For the quarterly period ended June 30, 2011

OR

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

For the transition period from            to

Commission File Number: 001-33958

RXi Pharmaceuticals Corporation

(Exact name of registrant as specified in its charter)

Delaware		20-8099512
(State of incorporation)		(I.R.S. Employer Identification No.)

60 Prescott Street, Worcester, MA 01605

(Address of principal executive office) (Zip code)

Registrant’s telephone number: (508) 767-3861

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on it corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter time that the registrant was required to submit and post such files).

Yes þ No o

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

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of August 11, 2011, RXi Pharmaceuticals Corporation had 41,986,800 shares of common stock, $0.0001 par value, outstanding.

 

 

RXi PHARMACEUTICALS CORPORATION
FORM 10-Q — QUARTER ENDED June 30, 2011

INDEX

						Page
Part No.		Item No.		Description		No.
I				FINANCIAL INFORMATION
		1		Financial Statements			2
				Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010 (unaudited)			2
				Condensed Consolidated Statements of Expenses for the three months ended June 30, 2011 and 2010, the six months ended June 30, 2011 and 2010, and the cumulative amounts for the period January 1, 2003 (date of inception) to June 30, 2011 (unaudited)			3
				Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010 and the cumulative amounts for the period January 1, 2003 (date of inception) to June 30, 2011(unaudited)			4
				Notes to Condensed Consolidated Financial Statements (unaudited)			7
		2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
		4		Controls and Procedures			19
II				OTHER INFORMATION
		1		Legal Proceedings			21
		1A		Risk Factors			21
		2		Unregistered Sales of Equity Securities and Use of Proceeds			21
		3		Defaults Upon Senior Securities			21
		4		(Removed and Reserved)			21
		5		Other Information			21
		6		Exhibits			21
Index to Exhibits							21
Signatures							22
EX-4.2
EX-10.1
EX-10.2
EX-10.3
EX-10.4
EX-10.5
EX-10.6
EX-10.8
EX-10.9
EX-10.10
EX-10.11
EX-10.12
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

PART I

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

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

RXi PHARMACEUTICALS CORPORATION
(A Development Stage Company)

RXi PHARMACEUTICALS CORPORATION
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

“ Derivatives and Hedging — Contracts in Entity’s Own Stock ”, the value of these warrants is required to be recorded as a liability, as the holders have an option to put the warrants back to the Company in certain events, as defined.

Obligations to Repurchase Shares of the Company’s Equity Securities

     In accordance with FASB ASC Topic 480-10, “Distinguishing Liabilities from Equity” , the Company recognizes all obligations to repurchase shares of its equity securities that require or may require the Company to settle the obligation by transferring assets, as liabilities or assets in some circumstances measured at fair value with changes in fair value reflected as current period income or loss and are accounted for as such.

Deferred Revenue

     Deferred revenue consists of advance payments received under government grants. The Company will recognize revenue when the obligations under the grants are fullfilled.

2. Apthera Acquisition

     On April 13, 2011, the Company completed its acquisition of Apthera, Inc., a Delaware corporation (“Apthera”) under an Agreement and Plan of Merger entered into on March 31, 2011. Subject to the terms and conditions of the merger agreement, the Company’s wholly owned subsidiary formed for this purpose was merged with and into Apthera, with Apthera surviving as a wholly-owned subsidiary of the Company. Under the merger agreement, the Company issued to Apthera’s stockholders approximately 5.0 million shares of common stock of the Company and agreed to make future contingent payments of up to $32 million based on the achievement of certain development and commercial milestones relating to the Company’s NeuVax product candidate. The contingent consideration is payable, at the election of the Company, in either cash or additional shares of common stock, provided that the Company may not issue any shares in satisfaction of any contingent consideration unless it has first obtained approval of its stockholders in accordance with Rule 5635(a) of the NASDAQ Marketplace Rules.

     In connection with the merger, the Company deposited with a third-party escrow agent certificates representing 10% of the Aggregate Stock Consideration, which shares will be available to compensate the Company and related parties for certain indemnifiable losses as described in the merger agreement.

