the assumed and actual achievement of future net sales, which are inputs that have no observable market (Level 3). These changes are classified in the Company's statement of operations as cost of product sales and contract manufacturing.

The following table is a reconciliation of the beginning and ending balance of the liabilities, consisting only of contingent consideration, measured at fair value using significant unobservable inputs (Level 3) during the nine months ended September 30, 2016.

Separate disclosure is required for assets and liabilities measured at fair value on a recurring basis from those measured at fair value on a non-recurring basis. As of September 30, 2016, the in-process research and development asset for the EV-035 series of molecules was measured at fair value on a non-recurring basis.

Inventories consisted of the following:

5. Property, plant and equipment

Property, plant and equipment consisted of the following:

Intangible assets consisted of the following:

In September 2015, the Company received data for the leading molecule in the EV-035 series of molecules, GC-072, that indicated a potential toxicity issue. The Company considered this information an indicator of impairment of the related EV-035 series of molecules in-process research and development ("IPR&D") asset, and completed an impairment assessment of this asset. Based on this assessment, the Company recorded a non-cash impairment charge of $9.8 million, which is included in the Company's statement of operations as research and development expense. The impairment assessment was performed using the income approach which discounts expected future cash flows to present value. The projected cash flows for the EV-035 series of molecules were based on key assumptions including: estimates of revenues and operating profits considering its stage of development; the time and resources needed to complete the development and approval of the product candidate; the life of the potential commercialized product and associated risks, including the inherent difficulties and uncertainties in developing a product candidate, such as obtaining marketing approval from the FDA and other regulatory agencies; and risks related to the viability of and potential for alternative treatments in any future target markets.

For the three months ended September 30, 2016 and 2015, the Company recorded amortization expense of $1.7 million and $1.8 million, respectively. For the nine months ended September 30, 2016 and 2015, the Company recorded amortization expense of $5.3 million and $5.5 million, respectively, for intangible assets, which has been recorded in operating expenses, specifically selling, general and administrative and cost of product sales and contract manufacturing. As of September 30, 2016, the weighted average amortization period remaining for intangible assets is 78 months.

7. Long-term debt

As of December 31, 2015, the Company reclassified debt issuance costs of $1.2 million and $4.9 million from prepaid expenses and other current assets and other assets, respectively, as a reduction to long-term debt.

On January 29, 2014, the Company issued $250.0 million aggregate principal amount of 2.875% Convertible Senior Notes due 2021 (the "Notes"). The Notes mature on January 15, 2021, unless earlier purchased by the Company or converted. The original conversion rate was equal to 30.8821 shares of common stock per $1,000 principal amount of notes (which is equivalent to a conversion price of approximately $32.38 per share of common stock). The conversion rate is subject to adjustment upon the occurrence of certain specified events but will not be adjusted for accrued and unpaid interest. As of August 1, 2016, certain conversion features were triggered due to the completion of the Aptevo spin-off. The conversion rate under the Notes was adjusted in accordance with the terms of the indenture. Effective August 12, 2016, the conversion rate was adjusted to 32.3860 shares of common stock per $1,000 principal amount of notes (which is equivalent to a conversion price of approximately $30.88 per share of common stock).

As of September 30, 2016, the Company had two stock-based employee compensation plans, the Fourth Amended and Restated Emergent BioSolutions Inc. 2006 Stock Incentive Plan (the "2006 Plan") and the Emergent BioSolutions Employee Stock Option Plan (the "2004 Plan"). The Company refers to both plans together as the "Emergent Plans." On May 19, 2016, at the Company's annual meeting, the Company's shareholders approved the Fourth Amended and Restated Emergent BioSolutions Inc. 2006 Stock Incentive Plan, and the issuance of 3.8 million shares thereunder. In addition, the Company's shareholders approved an increase in the number of authorized shares of common stock to 200 million shares from 100 million shares.

In connection with the Separation, on August 1, 2016 and in accordance with the employee matters agreement and the Emergent Plans, the Company made certain adjustments to the exercise price and number of equity awards. Continuing Emergent employees with equity awards issued prior to Distribution received an equitable adjustment reflecting a revised exercise price and number of equity awards granted. Continuing Aptevo employees who had been granted Emergent equity awards had their grants canceled and reissued as Aptevo equity awards with an adjusted exercise price.

The following is a summary of stock option award activity:

The following is a summary of restricted stock unit award activity:

On July 14, 2016, the Company's board of directors authorized management to repurchase, from time to time, up to an aggregate of $50 million of the Company's common stock under a board-approved share repurchase program. The timing, amount, and price of any repurchases will be made pursuant to one or more 10b5-1 plans. The term of the board authorization of the repurchase program is until December 31, 2017. The plan will permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The repurchase program may be suspended or discontinued at any time. Any repurchased shares will be available for use in connection with the Company's stock plans and for other corporate purposes. As of September 30, 2016, the Company has neither implemented a repurchase plan nor repurchased any shares under this program.

9. Income taxes

The estimated effective annual tax rate for continued operations, which excludes discrete adjustments, was 37% and 29%, respectively, for the nine months ended September 30, 2016 and 2015. The increase in the estimated effective annual tax rate on continuing operations was primarily related to tax on the sale, within the Emergent consolidated group, of assets from Canadian subsidiaries to U.S. subsidiaries in preparation of the spin-off of Aptevo and a valuation allowance charge related to Aptevo net deferred tax assets prior to the Distribution, partially offset by a release of valuation allowances associated with Canadian Scientific Research and Experimental Development tax credits.

10. Earnings per share

The following table presents the calculation of basic and diluted net income (loss) per share:

For the three and nine months ended September 30, 2016 and 2015, basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period.

For the three and nine months ended September 30, 2016 and 2015, diluted earnings per share is computed using the "if-converted" method by dividing the net income adjusted for interest expense and amortization of debt issuance cost, both net of tax, associated with the Company's Notes by the weighted average number of shares of common stock outstanding during the period. The weighted average number of shares is adjusted for the potential dilutive effect of the exercise of stock options and the vesting of restricted stock units along with the assumption of the conversion of the Notes, at the beginning of the period.

