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================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                          ---------------------------

                                    FORM 10-K

                ANNUAL REPORT PERSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997
                         Commission File Number 33-60134

                        HOLLIS-EDEN PHARMACEUTICALS, INC.
             (Exact name of Registrant as specified in its charter)


                  DELAWARE                                   13-3697002
    -----------------------------------                 ---------------------
        (State or other jurisdiction                      (I.R.S. Employer
     of incorporation or organization)                   Identification No.)

       9333 GENESEE AVENUE, SUITE 110
                SAN DIEGO, CA                                   92121
 ------------------------------------------             ---------------------
  (Address of principal executive offices)                   (Zip Code)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 587-9333

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                     Common stock, $.01 par value per share


        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 Act of 1934 during
the preceding months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.

                             YES  [X]       NO [ ]

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

        The aggregate market value of the voting stock held by nonaffiliates of
the Registrant as of March 11, 1998 totaled approximately $52,706,000 based on
the closing stock price as reported by NASDAQ Stock Market.

As of March 11, 1998, there were 6,801,315 shares of the Registrant's Common
Stock, $.01 par value per share, outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Registrant's definitive proxy statement to be filed with the Securities and
Exchange Commission, pursuant to regulation 14A in connection with the 1998
Annual Meeting of Stockholders to be held on May 18, 1998, is incorporated by
reference into Part III of this Report.

Certain Exhibits filed with the Registrant's (i) Registration Statement on Form
S-4 (No. 333-18725), as amended, and (ii) Form 10-Q for the quarter ended March
31, 1997, are incorporated by reference into Part IV of this Report.

================================================================================


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                        Hollis-Eden Pharmaceuticals, Inc.
                                    Form 10-K

                   For the Fiscal Year Ended December 31, 1997

                                      INDEX

<TABLE>
<CAPTION>
PART I                                                                                    PAGE
                                                                                          ----
<S>      <C>                                                                                <C>
Item 1   Business............................................................................3

Item 2   Properties.........................................................................18

Item 3   Legal Proceedings..................................................................18

Item 4   Submission Of Matters To A Vote Of Security Holders ...............................18


PART II

Item 5   Market For Registrant's Common Stock And Related Stockholder Matters...............19

Item 6   Selected Financial Data............................................................20

Item 7   Management's Discussion And Analysis Of Results Of Operations And
           Financial Condition..............................................................21

Item 7A  Quantitative and Qualitative Disclosures About Market Risk.........................23

Item 8   Financial Statements And Supplementary Data........................................23

Item 9   Changes In And Disagreements With Accountants On Accounting And
           Financial Disclosures............................................................23


PART III

Item 10  Directors And Executive Officers Of The Registrant.................................24

Item 11  Executive Compensation.............................................................24

Item 12  Security Ownership Of Certain Beneficial Owners And Management ....................24

Item 13  Certain Relationships And Related Transactions.....................................24


PART IV

Item 14  Exhibits, Financial Statements, Schedules And Reports On Form 8-K..................25

         Signatures.........................................................................26
</TABLE>





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This Annual Report on Form 10-K contains certain forward-looking statements that
involve risks and uncertainties. The actual future results for Hollis-Eden
Pharmaceuticals, Inc. may differ materially from those discussed here.
Additional information concerning factors that could cause or contribute to such
differences can be found in this Annual Report on Form 10-K in Part I, Item 1
under the caption "Risk Factors," Part II, Item 7 entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
elsewhere throughout this Annual Report.


                                     PART I

ITEM 1.        BUSINESS

GENERAL

        Hollis-Eden Pharmaceuticals, Inc. (the "Company" or "Hollis-Eden
Pharmaceuticals") is a development-stage pharmaceutical company engaged in the
discovery, development, and commercialization of products for the treatment of a
number of targeted disease states caused by viral, bacterial, parasitic or
fungal infections, including HIV/AIDS, hepatitis B and C, and malaria.
Hollis-Eden Pharmaceuticals believes that certain of its drug candidates may
provide the first long-term treatment for HIV without the development of viral
strain resistance to the drugs' effectiveness, significant toxicity or severe
side effects.

        Hollis-Eden Pharmaceuticals' development efforts are centered around
three unique approaches to identifying therapeutic or preventative
pharmaceutical agents that represent the Company's technology platforms. These
technology platforms and approaches have led to scientific discoveries developed
by Patrick T. Prendergast, Ph.D., and are based upon his research in the area of
viral-caused disorders and therapies. Hollis-Eden Pharmaceuticals products are
the beneficiary of more than 15 years of extensive research and development. The
Company intends to pursue approval of two of the products, INACTIVIN(TM) and
REVERSIONEX(TM), with the Food and Drug Administration ("FDA"). Each of these
drugs has a different mechanism of action and the Company believes that each may
be effectively used as a monotherapy. Hollis-Eden Pharmaceuticals also believes
that INACTIVIN and REVERSIONEX may be combined to increase their effectiveness
to inhibit HIV replication, strengthen and preserve the immune system, and
reduce the viral load in infected patients.

        During March 1997, Hollis-Eden, Inc. ("Hollis-Eden"), a Delaware
corporation, was merged with and into the Company (then known as Initial
Acquisition Corp. ("IAC")). Upon the consummation of the merger, Hollis-Eden
ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals. For
accounting and financial reporting purposes, the merger was treated as a
recapitalization of Hollis-Eden (see "Recapitalization" below). As used herein,
unless otherwise indicated, for periods prior to March 1997 the terms "Company"
and "Hollis-Eden Pharmaceuticals" shall refer to Hollis-Eden, not IAC.

TECHNOLOGY PLATFORMS

        The Company's scientific approaches are based on the study of mechanisms
utilized by viruses or pathogenic microorganisms to infect their host. These
technological approaches have led to a novel series of proprietary
pharmaceutical products that can be used for the treatment and/or prevention of
multiple targeted disease states caused by viral, bacterial, parasitic or fungal
infections. The underlying premise of the Company's technology is that the human
immune system inherently possesses the ability, when directed, to respond to a
specific infection or diseases. The Company's fundamental approach has been to





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identify these naturally occurring therapeutic agents and to design and produce
similar improved versions. The following platforms represent the Company's
innovative technological opportunities:

I.      Antivirals that inhibit the energy producing enzymes that interrupt the
        cellular factors the virus depends on for replication. By depriving the
        virus of the raw materials and energy to replicate, it is possible to
        effectively starve the virus and inhibit its replication.

II.     Immune modulators that either down regulate or up regulate the immune
        response system, thus enhancing the body's own ability to fight off
        infection.

III.    Novel enzyme inhibitors generally classified as cytokinins, to inhibit
        the synthesis of an organism's RNA and DNA.

These approaches have the advantage of producing fewer side effects and less
toxicity for patients.

TECHNOLOGY PLATFORM I - CELLULAR ENERGY REGULATORS

        The Company's first platform focuses on ways to interrupt the human
cellular energy factors needed by viruses to replicate in their host human
cells.

        The Company recently developed PPB2, trade named INACTIVIN, a new analog
of the Company's lead drug candidate, which has a unique mechanism of action for
antiretroviral treatment in HIV/AIDS and other infectious diseases. PPB2 has
demonstrated a 10-fold increase in antiretroviral potency over an earlier
version of INACTIVIN. In in vitro testing, PPB2 inhibits viral replication
against diverse and multiple drug resistant strains of the HIV virus. Currently
approved antiretroviral therapies are designed to block the action of specific
HIV viral proteins that have critical functions at particular stages of the
replication process. These therapies are subject to HIV mutation, resulting in
drug resistance.

        INACTIVIN (PPB2) appears to work independently of the viral structure by
inhibiting human cellular energy producing enzymes, which are necessary for
retroviral replication. The Company's research affiliates, headed by Dr. Patrick
Prendergast, discovered that HIV deprives the host cell of a natural human
molecule that regulates cellular energy. The result of this action causes the
cell to increase its supply of the known energy producing enzymes necessary for
retroviral (HIV) replication. The Company believes that INACTIVIN (PPB2)
decreases the supply of the energy producing enzymes the cell requires to
replicate HIV and therefore prohibits viral replication. The Company believes
that INACTIVIN (PPB2) will inhibit viral replication on a sustained basis and
will not develop drug resistance. The Company intends to advance INACTIVIN
(PPB2) into safety and efficacy clinical trials this year.

TECHNOLOGY PLATFORM II -IMMUNE SYSTEM REGULATORS

        The Company's second technology platform focuses on ways to up regulate
and down regulate the immune system of the body to treat various disorders.

        REVERSIONEX, the Company's drug candidate for up regulation of the
immune system, will be tested in immune suppressed patients suffering from
HIV/AIDS either as monotherapy or adjunctive therapy with INACTIVIN or other
antiretroviral HIV/AIDS drugs. IDPS, the Company's drug candidate for down
regulating the immune system, will be tested in accepted animal models to treat
organ transplant rejection. In addition to working on products for organ
transplant rejection, the Company is exploring agents using IDPS technology to
treat other immune system disorders such as lupus, multiple sclerosis,





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psoriasis, rheumatoid arthritis and scleroderma. The Company intends to advance
REVERSIONEX into safety and efficacy clinical trials this year.

TECHNOLOGY PLATFORM III - SYNTHESIS REGULATORS

        The Company's third platform is based on the regulation of biochemical
synthesis in the cell.

        The Company has discovered, developed and patented a range of modified
nucleosides, which are generally classified as cytokinins, and used as
antibacterial, antiparasitic, antifungal and antiviral agents to treat diseases
such as cytomegalovirus, tuberculosis, malaria, toxoplasmosis and leishmania.
The Company's drug candidates are directly involved with the control of protein
RNA and DNA synthesis and have demonstrated the ability to selectively inhibit
RNA synthesis and protein synthesis of a variety of intra-cellular infective
organisms.

        The Company's drug candidates interact with a very important high-energy
signal molecule called cyclic nucleotide adenosine monophosphate (cAMP), and
because of its unique multi-targeted approach it may be universally effective at
inhibiting a wide array of infectious organisms and viruses in very small
concentrations. Furthermore, the Company has demonstrated in vitro and in vivo
that, with very low levels of these drug candidates, it may be possible to
inhibit both RNA and DNA viruses. This approach has been shown to be non-toxic
to normal body cells.

MARKET OPPORTUNITIES

        The number of people suffering from diseases caused by microorganisms,
such as viruses, bacteria, fungi and parasites, is growing at an alarming rate
worldwide. At the same time, medical conditions involving immune system
disorders are being reported constantly in clinical journals, and new diseases
for which there are no known cures or treatments are becoming more prevalent.

        Today, AIDS is the number one killer of Americans between the ages of 25
and 44. It is estimated by the Centers for Disease Control that approximately
1.1 million Americans are infected with HIV. Globally, the World Health
Organization ("WHO") and the Joint United Nations Programme on HIV/AIDS reported
as of November 1997 that approximately 30 million adults and children are living
with HIV/AIDS. It is now estimated that there were 5.8 million newly infected
people in 1997 and that there will be 40 million people infected by the year
2000.

        WHO reports, that of the 170 million chronic carriers of hepatitis C in
the world, 20% are at risk of developing cirrhosis of the liver and 1% to 5% may
develop liver cancer. Today, the disease often is treated with Interferon, which
is only 20% effective, has significant side effects and is relatively expensive
to use.

        According to the United Network of Organ Sharing, each year
approximately 21,000 organ transplants are performed in the U.S., while more
than 60,000 people remain on waiting lists and more than 5% of those die
waiting. According to Frost and Sullivan, this has created a $1.2 billion U.S.
market for drugs that suppress the body's immune system so as not to reject the
implanted organs. Hollis-Eden is conducting research with drug candidates that
may down regulate the immune system, potentially allowing the body to better
tolerate a mismatched transplanted organ or tissue. The Company believes this
new drug development discovery could dramatically increase the number of
transplants each year and result in rapid market expansion in the U.S. and
throughout the world.

        Hollis-Eden Pharmaceutical's technology platforms enable the Company to
target multiple diseases and disorders. These technology platforms have already
identified molecules for drug candidates





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and have been tested both in vitro and in vivo. According to a recent release by
the Pharmaceutical Manufacturers Association, 3,995 of every 4,000 compounds
screened in preclinical animal testing never make it to human clinicals. Earlier
versions of INACTIVIN and REVERSIONEX have been used in human clinical tests and
appear to be well tolerated with no significant side effects. Furthermore, the
product significantly showed efficacy by reducing the viral load in infected
HIV/AIDS patients. Such safety and efficacy results coupled with the drugs'
non-pathogenic mechanism of action indicate that they can also be used in
several other diseases and disorders. Another advantage of the Company's
products is the fact that extensive research has been completed, thereby
reducing the time required for final development and commercialization.
Additionally, the Company is strategically pursuing its initial indications in
terminal or fatal diseases, such as HIV/AIDS, where the Company's FDA approval
process may be dramatically shorter if the Company's products qualify for the
FDA accelerated drug approval program. See "FDA Overview--Accelerated Drug
Approval."

COMPETITION

        Hollis-Eden Pharmaceuticals believes that its scientific approaches to
infectious diseases, which has led to multiple platform technologies, enables
the Company to develop products for multiple disease states. The Company
believes that certain of its initial products under development that are focused
on HIV/AIDS may realize more effective treatments than drugs currently being
used or developed by the competition. The principal drugs currently used to
treat HIV and AIDS (e.g., AZT, ddI, ddc, d4T and 3TC) are nucleoside analog
reverse transcriptase drugs. Additionally, newer drugs being developed and
recently being introduced are protease inhibitors; e.g., Invirase (Saquinavir),
Crixivan (Indinavir sulfate), Viracept (Nelfinavir) and Novir (Ritonavir).
Hollis-Eden Pharmaceuticals believes that the effectiveness of these types of
drugs may prove to be short-lived since HIV rapidly mutates and develops
resistance to the effectiveness of these drugs. Development of drug resistance
occurs when the virus can mutate its coat protein or enzyme structure so that
its interaction with the drug is altered. Another disadvantage of currently used
treatments is that nucleoside analogues and protease inhibitors are toxic and
may cause severe and intolerable side effects. INACTIVIN and REVERSIONEX are not
reverse transcriptase or protease inhibitors, but are derived from naturally
occurring substances and are expected to be well-tolerated by humans with
minimal side effects. Furthermore, Hollis-Eden Pharmaceuticals believes that
it's drug candidates will have a longer duration of effectiveness, be more
affordable and require smaller doses and fewer pills to be taken than the drugs
and combinations currently being used.

        Because INACTIVIN's antiviral effectiveness is not reliant on a direct
structural interaction with the virus itself, Hollis-Eden Pharmaceuticals
believes that INACTIVIN will inhibit replication of the virus regardless of its
mutation rates. By decreasing the synthesis of the viral raw materials in the
cell, INACTIVIN effectively slows and may eventually stop the virus' production
line. The Company further expects that INACTIVIN will decrease the energy supply
for viral synthesis regardless of the viral type or strain.

FDA OVERVIEW

GENERAL

        The manufacturing and marketing of Hollis-Eden Pharmaceuticals' proposed
products and its research and development activities are and will continue to be
subject to regulation by federal, state and local governmental authorities in
the United States and other countries. In the United States, pharmaceuticals are
subject to rigorous regulation by the FDA's Center for Drug Evaluation and
Research, which reviews and approves marketing of drugs. The Federal Food, Drug
and Cosmetic Act, the regulations promulgated thereunder, and other federal and
state statutes and regulations govern, among other things, the





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testing, manufacture, labeling, storage, record keeping, advertising and
promotion of Hollis-Eden Pharmaceuticals' potential products.


