**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

----

** **

**FORM 10-Q**

 

| **ý****QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d)** |
|-----------------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF  1934**                     |
|                                                            |
| **For the quarterly period ended September 30, 2003**           |
|                                                            |
| **OR**                                                          |
|                                                            |
| **o****TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d)**     |
| **OF  THE SECURITIES EXCHANGE ACT OF 1934**                     |
|                                                            |
| **Commission file number 0-18006**                              |

 

**THE IMMUNE RESPONSE CORPORATION**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    |   | **33-0255679**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **5931  Darwin Court  Carlsbad, California**                    |   | **92008**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |

 

 

Registrant’s telephone number, including areacode:  **(760) 431-7080**

 

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý    No o

 

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

Yes o    No ý

 

As of November 6, 2003, there were 40,951,806  shares of our common stock outstanding.

 

 

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**INDEX**

 
| **Part I**     | **FINANCIAL INFORMATION** |
|----------------|---------------------------|
|           |                      |   |
|           | Item 1.                   | Financial Statements: |
|           |                      |   |
|           |                      | Condensed Consolidated Balance Sheets -  September 30, 2003 and December 31, 2002 |
|           |                      |   |
|           |                      | Condensed Consolidated Statements of  Operations – Three and nine months ended September 30, 2003 and 2002 |
|           |                      |   |
|           |                      | Condensed Consolidated Statements of Cash  Flows - Nine months ended September 30, 2003 and 2002 |
|           |                      |   |
|           |                      | Condensed Consolidated Statement of  Stockholders’ Equity and Comprehensive Loss – Nine months ended September 30,  2003 |
|           |                      |   |
|           |                      | Notes to Condensed Consolidated Financial  Statements |
|           |                      |   |
|           | Item 2.                   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|           |                      |   |
|           | Item 3.                   | Quantitative and Qualitative Disclosures  About Market Risk |
|           |                      |   |
|           | Item 4.                   | Controls and Procedures |
|           |                      |   |
|           |                      |   |
| **Part II**    | **OTHER INFORMATION**     |
|           |                      |   |
|           | Item 1.                   | Legal Proceedings |
|           |                      |   |
|           | Item 2.                   | Changes in Securities and Use of Proceeds |
|           |                      |   |
|           | Item 3.                   | Defaults Upon Senior Securities |
|           |                      |   |
|           | Item 4.                   | Submission of Matters to a Vote of Security  Holders |
|           |                      |   |
|           | Item 5.                   | Other Information |
|           |                      |   |
|           | Item 6.                   | Exhibits and Reports on Form 8-K |
|           |                      |   |
|           |                      |   |
| **SIGNATURES** |
|                |                           |  |  |

 

2

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.****    FinancialStatements**

**TheImmune Response Corporation**

**CondensedConsolidated Balance Sheets**

*(in thousands, except for per share amounts)*

* *
|                                                                                                                                                                                 |   | **September  30,  2003** |       | **December  31,  2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                                                                                                                                                 |   | **(unaudited)**          | ** ** |                    | ** ** |
| **Assets**                                                                                                                                                                           |   |                     |       |                    |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Current Assets:                                                                                                                                                                      |   |                     |       |                    |       |
| Cash and equivalents                                                                                                                                                                 |   | $                        | 5,329      |                    | $          | 3,941 |   |
| Other current assets                                                                                                                                                                 |   | 727                      |       | 420                     |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
|                                                                                                                                                                                 |   | 6,056                    |       | 4,361                   |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Property and equipment, net                                                                                                                                                          |   | 5,053                    |       | 6,483                   |       |
| Licensed technology, net                                                                                                                                                             |   | 2,296                    |       | 2,825                   |       |
| Deposits and other assets ($600 restricted  as security for letter of credit)                                                                                                        |   | 699                      |       | 896                     |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
|                                                                                                                                                                                 |   | $                        | 14,104     |                    | $          | 14,565 |   |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| **Liabilities and  Stockholders’ Equity**                                                                                                                                       |   |                     |       |                    |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Current Liabilities:                                                                                                                                                                 |   |                     |       |                    |       |
| Accounts payable                                                                                                                                                                     |   | $                        | 574        |                    | $          | 1,326 |   |
| Accrued expenses                                                                                                                                                                     |   | 986                      |       | 1,014                   |       |
| Convertible promissory notes, related party                                                                                                                                          |   | 3,899                    |       |                    |       |
| Equipment notes payable                                                                                                                                                              |   |                     |       | 724                     |       |
| Other                                                                                                                                                                                |   | 56                       |       | 273                     |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
|                                                                                                                                                                                 |   | 5,515                    |       | 3,337                   |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Convertible promissory notes, related  party, net of discount of $4,757 and $10,848  and plus accrued interest of $431 and $594 at 2003 and 2002, respectively                       |   | 2,882                    |       | 3,487                   |       |
| Equipment notes payable                                                                                                                                                              |   |                     |       | 141                     |       |
| Accrued excess lease costs                                                                                                                                                           |   | 385                      |       | 637                     |       |
| Deferred revenue                                                                                                                                                                     |   | 337                      |       | 378                     |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
|                                                                                                                                                                                 |   | 3,604                    |       | 4,643                   |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Stockholders’ Equity:                                                                                                                                                           |   |                     |       |                    |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Preferred stock, 10,000,000 shares  authorized                                                                                                                                       |   |                     |       |                    |       |
| Common stock, $0.0025 par value,  170,000,000 shares authorized; 34,794,964  and 19,670,729 shares issued and outstanding at September 30, 2003 and  December 31, 2002, respectively |   | 87                       |       | 49                      |       |
| Common stock warrants                                                                                                                                                                |   | 12,751                   |       | 13,684                  |       |
| Additional paid-in capital                                                                                                                                                           |   | 284,495                  |       | 250,656                 |       |
| Accumulated other comprehensive income                                                                                                                                               |   | 4                        |       | 2                       |       |
| Accumulated deficit                                                                                                                                                                  |   | (292,352                 | )          | (257,806                | )          |
|                                                                                                                                                                                 |   |                     |       |                    |       |
| Total stockholders’ equity                                                                                                                                                      |   | 4,985                    |       | 6,585                   |       |
|                                                                                                                                                                                 |   |                     |       |                    |       |
|                                                                                                                                                                                 |   | $                        | 14,104     |                    | $          | 14,565 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

3

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**TheImmune Response Corporation**

**CondensedConsolidated Statements of Operations**

*(in thousands, except for per share amounts)*

*(unaudited)*

 
|                                                                                                                                               |   | **Three  Months Ended  September 30,** |    | **Nine  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
|                                                                                                                                               |   | **2003**                               |    | **2002**                              |   | **2003** |   | **2002** |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Revenues:                                                                                                                                          |   |                                   |    |                                  |   |   |   |   |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Contract research revenue                                                                                                                          |   | $                                      | 7       |                                  | $      | 7 |   | $ | 22 |   | $ | 21 |   |
| Licensed research revenue                                                                                                                          |   | 7                                      |    | 6                                     |   | 30 |   | 12 |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
|                                                                                                                                               |   | 14                                     |    | 13                                    |   | 52 |   | 33 |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Expenses:                                                                                                                                          |   |                                   |    |                                  |   |   |   |   |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Research and development                                                                                                                           |   | 3,131                                  |    | 3,221                                 |   | 8,135 |   | 10,782 |   |
| General and administrative                                                                                                                         |   | 1,024                                  |    | 1,343                                 |   | 4,361 |   | 3,723 |   |
| Exit and disposal related costs                                                                                                                    |   | 38                                     |    |                                  |   | 1,374 |   |   |   |
| Collaborative contract costs                                                                                                                       |   |                                   |    |                                  |   |   |   | 2,360 |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
|                                                                                                                                               |   | 4,193                                  |    | 4,564                                 |   | 13,870 |   | 16,865 |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Other Income (Expense):                                                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Investment income                                                                                                                                  |   | 6                                      |    | 34                                    |   | 17 |   | 56 |   |
| Interest expense – including non-cash  accretion of $2,345 and $713 for three months and $6,475 and $1,541 for the  nine months, respectively |   | (2,672                                 | )       | (991                                  | )      | (7,494 | ) | (2,137 | ) |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Net loss                                                                                                                                           |   | (6,845                                 | )       | (5,508                                | )      | (21,295 | ) | (18,913 | ) |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Deemed stock dividend                                                                                                                              |   | (13,251                                | )       |                                  |   | (13,251 | ) |   |   |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Net loss attributable to common  stockholders                                                                                                      |   | $                                      | (20,096 | )                                     | $      | (5,508 | ) | $ | (34,546 | ) | $ | (18,913 | ) |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Loss Per Share – Basic and Diluted:                                                                                                           |   |                                   |    |                                  |   |   |   |   |   |
| Net loss attributable to common  stockholders                                                                                                      |   | $                                      | (0.62   | )                                     | $      | (0.56 | ) | $ | (1.43 | ) | $ | (2.04 | ) |
|                                                                                                                                               |   |                                   |    |                                  |   |   |   |   |   |
| Weighted average  shares outstanding                                                                                                          |   | 32,277,179                             |    | 9,903,474                             |   | 24,096,802 |   | 9,252,963 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

4

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**TheImmune Response Corporation**

**Condensed Consolidated Statements of CashFlows**

*(in thousands, except for per share amounts)*

*(unaudited)*

 
|                                                                                        |   | **Nine  Months Ended September 30,** |    |
|---------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                        |   | **2003**                             |    | **2002** |   |
|                                                                                        |   |                                 |    |   |   |
| Cash Flows From Operating Activities:                                                       |   |                                 |    |   |   |
| Net loss                                                                                    |   | $                                    | (21,295 | ) | $ | (18,913 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used for) operating activities: |   |                                 |    |   |   |
| Depreciation and amortization                                                               |   | 1,455                                |    | 1,669 |   |
| Operating expenses paid with common stock  and warrants                                     |   | 541                                  |    | 43 |   |
| Collaborative contract costs                                                                |   |                                 |    | 2,360 |   |
| Deferred revenue                                                                            |   | (41                                  | )       | 317 |   |
| Accrued excess lease costs                                                                  |   | (252                                 | )       | 217 |   |
| Accretion of  notes                                                                    |   | 6,475                                |    | 1,541 |   |
| Stock option adjustments                                                                    |   | 917                                  |    |   |   |
| Long-term accrued interest                                                                  |   | 665                                  |    | 392 |   |
| Impairment of long-term asset                                                               |   | 438                                  |    |   |   |
| Gain on sale of assets                                                                      |   | (46                                  | )       |   |   |
| Changes in assets and liabilities:                                                          |   |                                 |    |   |   |
| Accounts payable                                                                            |   | (827                                 | )       | (110 | ) |
| Accrued expenses                                                                            |   | 57                                   |    | (244 | ) |
| Other                                                                                       |   | (153                                 | )       |   |   |
|                                                                                        |   |                                 |    |   |   |
| Net cash (used in) operating activities                                                     |   | (12,066                              | )       | (12,728 | ) |
|                                                                                        |   |                                 |    |   |   |
| Cash Flows From Investing Activities:                                                       |   |                                 |    |   |   |
| Sale of marketable securities, net                                                          |   |                                 |    | 251 |   |
| Proceeds from the sale of property and  equipment, net                                      |   | 112                                  |    |   |   |
| Other                                                                                       |   | 197                                  |    | (38 | ) |
|                                                                                        |   |                                 |    |   |   |
| Net cash provided by investing activities                                                   |   | 309                                  |    | 213 |   |
|                                                                                        |   |                                 |    |   |   |
| Cash Flows From Financing Activities:                                                       |   |                                 |    |   |   |
| Payments of equipment notes and capital  leases                                             |   | (1,082                               | )       | (593 | ) |
| Proceeds from issuance of promissory notes  and warrants                                    |   | 3,899                                |    | 11,794 |   |
| Proceeds from exercise of stock warrants                                                    |   | 10,138                               |    |   |   |
| Proceeds from employee stock purchases, net                                                 |   | 190                                  |    | 9 |   |
|                                                                                        |   |                                 |    |   |   |
| Net cash provided by financing activities                                                   |   | 13,145                               |    | 11,210 |   |
|                                                                                        |   |                                 |    |   |   |
| Net increase (decrease) in cash and  equivalents                                            |   | 1,388                                |    | (1,305 | ) |
|                                                                                        |   |                                 |    |   |   |
| Cash and equivalents – beginning of period                                             |   | 3,941                                |    | 2,430 |   |
|                                                                                        |   |                                 |    |   |   |
| Cash and equivalents – end of period                                                   |   | $                                    | 5,329   |   | $ | 1,125 |   |
|                                                                                        |   |                                 |    |   |   |
| Supplemental Disclosure Of Cash Flow  Information:                                          |   |                                 |    |   |   |
| Interest paid                                                                               |   | $                                    | 275     |   | $ | 181 |   |
|                                                                                        |   |                                 |    |   |   |
| Supplemental Disclosure Of Non-Cash Information:                                            |   |                                 |    |   |   |
| Common stock and warrants issued for  consulting services                                   |   | $                                    | 1,149   |   | $ | 134 |   |
| Common stock issued to research  collaborators                                              |   | $                                    |    |   | $ | 2,360 |   |
| Equipment purchased under capital leases                                                    |   | $                                    |    |   | $ | 425 |   |
| Unrealized gain (loss) on marketable securities                                             |   | $                                    | 2       |   | $ | (18 | ) |
| Value allocated to common stock as debt  discount                                           |   | $                                    | 385     |   | $ |   |   |
| Promissory notes and interest converted  into common stock                                  |   | $                                    | 7,361   |   | $ |   |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

5

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**The Immune ResponseCorporation**

**Condensed ConsolidatedStatement of Stockholders’ Equity and Comprehensive Loss**

*(in thousands)*

* *

*(unaudited)*

 
|                                                                   |   | **Common Stock** |       | **Warrants** |       | **Additional  Paid-in  Capital** |       | **Accumulated  Other  Comprehensive  Income (Loss)** |       | **Accumulated  Deficit** |       | **Total  Stockholders’  Equity** |       |
|------------------------------------------------------------------------|--------|------------------|------------|--------------|------------|----------------------------------|------------|------------------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| **Shares**                                                             |   | **Amount**       |
|                                                                   |   |             | ** ** |         | ** ** |                             | ** ** |                                                 | ** ** |                     | ** ** |                                  | ** ** |   | ** ** |
| Balance at December 31, 2002                                           |   | 19,671           |       | $            | 49         |                             | $          | 13,684                                               |       | $                        | 250,656    |                                  | $          | 2 |   | $ | (257,806 | ) | $ | 6,585 |   |
|                                                                   |   |             |       |         |       |                             |       |                                                 |       |                     |       |                                  |       |   |   |
| Conversion of convertible notes into  common stock                     |   | 1,613            |       | 4            |       |                             |       | 4,996                                                |       |                     |       |                                  |       | 5,000 |   |
| Conversion of convertible note into common  stock for warrant exercise |   | 1,775            |       | 4            |       | (502                             | )          | 2,859                                                |       |                     |       |                                  |       | 2,361 |   |
| Induced exercise of warrants, net                                      |   | 5,217            |       | 13           |       | (1,476                           | )          | 7,938                                                |       |                     |       |                                  |       | 6,475 |   |
| Warrants redeemed or cancelled                                         |   | 2,421            |       | 6            |       | (710                             | )          | 3,920                                                |       |                     |       |                                  |       | 3,216 |   |
| Deemed stock dividend as a result of  induced warrant exercise         |   | 3,496            |       | 9            |       | 1,364                            |       | 11,878                                               |       |                     |       | (13,251                               | )          |   |   |
| Equity issued in conjunction with  consulting contracts                |   | 263              |       | 1            |       | 391                              |       | 757                                                  |       |                     |       |                                  |       | 1,149 |   |
| Issuance of common stock in conjunction  with debt issuance            |   | 167              |       | 1            |       |                             |       | 384                                                  |       |                     |       |                                  |       | 385 |   |
| Issuance of common stock for employee  stock plans                     |   | 172              |       |         |       |                             |       | 190                                                  |       |                     |       |                                  |       | 190 |   |
| Intrinsic valuation for repriced employee  stock options               |   |             |       |         |       |                             |       | 736                                                  |       |                     |       |                                  |       | 736 |   |
| Variable accounting for options granted to  nonemployees               |   |             |       |         |       |                             |       | 181                                                  |       |                     |       |                                  |       | 181 |   |
| Net loss                                                               |   |             |       |         |       |                             |       |                                                 |       | 2                        |       | (21,295                               | )          | (21,293 | ) |
| Balance at September 30, 2003                                          |   | 34,795           |       | $            | 87         |                             | $          | 12,751                                               |       | $                        | 284,495    |                                  | $          | 4 |   | $ | (292,352 | ) | $ | 4,985 |   |

 

*See accompanying notes tocondensed consolidated financial statements.*

 

6

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**THE IMMUNE RESPONSE CORPORATION**

**Notesto Condensed Consolidated Financial Statements (unaudited)**

 

**Note 1 - InterimFinancial Statements:**

 

The accompanying condensed consolidated balance sheet as of September30, 2003 and the condensed consolidated statements of operations and of cashflows for the three and nine months ended September 30, 2003 and 2002 have beenprepared by The Immune Response Corporation (the “Company”) and have not beenaudited.  The condensed consolidatedfinancial statements of the Company include the accounts of its wholly-ownedsubsidiary I.R.C. Inc.  All significantintercompany transactions and accounts have been eliminated inconsolidation.  These financialstatements, in the opinion of management, include all adjustments (consistingonly of normal recurring accruals) necessary for a fair presentation of thefinancial position, results of operations and cash flows for all periodspresented.  The financial statementsshould be read in conjunction with the financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K filed for the year endedDecember 31, 2002.  Interim operatingresults are not necessarily indicative of operating results for the full year.