For the three months ended September 30, 2016, approximately 0.4 million stock options were excluded from the calculation of diluted earnings per share. For the three and nine months ended September 30, 2015, along with the nine months ended September 30, 2016, substantially all of the outstanding stock options to purchase shares of common stock were included in the calculation of diluted earnings per share.

11. Restructuring

In August 2016, the Company adopted a plan to restructure and reprioritize the operations of one of our facilities at the Emergent BioDefense Operations Lansing LLC ("EBOL") site due to the Company's large-scale manufacturing facility at EBOL commencing manufacturing operations. Severance and other related costs and asset-related charges are reflected within the Company's consolidated statement of income as a component of selling, general and administrative expense.

The Company has completed this restructuring. The costs of the restructuring as of September 30, 2016 are detailed below:

During the nine months ended September 30, 2016, the Company abandoned certain equipment and associated assets at its EBOL facility related to the manufacturing process at Building 12 ("manufacturing process") asset group. The Company recorded a charge for the manufacturing process asset group of $3.7 million. The additional expense is classified in the Company's statements of operations as selling, general and administrative expense. As of September 30, 2016, the Company has determined that there were no indications of impairment for the remaining assets groups at the EBOL site.

The following is a summary of the activity for the liabilities related to the EBOL restructuring:

In addition to the above restructuring costs, the Company also recorded a charge of $1.7 million during the nine months ended September 30, 2016 related to retention payments for certain employees at the EBOL site.

12. Related party transactions

In November 2015, the Company entered into a consulting arrangement with a member of the Company's Board of Directors, amended in July 2016, to provide assistance in connection with the planned spin-off of Aptevo. The total compensation under the agreement was approximately $0.2 million. The consulting agreement terminated on August 1, 2016.

13. Segment information

On August 6, 2015, the Company announced its plan to separate into two independent publicly-traded companies.  In anticipation of the spin-off, the Company realigned certain components of its biosciences business to the new Aptevo segment to be consistent with how the CODM allocates resources and makes decisions about the operations of the Company. Effective January 1, 2016, the Company changed its segment presentation to reflect this new structure, and recast all prior periods presented to conform to the new presentation. On August 1, 2016, the Company completed the spin-off of Aptevo. The results of operations and financial position of Aptevo are reflected as discontinued operations for all periods presented through the date of the spin-off.

For financial reporting purposes, in the periods following the spin-off of Aptevo, the Company reports financial information for one business segment.

For the three and nine months ended September 30, 2016 and 2015, substantially all of the Company's revenues are from the United States government.

14. Litigation

On July 19, 2016, Plaintiff William Sponn, or Sponn, filed a putative class action complaint in the United States District Court for the District of Maryland on behalf of purchasers of the Company's common stock between January 11, 2016 and June 21, 2016, inclusive, or the Class Period, seeking to pursue remedies under the Securities Exchange Act of 1934 against the Company and certain of its senior officers and directors, collectively, the Defendants. The complaint alleges, among other things, that the Company made materially false and misleading statements about the government's demand for BioThrax and expectations that the Company's five-year exclusive procurement contract with HHS would be renewed and omitted certain material facts. Sponn is seeking unspecified damages, including legal costs. On October 25, 2016 the Court added City of Cape Coral Municipal Firefighters' Retirement Plan and City of Sunrise Police Officers' Retirement Plan as plaintiffs and appointed them Lead Plaintiffs and Robins Geller Rudman & Dowd LLP as Lead Counsel. The Defendants believe that the allegations in the complaint are without merit and intend to defend themselves vigorously against those claims. As of the date of this filing, the range of potential loss cannot be determined or estimated.

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

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

Product Portfolio

Emergent BioSolutions Inc., or Emergent, is a specialty biopharmaceutical business focused on countermeasures that address public health threats, specifically Chemical, Biological, Radiological, Nuclear and Explosive, or CBRNE, threats as well as emerging infectious diseases, or EID. The U.S. government is the primary purchaser of our products and historically provided us with substantial funding for the development of our product candidates. We develop, manufacture, and deliver a portfolio of medical countermeasures primarily for government agencies in the areas of biological and chemical threats and emerging infectious diseases. Operations include manufacturing, regulatory affairs, quality assurance, quality control, international sales and marketing, and domestic government affairs in support of our marketed products, as well as product development and manufacturing infrastructure in support of our investigational stage product candidates.

On August 1, 2016, we completed the spin-off of Aptevo Therapeutics Inc., or Aptevo. As a result of the spin-off, the operating results of Aptevo have been reflected as discontinued operations for the three and nine months ended September 30, 2016 and 2015. See Note 2. "Discontinued Operations" for further details regarding the spin-off. Unless otherwise stated, financial results herein reflect continuing operations.

Our portfolio consists of the following marketed products and investigational stage product candidates.

Our marketed products are:

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BioThrax® (Anthrax Vaccine Adsorbed), the only vaccine licensed by the U.S. Food and Drug Administration, or the FDA, for the general use prophylaxis and post-exposure prophylaxis of anthrax disease;

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Anthrasil™ (Anthrax Immune Globulin Intravenous (Human)), the only polyclonal antibody therapeutic licensed by the FDA for the treatment of inhalational anthrax;

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BAT™ (Botulism Antitoxin Heptavalent (A,B,C,D,E,F,G)-Equine), the only heptavalent therapeutic licensed by the FDA for the treatment of botulinum disease;

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VIGIV (Vaccinia Immune Globulin Intravenous (Human)), the only therapeutic licensed by the FDA to address adverse events from smallpox vaccination; and

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RSDL® (Reactive Skin Decontamination Lotion Kit), the only device cleared by the FDA for the removal or neutralization of chemical agents, T-2 toxin and many pesticide-related chemicals from the skin.

Our investigational stage product candidates are:

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NuThrax™ (anthrax vaccine adsorbed with CPG 7909 adjuvant), a next generation anthrax vaccine;

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UV-4B, a novel antiviral being developed for dengue and influenza infections;

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GC-072, the lead compound in the EV-035 series of broad spectrum antibiotics, being developed for Burkholderia pseudomallei;

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VAX161C, a recombinant pandemic influenza vaccine candidate being developed by VaxInnate, Inc. and for which we have an exclusive license agreement to manufacture and sell in the event of a surge order from the Biomedical Advanced Research and Development Authority, or BARDA; and

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Other product candidates that are focused on public health threats and emerging infectious diseases.