APPROVAL PROCESS

        The process of obtaining FDA approval for a new drug may take several
years and generally involves the expenditure of substantial resources.
Hollis-Eden Pharmaceuticals will try to accelerate the drug approval process
because of the priority status of HIV/AIDS drugs. See "Accelerated Drug
Approval." The steps required before a new drug can be produced and marketed for
human use include clinical trials and the approval of the New Drug Application.

        Preclinical Testing. The promising compound is subjected to extensive
laboratory and animal testing to determine if the compound is biologically
active and safe.

        Investigational New Drug (IND). Before human tests can start, the drug
sponsor must file an IND application with the FDA, showing how the drug is made
and the results of animal testing. If the FDA does not reject the application
within 30 days, IND status allows initiation of clinical investigation.

        Human Testing (Clinical). The human clinical testing program usually
involves three phases which generally are conducted sequentially, but which,
particularly in the case of anti-cancer and other life saving drugs, may overlap
or be combined. Clinical trials are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety
and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA
as part of the IND filing. Each clinical study is conducted under the auspices
of an independent Institutional Review Board ("IRB") for each institution at
which the study will be conducted. The IRB will consider, among other things,
all existing pharmacology and toxicology information on the product, ethical
factors, the risk to human subjects, and the potential benefits of therapy
relative to risk.

        In Phase I clinical trials, studies usually are conducted on healthy
volunteers but, in the case of certain terminal illnesses such as AIDS, are
conducted on patients with disease that usually has failed to respond to other
treatment to determine the maximum tolerated dose, side effects and
pharmacokinetics of a product. Phase II studies are conducted on a small number
of patients having a specific disease to determine initial efficacy in humans
for that specific disease, the most effective doses and schedules of
administration, and possible adverse effects and safety risks. Phase II/III
differs from Phase II in that the trials involved may include more patients and,
at the sole discretion of the FDA, be considered the pivotal trial or trials for
FDA approval (see below). Phase III normally involves the pivotal trials of a
drug, consisting of wide-scale studies on patients with the same disease, in
order to evaluate the overall benefits and risks of the drug for the treated
disease compared with other available therapies. The FDA continually reviews the
clinical trial plans and results and may suggest design changes or may
discontinue the trials at any time if significant safety or other issues arise.

        New Drug Application (NDA). Upon completion of Phase III, the drug
sponsor must file an NDA containing all information that has been gathered. The
information must include the chemical composition of the drug, scientific
rationale, purpose, animal and laboratory studies, results of human tests,
formation and production details, and proposed labeling.

        Approval. Once an NDA is approved, the drug sponsor is required to
submit reports periodically to the FDA containing adverse reactions, production,
quality control and distribution records. The FDA may also require
post-marketing testing to support the conclusion of efficacy and safety of the
product, which





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can involve significant expense. After FDA approval is obtained for initial
indications, further clinical trials may be necessary to gain approval for the
use of the product for additional indications.

        The testing and approval process is likely to require substantial time
and effort, and there can be no assurance that any FDA approval will be granted
on a timely basis, if at all. The approval process is affected by a number of
factors, primarily the side effects of the drug (safety) and its therapeutic
benefits (efficacy). Additional preclinical or clinical trials may be required
during the FDA review period and may delay marketing approval. The FDA may also
deny an NDA if applicable regulatory criteria are not met.

        Outside the United States, Hollis-Eden Pharmaceuticals will be subject
to foreign regulatory requirements governing human clinical trials and marketing
approval for its products. The requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursements vary widely from country
to country.

ACCELERATED DRUG APPROVAL

        In December 1992, the FDA formalized procedures for accelerating the
approval of drugs to be marketed for the treatment of certain serious diseases.
To be eligible for this program, the products must treat serious or
life-threatening illnesses and provide meaningful therapeutic benefits beyond
existing treatments. Under these regulations, a significant new therapy could be
approved for marketing at the earliest possible point at which safety and
effectiveness are reasonably established under existing law. For example, the
approval of a drug could be accelerated by demonstrating a favorable effect on a
well-documented surrogate endpoint to predict clinical benefit, instead of
requiring that the drug demonstrate actual clinical benefit.

        An important and unique element of these regulations is that approval
would be granted only if the sponsor agrees to conduct additional post-marketing
studies to confirm the product's effectiveness and/or agrees to restrict
distribution of the product. In addition, if the further clinical trials do not
bear out the product's effectiveness or if restricted distribution is inadequate
to assure safe use, approval of the product would be withdrawn.

MANUFACTURING

        Hollis-Eden Pharmaceuticals does not have, and does not intend to
establish, manufacturing facilities to produce its products. Hollis-Eden
Pharmaceuticals plans to control its initial capital expenditures by using
contract manufacturers to make its products. Hollis-Eden Pharmaceuticals
believes that there are a sufficient number of high quality FDA approved
contract manufacturers available, and management has had discussions with
several of them, to fulfill its near-term production needs for both clinical and
commercial use.

        The manufacture of Hollis-Eden Pharmaceuticals' products, whether done
by outside contractors (as planned) or Hollis-Eden Pharmaceuticals, will be
subject to rigorous regulations, including the need to comply with the FDA's
current Good Manufacturing Practice standards. As part of obtaining FDA approval
for each product, each of the manufacturing facilities must be inspected,
approved by and registered with the FDA. In addition to obtaining FDA approval
of the prospective manufacturer's quality control and manufacturing procedures,
domestic and foreign manufacturing facilities are subject to periodic inspection
by the FDA and/or foreign regulatory authorities.





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PATENTS

        Hollis-Eden Pharmaceuticals considers the protection of its products,
whether owned or licensed, to the exclusion of use by others, to be vital to its
business. While the Company intends to focus primarily on patented or patentable
technology, it may also rely on trade secrets, unpatented property, know-how,
regulatory exclusivity, patent extensions and continuing technological
innovation to develop its competitive position. In the United States and certain
foreign countries, the exclusivity period provided by patents covering
pharmaceutical products may be extended by a portion of the time required to
obtain regulatory approval for a product.

        In certain countries, pharmaceuticals are not patentable or only
recently have become patentable, and enforcement of intellectual property rights
in many countries has been limited or non-existent. Future enforcement of
patents and proprietary rights in many countries can be expected to be
problematic or unpredictable. There can be no assurance that any patents issued
or licensed to Hollis-Eden Pharmaceuticals will provide it with competitive
advantages or will not be challenged by others. Furthermore, there can be no
assurance that others will not independently develop similar products or will
not design around patents issued or licensed to Hollis-Eden Pharmaceuticals.

        Patent applications in the United States are maintained in secrecy until
patents issue. Publication of discoveries in the scientific or patent
literature, if made, tends to lag behind actual discoveries by several months.
Consequently, the Company cannot be certain that its licensor was the first to
invent certain technology or compounds covered by pending patent applications or
issued patents or that it was the first to file patent applications for such
inventions. In addition, the patent positions of pharmaceutical companies,
including those of Hollis-Eden Pharmaceuticals, are generally uncertain, partly
because they involve complex legal and factual questions.

        In addition to the considerations discussed above, companies that obtain
patents claiming products, uses or processes that are necessary for or useful to
the development of Hollis-Eden Pharmaceuticals' products could bring legal
actions against the Company claiming infringement. Patent litigation is
typically costly and time-consuming, and if such an action were brought against
Hollis-Eden Pharmaceuticals it could result in significant cost and diversion of
management time. The Company may be required to obtain licenses to other patents
or proprietary rights and there can be no assurance that licenses would be made
available on terms acceptable to the Company. If Hollis-Eden Pharmaceuticals
does not obtain such licenses, it could encounter delays in product market
introductions while it attempts to license technology designed around such
patents or could find that the development, manufacture or sale of products
requiring such licenses is foreclosed.

        Further, there can be no assurance that patents that are issued will not
be challenged, invalidated or infringed upon or designed around by others, or
that the claims contained in such patents will not infringe the patent claims of
others, or provide Hollis-Eden Pharmaceuticals with significant protection
against competitive products, or otherwise be commercially valuable. There can
be no assurance that the Company will not need to acquire licenses under patents
belonging to others for technology potentially useful or necessary to the
Company or, if any such licenses are required, that they will be available on
terms acceptable to the Company, if at all. To the extent that Hollis-Eden
Pharmaceuticals is unable to obtain patent protection for its products or
technology, Hollis-Eden Pharmaceuticals' business may be adversely affected by
competitors who develop substantially equivalent technology.

LICENSE AGREEMENTS

        Certain provisions of agreements relating to the products have been
renegotiated and amended from time to time, primarily to defer cash payments due
under the agreements. The amendments have streamlined





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Hollis-Eden Pharmaceuticals' commitments and contingencies. The discussion below
reflects the nature of its agreements as in effect at the current time. Although
the Company believes the following summaries to be accurate, such summaries are
qualified in their entirety by reference to their original documents.

COLTHURST LICENSE AGREEMENT

        In May 1994, Hollis-Eden Pharmaceuticals entered into a license
agreement, as amended in August 1995 and October 1996 (the "Colthurst License
Agreement"), with Colthurst Limited ("Colthurst") and Patrick T. Prendergast,
Ph.D., pursuant to which Hollis-Eden Pharmaceuticals was granted exclusive
worldwide rights to all present and future patent rights, know-how and
background technology of Colthurst and Dr. Prendergast relating to the treatment
of retroviral infections for all uses thereunder to develop and commercialize
products based on the licensed rights. The Company also has the right to
sublicense any such rights.

        Hollis-Eden Pharmaceuticals paid a license fee of $100,000 to Colthurst
upon execution of the agreement and was required to pay an additional license
fee of $250,000, of which Hollis-Eden Pharmaceuticals paid $125,000 to Colthurst
in March 1995. The remainder of such fee becomes due according to the terms of
the Colthurst License Agreement. The Company issued 37,736 shares of Common
Stock to Colthurst and, beginning August 1995, the Company agreed to make
monthly payments of $5,000 to the licensors. Hollis-Eden Pharmaceuticals is also
obligated to pay to Colthurst royalties on revenues from products covered by the
licensed rights and on revenues received by the Company in connection with
sublicenses granted by the Company to third parties. Hollis-Eden Pharmaceuticals
must pay a renewable annual license fee, which fee is deductible from royalty
fees due to Colthurst during a certain period following renewal of the license.
There can be no assurance that the Company will be able to pay such annual fees
in the future, in which event the termination of the agreement and the licensing
of such rights to a third party would have a material adverse effect on the
Company's business.

EDENLAND LICENSE AGREEMENT

        In August 1994, Hollis-Eden Pharmaceuticals entered into a license
agreement, as amended in August 1995 (the "Edenland License Agreement"), with
Edenland, Inc. ("Edenland") and Dr. Prendergast pursuant to which Hollis-Eden
Pharmaceuticals was granted exclusive worldwide rights to all present and future
patent rights, know-how and background technology of Edenland and Dr.
Prendergast relating to the AFP anti-serum/vaccine for all uses thereunder to
develop and commercialize products based on the licensed rights. The Company
also has the right to sublicense any such rights.

        Hollis-Eden Pharmaceuticals paid a license fee of $25,000 upon execution
of the agreement and an additional license fee in the aggregate of $100,000 over
a six-month period ending February 28, 1995. The Company issued to Edenland and
Dr. Prendergast an aggregate of 543,396 shares of the Company Common Stock and
agreed that either Dr. Prendergast or his brother, Leo Prendergast, at
Edenland's election, has the right to serve on Hollis-Eden Pharmaceuticals'
Board of Directors for three years. The Company is also obligated to pay
Edenland a license fee of $572,000, of which the Company paid $125,000 to
Edenland in March 1995. The remainder of such fee becomes due according to the
terms of the Edenland License Agreement. Hollis-Eden Pharmaceuticals issued to
Edenland a warrant to purchase 37,736 shares of Common Stock at an exercise
price of $15.90 per share, 37,736 shares of Common Stock and registration rights
pari passu with certain other investors of Hollis-Eden Pharmaceuticals. In
addition, beginning August 1995, the Company agreed to make monthly payments of
$5,000 to the licensors. The Company is obligated to pay to Edenland royalties
on revenues from products covered by the licensed rights and on revenues
received by the Company in connection with sublicenses granted by the Company to
third parties. Pursuant to the terms of the Edenland License Agreement, with
certain limitations, Edenland has the option to receive such royalties in the
form of Common Stock. Furthermore, as a condition to the Company's





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<PAGE>   11

commercialization rights to any product for which regulatory approval is
obtained and a certain revenue milestone is achieved, the Company is obligated
to pay Edenland a renewable annual license fee for such product for a period of
six years. Such annual fee, however, is deductible from royalty fees due to
Edenland, including royalty payments due to Edenland in connection with
sublicenses granted by Hollis-Eden Pharmaceuticals, during the term of the
agreement. REVERSIONEX will cease to be a product covered by the license
agreement if Hollis-Eden Pharmaceuticals has not contributed a certain amount of
funding to the development of REVERSIONEX in accordance with the terms and
conditions of the related Research and Development Agreement (described below).
There can be no assurance that the Company will be able to pay such annual fees
in the future, in which event the termination of certain rights and the
licensing of such rights to a third party would have a material adverse effect
on the Company's business.

RESEARCH AND DEVELOPMENT AGREEMENT

        In August 1994, Hollis-Eden Pharmaceuticals entered into a research,
development and option agreement, as amended in August 1995 and October 1996
(the "Research and Development Agreement"), with Edenland and Dr. Prendergast
pursuant to which Edenland agreed to obtain an open IND for REVERSIONEX from the
FDA and to commence a patient Phase I IND study under the guidelines and
regulations of the FDA. The Company is obligated to pay Edenland the development
costs associated with such Phase I study, for which the Company has agreed to
commit a certain minimum amount from its annual research and development budget.
After the payment of such development costs and upon the determination that the
new product will not meet regulatory approval, Hollis-Eden Pharmaceuticals has
the right to terminate its obligation to pay any further development costs of
REVERSIONEX.

        Edenland granted Hollis-Eden Pharmaceuticals the exclusive option to
acquire exclusive worldwide rights to all new products of Edenland relating to
the modulating of the immune system and all patent rights, know-how and
background technology from which such new products were derived, which rights,
upon exercise of the option by Hollis-Eden Pharmaceuticals, are governed by the
terms and conditions of the Edenland License Agreement. The Research and
Development Agreement terminates concurrently with the termination of the
Edenland License Agreement.

RECAPITALIZATION

        On March 26, 1997, Hollis-Eden, was merged with and into IAC, pursuant
to an Agreement and Plan of Merger, dated November 1, 1996, among IAC,
Hollis-Eden, Mr. Salvatore J. Zizza and Mr. Richard B. Hollis (the "Merger
Agreement"). Upon consummation of the merger of Hollis-Eden with IAC (the
"Merger"), Hollis-Eden ceased to exist, and IAC changed its name to Hollis-Eden
Pharmaceuticals, Inc. IAC (now called Hollis-Eden Pharmaceuticals, Inc.) remains
the continuing legal entity and registrant for Securities and Exchange
Commission reporting purposes. The Merger was intended to be a tax-free
reorganization for federal income tax purposes and was accounted for as a
recapitalization of Hollis-Eden by an exchange of Common Stock of Hollis-Eden
for the net assets of IAC, consisting primarily of cash. IAC was formed to serve
as a vehicle to effect a merger, exchange of capital stock, asset acquisition or
other business combination with a target business, which IAC believed has
significant growth potential.

