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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q  (Mark
One)[ X ]
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period ended
March 31, 2004, or
 [  ]
    
    Transition Period Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Transition Period From to.
 Commission file number 0-19591 EPIMMUNE INC.  Delaware
    
    33-0245076(State of Incorporation)
    
    (I.R.S. EmployerIdentification No.)
 5820 Nancy Ridge Drive
San Diego, California 92121   (858) 860-2500   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]   No [  ] Indicate by check mark whether the Registrant is an accelerated filer as
defined in Rule 12b-2 of the Securities Exchange Act of 1934.
Yes [  ]  No [X] Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. Common Stock: $.01 par value 15,992,001 shares outstanding as of May 10, 2004.




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EPIMMUNE INC.
QUARTERLY REPORT
FORM 10-Q COVER PAGE
    
    
    1TABLE OF CONTENTS
    
    
    2PART I. FINANCIAL INFORMATIONITEM 1. Financial StatementsCondensed Balance Sheets as of March 31, 2004 (unaudited) and
December 31, 2003
    
    
    3Condensed Statements of Operations (unaudited) for the Three
Months Ended March 31, 2004 and 2003
    
    
    4Condensed Statements of Cash Flows (unaudited) for Three Months
Ended March 31, 2004 and 2003
    
    
    5Notes to Condensed Financial Statements (unaudited)
    
    
    6ITEM
2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    9ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    14Risk Factors
    
    
    15ITEM 4. Controls and Procedures
    
    
    28PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    29ITEM 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities
    
    
    *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
    
    
    29SIGNATURES
    
    
    32EXHIBIT 10.48EXHIBIT 10.49EXHIBIT 10.50EXHIBIT 10.51EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
   *
    
    No information provided due to inapplicability of item. 2




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PART I. FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS
 EPIMMUNE INC. 
 CONDENSED BALANCE SHEETS
 (in thousands, except share data)
 March 31,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,201
    
    
    $
    6,416Accounts receivable
    
    
    1,571
    
    
    
    1,012Prepaids and other current assets
    
    
    365
    
    
    
    186Total current assets
    
    
    7,137
    
    
    
    7,614Restricted long-term investment
    
    
    472
    
    
    
    472Property and equipment, net
    
    
    1,086
    
    
    
    1,145Patents and other assets
    
    
    3,562
    
    
    
    3,462TOTAL ASSETS
    
    $
    12,257
    
    
    $
    12,693LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    1,506
    
    
    $
    1,446Deferred contract revenues
    
    
    922
    
    
    
    1,151Accrued payroll and related expenses
    
    
    325
    
    
    
    173Total current liabilities
    
    
    2,753
    
    
    
    2,770Deferred rent
    
    
    215
    
    
    
    212Stockholders equity:Preferred stock, $.01 par value, 10,000,000 shares authorized,
1,409,288 shares issued and outstanding of Series S and S-1 convertible
preferred stock at March 31, 2004 and December 31, 2003. Liquidation
preference of $10,000,000 at March 31, 2004 and December 31, 2003.
    
    
    14
    
    
    
    14Common stock, $.01 par value, 25,000,000 shares authorized,
13,525,622 shares and 13,490,618 shares issued and outstanding
at March 31, 2004 and December 31, 2003, respectively.
    
    
    135
    
    
    
    135Additional paid-in capital
    
    
    167,588
    
    
    
    167,537Deferred compensation
    
    
    (38
    )
    
    
    (50
    )Accumulated deficit
    
    
    (158,410
    )
    
    
    (157,925
    )Total stockholders equity
    
    
    9,289
    
    
    
    9,711TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    12,257
    
    
    $
    12,693
 See accompanying notes. 3




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EPIMMUNE INC. 
 CONDENSED STATEMENTS OF OPERATIONS
 (unaudited)
 (in thousands, except per share data)
 Three months ended March 31,2004
    
    2003RevenuesLicense fees and milestones
    
    $
    97
    
    
    $
    202Research grants and contract revenue
    
    
    1,454
    
    
    
    255Related party revenue
    
    
    1,026
    
    
    
    973Total revenues
    
    
    2,577
    
    
    
    1,430Costs and expenses:Research and development
    
    
    2,407
    
    
    
    2,610General and administrative
    
    
    658
    
    
    
    683Total costs and expenses
    
    
    3,065
    
    
    
    3,293Loss from operations
    
    
    (488
    )
    
    
    (1,863
    )Interest income, net
    
    
    4
    
    
    
    65Other expense, net
    
    
    (1
    )
    
    
    (2
    )Net loss
    
    $
    (485
    )
    
    $
    (1,800
    )Net loss per share - basic and diluted
    
    $
    (0.04
    )
    
    $
    (0.15
    )Shares used in computing net loss per share - basic and diluted
    
    
    13,456
    
    
    
    11,676
 See accompanying notes. 4




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EPIMMUNE INC. 
 CONDENSED STATEMENTS OF CASH FLOWS
 (unaudited)
 (in thousands)
 Three months ended March 31,2004
    
    2003OPERATING ACTIVITIESNet loss
    
    $
    (485
    )
    
    $
    (1,800
    )Adjustments to reconcile net loss to net cash used in operating
activities:Interest on note held by stockholder
    
    
    
    
    
    
    (41
    )Depreciation and amortization
    
    
    220
    
    
    
    205Stock-based compensation
    
    
    12
    
    
    
    31Deferred rent
    
    
    3
    
    
    
    7Deferred contract revenue
    
    
    (229
    )
    
    
    387Loss on disposal of assets
    
    
    
    
    
    
    1Change in operating assets and liabilities:Prepaids and other current assets
    
    
    (738
    )
    
    
    (408
    )Accounts payable and accrued liabilities
    
    
    106
    
    
    
    (345
    )Accrued payroll and related expenses
    
    
    152
    
    
    
    13Net cash used in operating activities
    
    
    (959
    )
    
    
    (1,950
    )INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (17
    )
    
    
    (43
    )Patents and other assets
    
    
    (244
    )
    
    
    (179
    )Net cash used in investing activities
    
    
    (261
    )
    
    
    (222
    )FINANCING ACTIVITIESNet proceeds from issuance of common stock
    
    
    5
    
    
    
    23Principal payments under equipment notes payable and note
payable to bank
    
    
    
    
    
    
    (43
    )Net cash provided by (used in) financing activities
    
    
    
    
    
    
    (43
    )Decrease in cash and cash equivalents
    
    
    (1,220
    )
    
    
    (2,215
    )Cash and cash equivalents at beginning of year
    
    
    6,416
    
    
    
    9,745Cash and cash equivalents at end of period
    
    $
    5,196
    
    
    $
    7,530SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATIONInterest paid
    
    $
    4
    
    
    $
    2
 See accompanying notes. 5




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EPIMMUNE INC. 
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 (unaudited)
 March 31, 2004
 1. Basis of Presentation The interim unaudited condensed financial statements contained herein have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information. Accordingly, they do not
include all of the information and disclosures required by accounting
principles generally accepted in the United States for complete financial
statements. In managements opinion, the unaudited information includes all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position, results of operations and cash
flows for the periods presented. Interim results are not necessarily
indicative of results to be expected for the full year. The financial
statements should be read in conjunction with the audited consolidated
financial statements and disclosures thereto included in the Companys Form
10-K, as amended, for the year ended December 31, 2003. The Company has an accumulated deficit of $158.4 million as of March 31, 2004.
The Companys ability to attain profitable operations is dependent upon
obtaining sufficient working capital to complete the successful development of
its products, FDA approval of its products, achieving market acceptance of such
products and achievement of sufficient levels of revenue to support the
Companys cost structure. With existing cash and interest earned thereon,
along with receipts from existing contracts and its recent financing in April
2004, the Company expects to be able to maintain its current level of
operations through 2005, based on anticipated expenditures. If the Company is
unable to obtain additional funding, it will be required to delay, reduce the
scope of or eliminate one or more of its research and development projects,
sell the Company or certain of its assets or technologies, or dissolve and
liquidate all of its assets. Earnings per share (EPS) is computed in accordance with Statement of
Financial Accounting Standards (SFAS) No. 128, Earnings per Share. SFAS No. 128
requires dual presentation of basic and diluted earnings per share. Basic EPS
includes no dilution and is computed by dividing net income by the weighted
average number of common shares outstanding for the period, excluding owned but
unvested shares. There were 56,511 and 474,286 owned but unvested shares as of
March 31, 2004 and March 31, 2003, respectively that were excluded from the
earnings per share calculation. Diluted EPS reflects the potential dilution of
securities that could share in our earnings, such as common stock equivalents
that may be issuable upon exercise of outstanding common stock options or
warrants as well as all shares of preferred stock, which may be converted into
common stock. Prior to the application of the treasury stock method, common
stock equivalents of 4,334,950 and 3,990,115 for the three months ended March
31, 2004 and 2003 have been excluded from EPS as the effect is antidilutive.
On a fully diluted basis, assuming full vesting and conversion of all common
stock equivalents upon exercise of outstanding common stock options and
warrants as well as conversion of all shares of preferred stock, there were
17,804,061 and 15,698,748 shares outstanding as of March 31, 2004 and March 31,
2003, respectively. As permitted by SFAS No. 123, Accounting for Stock-based Compensation, the
Company elected to follow Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its employee stock options. Under APB Opinion No. 25, among
other things, when the exercise price of its employee stock options is not less
than the market price of the underlying stock on the date of grant, no
compensation expense is recognized. As required under SFAS No. 123, Accounting for Stock-Based Compensation, and
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, the pro forma effects of stock-based compensation on net income and
net earnings per common share have been estimated at the date of 6