A unique attribute of our investigational stage product portfolio is that most of our candidates are under an active development contract with significant funding from the U.S. government. This allows our development pipeline, along with our marketed products, to be aligned with the strategic priorities of our U.S. and allied foreign government customers.

We also have programs that leverage our proven manufacturing infrastructure and expertise.  We have responded to specific Task Order Requests issued by BARDA for the development and manufacture of specific countermeasures as part of our Center for Innovation in Advanced Development and Manufacturing, or CIADM, program focused on imminent public health threats, including pandemic influenza and Ebola. On June 27, 2016, we received a task order from BARDA to develop and manufacture three cGMP lots of Zika vaccine for use in a Phase 1 clinical trial. Using a base vaccine candidate provided by BARDA, we will conduct technology transfer of process materials and information, process and analytical method development, execute small-scale production runs, and perform cGMP cell banking leading to cGMP manufacture of bulk drug substance and final drug product. The task order consists of a 30-month base period valued at $17.9 million and includes options that, if executed, will bring the total value to up to $21.9 million.

We also have multiple platform technologies, including the MVAtor™ (modified vaccinia virus Ankara vector) platform technology and Emergard™, a military-grade auto-injector device designed for intramuscular self-injection of antidotes and other emergency response medical treatments that can address exposure to certain chemical agents and other similar emerging threats and our hyperimmune specialty plasma product manufacturing platform. In February 2016, we announced that Emergard was selected by the U.S. Department of Defense, or DoD, and Battelle Memorial Institute to be tested against and developed to U.S. military specifications as a platform for nerve agent antidote delivery. Initial development and testing of Emergard is expected to be completed in 2016 and, if successful, could lead to Emergard's future procurement for U.S. military and emergency responder use. The testing and development of Emergard will be performed under a subcontract with Battelle, which in turn has a prime contract with the DoD.

In addition, we provide contract manufacturing services to third-party customers. The majority of these services are performed at our facilities located in Baltimore, Maryland. At these facilities we perform pharmaceutical product development and filling services for injectable and other sterile products, as well as process design, technical transfer, manufacturing validation, laboratory support, aseptic filling, lyophilization, final packaging and accelerated and ongoing stability studies. We manufacture both vial and pre-filled syringe formats for a wide variety of drug products - small molecule and biological - in all stages of development and commercialization, including 20 licensed products, which are currently sold in more than 40 countries. This facility produces finished units of clinical and commercial drugs for a variety of customers ranging from small biopharmaceutical companies to major multinationals. The facility is an approved manufacturing facility under the regulatory regimes in the United States, Canada, Japan, Brazil, the Middle East and several countries in the European Union.

We have derived the majority of our historical product sales revenues from BioThrax sales to the U.S. government. We are focused on increasing the sales of our products to U.S. government customers and expanding the market for our product portfolio to other customers domestically and internationally. We are currently a party to a contract with the Centers for Disease Control and Prevention, or the CDC, an operating division of the U.S. Department of Health and Human Services, or HHS, to supply up to 44.75 million doses of BioThrax for the placement into the Strategic National Stockpile, or SNS, over a five-year period, which was scheduled to expire on September 30, 2016. On September 21, 2016, the CDC exercised an option to procure all remaining BioThrax doses under this contract, thereby committing to take delivery of the full 44.75 million doses and granted a no-cost extension to enable delivery of the remaining doses. We completed the delivery of doses under this no-cost extension in October 2016.

On June 21, 2016, HHS issued a Sole Source Notification indicating its intention to award Emergent a follow-on contract for the purchase of 29.4 million doses of BioThrax with a period of performance of five years. The solicitation does not state the number of doses expected to be procured per year, but represents a smaller annual procurement on average over the five-year period of the anticipated follow-on contract than under our current contract. The terms of the anticipated contract, including the price per dose and the timing of deliveries, remain subject to contract negotiation. In addition, the procurement of doses of BioThrax by the CDC remains subject to the availability of funding.

On August 10, 2016, the CDC exercised a contract option valued at $11.6 million over 12 months for the supply of Vaccinia Immune Globulin, or VIGIV, into the SNS. VIGIV is a therapeutic licensed by the FDA, for the treatment of complications arising from smallpox vaccinations. The contract option will require us to conduct manufacturing runs and additional activities in support of maintaining FDA licensure of VIGIV.

On September 30, 2016, we were awarded a multi-year contract with BARDA for the advanced development and delivery of NuThrax. The contract, valued at up to approximately $1.6 billion, consists of a five-year base period of performance valued at approximately $200 million to develop NuThrax for post-exposure prophylaxis of anthrax disease and to deliver to the SNS an initial two million doses following Emergency Use Authorization, or EUA, pre-approval by the FDA. We anticipate that the FDA could authorize NuThrax for emergency use as early as 2018, triggering deliveries of NuThrax to the SNS in 2019. The contract also includes procurement options for the delivery of an additional 7.5 million to 50 million doses of NuThrax to the SNS, valued from approximately $255 million to up to $1.4 billion, respectively, and options for an additional clinical study and post-marketing commitments valued at $48 million, which if both were to be exercised in full, would increase the total contract value to up to $1.6 billion.

Litigation

On July 19, 2016, Plaintiff William Sponn, or Sponn, filed a putative class action complaint in the United States District Court for the District of Maryland on behalf of purchasers of our common stock between January 11, 2016 and June 21, 2016, inclusive, or the Class Period, seeking to pursue remedies under the Securities Exchange Act of 1934 against us and certain of our senior officers and directors, collectively, the Defendants. The complaint alleges, among other things, that we made materially false and misleading statements about the government's demand for BioThrax and expectations that our five-year exclusive procurement contract with HHS would be renewed and omitted certain material facts. Sponn is seeking unspecified damages, including legal costs. On October 25, 2016 the Court added City of Cape Coral Municipal Firefighters' Retirement Plan and City of Sunrise Police Officers' Retirement Plan as plaintiffs and appointed them Lead Plaintiffs and Robins Geller Rudman & Dowd LLP as Lead Counsel.