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

Certain reclassifications have been made to conform prior periodfinancial information to the current presentation.  These reclassifications had no effect on reported income orlosses.

* *

*Stock-Based Compensation*

 

During April 2003, the Companyrepriced and accelerated the vesting of stock options to purchase 664,007shares previously granted to employees and outside directors.  The weighted average share price was reducedfrom $10.04 per share to $1.12 per share. This repricing was expensed using the intrinsic valuation methodrequired under APB No. 25.  The Companyrecorded additional employee compensation (benefit) expense of  ($371,000) and $736,000 for the repricedoptions during the three months and nine months ended September 30, 2003,respectively.

TheCompany measures its stock-based employee compensation using the intrinsicvalue method.  The following disclosuresutilizing the intrinsic value method, and pro forma amounts, after applying thefair value method, related to stock-based awards made to employees that wereoutstanding as of September 30, 2003 and 2002:

 

 
|                                         |   | **Three  Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |   |
|----------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|--------|
|                                         |   | **2003**                               |       | **2002**                             |   | **2003** |   | **2002** |   |
| Net loss:                                    |   |                                   |       |                                 |   |   |   |   |   |
| As reported                                  |   | $                                      | (6,845,000 | )                                    | $      | (5,508,000 | ) | $ | (21,295,000 | ) | $ | (18,913,000 | ) |
|                                         |   |                                   |       |                                 |   |   |   |   |   |
| Pro forma stock-based employee  compensation |   | (904,000                               | )          | (73,000                              | )      | (2,462,000 | ) | (219,000 | ) |
|                                         |   |                                   |       |                                 |   |   |   |   |   |
| Pro forma                                    |   | $                                      | (7,749,000 | )                                    | $      | (5,581,000 | ) | $ | (23,757,000 | ) | $ | (19,132,000 | ) |
|                                         |   |                                   |       |                                 |   |   |   |   |   |
| Net loss per share (basic and diluted):      |   |                                   |       |                                 |   |   |   |   |   |
| As reported                                  |   | $                                      | (0.21      | )                                    | $      | (0.56 | ) | $ | (0.88 | ) | $ | (2.04 | ) |
|                                         |   |                                   |       |                                 |   |   |   |   |   |
| Pro forma                                    |   | $                                      | (0.23      | )                                    | $      | (0.56 | ) | $ | (0.99 | ) | $ | (2.07 | ) |
|                                         |   |                                   |       |                                 |   |   |   |   |   |

 

 

**Note 2 - The Company:**

 

The Immune Response Corporation, a Delaware corporation, is abiopharmaceutical company developing a therapeutic vaccine for the treatment ofHIV infection.  We have developed Remune®,an immune-based therapy, to induce specific immune responses for the treatmentof HIV.  We also have created sixdistinct therapeutic vaccines in various stages of development for autoimmunediseases and cancer and have established an extensive patent portfolio spanningfour different technologies with a total of 173 patents issued to us worldwide.

 

As part of our restructuring program announced in September 2002, wehave ceased investment in the development of all therapeutic vaccines otherthan Remune®.  During May 2003, we disposed of excessassets, and in July 2003 we negotiated an early lease termination for ourformer vacated headquarters facility resulting in exit and disposal relatedcosts of approximately $1,400,000 recognized as of September 30, 2003.

 

 

**Note 3 - Going Concern:**

 

The accompanying condensed consolidated financial statements have beenprepared on a going concern basis, which contemplates the realization of assetsand the satisfaction of liabilities in the normal course of business.  The Company has incurred net losses sinceinception and has an accumulated deficit of $292,352,000 as of September 30,2003. The Company will not generate meaningful revenues in the foreseeablefuture and will need to raise additional capital to continue operations beyond2004.

 

These factors raise substantial doubt about the Company’s ability tocontinue as a going concern.  Ourindependent auditors, BDO Seidman, LLP, indicated in their report on the 2002consolidated financial statements, that there is substantial doubt about ourability to continue as a going concern.

 

Thecondensed consolidated financial statements do not include any adjustmentsrelating to the recoverability and classification of recorded asset amounts orthe amounts and classification of liabilities that might be necessary shouldthe Company be unable to continue as a going concern.

 

During 2003, the Company has improved its financial condition. FromJuly to September 2003, the Company raised approximately $12,500,000 in grossproceeds through the exercise of its Class A warrants.  The proceeds included

 

7

----

 

approximately $10,100,000 in cash and the cancellation of $2,400,000 ofconvertible notes previously issued to Cheshire, a related party (see Notes 6and 8).

 

On July 7, 2003, the Company received stockholder approval to conduct aprivate offering of up to $5,000,000 of Series A Convertible Preferred Stockwhich could include the conversion of $3,900,000 of related party convertiblenotes (see Note 8).

 

On October 10, 2003, the Company raised approximately $11,025,000,net of $975,000 in offering costs, in connection with a private placement of5,940,594 shares of common stock and accompanying warrants to purchase2,970,297 shares of common stock (see Note 8).

 

TheCompany believes that the aggregate proceeds from the October 10, 2003 privateplacement together with the proceeds from the 2003 exercise of the Class Awarrants will be sufficient to fund its planned operations, including necessarycapital expenditures and new clinical trials, through the end of 2004.  However, no assurance can be given that theCompany will be able to obtain additional financing when and as needed in thefuture.

 

 

**Note 4 - Licensed Technology:**

 

Intangible assets are recordedat cost and amortized over their estimated useful lives.  In December 1999, the Company acquiredlicenses to certain patent technology, which is being amortized over sevenyears.

 

In accordance with FAS No. 144, the Company had identifiedlicensed technology totaling $2,296,000 at September 30, 2003 as long-livedassets subject to annual impairment review. Given the current financial status of the Company, its historical lossesand the indeterminable outcome of the development and approval of its products,there is substantial uncertainty as to the Company’s ability to recover itsinvestment in these long-lived assets through the generation of net future cashflows.  In light of this uncertainty,the Company obtained an independent third-party appraisal of these long-livedassets in the first quarter of 2003.  Asa result of such appraisal, licensed technology did not require an impairmentcharge for the nine months ended September 30, 2003.

 

 

**Note 5 - ConvertiblePromissory Notes, Related Party (Current):**

 

Theconvertible promissory notes, described below, may be converted into shares ofSeries A convertible preferred stock which conversion was approved at a specialmeeting of our stockholders on July 7, 2003 (see Note 8).

 

OnMarch 28, 2003, we issued to Cheshire, a related party, a convertiblepromissory note in the amount of $2,000,000, bearing interest at the rate of 8%per annum, due March 28, 2004 (the “March Note”). The March Note is convertibleinto 1,626,016 shares of common stock at a price of $1.23 per share.

 

InMay 2003, we issued to Cheshire two convertible promissory notes in theaggregate amount of $1,080,000, bearing interest at the rate of 8% per annum,due May 2004 and November 2003, respectively (the “May Notes”).  One of the May Notes, with a principalbalance of $1,000,000, is convertible into shares of common stock on terms tobe negotiated in good faith prior to its maturity date.  The $80,000 May Note is convertible into59,259 shares of common stock at a price of $1.35 per share.

 

InJune 2003, we issued to Cheshire a convertible promissory note in the amount of$819,000, bearing interest at the rate of 8% per annum, due November 2003 (the“June Note”).  The June Note isconvertible into shares of common stock on terms to be negotiated in good faithprior to its maturity date.

 

8

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**Note6 - Convertible Promissory Notes, Related Party (Long-Term):**

 

Convertiblepromissory notes, related party (long-term) as presented on the balance sheetcomprises:

 
|                                                                        |   | **September  30,  2003** |   | **December  31,  2002** |   |
|-----------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                                        |   | **($’000’s)**  |   | **($’000’s)** |   |
|                                                                        |   |                     |   |                    |   |
| Convertible promissory notes, related party  (long-term) - face amount |   | $                        | 7,208  |                    | $      | 13,741 |   |
|                                                                        |   |                     |   |                    |   |
| Discount for warrants and beneficial conversion                             |   | (13,221                  | )      | (13,221                 | )      |
| Discount accreted on notes converted into private  placement                |   | (276                     | )      | (276                    | )      |
| Accretion of discount recorded as interest expense                          |   | 8,740                    |   | 2,649                   |   |
| Discount balance, net                                                       |   | (4,757                   | )      | (10,848                 | )      |
|                                                                        |   |                     |   |                    |   |
| Long-term accrued interest                                                  |   | 431                      |   | 594                     |   |
| Convertible promissory notes, related party  (long-term) - net              |   | $                        | 2,882  |                    | $      | 3,487 |   |

 

InNovember 2001, the Company entered into the Note Purchase Agreement andIntellectual Property Security Agreement with an accredited investor.  The investor, Kevin Kimberlin Partners, L.P.(“KKP”), is an affiliate of Kevin Kimberlin, a director and majorstockholder of the Company. Subsequently, the Note Purchase Agreement has been amended to add otheraffiliates and/or related parties of Kevin Kimberlin as investors.  These affiliated investors include OshkimLimited Partnership (“Oshkim”), The Kimberlin Family 1998 Irrevocable Trust(“KFIT”) and Cheshire Associates, LLC (“Cheshire”).  Since November 2001 through December 31, 2002, the Companyhas privately placed a total of $15,700,000 in convertible notes andwarrants.  In December 2002, $2,000,000of the notes were converted into the Company’s private placement of common stockand warrants resulting in the issuance of 2,259,888 shares of the Company’scommon stock.  In June 2003, $4,200,000of the notes plus $800,000 of accrued interest were converted into theCompany’s common stock resulting in the issuance of 1,613,572 shares of theCompany’s common stock. On July 7, 2003, a $2,400,000 note was cancelled aspayment for the aggregate exercise price for Class A warrants exercised byCheshire resulting in the issuance of 1,774,888 shares of the Company’s commonstock and an additional 887,444 incentive shares of the Company's commonstock.  At September 30, 2003 andDecember 31, 2002 the remaining balance of convertible notes was of$7,208,000 and $13,741,000, respectively.

 

Allthe notes bear interest at a fixed rate of 8% per year and are secured by theintellectual property of the Company. The notes have a three-year maturity from the date of originalissuance.  The notes are convertibleinto shares of the Company’s common stock at any time, at the option of theinvestors.  The conversion prices arebased on a percentage of the average closing bid prices of the Company’s commonstock for either a ten-day or five-day trading period ended on the daypreceding each closing.

 

Eachnote provides 100% warrant coverage. The warrants are for a term of ten years.  The warrants are exercisable into shares of the Company’s commonstock at any time, at the option of the investors.  The exercise prices are based on the average closing bid pricesof the Company’s common stock for either a ten-day or five-day trading periodended on the day preceding each closing. Both the conversion prices of the notes and the exercise prices of thewarrants provide anti-dilution protection for the investors.

 

9

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Followingis a summary of the various terms and conversion features of the outstandingconvertible promissory notes, related party (long-term) at September 30, 2003and December 31, 2002:

 
|               |   |               |   | **Convertible  Notes  Principal** |             | **At  Issuance** |                  | **# of  Days  Aver.  Closing  Bid** |             | **After  Dilution Adjustments** |   |
|--------------------|--------|--------------------|--------|-----------------------------------|------------------|------------------|-----------------------|-------------------------------------|------------------|---------------------------------|--------|
| **Issuance  Date** |   | **Maturity  Date** |   |                              | **# of  Shares** |             | **Conversion  Price** |                                | **% to  Market** |                            |   | **# of  Shares** |   | **Conversion  Price** |   |
| 09-Nov-01          |   | 09-Nov-04          |   | $                                 | 2,000,000        |             | 433,426               |                                | $                | 4.6144                          |   | 80 | % | 10 |   | 559,706 |   | $ | 3.5733 |   |
| 14-Feb-02          |   | 14-Feb-05          |   | 2,000,000                         |             | 429,000          |                  | 4.6620                              |             | 112.5                           | %      | 5 |   | 554,292 |   | 3.6082 |   |
| 03-May-02          |   | 03-May-05          |   | 4,000,000                         |             | 2,319,109        |                  | 1.7248                              |             | 80                              | %      | 10 |   | 2,745,367 |   | 1.4570 |   |
| 12-Nov-02          |   | 12-Nov-05          |   | 4,847,608                         |             | 4,243,354        |                  | 1.1424                              |             | 80                              | %      | 10 |   | 4,704,131 |   | 1.0305 |   |
| 15-Nov-02          |   | 15-Nov-05          |   | 200,000                           |             | 174,581          |                  | 1.1456                              |             | 80                              | %      | 10 |   | 193,648 |   | 1.0328 |   |
| 20-Nov-02          |   | 20-Nov-05          |   | 200,000                           |             | 184,638          |                  | 1.0832                              |             | 80                              | %      | 10 |   | 202,613 |   | 0.9871 |   |
| 27-Nov-02          |   | 27-Nov-05          |   | 215,000                           |             | 264,518          |                  | 0.8128                              |             | 80                              | %      | 10 |   | 272,462 |   | 0.7891 |   |
| 10-Dec-02          |   | 30-Jul-05          |   | 278,320                           |             | 187,851          |                  | 1.4816                              |             | 80                              | %      | 10 |   | 217,624 |   | 1.2789 |   |
| December 31, 2002  |   |               |   | 13,740,928                        |             | 8,236,477        |                  |                                |             |                            |   |   |   | 9,449,843 |   |   |   |
| 03-Jun-03          |   | Converted          |   | (4,195,000                        | )                | n/a              |                  | n/a                                 |             | n/a                             |   | n/a |   | (1,247,656 | ) | $ 1.457 - $3.6082 |   |
| 07-Jul-03          |   | Cancelled          |   | (2,337,822                        | )                | n/a              |                  | n/a                                 |             | n/a                             |   | n/a |   | (1,604,723 | ) | 1.457 |   |
| September 30, 2003 |   |               |   | $                                 | 7,208,106        |             |                  |                                |             |                            |   |   |   |   | 6,597,464 |   |   |   |
|                    |        |                    |        |                                   |                  |                  |                       |                                     |                  |                                 |        |  |  |  |  |  |  |  |  |  |

 

 

Followingis a summary of the various terms and exercise features of the warrants issuedin conjunction with the convertible promissory notes, related party (long-term)at September 30, 2003 and December 31, 2002:

 

 
| **Issuance  Date** |             | **Expiration  Date** |                | **Fair Value  Allocated to  Warrants** | ** **       | **At  Issuance** | ** **       | **After  Dilution Adjustments** |                |
|--------------------|------------------|----------------------|---------------------|----------------------------------------|------------------|------------------|------------------|---------------------------------|---------------------|
|               |
|               | **# of  Shares** |                 | **Exercise  Price** |                                   | **% to  Market** |             | **# of  Shares** |                            | **Exercise  Price** |   |
| 09-Nov-01          |             | 09-Nov-11            |                | $                                      | 1,076,000        |             | 433,426          |                            | $                   | 5.7680 |   | 100 | % | 565,841 |   | $ | 4.4182 |   |
| 14-Feb-02          |             | 14-Feb-12            |                | 906,000                                |             | 429,000          |             | 4.1440                          |                | 100 | % | 550,599 |   | 3.2288 |   |
| 03-May-02          |             | 03-May-12            |                | 2,038,000                              |             | 2,319,109        |             | 2.1560                          |                | 100 | % | 2,820,396 |   | 1.7728 |   |
| 12-Nov-02          |             | 12-Nov-12            |                | 2,697,000                              |             | 4,243,354        |             | 1.4280                          |                | 100 | % | 4,887,883 |   | 1.2397 |   |
| 15-Nov-02          |             | 15-Nov-12            |                | 107,000                                |             | 174,581          |             | 1.4320                          |                | 100 | % | 201,191 |   | 1.2426 |   |
| 20-Nov-02          |             | 20-Nov-12            |                | 72,000                                 |             | 184,638          |             | 1.3540                          |                | 100 | % | 210,881 |   | 1.1855 |   |
| 27-Nov-02          |             | 27-Nov-12            |                | 103,000                                |             | 264,518          |             | 1.0160                          |                | 100 | % | 286,544 |   | 0.9379 |   |
| 10-Dec-02          |             | 30-Jul-12            |                | 154,000                                |             | 187,851          |             | 1.8520                          |                | 100 | % | 224,422 |   | 1.5502 |   |
|               |             |                 |                | $                                      | 7,153,000        |             | 8,236,477        |                            |                |   |   |   | 9,747,757 |   |   |   |
|                    |                  |                      |                     |                                        |                  |                  |                  |                                 |                     |  |  |  |  |  |  |  |  |  |

 

Thecash proceeds of the notes were allocated pro-rata between the relative fairvalues of the notes and warrants at issuance using the Black Scholes valuationmodel for valuing the warrants.  Afterallocating the proceeds between the note and warrant, an effective conversionprice was calculated for the convertible note to determine the beneficialconversion discount for each note.  Thevalue of the beneficial conversion discount is recorded as additional discountto the note.  The resultant combined

 

10

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discountto the note is accreted back to the note principal balance over the three-yearterm of the note and recorded as interest expense.