Under the terms of the Merger Agreement, each share of Hollis-Eden Common Stock
outstanding immediately prior to the closing of the Merger converted into one
share of Common Stock of Hollis-Eden Pharmaceuticals, Inc. Common Stock
("Company Common Stock"), and all warrants and options to purchase Hollis-Eden
Common Stock outstanding immediately prior to the Merger converted into the
right to receive the same number of shares of Company Common Stock. At the
closing of the Merger, 4,911,004 shares of Company Common Stock were issued,
which represented approximately 85% of the shares of Company Common Stock
outstanding immediately after consummation of the Merger.





                                       11
<PAGE>   12

EMPLOYEES

        As of March 20, 1998, the Company had 9 full-time employees. The Company
believes that its relations with its employees are good.

FOUNDERS

        The Company was founded by Richard B. Hollis (see "Executive Officers")
and Patrick T. Prendergast, Ph.D. Dr. Prendergast, whose specialty is in
anti-viral drug screening and assessment, developed the drug candidates licensed
to Hollis-Eden Pharmaceuticals. His research interests are virology, molecular
immunological and genetic analysis of animal and human lentiviruses, human
herpes virology and immunology, anti-viral agent isolation and retroviral
diagnostics. Dr. Prendergast has been primarily engaged in medical research and
development activities through two research and development companies controlled
by him, Colthurst and Edenland, since 1985 and 1987, respectively. These
companies investigated and screened human hormones and proteins as anti-HIV
drugs. Dr. Prendergast filed foreign patents on the use of these agents for the
treatment of viral caused immune disorders. Dr. Prendergast received his Ph.D.
in microbiology from the University College of Galway, Ireland in 1982.

EXECUTIVE OFFICERS

        The executive officers of the Company and their ages as of March 20,
1998 are as follows:

<TABLE>
<CAPTION>
        NAME                 AGE                          POSITION
        ----                 ---                          --------
<S>                           <C>   <C>
Richard B. Hollis             45    Chairman of the Board and Chief Executive Officer

Terren S. Peizer              38    Vice Chairman and President

James M. Frincke, Ph.D.       47    Vice President, Research and Development

Robert L. Marsella            45    Vice President, Business Development and Marketing

Thomas C. Merigan, Jr., M.D.  64    Medical Director, Infectious Diseases

Robert W. Weber               47    Vice President - Controller
</TABLE>

        RICHARD B. HOLLIS is the founder of Hollis-Eden Pharmaceuticals and has
served as its Chairman and Chief Executive Officer since August 1994. Mr. Hollis
also served as the Company's President from August 1994 to February 1997. Mr.
Hollis has over 20 years experience in the health care industry in positions
ranging from sales to Chief Executive Officer. Mr. Hollis served as Chief
Operating Officer of Bioject Medical from 1991 to 1994 and as Vice President
Marketing and Sales/General Manager for Instromedix from 1989 to 1991. From 1986
to 1989, Mr. Hollis served as a general manager of the Western business unit of
Genentech, Inc., a manufacturer of biopharmaceuticals. Prior to joining
Genentech, Inc., Mr. Hollis served as a divisional manager of Imed Corporation,
Inc., a manufacturer of drug delivery systems: intravenous infusion pumps and
controllers. Mr. Hollis began his career in the health care industry with Baxter
Travenol from 1974 to 1977. Mr. Hollis received his B.A. in Psychology from San
Francisco State University in 1974.

        TERREN S. PEIZER became President and a director of the Company in
February 1997. Since 1993, Mr. Peizer has served as Chairman and Chief Executive
Officer of Beachwood Financial Company, Inc., an investment holding company with
significant Biotechnology equity holdings. From 1990 to 1993, Mr.





                                       12
<PAGE>   13

Peizer served as Chairman and Chief Executive Officer of Financial Group
Holdings, Inc., an investment holding company. From 1985 to 1990, Mr. Peizer
served as a senior member of the investment banking firm of Drexel Burnham
Lambert, Inc.'s High Yield Bond Department. Mr. Peizer held investment banking
positions from 1981 to 1985 at Goldman, Sachs & Co.'s Risk and International
Arbitrage Division as well as the First Boston Corp.'s High Yield Securities
Department. Mr. Peizer received his B.S.E. in Finance from The Wharton School of
Finance and Commerce in 1981.

        JAMES M. FRINCKE, Ph.D. became Vice President, Research and Development
of the Company in November 1997. During his 16 years in the industry, Dr.
Frincke has managed major programs for research and development of drugs,
biologicals, cellular and gene therapeutics that are aimed at the treatment of
cancer, infectious diseases and tissue transplantation. Since joining the
biotechnology industry, Dr. Frincke has held vice president, research and
development positions in several biotechnology companies including Hybritech/Eli
Lilly. Most recently, he served as Vice President of Therapeutics Research and
Development at Prolinx, from 1995 to 1997, Vice President of Bio-Organic
Chemistry and Vice President of Research and Development for Systemix from 1991
to 1995. In various capacities, he has been responsible for all aspects of
pharmaceutical development including early stage research programs, product
evaluation, pharmacology, manufacturing, and the management of the regulatory
and clinical matters of lead product opportunities. Dr. Frincke has authored and
co-authored more than 100 scientific articles, abstracts and regulatory filings.
Dr. Frincke received his Ph.D. in chemistry at the University of California,
Davis in 1978. In 1981, Dr. Frincke completed his postdoctoral work at the
University of California, San Diego.

        ROBERT L. MARSELLA became Vice President, Business Development and
Marketing of the Company in September 1997. Mr. Marsella has over 17 years of
medical sales, marketing, and distribution experience. Since 1994 Mr. Marsella
has been President of RLM Cardiac Products, an exclusive distributor in the
Southwestern United States of various cardiac related hospital products. From
1990 to 1994, Mr. Marsella marketed and distributed implantable pacemakers and
defibrillators for Telectronics Pacing Systems. From 1987 to 1990, Mr. Marsella
served as Regional Manager for Genentech, Inc. and launched ACTIVASE t-PATM (a
Biopharmaceutical drug) in the Western United States. From 1983 to 1987, Mr.
Marsella marketed intravenous infusion pumps for Imed Corporation. Mr. Marsella
began his career in 1980, as a field sales representative, and was quickly
promoted to regional sales manager for U.S. Surgical Corporation, auto suture
division. Mr. Marsella received his B.A. degree from San Diego State University
in 1975.

        THOMAS CHARLES MERIGAN, JR., M.D., became Chairman of the Scientific
Advisory Board and a director of the Company in March 1996. Dr. Merigan has been
George E. and Lucy Becker Professor of Medicine at Stanford University School of
Medicine from 1980 to the present. Dr. Merigan has also been the Principal
Investigator, NIAID Sponsored AIDS Clinical Trials Unit, from 1986 to the
present and has been Director of Stanford University's Center For AIDS Research
from 1988 to the present. Dr. Merigan is a member of various medical and
honorary societies, has lectured extensively within and outside the United
States, and authored numerous books and articles and has chaired and edited
symposia relating to viruses, infectious diseases, anti-viral agents, HIV and
other retroviruses and AIDS. From 1990 to the present, Dr. Merigan has been
Chairman, Editorial Board of "HIV: Advances in Research and Therapy". He is also
a member of the editorial boards of "Aids Research and Human Retroviruses"
(since 1983), "International Journal of Anti-Microbial Agents" (since 1990), and
"The Aids Reader" (since 1991), among others. He is a co-recipient of eight
patents which, among other things, relate to synthetic polynucleotides,
modification of hepatitis B virus infection, treatment of HIV infection,
purified cytomegalovirus protein and composition and treatment for herpes
simplex. Dr. Merigan has been Chair, Immunology Advisory Board, Bristol Myers
Squibb Corporation (1989 - 1995) and Chair, Scientific Advisory Board, Sequel
Corp. (1993 - 1996). In 1994, Stanford University School of Medicine honored him
with the establishment of the Annual Thomas C. Merigan Jr. Endowed Lectureship
in Infectious





                                       13
<PAGE>   14

Diseases, and, in 1996, Dr. Merigan was elected Fellow, American Association for
the Advancement of Science. From 1966 to 1992, Dr. Merigan was Head, Division of
Infectious Diseases, at Stanford School of Medicine. Dr. Merigan received his
B.A. (with honors) from the University of California at Berkeley in 1954 and his
M.D. from the University of California at San Francisco in 1958.

        ROBERT W. WEBER was appointed Vice President - Controller of the Company
in March 1996. Mr. Weber has over twenty years of experience in financial
management and has been employed at executive levels by multiple start-up
companies and contributed to the success of several turnaround situations. Most
recently he served as Vice President of Finance at Prometheus Products, a
subsidiary of Sierra Semiconductor, and Vice President Finance and Chief
Financial Officer for Amercom. From 1988 to 1993, Mr. Weber served as Vice
President Finance and Chief Financial Officer of Instromedix, which designs,
manufactures and markets medical electronic devices and software. Mr. Weber
received a B.S. from GMI Institute of Technology in 1975 and a MBA from Stanford
Graduate School of Business in 1977.

RISK FACTORS

        Dependence on New Products and FDA Approval. Hollis-Eden
Pharmaceutical's principal development efforts are currently centered around two
drug candidates licensed by the Company which the Company's management believes
show promise for the treatment and prevention of HIV/AIDS. Neither INACTIVIN nor
any of the other drug candidates have been approved for commercial sale and no
assurance can be given that approvals will be obtained. Hollis-Eden
Pharmaceuticals' current primary focus is on INACTIVIN. While limited clinical
trials of an earlier version of INACTIVIN have to date produced favorable
results, significant additional trials are required, and no assurance can be
given that the drug will ultimately be demonstrated to be safe or efficacious.
Hollis-Eden Pharmaceuticals has never commercially introduced a product, and no
assurance can be given that commercialization of any of the Company's drug
candidates in any country in which any of them may be approved will be
financially successful.

        Early Stage of Product Development; Substantial Operating Losses.
Hollis-Eden Pharmaceuticals has not yet generated any operating revenues. The
Company cannot predict when marketing approvals for any of its drug candidates
will be obtained, if ever. Even if such approvals are obtained, there can be no
assurance that the Company's drug candidates will be successfully
commercialized. Hollis-Eden Pharmaceuticals has experienced significant
operating losses due to substantial expenses incurred to acquire and fund
development of the Company's drug candidates, and, as of December 31, 1997, had
an accumulated deficit of $7.9 million. Hollis-Eden Pharmaceuticals expects its
operating expenses to increase over the next several years as it funds
development, clinical testing and other expenses of seeking FDA approval. The
Company's ability to achieve a profitable level of operations is dependent in
large part on obtaining regulatory approvals for its drug candidates, entering
into agreements for product development and commercialization, and expanding
from development into successful marketing, all of which will require
significant amounts of capital. There can be no assurance that Hollis-Eden
Pharmaceuticals will ever achieve a profitable level of operations.

        Patents and Proprietary Rights. Although certain of the Company's drug
candidates are patented, patents are not a guarantee of protection from
competitors, especially in an area characterized by rapid advances, and
enforcement of patents and proprietary rights in many countries can be expected
to be problematic or unpredictable. There can be no assurance that any patents
issued or licensed to Hollis-Eden Pharmaceuticals will not be challenged,
invalidated, infringed upon, or designed around by others or that the claims
contained in such patents will not infringe the patent claims of others.
Furthermore, there can be no assurance that others will not independently
develop similar products. The Company's business may be adversely affected by
competitors who develop substantially equivalent technology. Patent





                                       14
<PAGE>   15

litigation can be extremely expensive, and Hollis-Eden Pharmaceuticals may find
that it is unable to fund litigation necessary to defend its rights.

        Government Regulation and Product Approvals. The research, preclinical
development, clinical trial, manufacturing, marketing and sale of
pharmaceuticals are subject to extensive regulation by governmental authorities.
Products developed by Hollis-Eden Pharmaceuticals cannot be marketed
commercially in any jurisdiction in which they have not been approved. The
process of obtaining regulatory approvals is lengthy and extremely expensive.
Approval by United States authorities does not guarantee, nor at times even
facilitate or expedite, approval in other countries. Further, government
regulations are subject to change and it is possible that additional criteria
may be established or imposed which could prevent or delay regulatory approval
of any of the Company's drug candidates. Additionally, the facilities that
manufacture the Company's drug candidates will need to adhere to regulatory
guidelines. There can be no assurance that the Company will not be required to
incur significant costs to comply with laws and regulations in the future or
that laws and regulations will not have a material adverse effect on the
Company's business, financial condition or results of operations.

        Substantial Capital Needs. The Company's operations to date have
consumed substantial capital without generating any revenues, and the Company
will continue to require substantial and increasing amounts of funds to conduct
necessary research and development and preclinical and clinical testing of its
drug candidates, and to market any drug candidates that receive regulatory
approval. Hollis-Eden Pharmaceuticals does not expect to generate revenue from
operations for the foreseeable future, and the Company's ability to meet its
cash obligations as they become due and payable is expected to depend for at
least the next several years on its ability to sell securities, borrow funds or
some combination thereof. Based upon its current plans, management believes that
its existing capital resources, together with interest thereon, will be
sufficient to meet the Company's operating expenses and capital requirements
through at least the end of 1998. There can be no assurance, however, that
changes in Hollis-Eden Pharmaceuticals' research and development plans or other
events affecting Hollis-Eden Pharmaceuticals' operating expenses will not result
in the expenditure of such cash before that time. No assurance can be given that
the Company will be successful in raising necessary funds. The Company's future
capital requirements will depend upon many factors, including progress with
preclinical testing and clinical trials, the number and breadth of the Company's
programs, the time and costs involved in preparing, filing, prosecuting,
maintaining and enforcing patent claims and other proprietary rights, the time
and costs involved in obtaining regulatory approvals, competing technological
and market developments, the ability of the Company to establish collaborative
arrangements and effective commercialization and marketing activities and other
arrangements. In any event, Hollis-Eden Pharmaceuticals will continue to incur
increasing negative cash flows and net losses for the foreseeable future.

        Technological Change and Competition. The pharmaceutical industry is
characterized by intense competition and is subject to rapid and significant
technological change. Rapid technological development may cause the Company's
drug candidates to become obsolete before the Company recoups all or any portion
of the related expenses. Hollis-Eden Pharmaceuticals' competitors include major
pharmaceutical companies, biotechnology firms and universities and other
research institutions, both in the United States and abroad, which are actively
engaged in research and development of products in the therapeutic areas being
pursued by Hollis-Eden Pharmaceuticals. Most of Hollis-Eden Pharmaceuticals'
competitors have substantially greater financial, technical, manufacturing,
marketing, distribution and human resource capabilities than Hollis-Eden
Pharmaceuticals. In addition, many of Hollis-Eden Pharmaceuticals' competitors
have significantly greater experience in testing new or improved therapeutic
products and obtaining regulatory approvals of products. Accordingly,
Hollis-Eden Pharmaceuticals' competitors may succeed in obtaining regulatory
approval for products more rapidly than Hollis-Eden Pharmaceuticals. If
Hollis-Eden Pharmaceuticals commences significant commercial sales of its





                                       15
<PAGE>   16

products, it will also be competing with respect to manufacturing efficiencies
and marketing and distribution capabilities, areas in which it has little
experience.

        No Sales and Marketing Experience. Hollis-Eden Pharmaceuticals' efforts
to date have focused on the development and evaluation of its drug candidates.
As the Company continues clinical studies and prepares for commercialization of
its drug candidates, it must build a sales and marketing infrastructure.
Hollis-Eden Pharmaceuticals has no experience in the sales and marketing of its
drug candidates. It is possible that Hollis-Eden Pharmaceuticals will not be
able to attract and retain the skilled personnel necessary to develop the
infrastructure to effectively market its drug candidates.