Revenues

Effective September 30, 2011, we entered into a contract with the CDC to supply up to 44.75 million doses of BioThrax to the CDC over a five-year period from September 30, 2011 through September 30, 2016. On September 21, 2016, the CDC exercised an option to procure all remaining BioThrax doses, thereby committing to take delivery of the full 44.75 million doses under this contract and granted a no-cost extension to enable delivery of the remaining doses to be completed by November 30, 2016. Through September 30, 2016, we have approximately 1.0 million doses remaining to deliver under this contract, which were delivered in October 2016.

We have received contract and grant funding from BARDA, the CDC, Defense Threat Reduction Agency, or DTRA, and National Institute of Allergy and Infectious Diseases, or NIAID, for the following development programs:

Our revenue, operating results and profitability have varied, and we expect that they will continue to vary on a quarterly basis, primarily due to the timing of sales of our products and timing of work completed under existing and new grants, development contracts and collaborative relationships.

Cost of Product Sales and Contract Manufacturing

The primary expense that we incur to deliver to our customers our marketed vaccines and therapeutics and to perform for our customers our contract manufacturing operations is manufacturing costs consisting of fixed and variable costs. Variable manufacturing costs consist primarily of costs for materials and personnel-related expenses for direct and indirect manufacturing support staff, contract manufacturing and filling operations, and sales-based royalties. Fixed manufacturing costs include facilities, utilities and amortization of intangible assets. We determine the cost of product sales for products sold during a reporting period based on the average manufacturing cost per unit in the period those units were manufactured. In addition to the fixed and variable manufacturing costs described above, the cost of product sales depends on utilization of available manufacturing capacity.

The primary expense that we incur to deliver our medical devices to our customers is the cost per unit of production from our third-party contract manufacturers. Other associated expenses include sales-based royalties, amortization of intangible assets, shipping, logistics and the cost of support functions.

Research and Development Expenses

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

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personnel-related expenses;

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fees to professional service providers for, among other things, analytical testing, independent monitoring or other administration of our clinical trials and obtaining and evaluating data from our clinical trials and non-clinical studies;

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costs of contract manufacturing services for clinical trial material; and

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costs of materials used in clinical trials and research and development.

We intend to focus our product development efforts on promising late-stage candidates that we believe satisfy well-defined criteria and seek to utilize collaborations or non-dilutive funding. We plan to seek funding for development activities from external sources and third parties, such as governments and non-governmental organizations, or through collaborative partnerships. We expect our research and development spending will be dependent upon such factors as the results from our clinical trials, the availability of reimbursement of research and development spending, the number of product candidates under development, the size, structure and duration of any clinical programs that we may initiate, the costs associated with manufacturing our product candidates on a large-scale basis for later stage clinical trials, and our ability to use or rely on data generated by government agencies, such as studies involving BioThrax conducted by the CDC.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of personnel-related costs and professional fees in support of our executive, sales and marketing, business development, government affairs, finance, accounting, information technology, legal and human resource functions. Other costs include facility costs not otherwise included in cost of product sales and contract manufacturing or research and development expense.

There have been no significant changes to our Critical Accounting Policies and Estimates during the nine months ended September 30, 2016,. Refer to the Critical Accounting Policies and Estimates section in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission.

Results of Operations

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

Revenues

Product Sales:

      The decrease in BioThrax sales was primarily due to the timing of deliveries to the SNS. The decrease in other product sales was primarily due to the timing of BAT sales to the SNS.

Contract Manufacturing:

The increase in Contract manufacturing is primarily due to the timing of fill/finish services provided to third parties.

Contracts and grants:

The increase in Contracts and grants was primarily due to:

§

increased development funding of $6.9 million related to our CIADM program, including $3.2 million from new CIADM task orders;

§

increased development funding of $3.8 million for NuThrax related to non-clinical studies and manufacturing activities; and

§

increased development funding of $3.3 million for VIGIV related to plasma collection.

These increases were partially offset by:

§

decreased development funding of $5.7 million for Anthrasil related to the timing of plasma collection; and

§

decreased development funding of $5.2 million for large scale manufacturing of BioThrax due to our Building 55 facility receiving FDA approval in August 2016.

Cost of Product Sales and Contract Manufacturing

Cost of product sales and contract manufacturing increased by $4.4 million, or 13%, to $39.6 million for the three months ended September 30, 2016 from $35.2 million for the three months ended September 30, 2015. The increase was attributable to an increase in BioThrax sales to the SNS along with an increase in the BioThrax cost per dose sold associated with lower production yield in the period in which the doses sold were produced, partially offset by a decrease in BioThrax sales to the SNS. In addition, the increase is due to an increase in costs associated with underutilized manufacturing capacity at our Winnipeg site.

Research and Development Expenses

Research and development expenses decreased by $7.0 million, or 20%, to $27.2 million for the three months ended September 30, 2016 from $34.2 million for the three months ended September 30, 2015. This decrease primarily reflects lower contract service costs. Net of contracts and grants revenues, our research and development expenses were fully funded during the three months ended September 30, 2016. Net of contracts and grants revenues, we incurred net research and development expenses of $4.7 million during the three months ended September 30, 2015.

Our principal research and development expenses for the three months ended September 30, 2016 and 2015 are shown in the following table:

The decrease in expense for large-scale manufacturing of BioThrax was primarily due to the completion of development work and the licensure of the large-scale manufacturing facility in August 2016. The decrease in expense for BioThrax related programs was primarily related to the timing of clinical studies to support applications for label expansion for BioThrax. The decrease in expense for PreviThrax was primarily due to the timing of non-clinical studies. In light of reduced funding by the U.S. government for this product candidate, we determined to cease further development work on our PreviThrax vaccine and expect the spending for PreviThrax will be minimal in the future. The increase in expense for NuThrax was primarily due to the timing of non-clinical animal studies and manufacturing activities. The decrease in spending for Pandemic influenza was primarily for a $5.0 million milestone payment to VaxInnate Corporation in the third quarter of 2015. The decrease in expense for our Anthrasil program was primarily due to the timing of plasma collection services. The spending for our BAT program was primarily related to stability testing and plasma collection. The decrease in expense for our EV-035 series of molecules was primarily due to pharmacologic and formulation activities and a third quarter 2015 non-cash impairment charge of $9.8 million due to toxicity related issues, partially offset by a third quarter 2015 $6.7 million reduction of contingent consideration associated with the estimated timing and probability of achievement for certain development and regulatory milestones. The increase in expense for CIADM task orders was primarily for manufacturing development for Ebola monoclonal antibodies. The increase in expense for VIGIV was primarily due to the timing of plasma collection partially offset by a reduction in 2015 of a liability to BARDA associated with 2013 manufacturing activities. The increase in expense for Emergard was primarily for formulation development. The spending for our Other activities was primarily for our funded pre-clinical product candidates and manufacturing development activities.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $14.9 million, or 58%, to $40.7 million for the three months ended September 30, 2016 from $25.8 million for the three months ended September 30, 2015. The increase includes costs associated with the Aptevo spin-off, restructuring activities at our Lansing, Michigan site, along with increased professional services to support our strategic growth initiatives, and increased information technology investments. In addition, during the third quarter of 2015, we recorded a $3.3 million reduction in contingent consideration related to the estimated timing and probability of potential future sales of EV-035.