 

Thefollowing is a summary of the allocation of the cash proceeds to the relativefair values of the notes and warrants and the components of the discountrecorded upon issuance of each note:

 
| **(in thousands)  Issuance  Date**      |         | **Convertible  Notes  Principal** | ** **                       |   | ** **          | **Components  of Note Discount** |   | **Original  Note  Balance Net  of Discount** |   |
|-----------------------------------------|--------------|-----------------------------------|----------------------------------|--------|---------------------|----------------------------------|--------|----------------------------------------------|--------|
| **Fair Value  Allocation  at Issuance** | **Warrants** |                              | **Beneficial  Conversion  Cost** |   | **Total  Discount** |                             |   |
| **Warrants**                            |         | **Notes**                         |
| 09-Nov-01                               |         | $                                 | 2,000                            |   | $                   | 1,076                            |   | $                                            | 924    |   | $ | 1,076 |   | $ | 924 |   | $ | 2,000 |   | $ |   |   |
| 14-Feb-02                               |         | 2,000                             |                             | 906    |                | 1,094                            |   | 906                                          |   | 639 |   | 1,545 |   | 455 |   |
| 03-May-02                               |         | 4,000                             |                             | 2,038  |                | 1,962                            |   | 2,038                                        |   | 1,962 |   | 4,000 |   |   |   |
| 12-Nov-02                               |         | 4,848                             |                             | 2,697  |                | 2,151                            |   | 2,697                                        |   | 2,151 |   | 4,848 |   |   |   |
| 15-Nov-02                               |         | 200                               |                             | 107    |                | 93                               |   | 107                                          |   | 93 |   | 200 |   |   |   |
| 20-Nov-02                               |         | 200                               |                             | 72     |                | 128                              |   | 72                                           |   | 72 |   | 144 |   | 56 |   |
| 27-Nov-02                               |         | 215                               |                             | 103    |                | 112                              |   | 103                                          |   | 103 |   | 206 |   | 9 |   |
| 10-Dec-02                               |         | 278                               |                             | 154    |                | 124                              |   | 154                                          |   | 124 |   | 278 |   |   |   |
| 31-Dec-02                               |         | 13,741                            |                             | 7,153  |                | 6,588                            |   | 7,153                                        |   | 6,068 |   | 13,221 |   | 520 |   |
| 03-Jun-03                               |         | (4,195                            | )                                | (2,081 | )                   | (2,114                           | )      | (2,081                                       | )      | (1,659 | ) | (3,740 | ) | (455 | ) |
| 07-Jul-03                               |         | (2,338                            | )                                | (1,191 | )                   | (1,147                           | )      | (1,191                                       | )      | (1,147 | ) | (2,338 | ) |   |   |
| 30-Sep-03                               |         | $                                 | 7,208                            |   | $                   | 3,881                            |   | $                                            | 3,327  |   | $ | 3,881 |   | $ | 3,262 |   | $ | 7,143 |   | $ | 65 |   |

 

 

*December Conversion*

 

InDecember 2002, as part of the Private Placement (as defined below), the Companyconverted $2,000,000 of related party convertible promissory notes and cancelledwarrants previously issued in June and July 2002.  The Company recorded a $3,200,000 beneficial inducement cost as aresult of the conversion.  The partiallyunpaid principal balance of $278,320 from the third note dated July 30,2002 was reissued to Cheshire on December 10, 2002 but with all theoriginal terms of the July 30, 2002 convertible note and warrant pursuantto the amended Note Purchase Agreement and Intellectual Property SecurityAgreement.  In addition, approximately$74,000 of accrued interest for the three notes was repaid with conversionproceeds.

 

Thefollowing is a summary of the previous notes, warrants, the remaining balancesand their terms, less the amounts converted in the Private Placement:

 
|               |   | **Convertible  Notes Principal &  Interest** |             | **Convertible  Notes** |                  | **Warrants** |             |
|--------------------|--------|-------------------------------------------------------|------------------|------------------------|-----------------------|--------------|------------------|
| **Issuance  Date** |   |                                                  | **# of  Shares** |                   | **Conversion  Price** |         | **# of  Shares** |   | **Exercise  Price** |   |
| 24-Jun-02          |   | $                                                     | 1,000,000        |                   | 523,451               |         | $                | 1.9104 |   | 523,451 |   | $ | 2.3880 |   |
| 11-Jul-02          |   | 566,638                                               |             | 354,858                |                  | 1.5968       |             | 354,858 |   | 1.9960 |   |
| 30-Jul-02          |   | 637,189                                               |             | 430,068                |                  | 1.4816       |             | 430,068 |   | 1.8520 |   |
| Accrued Interest   |   | 74,493                                                |             |                   |                  |         |             |   |   |   |   |
| 10-Dec-02          |   | (2,000,000                                            | )                | (1,121,000             | )                     |         |             | (1,121,000 | ) |   |   |
| 10-Dec-02          |   | $                                                     | 278,320          |                   | 187,377               |         | $                | 1.4816 |   | 187,377 |   | $ | 1.8520 |   |

 

11

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*June and July 2003 Conversions*

 

DuringJune 2003, Cheshire exercised its option to convert $4,200,000 of principal onnotes issued to it in November 2001, February 2002, part of the principal ofthe May 2002 note and all accrued and unpaid interest of $800,000 into1,613,572 shares of our common stock. The balance of the May 2002 note and allaccrued and unpaid interest thereon was transferred to two new notes in theapproximate amounts of $2,400,000 and $1,400,000, respectively.  During July 2003, the note in the amount of$2,400,000 was cancelled as payment for the aggregate exercise price of Class Awarrants to purchase 1,774,888 shares and an additional 887,444 incentiveshares of our common stock in connection with the July 7, 2003 Class A warrant  exercise (see Note 8).

 

Thefollowing is a summary of the previous notes, the remaining balance and theirterms, less the amounts converted into common stock:

 
|               |   |                                                  |      | **Convertible  Notes** |      |
|--------------------|--------|-------------------------------------------------------|-----------|------------------------|-----------|
| **Issuance  Date** |   | **Convertible  Notes  Principal & Interest** |      | **# of  Shares**       |      | **Conversion  Price** |   |
| 09-Nov-01          |   | $                                                     | 2,000,000 |                   | 559,706   |   | $ | 3.5733 |   |
| 14-Feb-02          |   | 2,000,000                                             |      | 554,292                |      | 3.6082 |   |
| 03-May-02          |   | 4,000,000                                             |      | 2,745,367              |      | 1.4570 |   |
| Accrued Interest   |   | 805,000                                               |      | 365,915                |      | various |   |
| 03-Jun-03          |   | (5,000,000                                            | )         | (1,613,572             | )         |   |   |
| 07-Jul-03          |   | (2,338,000                                            | )         | (1,604,723             | )         |   |   |
| 30-Sep-03          |   | $                                                     | 1,467,000 |                   | 1,006,986 |   | $ | 1.4570 |   |

 

 

**Note 7 - Equipment Notes Payable:**

 

In June 2002, the Company restructured its equipment loans withTransamerica Technology Finance Corporation (“Transamerica”).  As a result of the loan restructuring, theCompany cured the existing default under those loans and limited thecircumstances which could serve as the basis for any future default by theCompany.  Pursuant to the agreementssigned with Transamerica, the Company paid Transamerica $200,000 upon theclosing of the December 2002 private placement.

 

During May 2003, the Company held an auction to sell excess assetsassociated with our vacated headquarters facility located in Carlsbad,California.  Transamerica was paid$187,000 of total auction proceeds.  InJuly 2003, the Company paid $200,000, the second milestone payment, as a resultof the exercise of the Class A warrants. In August 2003, the loans were paid in full with a final negotiatedpayment of $35,000.

 

 

**Note 8 - Stockholders’Equity:**

* *

*Common Stock*

 

InOctober 2002, the Company’s Board of Directors formally declared a one-for-fourreverse stock split of issued and outstanding shares of common stock.  The Company’s stockholders authorized thereverse split at their annual meeting held in June 2002.  All common share balances and net loss pershare amounts presented in these financial statements have been retroactivelyadjusted to reflect the reverse stock split.

 

InDecember 2002, the Company completed the Private Placement, which raisedapproximately $8,400,000 in gross proceeds, including $6,400,000 in newinvestment proceeds and $2,000,000 of non-cash proceeds converted frompreviously issued related party convertible promissory notes. The net proceedstotaled $4,900,000 after issuance costs of approximately $1,500,000.  The Company also issued to Spencer TraskVentures, Inc., the placement agent for the Private Placement, an option topurchase 1,452,419 shares of common stock and 1,452,419 Class A warrants,which are not redeemable by the

 

12

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Company. Each unit had a purchase price of $100,000 and consists of(a) 112,995 shares of common stock and (b) 112,995 Class Awarrants.  The Class A warrants areexercisable for one share of common stock and a Class B Warrant at $1.33,a 50 percent premium to the $0.885 discounted Unit Price.  The Class B warrants are exercisablefor one share of common stock at $1.77, a one hundred percent premium to the$0.885 discounted Unit Price.

 

In June2003, the Company issued $1,000,000 of unsecured promissory notes to accreditedinvestors, which bear interest at the rate of 12% per annum.  In conjunction with the the issuance of thenotes, the Company issued 166,665 shares of common stock to the investors.  The Company recorded a discount on the loanof $385,000 as the fair value allocation between the stock granted and the loanprincipal.  The notes and interest wererepaid in July 2003 with proceeds from the Class A warrant incentive shareoffering.

 

DuringJune 2003, the Company converted $4,200,000 of principal on notes issued inNovember 2001, February 2002, part of the principal of the May 2002 note andall accrued and unpaid interest of $800,000 into 1,613,572 shares of our commonstock by Cheshire.  The balance of theMay 2002 note and all accrued and unpaid interest thereon was transferred totwo new notes in the approximate amounts of $2,400,000 and $1,400,000,respectively.

 

During July 2003, we raised $9,300,000 in gross proceeds through thevoluntary exercise of 6,992,236 of the Class A warrants.  The proceeds included $6,900,000 in cash andthe cancellation of a $2,400,000 of convertible note previously issued toCheshire as payment for the aggregate exercise price for the purchase of1,774,888 shares and an additional 887,444 incentive shares. The Companyissued an additional 3,496,118 shares equal to one half share of common stockfor each Class A warrant exercised as an incentive to induce holders of theClass A warrants to exercise their Class A warrants and to allow the Company toobtain a “lock-up” on the shares of common stock issued to the holders of suchexercised Class A warrants in the December 2002 unit offering and the shares ofthe common stock issued upon the exercise of the Class A warrants (includingthe additional one half share of common stock), prohibiting the sale of suchcommon stock for 270 days, with the “lock-up” period expiring on April 4, 2004.The incentive shares issued as part of the offering represent a deemed dividendfor participating in the voluntary exercise and resulted in a charge toaccumulated deficit in the third quarter of $11,887,000.  Additionally, on July 30, 2003 the Companyexercised its option to redeem the remaining outstanding Class A warrants onSeptember 3, 2003 (subsequently extended to September 8, 2003) resulting in theexercise of 2,420,862 outstanding Class A warrants and gross proceeds ofapproximately $3,216,000. Approximately 109,000 remaining Class A warrants wereredeemed by the Company at $.01 each for a total cost of $1,090. As a result ofthe voluntary exercise and redemption, the Company reclassified $2,688,000 fromcommon stock warrants to additional paid-in capital representing the valueoriginally ascribed to the Class A warrants.

 

On July 7, 2003, our stockholders approved a proposal to conduct aprivate offering of up to $5,000,000 of Series A convertible preferredstock and the conversion of convertible notes issued from January 1, 2003and July 7, 2003, plus all accrued interest thereon at a rate of 8% perannum, into shares of Series A convertible preferred stock. Accordingly,we anticipate that at least $3,899,000 and up to $5,000,000 of related partyconvertible promissory notes may be converted into Series A convertiblepreferred stock.  The holders of sharesof Series A convertible preferred stock would have the right to furtherconvert each share of Series A convertible preferred stock into anywherefrom four to twelve shares of common stock, depending on the date ofconversion. The Series A convertible preferred stock will be entitled toreceive dividend and liquidation preferences prior and in preference to commonstock holders. In addition, if issued, the holders of Series A convertiblepreferred stock would be entitled to protective provisions that require 66 2/3% of the outstanding Series A convertible preferred stock toapprove, among other things, increasing the number of shares of Series Aconvertible preferred stock, altering adversely and materially the rights ofthe Series A convertible preferred stock, creating a new class of securitywith dividend or liquidation rights equal or senior to the Series Aconvertible preferred stock, a liquidation or recapitalization or increasingthe number of shares reserved for issuance under our stock option plans togreater than 10% of our outstanding capital stock (on an as if converted,fully-diluted basis).

 

On October 10, 2003, the Company raised $11,025,000, net of$975,000 of offering costs, in connection with a private placement of 5,940,594shares of common stock and accompanying warrants to purchase 2,970,297 sharesof common stock. In connection with this private placement, we issued anadditional 61,576 shares of common stock and warrants to purchase 594,059 sharesof common stock to Rodman & Renshaw, Inc., our placement agent, and otherservice providers (see Note 11).

 

13

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For the period January 2003through September 2003, the Company issued 230,920 shares of its common stockfor consulting services performed during 2003 equal to $371,000. In August2003, the Company issued 31,914 shares of its common stock for legal servicesequal to $75,000.  As of September 30,2003, the Company has accrued $312,000 for consulting services that is expectedto be paid in 221,265 shares of its common stock.  For theperiod January 2003 through September 30, 2003, the Company has issued $391,000 in warrantsfor consulting services exercisable for 263,933 shares of its common stock.

 

*Common Stock Warrants*

 

The publicly traded Class A warrants were voluntarily exercised, withthe remainder being called by the Company, in July 2003 .

 

Spencer Trask, our placementagent in our December 2002 private placement, and its transferees, holdunit options at September 30, 2003 exercisable for 1,952,419 shares of ourcommon stock, Class A warrants to purchase an aggregate of 1,452,419shares of our common stock and Class B warrants, issuable upon exercise ofthe Class A warrants, to purchase an aggregate of 1,452,419 shares of ourcommon stock. The Class A warrants have an initial exercise price of$1.33.  During July, 2003 the Companyagreed to issue an additional 500,000 shares in consideration of the holders ofthe placement agent unit options agreement not to exercise their unit optionsuntil April 4, 2004. The additional 500,000 shares to be issued represents  a deemed dividend for participating in thevoluntary lock-up and resulted in a charge to accumulated deficit in the thirdquarter of $1,364,000.