        Dependence on License Agreements. Hollis-Eden Pharmaceuticals licenses
its drug candidates from Dr. Patrick T. Prendergast and from Edenland and
Colthurst, two organizations Dr. Prendergast controls. The Company is obligated
to make license payments and provide certain funding, including funding for the
development and testing of the Company's drug candidates, at specified times.
There can be no assurance that the Company will be able to meet future payment
or funding obligations, in which event the Company could lose all rights to one
or more of its drug candidates, which would have a material adverse effect on
the Company.

        Dependence on Officers and Future Employees. Hollis-Eden Pharmaceuticals
is (and will be) highly dependent upon its Chief Executive Officer, Richard B.
Hollis, the loss of whose services could adversely affect Hollis-Eden
Pharmaceuticals and impede the achievement of Hollis-Eden Pharmaceuticals'
research and development objectives. Recruiting and retaining additional
management personnel, as well as qualified scientific personnel to perform
research and development work in the future, will also be critical to the
Company's success. Because competition for experienced scientific personnel
among numerous pharmaceutical and biotechnology companies and research and
academic institutions is intense, there can be no assurance that the Company
will be able to attract and retain such personnel.

        Technological Uncertainties. All of Hollis-Eden Pharmaceuticals' product
development efforts are based upon technologies and therapeutic approaches that
have not been widely used in humans for therapeutic purposes. There is,
therefore, significant risk that these approaches will not prove to be
successful. While the Company believes that the positive results obtained to
date in preclinical and limited clinical human studies support further research
and development, such positive results are not necessarily indicative of results
that will be obtained in further human clinical testing.

        Pharmaceutical Pricing; Pending Health Care Reforms. Government health
administration authorities, together with private health insurers, increasingly
are attempting to contain health care costs by limiting the price or
reimbursement levels for medical products and services. In certain foreign
markets, pricing or profitability of prescriptive pharmaceuticals is subject to
government control. In the United States, there have been a number of federal
and state proposals to implement similar government controls or otherwise
significantly reform the existing health care system. Due to uncertainties as to
the ultimate features of this or any other reform initiatives that may be
enacted, Hollis-Eden Pharmaceuticals cannot predict which, if any, of such
reform proposals will be adopted, when they may be adopted, or what impact they
may have on Hollis-Eden Pharmaceuticals. It is possible that any legislation
that is enacted will include provisions resulting in price limits, utilization
controls or other consequences that may adversely affect Hollis-Eden
Pharmaceuticals.

        Manufacturing Limitations and Uncertainties. Hollis-Eden Pharmaceuticals
currently relies on outside manufacturers for the production of its drug
candidates to supply sufficient quantities of compounds to conduct clinical
trials on its drug candidates. If the Company is unable to contract on
acceptable terms or to obtain a sufficient supply of its drug candidates or such
supplies are delayed or





                                       16
<PAGE>   17

contaminated, the Company could experience significant delays in bringing its
drug candidates to market as well as delays in human clinical testing schedules
and delays in submissions of its drug candidates for regulatory approval and
initiation of further development progress, any of which could have a material
adverse effect on the Company's business and results of operations. If
Hollis-Eden Pharmaceuticals should encounter delays or difficulties in
establishing relationships with manufacturers to produce, package or distribute
its finished pharmaceutical products, market introduction and subsequent sales
of such products would be adversely affected. Moreover, contract manufacturers
that the Company may use must adhere to current Good Manufacturing Practices
("GMP") regulations enforced by the FDA through its facilities inspection
program. These facilities must pass a pre-approval plant inspection before the
FDA will issue a pre-market approval of the Company's drug candidates. If
Hollis-Eden Pharmaceuticals is unable to obtain or retain third party
manufacturing on commercially acceptable terms, it may not be able to
commercialize pharmaceutical products as planned. The Company's dependence upon
third parties for the manufacture of pharmaceutical products may adversely
affect the Company's profit margins and its ability to develop and deliver
pharmaceutical products on a timely and competitive basis.

        Even if Hollis-Eden Pharmaceuticals is successful in raising the
substantial amounts of capital it requires (as to which there can be no
assurance), Hollis-Eden Pharmaceuticals does not intend to manufacture any
pharmaceutical products itself, although it may choose to do so in the future.
The Company has no experience in manufacturing pharmaceutical products in
clinical quantities or for commercial purposes. Hollis-Eden Pharmaceuticals
believes that its strategy of outsourcing manufacturing is cost effective since
it avoids the high fixed costs of plant, equipment and large manufacturing staff
and thereby enables Hollis-Eden Pharmaceuticals to conserve its resources.
Should the Company determine to manufacture products itself, the Company would
be subject to the regulatory requirements described above, would be subject to
similar risks regarding delays or difficulties encountered in manufacturing any
such pharmaceutical products and would require substantial additional capital.
In addition, there can be no assurance that Hollis-Eden Pharmaceuticals would be
able to manufacture any such products successfully and in a cost-effective
manner.

        Management of Growth. Hollis-Eden Pharmaceuticals' ability to manage its
growth, if any, will require it to continue to improve and expand its
management, operational and financial systems and controls. If the Company's
management is unable to manage growth effectively, the Company's business and
results of operations will be adversely affected.

        Product Liability; Lack of Insurance. Hollis-Eden Pharmaceuticals'
business will expose it to potential product liability risks which are inherent
in the testing, manufacturing, marketing and sale of pharmaceutical products,
and product liability claims may be asserted against Hollis-Eden
Pharmaceuticals. Product liability insurance for the pharmaceutical industry
generally is expensive to the extent that it is available at all. Hollis-Eden
Pharmaceuticals currently does not have product liability insurance. There can
be no assurance that adequate insurance coverage will be available at acceptable
costs, if at all, or that a product liability claim would not adversely affect
the business or financial condition of the Company.

        Authorized Preferred Stock. Hollis-Eden Pharmaceuticals' Board of
Directors will be authorized, without further action required on the part of
stockholders, to issue one or more classes of preferred stock and to designate
the rights, preferences and privileges of such preferred stock including voting,
dividend and liquidation rights which may be superior to those of the holders of
Common Stock. The issuance of one or more classes of preferred stock could
materially adversely affect the rights of holders of Common Stock.

        Indemnification and Limited Monetary Damages. Hollis-Eden
Pharmaceuticals' Certificate of Incorporation provides that the Company's
directors shall not be liable for monetary damages to Hollis-





                                       17
<PAGE>   18

Eden Pharmaceuticals' stockholders except as required by law. In addition, the
Company's Bylaws provide indemnification of its officers and directors to the
fullest extent permitted by Delaware law. To the extent that stockholders are
unable to prevail in actions for monetary damages against the Company's
directors, such stockholders' rights in this regard are limited in comparison to
rights of stockholders of a corporation that has not adopted such provisions. In
addition, to the extent that the officers and directors may obtain
indemnification from the Company, the Company may incur substantial financial
losses.

        Dividends Unlikely. Hollis-Eden Pharmaceuticals has never paid dividends
on its shares of Common Stock. The payment of dividends in the future, if any,
will be contingent upon the Company's revenues and earnings, if any, capital
requirements and general financial condition. The payment of any dividends in
the future will be within the discretion of the Company's Board of Directors.
The Company intends to retain all earnings, if any, for use in the Company's
business operations and, accordingly, the Board of Directors does not anticipate
declaring any dividends in the foreseeable future.

        Concentration of Ownership. Richard B. Hollis, Hollis-Eden
Pharmaceuticals' Chief Executive Officer, owns approximately 40.2% of the
outstanding shares of Common Stock (without giving effect to the exercise of any
warrants or options). Accordingly, Mr. Hollis will control the business,
policies and affairs of the Company, including the election of members of the
Company's Board of Directors. Assuming the exercise of the Company's outstanding
warrants and options, Mr. Hollis would own approximately 25.8% of the then
outstanding shares of Common Stock, and Mr. Terren S. Peizer, President and a
Director of the Company, would own approximately 18.7%.

        Classified Board of Directors; Possible Deterrent to Takeovers, Changes
in Board and Other Changes in Control. Hollis-Eden Pharmaceuticals' Board of
Directors is a "classified board," with approximately one-third of its directors
coming up for election each year. This provision is applicable to every election
of directors. As a result of having a classified board, two annual meetings will
be necessary to change a majority of the directors. The existence of a
classified board may, in certain circumstances, deter or delay mergers, tender
offers, other possible takeover attempts or changes in management of the Board
of Directors which may be favored by some or a majority of Hollis-Eden
Pharmaceuticals' stockholders.

        Possible Volatility in Stock Price. There is no assurance that a market
for securities of Hollis-Eden Pharmaceuticals will continue to exist. The prices
at which Common Stock trades will depend on many factors, including prevailing
interest rates, markets for similar securities, industry conditions, and the
performance of, and investor expectations for, Hollis-Eden Pharmaceuticals'
prospects.

ITEM 2.        PROPERTIES

        The Company's corporate headquarters are located at 9333 Genesee Avenue,
Suite 110, San Diego, California 92121, where the Company leases approximately
5,000 square feet. The lease expires in August 2000. The Company believes that
its facilities are adequate for its current operations.

ITEM 3.        LEGAL PROCEEDINGS

        The Company currently is not a party to any legal proceedings.

ITEM 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1997.





                                       18
<PAGE>   19

                                     PART II

ITEM 5.        MARKET FOR REGISTRANT'S COMMON STOCK AND
               RELATED STOCKHOLDER MATTERS

        The Company's common stock is traded in the over-the-counter market and
prices are quoted on the NASDAQ SmallCap Market under the symbol HEPH. Prior to
September 1997, the Company's common stock, Class A Warrants, Class B Warrants
and Units were traded on the OTC Electronic Bulletin Board (the "OTC") under the
symbol HEPH and prior to the merger under the symbols IACQ, IACQW, IACQZ and
IACQU, respectively.

        The following table sets forth the quarterly high and low bid quotations
on the OTC Electronic Bulletin Board for the securities of the Company and the
high and low selling prices as reported by NASDAQ SmallCap Market since
September 1997.

<TABLE>
<CAPTION>
Common Stock                                      High          Low
--------------------------------------------------------------------
<S>                                             <C>           <C>
1996
        First Quarter                           $10.125       $8.875
        Second Quarter                           10.625        9.250
        Third Quarter                             9.875        9.250
        Fourth Quarter                           11.250        8.875

1997
        First Quarter                           $12.000       $9.000
        Second Quarter                           11.750        4.125
        Third Quarter                             8.440        4.500
        Fourth Quarter                            8.875        5.000


Class A Warrants                                  High          Low
--------------------------------------------------------------------
1996
        First Quarter                           $ 0.750       $0.500
        Second Quarter                            1.125        0.625
        Third Quarter                             1.000        0.625
        Fourth Quarter                            1.000        0.625

1997
        First Quarter                           $ 2.500       $0.750
        Second Quarter                            1.500        0.031


Class B Warrants                                  High          Low
--------------------------------------------------------------------
1996
        First Quarter                           $ 5.250       $3.750
        Second Quarter                            6.000        4.500
        Third Quarter                             6.000        4.250
        Fourth Quarter                            6.000        3.250

1997
        First Quarter                           $13.50        $3.250
        Second Quarter                           10.50         7.500


Units                                             High          Low
--------------------------------------------------------------------
1997
        First Quarter                           $10.000       $9.000
</TABLE>





                                       19
<PAGE>   20

<TABLE>
<S>                                             <C>           <C>
        Second Quarter                           10.000        9.625
        Third Quarter                            10.125        9.625
        Fourth Quarter                           11.125        9.500

1997
        First Quarter                           $13.75        $9.750
        Second Quarter                           11.00         8.000
</TABLE>

        On March 11, 1998, the closing price of the Company's common stock as
reported by the NASDAQ stock market was $16.00 per share. There were
approximately 1,900 shareholders of record plus beneficial stockholders of the
Company's common stock as of such date. The Company has not paid cash dividends
on its common stock and does not intend to do so in the foreseeable future.

        On March 27, 1997, the Company sent a Notice of Redemption to holders of
its Class A Warrants and Class B Warrants, stating that it would redeem all of
such outstanding warrants on April 28, 1997. 603,415 of the Class A Warrants and
254,950 Class B Warrants were exercised. On April 28, 1997, the Company redeemed
all remaining Class A and Class B Warrants listed on the OTC. The Class A
Warrants underlying the Units listed on the OTC were also redeemed, leaving only
the Company's common stock remaining from such Units.

ITEM 6.        SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                                                      PERIOD FROM
                                                                                                       INCEPTION
                                                                                                     (AUG.15, 1994)
                                                  AS OF OR FOR THE YEAR ENDED DECEMBER 31,                  TO
                                       -----------------------------------------------------------     DECEMBER 31,
                                           1997            1996            1995           1994             1997
                                       -----------     -----------     -----------     -----------     -----------
<S>                                    <C>             <C>             <C>             <C>             <C>
STATEMENT OF OPERATIONS DATA:
 Research and development............  $ 3,488,358     $   184,276     $   463,000     $ 1,166,762     $ 5,302,396
 General and administrative..........    2,044,139         510,534         170,929         103,564       2,829,166
                                       -----------     -----------     -----------     -----------     -----------
 Total operating expenses............    5,532,497         694,810         633,929       1,270,326       8,131,562
 Other income (expense), net.........      279,613           2,590         (37,762)         (6,720)        237,721
                                       -----------     -----------     -----------     -----------     -----------
 Net loss............................  $(5,252,884)    $  (692,220)    $  (671,691)    $(1,277,046)    $(7,893,841)
                                       ===========     ===========     ===========     ===========     ===========
 Net loss per share..................  $     (0.85)    $     (0.15)    $     (0.17)    $     (0.38)
 Weighted average number
  of common shares outstanding.......    6,192,764       4,657,650       3,867,924       3,396,226

BALANCE SHEET DATA:
 Total assets........................  $ 7,399,848     $   241,206     $         -     $         -
 Notes and accounts payable and
  accrued interest to related party..            -               -         367,522         216,720
 License fees payable................            -         499,700         928,000         927,000
 Stockholders' equity (deficit)......  $ 6,933,217     $  (566,159)    $(1,537,633)    $(1,143,720)
</TABLE>






                                       20

<PAGE>   21


ITEM 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
            AND FINANCIAL CONDITION

        The forward-looking comments contained in the following discussion
involve risks and uncertainties. The Company's actual results may differ
materially from those discussed here. Factors that could cause or contribute to
such differences can be found in the following discussion and elsewhere
throughout this Annual Report on Form 10-K.

GENERAL

        Hollis-Eden Pharmaceuticals, a development-stage pharmaceutical company,
is engaged in the discovery, development and commercialization of products for
the treatment of a number of targeted disease states caused by viral, bacterial,
parasitic or fungal infections, including HIV/AIDS, hepatitis B and C, and
malaria. The Company has three technology platforms, one based on cellular
energy regulation, the second on a unique immune system modulation technology,
and the third on biochemical synthesis regulators. The Company believes that
certain of its drug candidates may provide the first long-term treatment for HIV
without the development of viral strain resistance to the drugs' effectiveness,
significant toxicity or severe side effects. The Company has not yet generated
any operating revenues. The Company has experienced significant operating losses
due to substantial expenses incurred to acquire and fund development of its drug
candidates and, as of December 31, 1997, had an accumulated deficit of $7.9
million.

        When and if any of the Company's drug candidates have been approved for
commercial sale, the Company plans to market them in the United States. For
international markets, the Company intends to develop strategic alliances with
major pharmaceutical companies that have foreign regulatory expertise and
established distribution channels, and will also consider corporate strategic
partnerships and co-marketing agreements. No assurances can be given that any of
the Company's drug candidates will be approved for commercial sale or that any
of the foregoing proposed arrangements will be implemented or prove to be
successful.