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grant using the Black-Scholes option pricing model based on the following
weighted average assumptions for March 31, 2004 and March 31, 2003: risk-free
interest rates of 4.5% and 6%, respectively; dividend yield of 0 for both
periods; and a weighted average expected life for all options of six years.
The volatility factor assumptions of the expected market price of the Companys
common stock were 107% and 114% for March 31, 2004 and 2003, respectively. For purposes of adjusted pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting period. The effect of
applying SFAS No. 123 for purposes of providing pro forma disclosures is not
likely to be representative of the effects on the Companys operating results
for future years because changes in the subjective input assumptions can
materially affect future value estimates. Pro forma information for the three
months ended March 31, 2004 and 2003 is as follows: Three months ended March 31,2004
    
    2003Adjusted pro forma basic and diluted net loss
    
    $
    (701,000
    )
    
    $
    (1,966,000
    )Adjusted pro forma basic and diluted net loss per share
    
    $
    (0.05
    )
    
    $
    (0.17
    )
 2. New Accounting Standards In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.This statement
establishes standards for how the Company classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that the Company classify a financial instrument within its scope as a
liability. Some of the provisions of this statement are consistent with the
current definition of liabilities in FASB Concepts Statement No. 6, Elements of
Financial Statements.The remaining provisions of this statement are consistent
with the FASBs proposal to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own
equity shares, depending on the nature of the relationship established between
the holder and the issuer. This statement is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 had no material impact on the Companys
financial position or results of operations. 3. Genencor International, Inc. and Innogenetics NV In July 2001, the Company entered into a collaboration with Genencor
International, Inc. for vaccines to treat or prevent hepatitis B virus,
hepatitis C virus and human papilloma virus. Pursuant to the agreement,
Epimmune exclusively licensed to Genencor its PADRE® and epitope technologies
for vaccines to treat or prevent hepatitis B, hepatitis C and human papilloma
virus. In connection with this collaboration, the Company received an upfront
license fee, which is being amortized over the collaboration term. In
addition, Genencor made an initial ten percent equity investment in Epimmune
common stock at a premium to the market price. The agreement provided for the
Company to receive up to a total of approximately $60 million in payments,
including the initial equity investment but excluding royalties. In January
2002, Epimmune received a payment from Genencor for achievement of the first
milestone, identification of a product candidate to treat chronic hepatitis B
infection. In February 2004, the Company announced it had earned a milestone
payment from Genencor as a result of Genencor filing an IND for a vaccine to
treat hepatitis B. The milestone payments were recognized as revenue when
received. The collaboration revenues have been recognized as incurred. In
addition, Genencor fully funded Epimmunes research in these specific
indications and was obligated to pay the Company royalties on sales of any
products that may have been developed under the collaboration. All revenues
from Genencor have been included in related party revenue. The initial
collaboration had a term through September 2003, and in October 2002, was
extended to September 2004. 7




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In March 2004, Genencor assigned its rights under the collaboration and license
agreements to Innogenetics NV, an unrelated company. In connection with the
assignment by Genencor, the Company extended the collaboration term with
Innogenetics through September 2005. In addition, Genencor agreed not to sell
or otherwise dispose of any of the Companys common stock it held, without the
Companys prior approval, for a minimum of twelve months. Innogenetics has the
right to terminate the collaboration early, upon three months written notice,
if Epimmune breaches its obligations under the collaboration agreement or upon
certain force majeure events. 4. National Cancer Institute In March 2004, the Company received a grant from the National Cancer Institute
(NCI), an institute of the National Institutes of Health (NIH), to define and
conduct preclinical testing of a multi-epitope, clinical vaccine candidate for
ovarian and breast cancer. The Company will collaborate with investigators at
the University of Washington on the program with an objective of designing a
vaccine to induce helper T cell (HTL) responses directed against multiple Tumor
Associated Antigens (TAA), in order to prevent or delay disease recurrence
after surgery and chemotherapy. The Phase I grant has a total potential value
of approximately $0.6 million over two years. From the Phase I program, it is
contemplated that a multi-epitope based vaccine will be designated for
development and clinical testing in a potential Phase II program. The Company
will record the revenues from the grant as the services are performed. 5. Private Placement In April 2004, the Company completed a private placement of 2,466,379 shares of
common stock and warrants to purchase up to 1,233,188 shares of common stock to
selected institutional and accredited investors, including current
shareholders, for a total purchase price of $5.5 million. The Company received
net proceeds of $5.1 million. The purchase price of each security, which is
the combination of one share of common stock and, for each two shares of common
stock purchased, a warrant to purchase one share of common stock, was priced at
the market value of $2.2125, which was equal to or greater than the sum of the
closing bid price of Epimmune common stock as quoted on the Nasdaq National
Market on the date of execution of the purchase agreements, and $0.0625, the
imputed value of a warrant to purchase one share of common stock. In addition,
the Company issued warrants to purchase an aggregate of 250,000 shares of its
common stock to a placement agent for services rendered in connection with the
private placement. Each warrant, including the warrant issued to the placement
agent, has a three-year term and an exercise price equal to 120% of $2.2125 or
$2.655 per share. The Companys stockholders equity was $9.3 million and $9.7 million as of
March 31, 2004 and December 31, 2003, respectively. On April 1, 2004, the
Company received a letter from the Nasdaq National Market notifying the Company
that the Company was not in compliance with the minimum $10.0 million
stockholders equity requirement for continued listing on the Nasdaq National
Market. After receipt of the proceeds from the private placement, the Company
believes that it satisfies the $10.0 million continued listing requirement of
the Nasdaq National Market as of the date of filing of this report. The
Companys ongoing compliance with the minimum stockholders equity requirement
will be monitored by the Nasdaq National Market and, if the Company does not
comply with the minimum stockholders equity requirement at the time of its
quarterly report for the second quarter of 2004 or at any other time in the
future, the Company may be subject to delisting. 8




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ITEM 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those discussed
here. Factors that could cause or contribute to such differences include,
without limitation, those discussed below and in the section entitled Risk
Factors. Epimmune® and PADRE® are our trademarks and EIS® and ImmunoSense® are
our service marks. Since 1997, we have devoted substantially all of our resources to the discovery
and development of potential therapeutic and prophylactic products. To date, we
have not received any revenues from the sale of products. We began a Phase I/II
clinical trial targeting HIV in September 2002 and a Phase I/II clinical trial
targeting lung and colorectal cancer in February 2003. We have funded our
research and development primarily from equity-derived working capital and
through strategic alliances and collaborations with other companies. We have
not been profitable since our inception and expect to incur substantial
operating losses for at least the next several years. As of March 31, 2004, our
accumulated deficit was approximately $158.4 million. In July 2001, we entered into a collaboration with Genencor International, Inc.
for vaccines to treat or prevent hepatitis B virus, hepatitis C virus and human
papilloma virus. In February 2004, we announced that we had earned a milestone
payment from Genencor as a result of Genencor filing an Investigational New
Drug Application, or IND, for a vaccine to treat hepatitis B, the lead program
in the collaboration. In March 2004, Genencor assigned its rights under our
collaboration to Innogenetics NV. In connection with the assignment by
Genencor, we extended the collaboration term with Innogenetics through
September 2005. Innogenetics has the right to terminate the collaboration
early, upon three months written notice. In April 2004, we completed a private placement of 2,466,379 shares of common
stock and warrants to purchase up to 1,233,188 shares of common stock to
selected institutional and accredited investors, including current
shareholders, for a total purchase price of $5.5 million. We received net
proceeds of $5.1 million. The purchase price of each security, which is the
combination of one share of common stock and, for each two shares of common
stock purchased, a warrant to purchase one share of common stock, was priced at
the market value of $2.2125, which was equal to or greater than the sum of the
closing bid price of our common stock as quoted on the Nasdaq National Market
on the date of execution of the purchase agreements, and $0.0625, the imputed
value of a warrant to purchase one share of common stock. In addition, we
issued warrants to purchase an aggregate of 250,000 shares of our common stock
to a placement agent for services rendered in connection with the private
placement. Each warrant, including the warrant issued to the placement agent,
has a three-year term and an exercise price equal to 120% of $2.2125 or $2.655
per share. Critical Accounting Policies Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates, including
those related to revenue recognition, patents and income taxes. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions. We
believe the following critical accounting 9