     The Company’s acquisition of Apthera was in concert with the decision by the Company’s Board of Directors to diversify its development programs and to become a late stage clinical development company. The Company believes that acquiring Apthera will enhance its long-term prospects by giving the Company access to a late stage product candidate, NeuVax, which is expected to enter a Phase 3 clinical trial under an FDA-approved Special Protocol Assessment (“SPA”) for the adjuvant treatment of early stage HER2 breast cancer in the first half of 2012. To do so, the Company must satisfy certain FDA information requirements to be released from a partial clinical hold to commence the Phase 3 trial. Based on Apthera’s prior clinical trials, the Company also believes that NeuVax has the potential to treat other cancers, including prostate, bladder and ovarian cancers. With the Company’s increasing focus on its cancer product candidates, the Company is assessing its strategic options with respect to its RNAi therapeutics technology platform.

The purchase price consideration and allocation of purchase price was as follows:

		(in 000’s)
Calculation of allocable purchase price(i):
Fair value of shares issued at closing including escrowed shares expected to be released		$	6,367	(ii)
Estimated value of earn-out			6,460
Total allocable purchase price		$	12,827
Estimated allocation of purchase price(i):
Cash		$	168
Prepaid expenses and other current assets			14
Equipment and furnishings			11
Goodwill			845
In-process research and development			12,864
Accounts payable			(931	)
Accrued expenses and other current liabilities			(143	)
Notes payable			(1	)
		$	12,827

     stock as of the close of business on April 13, 2011.

The following presents the pro forma net loss and net loss per common share for the three and six months ended June 30, 2011 and 2010 of the Company’s acquisition of Apthera assuming the acquisition occurred as of January 1, 2010:

3. Fair Value Measurements

     Effective January 1, 2008, the Company implemented FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”) for the Company’s financial assets and liabilities that are re-measured and reported at fair value at each reporting period, and are re-measured and reported at fair value at least annually using a fair value hierarchy that is broken down into three levels. Level inputs are as defined as follows:

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

Level 2 — other significant observable inputs for the assets or liabilities through corroboration with market data at the measurement date.

Level 3 — significant unobservable inputs that reflect management’s best estimate of what market participants would use to price the assets or liabilities at the measurement date.

     The Company categorized its cash equivalents as a Level 1 hierarchy. The valuation for Level 1 was determined based on a “market approach” using quoted prices in active markets for identical assets. Valuations of these assets do not require a significant degree of judgment. The Company categorized its warrants potentially settled in cash and its common stock potentially redeemable in cash as a Level 2 hierarchy. The warrants are measured at market value on a recurring basis and are being marked to market each quarter-end until they are completely settled. The warrants are valued using the Black-Scholes method, using assumptions consistent with our application of ASC 718.

     On March 30, 2011, the Company entered into a severance agreement with its former President and Chief Executive Officer whereby, among other things, it agreed to issue shares to the former officer such that the number of shares issued times the market price of the shares on the day immediately following the separation date equal a value of $300,000. The agreement further provides that the Company will, at its option, provide a cash payment or additional shares to the former officer if necessary such that the value of 1/3 of the shares issued and 2/3 of the shares issued, respectively, at the separation date equal a guaranteed value of $100,000 as of the 90 ^th day following the seperation date and $200,000 as of the 180 ^th day following the seperation date based on the closing price of the Company’s common stock for the five days preceding each measurement date. At June 30, 2011, a liability of $200,000 was included in accrued expenses representing the guaranteed value under the severance agreement for the remaining 2/3 shares issued.

Fair Value of Financial Instruments

     The carrying amounts reported in the balance sheet for cash equivalents, accounts payable, and capital leases approximate their fair values due to their short-term nature and market rates of interest.

RXi PHARMACEUTICALS CORPORATION
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4. Stock Based Compensation

     The Company follows the provisions of the FASB ASC Topic 718, “ Compensation — Stock Compensation ” (“ASC 718”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, non-employee directors, and consultants, including employee stock options. Stock compensation expense based on the grant date fair value estimated in accordance with the provisions of ASC 718 is recognized as an expense over the requisite service period.

     For stock options granted as consideration for services rendered by non-employees, the Company recognizes compensation expense in accordance with the requirements of FASB ASC Topic 505-50, “ Equity Based Payments to Non- Employees.”

     Non-employee option grants that do not vest immediately upon grant are recorded as an expense over the vesting period of the underlying stock options. At the end of each financial reporting period prior to vesting, the value of these options, as calculated using the Black-Scholes option-pricing model, will be re-measured using the fair value of the Company’s common stock and the non-cash compensation recognized during the period will be adjusted accordingly. Since the fair market value of options granted to non-employees is subject to change in the future, the amount of the future compensation expense will include fair value re-measurements until the stock options are fully vested.