        The Company has been unprofitable since inception and expects to incur
substantial additional operating losses for at least the next few years as it
increases expenditures on research and development and begins to allocate
significant and increasing resources to its clinical testing and other
activities. In addition, during the next few years, the Company will have to
meet the substantial new challenge of developing the capability to market
products. Accordingly, the Company's activities to date are not as broad in
depth or scope as the activities it must undertake in the future, and the
Company's historical operations and financial information are not indicative of
the Company's future operating results or financial condition or its ability to
operate profitably as a commercial enterprise when and if it succeeds in
bringing any drug candidate to market.

RESULTS OF OPERATIONS

        The Company has not generated any revenues for the period from August
15, 1994 (inception of Hollis-Eden) through December 31, 1997. The Company has
devoted substantially all its resources to the payment of licensing fees and
research and development fees plus expenses related to the startup of its
business. From inception until December 31, 1997, the Company incurred expenses
of approximately $5.3 million in research and development fees, $2.8 million in
general and administrative expenses, and $200,000 in net interest income
resulting in a loss of $7.9 million for the period.

        Research and development expenses increased to $3.5 million in 1997 from
$184,000 in 1996 and decreased to $184,000 from $463,000 in 1995. A substantial
portion of the research and development expenses has been incurred since the
completion of the Merger on March 26, 1997 as described below. 1995 research and
development expenses included the cost of a small clinical trial in Houston,
Texas.




                                       21
<PAGE>   22

        General and administrative expenses increased to $2.0 million in 1997
from $510,000 and $170,000 in 1996 and 1995, respectively. These increases are
due primarily to (i) the non-cash charges for the issuance of warrants to a
certain director (described below), (ii) the amortization of the unearned
compensation charge of certain stock options, (iii) increased expenses as a
public company such as legal fees, filing fees, and directors and officers
insurance, and (iv) increased staffing.

        Upon the completion of the Merger and the exercise of warrants, the
Company incurred significant non-recurring charges to operations that have been
recorded as expenses during the quarters ended March 31 and June 30, 1997. In
particular, the Company incurred (i) a $1.5 million and a $1.2 million expense
for research and development fees during the first and second quarters,
respectively, and (ii) a $570,000 non-cash charge relating to the issuance of
warrants to a certain director and former officer during the first quarter. The
$2.7 million research and development fees will be used by Edenland, a related
party, as funding to continue the development of the Company's second drug
candidate, REVERSIONEX.

LIQUIDITY AND CAPITAL RESOURCES

        The Company has financed its operations since inception through the sale
of shares of Common Stock and with loans from the Company's founder, Richard B.
Hollis. The Company repaid Mr. Hollis in January 1996.

        During the year ended December 31, 1995, the Company received cash
proceeds of $250,000 from the sale of its securities. In May 1996, the Company
completed a private placement of shares of Common Stock, from which it received
aggregate gross proceeds of $1.3 million. In March 1997, the Merger of IAC and
Hollis-Eden provided the Company with $6.5 million in cash and other
receivables.

        Under its license agreements with Dr. Patrick T. Prendergast, Colthurst
and Edenland, the Company is obligated to pay certain minimum license fees to
maintain its rights to its drug candidates. Under these agreements, the Company
is obligated to pay the licensors an aggregate of two and one-half percent of
all such proceeds raised hereafter through April 28, 1998. An annual renewal
license fee of $500,000 is due when one of the following events occur: the
Company raises a predetermined amount of capital; the Company sublicenses the
technology received under the Colthurst License Agreement; the Company generates
sales; the Company licenses or funds new technologies not covered under the
existing agreements; or a predetermined date in the future. As of December 31,
1997, the Company is current on all license fee obligations under these
agreements.

        Under its Research and Development Agreement with Edenland and Dr.
Patrick T. Prendergast, the Company is committed to pay $3.0 million for the
development costs related to REVERSIONEX. An amount of $1.5 million was recorded
as a charge to operations upon the closing of the Merger and was paid in April
1997. An additional $1.2 million was recorded as a charge to operations upon the
exercise of the warrants and was paid in May 1997. The remaining $300,000 was
accrued as an expense during the fourth quarter of 1997 and is payable by April
28, 1998. In addition, the Company has agreed to commit at least 30% of its
annual research and development budget up to a maximum of $50.0 million during
the term of the agreement, but a minimum of $2.0 million and maximum of $10.0
million for any given calendar year, to pay development costs for REVERSIONEX or
any new product developed under the agreement. In addition, payments made
towards the $3.0 million development costs are deductible from the amounts due
for the $2.0 million per year of research. Accordingly, with respect to the $2.0
million per year obligation, assuming only such minimum amounts will be due,
only $1.0 million will be due in 1998.

        The Company's operations to date have consumed substantial capital
without generating any revenues, and the Company will continue to require
substantial and increasing amounts of funds to conduct necessary research and
development and preclinical and clinical testing of its drug candidates, and to
market any drug candidates that receive regulatory approval. The Company does
not expect to generate revenue from operations for the foreseeable future, and
the Company's ability to meet its cash obligations as they become due and
payable is expected to depend





                                       22
<PAGE>   23

for at least the next several years on its ability to sell securities, borrow
funds or some combination thereof. Based upon its current plans, the Company's
management believes that its existing capital resources, together with interest
thereon, will be sufficient to meet the Company's operating expenses and capital
requirements through at least the end of 1998. There can be no assurance,
however, that changes in the Company's research and development plans or other
events affecting the Company's operating expenses will not result in the
expenditure of such cash before that time. No assurance can be given that the
Company will be successful in raising necessary funds. The Company's future
capital requirements will depend upon many factors, including progress with
preclinical testing and clinical trials, the number and breadth of the Company's
programs, the time and costs involved in preparing, filing, prosecuting,
maintaining and enforcing patent claims and other proprietary rights, the time
and costs involved in obtaining regulatory approvals, competing technological
and market developments, the ability of the Company to establish collaborative
arrangements and effective commercialization and marketing activities and other
arrangements. In any event, the Company will continue to incur increasing
negative cash flows and net losses for the foreseeable future.

YEAR 2000 ISSUE

        The year 2000 computer issue is not expected to have any material affect
on the company's financial statements or operations of the Company.


ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Not applicable.

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The information required by this Item is attached as Appendix F.


ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
            AND FINANCIAL DISCLOSURES

            None.






                                       23
<PAGE>   24


PART  III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        See the section entitled "Executive Officers" in Part I, Item 1 hereof
for information regarding executive officers.

        The information required by this item with respect to directors is
incorporated by reference from the information under the caption of "Election of
Directors," contained in the Company's definitive Proxy Statement to be filed
with the Commission pursuant to Regulation 14A in connection with the 1997
Annual Meeting (the "Proxy Statement").

ITEM 11.    EXECUTIVE COMPENSATION

        The information concerning executive compensation is set forth in the
Proxy Statement under the heading "Executive Compensation," which information is
incorporated herein by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The information concerning security ownership of certain beneficial
owners and management is set forth in the Proxy Statement under the heading
"Security Ownership of Certain Beneficial Owners and Management," which
information is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        The information concerning certain relationships and related
transactions is set forth in the Proxy Statement under the heading "Certain
Transactions," which information is incorporated herein by reference.








                                       24
<PAGE>   25


PART  IV

Item 14.    Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) List of documents filed as part of this Annual Report on Form 10-K:

            1.    Financial Statements: The financial statements of Hollis-Eden
                  Pharmaceuticals are included as Appendix F of this report. See
                  Index to Financial Statements on page F-1.

            2.    Financial Statement Schedules: Financial statement schedules
                  required under the related instructions are not applicable for
                  the three years ended December 31, 1997, and have therefore
                  been omitted.

            3.    Exhibits: The exhibits which are filed with this Report or
                  which are incorporated herein by reference are set forth in
                  the Exhibit Index on page E-1.

(b)     Reports on Form 8-K

        No reports on Form 8-K were filed during the fourth quarter of fiscal
        1997.









                                       25
<PAGE>   26

                                   SIGNATURES

        Pursuant to the requirements of the Section 13 or 15(d) 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 on March
23, 1998.


                                  HOLLIS-EDEN PHARMACEUTICALS, INC.


                                  By: /s/ RICHARD B. HOLLIS
                                     ------------------------------------------
                                      Richard B. Hollis, Chairman of the Board
                                      of Directors and Chief Executive Officer

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints RICHARD B. HOLLIS and TERREN S. PEIZER,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place, and
stead, in any and all capacities, to sign any and all amendments to this Report,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming that all said
attorneys-in-fact and agents, or any of them or their or his substitute or
substituted, may lawfully do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.

<TABLE>
<CAPTION>
Signature                                          Title                                 Date
---------                                          -----                                 ----
<S>                                 <C>                                             <C>
/s/ RiCHARD B. HOLLIS               Chairman of the Board of Directors              March 23, 1998
-------------------------------     and Chief Executive Officer
Richard B. Hollis


/s/ TERREN S. PEIZER
-------------------------------     Vice Chairman of the Board of                   March 23, 1998
Directors   March 23, 1998          and President
Terren S. Peizer


/s/ ROBERT W. WEBER                 Vice President -- Controller                    March 23, 1998
-------------------------------     (Principal Financial and Accounting Officer)
Robert W. Weber
March 23, 1998


/s/ PAUL BAGLEY                     Director                                        March 6, 1998
-------------------------------
Paul Bagley


/s/ BRENDAN R. MCDONNELL            Secretary and Director                          March 23, 1998
-------------------------------
Brendan R. McDonnell

</TABLE>




                                       26
<PAGE>   27

<TABLE>

<S>                                 <C>                                             <C>

/s/ THOMAS C. MERIGAN JR. M.D.      Medical Director, Infectious Diseases and       March 23, 1998
-------------------------------     Director
Thomas C. Merigan, Jr. M.D.


/s/ SALVATORE J. ZIZZA              Director                                        March 23, 1998
-------------------------------
Salvatore J. Zizza
</TABLE>




                                       27
<PAGE>   28

                                                                      APPENDIX E

                        HOLLIS-EDEN PHARMACEUTICALS, INC.
                           ANNUAL REPORT ON FORM 10-K

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                        DESCRIPTION OF DOCUMENT
-------                       -----------------------
<S>       <C>
  3.1     Amended and Restated Certificate of Incorporation of the Registrant
          (incorporated by reference to Exhibit 4.1 to Registrant's Registration
          Statement on Form S-4 (No. 333-18725), as amended (the "Form S-4)).

  3.2     Bylaws of Registrant (incorporated by reference to Exhibit 4.2 to the
          Form S-4).

 10.1     Registrant's 1997 Incentive Stock Option Plan (the "Option Plan")
          (incorporated by reference to Exhibit 10.3 to the Form S-4).

 10.2     Forms of Incentive Stock Options and Nonstatutory Stock Options under
          the Option Plan (incorporated by reference to Exhibit 10.5 to the Form
          S-4).

 10.3     Employment Agreement by and between Registrant and Richard B. Hollis
          dated November 1, 1996 (incorporated by reference to Exhibit 10.6 to
          the Form S-4).

 10.4     Employment Agreement by and between Registrant and Terren S. Peizer
          dated February 5, 1997 (incorporated by reference to Exhibit 10.11 to
          the Form S-4).

 10.5     Amendment to Employment Agreement by and between Registrant and Terren
          S. Peizer dated April 1, 1997 (incorporated by reference to Exhibit
          10.1 to Registrant's Current Report on Form 8-K dated March 26, 1997).

 10.6     License Agreement by and among Registrant, Colthurst Limited and
          Patrick T. Prendergast, Ph.D. dated May 18, 1994, including all
          amendments thereto (incorporated by reference to Exhibit 10.7 to the
          Form S-4).

 10.7     License Agreement by and among Registrant, Edenland, Inc. and Patrick
          T. Prendergast, Ph.D. dated August 25, 1994, including all amendments
          thereto (incorporated by reference to Exhibit 10.8 to the Form S-4).

 10.8     Research, Development and Option Agreement by and among Registrant,
          Edenland, Inc. and Patrick T. Prendergast, Ph.D. dated August 25,
          1994, including all amendments thereto (incorporated by reference to
          Exhibit 10.9 to the Form S-4).

 23.1     Consent of BDO Seidman, LLP.

 24.1     Power of Attorney. Reference is made to signature page.

 27       Financial Data Schedule (filed electronically only).
</TABLE>




                                      E-1

<PAGE>   29

                                                                      APPENDIX F


                        HOLLIS-EDEN PHARMACEUTICALS, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                                          Page
                                                                                          ----
<S>                                                                                          <C>
Report Of Independent Certified Public Accountants ........................................F-2


Balance Sheets as of December 31, 1997 and 1996............................................F-3


Statements Of Operations for the Fiscal Years Ended December 31,1997, December 31, 1996,
              December 31, 1995 and the Period From Inception (August 15, 1994) to
              December 31, 1997............................................................F-4


Statements of Stockholders' Equity for the Fiscal Years Ended December 31, 1997,
              December 31 1996, December 31, 1995 and the Period from Inception
              (August 15, 1994) to December 31, 1997.......................................F-5


Statements Of Cash Flows for the Fiscal Years Ended December 31, 1997,
              December 31 1996, December 31, 1995 and the Period from
              Inception (August 15, 1994) to December 31, 1997.............................F-6


Notes To Financial Statements..............................................................F-8
</TABLE>









                                      F-1
<PAGE>   30


REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


To the Board of Directors and Stockholders of
Hollis-Eden Pharmaceuticals, Inc.
San Diego, CA

We have audited the accompanying balance sheets of Hollis-Eden Pharmaceuticals,
Inc. (a development stage company) as of December 31, 1997 and 1996 and the
related statements of operations, stockholders' equity, and cash flows for each
of the three years ended December 31, 1997 and for the period from inception
(August 15, 1994) to December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly in all
material respects, the financial position of Hollis-Eden Pharmaceuticals, Inc.
as of December 31, 1997 and 1996 and the results its operations and its cash
flows for each of the three years ended December 31, 1997 and for the period
from inception (August 15, 1994) to December 31, 1997, in conformity with
generally accepted accounting principles.