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policies affect the significant judgments and estimates used in the preparation
of our consolidated financial statements (see Note 1 to our financial
statements on page F-7 of the Form 10-K, as amended, filed for the year ended
December 31, 2003). Revenue Recognition We recognize revenues pursuant to Staff Accounting Bulletin No. 101, Revenue
Recognition. License fees are earned and recognized in accordance with the
provisions of each agreement. Upfront license fees for perpetual licenses
where we have no performance obligations are recognized when received. License
fees under agreements in which we have ongoing involvement or performance
obligations are recognized over the term of the agreement. Milestone payments
are recognized as revenue upon the completion of the milestone as long as the
milestone event was substantive, and its achievability was not reasonably
assured at inception and our performance obligations after milestone
achievement will continue to be funded at a comparable level before the
milestone achievement. Contract research and development funding is recognized
as revenue in the same period as reimbursable expenses under a contract are
incurred and in an amount or at a rate billable under each contracts terms.
Revenues from grants are recognized on a percentage-of-completion basis as
related costs are incurred. We defer revenue recognition until performance
obligations have been completed and collectibility is reasonably assured. Patents We capitalize the costs incurred to file patent applications when we believe
there is a high likelihood that the patent will issue and there will be future
economic benefit associated with the patent. These costs are amortized over a
ten-year life from the date of patent filing. We expense all costs related to
abandoned patent applications. In addition, we review the carrying value of
patents for indicators of impairment on a periodic basis. If we elect to
abandon any of our currently issued or unissued patents or we determine that
the carrying value is impaired, the related expense could be material to our
results of operations for the period of the abandonment. Investment Policy The primary objective of our investment activities is to preserve principal
while at the same time achieving competitive yields, without significantly
increasing risk. To achieve this objective, we primarily invest in cash and
money market accounts as well as A1 or P1 or higher rated debt securities with
maturities of less than two years, with the weighted average maturity not to
exceed eighteen months. We also attempt to minimize our portfolio risk by
placing constraints on how much of our portfolio may be held in a specific type
of investment such as asset-backed securities or collateralized mortgage
obligations as well as limiting our holdings in any one issuer. At March 31,
2004, our investment portfolio included only cash and money market accounts and
had no fixed-income securities. Results of Operations Three months ended March 31, 2004, as compared with three months ended March
31, 2003. In the three months ended March 31, 2004, we had total revenues of $2.6
million, as compared to $1.4 million in revenue in the three months ended March
31, 2003. The increase in the three months ended March 31, 2004 relates
primarily to a $1.2 million increase in grant and contract revenue and a $0.1
million increase in related party revenue, offset by a $0.1 million decrease in
licensing and milestone revenue. The increase in grant and contract revenue
was primarily due to reimbursement under new grants and contracts we received
from the National Institutes of Health (NIH) in the second half of 2003.
Related party revenue includes milestone payments, amortization of license fees
and contract research and development funding, as a result of our collaboration
with Genencor. The increase in related party revenue was a result of a
milestone payment we received on the program as a result of the filing of an 10




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Investigational New Drug application (IND) for a vaccine to treat hepatitis B
virus, partially offset by a reduction in contract research and development
funding due to the shift in focus from scientific research activities, the part
of the collaboration in which we are most involved, to preclinical development
on the lead program in support of the IND filing. In March 2004, Genencor
assigned its rights under our collaboration to Innogenetics NV. In connection
with the assignment by Genencor, we extended the collaboration term with
Innogenetics through September 2005. Innogenetics has the right to terminate
the collaboration early, upon three months written notice, if we breach our
obligations under the collaboration agreement or upon certain force majeure
events. The decrease in licensing and milestone revenue during the first
quarter of 2004 was a result of previously received evaluation and license
option fees being fully amortized into revenue by the end of 2003. Research and development expenses decreased to $2.4 million in the three months
ended March 31, 2004 from $2.6 million in the comparable period of 2003. The
decrease in the three months ended March 31, 2004 relates primarily to
reductions in labor and associated costs as a result of our work force
reduction in September 2003, partially offset by increases in subcontract and
other outside costs related to activities on new NIH grants and contracts we
received in the second half of 2003. We expect to incur research and
development costs in 2004 for, among other things, outside costs related to
clinical trials and development activities for our new NIH contract for a
preventive HIV vaccine, product formulation and manufacturing of product for
use in clinical trials, medical and clinical consultant costs and preclinical
development costs for additional vaccine candidates. General and administrative costs were approximately $0.7 million in the three
months ended March 31, 2004 and in the three months ended March 31, 2003.
Decreases in legal, accounting, printing and other outside costs in the three
months ended March 31, 2004 were offset by an increase in non-cash, stock-based
compensation charges related to a higher stock price for variable stock equity
instruments. The higher legal, accounting, printing and other outside costs in
the three months ended March 31, 2003 were related to a planned follow-on
public offering that was terminated during the first quarter of 2003. We
expect our general and administrative expenses to continue to decrease in 2004
over corresponding 2003 levels as due to reductions in labor and associated
costs as a result of our work force reduction in September 2003. Net interest income was negligible in the three months ended March 31, 2004 and
$0.1 million in the three months ended March 31, 2003. The decrease in
interest income was primarily due to the prepayment, in the second quarter of
2003, of the note issued for the purchase of shares by Dr. Emile Loria, our
president and chief executive officer, in January 2001. We also had lower
average cash balances and rates of return in the three months ended March 31,
2004, compared to the three months ended March 31, 2003. We expect to incur significant operating losses over the next several years due
to continuing expenses associated with our research and development programs,
including clinical trials, preclinical testing and development activities.
Operating losses may fluctuate from quarter to quarter as a result of
differences in the timing of revenues received and expenses incurred, and such
fluctuations may be substantial. Liquidity and Capital Resources We have financed operations since inception primarily through private
placements of equity securities, two public common stock offerings, revenues
under collaborative research and development agreements, grant revenues,
certain asset divestitures and interest income. Through March 31, 2004, we had
raised approximately $165.1 million from the sale of equity securities. As of
March 31, 2004, we had 15,228,920 shares outstanding on an as-converted to
common stock basis, assuming conversion of preferred shares. As of March 31, 2004, our cash and cash equivalents were $5.2 million compared
to $6.4 million at December 31, 2003. The decrease was primarily due to $1.0
million of cash to fund our clinical trials 11