     The Company is currently using the Black-Scholes option-pricing model to determine the fair value of all its option grants. For option grants issued in the three and six months periods ended June 30, 2011 and 2010, the following assumptions were used:

The weighted average fair value of options granted during the six month period ended June 30, 2011 and 2010 was $1.18 and $4.34 per share, respectively.

The weighted average fair value of options granted during the three month period ended June 30, 2011 and 2010 was $1.01 and $4.87 per share, respectively.

     RXi’s expected common stock price volatility assumption is based upon the volatility of a basket of comparable companies. The expected life assumptions for employee grants were based upon the simplified method provided for under ASC 718-10. The expected life assumptions for non-employees were based upon the contractual term of the option. The dividend yield assumption of zero is based upon the fact that RXi has never paid cash dividends and presently has no intention of paying cash dividends. The risk-free interest rate used for each grant was also based upon prevailing short-term interest rates. RXi has estimated an annualized forfeiture rate of 15.0% for options granted to its employees, 8.0% for options granted to senior management and no forfeiture rate for the directors. RXi will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeiture rates are higher than estimated.

     The following table summarizes stock option activity from January 1, 2011 through June 30, 2011:

     The aggregate intrinsic values of outstanding and exercisable options at June 30, 2011 were calculated based on the closing price of the Company’s common stock on June 30, 2011 of $0.98 per share less the exercise price of those shares. The aggregate intrinsic values of options exercised was calculated based on the difference, if any, between the exercise price of the underlying awards and the quoted price of the Company’s common stock on the date of exercise.

5. Net Loss Per Share

     The Company accounts for and discloses net loss per common share in accordance with FASB ASC Topic 260 “ Earnings per Share.” Basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares that would have been outstanding during the period assuming the issuance of common shares for all potential dilutive common shares outstanding. Potential common shares consist of shares issuable upon the exercise of stock options and warrants. Because the inclusion of potential common shares would be anti-dilutive for all periods presented, diluted net loss per common share is the same as basic net loss per common share.

     The following table sets forth the potential common shares excluded from the calculation of net loss per common share because their inclusion would be anti-dilutive:

6. License Agreements

     As part of its business, the Company enters into licensing agreements, which often require milestone and royalty payments based on the progress of the asset through development stages. Milestone payments may be required, for example, upon approval of the product for marketing by a regulatory agency. In certain agreements, RXi is required to make royalty payments based upon a percentage of product sales.

     An individual milestone payment required under the licensing arrangements may be material, and in the event that multiple milestones are reached in the same period, the aggregate payments associated with the milestones could adversely affect the results of operations or affect the comparability of our period-to-period results. In addition, these licensing arrangements often give the Company the discretion to unilaterally terminate development of the product, which would allow the Company to avoid making the contingent payments; however, the Company is unlikely to cease development if the compound successfully achieves clinical testing objectives. During the quarter, the Company cancelled several of its licenses with the University of Massachusetts Medical School (“UMMS”). Additionally, in conjunction with the acquisition of Apthera, the Company assumed the rights and obligations of a certain license agreement, as amended, from The University of Texas M. D. Anderson Cancer Center (“MDACC”) and The Henry M. Jackson Foundation for the Advancement of Military Medicine, Inc. (“HJF”) which grants exclusive worldwide rights to the use of one patent and one patent application involving the use of the E75 peptide. Under the terms of this license, we are required to make future annual maintenance fee payments, as well as clinical milestone payments and royalty payments based on sales of therapeutic products developed from the licensed technologies. As part of the expected payments under the terms of the license, the Company must pay an annual maintenance fee of $175,000 in 2011 and $200,000 in 2012. In addition, upon commencing the Phase 3 trial, we will pay a milestone payment of $200,000.

7. Equity

2011 Financings

     On April 20, 2011, the Company completed an underwritten public offering of 11,950,000 units at a price to the public of $1.00 per unit for gross proceeds of approximately $12 million (the “April 2011 Offering”). Each unit consisted of one share of common stock and a warrant to purchase one share of common stock at an exercise price of $1.00 per share. The shares of common stock and warrants were immediately separable and no separate units were issued. The warrants are exercisable beginning one year and one day from the date of issuance, but only if the Company’s stockholders approve an increase in the number of authorized shares of common stock of the Company, and expire on the sixth

anniversary of the date of issuance. Net proceeds, after underwriting discounts and commissions and other offering expenses, were approximately $10.9 million. In connection with the April financing, the Company agreed to hold a stockholders meeting no later than July 31, 2011 in order to seek stockholder approval for an amendment to the Company’s Amended and Restated Certificate of Incorporation to increase the authorized number of shares or our common stock. The Board of Directors of the Company subsequently adopted an amendment to increase the authorized shares of common stock to 125,000,000, which was presented to and approved by the stockholders of the Company at the 2011 Annual Meeting of Stockholders held on July 15, 2011.