Provision for Income Taxes

Provision for income taxes decreased by $6.9 million, or 34%, to $13.1 million for the three months ended September 30, 2016 from $20.1 million for the three months ended September 30, 2015. The decrease was primarily due to a $28.5 million decrease in income before provision for income taxes, partially offset by an increase in the effective tax rate related to one-time, non-cash charges to complete the Aptevo spin-off.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

Revenues

Product Sales:

        The increase in BioThrax sales was primarily due to the timing of deliveries to the SNS. The decrease in Other product sales was primarily due to the timing of a $6.7 million decrease in BAT sales to the SNS and a one-time payment of $7.0 million for Anthrasil associated with FDA approval in the first quarter of 2015.

Contracts and grants:

The increase in Contracts and grants was primarily due to:

§

increased development funding of $25.5 million related to our CIADM program, including $13.0 million from new CIADM task orders;

§

increased development funding of $7.2 million for NuThrax related to non-clinical animal studies and manufacturing activities;and

§

increased development funding of $18.8 million for VIGIV related to plasma collection.

These increases were partially offset by:

§

decreased development funding of $36.9 million for Anthrasil related to the timing of plasma collection; and

§

decreased development funding of $8.5 million for large scale manufacturing of BioThrax due to our Building 55 facility receiving FDA approval in August 2016.

Cost of Product Sales and Contract Manufacturing

Cost of product sales and contract manufacturing increased by $19.9 million, or 27%, to $93.0 million for the nine months ended September 30, 2016 from $73.1 million for the nine months ended September 30, 2015. The increase was attributable to an increase in BioThrax sales to the SNS along with an increase in the BioThrax cost per dose sold associated with lower production yield in the period in which the doses sold were produced. In addition, the increase is due to an increase in costs associated with underutilized manufacturing capacity at our Winnipeg site.

Research and Development Expenses

Research and development expenses decreased by $12.6 million, or 13%, to $81.2 million for the nine months ended September 30, 2016 from $93.8 million for the nine months ended September 30, 2015. This decrease primarily reflects lower contract service costs. Net of contracts and grants revenues, our research and development expenses were fully funded during the nine months ended September 30, 2016. Net of contracts and grants revenues, we incurred net research and development expenses of $1.3 million during the nine months ended September 30, 2015.

Our principal research and development expenses for the nine months ended September 30, 2016 and 2015 are shown in the following table:

The decrease in expense for large-scale manufacturing of BioThrax was primarily due to the timing of manufacturing development activities due to the licensure of the large-scale manufacturing facility in August 2016. The spending for BioThrax related programs was primarily related to the timing of clinical studies to support applications for label expansion for BioThrax. The decrease in expense for PreviThrax was primarily due to the timing of non-clinical studies, and in light of reduced funding by the U.S. government for this product candidate, we determined to cease further development work on our PreviThrax vaccine and expect the spending for PreviThrax will be minimal in the future. The increase in expense for NuThrax was primarily due to the timing of non-clinical animal studies and manufacturing activities. The decrease in spending for Pandemic influenza was primarily for a $5.0 million milestone payment to VaxInnate Corporation in the third quarter of 2015. The decrease in expense for our Anthrasil program was primarily due to the timing of plasma collection services. The decrease in expense for our BAT program was primarily related to stability testing and plasma collection. The decrease in expense for EV-035 series of molecules was primarily due to pharmacologic and formulation activities and a third quarter 2015 non-cash impairment charge of $9.8 million due to toxicity related issues, partially offset by a third quarter 2015 $6.7 million reduction of contingent consideration associated with the estimated timing and probability of achievement for certain development and regulatory milestones. The increase in expense for CIADM task orders awarded was primarily for manufacturing development of Ebola monoclonal antibodies. The increase in expense for VIGIV was primarily due to the timing of plasma collection partially offset by a reduction in 2015 of a liability to BARDA associated with 2013 manufacturing activities. The increase in expense for Emergard was primarily for formulation development. The increase in spending for our Other activities was primarily for manufacturing development activities.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $22.0 million, or 25%, to $108.3 million for the three months ended September 30, 2016 from $86.3 million for the nine months ended September 30, 2015. The increase includes costs associated with the Aptevo spin-off, restructuring activities at our Lansing, Michigan site, along with increased professional services to support our strategic growth initiatives, and increased information technology investments. In addition, during the third quarter of 2015 we recorded a $3.3 million reduction in contingent consideration related to the estimated timing and probability of potential future sales of EV-035.

Provision for Income Taxes

Provision for income taxes decreased by $3.7 million, or 16%, to $19.9 million for the nine months ended September 30, 2016 from $23.6 million for the nine months ended September 30, 2015. The decrease was primarily due to a $22.2 million decrease in income before provision for income taxes, partially offset by an increase in the effective tax rate related to one-time, non-cash charges to complete the Aptevo spin-off.

Sources of Liquidity

From inception through September 30, 2016, we have funded our cash requirements principally with a combination of revenues from sales of BioThrax, debt financing, development funding from government entities, non-government and philanthropic organizations, and collaborative partners, the net proceeds from our initial public offering and the sale of our common stock upon exercise of stock options. We have operated profitably for each of the five years ended December 31, 2015. As of September 30, 2016, we had cash and cash equivalents of $298.9 million.