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and research and development activities and $0.2 million for capitalized patent
costs. We expect to continue to use our cash and cash equivalents to fund our
ongoing and future clinical trials, as well as drug research and development
programs. Capital expenditures were negligible in the three months ended March 31, 2004
and in the three months ended March 31, 2003. In the past, we have financed
our laboratory equipment and research and office facilities primarily through
operating lease arrangements and a note payable. We fully paid off our note
payable as of the end of the first quarter of 2003. During 2004, we anticipate
that payments related to capital expenditures will increase modestly compared
to 2003 levels to a range of approximately $0.3 million to $0.4 million,
primarily for the purchase of equipment to support our clinical trials. We
will also pay approximately $0.6 million in rent on our lease commitments
during 2004. The future minimum rental commitment for the lease of our
facility will range from approximately $0.6 million to $0.7 million each year
over six years, based upon pre-established annual rent increases. Payments related to capitalized patent expenses were $0.2 million in the three
months ended March 31, 2004 compared to $0.1 million in the three months ended
March 31, 2003. The increase in the three months ended March 31, 2003 was
primarily due to expenses associated with consolidation of our patent portfolio
that we do not expect to be reoccurring. We expect payments related to patents
to be relatively flat in 2004 compared to 2003 as we anticipate seeing a full
year of benefit of our portfolio consolidation with one outside law firm, and
as we continue to perform administrative tasks in house whenever possible as we
pursue filings and claims in our intellectual property portfolio. Although we expect our use of cash to continue decreasing in 2004, we expect to
incur higher research and development expenditures in 2004 compared to 2003
levels in connection with our ongoing drug research and development programs,
including costs related to clinical trials, research and development activities
on sponsored programs and contracts, preclinical testing of product candidates
and manufacturing of clinical supplies. We intend to seek collaborative
research and development relationships with suitable corporate partners and
U.S. government agencies. We have in the past and may in the future also
license to third parties some of our technology in markets that we are not
pursuing ourselves or through our collaborations. Any agreements that may
result from these discussions may not successfully reduce our funding
requirements or, if entered into, may be terminated. We currently anticipate that total revenue for 2004 will be in the range of
$8.5 million to $10.0 million, which includes anticipated grant and contract
revenue, related party revenue and certain license fees. Our estimate assumes
that we recognize revenue from milestone or licensing payments under existing
agreements with third parties related to the licensing of our technology. We
also anticipate that operating expenses for the full year 2004 will rise from
$14.4 million in 2003 to between approximately $14.5 million and $15.5 million,
representing a 1% to 8% increase over 2003. The anticipated rise in expenses
relates to our ongoing Phase I/II clinical trials targeting HIV, lung cancer
and colorectal cancer and an increase in expenses under funded grants and
contracts from the NIH. We also anticipate using some of our cash in 2004 to
fund certain activities in our collaboration with Bavarian Nordic. We will
share equally with Bavarian Nordic in all research related expenses not covered
under our HIV vaccine contract from the NIH and have included these anticipated
expenditures in our operating expense forecast for 2004. We will also become
liable in 2004 for payment of license fees of up to $0.1 million. With existing cash and interest earned thereon, along with receipts from
existing contracts and our recent financing in April 2004, we expect to be able
to maintain our current level of operations through 2005, based on anticipated
expenditures. We will continue to spend substantial amounts on research and
development, including amounts spent for manufacturing clinical supplies,
conducting clinical trials for our product candidates and advancing development
of certain sponsored and partnered programs. Therefore, we will need to obtain
additional funding. We do not have committed external sources of funding and
may not be able to obtain any additional funding, especially if volatile market
conditions persist for biotechnology companies. If we are unable to obtain
additional funding, we will be required to 12




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delay, further reduce the scope of or eliminate one or more of our research and
development projects, sell the Company or certain of its assets or
technologies, or dissolve and liquidate all of its assets. As of March 31,
2004, we had approximately $5.2 million in cash and cash equivalents. Our
future operational and capital requirements will depend on many factors,
including:  
    
    whether we are able to secure additional financing on favorable
terms, or at all;
    
    the costs associated with our clinical trials for our vaccine
targeting HIV, which began in September 2002, including the status of
our contract with the NIH;
    
    the costs associated with our clinical trials for our vaccine
targeting lung and colorectal cancer, which began in February 2003;
    
    progress with other preclinical testing and clinical trials in the
future;
    
    our ability to establish and maintain collaboration and license
agreements and any government contracts and grants;
    
    the actual revenue we receive under our collaboration and license agreements;
    
    the actual costs we incur under our research collaboration with Bavarian Nordic;
    
    the actual payment of license fees which may become payable at the option of the licensor;
    
    the time and costs involved in obtaining regulatory approvals;
    
    the costs involved in filing, prosecuting, enforcing and defending
patent claims and any other proprietary rights;
    
    competing technological and market developments;
    
    changes in our existing research relationships;
    
    continued scientific progress in our drug discovery programs; and
    
    the magnitude of our drug discovery and development programs. As is typical in the biotechnology industry, our commercial success will depend
in part on not infringing upon the patent or other proprietary rights of others
and maintaining the technology licenses upon which our products might be based.
Our business is also subject to other significant risks, including the
uncertainties associated with our ability to enter into and maintain
collaborations, the lengthy regulatory approval process, and potential
competition from other products. Even if our products appear promising at an
early stage of development, they may not reach the market for a number of
reasons. Such reasons include, but are not limited to, our inability to fund
clinical development of such products, or the possibilities that the potential
products will be found ineffective during clinical trials, fail to receive
necessary regulatory approvals, be difficult to manufacture on a large scale or
be uneconomical to market. 13




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At March 31, 2004, our investment portfolio included only cash and money market
accounts and had no fixed-income securities. There would be no material impact
to our investment portfolio, in the short term, associated with any change in
interest rates and any decline in interest rates over time will reduce our
interest income, while increases in interest rates over time will increase our
interest income. 14




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RISK FACTORS We wish to caution readers that the following important factors, among others,
in some cases have affected our results and in the future could cause our
actual results and needs to vary materially from forward-looking statements
made from time to time by us on the basis of managements then-current
expectations. The business in which we are engaged is in rapidly changing and
competitive markets and involves a high degree of risk, and accuracy with
respect to forward-looking projections is difficult. Our substantial additional financing requirements and limited access to
financing may adversely affect our ability to develop products and fund our
operations. We will continue to spend substantial amounts on research and development,
including amounts spent for manufacturing clinical supplies, conducting
clinical trials for our product candidates and advancing development of certain
sponsored and partnered programs. Therefore, we will need to raise additional
funding, in addition to the approximately $5.5 million we raised in April 2004.
We do not have committed external sources of funding and may not be able to
obtain any additional funding, especially if volatile market conditions persist
for biotechnology companies. If we are unable to obtain additional funding, we
will be required to delay, further reduce the scope of or eliminate one or more
of our research and development projects, sell the Company or certain of its
assets or technologies, or dissolve and liquidate all of its assets. As of
March 31, 2004, we had approximately $5.2 million in cash and cash equivalents,
which excludes the net proceeds to us from our April 2004 financing. Our
future operational and capital requirements will depend on many factors,
including:  
    
    whether we are able to secure additional financing on favorable
terms, or at all;
    
    the costs associated with our clinical trials for our vaccine
targeting HIV, which began in September 2002, including the status of
our contract with the NIH;
    
    the costs associated with our clinical trials for our vaccine
targeting lung and colorectal cancer, which began in February 2003;
    
    progress with other preclinical testing and clinical trials in the
future;
    
    our ability to establish and maintain collaboration and license
agreements and any government contracts and grants;
    
    the actual revenue we receive under our collaboration and license agreements;
    
    the actual costs we incur under our research collaboration with Bavarian Nordic;
    
    the actual payment of license fees which may become payable at the option of the licensor;
    
    the time and costs involved in obtaining regulatory approvals;
    
    the costs involved in filing, prosecuting, enforcing and defending
patent claims and any other proprietary rights;
    
    competing technological and market developments;
    
    changes in our existing research relationships;
    