 

As of September 30, 2003, therewere Class B warrants outstanding to purchase 9,413,098 shares of ourcommon stock. Each Class B warrant will entitle the holder to purchaseinitially one share of our common stock. The Class B warrants have aninitial exercise price of $1.77. These warrants contain provisions which adjustthe exercise price and the aggregate number of shares that may be issued uponexercise of the warrant if a stock dividend, stock split, reorganization,reclassification, consolidation or other specified dilutive issuances occur.Both the exercise price and the number of securities issued upon exercise of aClass B warrant are subject to adjustments in some cases. The Class Bwarrants have a term of five years from their issuance. Upon thirty(30) days prior written notice to the holders of the Class Bwarrants, we have the right, but not the obligation, to redeem from the holdersthe Class B warrants at any time after the date of issuance, at a price of$0.01 per Class B warrant, if the average of the closing bid prices of ourcommon stock for any ten consecutive trading days ending withinthirty days prior to the date of the notice of redemption is greater thanor equal to $3.32, subject to any stock splits, combinations or otheradjustments.

 

As of September 30, 2003,warrants to purchase an aggregate of 9,844,190 shares of our common stock wereoutstanding at a weighted average exercise price of $1.70 per share. Thesewarrants contain provisions that adjust the exercise price and the aggregatenumber of shares that may be issued upon exercise of the warrant if a stockdividend, stock split, reorganization, reclassification or consolidationoccurs.

 

In connection with theOctober 10, 2003 private placement, warrants were issued to purchase3,564,356 shares of common stock. The warrants have an initial exercise priceof $3.32 per share. These warrants contain provisions that adjust the exerciseprice and the aggregate number of shares that may be issued upon exercise ofthe warrant if a stock dividend, stock split, reorganization, reclassificationor consolidation occurs. These warrants will expire, if not earlier exercisedor redeemed, on October 10, 2008. Upon five business days’ prior writtennotice to the holders of the warrants, we shall have the right, but not theobligation, to redeem from the holders the warrants at any time after the dateof issuance, at a price of $0.05 per warrant, if the average of the closing bidprices of our common stock for any twenty consecutive trading days is greaterthan or equal to $8.00, subject to any stock splits, combinations or otheradjustments.

 

At September 30, 2003,approximately 40,200,000 shares of common stock were reserved for the exerciseof stock options, employee stock purchase plan, exercise of warrants,conversion of convertible notes payable, contingent warrants and contingentshares subject to milestones per the amendments to the Company’s License andCollaboration Agreement.

 

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**Note 9 - Net Loss perShare:**

 

Basic and diluted net loss per share is computed using the weightedaverage number of common shares outstanding during the period.  Potentially dilutive securities are excludedfrom the diluted net loss per share calculation, as the effect would beantidilutive.  Potentially dilutiveshares not included are 4,100,000 shares for outstanding employee stockoptions, 9,100,000 shares issuable under convertible promissory notes, relatedparty, 9,800,000 shares issuable under warrants outstanding, 9,400,000 sharesissuable under B warrants outstanding and 2,000,000 shares issuable under anoption issued to the placement agent for the private offering in December 2002.

 

**Note 10 - Remune® Collaboration:**

 

Inlate June 2002, the Company amended its Remuneâ license and collaboration contract withTrinity Medical Group USA, Inc (“Trinity”). The amended contract provides for manufacturing costs and mark-up plus$50 per unit to be paid to the Company. The $50 per unit mark-up would expire upon the earlier of the firstone million doses of Remuneâ purchased by Trinity or December 31,2007.  As consideration for theincreased per unit, purchase price to be paid to the Company, Trinity wasissued

 

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1,000,000shares of restricted common stock valued at $2,360,000 and up to an additional750,000 shares upon the occurrence of certain sales milestones.  All of the restricted shares issued toTrinity are subject to registration rights. In addition, the Company waived the final $5,000,000 common stockpurchase obligation set forth in the original agreement, which would haveapplied in the event of the optional technology transfer of Remuneâ manufacturing rights in Trinity’s licensedterritories.  Also, the Company providedan increase in the amount of shares that Trinity will receive in exchange for a$5,000,000 payment upon Thai government approval of Remuneâ to 500,000 shares from 83,333 shares.

 

 

**Note 11 - Subsequent Events:**

 

On October 10, 2003, the Company raised $11,025,000, net of$975,000 of offering costs, in connection with a private placement of 5,940,594shares of common stock and accompanying warrants to purchase 2,970,297 sharesof common stock. In connection with this private placement, we issued anadditional 61,576 shares of common stock and warrants to purchase 594,059shares of  common stock to Rodman &Renshaw, Inc., our placement agent, and other service providers.

 

 

**Note 12 - Contingencies:**

** **

Fromtime to time, the Company is subject to various claims and litigationincidental to our business activities. Since July 2001, several complaints have been filed in the United StatesDistrict Court for the Southern District of California seeking an unspecifiedamount of damages on behalf of an alleged class of persons, who purchasedshares of the Company’s common stock at various times between May 17, 1999and July 6, 2001.  The complaintshave been consolidated into a single action under the name *In re Immune Response SecuritiesLitigation* by order of the Court and a consolidated, amendedcomplaint was filed in July 2003.  Theconsolidated, amended complaint names the Company and certain of its formerofficers as defendants, as well as Agouron Pharmaceuticals, Inc. and one of itsofficers.  The consolidated, amendedcomplaint alleges that the Company, Agouron and/or such officers violatedfederal securities laws by misrepresenting and failing to disclose certaininformation about the results of clinical trials of Remuneâ. On October 31, 2003, the defendants filedmotions to dismiss the consolidated, amended complaint. A hearing date for themotions has not been set.  Although theCompany intends to vigorously defend the actions, the Company can not nowpredict or determine the outcome or resolution of these proceedings, or toestimate the amounts of, or potential range of, loss with respect to theseproceedings.  In addition, the timing ofthe final resolution of these proceedings is uncertain.  The range of possible resolutions of theseproceedings could include judgments against us or our former officers orsettlements that could require substantial payments by the Company, which couldhave a material adverse impact on our consolidated financial position, resultsof operations and cash flows.  Theseproceedings also might require substantial attention of our management team andtherefore divert their time and attention from our business and operations.

 

 

**Note 13 - Recent Accounting Pronouncements:**

 

In August 2001, the Financial Accounting Standards Board, FASB, issuedFAS No. 143, “Accounting for Asset Retirement Obligations.”  This statement addresses financialaccounting and reporting for obligations associated with the retirement oftangible long-lived assets and the associated asset retirement costs.  It applies to all entities and legalobligations associated with the retirement of long-lived assets that resultfrom the acquisition, construction, development and/or normal operation oflong-lived assets, except for certain obligations of lessees.  This statement amends FAS No. 19,“Financial Accounting and Reporting by Oil and Gas Producing Companies,” andwas effective for financial statements issued for fiscal years beginning afterJune 15, 2002.  The adoption of FASNo. 143 did not have a material impact on the Company’s consolidatedfinancial position or results of operations.

 

In June 2002, the FASB issued FAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” FAS No. 146 addresses accounting and reporting for costs associatedwith exit or disposal activities and nullifies Emerging Issues Task Force IssueNo. 94-3, “Liability Recognition for Certain Employee Termination Benefitsand Other Costs to Exit an Activity (Including

 

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Certain Costs Incurred in a Restructuring).”  FAS No. 146 requires that a liability for a cost associatedwith an exit or disposal activity be recognized and measured initially at fairvalue when the liability is incurred. FAS No. 146 is effective for exit or disposal activities that areinitiated after December 31, 2002. See Note 2 for the current year costs from the exit and disposal of ourvacated headquarters facility including the completion of an early leasetermination during the third quarter of 2003.

 

In November 2002, the FASB issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others,” which disclosures are effectivefor financial statements issued after December 15, 2002.  While the Company has various guaranteesincluded in contracts in the normal course of business, primarily in the formof indemnities, these guarantees would only result in immaterial increases infuture costs, but do not represent significant commitments or contingentliabilities of the indebtedness of others. The adoption of this statement did not have a material impact on theCompany’s financial position or results of operations.

 

In May 2003, the FASB issued FAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity,”which establishes standards for the classification and measurement of certainfinancial instruments with characteristics of both liability and equity.  This statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective for the Company on July 1, 2003. We do not expect the adoption of SFAS No. 150 to have a material effecton our consolidated financial statements.

 

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**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

This Management’s Discussion and Analysis of Financial Condition andResults of Operations as of September 30, 2003 and for the three and nine monthperiods ended September 30, 2003 and 2002 should be read in conjunction withthe unaudited condensed consolidated financial statements and notes thereto setforth in Item 1 of this report and the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inour Annual Report on Form 10-K for the year ended December 31, 2002.

 

The information contained in this Management’s Discussion and Analysisof Financial Condition and Results of Operations and elsewhere in thisQuarterly Report on Form 10-Q contains both historical financial informationand forward-looking statements.  Forward­-lookingstatements can be identified by use of forward-­looking terminology such as“believes,” “expects,” “may,” “projects,” “predicts,” “intends,” “will,”“seeks,” “should,” “could” and “anticipates,” or the negative thereof or othervariations thereon or comparable terminology, or by discussions of strategy.These are statements that relate principally to whether we will continue as agoing concern and successfully raise proceeds from financing activitiessufficient to fund operations and additional clinical trials of REMUNE®, theuncertainty of successful completion of any such clinical trials, whetherREMUNE® will be effective as either a preventive or therapeutic vaccine,whether future trials will be conducted and whether the results of such trialswill coincide with the results of REMUNE® in preclinical trials, whether wewill satisfy regulatory and export requirements, the uncertainty of successfulexpansion of production capacity, the uncertainty of expected expense levels,plans to reduce expenses, future capital requirements, and capitalexpenditures, the adequacy of patent protection, whether outstanding warrantswill be exercised, whether we will enter into collaborative arrangements andwhether our litigation strategy will be successful. Although we believe thesestatements are based upon reasonable assumptions, no assurance can be giventhat the future results covered by the forward-­looking statements will beachieved. Forward­-looking statements are subject to risks, uncertainties andother factors that may be outside of our control or that are not presently knownto us and that could cause actual results to differ materially from futureresults expressed or implied by the forward-looking statements. The moresignificant risks, uncertainties and other factors are discussed under theheading “CERTAIN RISK FACTORS.”  These forward­-looking statements speakonly as of the date hereof. We expressly disclaim any obligation or undertakingto release publicly any updates or revisions to any forward-­looking statementscontained herein to reflect any change in our expectations with regard theretoor any change in events, conditions or circumstances on which any suchstatement is based. New factors may emerge from time to time, and it is notpossible for us to predict which factors will arise. In addition, we cannotassess the impact of each factor on our business or the extent to which anyfactor, or combination of factors, may cause actual results to differmaterially from those contained in any forward­-looking statement.

 

 

**TheCompany**

 

The Immune Response Corporation (the “Company”), a Delawarecorporation, is a biopharmaceutical company developing a therapeutic vaccinefor the treatment of HIV infection.  Wehave developed Remune®,an immune-based therapy, to induce specific immune responses for the treatmentof HIV.  We also have created sixdistinct therapeutic vaccines in various stages of development for autoimmunediseases and cancer and have established an extensive patent portfolio spanningfour different technologies with a total of 173 patents issued to us worldwide.

 

As part of our restructuring program announced in September 2002, wehave ceased investment in the development of all therapeutic vaccines otherthan Remune®.

 

 

**Resultsof Operations**

 

We recorded revenues for the three and ninemonths ended September 30, 2003 of $14,000 and $52,000, respectively, ascompared to $13,000 and $33,000 for the corresponding periods in 2002. Theincrease in revenues in 2003 is due to the amortization of additionalmulti-year out-licensing contracts of various intellectual property and/orpatents that we own. We

 

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expect no additional revenues unless it isearned through corporate collaborations or new research and developmentagreements.  We have not received anyrevenues from the sale of products and do not expect to derive revenue from thesale of any products for the foreseeable future.

 

Our research and development expenditures forthe three and nine months ended September 30, 2003 were $3.1 million and $8.1million, respectively, as compared to $3.2 million and $10.8 million for thecorresponding periods in 2002. The decrease in research and developmentexpenses is attributable to significant reductions in salaries, benefits andoperating supplies, adjustments to our operational timelines and delayingexpenditures, hiring and manufacturing scale-up activities of REMUNE®, as wellas reduced spending for clinical trials and related regulatory activities in2003. These significant reductions are a direct result of our restructuringprogram announced in September 2002 and included completion or termination ofclinical studies in our immune-based therapy programs and decreasing activitieson our other non-HIV development programs.

 

Expenses associated with our scale-up of the manufacturingprocess for REMUNE® and the cost of producing clinical supplies for ongoing andfuture REMUNE® studies is expected to increase during the next several quartersas we focus our financial resources on REMUNE®. Clinical study spending for ourother development programs has decreased beginning in the second quarter of2002 as we completed our Phase I/II clinical trial relating to multiplesclerosis during the first quarter of 2002. We expect research and developmentexpenditures for our other development programs to also continue to decreasedue to our restructuring in September 2002 which, among other things, wasintended to focus our resources on REMUNE®. Overall, we expect future researchand development expenditures for REMUNE® to increase but quarter to quarterfluctuations may occur due to the timing of expenditures. If we enter intoadditional collaborations, research and development expenditures for our otherdevelopment programs would likely increase over their current levels. There canbe no assurance that we will enter into any collaborations, that existingcollaborations will not be terminated, or that we will be able to obtain otherfinancing needed to continue our research and development efforts.

 

General and administrative expenses for thethree and nine months ended September 30, 2003 were $1.0 million and $4.4million, respectively, as compared to $1.3 and $3.7 million for thecorresponding periods in 2002.  Thisyear-to-date increase was primarily attributable to additional compensationexpense of $1.1 million in the second quarter of 2003 offset by ($371,000) inthe third quarter of 2003 to reflect the repricing of employee stockoptions.  We expect quarterly generaland administrative expenses to remain consistent with prior quarters withsavings attributed to the September 2002 restructuring being offset by possibleincreased consulting fees.

 

On September 9, 2002, we commenced the implementation of a costreduction strategy to focus our core competencies on efforts related to the research,development, commercialization and production of REMUNE®. The cost reductionsrelated to research, administrative and operational costs have been offset byincreased costs relating to increasing our production capabilities at our Kingof Prussia, Pennsylvania facility and increased clinical trials.

 

During May 2003, we disposed of excess assets, and during August 2003,we negotiated an early lease termination for our former vacated headquartersfacility resulting in exit and disposal related costs of approximately $1.4million.

 

Investment income decreased to $6,000 and$17,000 for the three and nine months ended September 30, 2003, respectively,from $34,000 and $56,000 for the same periods in 2002. The decrease ininvestment income in 2003 from 2002 was primarily due to overall lower cashbalances in interest bearing investments and lower interest rates earned.

 

Interest expense increased to $2.7 millionand $7.5 million for the three and nine months ended September 30, 2003,respectively, as compared to $1.0 and $2.1 million for the correspondingperiods in 2002.  Accretion ofconvertible notes payable, as a component of interest expense, was $2.3 millionand  $6.5 million for the three and ninemonths ended September 30, 2003, respectively, as compared to $713,000 and $1.5million for the corresponding periods in 2002. Accretion of short-term unsecured promissory notes, as a component ofinterest expense, was $314,000 and $385,000 for the three and nine months endedSeptember 30, 2003, respectively.  Theincrease in 2003 from 2002 is partly attributable to two conversions of $6.5million of convertible debt into common stock with an additional beneficialconversion expense of $3.4 million recognized upon conversion.  The remainder of the increase is due tohigher non-cash accretion overall due to higher average convertible debtbalances in 2003 as compared to 2002. Accretion represents the amortization to interest expense, over athree-year period, of the value of the notes allocated to the value of warrantsissued in connection with the convertible notes and beneficial conversionfeature.