     On March 4, 2011, the Company closed an underwritten public offering of 6,000,000 units at a price to the public of $1.35 per unit for gross proceeds of $8.1 million (the“March 2011 Offering”). The offering provided approximately $7.3 million to the Company after deducting the underwriting discounts and commissions and offering expenses. Each unit consists of (i) one share of common stock, (ii) a thirteen-month warrant to purchase 0.50 of a share of common stock at an exercise price of $1.70 per share (subject to anti-dilution adjustment) and (iii) a five-year warrant to purchase 0.50 of a share of common stock at an exercise price of $1.87 per share (subject to anti-dilution adjustment). On April 15, 2011, the holders of outstanding warrants issued in the March 2011 Offering to purchase an aggregate of 3,450,000 shares of common stock agreed to exchange such warrants for warrants exercisable for the same number of shares as those being exchanged, but otherwise on the same terms of the warrants sold in the Company’s April 2011 financing. Prior to the exchange, the Company recorded a decrease in fair value of $1,000,000 related to the exchanged warrants. Upon the exchange, the Company recorded a loss of $900,000, which represented the difference between the adjusted fair value of the March 2011 warrants as compared to the fair value of the April 2011 warrants received in the exchange. As a result of a subsequent offering that was completed on April 15, 2011, the exercise price of the remaining 2,550,000 outstanding warrants sold in the March 2011 Offering was reduced to $1.00 per share as a result of the anti-dilution adjustment.

Warrants Potentially Settleable in Cash

     Certain warrants issued in connection with a registered direct stock offering on August 3, 2009 (the “2009 Offering”) were determined not to be indexed to the Company’s common stock as they are potentially settleable in cash. The fair value of the warrants at the dates of issuance totaling $2,863,000 was recorded as a liability and a cost of equity and was determined by the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 122.69%. The expected life assumption is based on the contract term of five years. The dividend yield of zero is based on the fact that the Company has no present intention to pay cash dividends. The risk free rate of 1.72% used for the warrants is equal to the zero coupon rate in effect at the time of the grant. The decrease in the fair value of the warrants from the date of issuance to June 30, 2011 is $2,718,000, of which $1,799,000 has been included in other income and expense in the accompanying condensed statements of expenses for the six months ended June 30, 2011. The fair value of the warrants at June 30, 2011 of $144,000 is included as a current liability in the accompanying balance sheets and was determined by the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 74.52%. The expected life assumption is based on the remaining contract term of 3.1 years. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. The risk free rate of 0.81% used for the warrants is equal to the zero coupon rate in effect on the date of the re-measurement.

     Certain warrants issued in connection with the March 22, 2010 stock offering (the “2010 Offering”) were determined not to be indexed to the Company’s common stock as they are potentially settleable in cash. The fair value of the warrants at the dates of issuance totaling $2,466,000 was recorded as a liability and a cost of equity and was determined using the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, our expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 119.49%. The expected life assumption is based on the contract term of 6.5 years. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. The risk free rate of 3.22% used for the warrants is equal to the zero coupon rate in effect at the time of the grant. The decrease in the fair value of the warrants from date of issuance to June 30, 2011 is $2,245,000, of which $974,000 has been included in other income and expense in the accompanying condensed statements of expenses for the six months ended June 30, 2011. The fair value of the warrants at June 30, 2011 of $221,000 is included as a current liability in the accompanying balance sheets and was determined by the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 74.52%. The expected life assumption is based on the remaining contract term of 5.25 years. The dividend yield of zero is based on the fact that the Company has no present intention to pay cash dividends. The risk free rate of 1.76% used for the warrants is equal to the zero coupon rate in effect on the date of the re-measurement.