    continued scientific progress in our drug discovery programs; and 15




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
    
    the magnitude of our drug discovery and development programs. We intend to seek additional funding through collaboration and license
agreements, government research grants or equity or debt financings. In the
event we are able to obtain financing, it may not be on favorable terms. In
addition, we may not be able to enter into additional collaborations to reduce
our funding requirements. If we acquire funds by issuing securities, dilution
to existing stockholders will result, in addition to the dilution that occurred
as a result of our September 2003 and April 2004 financings. If we raise funds
through additional collaborations and license agreements, we will likely have
to relinquish some or all of the rights to product candidates or technologies
that we may have otherwise developed ourselves. If we are unable to obtain
funding, we may be required to engage in another restructuring, cease
development of some product candidates, further reduce the scope of our
operations, sell the Company or certain of its assets or technologies or cease
operations. We may not meet all of The Nasdaq National Markets continued listing
requirements and we may be delisted, which could reduce the liquidity of our
common stock and adversely affect our ability to raise additional necessary
capital. In order to continue trading on The Nasdaq National Market, we must comply with
The Nasdaq National Markets continued listing requirements, which require that
we maintain a minimum stockholders equity of $10.0 million and a minimum
closing bid price of $1.00 per share. Our stockholders equity was $9.3
million and $9.7 million as of March 31, 2004 and December 31, 2003,
respectively, which did not satisfy the $10.0 million continued listing
requirement. We believe that, after receipt of the net proceeds from our April
2004 financing, we satisfy the $10.0 million continued listing requirement as
of the date of filing of this report. The Nasdaq National Market will monitor
our ongoing compliance with listing requirements. If we fail to satisfy The
Nasdaq National Markets continued listing requirements at the time of our next
quarterly report on Form 10-Q or at any other time in the future, our common
stock may be delisted from The Nasdaq National Market. The delisting of our
common stock may result in the trading of the stock on The Nasdaq SmallCap
Market or the OTC Bulletin Board. Consequently, a delisting of our common
stock from The Nasdaq National Market may reduce the liquidity of our common
stock and adversely affect our ability to raise additional necessary capital. The process of developing therapeutic products requires significant research
and development, preclinical testing and clinical trials, all of which are
extremely expensive and time-consuming and may not result in a commercial
product. Except for our HIV and lung and colorectal cancer vaccine candidates, for which
we began clinical trials in September 2002 and February 2003 respectively, all
of our potential vaccine products are in research or preclinical development,
the results of which do not necessarily predict or prove safety or efficacy in
humans. We must demonstrate for each vaccine, safety and efficacy in humans
through extensive clinical testing, which is very expensive, can take many
years, and has an uncertain outcome. We may experience numerous unforeseen
events during or as a result of the testing process that could delay or prevent
testing or commercialization of our products, including the following:  
    
    the results of preclinical studies may be inconclusive, or they may
not be indicative of results that will be obtained in human clinical
trials;
    
    after reviewing test results, we or our collaborators may abandon
projects that we might previously have believed to be promising;
    
    we, our collaborators or regulators may suspend or terminate
clinical trials if the participating subjects or patients are being
exposed to unacceptable health risks; 16




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
    
    we may have to delay clinical trials as a result of scheduling
conflicts with participating clinicians and clinical institutions, or
difficulties in identifying and enrolling patients who meet trial
eligibility criteria;
    
    safety and efficacy results attained in early human clinical trials
may not be indicative of results that are obtained in later clinical
trials; and
    
    the effects our vaccine candidates have may not be the desired
effects or may include undesirable side effects or other
characteristics that preclude regulatory approval or limit their
commercial use if ever approved. The data collected from clinical trials may not be sufficient to support
regulatory approval of any of our products, and the FDA may not ultimately
approve any of our therapeutic products for commercial sale, which will
adversely affect our revenues and prospects. If we fail to commence or
complete, or experience delays in, any of our planned clinical trials, our
operating income, our stock price and our ability to conduct our business as
currently planned could be harmed. Some of our programs are funded by the government and the government may not
allocate funds for these programs in future fiscal years. We fund certain of our research and development related to our HIV, cancer and
malaria programs pursuant to multi-year grants and contracts from the
government. The government is under no obligation to and may not fund these
programs over their full term which would have a significant impact on our
ability to continue development of our HIV, cancer and malaria programs. Our history of operating losses and our expectations of continuing losses may
hurt our ability to reach profitability or continue operations. We have experienced significant operating losses since our inception in 1987.
As of March 31, 2004, we had an accumulated deficit of $158.4 million. We
expect to continue to incur substantial operating expenses and net operating
losses for the foreseeable future, which may hurt our ability to continue
operations. We have not generated revenues from the commercialization of any
product. All of our revenues to date have consisted of contract research and
development revenues, license and milestone payments, research grants, certain
asset divestitures and interest income. We expect that substantially all of our
revenues for the foreseeable future will result from similar sources. To
achieve profitable operations, we, alone or with collaborators, must
successfully identify, develop, register and market proprietary products. We do
not expect to generate revenues from the commercialization of any product for
at least six years (and this would assume approval of either our HIV or lung
and colorectal product candidates, which may not occur). We may not be able to
generate sufficient product revenue to become profitable. Even if we do achieve
profitability, we may not be able to sustain or increase our profitability on a
quarterly or yearly basis. The subordination of our common stock to our preferred stock could hurt common
stockholders and, upon conversion, our preferred stock will further dilute our
holders of common stock. Our common stock is expressly subordinate to our series S and series S-1
preferred stock in the event of our liquidation, dissolution or winding up.
With respect to our series S preferred, any merger or sale of substantially all
of our assets shall be considered a deemed liquidation. If we were to cease
operations and liquidate our assets, we would first be required to pay $10
million to our holders of preferred stock and there may not be any remaining
value available for distribution to the holders of common stock after providing
for the series S and series S-1 preferred stock liquidation preference. In
addition, due to adjustments to the conversion price of our series S preferred
stock, in the event our series S preferred stock is converted to common stock,
it will further dilute our holders of common stock. 17




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We are at an early stage of development, and we may experience delays and other
problems in entering clinical trials. We are an early stage research and development company, and only commenced our
first Phase I/II clinical trials for two of our vaccines within the past two
years. There are many factors outside of our control that may affect the timing
of completion of our current clinical trials, and any future clinical trials
may not commence when planned or be completed within any anticipated time
frame. We have already experienced unexpected delays in filing an IND for our
therapeutic vaccine candidate targeting HIV, due to additional time necessary
to complete all of the animal safety studies that were contemplated in our
pre-IND discussions with the FDA. We may experience unexpected delays in our
research and development efforts that would require us to postpone the
commencement or completion of clinical trials of other vaccine candidates. The
FDA may comment or raise concerns or questions with respect to any IND that we
file and, therefore, clinical trials may not begin when planned, if at all. Our failure to obtain issued patents and, consequently, to protect our
proprietary technology, could hurt our competitive position. Our success will depend in part on our ability to obtain and enforce claims in
our patents directed to our products, technologies and processes, both in the
United States and other countries. Although we have filed various patent
applications, our patent position is highly uncertain and involves complex
legal and factual questions. Legal standards relating to patentability,
validity and scope of patent claims in epitope identification and other aspects
of our technology field are still evolving. Patents may not issue from any of
the patent applications that we own or license and, if patents do issue, claims
issued in the patents may not be sufficiently broad to protect our vaccines,
technologies and processes. For example, even though our patent portfolio
includes patent applications with claims directed to peptide epitopes and
methods of utilizing sequence motifs to identify peptide epitopes, we cannot
assure you of the breadth of claims that will be allowed or that may issue in
future patents. Other risks and uncertainties that we face with respect to our
patents and patent applications include the following:  
    
    the pending patent applications we have filed or to which we have
exclusive rights may not result in issued patents or may take longer
than we expect to result in issued patents;
    
    the allowed claims of any patents that issue may not provide meaningful protection;
    
    we may be unable to develop additional proprietary technologies that are patentable;
    
    the patents licensed or issued to us may not provide a competitive advantage;
    
    other companies may challenge patents licensed or issued to us;
    
    disputes may arise regarding inventions and corresponding ownership
rights in inventions and know-how resulting from the joint creation or
use of intellectual property by us, our licensors, or collaborators;
and
    
    other companies may design around our patented technologies. Our competitors may develop products that are more effective and that render
our potential products obsolete. The biotechnology industry continues to undergo rapid change, and competition
is intense and is expected to increase. Our competitors may succeed in
developing technologies, vaccines or other therapeutic products that are more
effective than any of the products we are developing, which would render our
technology and products obsolete and noncompetitive. 18