 

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**Liquidityand Capital Resources**

 

Since our inception in 1986, we have financedour activities primarily from public and private sales of equity, funding fromcollaborations with corporate partners, investment income and the issuance toentities affiliated with or related to Mr. Kimberlin, who is one of ourdirectors and our principal stockholder, of convertible notes and warrants andshort-term promissory notes.

 

In June2003, the Company issued $1,000,000 of unsecured promissory notes to accreditedinvestors, which bear interest at the rate of 12% per annum.  In conjunction with the issuance of thenotes, the Company issued 166,665 shares of common stock  to investors.  The Company recorded a discount on the loan of $385,000 as thefair value allocation between the stock granted and the loan principal.  The notes and interest were repaid in July2003 with proceeds from the Class A warrant incentive share offering.

 

DuringJune 2003, the Company converted $4,200,000 of principal on notes issued inNovember 2001, February 2002, part of the principal of the May 2002 note andall accrued and unpaid interest of $800,000 into 1,613,572 shares of our commonstock by Cheshire.  The balance of theMay 2002 note and all accrued and unpaid interest thereon was transferred totwo new notes in the approximate amounts of $2,400,000 and $1,400,000,respectively.

 

DuringJuly 2003, we raised $9,300,000 in gross proceeds through the voluntaryexercise of 6,992,236 of the Class A warrants. The proceeds included $6,900,000 in cash and the cancellation of$2,400,000 of convertible notes previously issued to Cheshire as payment for theaggregate exercise price for the purchase of 1,774,888 shares and an additional887,444 incentive shares. The Company issued an additional 3,496,118 sharesequal to one half share of common stock for each Class A warrant exercised asan incentive to induce holders of the Class A warrants to exercise their ClassA warrants and to allow the Company to obtain a “lock-up” on the shares ofcommon stock issued to the holders of such exercised Class A warrants in theDecember 2002 unit offering and the shares of the common stock issued upon theexercise of the Class A warrants (including the additional one half share ofcommon stock), prohibiting the sale of such common stock for 270 days, with the“lock-up” period expiring on April 4, 2004. Additionally, on July 30, 2003 theCompany exercised its option to redeem the remaining outstanding Class Awarrants on September 3, 2003 (subsequently extended to September 8, 2003)resulting in the exercise of 2,420,862 outstanding Class A warrants and grossproceeds of approximately $3,216,000.

 

OnJuly 7, 2003, our stockholders approved a proposal to conduct a privateoffering of up to $5,000,000 of Series A Convertible Preferred Stock andthe conversion of convertible notes issued from January 1, 2003 andJuly 7, 2003, plus all accrued interest thereon at a rate of 8% per annum,into shares of Series A Convertible Preferred Stock. Accordingly, weanticipate that at least $3,899,000 and up to $5,000,000 of related partyconvertible notes may be converted into Series A Convertible PreferredStock.  The holders of shares ofSeries A Convertible Preferred Stock would have the right to furtherconvert each share of Series A Convertible Preferred Stock into anywherefrom four to twelve shares of common stock, depending on the date ofconversion. As of November 14, 2003, no shares of Series AConvertible Preferred Stock had been designated or issued.

 

Forthe period January 2003 through September 2003, the Company issued 230,920shares of its common stock for consulting services performed during 2003 equalto $371,000. In August 2003, the Company issued 31,914 shares of its commonstock for legal services equal to $75,000. As of September 30, 2003, the Company has accrued $312,000 for consultingservices that will be paid in 221,265 shares of its common stock.  For the period January 2003 through September 30, 2003, the Company has issued $391,000 in warrants forconsulting services exercisable for up to 263,933 shares of its common stock.

 

OnOctober 10, 2003, the Company raised $11,025,000, net of $975,000 ofoffering costs, in connection with a private placement of 5,940,594 shares ofcommon stock and accompanying warrants to purchase 2,970,297 shares of commonstock. In connection with this private placement, we issued an additional61,576 shares of common stock and warrants to purchase 594,059 shares of  common stock to Rodman & Renshaw, Inc.,our placement agent, and other service providers.

 

TheCompany believes that the aggregate proceeds from the October 2003 privateplacement and the exercise of the Class A warrants will be sufficient to fundour planned operations, including necessary capital expenditures and newclinical trials, through the end of 2004. However, no assurance can be given that the Company will be able to obtainadditional financing when and as needed in the future.

 

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We could raise an additional $16.7 million if all of theClass B warrants issued as a result of Class A warrant exercises since July 7,2003, which are redeemable by us if the price of our common stock is equal toor greater than $3.32, are exercised. There can be no assurances that all or any portion of the warrants willbe exercised by the initial purchasers or by any subsequent holders.

 

In addition, we could raise an additional $11.8 million if all thewarrants issued in connection with the October 2003 private placement areexercised for cash. The warrants issued in the October 2003 private placementare redeemable by us if the price of our common stock is equal to or greaterthan $8.00 for 20 consecutive trading days. We believe the proceeds there fromwould provide us with sufficient funds to fund our planned operations,including capital improvements and new clinical trial costs, for an additionaltwelve months. However, there can be no assurances that all or any portion ofthe warrants will be exercised by the initial purchasers or by any subsequentholders.

 

Once we have used our current cash balances,we will be forced to look for alternative sources of funding which, even ifavailable, may be on terms substantially less favorable.  If we are unable to raise adequate capital,we may be required to delay, or reduce the scope of, our research or developmentof REMUNE®, or take other measures to cut costs, which would have a materialadverse effect on us and likely result in our inability to continue as a goingconcern. In any event, we will need to raise substantial additional capital tofund our operations beyond the fourth quarter of 2004. We cannot provide anyassurance, however, that changes in our research and development plans or otherchanges affecting our operating expenses will not result in the expenditure ofsuch resources before such time. See Risk Factors.

 

We will need to raise substantial additionalfunds to conduct research and development, preclinical studies and clinicaltrials necessary to bring potential products to market and to establishmanufacturing and marketing capabilities. We anticipate that for theforeseeable future, the scale-up of the manufacturing process for REMUNE® andthe cost of producing clinical supplies for ongoing and future REMUNE® studieswill continue to represent a significant portion of our overall expenditures.Overall, future REMUNE® research and development expenditures are expected toincrease from current levels in the event additional financing is obtained.Future spending for research and development may further increase if we enterinto additional collaborations, but there can be no assurance that we willenter into any such collaborations. We anticipate additional capitalimprovements of approximately $1.0 million to scale-up of the manufacturingprocess for REMUNE®. Other anticipated costs with respect to REMUNE ®,including investment in inventory, will depend on many factors including theneed for additional clinical trials and other factors, which will influence ourdetermination of the appropriate continued investment of our financialresources in this program.

 

Our future capital requirements will dependon many factors including whether the remaining warrants will be exercised bythe initial purchasers or by any subsequent holders. Other capital requirementfactors include continued scientific progress in our research and development programs,the scope and results of preclinical studies and clinical trials, the time andcosts involved in obtaining regulatory approvals, the costs involved in filing,prosecuting and enforcing patent claims, the costs involved in defending claimsin class actions, competing technological and market developments, the cost ofmanufacturing scale-up and inventories, effective commercialization activitiesand arrangements and other factors not within our control. We intend to seekadditional funding through additional research and development agreements withsuitable corporate collaborators and through public or private financing, ifavailable. However, we cannot provide assurance that such collaborationarrangements or any public or private financing will be available on acceptableterms, if at all.  If we raise fundsthrough future equity arrangements, further dilution to stockholders willresult.

 

 

**CriticalAccounting Policies and Estimates**

 

We believe that patents and other proprietaryrights are important to our business. Intangible assets are recorded at costand are amortized over their estimated useful lives. In December 1999, weacquired licenses to certain patent technology, which are being amortized overseven years. Changes in our estimates of useful lives may have a materialeffect on our financial statements.

 

We evaluate potential impairment oflong-lived assets in accordance with FAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” FAS No. 144 requires that certainlong-lived assets be reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not be fullyrecoverable based on expected undiscounted cash flows that result from the useand eventual disposition of the asset. The amount of any impairment is measuredas the difference between the carrying value and the fair value of the impairedasset.

 

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In accordance with FAS No. 144, the Companyhas identified our property and equipment and licensed technology as long-livedassets subject to annual impairment review. Given our current financial status,our historical losses and the indeterminable outcome of the development andapproval of our products, there is substantial uncertainty as to our ability torecover our investment in these long-lived assets through the generation of netfuture cash flows. In light of this uncertainty, we obtained an independentthird-party appraisal of these long-lived assets in the first quarter of 2003.As a result of such appraisal, we recognized substantial impairment chargesrelated to property and equipment for the year ended December 31, 2002.

 

 

***CertainRisk Factors***

 

Our future operating results are subject to a number of factors, including:

 

**Our failure to successfully develop our soleproduct, REMUNE®, may cause us to cease operations**

 

We have not completed the development of REMUNE® or any product. Aspart of our restructuring program announced in September 2002, we halteddevelopment of all products other than REMUNE®. Our other potential therapies,which were under development prior to September 2002, would requiresignificant additional research and development efforts, funding and regulatoryapprovals if we recommence development in the future. We are entirely dependentupon our ability to successfully develop REMUNE® and our failure to do so maycause us to cease operations.

 

In May 1999 we discontinued a Phase III clinical endpoint trial ofREMUNE® because differences in clinical endpoints were not observed betweentreatment groups and extending the trial would have been unlikely to providesufficient additional clinical endpoints. The discontinuation of the Phase IIItrial has had a material adverse effect on us. Additionally, the most recentpivotal trial of REMUNE® conducted by our former collaborative partner, Pfizer,was discontinued by us. See “—Pfizer Has Terminated Its Collaboration With UsAnd We Have Had To Delay The Continued Development And Commercialization OfREMUNE®.” We cannot assure you that any future Phase III trials of REMUNE®will be conducted. Furthermore, we cannot guarantee that we, or our corporatecollaborators, if any, will ever obtain any regulatory approvals of REMUNE®.

 

Prior to the cessation of the development efforts of our products otherthan REMUNE® in September 2002, our technologies and other potentialtherapies were at earlier stages of development than REMUNE® and had not beenshown to be safe or effective. Some of our technologies have not been tested onhumans. Even if we do continue development of our other potential products,regulatory authorities may not permit human testing of the potential productsbased on these technologies. Even if human testing were permitted, the productsbased on these technologies may not be successfully developed or shown to besafe or effective.

 

The results of our pre-clinical studies and clinical trials may not beindicative of future clinical trial results. A commitment of substantialfinancial and other resources to conduct time-consuming research, preclinicalstudies and clinical trials will be required if we are to develop any products.Delays in planned patient enrollment in clinical trials may result in increasedcosts, program delays or both. None of our potential products may prove to besafe or effective in clinical trials. Approval by the Food and DrugAdministration, the FDA, or other regulatory approvals, including exportlicense permissions, may not be obtained and even if successfully developed andapproved, our products may not achieve market acceptance. Any productsresulting from our programs may not be successfully developed or commerciallyavailable for several years, if at all.

 

Moreover, unacceptable toxicity or side effects could occur at any timein the course of human clinical trials or, if any products are successfullydeveloped and approved for marketing, during commercial use of our products.Although preliminary research and clinical evidence has shown REMUNE® to besafe, the appearance of any unacceptable toxicity or side effects couldinterrupt, limit, delay or abort the development of any of our products or, ifpreviously approved, necessitate their withdrawal from the market.

 

**Our current cash position, financingrequirements and limited access to financing will adversely affect our abilityto develop products and continue operations**

 

We have never generated any operating revenue. As of September 30,2003, we had an accumulated deficit of approximately $292.4 million, cashand cash equivalents of only approximately $5.3 million and workingcapital of only approximately $541,000. Because we do not anticipate generatingany revenue from our products until at least the first quarter of 2007, if atall, we will continue to have negative cash flow and will need to raisesubstantial additional capital to fund our operations beyond this time. We

 

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will need to raise substantial funds to continue our operations and toconduct research and development, preclinical studies and clinical trialsnecessary to bring our potential products to market and to establishmanufacturing and marketing capabilities.

 

We will continue to have limited cash resources. Although ourmanagement recognizes the need to secure additional financing and currently isexploring its options, there can be no assurance that we will be successful inconsummating any financing transaction or, if consummated, that the terms andconditions will not be unfavorable to us. The failure by us to obtainadditional and sufficient financing before the fourth quarter of 2004 will havea material adverse effect on us and likely result in our inability to continueas a going concern.

 

We could raise an additional $16.7 million if all of the Class Bwarrants that were issued upon exercise of our Class A warrants areexercised. Our Class B warrants are redeemable by us if the price of ourcommon stock is equal to or greater than $3.32 for ten consecutive tradingdays. We believe the proceeds therefrom would provide us with sufficient fundsto fund our planned operations, including capital improvements and new clinicaltrial costs, for an additional twelve months. However, there can be noassurances that all or any portion of the warrants will be exercised by theinitial purchasers or by any subsequent holders.

 

In addition, we could raise an additional $11.8 million if all thewarrants issued in connection with the October 2003 private placement areexercised for cash. The warrants issued in the October 2003 private placementare redeemable by us if the price of our common stock is equal to or greaterthan $8.00 for 20 consecutive trading days. We believe the proceeds therefromwould provide us with sufficient funds to fund our planned operations, includingcapital improvements and new clinical trial costs, for an additional twelvemonths. However, there can be no assurances that all or any portion of thewarrants will be exercised by the initial purchasers or by any subsequentholders.

 

Although we anticipate that development of REMUNE® will continue torepresent a significant portion of our overall expenditures, costs related tothe development of REMUNE® decreased in 2002. We expect our costs related tothe development of REMUNE® to increase in 2003 and 2004 in the event we areable to raise additional capital enabling us to pursue additional research anddevelopment projects. Other anticipated costs relating to the development ofREMUNE® will depend on many factors—in particular, a potential decrease incosts associated with our ability to establish a new collaborative, strategicor marketing partner to replace Pfizer Inc., or Pfizer. See “—Pfizer HasTerminated Its Collaboration With Us And We Have Had To Delay Or Abandon TheContinued Development And Commercialization Of REMUNE®,” “We May Be Unable ToEnter Into Additional Collaborations Or Maintain Existing Ones” And “OurFailure To Develop And Commercialize Products Successfully May Cause Us ToCease Operations.”

 

On September 9, 2002, we commenced the implementation of a costreduction strategy to focus our core competencies on efforts related to theresearch, development, commercialization and production of REMUNE®. The costreductions related to research, administrative and operational costs have beenoffset by increased costs relating to increasing our production capabilities atour King of Prussia, Pennsylvania facility and increased clinical trials.

 

The timing and amount of our future capital requirements will depend onmany factors, including (but not limited to):

 

•              ourability to raise additional funding and the amounts raised, if any;

 

•              thetime and costs involved in obtaining regulatory approvals;

 

•              continuedscientific progress in our research and development programs;

 

•              thescope and results of preclinical studies and clinical trials;

 

•              thecost of manufacturing scale-up;

 

•              thecosts involved in filing, prosecuting and enforcing patent claims;

 

•              competingtechnological and market developments;

 

•              effectivecommercialization activities and arrangements;

 

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•              the costs ofdefending against and settling lawsuits; and/or

 

•              other factors notwithin our control or known to us.

 

Our access to capital could belimited if we do not progress in:

 

•              obtaining regulatoryapprovals;

 

•              our research anddevelopment programs;

 

•              our preclinical andclinical trials; or

 

•              scaling upmanufacturing.

 

Our access to capital also could be limited by:

 

•              overall financialmarket conditions;

 

•              applicable NationalAssociation of Securities Dealers, or NASD, rules and federal and statesecurities laws;

 

•              the perfectedsecurity interest in our intellectual property in respect of the aggregate$7.2 million in convertible promissory notes issued to affiliates and/orrelated parties of Kevin B. Kimberlin, (who is one of our directors and ourprincipal stockholder and the controlling stockholder of the parent company ofSpencer Trask Ventures, Inc., which acted as our exclusive placement agent for,and received fees from us in connection with, our private placement in December2002) (See “An Existing Stockholder Owns Approximately 23.4% Of Our OutstandingCommon Stock And Has The Rights To Acquire An Additional 24,043,458 Shares OfOur Common Stock Which Could Result In Ownership Of Up To Approximately 51.8%Of Our Outstanding Shares And Could Allow Him to Influence Votes”);

 

•              the effect of theexercise of outstanding options and warrants exercisable into approximately19.0 million shares of common stock;

 

•              the effect of theconversion of notes that are convertible into approximately 9.1 millionshares of common stock or approximately 835,000 shares of Series AConvertible Preferred Stock and 6.6 million shares of common stock;

 

•              the effect of theexercise of Class B warrants into approximately 9.4 million shares ofcommon stock; and

 

•              the issuance of theplacement agent option to Spencer Trask Ventures, Inc., (an affiliate ofMr. Kimberlin) and its transferees that is exercisable for 1,952,419shares of common stock and 1,452,419 Class A warrants, which are notredeemable by us.