     The thirteen-month and five-year warrants issued in connection with the March 2011 Offering were determined not to be indexed to the Company’s common stock as they are potentially settleable in cash. The fair value of the remaining 2,550,000 warrants at the date of issuance totaling $1,790,000 was recorded as a liability and a cost of equity and was determined using the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 113.25%. The expected life assumption is based on the contract term of 1.08 years used for the thirteen-month warrants and 5 years used for the five-year warrants. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. The risk free rate of 0.26% used for the thirteen-month warrants and 2.17% used for the five-year warrants is

equal to the zero coupon rate in effect at the time of the grant. The decrease in the fair value of the warrants from date of issuance to June 30, 2011 of $745,000 has been included in other income and expense in the accompanying condensed statements of expenses for the six months ended June 30, 2011. The fair value of the warrants at June 30, 2011 of $1,050,000 is included as a current liability in the accompanying balance sheets and was determined using the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 74.52%. The expected life assumption is based on the remaining contract term of one year used for the thirteen-month warrants and 4.7 years used for the five- year warrants. The dividend yield of zero is based on the fact that the Company has no present intention to pay cash dividends. The risk free rate of 0.19% used for the thirteen-month warrants and 1.76% used for the five-year warrants is equal to the zero coupon rate in effect on the date of the re-measurement.

     The warrants issued in connection with the April 2011 Offering, including the warrants issued in exchanged for the March 2011 warrants, were determined not to be indexed to the Company’s common stock as they are potentially settleable in cash. The fair value of the warrants at the dates of issuance totaling $11,442,000 was recorded as a liability and a cost of equity and was determined using the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 99.04%. The expected life assumption is based on the contract term of 7.0 years. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. The risk free rate of 2.81% used for the warrants is equal to the zero coupon rate in effect at the time of the grant. The decrease in the fair value of the warrants from date of issuance to June 30, 2011 is $1,875,000, of which all has been included in other income and expense in the accompanying condensed statements of expenses for the six months ended June 30, 2011. The fair value of the warrants at June 30, 2011 of $10,467,000 is included as a current liability in the accompanying balance sheets and was determined by the Black-Scholes option pricing model. Due to the fact that the Company has limited trading history, the Company’s expected stock volatility assumption is based on a combination of implied volatilities of similar entities whose shares or options are publicly traded. The Company used a weighted average expected stock volatility of 74.52%. The expected life assumption is based on the remaining contract term of 6.8 years. The dividend yield of zero is based on the fact that the Company has no present intention to pay cash dividends. The risk free rate of 2.5% used for the warrants is equal to the zero coupon rate in effect on the date of the re-measurement. Additionally, in connection with the previously discussed exchange, the Company recorded a loss of approximately $900,000 which accounts for the remaining change in value during the period.

Stock Options Modified

     On April 14, 2011, all of the Company’s directors and certain of the Company’s executive officers executed agreements with the Company under which they agreed that none of their outstanding stock options will be exercisable unless and until the Company increases the number of authorized shares of common stock to a number that is sufficient to permit the exercise or conversion in full of all then outstanding options of the Company (including their stock options), warrants and other securities of the Company that are convertible into shares of common stock. An aggregate of 3,489,256 option shares are covered by these agreements. For accounting purposes, the agreement of all of the Company’s directors and certain executive officers to place restrictions of the exercisability of their options is treated as a modification of their options resulting in the reclassification of the options from equity to a liability. In connection with the modification, the Company will recognize compensation cost equal to the greater of (a) the grant date fair value of the original equity award plus an incremental cost associated with the modification or (b) the fair value of the modified award when it is settled. As of June 30, 2011, the Company recorded a liability of $682,000 representing the fair value of the vested portion of these options with a corresponding decrease of $674,000 to additional paid in capital for previously recognized stock compensation expense and a $7,000 charge to operations.

RXi PHARMACEUTICALS CORPORATION
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8. Recent Accounting Pronouncements

     Effective January 1, 2010, the Company adopted Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements , or ASU 2010-06. A reporting entity should provide additional disclosures about the different classes of assets and liabilities measured at fair value, the valuation techniques and inputs used, the activity in Level 3 fair value measurements, and the transfers between Levels 1, 2, and 3 fair value measurements. The adoption of the additional disclosures for Level 1 and Level 2 fair value measurements did not have an impact on the Company’s financial position, results of operations or cash flows. The disclosures regarding Level 3 fair value measurements were adopted by the Company January 1, 2011 and did not have an impact on the Company’s financial position, results of operations or cash flows or require additional disclosures.

     Effective January 1, 2010, the Company adopted ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, or ASU 2009-17. The amendments in this update replace the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this update also require additional disclosures about a reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements. The Company evaluated its business relationships to identify potential variable interest entities and has concluded that consolidation of such entities is not required for the periods presented. On a quarterly basis, the Company will continue to has reassess its involvement with variable interest entities.