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If we are unable to compete effectively in the highly competitive biotechnology
industry, our business will fail. Many companies and institutions compete with us in developing vaccines and
other therapies to activate the bodys immune system or to otherwise treat or
more effectively manage infectious diseases and cancer, including:  
    
    pharmaceutical companies;
    
    chemical companies;
    
    specialized biotechnology companies;
    
    academic institutions; and
    
    research organizations. Many of the companies developing competing technologies and products have
significantly greater financial resources and expertise in research and
development, manufacturing, preclinical and clinical development, obtaining
regulatory approvals and marketing than we do, and we may not be able to
compete effectively against them. Our vaccines under development address a range of cancer and infectious disease
markets. The competition in these markets is extremely formidable. There are 27
drugs currently approved in the United States for HIV and according to a PhRMA
2003 report on pharmaceutical drug development, there were 83 new product
candidates in clinical development for HIV and related conditions, including 15
HIV vaccines. In addition, according to the PhRMA2003 report, there were 395
new product candidates in clinical development for the treatment of cancer, and
at least 30 companies were developing more than 50 vaccines against various
cancers. An important factor in competition may be the timing of market
introduction of our vaccines and competitive products. Accordingly, the
relative speed with which we can develop vaccines, complete the clinical trials
and approval processes and supply commercial quantities of the vaccines to the
market are expected to be important competitive factors. We expect that
competition among products approved for sale will be based, among other things,
on product effectiveness, safety, reliability, availability, price and patent
position. Litigation regarding intellectual property rights owned or used by us may be
costly and time-consuming. Litigation may be necessary to enforce the claims in any patents issued to us,
to defend ourselves against any patents owned by third parties that are
asserted against us, or to determine the scope and validity of others
proprietary rights. In addition, we may have to participate in one or more
interference proceedings declared by the United States Patent and Trademark
Office, which could result in substantial costs to determine the priority of
inventions. If we become involved in litigation or interference proceedings, we may incur
substantial expense, and the proceedings may divert the attention of our
technical and management personnel, even if we ultimately prevail. An adverse
determination in proceedings of this type could subject us to significant
liabilities, allow our competitors to market competitive products without
obtaining a license from us, prohibit us from marketing vaccines or other
products or require us to seek licenses from third parties that may not be
available on commercially reasonable terms, if at all. If we cannot obtain such
licenses, we may be restricted or prevented from developing and commercializing
our product candidates. 19




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The enforcement, defense and prosecution of intellectual property rights,
United States Patent and Trademark Office interference proceedings and related
legal and administrative proceedings in the United States and elsewhere involve
complex legal and factual questions. As a result, these proceedings are costly
and time-consuming, and their outcome is uncertain. Litigation may be necessary
to:  
    
    assert against others or defend ourselves against claims of infringement;
    
    enforce patents in our portfolio owned by us or licensed from another party;
    
    protect our trade secrets or know-how; or
    
    determine the enforceability, scope and validity of the proprietary rights of ours or others. Unexpected side effects or other characteristics of our technology may delay or
otherwise hurt the development of our vaccine candidates. There may be side effects in our current or future clinical trials that we may
discover, including side effects that become apparent only after long-term
exposure, even though our safety tests may indicate favorable results. We may
also encounter technological challenges relating to these technologies and
applications in our research and development programs that we may not be able
to resolve. Any such unexpected side effects or technological challenges may
delay or otherwise adversely affect the development, regulatory approval or
commercialization of our drug candidates. There are no therapeutic vaccines that have been approved for use by the FDA
and our vaccines may not work, which would prevent us from ever becoming
profitable. Because there are not yet any therapeutic vaccines that have undergone the
complete clinical development process and FDA review, there is still
insufficient evidence that therapeutic vaccines will become products. Our
business is dependent upon the concept of therapeutic vaccines and, therefore,
if therapeutic vaccines were found not to be safe or effective, we would never
commercialize a product candidate and would never make a profit. Adverse publicity regarding the safety or side effects of the technology
approach or products of others could reduce our revenues and cause our stock
price to fall. Despite any favorable safety tests that may be completed with respect to our
product candidates, adverse publicity regarding vaccines or products being
developed or marketed by others could negatively affect us. If other
researchers studies raise or substantiate concerns over the safety or side
effects of vaccines or our technology approach or product development efforts
generally, our reputation and public support for our clinical trials or
products could be harmed, which would harm our business and could cause our
stock price to fall. Our research and development programs may not yield effective product
candidates, which could prevent us from developing our products. We cannot guarantee that our research and development programs will be
successful in identifying vaccine candidates for clinical trials. Even if we do
receive positive data during preclinical testing and during Phase I/II clinical
trials for our therapeutic vaccine candidates targeting HIV, and lung and
colorectal cancer or any other candidates we may develop, this data cannot be
relied upon as evidence that the clinical candidate will be safe and effective
in humans, and assuming we initiate any Phase III trials, data from Phase III
or other pivotal clinical trials may not be consistent with earlier data or be
sufficient to support regulatory approval. 20




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We may not identify the correct epitopes and, therefore, not develop a safe or
effective vaccine. Our strategy involves identifying multiple epitopes in order to create our
vaccines. If we are unable to identify the correct epitopes, or if we are
unable to combine them in the correct manner, to stimulate desired immune
responses we may never develop a vaccine that is safe or effective in any of
the indications that we are pursuing. Our business is based on a novel technology, which has not been used in any
commercial drugs, and may not work. Our vaccine candidates use epitopes to stimulate specific T cell immune
responses, but we are not aware of any commercial drugs that are based on this
technology. Our technology related to T cell stimulation is unproven and may
not produce any commercial vaccines. If we cannot obtain and maintain strategic collaborations on acceptable terms
in the future, we may not be able to develop products in markets where it would
be too costly or complex to do so on our own. We will need to enter into and maintain collaborative arrangements with
pharmaceutical and biotechnology companies or other strategic partners both for
development and commercialization of potential vaccine products in markets
where it would be too costly or complex to do so on our own. Currently, our
only collaborations are with Innogenetics and Bavarian Nordic. If we are not
able to enter into and maintain additional research and development
collaborations or other collaborations in the future on acceptable terms, we
may be forced to abandon development and commercialization of some vaccine
product candidates. If our collaboration or license arrangements are unsuccessful, our revenues and
product development may be limited. Our collaborations and license arrangements generally pose the following risks:  
    
    collaborators and licensees may not pursue further development and
commercialization of potential products resulting from our
collaborations or may elect not to renew research and development
programs;
    
    collaborators and licensees may delay clinical trials, underfund a
clinical trial program, stop a clinical trial or abandon a product
candidate, repeat or conduct new clinical trials or require new
formulation of a product candidate for clinical testing;
    
    expected revenue might not be generated because milestones may not
be achieved and product candidates may not be developed;
    
    collaborators and licensees could independently develop, or develop
with third parties, products that could compete with our future
products;
    
    the terms of our contracts with our current or future collaborators
and licensees may not be favorable to us in the future;
    
    a collaborator or licensee with marketing and distribution rights
to one or more of our products may not commit enough resources to the
marketing and distribution of our products, limiting our potential
revenues from the commercialization of a product; 21




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
    
    disputes may arise delaying or terminating the research,
development or commercialization of our product candidates, or result
in significant and costly litigation or arbitration; and
    
    collaborations and licensee arrangements may be terminated and we
will experience increased operating expenses and capital requirements
if we elect to pursue further development of the product candidate. We may not be able to obtain licenses to technology that is necessary for us to
develop products. We may be required to enter into licenses or other collaborations with third
parties in order to access technology that is necessary to successfully develop
certain of our products. We may not successfully negotiate acceptable licenses
or other collaborative arrangements that will allow us to access such
technologies. If we cannot obtain and maintain license rights on acceptable
terms to access necessary technologies, we may be prevented from developing
some product candidates. In addition, any technologies accessed through such
licenses or other collaborations may not help us achieve our product
development goals. We may not be able to commercialize our products under development if they
infringe claims in existing patents or patents that have not yet issued, and
this would materially harm our ability to operate. As is typical in the biotechnology industry, our commercial success will depend
in part on our ability to avoid infringing patents issued to others or
breaching the technology licenses upon which we might base our vaccines or
other products. We are aware of patents issued to others that contain claims
that may cover certain aspects of our or our collaborators technologies,
including cancer vaccine epitopes, HIV vaccine epitopes, and methods for
delivering DNA vaccines to patients. We do not believe that any of these known
patents are likely to require us to obtain a license in order to pursue the
development or commercialization of our vaccine product candidates. However, we
may be required to take a license under one or more of these patents to
practice certain aspects of our vaccine technologies in the United States, and
such a license may not be available on commercially reasonable terms, if at
all. If we fail to obtain a license on acceptable terms to any technology that
we need in order to develop or commercialize our vaccines or other products, or
to develop an alternative vaccine or other product that does not infringe on
the patent rights of others, we would be prevented from commercializing our
vaccine, and our business would be harmed. If we or our collaborators cannot cost-effectively manufacture vaccines in
commercial quantities and for clinical trials in compliance with regulatory
requirements, we or our collaborators may not be able to successfully
commercialize the products. We have not commercialized any products, and we do not have the experience,
resources or facilities to manufacture vaccines on a commercial scale. We will
not be able to commercialize any vaccines and earn product revenues unless we
or our collaborators demonstrate that we can manufacture commercial quantities
of vaccines in accordance with regulatory requirements. Among the other
requirements for regulatory approval is the requirement that prospective
manufacturers conform to the FDAs Good Manufacturing Practices, or GMP,
requirements specifically for biological drugs, as well as for other drugs. 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 the product meets applicable specifications and other
requirements. We currently rely and intend to continue to rely on third-party contract
manufacturers to produce materials needed for clinical trials and, ultimately,
for product commercialization. Third-party manufacturers may not be able to
meet our needs with respect to timing, quantity or quality. If we are unable to
contract for a sufficient supply of needed materials on acceptable terms, or if
we encounter 22