At the closing of the spin-off of Aptevo from Emergent,we provided to Aptevo cash of $45 million from our cash reserves, along with a commitment in the form of a promissory note to provide another $20 million due within six to 12 months after the separation.

Cash Flows

The following table provides information regarding our cash flows for the nine months ended September 30, 2016 and 2015:

(i) Includes the effect of exchange rates on cash and cash equivalents.

Net cash provided by operating activities of $62.8 million for the nine months ended September 30, 2016 was primarily due to our net income of $14.4 million, a $45.0 million decrease in accounts receivable related to the timing of collection of amounts billed primarily to the CDC along with non-cash charges of $28.2 million for depreciation and amortization and a $14.5 million increase in stock-based compensation expense, partially offset by an increase in inventories of $16.2 million, primarily due to the timing of deliveries of BioThrax to the CDC.

Net cash provided by operating activities of $41.4 million for the nine months ended September 30, 2015 was primarily due to our net income of $29.5 million and non-cash charges of $25.9 million for depreciation and amortization along with a $9.8 million impairment charge for EV-035, partially offset by an increase in inventories of $14.4 million primarily due to the timing of deliveries of BioThrax to the CDC and a $10.9 million decrease in contingent consideration to Evolva for regulatory, development and sales-based royalty contingencies.

Net cash used in investing activities of $56.2 million for the nine months ended September 30, 2016 was due to infrastructure and equipment investments, including the construction of a third manufacturing suite at our Baltimore CIADM manufacturing facility.

Net cash used in investing activities of $33.6 million for the nine months ended September 30, 2015 was due to infrastructure and equipment investments.

Net cash used in financing activities of $20.4 million for the nine months ended September 30, 2016 was primarily due to $15.0 million in proceeds from the issuance of common stock pursuant to employee equity plans and $10.4 million in excess tax benefits from exercise of stock options that is partially offset by $45.0 million in cash provided to Aptevo on date of distribution, August 1, 2016.

Net cash provided by financing activities of $20.5 million for the nine months ended September 30, 2015 was primarily due to $15.9 million in proceeds from the issuance of common stock pursuant to employee equity plans, $8.0 million in excess tax benefits from the exercise of stock options and $2.0 million in proceeds from long-term indebtedness, partially offset by $5.4 million in contingent obligation payments.

Funding Requirements

We expect to continue to fund our anticipated operating expenses, capital expenditures, debt service requirements and any future repurchase of our common stock from the following sources: existing cash and cash equivalents; revenues from product sales; development contracts and grants funding; contract manufacturing services and our revolving credit facility and any other lines of credit we may establish from time to time. There are numerous risks and uncertainties associated with product sales and with the development and commercialization of our product candidates. We may seek additional external financing to provide additional financial flexibility. Our future capital requirements will depend on many factors, including (but not limited to):

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our ability to secure a new BioThrax procurement contract on favorable terms;

§

the level, timing and cost of product sales;

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

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the acquisition of new facilities and capital improvements to new or existing facilities;

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the payment obligations under our indebtedness;

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

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our ability to obtain funding from collaborative partners, government entities and non-governmental organizations for our development programs;

§

the extent to which we repurchase our common stock under our share repurchase program; and

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

If our capital resources are insufficient to meet our future capital requirements, we will need to finance our cash needs through public or private equity or debt offerings, bank loans or collaboration and licensing arrangements. In May 2015, we filed an automatic shelf registration statement, which immediately became effective under SEC rules. For so long as we continue to satisfy the requirements to be deemed a "well-known seasoned issuer" under SEC rules, this shelf registration statement, effective until May 2018, allows us to issue an unrestricted amount of equity, debt and certain other types of securities through one or more future primary or secondary offerings. If we raise funds by issuing equity securities, our stockholders may experience dilution. Public or bank debt financing, if available, may involve agreements that include covenants, like those contained in our senior secured revolving credit facility, which could limit or restrict our ability to take specific actions, such as incurring additional debt, making capital expenditures, pursuing acquisition opportunities, buying back shares or declaring dividends. If we raise funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies or product candidates or grant licenses on terms that may not be favorable to us.

We are not restricted under the terms of the indenture governing our senior convertible notes from incurring additional debt, securing existing or future debt, recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing our notes that could have the effect of diminishing our ability to make payments on our indebtedness. However, our credit facility restricts our ability to incur additional indebtedness, including secured indebtedness.

Current economic conditions may make it difficult to obtain financing on attractive terms, or at all. If financing is unavailable or lost, our business, results of operations and financial condition would be adversely affected and we could be forced to delay, reduce the scope of or eliminate many of our planned activities.

Share Repurchase Program

On July 14, 2016, our board of directors authorized our management to repurchase, from time to time, up to an aggregate of $50 million of our common stock under a board-approved share repurchase program. The timing, amount, and price of any repurchases will be made pursuant to one or more 10b5-1 plans. The term of the board authorization of the repurchase program is until December 31, 2017. The plan will permit shares to be repurchased when we might otherwise be precluded from doing so based upon insider trading laws. The repurchase program may be suspended or discontinued at any time. Any repurchased shares will be available for use in connection with our stock plans and for other corporate purposes. As of September 30, 2016, we have neither implemented a repurchase plan nor repurchased any shares under this program.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2016. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2016, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

During 2016, we completed the implementation of an enterprise resource planning ("ERP") system. In connection with the implementation, we updated the processes that constitute our internal control over financial reporting, as necessary, to accommodate related changes to our business processes and accounting procedures.

Although the processes that constitute our internal control over financial reporting have been materially affected by the implementation of this system and will require testing for effectiveness as the implementation progresses, we do not believe that the implementation has had or will have a material adverse effect on our internal control over financial reporting.

Except as otherwise described above, there have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the nine months ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 1A. RISK FACTORS

You should carefully consider, among other matters, the following risk factors in addition to the other information in this Quarterly Report on Form 10-Q when evaluating our business because these risk factors may have a significant impact on our business, financial condition, operating results or cash flow. If any of the risks described below or in subsequent reports we file with the SEC actually occur, they may materially harm our business, financial condition, operating results or cash flow. Additional risks and uncertainties that we have not yet identified or that we presently consider to be immaterial may also materially harm our business, financial condition, operating results or cash flow.

THE SPIN-OFF OF OUR BIOSCIENCES BUSINESS

We may not realize some or all of the anticipated benefits of the spin-off of Aptevo due to a number of factors.