     In December 2010, the FASB issued ASU No. 2010-28, Intangibles — Goodwill and Other (Topic 350): “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts . ASU 2010-28 is effective for fiscal years beginning after December 15, 2010 and amends the criteria for performing Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts and requires performing Step 2 if qualitative factors indicate that it is more likely than not that a goodwill impairment exists. We do not believe that this will have a material impact on our consolidated financial statements.

     In December 2010, the FASB issued ASC Update 2010-29, Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations (Update No. 2010-29). This Update requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. This Update affects any public entity that enters into business combinations that are material on an individual or aggregate basis and is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted updated No. 2010-29 beginning January 1, 2011. The financial statements have been updated to reflect the adoption of this pronouncement.

     In May 2011, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard that clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new standard is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. The Company does not expect that adoption of this new standard will have a material impact on its condensed consolidated financial statements.

     In June 2011, the FASB issued a new accounting standard that eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity, requires the consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this new standard do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. This new standard is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011. As this new standard only requires enhanced disclosure, the adoption of this standard will not impact the Company’s condensed consolidated financial statements.

RXi PHARMACEUTICALS CORPORATION
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

9. Subsequent Events

     The Company evaluated all events or transactions that occurred after June 30, 2011 up through the date these financial statements were issued. Other than what is disclosed below, during this period, the Company did not have any material recognizable or unrecognizable subsequent events.

     On April 21, 2011, the Company’s Board of Directors authorized an increase in the Company’s authorized shares of common stock to 125,000,000 shares, subject to approval of the Company’s stockholders. On July 15, 2011, the Company’s stockholders approved the amendment.

     On April 21, 2011, our Board of Directors adopted an amendment to the 2007 Incentive Plan that would increase the maximum number of shares of common stock authorized for issuance under the 2007 Incentive Plan by 2,000,000 shares to a total of 8,750,000 shares. On July 15, 2011, the Company’s stockholders approved the amendment.

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

      In this document, “we,” “our,” “ours,” “us,” “RXi” and the “Company” refer to RXi Pharmaceuticals Corporation and Apthera, Inc., its wholly owned subsidiary.

      This management’s discussion and analysis of financial condition as of June 30, 2011 and results of operations for the three months and six months ended June 30, 2011 and 2010 should be read in conjunction with management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2010 which was filed with the SEC on April 15, 2011.

      The discussion and analysis below includes certain forward-looking statements related to future operating losses and our potential for profitability, the sufficiency of our cash resources, our ability to obtain additional equity or debt financing, possible partnering or other strategic opportunities for the development of our products, as well as other statements related to the progress and timing of product development, present or future licensing, collaborative or financing arrangements or that otherwise relate to future periods, which are all forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements represent, among other things, the expectations, beliefs, plans and objectives of management and/or assumptions underlying or judgments concerning the future financial performance and other matters discussed in this document. The words “may,” “will,” “should,” “plan,” “believe,” “estimate,” “intend,” “anticipate,” “project,” and “expect” and similar expressions are intended to identify forward-looking statements. All forward-looking statements involve certain risks, uncertainties and other factors described elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2010, that could cause our actual results of operations, performance, financial position and business prospects and opportunities for this quarter and the periods that follow to differ materially from those expressed in, or implied by, those forward-looking statements. We caution investors not to place significant reliance on the forward-looking statements contained in this report. These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise forward-looking statements.

Overview

     RXi Pharmaceuticals Corporation (NASDAQ: RXII) is a biotechnology company focused on discovering, developing and commercializing innovative therapies addressing major unmet medical needs using targeted biotherapeutics. RXi is pursuing the development of novel cancer therapeutics using peptide-based immunotherapy products, including our main product candidate, NeuVax™ (E75), for the treatment of various cancers.

Results of Operations

For the Three and Six Months Ended June 30, 2011 and June 30, 2010

     We reported a loss from operations of $4,622,000, which includes $506,000 of non-cash equity based compensation, for the three months ended June 30, 2011 compared with a loss from operations of $4,754,000, which includes $1,616,000 of non-cash equity compensation, in 2010. The decrease in loss of $132,000, or 3%, was due primarily to a $1,110,000 decrease in non-cash equity compensation and a $44,000 decrease in general and administrative expenses offset by an increase of $1,022,000 in research and development expenses, as noted below.