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delays or difficulties in our relationships with manufacturers, it may delay
clinical trials, regulatory approvals and marketing efforts for our vaccines.
Such delays could adversely affect our ability to earn revenues and our chances
of achieving profitability. We cannot be sure that we can manufacture, either
on our own our through contracts with outside parties, vaccines at a cost or in
quantities that are commercially viable. If we do not successfully develop and commercialize our products, we may never
generate significant revenues or become profitable. We have not completed the development of any product and, accordingly, have not
begun to market or generate revenues from the commercialization of any product.
We do not expect to market any of our therapeutic or prophylactic vaccines or
any other products for at least six years (and this would assume approval of
either our HIV or lung and colorectal product candidate, which may not occur).
If we do not successfully develop and commercialize products, we will never
generate revenues that would allow us to become profitable. The lengthy approval process and uncertainty of government regulatory
requirements may impair our ability to develop, manufacture and sell any
vaccines. We and our collaborators cannot commercialize our vaccines or other products if
we do not receive FDA or state regulatory approval to market our products. The
regulatory process for new therapeutic drug products, including the required
preclinical studies and clinical testing, is lengthy, uncertain and expensive.
We and our collaborators may not receive necessary FDA clearances for any of
our vaccines or other potential products in a timely manner, or at all. Once
approved, we are subject to the continuing requirements of the FDA.
Noncompliance with initial or continuing requirements can result in, among
other things:  
    
    fines and penalties;
    
    injunctions;
    
    seizure of products;
    
    total or partial suspension of product marketing;
    
    failure of the government to grant a new drug application;
    
    withdrawal of marketing approvals; and
    
    criminal prosecution. The length of the clinical trial process and the number of patients the FDA
will require to be enrolled in clinical trials in order to establish the safety
and efficacy of our products is uncertain. In addition, our clinical studies
may not provide the FDA with sufficient clinical data to permit approval of a
new drug application, or NDA, or a biologic license application, or BLA, even
though we or our collaborators believe we are doing the right studies based on
the protocol. The FDA or we and our collaborators may decide to discontinue or
suspend clinical trials at any time if the subjects or patients who are
participating in such trials are being exposed to unacceptable health risks or
if the results show no or limited benefit in patients treated with the vaccine
compared to patients in the control group. Regulatory requirements are evolving and uncertain. Future United States or
state legislative or administrative acts could also prevent or delay regulatory
approval of our products. Even if we obtain 23




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commercial regulatory approvals, the approvals may significantly limit the
indicated uses for which we may market our products. The approval process outside the United States is also uncertain and may limit
our ability to develop, manufacture and sell our products internationally. To market any drug products outside of the United States, we and our
collaborators are also subject to numerous and varying foreign regulatory
requirements, implemented by foreign health authorities, governing the design
and conduct of human clinical trials and marketing approval for vaccines or
other drug products. The approval procedure varies among countries and can
involve additional testing, and the time required to obtain approval may differ
from that required to obtain FDA approval. The foreign regulatory approval
process includes all of the risks associated with obtaining FDA approval set
forth above, and approval by the FDA does not ensure approval by the health
authorities of any other country, nor does the approval by foreign health
authorities ensure approval by the FDA. Even if we obtain regulatory approval, we may be required to perform additional
clinical trials or change the labeling of our products if we or others identify
side effects after our products are on the market, which could harm sales of
the affected products. If we or others identify adverse side effects after any of our vaccines or
other drug products are on the market, or if manufacturing problems occur:  
    
    regulatory approval may be withdrawn;
    
    reformulation of our products, additional clinical trials, changes
in labeling of our products or changes to or re-approvals of our
manufacturing facilities may be required;
    
    sales of the affected products may drop significantly;
    
    our reputation in the marketplace may suffer; and
    
    lawsuits, including costly and lengthy class action suits, may be brought against us. Any of the above occurrences could halt or reduce sales of the affected
vaccines or other products or could increase the costs and expenses of
commercializing and marketing these vaccines or other products. If we are unable to protect our trade secrets, we may be unable to protect from
competitors our interests in proprietary know-how that is not patentable or for
which we have elected not to seek patent protection. Our competitive position depends in part on our ability to protect trade
secrets that are not patentable or for which we have elected not to seek patent
protection. To protect our trade secrets, we rely primarily on confidentiality
agreements with our collaborative partners, employees and consultants.
Nevertheless, our collaborative partners, employees and consultants may breach
these agreements and we may be unable to enforce these agreements. In addition,
other companies may develop similar or alternative technologies, methods or
products or duplicate our technologies, methods or vaccines that are not
protected by our patents or otherwise obtain and use information that we regard
as proprietary, and we may not have adequate remedies in such event. Any
material leak of our confidential information into the public domain or to
third parties could harm our competitive position. 24




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If we lose our key scientific and management personnel or are unable to attract
and retain qualified personnel, it could delay or hurt our epitope
identification and vaccine development efforts. We are highly dependent on the principal members of our scientific and
management staff. We do not maintain key person life insurance on the life of
any employee and, although we have an employment contract with Dr. Emile Loria,
he may terminate his employment at any time. Our ability to identify epitopes,
develop vaccines and achieve our other business objectives also will depend in
part on the continued service of our key scientific and management personnel
and our ability to identify, hire and retain additional qualified personnel.
There is intense competition for qualified personnel in biochemistry, molecular
biology, immunology and other areas of our activities, and we may not be able
to continue to attract and retain such personnel necessary for the development
of our business. Because of the intense competition for qualified personnel
among technology-based businesses, particularly in the San Diego area, we may
not be successful in adding technical personnel as needed to meet the staffing
requirements of additional collaborative relationships. Our failure to attract
and retain key personnel could delay or be significantly detrimental to our
product development programs and could cause our stock price to decline. We out-license technology outside of our core area of focus, and these
licensees may not develop any products using our technology, which may limit
our revenue. We have licensed to third parties some of our technology in markets that we are
not pursuing ourselves or with our collaborators. If these licensees are not
successful in developing and commercializing products using our technology, our
revenues would be limited. Our licensees may pursue alternative technologies or
develop alternative products either on their own or in collaboration with
others in competition with products developed under licenses or collaborations
with us. Some of our programs are funded by the government and, therefore, the
government may have rights to certain of our technology and could require us to
grant licenses of our technology to third parties. We fund certain of our research and development related to our HIV, cancer and
malaria programs pursuant to grants from the government. As a result of these
grants, the government may have rights in the technology, including inventions
developed with government funding. In addition, the government may require us
to grant to a third party an exclusive license to any inventions resulting from
the grant if the government determines that we have not taken adequate steps to
commercialize inventions, or for public health or safety needs. Adverse determinations concerning product pricing, reimbursement and related
matters could prevent us from successfully commercializing products and impair
our ability to generate revenues. Our ability to successfully commercialize our vaccines or other products may
depend in part on the extent to which reimbursement for the cost of such
products and related treatment will be available from government health
administration authorities, private health insurers and other organizations.
Third-party payors are increasingly challenging the price of medical products
and services. Significant uncertainty exists as to the reimbursement status of
newly approved health care products, and adequate third-party coverage may not
be available to enable us to maintain price levels sufficient to realize an
appropriate return on our investment in product development. 25