                                                BDO Seidman, LLP
                                                New York, NY



March 6, 1998





                                      F-2
<PAGE>   31

HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
================================================================================


<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                     -------------------------------
                                                                         1997               1996
                                                                     ------------       ------------
<S>                                                                  <C>                <C>
ASSETS:
 Current assets:
 Cash and  cash equivalents                                          $  7,102,620       $     17,914
 Prepaid expenses                                                          53,009            116,885
 Deposits                                                                   9,163            100,000
 Other receivable - tax refund (Note 7)                                   105,436                 --
 Other receivable from related party                                       46,679                 --
                                                                     ------------       ------------
 Total current assets                                                   7,316,907            234,799

 Property and equipment, net of accumulated
     depreciation of $6,602 and $594                                       82,941              6,407
                                                                     ------------       ------------
 Total assets                                                        $  7,399,848       $    241,206
                                                                     ============       ============

LIABILITIES AND STOCKHOLDERS' EQUITY:
 Current liabilities:
 Account payable and accrued expenses                                $    128,631       $    210,894
 Wages payable                                                                 --             96,771
 License fees payable to related party                                         --            499,700
 R & D fees payable to related party (Note 9)                             338,000                 --
                                                                     ------------       ------------
 Total current liabilities                                                466,631            807,365

 Commitments and contingencies (see Note 9, 13, 14)

 Stockholders' equity (deficit): (Notes 3, 4, 5, 8, 10, 11, 12)

 Preferred stock, no par value, 10,000,000 shares
     authorized; no shares issued or outstanding                               --                 --
 Common stock, $.01 and $.0001 par value,
     30,000,000 shares authorized; 6,772,023 and
     4,911,004 shares issued and outstanding                               67,720                491
 Paid-in capital                                                       16,325,338          2,074,307
 Deferred compensation-stock options, net of
     accumulated amortization of $282,000                              (1,566,000)                --
 Deficit accumulated during development stage                          (7,893,841)        (2,640,957)
                                                                     ------------       ------------
 Total stockholders' equity ( deficit)                                  6,933,217           (566,159)
                                                                     ------------       ------------

 Total liabilities and stockholders' equity                          $  7,399,848       $    241,206
                                                                     ============       ============
</TABLE>


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





                                      F-3
<PAGE>   32

HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
================================================================================


<TABLE>
<CAPTION>
                                                                               PERIOD FROM
                                                                                INCEPTION
                                                                               (AUG.15,1994)
                                        FOR THE YEAR ENDED DECEMBER 31,              TO
                                -------------------------------------------     DECEMBER 31,
                                    1997            1996            1995           1997
                                -----------     -----------     -----------     -----------
<S>                             <C>             <C>             <C>             <C>
Operating expenses:
 Research and development       $ 3,488,358     $   184,276     $   463,000     $ 5,302,396
 General and administrative       2,044,139         510,534         170,929       2,829,166
                                -----------     -----------     -----------     -----------

Total operating expenses          5,532,497         694,810         633,929       8,131,562

Other income (expense):
 Interest income                    279,812           5,732              --         285,544
 Interest expense                      (199)         (3,142)        (37,762)        (47,823)
                                -----------     -----------     -----------     -----------

Total other income (expense)        279,613           2,590         (37,762)        237,721
                                -----------     -----------     -----------     -----------

Net loss                        $(5,252,884)    $  (692,220)    $  (671,691)    $(7,893,841)
                                ===========     ===========     ===========     ===========

Net loss per share              $     (0.85)    $     (0.15)    $     (0.17)

Weighted average number of
 common shares outstanding        6,192,764       4,657,650       3,867,924
</TABLE>


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





                                      F-4
<PAGE>   33

HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY
================================================================================


<TABLE>
<CAPTION>
                                                                                                           DEFICIT
                                                            COMMON STOCK                                 ACCUMULATED
                                                            AT PAR VALUE       CAPITAL IN                   DURING
                                                     ------------------------   EXCESS OF    DEFERRED     DEVELOPMENT
                                                        SHARES       AMOUNT     PAR VALUE  COMPENSATION      STAGE         TOTAL
                                                     -----------  -----------  -----------  -----------   -----------   -----------
<S>                                                    <C>        <C>          <C>          <C>           <C>           <C>
Contribution by stockholder                                   --  $        --  $   103,564  $        --   $        --   $   103,564
Common stock issued for cash                           2,852,830          285       24,715           --            --        25,000
Common stock issued as consideration for
 amendments to the license agreements (Note 7)           543,396           55        4,707           --            --         4,762
Net loss                                                      --           --           --           --    (1,277,046)   (1,277,046)
                                                       ---------  -----------  -----------  -----------   -----------   -----------
Balance at December 31, 1994                           3,396,226          340      132,986           --    (1,277,046)   (1,143,720)

Common stock issued for cash                             679,245           68      249,932           --            --       250,000
Common stock issued as consideration for
 amendments to the license agreements (Note 7)            75,472            7       27,771           --            --        27,778
Net loss                                                      --           --           --           --      (671,691)     (671,691)
                                                       ---------  -----------  -----------  -----------   -----------   -----------
Balance at December 31, 1995                           4,150,943          415      410,689           --    (1,948,737)   (1,537,633)

Common stock issued in conversion of debt (Note 11)      164,962           16      371,148           --            --       371,164
Common stock issued for cash, net of
 issuance costs of $203,622 (Note 11)                    580,005           58    1,234,441           --            --     1,234,499
Common stock issued as consideration
 for termination of a finance agreement                   15,094            2       33,960           --            --        33,962
Warrants issued to consultants
 for services rendered                                        --           --       24,069           --            --        24,069
Net loss                                                      --           --           --           --      (692,220)     (692,220)
                                                       ---------  -----------  -----------  -----------   -----------   -----------
Balance at December 31, 1996                           4,911,004          491    2,074,307           --    (2,640,957)     (566,159)

Recapitalization of Company upon the merger
 with Initial Acquisition Corp. (Note 3)                 883,250       57,453    6,213,329           --            --     6,270,782
Warrants issued to a certain director
 upon the successful closure of the merger                    --           --      570,000           --            --       570,000
Exercise of warrants, net of expenses (Note 5)           977,603        9,775    5,619,330           --            --     5,629,105
Deferred compensation - stock options (Note 12)               --           --    1,848,000   (1,848,000)           --            --
Amortization of deferred compensation                         --           --           --      282,000            --       282,000
Exercise of stock options                                    166            1          372           --            --           373
Net loss                                                      --           --           --           --    (5,252,884)   (5,252,884)
                                                       ---------  -----------  -----------  -----------   -----------   -----------
Balance at December 31, 1997                           6,772,023  $    67,720  $16,325,338  $(1,566,000)  $(7,893,841)  $ 6,933,217
                                                       =========  ===========  ===========  ===========   ===========   ===========
</TABLE>


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





                                      F-5
<PAGE>   34

HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
================================================================================


<TABLE>
<CAPTION>
                                                                                                       PERIOD FROM
                                                                                                        INCEPTION
                                                                                                      (AUG. 15, 1994)
                                                                FOR THE YEAR ENDED DECEMBER 31,               TO
                                                     ----------------------------------------------      DECEMBER 31.
                                                         1997             1996             1995             1997
                                                     ------------     ------------     ------------     ------------
<S>                                                  <C>              <C>              <C>              <C>
Cash flows from operating activities:
  Net loss                                           $ (5,252,884)    $   (692,220)    $   (671,691)    $ (7,893,841)

Adjustments to reconcile net loss to net
  cash used in operating activities:
      Depreciation                                          6,008              594               --            6,602
      Common stock issued as consideration
       for amendments to the license agreements                --               --           27,778           32,540
      Common stock issued as consideration
       for termination of a finance agreement                  --           33,962               --           33,962
      Expense related to options issued as
       consideration to consultants                         8,024            6,017               --           14,041
      Expense related to warrants issued to a
       director for successful closure of merger          570,000               --               --          570,000
      Deferred compensation expense related
       to options issued                                  282,000               --               --          282,000

Changes in assets and liabilities:
  Prepaid expenses                                         55,852          (98,833)              --          (42,981)
  Deposits                                                 90,837         (100,000)              --           (9,163)
  Other receivable - tax refund                          (105,436)              --               --         (105,436)
  Other receivable from related party                     (46,679)              --               --          (46,679)
  Accounts payable and accrued expenses                   (82,263)         118,783           92,111          128,631
  Accrued expenses for clinical trials                         --         (150,000)         150,000               --
  Wages payable                                           (96,771)          96,771               --               --
  Accounts payable to related party                            --          (73,040)          73,040               --
  License fees payable to related party                  (499,700)        (428,300)           1,000               --
  R & D fees payable to related party                     338,000               --               --          338,000
  Accrued interest expense                                     --          (44,482)          37,762               --
                                                     ------------     ------------     ------------     ------------
      Net cash used in operating activities            (4,733,012)      (1,330,748)        (290,000)      (6,692,324)

Cash flows provided by investing activities:
  Purchase of property and equipment                      (82,542)          (7,001)              --          (89,543)
                                                     ------------     ------------     ------------     ------------
      Net cash used in investing activities               (82,542)          (7,001)              --          (89,543)

Cash flows from financing activities:
  Borrowings from related party                            92,000               --           40,000          342,000
  Payments on note payable to related party               (92,000)        (250,000)              --         (342,000)
  Contributions from stockholder                               --               --               --          103,564
  Net proceeds from sale of common stock                       --        1,234,499          250,000        1,509,499
  Proceeds from issuance of debt                               --          371,164               --          371,164
  Net proceeds from recapitalization                    6,270,782               --               --        6,270,782
  Net proceeds from warrants exercised                  5,629,478               --               --        5,629,478
                                                     ------------     ------------     ------------     ------------
      Net cash from financing activities               11,900,260        1,355,663          290,000       13,884,487

Net increase in cash                                    7,084,706           17,914               --        7,102,620
Cash at beginning of period                                17,914               --               --               --
                                                     ------------     ------------     ------------     ------------
Cash at end of period                                $  7,102,620     $     17,914     $         --     $  7,102,620
                                                     ============     ============     ============     ============
</TABLE>


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




                                      F-6
<PAGE>   35

HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS (CONT.)
================================================================================



<TABLE>
<CAPTION>
                                                                                                        PERIOD FROM
                                                                                                         INCEPTION
                                                                                                      (AUG. 15, 1994)
                                                             FOR THE YEAR ENDED DECEMBER 31,                TO
                                                     ----------------------------------------------     DECEMBER 31,
                                                         1997             1996             1995             1997
                                                     ------------     ------------     ------------     ------------
<S>                                                  <C>              <C>              <C>              <C>
Supplemental disclosure of cash flow information:
Interest paid                                        $        199     $     44,482               --     $     47,823
Conversion of debt to equity                                   --          371,164               --          371,164
Options issued to consultants in
lieu of cash, three  year vesting                              --           24,069               --           24,069
Options issued in lieu of cash,
commissions on private placement                               --          133,110               --          133,110
</TABLE>


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






                                      F-7
<PAGE>   36
                        HOLLIS-EDEN PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                          NOTES TO FINANCIAL STATEMENTS

1.   THE COMPANY

        Hollis-Eden Pharmaceuticals, Inc. (the Company) was formed on August 15,
1994 and is engaged in developing therapeutic and/or preventative pharmaceutical
agents for the treatment of a number of targeted disease states caused by viral,
bacterial, parasitic or fungal infections, including HIV and AIDS. The Company
believes that certain of its drug candidates may provide the first long-term
treatment for HIV without the development of viral strain resistance to the
drugs' effectiveness, significant toxicity or severe side effects. The Company's
development efforts are based upon the pioneering research conducted by Dr.
Patrick T. Prendergast through his research and development organization,
Edenland, Inc. The Company has extensive business arrangements with Edenland,
Inc. (See Note 9) and both Edenland, Inc. and Dr. Prendergast are significant
stockholders of the Company. The Company has adopted a December 31 year-end. The
Company is a development stage company that was organized under the laws of the
State of Delaware. Since its inception (August 15, 1994) through March 1997, the
Company's efforts have been directed toward organizing and preparing for
offerings of shares of its common stock. As a result, the Company has not
developed commercial products or generated sales for the period August 15, 1994
through December 31, 1997.

        On March 26, 1997, Hollis-Eden, Inc. ("Hollis-Eden"), a Delaware
corporation, was merged with and into the Company (then known as Initial
Acquisition Corp. ("IAC")), a Delaware corporation, pursuant to an Agreement and
Plan of Merger, dated November 1, 1996. Upon consummation of the merger of
Hollis-Eden with IAC (the "Merger"), Hollis-Eden ceased to exist, and IAC
changed its name to Hollis-Eden Pharmaceuticals, Inc. (See Note 3).

2.   SUMMARY OF ACCOUNTING POLICIES

CASH EQUIVALENTS
The Company considers any liquid investments with a maturity of three months or
less when purchased to be cash equivalents. Because of the short maturities of
these investments, the carrying amount is a reasonable estimate of fair value.
At December 31, 1997, the Company's cash equivalents totaling $7,064,000 are
deposited in a money market mutual fund with a large financial institution.

PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated over the estimated
useful lives of the assets (five and seven years) using the straight-line
method.

RESEARCH AND DEVELOPMENT
Research and development costs consist of license fee expenses related to
license agreements as well as research and development expenses with related
parties and clinical trial expenses. Such amounts paid or payable to related
parties aggregated $3,068,000, $20,000 and $313,000 for the years ended December
31, 1997, 1996 and 1995, respectively, and $4,567,762 for the period from
inception (August 15, 1994) to December 31, 1997. Such expenses are recognized
as research and development, as incurred.

INCOME TAXES
The Company provides for income taxes under the principles of Statement of
Financial Accounting Standards No. 109 (SFAS 109) which requires that provision
be made for taxes currently due and for the expected future tax effects of
temporary differences between book and tax bases of assets and liabilities.





                                      F-8
<PAGE>   37
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash, other
receivables, accounts payable, accrued expenses and license fees payable. These
financial instruments are stated at their respective carrying values, which
approximate their fair values.

USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

NET LOSS PER SHARE
In February 1997, the FASB issued Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("Statement 128"). Statement 128 became effective
for financial statements issued for periods ending after December 15, 1997 and
all prior years were required to be restated, if applicable. Statement 128
simplifies the computation of earnings per share by replacing the presentation
of primary earnings per share with a presentation of basic earnings per share,
as defined. The statement requires dual presentation of basic and diluted
earnings per share by entities with complex capital structures. Basic earnings
per share includes no dilution and is computed by dividing income available to
common shareholders by the weighted average number of shares outstanding for the
period. Diluted earnings per share reflect the potential dilution of securities
that could share in the earnings of an entity similar to fully diluted earnings
per share. Statement 128 did not have a significant impact on the Company's
financial statements.

Net loss per share is presented as basic earnings based upon the weighted
average number of common shares. Diluted earnings per share have not been
presented as the common stock equivalents and their effect on earnings per share
is anti-dilutive.

RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("Statement 130") and Statement of Financial Accounting
Standards No. 131, "Disclosure about Segments of an Enterprise and Related
Information" ("Statement 131") were issued. Statement 130 addresses standards
for reporting and display of comprehensive income and its components, and
Statement 131 requires disclosure of reportable operating segments. Both
statements are effective for the Company's 1998 fiscal year. These
pronouncements are not expected to materially affect the Company's financial
statements.

3.   RECAPITALIZATION

            On March 26, 1997, Hollis-Eden , was merged with and into the
Company (then known as IAC), pursuant to an Agreement and Plan of Merger, dated
November 1, 1996, among IAC, Hollis-Eden, Mr. Salvatore J. Zizza and Mr. Richard
B. Hollis (the "Merger Agreement"). Upon consummation of the Merger, Hollis-Eden
ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals, Inc.
IAC (now called Hollis-Eden Pharmaceuticals, Inc.) remains the continuing legal
entity and registrant for Securities and Exchange Commission reporting purposes.
The Merger was intended to be a tax-free reorganization for federal income tax
purposes and was accounted for as a recapitalization of Hollis-Eden





                                      F-9
<PAGE>   38
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


by an exchange of Common Stock of Hollis-Eden, $.0001 par value ("Hollis-Eden
Common Stock"), for the net assets of IAC, consisting primarily of cash.

        Under the terms of the Merger Agreement, each share of Hollis-Eden
Common Stock outstanding immediately prior to the closing of the Merger
converted into one share of Common Stock, $.01 par value, of Hollis-Eden
Pharmaceuticals, Inc. Common Stock ("Company Common Stock"), and all warrants
and options to purchase Hollis-Eden Common Stock outstanding immediately prior
to the Merger converted into the right to receive the same number of shares of
Company Common Stock. At the closing of the Merger, 4,911,004 shares of Company
Common Stock were issued, which represented approximately 85% of the shares of
Company Common Stock outstanding immediately after consummation of the Merger.