     We reported a loss from operations of $9,901,000, which includes $1,919,000 of non-cash equity based compensation, for the six months ended June 30, 2011 compared with a loss from operations of $9,210,000, which includes $3,125,000 of non-cash equity based compensation, in 2010. The increase in loss of $691,000, or 8%, was due primarily to a $1,206,000 decrease in non-cash equity compensation offset by a $1,468,000 increase in research and development expenses and an increase of $429,000 in general and administrative expenses, as noted below.

     For the three months ended June 30, 2011, our net loss was approximately $1,382,000 compared with a net loss of $2,141,000 for the three months ended June 30, 2010. The decrease in net loss of $759,000 or 35% includes the loss from operations of $4,622,000 and $3,243,000 in non-cash other income related to the change in fair value of common stock warrants issued in several financing transactions. The result was a net loss per share of $0.04 and $0.12 for the three months ended June 30, 2011 and 2010, respectively. Variations in the losses between the two periods are discussed below.

      For the six months ended June 30, 2011, our net loss was approximately $5,227,000 compared with a net loss of $6,027,000 for the six months ended June 30, 2010. The decrease in net loss of $800,000, or 13%, includes the loss from operations of $9,901,000 offset by other income of $4,678,000 related to the change in fair value of warrants issued in several financing transactions and government grant monies received. The result was a net loss per share of $0.18 and $0.35 for the six months ended June 30, 2011 and 2010, respectively. Variations in the losses between the two periods are discussed below.

Research and Development Expense

     Research and development expense consists primarily of compensation-related costs for our employees dedicated to research and development activities and for our Scientific Advisory Board (“SAB”) members, as well as licensing fees, patent prosecution costs, and the cost of lab supplies used in our research and development programs. We expect research and development expenses to increase as we expand our discovery and development activities.

     Total research and development expenses were approximately $2,673,000 for the three months ended June 30, 2011, compared with $2,264,000 for the three months ended June 30, 2010. The increase of $409,000, or 18%, was primarily due to an increase of $1,022,000 in research and development cash expenses due to a ramp up in NeuVax-related consulting fees and activities in our progression toward releasing NeuVax off clinical hold offset by a decrease of $558,000 in non-employee non-cash stock based compensation related to a change in our Black-Scholes assumptions and $55,000 in employee non-cash stock based compensation.

     Total research and development expenses were approximately $4,833,000 for the six months ended June 30, 2011, compared with $4,190,000 for the six months ended June 30, 2010. The increase of $643,000, or 15%, was primarily due to an increase of $1,468,000 in research and development cash expenses due to a ramp up in NeuVax-related consulting fees and activities in our progression toward releasing NeuVax off clinical hold, which was partially offset by a decrease of $743,000 in non-employee non-cash stock based compensation and a $82,000 decrease in employee non-cash stock based compensation.

General and Administrative Expense

     General and administrative expenses include compensation-related costs for our employees dedicated to general and administrative activities, legal fees, audit and tax fees, consultants and professional services, and general corporate expenses.

     General and administrative expenses were approximately $1,949,000 for the three months ended June 30, 2011, compared with $2,490,000 for the three months ended June 30, 2010. The decrease of $541,000, or 22%, was primarily due to a $318,000 decrease in non-cash employee stock based compensation and a $179,000 decrease due to non-cash stock based compensation expense related to a change in our Black-Scholes assumptions. Excluding these non-cash items, general and administrative expenses were approximately $1,610,000 for the three months ended June 30, 2011, compared with $1,654,000 for the three months ended June 30, 2010. The decrease of $44,000 was primarily due to a decrease in headcount offset by severance payments in connection with a reduction in force.

     General and administrative expenses were approximately $5,068,000 for the six months ended June 30, 2011, compared with $5,020,000 for the six months ended June 30, 2010. The increase of $48,000, or 1%, was primarily due to a $413,000 decrease in non-cash stock based compensation related to a warrant issued for business advisory services offset by a $9,000 increase in employee non-cash stock based compensation and a $23,000 increase due to non-cash stock based compensation expense. Excluding these non-cash items, general and administration expense were approximately $3,531,000 for the six months ended June 30, 2011, compared with $3,102,000 for the six months ended June 30, 2010. The increase of $429,000 was primarily due to severance payments in connection with a reduction in force.

Interest Income

     Interest income was negligible for the three and six months ended June 30, 2011 and 2010. The key objectives of our investment policy are to preserve principal and ensure sufficient liquidity, so our invested cash may not earn as high a level of income as longer-term or higher risk securities, which generally have less liquidity and more volatility.