On August 1, 2016, we completed the spin-off of Aptevo Therapeutics Inc. Aptevo is now an independent public company trading under the symbol "APVO" on the NASDAQ Global Select Market. We may not realize some or all of the anticipated strategic, financial or other benefits from the spin-off. We are now smaller, less diversified with a narrower business focus and may be more vulnerable to changing market conditions, which could materially and adversely affect our business, financial condition and results of operations. Further, the combined value of the common stock of the two publicly-traded companies may not be equal to or greater than what the value of our common stock would have been had the spin-off not occurred.

If our distribution on August 1, 2016 of all of the outstanding shares of Aptevo common stock to our stockholders, together with certain related transactions, does not qualify as a tax-free transaction for U.S. federal income tax purposes, we and our stockholders could be subject to significant tax liabilities.

 

It is intended that our distribution on August 1, 2016 of all of the outstanding shares of Aptevo common stock to our stockholders, or the Distribution, together with certain related transactions, qualify as a tax-free transaction described under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended, or the Code.  In anticipation of the Distribution, we received a favorable private letter ruling from the Internal Revenue Service, or the IRS, regarding certain U.S. federal income tax matters relating to the Distribution and certain related transaction and an opinion of counsel substantially to the effect that, for U.S. federal income tax purposes, the Distribution, together with certain related transactions, will qualify as a transaction described under Sections 355 and 368(a)(1)(D) of the Code. A "private letter ruling," is a written statement issued to a taxpayer by an Associate Chief Counsel Office of the Office of Chief Counsel that interprets and applies the tax laws to a specific set of facts. Our private letter ruling is based on certain facts and representations submitted by us to the IRS and the opinion of counsel was based upon and relied on, among other things, the IRS private letter ruling and certain facts and assumptions, as well as certain representations and covenants of Emergent and Aptevo contained in a tax matters agreement and certain representations contained in representation letters provided by Emergent, Aptevo and certain stockholders to such counsel, including representations and covenants relating to the past and future conduct of Emergent, Aptevo and such stockholders. If any of these facts, assumptions, representations, or covenants are, or become, inaccurate or incomplete, the IRS private letter ruling and/or the opinion of counsel may be invalid and the conclusions reached therein could be jeopardized and, as a result, the Distribution, together with certain related transactions, could fail to qualify as a tax-free transaction described under Sections 355 and 368(a)(1)(D) of the Code for U.S. federal income tax purposes.

 

In addition, the IRS private letter ruling only addresses certain limited matters relevant to determining whether the Distribution, together with certain related transactions, qualifies as a transaction described under Sections 355 and 368(a)(1)(D) of the Code, and the opinion of counsel only represents the judgment of such counsel, which is not binding on the IRS or any court. Accordingly, notwithstanding the IRS private letter ruling and the opinion of counsel, there can be no assurance that the IRS will not assert that the Distribution, together with certain related transactions, should be treated as a taxable transaction for U.S. federal income tax purposes or that a court would not sustain such a challenge.

If the Distribution, together with certain related transactions, fails to qualify as a tax-free transaction described under Sections 355 and 368(a)(1)(D) of the Code, for U.S. federal income tax purposes, in general, (i) we would recognize taxable gain on the Distribution equal to the amount by which the fair market value of the Aptevo shares distributed to our shareholders exceeded our tax basis in the Aptevo shares and (ii) each of our shareholders who received Aptevo shares in the Distribution would be treated as receiving a taxable distribution equal to the fair market value of the Aptevo shares received by such shareholder.

Under the tax matters agreement that we entered into with Aptevo in connection with the spin-off, Aptevo may be required to indemnify us against any tax liabilities and related expenses resulting from the failure of the Distribution, together with certain related transactions, to qualify as a transaction described under Sections 355 and 368(a)(1)(D) of the Code to the extent that the failure to so qualify is attributable to actions, events or transactions relating to Aptevo's stock, assets or business, or a breach of the relevant representations or covenants made by Aptevo in the tax matters agreement or the IRS private letter ruling or in the representation letters provided  to our counsel for purposes of their opinion. Any such indemnity obligations could be material, and there can be no assurance that Aptevo will be able to pay any such indemnification.

To preserve the tax-free treatment of the Distribution, together with certain related transactions, and in addition to Aptevo's indemnity obligation, the tax matters agreement restricts Aptevo from taking any action that prevents such transactions from being tax-free for U.S. federal income tax purposes.  In particular, for the two-year period following the Distribution, Aptevo is restricted from taking certain actions (including restrictions on share issuances, business combinations, sales of assets, amendments to organizational documents and similar transactions) that could cause the Distribution, together with certain related transactions, to fail to qualify as a tax-free transaction for U.S. federal income tax purposes. There can be no assurance that Aptevo will comply with these restrictions. Failure of Aptevo to satisfy its obligations could have a substantial impact on our tax obligations, consolidated financial condition and cash flows.

GOVERNMENT CONTRACTING RISKS

We currently derive the majority of our revenue from sales of BioThrax to our principal customer, the U.S. government. If we are unable to secure a new procurement contract for BioThrax on favorable terms, or the U.S. government's demand for and funding for procurement of BioThrax is substantially reduced, our business, financial condition, operating results and cash flow could be materially harmed.

We have derived and currently expect to derive the majority of our revenue from sales of BioThrax, our anthrax vaccine licensed by the U.S. Food and Drug Administration, or the FDA, to the U.S. government. We are currently party to a contract with the Centers for Disease Control and Prevention, or the CDC, for the supply of up to 44.75 million doses of BioThrax for placement into the Strategic National Stockpile, or the SNS, over a five-year period, which was scheduled to expire on September 30, 2016.  On September 21, 2016, the CDC exercised an option to procure all remaining BioThrax doses, thereby committing to take delivery of the full 44.75 million doses and granted a no-cost extension to enable delivery of the remaining doses under this contract to be completed by November 30, 2016.