For accounting and financial reporting purposes, the Merger was treated as a
recapitalization of Hollis-Eden. Since IAC had no business operations other than
the search for a suitable target business, IAC's assets were recorded in the
balance sheet of the Company at book value. Upon the consummation of the Merger,
the Company had $6.5 million in cash and other receivables, and incurred
transaction costs of approximately $230,000 associated with the Merger for net
proceeds totaling $6.3 million which was recorded as equity. Additional
transaction costs totaling $4.7 million represent a charge for (i) warrants to
purchase an aggregate of 452,830 shares of Company Common Stock at an exercise
price of $2.475 issued to the placement agent (Note 10) upon the closing of the
Merger pursuant to an agreement and (ii) an aggregate of 50,000 shares of
Company Common Stock issued for legal and consulting services upon the closing
of the Merger. An estimate of $11.50 per share was used to calculate the charges
which approximates fair market value on the date of the Merger. These charges
constitute transaction fees and accordingly have been recorded as a charge and
an offsetting credit to additional paid-in capital.

        Upon the consummation of the Merger, pursuant to an agreement, the
Company issued warrants to purchase an aggregate of 50,000 shares of Company
Common Stock at an exercise price of $0.10 per share to a director and former
officer. Additional paid-in capital was increased by $570,000 with an offsetting
$570,000 charge recorded to operations during the three months ended March 31,
1997.

        At the IAC annual and special meeting of shareholders (IAC Special
Meeting), none of the stockholders who held shares of IAC common stock that was
sold during IAC's initial public offering (IAC Non-Affiliate Stockholders)
elected to redeem their shares of IAC Common Stock and therefore may be eligible
for Additional Merger Shares. (See Note 4).

        The Company's 1997 Stock Incentive Stock Option Plan became effective on
February 5, 1997 and was approved by the stockholders on March 26, 1997. A total
of 1,000,000 shares of Company Common Stock have been authorized for issuance
under the plan (see Note 12).

4.   ADDITIONAL MERGER SHARES

        Pursuant to IAC's prospectus dated May 15, 1995, each of the IAC
Non-Affiliate Stockholders (and each IAC stockholder prior to IAC's initial
public offering who (i) participated in the February 1993 private placement of
IAC securities and (ii) purchased shares of IAC common stock in the open market
after May 15, 1995 (the "After Acquired Stock"), but only to the extent of the
After Acquired Stock)) had the right (the "Redemption Right") to elect to have
any or all of his or her shares of IAC common stock redeemed for approximately
$11.00 per share (the "Redemption Value"). At the IAC special meeting, none of
the IAC





                                      F-10
<PAGE>   39
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


Non-Affiliate Stockholders elected to redeem their shares of IAC common stock.
In connection with the Merger, IAC offered each IAC Non-Affiliate Stockholder
the opportunity to exchange his or her Redemption Right for the right to receive
additional shares of Company common stock ("Additional Merger Shares"), should
any be issued.

        In order to perfect the right to receive Additional Merger Shares, if
any, an IAC Non-Affiliate Stockholder must (i) not have exercised his or her
Redemption Right in connection with the Merger and (ii) prior to May 25, 1997
(60 days following March 26, 1997, the effective time of the Merger (the
"Effective Time")), have taken whatever action necessary to cause such IAC
Non-Affiliate Stockholder to become the registered owner of his shares of
Company Common Stock (each, a "Rights Share" and, collectively, the "Rights
Shares"). By not exercising his or her Redemption Right in connection with the
Merger, an IAC Non-Affiliate Stockholder was deemed to have waived his or her
Redemption Right and accepted IAC's offer to receive the right to receive
Additional Merger Shares, if any are issued (provided such IAC Non-Affiliate
Stockholder was not a dissenting stockholder and became the registered owner of
his or her shares of Company Common Stock as provided above). The Company will
cause to be issued to each IAC Non-Affiliate Stockholder who shall have
perfected his or her right to receive Additional Merger Shares, if any,
certificates evidencing one right (each, a "Right" and, collectively, the
"Rights") for each Rights Share held by such IAC Non-Affiliate Stockholder (the
"Rights Certificates"). The Rights Certificates shall not be transferable,
assignable, subject to pledge or otherwise alienable, and the registered holder
of such Rights Certificates shall forfeit the number of Rights (the "Forfeited
Rights") equal to the number of shares of Company Common Stock sold or otherwise
transferred by such holder during the period commencing at the Effective Time
and ending on the date that a final determination of whether any Additional
Merger Shares will be issued is made (i.e., the second anniversary of the
Effective Time) (the "Holding Period"). The Forfeited Rights, at the moment of
such sale or transfer, shall be null and void and have no further force or
effect.

        Additional Merger Shares, if any, shall be issued to the holders of
Rights Certificates who have not otherwise forfeited their Rights as a result of
their selling or otherwise transferring shares of Company Common Stock during
the Holding Period if, at no time during the 24-month period immediately
following the Effective Time, the average closing price per share of Company
Common Stock over a period of 20 consecutive trading days equals or exceeds
$20.00 per share (subject to adjustment as set forth below). The Additional
Merger Shares shall be issued in accordance with the records of the Company as
promptly as practicable following the second anniversary of the Effective Time
to those holders of Rights Certificates who have not otherwise forfeited their
Rights. The number of Additional Merger Shares, if any, to be issued to the
holders of the Rights Certificates shall be calculated as follows: each
outstanding Right (i.e., any Right other than a Forfeited Right) shall entitle
the holder thereof to the number of Additional Merger Shares equal to (a) the
difference between (i) $20.00 (subject to adjustment as set forth below) and
(ii) the average of the highest 60 closing prices per share of Company Common
Stock during the one-year period immediately prior to the second anniversary of
the Effective Time (the "Sixty Day Average Price"), divided by (b) the Sixty Day
Average Price. No fractional Additional Merger Shares shall be issued. In lieu
thereof, any fractional shares shall be rounded to the nearest whole share of
Company Common Stock. The amount of Additional Merger Shares, if any, to be
issued shall be computed by the Company's independent public accountants as soon
as practicable following the second anniversary of the Effective Time. The
determination by such independent public accountants shall be final and binding
on the Company and the holders of the Rights. Notwithstanding the foregoing, the
Sixty Day Average Price shall in no event be less than $5.00 per share (subject
to adjustment as set forth below).





                                      F-11
<PAGE>   40
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


        In the event of a stock dividend, stock split, share combination,
exchange of shares, recapitalization, merger, consolidation, acquisition or
disposition of property or shares, reorganization, liquidation or other similar
change or transaction of or by the Company following the Effective Time, the
closing price per share of Company Common Stock and the Sixty Day Average Price
shall be adjusted as appropriate to give proper effect to the event.

        Notwithstanding the foregoing, the Company shall have the unilateral
right to redeem and cancel all, but not less than all, of the Rights evidenced
by the Rights Certificates, at a redemption price of $.001 per Right, if the
Company, at any time during the Holding Period, closes an equity offering
pursuant to which the Company (i) issues shares of Company Common Stock at a per
share price of not less than $15.00 per share and (ii) raises net proceeds to
the Company of not less than $10 million.

5.   NOTICE OF REDEMPTION AND EXERCISE OF WARRANTS

        On March 27, 1997, the Company sent a Notice of Redemption to holders of
its Class A Common Stock Purchase Warrants and Class B Unit Purchase Warrants,
stating that it would redeem all of such outstanding warrants on April 28, 1997
at a redemption price of $0.05. The right to exercise such Warrants terminated
on April 25, 1997. 603,415 of the Class A Common Stock Purchase Warrants and
254,950 Class B Unit Purchase Warrants were exercised into an aggregate of
858,365 shares of Company Common Stock. The gross proceeds to the Company were
$5.5 million. The Company incurred approximately $42,000 in transaction costs
associated with the exercise and redemption of the warrants which was recorded
against equity.

        A director and former officer exercised warrants to purchase 50,000
shares of Company Common Stock at an exercise price of $0.10 per share.

        Two holders of Placement Agent Warrants exercised warrants to purchase
69,238 shares of Company Common Stock at an exercise price of $2.48 per share.

6.   NOTES PAYABLE TO RELATED PARTY

        At December 31, 1995, the Company had an unsecured note payable to a
stockholder/officer in the amount of $250,000. This note was payable on demand,
with interest at 15%. This note was paid in full during April 1996. See further
discussion in Note 11.

        During the first quarter of 1997, the Company borrowed $92,000 from a
stockholder/officer of the Company. The loaned amount plus accrued interest was
due on the earlier of the effective date of the merger of Hollis-Eden with IAC
or December 31, 1997. The loan was fully paid on March 27, 1997.

7.   INCOME TAXES

        The Company has available a net operating loss carryforward of
approximately $4.6 million at December 31, 1997 which may be carried forward as
an offset to taxable income, if any, in future years through its expiration in
2009 to 2012. The Company has a net deferred tax asset of approximately
$3,140,000 at December 31, 1997 comprised of capitalized start-up costs,
research and development credits, and the net operating loss carryforward. The
net deferred tax asset has been fully reserved due to the uncertainty of the
Company being able to generate net operating income under the more likely than





                                      F-12
<PAGE>   41
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


not criteria of SFAS 109. If certain substantial changes in the Company's
ownership should occur, there would potentially be an annual limitation on the
amount of the carryforwards, which could be utilized in a tax year.

        The Company is carrying back an operating loss to recover $105,436 in
taxes paid by IAC for the year ending 1996.

8.   REVERSE STOCK SPLITS

        In March 1996, a 1 for 2.65 split of the Company's common stock was
effected. Also, on February 13, 1995 there was a 3 for 5 split of the Company's
common stock. All stock splits have been retroactively restated for all periods
presented.

9.   RELATED PARTY LICENSES AND OTHER AGREEMENTS AND COMMITMENTS AND
     CONTINGENCIES

        The Company entered into two license agreements and one research,
development and option agreement as discussed in the following paragraphs.

        Pursuant to a license agreement dated May 18, 1994 (Colthurst License
Agreement) with related parties Patrick T. Prendergast, a significant
stockholder, and with Colthurst Limited, a company controlled by Patrick T.
Prendergast, the Company acquired the exclusive worldwide rights of Patrick T.
Prendergast's patent rights, know-how and background technology relating to the
treatment of human/animal immunodeficiency as disclosed in U.S. patent No.
4,956,355 entitled "Agents for the Arrest and Therapy of Retroviral Infections."
Upon execution of this agreement, the Company paid a license fee of $100,000 and
was contractually obligated to pay $250,000 no later than November 18, 1994. The
payment of this obligation was delinquent at December 31, 1994 and was included
in license fees payable on the balance sheet at December 31, 1994. The agreement
was amended on August 11, 1995 to change the license fee payment terms as
discussed below in paragraph five of this Note 9. Also, per the Colthurst
License Agreement, if the Company obtained financing of at least $10,000,000 by
December 31, 1995, payments of $15,000 per month for services commencing on June
1, 1994 through the completion of FDA Phase II would have been payable to
Patrick T. Prendergast ($105,000 was included in license fees payable on the
balance sheet at December 31, 1994 based on a pending financing agreement).
These monthly service fees were eliminated entirely pursuant to an amendment to
the agreement on March 17, 1995 and the previously accrued amount of $105,000
was restructured as discussed in paragraph five of this Note 9. Per the amended
license agreement, a renewal annual license fee of $500,000 is payable
commencing 18 months after the $350,000 license fee, as discussed below in
paragraph five of this Note 9, is paid.

        Also, the Company has agreed to pay royalties of 6% on product revenues.
In the event of a sale of sublicenses or any other third-party agreements, 25%
of any fees are payable to Colthurst Limited.

        On August 25, 1994, the Company entered into a license agreement
(Edenland License Agreement) with a related party, Edenland Inc., a company
controlled by Patrick T. Prendergast, for the exclusive worldwide rights of
Patrick T. Prendergast's patent rights, know-how and background technology
related to the substance trade named REVERSIONEX and to any other pharmaceutical
product that becomes subject to the license agreement under the research,
development and option agreement discussed below. Upon execution of this
agreement, the Company paid a license fee of





                                      F-13
<PAGE>   42

                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


$25,000. The agreement was amended in August 1994 and required the Company to
pay a license fee of $572,000 as follows: $150,000 payable no later than
February 28, 1995, $300,000 on February 28, 1995, and $122,000 payable no later
than March 31, 1995. These amounts were included in license fees payable on the
balance sheet at December 31, 1994. The agreement was again amended on August
11, 1995 to change the license fee payment terms as discussed below in paragraph
five of this Note 9. Per the Edenland License Agreement, the Company has agreed
to pay royalties of 4% of product revenues. In the event of a sale of
sublicenses or any other third-party agreements, 25% of any fees are payable to
Edenland, Inc. Additionally, the Company granted Edenland, Inc. the option to
receive payment of its royalties under the license agreement in the form of
shares of the Company's stock. The option is limited to a maximum of 5% of the
Company's outstanding shares at August 25, 1994. The option is subject to the
products and/or vaccine developed therefrom receiving approval and generating
product revenues to the Company of at least $200,000,000. The option exercise
price per share is the fair market value on the date when and if such revenue
milestone is achieved, and the option has a term of five years beginning from
such date.

        Effective August 11, 1995, Edenland, Inc., Colthurst Limited and the
Company entered into amendments concerning the license fee payment terms to the
two agreements described above. Under the August 11, 1995 amendment, the Company
was obligated to pay $350,000 by April 28, 1996 and up to an additional $600,000
within 24 months of the $350,000 payment. The $600,000 fee will be payable by
way of a five percent payment of the first $12,000,000 of net proceeds or funds
or investments acquired by or expended on behalf of the Company by way of equity
sale, partnership agreement, loan or other means. At the end of the 24 month
period, any unpaid portion of the $600,000 fee is due immediately. If during the
24 month period the net proceeds exceed $12,000,000, then an additional fee is
due by way of two and one-half percent of all such proceeds. As of December 31,
1995, the Company had paid $22,000 of the $350,000 fee, and the remaining
$328,000 and the $600,000 fee were included in license fees payable as of
December 31, 1995 on the balance sheet. During April 1996, the $328,000 balance
was paid in full. During 1996, the Company advanced license fees of $100,300
related to the $600,000 owed to Edenland upon obtaining additional funding.
During April and May 1997, the balance of the $600,000 fee was paid in full. As
consideration for entering into certain amendments, the Company issued 75,472
shares of the Company's common stock at fair market value to Edenland, Inc. and
Colthurst Limited. Such valuation was determined by the Board of Directors and
was charged to general and administration expense for the year ended December
31, 1995.

        In August 1994, the Company entered into a contingent research
development and option agreement, as amended, with Edenland, Inc. and Patrick T.
Prendergast. The agreement provides for the development of REVERSIONEX to a
stage of development that demonstrates the toxicity and safety profile and also
indicates potential efficacy in Phase II (FDA) patient studies, and grants the
Company the right of first option on new products developed by Edenland, Inc.
The agreement commits the Company to pay for the development costs related to
REVERSIONEX up to the amount of $3,000,000 contingent upon the Company's receipt
of funds realized by way of equity sale, sublicense, partnership agreements,
loans, private placements and public offerings which take place following April
28, 1996 but not later than 24 months from 7 days following a private offering.
Additionally, the Company has agreed to pay a maximum of $250,000 per year to
fund off-budget projects to commence if and on the date the Company obtains
$10,000,000 in financing. Commencing April 28, 1996, the Company agreed to
commit at least thirty percent of its annual research and development budget up
to a maximum of $50 million during the term of this agreement, but at least a
minimum of $2 million and a maximum of $10 million for any given





                                      F-14
<PAGE>   43

                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


calendar year to pay development costs for REVERSIONEX or any new product
developed per the agreement.