 

**Our independent auditors have expressedsubstantial doubt as to our ability to continue as a going concern**

 

As of September 30, 2003, we had a consolidated accumulateddeficit of $292.4 million. We have not generated revenues from thecommercialization of any product. We expect to continue to incur substantialnet operating losses over the next several years, which would imperil ourability to continue operations. We may not be able to generate sufficientproduct revenue to become profitable on a sustained basis, or at all, and donot expect to generate sufficient product revenue before the first quarter of2007, if at all. We have operating and liquidity concerns due to oursignificant net losses, negative cash flows from operations and substantialworking capital deficit. Additionally, it may take a significant length of timebefore we can raise capital from any subsequent financing. As a result of theseand other factors, our independent auditors, BDO Seidman, LLP, indicated, intheir report on the 2002 consolidated financial statements,  that there is substantial doubt about ourability to continue as a going concern.

 

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**The lengthy product approval process anduncertainty of government regulatory requirements may delay or prevent us fromcommercializing products**

 

Clinical testing, manufacture, promotion, export and sale of ourproducts are subject to extensive regulation by numerous governmentalauthorities in the United States, principally the FDA, and corresponding stateand foreign regulatory agencies. This regulation may delay or prevent us fromcommercializing products. Noncompliance with applicable requirements can resultin, among other things, fines, injunctions, seizure or recall of products,total or partial suspension of product manufacturing and marketing, failure ofthe government to grant premarket approval, withdrawal of marketing approvalsand criminal prosecution.

 

The regulatory process for new therapeutic drug products, including therequired preclinical studies and clinical testing, is lengthy and expensive. Wemay not receive necessary FDA clearances for REMUNE® or any of our otherpotential products in a timely manner, or at all. The length of the clinicaltrial process and the number of patients the FDA will require to be enrolled inthe clinical trials in order to establish the safety and efficacy of ourproducts is uncertain.

 

Even if additional Phase III clinical trials of REMUNE® areinitiated and successfully completed, the FDA may not approve REMUNE® forcommercial sale. We may encounter significant delays or excessive costs in ourefforts to secure necessary approvals. Regulatory requirements are evolving anduncertain. Future United States or foreign legislative or administrative actscould also prevent or delay regulatory approval of our products. We may not beable to obtain the necessary approvals for clinical trials, manufacturing ormarketing of any of our products under development. Even if commercialregulatory approvals are obtained, they may include significant limitations onthe indicated uses for which a product may be marketed.

 

In addition, a marketed product is subject to continual FDA review.Later discovery of previously unknown problems or failure to comply with theapplicable regulatory requirements may result in restrictions on the marketingof a product or withdrawal of the product from the market, as well as possiblecivil or criminal sanctions.

 

Among the other requirements for regulatory approval is the requirementthat prospective manufacturers conform to the FDA’s Good ManufacturingPractices, or GMP, requirements. In complying with the FDA’s GMP requirements,manufacturers must continue to expend time, money and effort in production,record keeping and quality control to assure that products meet applicablespecifications and other requirements. Failure to comply and maintaincompliance with the FDA’s GMP requirements subjects manufacturers to possibleFDA regulatory action and as a result, may have a material adverse effect onus. We, or our contract manufacturers, if any, may not be able to maintaincompliance with the FDA’s GMP requirements on a continuing basis. Failure tomaintain compliance could have a material adverse effect on us.

 

The FDA has not designated expanded access protocols for REMUNE® as“treatment” protocols. The FDA may not determine that REMUNE® meets all of theFDA’s criteria for use of an investigational drug for treatment use. Even ifREMUNE® is allowed for treatment use, third party payers may not providereimbursement for the costs of treatment with REMUNE®. The FDA also may notconsider REMUNE® or any other of our products under development to beappropriate candidates for accelerated approval, expedited review or fast trackdesignation.

 

Marketing any drug products outside of the United States will subjectus to numerous and varying foreign regulatory requirements governing the designand conduct of human clinical trials and marketing approval. Additionally, ourability to export drug candidates outside the United States on a commercialbasis is subject to the receipt from the FDA of export permission, which maynot be available on a timely basis, if at all. Approval procedures vary amongcountries and can involve additional testing, and the time required to obtainapproval may be even longer than that required to obtain FDA approval. Foreignregulatory approval processes include all of the risks associated with obtainingFDA approval set forth above, and approval by the FDA does not ensure approvalby the health authorities of any other country, including those in Thailand.

 

Specifically, before we will be permitted to export REMUNE® to Thailandfor clinical use in that country, we need to meet a number of regulatoryrequirements. One of those requirements is that we must ensure that we canmanufacture REMUNE® at our United States manufacturing facility in a mannerthat is in “substantial compliance” with current United States GMPrequirements. We must provide the FDA with “credible scientific evidence” thatREMUNE® would be safe and effective under the conditions of proposed use inThailand. Furthermore, the Thailand FDA must (i) formally request the FDAto approve export of REMUNE® to Thailand, (ii) certify to the FDA that itis aware that REMUNE® is not approved in the United States or in any of severalother countries with comprehensive drug review and approval systems and(iii) concur that the scientific evidence presented to the FDA is“credible

 

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scientific evidence that REMUNE® will be reasonably safe and effective”for use in Thailand. There can be no assurance, however, that we willsuccessfully meet any or all of these requirements for the export of REMUNE®,and if we are unable to successfully meet all regulatory requirements, we willnot be permitted by the FDA to export REMUNE® to Thailand for clinical use,even if the Thai government were to approve REMUNE® for clinical use. There canbe no assurance that Trinity Medical Group USA, Inc. and its affiliate,Trinity Medical Group, Co. Ltd., a Thai company, collectively, Trinity,our collaborative partner, will be successful in its capacity or efforts toobtain regulatory approval from the Thailand FDA.

 

**Technological change and competition mayrender our potential products obsolete**

 

The pharmaceutical and biotechnology industries continue to undergorapid change, and competition is intense and we expect it to increase.Competitors may succeed in developing technologies and products that are moreeffective or affordable than any that we are developing or that would renderour technology and products obsolete or noncompetitive. Many of our competitorshave substantially greater experience, financial and technical resources andproduction, marketing and development capabilities than us. Accordingly, someof our competitors may succeed in obtaining regulatory approval for productsmore rapidly or effectively than us, or technologies and products that are moreeffective and/or affordable than any that we are developing.

 

**Our lack of commercial manufacturing andmarketing experience may prevent us from successfully commercializing products**

 

We have not manufactured any of our products in commercial quantities.We may not successfully make the transition from manufacturing clinical trialquantities to commercial production quantities or be able to arrange forcontract manufacturing and this could prevent us from commercializing productsor limit our profitability from our products. Even if REMUNE® is successfullydeveloped and receives FDA approval, we have not demonstrated the capability tomanufacture REMUNE® in commercial quantities. Except for REMUNE®, we have notdemonstrated the ability to manufacture any of our treatments in large-scaleclinical quantities. We rely on a third party for the final inactivation stepof the REMUNE® manufacturing process. If the existing manufacturing operationsprove inadequate, there can be no assurance that any arrangement with a thirdparty can be established on a timely basis or that we can establish othermanufacturing capacity on a timely basis.

 

We have no experience in the sales, marketing and distribution ofpharmaceutical or biotechnology products. Thus, our products may not besuccessfully commercialized even if they are developed and approved forcommercialization.

 

The manufacturing process of our products involves a number of stepsand requires compliance with stringent quality control specifications imposedby us and by the FDA. Moreover, our products can be manufactured only in afacility that has undergone a satisfactory inspection and certification by theFDA. For these reasons, we would not be able to quickly replace our manufacturingcapacity if we were unable to use our manufacturing facilities as a result of afire, natural disaster (including an earthquake), equipment failure or otherdifficulty, or if our manufacturing facilities are deemed not in compliancewith the GMP requirements, and the non-compliance could not be rapidlyrectified. Our inability or reduced capacity to manufacture our products wouldprevent us from successfully commercializing our products.

 

We may enter into arrangements with contract manufacturing companies toexpand our own production capacity in order to meet requirements for ourproducts, or to attempt to improve manufacturing efficiency. If we choose tocontract for manufacturing services, we may encounter costs, delays and /orother difficulties in producing, packaging and distributing our clinical trialsand finished product. Further, contract manufacturers must also operate incompliance with the GMP requirements; failure to do so could result in, amongother things, the disruption of our product supplies. Our potential dependenceupon third parties for the manufacture of our products may adversely affect ourprofit margins and our ability to develop and deliver products on a timely andcompetitive basis.

 

**Adverse determinations concerning productpricing, reimbursement and related matters could prevent us from successfullycommercializing REMUNE® or any of our other products**

 

Our ability to earn revenue on REMUNE® or any other of our productswill depend in part on the extent to which reimbursement for the costs of theproducts and related treatments will be available from government healthadministration authorities, private health coverage insurers, managed careorganizations and other organizations. Failure to obtain appropriate reimbursementmay prevent us from successfully commercializing REMUNE® or any of our otherproducts. Third-party payers are increasingly challenging the

 

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prices of medical products and services. If purchasers or users ofREMUNE® or any of our other products are not able to obtain adequatereimbursement for the cost of using the products, they may forego or reducetheir use. Significant uncertainty exists as to the reimbursement status ofnewly approved health care products and whether adequate third party coveragewill be available.

 

**Our success may depend upon the acceptance ofREMUNE® by the medical and HIV-activist communities**

 

Our ability to market and commercialize REMUNE® depends on theacceptance and utilization of REMUNE® by the medical and HIV-activistcommunities. We will need to develop commercialization initiatives designed toincrease awareness about us and REMUNE® among targeted audiences, includingpublic health and AIDS activists and community-based outreach groups inaddition to the investment community. Currently, we have not developed anycommercialization initiatives. Without commercial acceptance of REMUNE®, theproduct upon which we are completely dependent, we may not be able tosuccessfully commercialize REMUNE® or generate revenue.

 

**Product liability exposure may expose us tosignificant liability**

 

We face an inherent business risk of exposure to product liability andother claims and lawsuits in the event that the development or use of our technologyor prospective products is alleged to have resulted in adverse effects. We maynot be able to avoid significant liability exposure. We may not have sufficientinsurance coverage, and we may not be able to obtain sufficient coverage at areasonable cost. An inability to obtain product liability insurance atacceptable cost or to otherwise protect against potential product liabilityclaims could prevent or inhibit the commercialization of our products. Aproduct liability claim could hurt our financial performance. Even if we avoidliability exposure, significant costs could be incurred that could hurt ourfinancial performance and condition.

 

**Hazardous materials and environmental matterscould expose us to significant costs**

 

We may be required to incur significant costs to comply with current orfuture environmental laws and regulations. Although we do not currentlymanufacture commercial quantities of our product candidates, we produce limitedquantities of these products for our clinical trials. Our research anddevelopment and manufacturing processes involve the controlled storage, use anddisposal of hazardous materials, biological hazardous materials and radioactivecompounds. We are subject to federal, state and local laws and regulationsgoverning the use, manufacture, storage, handling and disposal of thesematerials and some waste products. Although we believe that our safetyprocedures for handling and disposing of these materials comply with thestandards prescribed by these laws and regulations, the risk of contaminationor injury from these materials cannot be completely eliminated. In the event ofan incident, we could be held liable for any damages that result, and anyliability could exceed our resources. Current or future environmental laws orregulations may have a material adverse effect on our operations, business andassets.

 

**Pfizer has terminated its collaboration withus and we have had to delay or abandon the continued development andcommercialization of REMUNE®**

 

We received in July 2001, a letter from Pfizer which indicatedthat Pfizer had elected to immediately terminate, in their entirety, all of itsrights and obligations under our agreement with them. Our agreement with Pfizerpermitted this termination and the letter we received from Pfizer provided noexplanation as to why Pfizer had elected to exercise its termination right. Inaddition, no explanation has been provided to us by Pfizer at any time afterthe July 2001 termination letter. Although we retained all rights relatingto REMUNE® upon Pfizer’s termination, we lost a significant source of funding.Following the termination of our agreement with Pfizer, we decided not toproceed with one of our clinical trials of REMUNE® developed by Agouron(subsequently acquired by Pfizer). The termination of this agreement has had,and may continue to have, a material adverse effect on our stock price and,consequently, our ability to successfully raise additional capital.

 

**We may be unable to enter into additionalcollaborations or maintain existing ones**

 

We are seeking additional collaborative arrangements to develop andcommercialize our products. We may not be able to negotiate collaborativearrangements on favorable terms in the future, or at all, and our current orfuture collaborative arrangements may not be successful or continue.

 

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Cheshire Associates (an affiliate and/or related person ofMr. Kimberlin) has a perfected security interest in our intellectualproperty as collateral for the notes issued to parties affiliated with and/orrelated Mr. Kimberlin, one of our directors and principal stockholders.Pursuant to an agreement with Cheshire Associates, we must comply withcovenants with respect to our intellectual property. The security interests andcovenants could impair our ability to enter into collaborative and licensingarrangements.

 

**Our patents and proprietary technology maynot be enforceable and the patents and proprietary technology of others mayprevent us from commercializing products**

 

We have a portfolio of 173 patents worldwide. Although we believe thesepatents to be protected and enforceable, the failure to obtain meaningfulpatent protection for our potential products and processes would greatlydiminish the value of our potential products and processes.

 

In addition, whether or not our patents are issued, or issued withlimited coverage, others may receive patents, which contain claims applicableto our products. Patents we are not aware of may adversely affect our abilityto develop and commercialize products. Also, our patents related to HIV therapyhave expiration dates that range from 2010 to 2015 and our patents related toautoimmune diseases have expiration dates that range from 2010 to 2018. Thelimited duration of our patents could diminish the value of our potentialproducts and processes, particularly since we do not expect to generate anyrevenue from our products sooner than the first quarter of 2007, if at all.

 

The patent positions of biotechnology and pharmaceutical companies areoften highly uncertain and involve complex legal and factual questions.Therefore, the breadth of claims allowed in biotechnology and pharmaceuticalpatents cannot be predicted. We also rely upon non-patented trade secrets andknow how, and others may independently develop substantially equivalent tradesecrets or know how. We also rely on protecting our proprietary technology inpart through confidentiality agreements with our current and former corporatecollaborators, employees, consultants and some contractors. These agreementsmay be breached, and we may not have adequate remedies for any breaches. Inaddition, our trade secrets may otherwise become known or independentlydiscovered by our competitors. Litigation may be necessary to defend againstclaims of infringement, to enforce our patents and/or to protect trade secrets.Litigation could result in substantial costs and diversion of managementefforts regardless of the results of the litigation. An adverse result in litigationcould subject us to significant liabilities to third parties, require disputedrights to be licensed or require us to cease using proprietary technologies.

 

Our products and processes may infringe, or be found to infringe, onpatents not owned or controlled by us. If relevant claims of third-partypatents are upheld as valid and enforceable, we could be prevented frompracticing the subject matter claimed in the patents, or be required to obtainlicenses or redesign our products or processes to avoid infringement.

 

**You could suffer substantial dilution of yourinvestment as a result of financings**

 

We will continue to have limited cash resources. Although ourmanagement recognizes the need to secure additional financing, there can be noassurance that we will be successful in consummating any financing transactionor, if consummated, that the terms and conditions of the financing will not beunfavorable to us. The failure by us to obtain sufficient additional financingbefore the fourth quarter of 2004 will have a material adverse effect on us andlikely result in our inability to continue as a going concern. Our independentauditors have concluded that there is substantial doubt as to our ability tocontinue as a going concern for a reasonable period of time, and have,therefore, modified their report in the form of an explanatory paragraphdescribing the events that have given rise to this uncertainty regarding ourannual consolidated financial statements.