Other Income/Expense

     Other income and expense for the three months ended June 30, 2011 was approximately $3,243,000 which includes $3,057,000 in non-cash income related to a gain on the change in the fair value of common stock warrants issued in connection with several financing transactions in 2009, 2010 and 2011 and $186,000 in government grant monies received.

     Other income and expense for the six months ended June 30, 2011 was approximately $4,678,000 which includes $4,493,000 in non-cash income related to a gain on the change in the fair value of common stock warrants issued in connection with several financing transactions in 2009, 2010 and 2011 and $186,000 in government grant monies received. The fair value of the 2009, 2010 and 2011 warrants of $11,882,000 at June 30, 2011 is included as a current liability in the accompanying balance sheets and were determined using the Black-Scholes option pricing model.

Liquidity and Capital Resources

     We had cash and cash equivalents of approximately $17.9 million as of June 30, 2011, compared with $5.1 million as of June 30, 2010. We have not generated revenue to date and may not generate product revenue in the foreseeable future, if ever. We expect to incur significant operating losses as we advance our product candidates through the drug development and regulatory process. In addition to increasing research and development expenses, we expect general and administrative costs to increase as we add personnel and assume Apthera’s operations. We will need to generate significant revenues to achieve profitability and might never do so. In the absence of product revenues, our potential

sources of operational funding are expected to be the proceeds from the sale of equity, funded research and development payments and payments received under partnership and collaborative agreements.

     As a result of our acquisition of Apthera and the expenses expected to be incurred in connection with the Phase 3 clinical trial for NeuVax, we expect that our expenses will increase significantly from historic levels for the foreseeable future. We believe that our existing cash and cash equivalents should be sufficient to fund our operations through at least the second quarter of 2012. In the future, we will be dependent on obtaining funding from third parties, such as proceeds from the sale of equity, funded research and development payments and payments under partnership and collaborative agreements, in order to maintain our operations and meet our obligations to licensors. There is no guarantee that additional equity or other funding will be available to us on acceptable terms, or at all. If we fail to obtain additional funding when needed, we would be forced to scale back, or terminate, our operations or to seek to merge with or to be acquired by another company.

Net Cash Flow from Operating Activities

     Net cash used in operating activities was approximately $7,086,000 for the six months ended June 30, 2011, compared with $6,151,000 for the six months ended June 30, 2010. The increase of approximately $935,000 resulted primarily from a net loss of $5,227,000, of which $1,810,000 related to stock-based compensation, $23,000 related to common stock issued in exchange for services, $87,000 related to stock warrant expense in exchange for services, $84,000 related to depreciation, a $7,000 loss on disposal of equipment, $900,000 related to the loss on exchange of equity instruments, and $5,393,000 that reflects the fair value of warrants and mandatorily redeemable stock obligations issued in financings completed by the Company in 2009, 2010 and 2011 and $651,000 related to changes in current assets and liabilities.

Net Cash Flow from Investing Activities

     Net cash used in investing activities was approximately $115,000 for the six months ended June 30, 2011, compared with $6,050,000 for the six months ended June 30, 2010. The increase was primarily due to $168,000 in cash received from the Apthera acquisition offset by $53,000 in purchases of equipment and furnishings in 2011 compared with $5,996,000 in the purchase of short term investments and $54,000 in purchases of equipment and furnishing for the same period in 2010.

Net Cash Flow from Financing Activities

     Net cash provided by financing activities was $18,013,000 for the six months ended June 30, 2011, compared with $11,610,000 for the six months ended June 30, 2010. The increase was primarily due to net proceeds from the issuance of common stock in the amount of $18,060,000 from the March and April 2011 financings compared with net proceeds from the issuance of common stock in the amount of $15,235,000 from the financing completed in the first half of 2010.

Off-Balance Sheet Arrangements

     We have not entered into off-balance sheet financing, other than operating leases.

Critical Accounting Policies and Estimates

     In our Annual Report on Form 10-K for the year ended December 31, 2010, we disclosed our critical accounting policies and estimates upon which our financial statements are derived. There have been no changes to these policies since December 31, 2010. Readers are encouraged to review these disclosures in conjunction with the review of this quarterly report on Form 10-Q.

Certifying Officers, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

     There has not been any change in our internal control over financial reporting that occurred during the quarterly period ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

RXi PHARMACEUTICALS CORPORATION

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.