        In October 1996, the Company and Colthurst Limited entered into an
amendment to the existing agreement. The amendment changes the due date of the
renewable annual license of $500,000 from October 1997 to the first date that
one of the following events occurs: the Company raises a predetermined amount of
capital occurring after May 18, 1994; the Company sublicenses the technology
received under the Colthurst License Agreement; the Company generates sales; the
Company licenses or funds new technologies not covered under the existing
agreements; or, February 10, 1999. The amendment also requires an additional
license fee of $10,000 per month beginning November 5, 1996 through the earlier
of the effective date of the Merger or May 5, 1997. This amendment was
contingent upon the successful closure of the Merger.

        In October 1996, the Company and Edenland, Inc. entered into an
amendment to the existing Research, Development and Option agreement. This
amendment accelerated the date that the $3,000,000 payment for REVERSIONEX or
other product development costs is to be made. A payment of $1,500,000 was
payable upon the closure of the Merger and the balance is contingent upon future
funding events by allocating 22% of the funds raised to the Research,
Development and Option agreement until the $3,000,000 has been paid in full.
$2,700,000 of the $3,000,000 was paid in 1997 with the remaining $300,000
accrued as an expense in 1997 and is payable by April 28, 1998. Under the
existing agreement, the Company was obligated to fund $2,000,000 per year for
research with the first payment due in April 1997. This obligation will not
commence until the Company raises an aggregate of $10 million in capital
occurring after May 18, 1994. Payments made toward the $3,000,000 REVERSIONEX
development costs are deductible from the amounts due for the $2,000,000 per
year of research. This amendment was contingent upon the successful closure of
the Merger.

10.   COMMON STOCK PURCHASE WARRANTS

SERIES A WARRANTS
During April 1996, in accordance with anti-dilution privileges triggered by an
offering in March 1995, the Company issued 1,018,867 Series A Warrants to all
stockholders of record as of March 1995 to purchase the same number of shares of
common stock at a price of $11.02 per share, exercisable for a period of three
years following the registration of the underlying shares.

SERIES B WARRANTS
During February 1995, the Company issued 37,736 Series B Warrants to Edenland,
Inc. in consideration for an amendment to the Edenland License Agreement. The
warrants are exercisable until February 5, 2000, to purchase the same number of
shares of common stock at a price of $15.90 per share.





                                      F-15
<PAGE>   44

                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


CONSULTANT'S OPTIONS
On July 12, 1995, as payment for investor relations counseling and consulting
services provided by Coffin Communications Group for the twelve-month period
ended July 1, 1996 the Company issued to Coffin Communications Group an option,
exercisable until July 12, 2000, to purchase 18,868 shares of common stock at a
price of $2.65 per share, 9,434 shares at a price of $5.30 per share, and 9,434
shares at a price of $7.95 per share.

PLACEMENT AGENT WARRANTS
During May 1996, the Company issued to the placement agent, for the completion
of the private placement in April 1996 (see Note 11), a warrant to purchase an
aggregate of up to 445,000 shares of common stock, at an exercise price of
$2.475 per share. The fair value of the 445,000 options is deducted from the net
proceeds of the private placement as a cost of raising capital and totaled
approximately $133,000.

Upon the successful closure of the Merger and Redemption of the Class A Common
Stock Purchase Warrants (the "Class A Warrants") and Class B Unit Purchase
Warrants (the "Class B Warrants"), the Company issued additional placement agent
warrants to purchase 452,830 shares of common stock at an exercise price of
$2.475 per share.

OTHER WARRANTS
During April 1994, the Company issued warrants, to existing shareholders and
management, to purchase 160,000 units (the "Units") at $10.00 per Unit, each
unit to be identical to the Units issued as part of its initial public offering,
exercisable until May 15, 2000. Each Unit consists of (i) one share of common
stock, $.01 par value per share and (ii) one Class A Warrants entitling the
holder to purchase one share of common stock at a price of $9.00 per share.

REPRESENTATIVES WARRANTS
In connection with the Company's initial public offering, the Company issued
warrants to the underwriters for 60,000 Units at an exercise price of $11.00 per
Unit and 24,000 Class B Warrants at an exercise price of $5.775 per warrant and
exercisable until May 15, 2000. Each Class B Warrant entitles the holder to
purchase one Unit (i.e. one share of common stock and one Class A Warrant).

11.     COMMON STOCK

        On January 21, 1996, the Company completed a $367,522 round of debt
financing with a group of private investors (Bridge Finance Offering). These
notes were due on or before the earlier of (i) January 21, 1997 or (ii) the
closing of a private or public offering of securities. These notes bear interest
at 8% per annum. The Company had the option to repay these notes with common
stock of the Company valued at a price of $2.25 per share or such price at which
shares were sold to investors in the Bridge Finance Offering. Proceeds from this
debt financing were used to repay the note and accounts payable to related
party, and accrued interest totaling $367,522. During April 1996, the debt
financing, plus accrued interest, were converted into 164,962 shares of common
stock at a price of $2.25 per share. From March 19, 1996 through April 19, 1996,
the Company privately issued 580,005 shares of the Company's common stock at an
offering price of $2.25 per share. Total proceeds from this offering aggregated
$1,234,499.





                                      F-16
<PAGE>   45
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


12.  STOCK OPTIONS

        The 1997 Stock Option Plan (the "Plan") was approved by the shareholders
in 1997. Under the Plan, 1,000,000 shares of common stock have been reserved for
issuance to employees, officers, directors, and consultants of the Company and
provides for the grant of incentive and nonstatutory stock options. Terms of the
stock option agreements, including vesting requirements, are determined by the
Board of Directors. The exercise price of incentive stock options must equal at
least the fair market value on the date of grant. The options expire not later
than ten years from the date of the grant and become exercisable immediately or
generally are exercisable ratably over a three-year period beginning one year
from the date of the grant.

The following table summarizes stock option activity under the Plan for 1997:

<TABLE>
<CAPTION>
                                                        Price Per Share
                                                     --------------------
                                                                  Weighted
                                       Shares           Range     Average
                                       -------       ----------   --------
<S>                                    <C>           <C>           <C>
Granted                                518,500        2.25-8.70     7.12
Exercised                                  166             2.25     2.25
Canceled                                   334             2.25     2.25

Outstanding, December 31, 1997         518,000       $6.75-8.70     7.13
</TABLE>

        The Company entered into stock options agreements not pursuant to the
Plan with certain directors, officers and consultants. These options become
exercisable according to a schedule of vesting as determined by the Board of
Directors. The options become exercisable immediately or over a period of years.
During 1996, the Company recognized a prepaid expense related to the options
issued to consultants. The Company will recognize the expense of approximately
$24,000 related to these options ratably over the three-year vesting period.

        In February, 1997, as part of an employment agreement, the Company
granted a non-statutory stock option to a certain officer to purchase 2,400,000
shares of the Company's common stock at a price of $5.00 per share, which option
vests ratably over a six-year period. The Company engaged an independent
appraiser to prepare several financial and valuation analyses to estimate the
fair value for accounting purposes. The appraiser estimated the intrinsic value
of the options to be $1,848,000. As a result, the Company has recorded as
deferred compensation a non-cash charge of $1,848,000, which will be amortized
ratably over the six-year vesting period. For the year ending December 31, 1997
the Company has amortized a total of $282,000.






                                      F-17
<PAGE>   46
                        HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


The following table summarizes stock option activity not pursuant to the Plan
for 1995 through 1997:

<TABLE>
<CAPTION>
                                                    PRICE PER SHARE
                                               ------------------------
                                                              WEIGHTED
                                    SHARES       RANGE         AVERAGE
                                  ---------   ----------      --------
<S>                               <C>         <C>               <C>
Outstanding, January 1, 1995              0   $        0            0
Granted                              37,736    2.65-7.95         4.64
Exercised                                 0            0            0
Canceled                                  0            0            0

Outstanding, December 31, 1995       37,736   $2.65-7.95         4.64
Granted                             570,000         2.25         2.25
Exercised                                 0            0            0
Canceled                                  0            0            0

Outstanding, December 31, 1996      607,736   $2.25-7.95         2.40
Granted                           2,400,000         5.00         5.00
Exercised                                 0            0            0
Canceled                                  0            0            0

Outstanding, December 31, 1997    3,007,736   $2.25-7.95         4.47
</TABLE>

For various price ranges, weighted average characteristics of outstanding stock
options at December 31, 1997 were as follows:

<TABLE>
<CAPTION>
                                 Outstanding options               Exercisable options
                    ------------------------------------------   -----------------------
     Range of                    Remaining life     Weighted                 Weighted
 Exercise Prices      Shares        (years)      average price    Shares   average price
 ---------------    ---------    --------------  -------------   -------   -------------
<S>                 <C>             <C>             <C>          <C>          <C>
   $2.25-$4.99        588,868         6.8           $   2.26     373,586      $   2.27
   $5.00-$8.70      2,936,868        11.2           $   5.39      37,368      $   6.69
</TABLE>

Statement  of Financial Accounting Standards No. 123 ("SFAS 123")
During 1995, the Financial Accounting Standards Board issued SFAS 123,
Accounting for Stock-Based Compensation, which defines a fair-value-based method
of accounting for stock compensation plans. However, it also allows an entity to
continue to measure compensation cost related to stock compensation plans using
the method of accounting prescribed by the Accounting Principles Board Opinion
No. 25 (APB 25), Accounting for Stock Issued to Employees. Entities electing to
follow APB 25 must make pro forma disclosures of net income, as if the
fair-value-based method of accounting defined in SFAS had been applied.





                                      F-18
<PAGE>   47
                        HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS

The Company has elected to account for its stock-based compensation plans under
APB 25; however, for pro forma disclosure purposes, the Company has computed the
value of all options granted to employees during 1995 through 1997, using the
minimum value pricing model as prescribed by SFAS 123 for 1995 and 1996 and the
Black-Scholes option pricing model for 1997 with the following weighted average
assumptions:

<TABLE>
<CAPTION>
                                                  1997                  1996
                                                 -------               -------
            <S>                                  <C>                   <C>
            Risk free interest rate                5.90%                 6.09%
            Expected dividend yield                   0%                    0%
            Expected lives                       5 years               5 years
            Expected volatility                    46.5%                   N/A
</TABLE>

The warrants were assumed to be exercised at maturities of four and five years,
while the stock options were assumed to be exercised in five to seven years.
Adjustments are made for options forfeited prior to vesting. The total value of
warrants and options was computed to be the following approximate amounts, which
would be amortized on the straight-line basis over the vesting period of the
options:

<TABLE>
            <S>                                          <C>
            Year ended December 31, 1995                 $        --
            Year ended December 31, 1996                 $   385,042
            Year ended December 31, 1997                 $ 1,777,270
</TABLE>

If the Company had accounted for stock options issued to employees and directors
in accordance with SFAS 123, the Company's net loss would have been reported as
follows:

            Net loss

<TABLE>
<CAPTION>
                                                  Year ended December 31,
                                       ---------------------------------------
                                          1997          1996           1995
                                       ----------    ----------     ----------
            <S>                        <C>           <C>            <C>
            As reported                $4,952,884    $  686,203     $  671,691
            Pro forma                   5,248,469       797,374        671,691
</TABLE>

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options. The weighted average, estimated fair
values of employee stock options granted during fiscal 1997 and 1996 were $5.38
and $2.25 per share, respectively.

13.     EMPLOYMENT AGREEMENTS

        Pursuant to an employment agreement between Hollis-Eden and Mr. Richard
B. Hollis entered into in November 1996 (the "Hollis Employment Agreement"). Mr.
Hollis' annual base salary was increased to $225,000 upon the consummation of
the Merger, with bonuses and equity compensation as determined by the
Hollis-Eden Pharmaceuticals Board of Directors. If Mr. Hollis' employment is
terminated "without cause," "for insufficient reason" or pursuant to a "change
in control" (as such terms are defined in the Hollis Employment Agreement), Mr.
Hollis will receive as severance (i) an amount equal to five times his then
current annual base salary plus five times the amount of the bonus awarded to
him in the prior



                                      F-19
<PAGE>   48
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


calendar year, (ii) immediate vesting of all unvested stock options of
Hollis-Eden Pharmaceuticals (or the Surviving Corporation, if applicable) held
by him and (iii) continued benefits under all employee benefit plans and
programs for a period of three years. All of such payments are to be made in one
lump sum within 30 days of termination. If Mr. Hollis' employment is terminated
"with cause" or if Mr. Hollis resigns other than for "sufficient reason," Mr.
Hollis' compensation and benefits will cease immediately and Mr. Hollis will not
be entitled to severance benefits.

        Pursuant to a six-year employment agreement between Hollis-Eden
Pharmaceuticals and Mr. Terren S. Peizer entered into during February 1997 (the
"Peizer Employment Agreement"), Mr. Peizer was entitled to receive, upon
consummation of the Merger, an annual base salary of $175,000 and bonuses as
determined by the Hollis-Eden Pharmaceuticals Board of Directors. In addition,
Hollis-Eden Pharmaceuticals has granted Mr. Peizer a nonstatutory stock option
to purchase up to 2,400,000 shares of Hollis-Eden Common Stock, at $5.00 per
share, with 400,000 shares vesting on February 6, 1998 and each successive
February 6 thereafter. If Mr. Peizer's employment is terminated "without cause"
(as defined in the Peizer Employment Agreement), Mr. Peizer will receive as
severance (i) continuation of his then current base salary for one year from the
date of termination and (ii)(A) in the event the date of termination is on or
after February 6, 1999, in addition to the shares already vested under his
option, vesting for an additional 400,000 shares shall be accelerated and (B) in
the event the date of termination is prior to February 6, 1999, (x) his option's
vesting will be accelerated to the extent necessary to entitle Mr. Peizer to an
aggregate of 800,000 shares upon exercise of his option and (y) Mr. Peizer will
have the right to purchase up to 200,000 shares of Hollis-Eden Pharmaceuticals
Common Stock from Mr. Hollis at $5.00 per share. If Mr. Peizer's employment is
terminated "with cause" (as defined in the Peizer Employment Agreement) or if
Mr. Peizer resigns, Mr. Peizer's compensation will cease immediately and Mr.
Peizer will not be entitled to any severance benefits.

        Mr. Peizer's Employment Agreement was amended during April 1997. The
minimum salary was increased to the minimum salary paid by the Company to its
chairman and CEO. In addition, if Mr. Peizer's employment is terminated "without
cause," Mr. Peizer shall be entitled to immediate vesting of all unvested stock
options granted to him. Pursuant to the amendment, Mr. Peizer's employment with
the Company can not be terminated unless a majority of the Board of Directors
have voted in favor of termination.

14.  LEASES

        Rental expenses for principally leased facilities under operating leases
were $17,000 and $69,000 for 1996 and 1997. Future minimum payments for
operating leases are as follows:

<TABLE>
<CAPTION>
                                                  Operating Leases
                                                  ----------------
<S>                                                  <C>
1998                                                 $  115,000
1999                                                    120,000
2000                                                     83,000
2001                                                      4,000
2002                                                      4,000
Thereafter                                                    0
                                                     ----------
Total minimum lease payments                         $  326,000
                                                     ==========
</TABLE>





                                      F-20
<PAGE>   49
                       HOLLIS-EDEN PHARMACEUTICALS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
                         NOTES TO FINANCIAL STATEMENTS


15.  SUBSEQUENT EVENTS

        During February 1998, the Company entered into an agreement with an
investors relations firm where the Company has agreed to issue, as part of the
compensation for services to be rendered during 1998, 150,000 warrants with an
exercise price of $14.75 per share and an expiration date of December 31, 1998.
The warrants were estimated to have a value of $408,000, which amount will be
expensed in 1998.





















                                      F-21