 

During 2001 and 2002 we issued convertible notes, and on July 7,2003 we reissued a portion of one of these convertible notes, to affiliates and/or related parties of Mr. Kimberlin. The notes are convertible into anaggregate of 9,063,047 shares of our common stock at prices ranging from $0.79to $1.46 per share.

 

In addition, between January 1, 2003 and June 6, 2003 weissued convertible notes in the principal amount of $3,899,000 to affiliatesand /or related parties of Mr. Kimberlin, which notes are currentlyoutstanding. Notes issued during this period in the principal amount of$2,080,000 are convertible into an aggregate of 1,685,275 shares of our commonstock at prices ranging from $1.23 to $1.35 per share. Notes issued during thisperiod in the principal amount of $1,819,000 are convertible on terms to benegotiated in good faith prior to their maturity date.

 

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On July 7, 2003, our stockholders approved our proposal to conducta private offering of up to $5.0 million of Series A Convertible PreferredStock and the conversion of convertible notes issued from January 1, 2003and July 7, 2003, plus all accrued interest thereon at a rate of 8% perannum, into shares of Series A Convertible Preferred Stock. Accordingly,we anticipate that at least $3,899,000 and up to $5.0 million of convertiblenotes may be converted into Series A Convertible Preferred Stock. If wedetermine to convert a maximum of $5.0 million of notes, it will result in theissuance of 835,561 shares of Series A Convertible Preferred Stock. The holdersof shares of our Series A Convertible Preferred Stock would have the rightto further convert each share of Series A Convertible Preferred Stock intoanywhere from four to 12 shares of our common stock (depending on the date ofconversion). In addition, the Series A Convertible Preferred Stock will beentitled to receive dividend and liquidation preferences prior and inpreference to our common stock. In addition, if issued, the holders ofSeries A Preferred Stock would be entitled to protective provisions thatrequire 66 2/3%of the outstanding Series A Convertible Preferred Stock to approve, amongother things, increasing the number of shares of Series A ConvertiblePreferred Stock, altering adversely and materially the rights of theSeries A Convertible Preferred Stock, creating a new class of securitywith dividend or liquidation rights equal or senior to the Series AConvertible Preferred Stock, a liquidation or recapitalization or increasingthe number of shares reserved for issuance under our stock option plans togreater than 10% of our outstanding capital stock (on an as if converted,fully-diluted basis). As of October 2003, no shares of Series AConvertible Preferred Stock had been designated or issued.

 

During July 2003, we raised $9.3 million in gross proceedsthrough the voluntary exercise of 6,992,236 of our Class A warrants.Included in the gross proceeds was a cashless exercise of approximately$2.4 million with a long-term convertible promissory note issued to anaffiliate and /or related party of Mr. Kimberlin surrendered in lieu ofcash. We issued an additional 3,496,118 shares, equal to one-half share ofcommon stock for each Class A warrant exercised as an incentive to induceholders of the Class A warrants to exercise their Class A warrantsand to allow us to obtain a “lock-up” on the shares of common stock issued tothe holders of the exercised Class A warrants in the December 2002unit offering and the shares of the common stock issued upon the exercise ofthe Class A warrants (including the additional one-half shares of commonstock), prohibiting the sale of the common stock for 270 days, with the“lock-up” period expiring on April 4, 2004, unless we decide to waive the“lock-up” period prior to its expiration.

 

On October 10, 2003, we raised $12.0 million in grossproceeds in connection with a private placement of 5,940,594 shares of ourcommon stock and accompanying warrants to purchase 2,970,297 shares of ourcommon stock. In connection with this private placement, we issued anadditional 61,576 shares of our common stock and warrants to purchase 594,059shares of our common stock to Rodman & Renshaw, Inc., our placement agent,and other service providers. The net cash proceeds were approximately$11.0 million net of $1.0 million in offering costs.

 

Spencer Trask Ventures, Inc., our placement agent for theDecember 2002 private placement, and its transferees, hold unit options topurchase 1,952,419 shares of common stock and 1,452,419 Class A warrants,which are not redeemable by us. The Class A warrants are exercisable foradditional shares of common stock and Class B warrants. As of July 2003,in consideration of the holders of the placement agent options agreement not toexercise their options until April 4, 2004, we agreed to issue anadditional share of common stock for every two options exercised.

 

Any subsequent offerings may require the creation or issuance of aclass or series of stock that by its terms ranks senior to the common stockwith respect to rights relating to dividends, voting and/or liquidation. If weare unable to raise funds on terms favorable to our then existing shareholders,your ownership interest and the value of your investment may be significantlydiluted.

 

**You could suffer substantial dilution of yourinvestment as the result of adjustments to, or conversion of, notes, warrants,other securities and other contracts issued In 2001, 2002 and 2003**

 

During 2001 and 2002 we issued, convertible notes, and on July 7, 2003we reissued a portion of one of these convertible notes, to affiliates and /orrelated parties of Mr. Kimberlin. The notes are convertible into anaggregate of 9,063,047 shares of our common stock at prices ranging from $0.79to $1.46 per share.

 

In addition, between January 1, 2003 and June 6, 2003 weissued convertible notes in the principal amount of $3,899,000 to affiliatesand /or related parties of Mr. Kimberlin, which notes are currentlyoutstanding. Notes issued during this period in the principal amount of $2,080,000are convertible into an aggregate of 1,685,275 shares of our common stock atprices ranging from $1.23 to $1.35 per share. Notes issued during this periodin the principal amount of $1,819,000 are convertible on terms to be negotiatedin good faith prior to their maturity date.

 

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On July 7, 2003 our stockholders approved our proposal to conduct aprivate offering of up to $5.0 million and the conversion of convertible notesissued from January 1, 2003 and July 7, 2003 plus all accrued interest thereonat a rate of 8% per annum, into shares of Series A Convertible Preferred Stock.Accordingly, we anticipate that at least $3,899,000 and up to $5.0 million ofconvertible notes may be converted into Series A Convertible Preferred Stock.If we determine to convert a maximum of $5.0 million of notes, it will resultin the issuance of 835,561 shares of Series A Convertible Preferred Stock. Theholders of shares of our Series A Convertible Preferred Stock would havethe right to further convert each share of Series A Convertible PreferredStock into anywhere from four to 12 shares of our common stock (depending onthe date of conversion). The Series A Convertible Preferred Stock wouldreceive dividends in preference to any dividend issued to holders of shares ofour common stock and would be entitled to a liquidation preference. Inaddition, if issued, the holders of Series A Preferred Stock would beentitled to protective provisions that require 66 2/3%of the outstanding Series A Convertible Preferred Stock to approve, amongother things, increasing the number of shares of Series A ConvertiblePreferred Stock, altering adversely and materially the rights of theSeries A Convertible Preferred Stock, creating a new class of securitywith dividend or liquidation rights equal or senior to the Series AConvertible Preferred Stock, a liquidation or recapitalization or increasingthe number of shares reserved for issuance under our stock option plans togreater than 10% of our outstanding capital stock (on an as if converted, fully-dilutedbasis). As of October 2003, no shares of Series A ConvertiblePreferred Stock had been designated or issued.

 

These notes provide that the number of shares, as well as theapplicable conversion or exercise price, as the case may be, are subject toweighted average anti-dilution adjustment in the event that we issue non-exemptsecurities below the applicable conversion or exercise price and in otherevents which would dilute your interest in us.

 

We also issued a non-redeemable option to our placement agent and itstransferees to purchase 1,952,419 shares of common stock and 1,452,419Class A warrants (which are not redeemable by us) which, if exercised, maydilute your interest in us. As of July 2003, in consideration of theholders of the placement agent options agreement not to exercise their optionsuntil April 4, 2003, we agreed to issue an additional share of commonstock for every two options upon exercise.

 

On June 26, 2002, we entered into an agreement with Trinity toamend some of our existing agreements with Trinity. In consideration forentering into these amendments, Trinity has received 1.0 million shares ofour common stock valued at approximately $2.4 million at the date of theamendments and also will receive as additional consideration, 250,000 shares ofour common stock (up to 750,000 shares in the aggregate) as of the date of thesatisfaction by Trinity of each of the following obligations: (i) thepurchase by Trinity from us of an aggregate of 300,000 doses of REMUNE®,(ii) the purchase by Trinity from us of an aggregate of 600,000 doses ofREMUNE® and (iii) the purchase by Trinity from us of an aggregate of1.0 million doses of REMUNE®. Under the current agreement, Trinity also isobligated to purchase 500,000 shares of common stock at a purchase price of $10per share on the date that is 30 days after the date on which Trinityreceives the required marketing approval from the Food and Drug Administrationof the Ministry of the Public Health of Thailand, or the Thai FDA. The issuanceby us to Trinity of these 2,250,000 shares of common stock, and the granting byus to Trinity of registration rights relating to their shares, will dilute yourinterest in us. On June 23, 2002, the registration statement covering thesale of 500,000 shares of common stock, held in the name of Trinity, wasdeclared effective by the SEC.

 

We may in the future issue additional convertible notes, warrants orother securities.

 

**You could suffer substantial dilution of yourinvestment if warrants and options to purchase common stock are exercised forcommon stock**

 

As of October 17, 2003, we had reserved approximately5.6 million shares of our common stock for potential issuance upon theexercise of stock options or purchases under our employee stock purchase plan.Issuance of any of these additional shares could substantially dilute yourinterest in us. Furthermore, we have warrants outstanding which, if exercised,will purchase approximately 25.7 million shares of our common stock andapproximately 9.1 million shares which are issuable upon conversion of ouroutstanding convertible notes, subject to adjustment. Additionally, ourplacement agent in the December 2002 private placement, and its transferees,hold unit options to purchase up to 1,952,419 shares of common stock and1,452,419 Class A warrants, which are not redeemable by us, subject toadjustment. The Class A warrants are exercisable for additional shares ofcommon stock and Class B warrants, subject to adjustment. In addition, wemay issue up to 1,250,000 shares of our common stock to Trinity pursuant to ourLicense and Collaboration Agreement. See also “—You Could Suffer Substantial Dilution of Your Investmentas The Result of Adjustments To, Or Conversion Of, Notes, Warrants, OtherSecurities and Other Contracts Issued In 2001, 2002 and 2003.”

 

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**Our stock may become delisted and subject topenny stock rules, which may make it more difficult for you to sell yoursecurities**

 

Our common stock was moved to The Nasdaq SmallCap Market, effectiveSeptember 9, 2002. As of June 30, 2003, we had fallen below theminimum stockholders’ equity requirement of $2.5 million for the NasdaqSmallCap Market’s continued listing requirement. However, we currently meet theminimum stockholders’ equity requirement as well as an alternative test whichrequires the market value of our securities to exceed $35 million. See“—We Implemented A 1-For-4 Reverse Stock Split. The Effect Of A Reverse SplitOn The Trading Price Of Our Common Stock Is Unpredictable.”

 

The transfer of our common stock to The Nasdaq SmallCap Market mayadversely affect the liquidity and trading volume of our common stock andreduce the number of market makers willing to trade in our common stock, makingit more likely that wider fluctuations in the quoted price of our common stockwill occur. As a result, there is a risk that holders of our common stock willnot be able to obtain accurate price quotes or be able to correctly assess themarket price of our common stock. Increases in volatility also could make itmore difficult to pledge shares of our common stock as collateral, if holderssought to do so, because a lender also might be unable to accurately value ourcommon stock.

 

If we are delisted from the Nasdaq for any reason, our common stockwill be considered a penny stock under regulations of the Securities andExchange Commission, or the SEC, and therefore would be subject to rules thatimpose additional sales practice requirements on broker-dealers who buy andsell our securities. The additional burdens imposed upon broker-dealers bythese requirements could discourage broker-dealers from effecting transactionsin our common stock, which could severely limit the market liquidity of thecommon stock and warrants and your ability to sell our securities in thesecondary market. We cannot assure you that we will be able to maintain ourlisting on the Nasdaq. Being delisted would also limit our ability to raiseadditional financing.

 

**We implemented a 1-for-4 reverse stock split.The effect of a reverse split on the trading price of our common stock isunpredictable**

 

In order to raise the closing bid price of our common stock above $1.00to comply with Nasdaq listing rules, at our Annual Meeting of Stockholders heldon June 17, 2002, our stockholders granted to our Board of Directors thediscretion to effect a 1-for-4 reverse stock split. On October 9, 2002, weannounced that our Board of Directors had formally declared a 1-for-4 reversestock split of issued and outstanding shares of our common stock effective asof the open of trading on October 9, 2002. Although the theoretical effectof a reverse stock split is to increase the per share price of common stock,the actual price effect of a reverse stock split is difficult to predict. Thereis historical evidence and academic research relating to reverse stock splitswhich indicates that shares of listed companies do not perform well subsequentto a reverse stock split. It is possible that the post-split trading price ofour stock could fall below the level one would expect based on the proportionaleffect of the split alone. As a result, the closing bid price of our commonstock may nevertheless fall below $1.00 per share for 30 consecutive days inwhich event we may not be eligible for the Nasdaq listing requirements. Seealso—”Our Stock May Become Delisted And Subject to Penny Stock Rules, Which MayMake It More Difficult For You To Sell Your Securities.”

 

**An existing stockholder owns approximately23.4% of our outstanding common stock and has the rights to acquire anadditional 24,043,458 shares of our common stock, which could result inownership of up to approximately 51.8% of our outstanding shares and couldallow him to influence stockholder votes**

 

Kevin B. Kimberlin, a member of our Board of Directors, together withhis affiliates and/or related parties, currently own of record approximately23.4% of our outstanding shares of common stock and have the right to acquire,through the conversion of notes and exercise of options and warrantsbeneficially owned by them, 24,043,458 additional shares. If the notes, optionsand warrants were to be converted and exercised in full, Mr. Kimberlin andhis affiliates and/or related parties would own approximately 51.8% of ouroutstanding shares of common stock on a post-conversion/exercised basis. As aresult of his ownership of our common stock and the ability to acquireadditional shares, Mr. Kimberlin and his affiliates and/or related personshas the ability to influence, and possibly control, substantially all mattersrequiring approval by our stockholders, including the election of directors andthe approval of mergers or other business combination transactions. If yourinterests as a stockholder are different from his interests, you may not agreewith his decisions and you might be adversely affected thereby.

 

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Mr. Kimberlin, in addition to being one of our directors and ourprincipal stockholder, is the controlling stockholder of SpencerTrask & Co., which is the parent company of Spencer TraskVentures, Inc., which acted as exclusive placement agent for, and was paidfees by us in connection with, the private placement of unit options topurchase shares of common stock and Class A and Class B warrants that areexercisable for common stock completed in December 2002.

 

**The warrant terms were arbitrarily determined**

 

The exercise and redemption prices and other terms of the Class Aand Class B warrants sold and issuable upon exercise of the placementagent unit options as part of our private offering completed onDecember 10, 2002 were determined through negotiations between us and ourplacement agent and do not necessarily bear any relationship to our assets,book value, revenues or financial condition, or to any other recognizedcriterion of value. The prices and other terms of the warrants should not beconstrued to indicate or predict future trading prices of our warrants orcommon stock in the public markets.

 

**Legal proceedings could require us to spendsubstantial amounts of money and impair our operations**

 

Fromtime to time, the Company is subject to various claims and litigationincidental to our business activities. Since July 2001, several complaints have been filed in the United StatesDistrict Court for the Southern District of California seeking an unspecifiedamount of damages on behalf of an alleged class of persons, who purchasedshares of the Company’s common stock at various times between May 17, 1999and July 6, 2001.  The complaintshave been consolidated into a single action under the name *In re Immune Response SecuritiesLitigation* by order of the Court and a consolidated, amendedcomplaint was filed in July 2003.  Theconsolidated, amended complaint names the Company and certain of its formerofficers as defendants, as well as Agouron Pharmaceuticals, Inc. and one of itsofficers.  The consolidated, amendedcomplaint alleges that the Company, Agouron and/or such officers violatedfederal securities laws by misrepresenting and failing to disclose certaininformation about the results of clinical trials of Remuneâ. On October 31, 2003, the defendants filedmotions to dismiss the consolidated, amended complaint. A hearing date for themotions has not been set.  Although theCompany intends to vigorously defend the actions, the Company can not nowpredict or determine the outcome or resolution of these proceedings, or toestimate the amounts of, or potential range of, loss with respect to theseproceedings.  In addition, the timing ofthe final resolution of these proceedings is uncertain.  The range of possible resolutions of theseproceedings could include judgments against us or our former officers or settlementsthat could require substantial payments by the Company, which could have amaterial adverse impact on our consolidated financial position, results ofoperations and cash flows.  Theseproceedings also might require substantial attention of our management team andtherefore divert their time and attention from our business and operations.