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Product liability risks may expose us to significant liability that could cause
us to incur significant costs or cease developing our products. Our business exposes us to potential product liability risks that are inherent

in the testing, manufacturing and marketing of human therapeutic products.
While we currently have product liability insurance for an early stage clinical
trial, we cannot be sure that we can maintain such insurance on acceptable
terms or obtain acceptable insurance as we progress through product development
and commercialization, or that our insurance will provide adequate coverage
against potential liabilities, either in human clinical trials or following
commercialization of any vaccines we may develop. Our use of hazardous materials could expose us to significant costs. Our research and development processes involve the controlled storage, use and
disposal of hazardous materials, chemicals and radioactive compounds. We are
subject to federal, state and local laws and regulations governing the use,
manufacture, storage, handling and disposal of these materials and some waste
products. The risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of an accident, we could be held
liable for any damages that result, and any liability could exceed our
resources. We cannot be sure that compliance with environmental laws and
regulations in the future will not entail significant costs, or that our
ability to conduct research and development activities will not be harmed by
current or future environmental laws or regulations. The volatility of the price of our common stock may hurt our stockholders. The market prices for securities of biotechnology companies, including our
common stock, have historically been highly volatile, and the market from time
to time has experienced significant price and volume fluctuations that are not
necessarily related to the operating performance of such companies. From
January 1, 2003 through March 31, 2004, our closing stock price has ranged from
$0.760 to $3.166 and has been and will continue to be influenced by general
market and industry conditions. In addition, the following factors may have a
significant effect on the market price of our common stock:  
    
    whether we are able to secure additional financing on favorable
terms, or at all;
    
    announcements of technological innovations or new commercial
vaccines or other therapeutic products by us or others;
    
    governmental regulation that affects the biotechnology and pharmaceutical industries;
    
    developments in patent or other proprietary rights;
    
    receipt of funding under collaboration and license agreements and government grants;
    
    developments in, or termination of, our relationships with our collaborators and licensees;
    
    public concern as to the clinical results and/or the safety of
drugs developed by us or others; and
    
    announcements related to the sale of our stock. Fluctuations in our financial performance from period to period also may have a
significant impact on the market price of our common stock. 26




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Concentration of ownership among our existing officers, directors and principal
stockholders may prevent other stockholders from influencing significant
corporate decisions and depress our stock price. As of March 31, 2004, our officers, directors and those stockholders owning at
least five percent of our outstanding stock together control approximately
42.4% of our outstanding common stock as converted and Pharmacia, now part of
Pfizer, holds 100% of our preferred stock. If some or all of these officers,
directors and principal stockholders act together, they will be able to exert a
significant degree of influence over our management and affairs and over
matters requiring stockholder approval, including the election of directors and
approval or disapproval of any proposed merger or financing or other business
combination transaction. The interests of this concentration of ownership may
not always coincide with our interests or the interests of other stockholders.
For instance, officers, directors and principal stockholders, acting together,
could cause us to enter into transactions or agreements that we would not
otherwise consider. Similarly, this concentration of ownership may have the
effect of delaying or preventing a change in control of our company otherwise
favored by our other stockholders. This concentration of ownership also could
depress our stock price. 27




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ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted
an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures, as such term is defined under Rules
13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934,
as amended, within 90 days prior to the filing date of this report. Based on
their evaluation, our principal executive officer and principal financial
officer concluded that our disclosure controls and procedures are effective as
of the evaluation date. (b) Changes in Internal Controls There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above. 28




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS From time to time we are involved in certain litigation arising out
of our operations. We are not currently engaged in any legal
proceedings. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 3.1
    
    Amended and Restated Certificate of Incorporation filed
with the Secretary of State of Delaware on December 2,
1991.(1)Exhibit 3.2
    
    Certificate of Designation of Series A Junior
Participating Preferred Stock filed with the Secretary of
State of Delaware on April 2, 1993.(2)Exhibit 3.3
    
    Certificate of Amendment of Amended and Restated
Certificate of Incorporation filed with the Secretary of State
of Delaware on July 5, 1995.(3)Exhibit 3.4
    
    Certificate of Increase of Series A Junior
Participating Preferred Stock filed with the Secretary of
State of Delaware on July 5, 1995.Exhibit 3.5
    
    Certificate of Amendment of Amended and Restated
Certificate of Incorporation filed with the Secretary of State
of Delaware on July 2, 1998.(4)Exhibit 3.6
    
    Certificate of Increase of Series A Junior
Participating Preferred Stock filed with the Secretary of
State of Delaware on July 2, 1998.(4)Exhibit 3.7
    
    Certificate of Amendment of Amended and Restated
Certificate of Incorporation filed with the Secretary of State
of Delaware on November 12, 1998.(5)Exhibit 3.8
    
    Certificate of Designations of the Series S and Series
S-1 Preferred Stock filed with the Secretary of State of
Delaware on June 29, 1999.(6)Exhibit 3.9
    
    Certificate of Amendment of Amended and Restated
Certificate of Incorporation filed with the Secretary of State
of Delaware on July 1, 1999.(7)Exhibit 3.10
    
    Certificate of Amendment of Amended and Restated
Certificate of Incorporation filed with the Secretary of State
of Delaware on September 23, 1999.(8)Exhibit 3.11
    
    Certificate of Decrease of Series A Junior
Participating Preferred Stock filed with the Secretary of
State of Delaware on September 23, 1999.(8)Exhibit 3.12
    
    Amended and Restated Bylaws of the Registrant.(9)Exhibit 4.1
    
    Reference is made to Exhibits 3.1 through 3.12.Exhibit 4.2
    
    Specimen certificate of the common stock.(1)
 29




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Exhibit 10.48
    
    Second Amendment to the Collaboration Agreement dated
October 7, 2003 between Epimmune and Genencor International,
Inc.Exhibit 10.49
    
    Second Amendment to the License Agreement dated March
14, 2004 between Epimmune and Genencor International, Inc.
(with certain confidential portions deleted). (10)Exhibit 10.50
    
    Third Amendment to the Collaboration Agreement dated
March 16, 2004 between Epimmune and Innogenetics NV (with
certain confidential portions deleted). (10)Exhibit 10.51
    
    Third Amendment to the License Agreement dated March
29, 2004 between Epimmune and Innogenetics NV (with certain
confidential portions deleted). (10)Exhibit 31.1
    
    Certification of Principal Executive Officer pursuant
to Section 302 of the Public Company Accounting Reform and
Investor Protection Act of 2002 (18 U.S.C. § 1350, as adopted)Exhibit 31.2
    
    Certification of Principal Financial Officer pursuant
to Section 302 of the Public Company Accounting Reform and
Investor Protection Act of 2002 (18 U.S.C. § 1350, as adopted)Exhibit 32.1
    
    Certification pursuant to Section 906 of the Public
Company Accounting Reform and Investor Protection Act of 2002
(18 U.S.C. § 1350, as adopted)
   (1)
    
    Incorporated by reference to the Companys Form
S-1 Registration Statement and Amendments thereto (File No.
33-43356).(2)
    
    Incorporated by reference to the Companys Form
8-K, filed on March 22, 1993.(3)
    
    Incorporated by reference to the Companys Annual
Report on Form 10-K for the fiscal year ended December 31,
1994, filed on March 31, 1995.(4)
    
    Incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1998, filed on August 14, 1998.(5)
    
    Incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1998, filed on November 16, 1998.(6)
    
    Incorporated by reference to the Companys Form
8-K, filed on July 16, 1999.(7)
    
    Incorporated by reference to the Companys
Definitive Proxy Statement, filed on Form DEF 14A on July 28,
1999.(8)
    
    Incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1999, filed on November 15, 1999.(9)
    
    Incorporated by reference to the Companys Annual
Report on Form 10-K for the fiscal year ended December 31,
2001, filed on March 29, 2002. 30




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(10)
    
    Confidential Treatment has been requested with
respect to certain portions of this exhibit. Omitted portions
have been filed separately with the Securities and Exchange
Commission. (b) Reports on Form 8-K during the quarter ended March 31, 2004  1.)
    
    The Company filed a Report on Form 8-K on March
30, 2004 announcing its financial results for the quarter and
year ended December 31, 2003, and announcing the assignment by
the Companys corporate partner, Genencor International, Inc.,
of its rights under the collaboration between the parties to
Innogenetics NV. 31




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EPIMMUNE INC. 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.  EPIMMUNE INC.Date: May 10, 2004
    
    By:
    
    /s/ Emile LoriaEmile Loria, M.D.President, Chief Executive Officer and Director(Principal Executive Officer)Date: May 10, 2004
    
    By:
    
    /s/ Robert De VaereRobert De VaereVice President, Finance and Administration,Chief Financial Officer, Secretary(Principal Financial and Accounting Officer)
 32