On June 21, 2016, the U.S. Department of Health and Human Services, or HHS, issued a Sole Source Notification indicating its intention to award Emergent a follow-on contract for the purchase of 29.4 million doses of BioThrax with a period of performance of five years.  The solicitation does not state the number of doses expected to be procured per year, but represents a smaller annual procurement on average over the five-year period of the anticipated contract than under our current contract. As of the date hereof, we remain in active negotiations with respect to this anticipated contract. The terms of the anticipated contract, including the price per dose and the timing of deliveries, remain subject to contract negotiation, and there can be no assurance that we will reach agreement on the terms of a follow-on BioThrax procurement contract.

In addition, the procurement of doses of BioThrax by the CDC remains subject to the availability of funding. Our existing contract with the CDC for BioThrax does not, and any follow-on procurement contract for BioThrax will not, guarantee that funding for the procurement of doses will be made available. If the SNS priorities change, funding to procure doses of BioThrax may be limited or not available, and our business, financial condition and operating results could be materially harmed. The success of our business and our operating results for the foreseeable future are significantly dependent on the level of funding for the procurement of BioThrax and the terms of our BioThrax sales to the U.S. government, including the price per dose, the number of doses and the timing of deliveries. If we are unable to secure a new contract for procurement of BioThrax on acceptable terms, or if the U.S. government's demand for and level of funding for procurement of BioThrax is reduced, our business, financial condition, operating results and cash flows could be materially harmed.

Our submission of NuThrax for Emergency Use Authorization pre-approval and eventual FDA licensure may not be approved by the FDA in a timely manner or at all.  Delays in our ability to achieve such pre-approval and licensure could prevent us from realizing the full potential value of our BARDA contract for the advanced development and delivery of NuThrax.

On September 30, 2016, we entered into a contract with HHS, through the Biomedical Advanced Research and Development Authority, or BARDA, for the advanced development and delivery of NuThrax, our next generation anthrax vaccine candidate.  The contract, valued at up to approximately $1.6 billion, consists of a five-year base period of performance valued at approximately $200 million to develop NuThrax for post-exposure prophylaxis of anthrax disease and to deliver to the SNS an initial two million doses, following receipt of Emergency Use Authorization, or EUA, pre-approval by the FDA. Although there can be no assurances, we currently anticipate that the FDA could authorize NuThrax for emergency use as early as 2018, triggering deliveries of NuThrax to the SNS in 2019. The contract also includes procurement options for the delivery of an additional 7.5 million to 50 million doses of NuThrax to the SNS, valued from approximately $255 million to up to $1.4 billion, respectively, and options for an additional clinical study and post-marketing commitments valued at approximately $48 million, which if both were to be exercised in full, would increase the potential total contract value to up to approximately $1.6 billion.

We currently intend to submit an application in 2017 with the FDA for EUA pre-approval, so that NuThrax may be delivered to the SNS for use in an emergency situation as early as 2019.  However, the FDA does not have review deadlines with respect to such submissions and, therefore, the timing of any approval of an EUA pre-approval submission is uncertain.  We cannot guarantee that the FDA will review our data in a timely manner, or that the FDA will accept the data when reviewed. The FDA may decide that our data are insufficient for EUA pre-approval and require additional pre-clinical, clinical or other studies and refuse to approve our application. If we are unsuccessful in obtaining EUA pre-approval for NuThrax and eventual FDA licensure in a timely manner or at all, we may not be able to realize the full potential value of the contract, which could have a material adverse effect on our future business, financial condition, operating results and cash flow.

In addition, if the SNS priorities change, funding to procure any future doses of NuThrax may be limited or not available, and our future business, financial condition and operating results could be materially harmed.

Our U.S. government procurement and development contracts require ongoing funding decisions by the U.S. government. Reduced or discontinued funding of these contracts could cause our business, financial condition, operating results and cash flow to suffer materially.

Our principal customer for BioThrax, BAT, Anthrasil, VIGIV and RSDL products and our primary source of funds for the development of our NuThrax product candidate is the U.S. government. We anticipate that the U.S. government will also be a principal customer for other Biodefense products that we successfully acquire or develop. Additionally, a significant portion of our revenue comes from U.S. government development contracts and grants. Over its lifetime, a U.S. government procurement or development program may be implemented through the award of many different individual contracts and subcontracts. The funding for such government programs is subject to Congressional appropriations, generally made on a fiscal year basis, even for programs designed to continue for several years. For example, sales of BioThrax supplied under our current procurement contract with the CDC as well as sales of BioThrax to be supplied under our expected follow-on procurement contract with the CDC and any future sales of NuThrax that may be supplied under our contract with BARDA for the development and delivery of NuThrax to the SNS are subject to the availability of funding, mostly from annual appropriations. These appropriations can be subject to political considerations and stringent budgetary constraints. For example, in April 2016, we were notified by BARDA that, after prioritization of its development funding, BARDA would not be exercising the clinical trial option for our PreviThrax rPA vaccine development program. As a consequence of this decision, we determined to cease further development work on our PreviThrax vaccine product candidate. Additionally, our government-funded development contracts typically give the U.S. government the right, exercisable in its sole discretion, to extend these contracts for successive option periods following a base period of performance. The value of the services to be performed during these option periods may constitute the majority of the total value of the underlying contract. For example, the contract with BARDA we were awarded in September 2016 for the development and delivery to the SNS of NuThrax for post-exposure prophylaxis of anthrax disease consists of a five-year base period of performance valued at approximately $200 million to develop NuThrax to deliver to the SNS an initial two million doses, following receipt of EUA pre-approval by the FDA, includes procurement options for the delivery of an additional 7.5 million to 50 million doses of NuThrax to the SNS, valued from approximately $255 million to up to $1.4 billion, respectively, and options for an additional clinical study and post-marketing commitments valued at $48 million, which if both were to be exercised in full, would increase the total contract value to up to $1.6 billion.  If levels of government expenditures and authorizations for biodefense decrease or shift to programs in areas where we do not offer products or are not developing product candidates, or if the U.S. government otherwise declines to exercise its options under our contracts, our business, revenues and operating results would suffer.

The government contracting process is typically a competitive bidding process and involves unique risks and requirements.

Our business involves government contracts and grants, which may be awarded through competitive bidding. Competitive bidding for government contracts presents a number of risks and requirements, including:

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

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

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the possibility that we may be ineligible to respond to a request for proposal issued by the government;

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the submission by third parties of protests to our responses to requests for proposal that could result in delays or withdrawals of those requests for proposal; and