 

**Our certificate of incorporation and bylawsinclude provisions that could make attempts by stockholders to changemanagement more difficult**

 

The approval of 66 2/3%of our voting stock is required to approve specified transactions and to takespecified stockholder actions, including the calling of special meetings ofstockholders and the amendment of any of the anti-takeover provisions,including those providing for a classified board of directors, contained in ourcertificate of incorporation. Further, pursuant to the terms of our stockholderrights plan, we have distributed a dividend of one preferred stock purchaseright for each outstanding share of common stock. These rights will causesubstantial dilution to the ownership of a person or group that attempts toacquire us on terms not approved by our Board of Directors and may have theeffect of deterring hostile takeover attempts. The substantial aggregate equitypositions of Mr. Kimberlin and his affiliates and/or related parties wouldmake a hostile takeover attempts very unlikely. The practical effect of theseprovisions is to require a party seeking control of us to negotiate with ourBoard of Directors, which could delay or prevent a change in control. Theseprovisions could limit the price that investors might be willing to pay in thefuture for our securities and make attempts by stockholders to changemanagement more difficult.

 

We are subject to the anti-takeover provisions of Section 203 ofthe Delaware General Corporation Law, which prohibits us from engaging in a“business combination” with an “interested stockholder” for a period of threeyears after the date of the transaction in which the person first becomes an“interested stockholder,” unless the business combination is approved in aprescribed manner. The application of Section 203 also could have theeffect of delaying or preventing a change of control.

 

**Volatility of our stock price and absence ofdividends may hurt our security holders**

 

The market price of our common stock has been and is likely to continueto be highly volatile. Factors including (but not limited to) the followingcould have a significant adverse impact on the market price of our commonstock:

 

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•              our ability toobtain additional financing and, if available, the terms and conditions of thefinancing;

 

•              our financialposition and results of operations;

 

•              the results ofpreclinical studies and clinical trials by us, our collaborators or ourcompetitors;

 

•              concern as to, orother evidence of, the safety or efficacy of our products or our competitors’products;

 

•              announcements oftechnological innovations or new products by us or our competitors;

 

•              U.S. and foreigngovernmental regulatory actions;

 

•              actual oranticipated changes in drug reimbursement policies;

 

•              developments withour collaborators;

 

•              developmentsconcerning patent or other proprietary rights of ours or our competitors(including litigation);

 

•              status oflitigation;

 

•              period-to-periodfluctuation in our operating results;

 

•              changes in estimatesof our performance by any securities analysts;

 

•              new regulatoryrequirements and changes in the existing regulatory environment;

 

•              market conditionsfor biopharmaceutical stocks in general; and

 

•              other factors notwithin our control.

 

We have never paid cash dividends on our common stock and do notanticipate paying any cash dividends in the foreseeable future.

 

**If we lose our key personnel or are unable toattract and retain additional personnel, we may be unable to successfullydevelop our technology**

 

Since 2001, we have lost key members of our executive management, whomwe subsequently replaced. There can be no assurances that we will not loseadditional members of our executive management team or, if so, whether we wouldbe able to hire adequate replacements.

 

Additionally, our ability to conduct business, raise additionalfinancing and commercialize REMUNE® or our other products may be hindered if welose additional executive officers or experienced personnel with historicalknowledge of our business, transactions, science and technology. Currently, ourmost experienced executive officer has been with us for less than one year.

 

In addition, recruiting and retaining qualified scientific personnel toassist in scaling up our manufacturing facilities and performing futureresearch and development work will be critical to our success. It has beenparticularly difficult for us to retain personnel in light of the performanceof our common stock and the incurrence of substantial net operating losses. Wedo not have sufficient personnel to fully execute our business plan, and thereis currently a shortage of skilled executives and scientists, which is likelyto continue. As a result, competition for experienced executives and scientistsfrom numerous companies and academic and other research institutions may limitour ability to hire or retain new executives and other qualified personnel onacceptable terms. If we fail to attract and retain sufficient qualifiedpersonnel, we may not be able to develop or implement our technology.

 

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**There may be risks related to our previous useof Arthur Andersen LLP as our independent auditors**

 

On March 14, 2002, Arthur Andersen LLP, our independent publicauditor, was indicted on federal obstruction of justice charges arising fromthe federal government’s investigation of Enron Corporation. On June 15,2002, Arthur Andersen was convicted of these charges. Although we engaged BDOSeidman, LLP, effective as of August 5, 2002, to replace Arthur Andersenas our independent public auditors, there are risks related to our consolidatedfinancial statements for the fiscal year ended December 31, 2000, whichwas audited by Arthur Andersen. The SEC has said that it will continueaccepting financial statements audited by Arthur Andersen as long as areasonable effort is made to have Arthur Andersen reissue its reports and toobtain a manually signed accountant’s report from Arthur Andersen. Formerrepresentatives of Arthur Andersen have notified us that Arthur Andersen is nolonger able to reissue its reports because the firm is no longer in existence.

 

Our current independent auditor, BDO Seidman, LLP, informed us that itdiscovered misclassifications of some convertible notes issued by us to arelated party in the financial statements included in our Annual Report onForm 10-K, as amended by Amendment No. 1 to Form 10-K, for thefiscal year ended December 31, 2001. As a result of thismisclassification, BDO Seidman, LLP re-audited our financial statements and wehave restated certain financial information contained in our Form 10-K/Afor the fiscal year ended 2001. We also have restated certain financialinformation contained in our Quarterly Report on Form 10-Q for thequarterly period ended March 31, 2002 by filing Amendment No. 1 tothe Quarterly Report. Some amounts were incorrectly classified as debt ratherthan equity.

 

Some investors, including significant funds and institutionalinvestors, may choose not to hold or invest in securities of a company thatdoes not have current financial reports available. Our access to the capitalmarkets and our ability to make timely filings with the SEC could be impairedif the SEC ceases accepting financial statements from a prior period audited byArthur Andersen for which Arthur Andersen will not or can not reissue an auditreport. In that case, we would not be able to access the public capital marketsunless another independent accounting firm is able to audit the financialstatements originally audited by Arthur Andersen. Any delay or inability toaccess the public capital markets caused by these circumstances would bedisruptive and adversely affect the price and liquidity of our securities andwould have a material adverse effect on our business and financial condition.

 

**Changesto financial accounting standards may affect our reported results of operations**

 

We prepare our financial statements inconformity with accounting principles generally accepted in the United States,or GAAP. GAAP are subject to interpretation by the American Institute ofCertified Public Accountants, the SEC and various bodies formed to interpretand create appropriate accounting policies. A change in those policies can havea significant effect on our reported results and may even affect our reportingof transactions completed before a change is announced. Accounting policiesaffecting many other aspects of our business, including rules relating to thecarrying value of long-lived assets, employee stock option grants and revenuerecognition have recently been revised or are under review. Changes to thoserules or the questioning of current practices may adversely affect our reportedfinancial results or the way we conduct our business. In addition, ourpreparation of financial statements in accordance with GAAP requires that wemake estimates and assumptions that affect the recorded amounts of assets andliabilities, disclosure of those assets and liabilities at the date of thefinancial statements and the recorded amounts of expenses during the reportingperiod. A change in the facts and circumstances surrounding those estimatescould result in a change to our estimates and could impact our future operatingresults. Additionally, certain provisions of the Sarbanes-Oxley Act of 2002will impact our business. In particular, the creation by the SEC of anindependent accounting oversight board to oversee and regulate audits willaffect us and all public companies.

 

 

**Item 3.****    Quantitativeand Qualitative Disclosures about Market Risk**

 

Ourmarket risk consists primarily of the potential for changes in interest rates.We invest our excess cash primarily in U.S. government securities and moneymarket accounts.  These instruments havematurities of two years or less when acquired. We do not utilize derivative financial instruments, derivative commodityinstruments or other market risk sensitive instruments, positions ortransactions.

 

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**Item 4.    Controls and Procedures**

 

**Evaluationof disclosure controls and procedures**

 

We maintain “disclosure controls and procedures,” as such term isdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934 (the “Exchange Act”), that are designed to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in Securities and Exchange Commission rules and forms, andthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, as appropriate,to allow timely decisions regarding required disclosure.  In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the disclosure controls andprocedures are met.  Additionally, indesigning disclosure controls and procedures, our management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible disclosure controls and procedures. The design of any disclosure controls and procedures also is based inpart upon certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions.

 

Based on their evaluation as of the end of the period covered by thisQuarterly Report on Form 10-Q, our Chief Executive Officer and Chief FinancialOfficer have concluded that, subject to the limitations noted above, ourdisclosure controls and procedures were effective to ensure that materialinformation relating to us, including our consolidated subsidiaries, is madeknown to them by others within those entities, particularly during the periodin which this Quarterly Report on Form 10-Q was being prepared.

** **

**Changes in internalcontrol over financial reporting**

 

Therewere no significant changes in our internal control over financial reportingor, to our knowledge, in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

 

**PART II.  OTHER INFORMATION**

 

**Item 1.    LegalProceedings**

 

Fromtime to time, the Company is subject to various claims and litigationincidental to our business activities. Since July 2001, several complaints have been filed in the United StatesDistrict Court for the Southern District of California seeking an unspecifiedamount of damages on behalf of an alleged class of persons, who purchasedshares of the Company’s common stock at various times between May 17, 1999and July 6, 2001.  The complaintshave been consolidated into a single action under the name *In re Immune Response SecuritiesLitigation* by order of the Court and a consolidated, amendedcomplaint was filed in July 2003.  Theconsolidated, amended complaint names the Company and certain of its formerofficers as defendants, as well as Agouron Pharmaceuticals, Inc. and one of itsofficers.  The consolidated, amendedcomplaint alleges that the Company, Agouron and/or such officers violatedfederal securities laws by misrepresenting and failing to disclose certaininformation about the results of clinical trials of Remuneâ. On October 31, 2003, the defendants filedmotions to dismiss the consolidated, amended complaint. A hearing date for themotions has not been set.  Although theCompany intends to vigorously defend the actions, the Company can not nowpredict or determine the outcome or resolution of these proceedings, or toestimate the amounts of, or potential range of, loss with respect to theseproceedings.  In addition, the timing ofthe final resolution of these proceedings is uncertain.  The range of possible resolutions of theseproceedings could include judgments against us or our former officers orsettlements that could require substantial payments by the Company, which couldhave a material adverse impact on our consolidated financial position, resultsof operations and cash flows.  Theseproceedings also might require substantial attention of our management team andtherefore divert their time and attention from our business and operations.

 

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**Item 2.    Changes in Securities and Use of Proceeds**

 

During the third quarter, we issued 188,342 shares of common stock toconsultants for services rendered. We determined that the considerationreceived by the Company in the form of services rendered was at least $343,000.

 

During the third quarter, ourBoard of Directors approved the issuance of up to 500,000 sharesof our common stock issuable to our placement agent’s transferees upon theexercise of options issued originally to our placement agent in connection withour December 2002 private placement in consideration of an agreement notto exercise the options until April 4, 2004.

 

On July 7, 2003, we issued 3,496,118 shares (equal to one half share ofcommon stock for each Class A warrant exercised) as an incentive to induceholders of 6,992,236 Class A warrants to exercise their Class A warrant as partof the incentive share offering.

 

The issuances of these securities shares were completed in relianceupon the safe harbors provided by Section 4(2) of the Securities Act of 1933.

 

 

**Item 3.****  ****Defaults Upon Senior Securities**

 

None

 

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

 

On July 7, 2003, the Company held a special meeting ofStockholders.  There were issued andoutstanding on June 12, 2003, the record date, 21,284,301 shares of commonstock.  There were present at themeeting in person or by proxy, stockholders of the Company who were the holdersof 10,858,467 shares of common stock entitled to vote, constituting aquorum.  The following actions weretaken at the meeting:

 

1.                                       An amendment tothe Company’s restated Certificate of Incorporation to increase the number ofauthorized shares of preferred stock was approved. Shares voted for theamendment were 10,674,663, with 164,787 shares voted against, 18,917 sharesabstained and 282,586 were broker non-votes.

 

2.                                       The proposal torevise terms and conditions for certain holders of shares of common stock andClass A warrants of the Company in connection with the Company’s privateplacement completed in December 2002 was approved. Shares voted for theproposal were 10,701,168, with 132,509 shares against, 24,490 shares abstainedand 300 were broker non-votes.

 

3.                                       The proposal toissue up to $5.0 million shares of Series A Convertible Preferred Stock inconnection with the Company’s proposed private placement was approved. Theholders will have the right to convert each share into shares of common stock.Shares voted for the proposal were 10,699,904, with 142,273 shares votedagainst, 16,190 shares abstained and 100 were broker non-votes.

 

 

**Item 5.****     Other Information**

 

The Chief Executive Officer and Chief Financial Officer of the Companyhave certified that the Quarterly Report of the Company and Form 10-Q for thequarterly period ended September 30, 2003 fully complies with the requirementsof section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C.(ss) 78m or (ss) 78o(d)) and that information contained in such report fairlypresents, in all material respects, the financial condition and results ofoperations of the Company.

 

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**Item 6.   Exhibits and Reports on Form 8-K**

 
| a) | Exhibits |
|----|----------|

 
|   | **Exhibit  Number** |   | **Description  of Document**                                                                                                                            |
|--------|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                |   |                                                                                                                                                    |
|   | 3(i)                |   | Integrated copy of the Restated Certificate of Incorporation, as  amended.                                                                              |
|   | 10.145              |   | Securities Purchase Agreement dated October 10, 2003 by and  among the Company and the purchasers identified in the signature  pages thereto. |
|   | 10.146              |   | Registration Rights Agreement dated October 10, 2003 by and among the  Company and the purchasers identified in the signature pages  thereto. |
|   | 10.147              |   | Warrants dated as of October 10, 2003 issued to Rodman & Renshaw,  Inc.                                                                             |
|   | 10.148              |   | Warrant dated as of October 10, 2003 issued to Cardinal Securities,  LLC.                                                                               |
|   | 31.1                |   | Certification of the Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
|   | 31.2                |   | Certification of the Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
|   | 32.1                |   | Certification pursuant to  Section 1350 of Chapter 63 of U.S.C. as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                  |
|   | 32.2                |   | Certification pursuant to  Section 1350 of Chapter 63 of U.S.C. as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                  |
|   |
| b)     | Reports on Form 8-K |
|   |                |
|   | None                |
|        |                     |        |                                                                                                                                                         |  |

 

 

**SIGNATURE**

 

 

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

 

 
|                          |   | **THE IMMUNE RESPONSE  CORPORATION**                                            |
|-------------------------------|--------|---------------------------------------------------------------------------------|
|                          |   |                                                                            |
|                          |   |                                                                            |
| Date:  November 14, 2003 |   | /s/ Michael K. Green                                                            |   |
|                          |   | Michael K. Green                                                                |
|                          |   | Vice President, Finance and Chief Financial Officer                             |
|                          |   | (signing  both as a duly authorized officer and as principal financial officer) |

 

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**PART 111 –EXHIBITS TO FORM 10-Q**

 

 

**THE IMMUNE RESPONSECORPORATION**

 

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**ExhibitIndex**

 
| **Exhibit  Number** |   | **Description  of Document**                                                                                                                            |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                    |
| 3(i)                |   | Integrated copy of the Restated Certificate of Incorporation, as  amended.                                                                              |
| 10.145              |   | Securities Purchase Agreement dated October 10, 2003 by and  among the Company and the purchasers identified in the signature  pages thereto. |
| 10.146              |   | Registration Rights Agreement dated October 10, 2003 by and among the  Company and the purchasers identified in the signature pages  thereto. |
| 10.147              |   | Warrants dated as of October 10, 2003 issued to Rodman & Renshaw,  Inc.                                                                             |
| 10.148              |   | Warrant dated as of October 10, 2003 issued to Cardinal Securities,  LLC.                                                                               |
| 31.1                |   | Certification of the Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
| 31.2                |   | Certification of the Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
| 32.1                |   | Certification pursuant to  Section 1350 of Chapter 63 of U.S.C. as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                  |
| 32.2                |   | Certification pursuant to  Section 1350 of Chapter 63 of U.S.C. as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                  |

 

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