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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER 33-60134
HOLLIS-EDEN PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-3697002
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
9333 GENESEE AVENUE, SUITE 110
SAN DIEGO, CA 92121
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 587-9333
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common stock, $.01 par value per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934
during the preceding months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of March 15, 1999 totaled approximately $162,189,762 based on
the closing stock price as reported by NASDAQ Stock Market.
As of March 15, 1999, there were 10,725,863 shares of the Registrant's
Common Stock, $.01 par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of Registrant's Annual Report to Stockholders for the
fiscal year ended December 31, 1998, are incorporated by reference into Part
II of this report. Registrant's definitive proxy statement to be filed with
the Securities and Exchange Commission, pursuant to regulation 14A in
connection with the 1999 Annual Meeting of Stockholders to be held on May 17,
1999, is incorporated by reference into Part III of this Report.
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HOLLIS-EDEN PHARMACEUTICALS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
INDEX
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PART I
Item 1 Business...................................................... 3
Item 2 Properties.................................................... 17
Item 3 Legal Proceedings............................................. 17
Item 4 Submission Of Matters To A Vote Of Security Holders........... 17
PART II
Market For Registrant's Common Stock And Related Stockholder
Item 5 Matters....................................................... 18
Item 6 Selected Financial Data....................................... 18
Item 7 Management's Discussion And Analysis Of Results Of Operations
And Financial Condition...................................... 18
Item 7A Quantitative and Qualitative Disclosures About Market Risk.... 18
Item 8 Financial Statements And Supplementary Data................... 18
Item 9 Changes In And Disagreements With Accountants On Accounting
And Financial Disclosures..................................... 18
PART III
Item 10 Directors And Executive Officers Of The Registrant............ 19
Item 11 Executive Compensation........................................ 19
Security Ownership Of Certain Beneficial Owners And
Item 12 Management.................................................... 19
Item 13 Certain Relationships And Related Transactions................ 19
PART IV
Exhibits, Financial Statements, Schedules And Reports On Form
Item 14 8-K........................................................... 20
Signatures.................................................... 21
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This Annual Report on Form 10-K contains certain forward-looking statements
that involve risks and uncertainties. The actual future results for Hollis-
Eden Pharmaceuticals, Inc. may differ materially from those discussed here.
Additional information concerning factors that could cause or contribute to
such differences can be found in this Annual Report on Form 10-K in Part I,
Item 1 under the caption "Risk Factors," Part II, Item 7 entitled
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" and elsewhere throughout this Annual Report.
PART I
ITEM 1. BUSINESS
GENERAL
Hollis-Eden Pharmaceuticals Inc., a development-stage pharmaceutical
company, is engaged in the discovery, development and commercialization of
products for the treatment of a number of targeted disease states caused by
viral, bacterial, parasitic or fungal infections, including HIV/AIDS,
hepatitis B and C, and malaria. The Company has three technology platforms,
one based on cellular energy regulation, the second on a unique immune system
modulation technology, and the third on biochemical synthesis regulators. The
Company believes that certain of its drug candidates may provide the first
long-term treatment for HIV without the development of viral strain resistance
to the drugs' effectiveness, significant toxicity or severe side effects. The
Company has not yet generated any operating revenues. The Company has
experienced significant operating losses due to substantial expenses incurred
to acquire and fund development of its drug candidates and, as of December 31,
1998, had an accumulated deficit of approximately $13.3 million. In February
1999, the Company received clearance from the FDA to begin clinical trials in
the United States for HE2000, the Company's lead drug candidate.
When and if any of the Company's drug candidates have been approved for
commercial sale, the Company plans to market them in the United States. For
international markets, the Company intends to develop strategic alliances with
major pharmaceutical companies that have foreign regulatory expertise and
established distribution channels, and will also consider corporate strategic
partnerships and co-marketing agreements. No assurances can be given that any
of the Company's drug candidates will be approved for commercial sale or that
any of the foregoing proposed arrangements will be implemented or prove to be
successful.
The Company has been unprofitable since inception and expects to incur
substantial additional operating losses for at least the next few years as it
increases expenditures on research and development and begins to allocate
significant and increasing resources to its clinical testing and other
activities. In addition, during the next few years, the Company will have to
meet the substantial new challenge of developing the capability to market
products. Accordingly, the Company's activities to date are not as broad in
depth or scope as the activities it must undertake in the future, and the
Company's historical operations and financial information are not indicative
of the Company's future operating results or financial condition or its
ability to operate profitably as a commercial enterprise when and if it
succeeds in bringing any drug candidate to market.
During March 1997, Hollis-Eden, Inc. ("Hollis-Eden"), a Delaware
corporation, was merged with and into the Company (then known as Initial
Acquisition Corp. ("IAC")). Upon the consummation of the merger, Hollis-Eden
ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals, Inc.
For accounting and financial reporting purposes, the merger was treated as a
recapitalization of Hollis-Eden. As used herein, unless otherwise indicated,
for periods prior to March 1997, the terms "Company" and "Hollis-Eden
Pharmaceuticals" shall refer to Hollis-Eden, not IAC.
TECHNOLOGY PLATFORMS
The Company's scientific approaches are based on the study of mechanisms
utilized by viruses or pathogenic microorganisms to infect their host. These
technological approaches have led to a novel series of proprietary
pharmaceutical products that will be tested for the treatment and/or
prevention of multiple targeted
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disease states caused by viral, bacterial, parasitic or fungal infections. The
underlying premise of the Company's technology is that the human immune system
inherently possesses the ability, when directed, to respond to a specific
infection or diseases. The Company's fundamental approach has been to identify
these naturally occurring therapeutic agents and to design and produce similar
improved versions. The following platforms represent the Company's innovative
technological opportunities:
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I. Antivirals that inhibit the energy producing enzymes that interrupt the
cellular factors the virus depends on for replication. By depriving the
virus of the raw materials and energy to replicate, it is possible to
effectively starve the virus and inhibit its replication.
II. Immune modulators that either down regulate or up regulate the immune
response system, thus enhancing the body's own ability to fight off
infection.
III. Novel enzyme inhibitors generally classified as cytokinins, to inhibit
the synthesis of an organism's RNA and DNA.
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These approaches have the advantage of producing fewer side effects and less
toxicity for patients.
TECHNOLOGY PLATFORM I - CELLULAR ENERGY REGULATORS
The Company's first platform focuses on ways to interrupt the human cellular
energy factors needed by viruses to replicate in their host human cells.
The Company recently developed HE2000, a new analog of the Company's lead
drug candidate, which has a unique mechanism of action for antiretroviral
treatment in HIV/AIDS and other infectious diseases. HE2000 has demonstrated a
10-fold increase in antiretroviral potency over an earlier version of HE2000.
In in vitro testing, HE2000 inhibits viral replication against diverse and
multiple drug resistant strains of the HIV virus. Currently approved
antiretroviral therapies are designed to block the action of specific HIV
viral proteins that have critical functions at particular stages of the
replication process. These therapies are subject to HIV mutation, resulting in
drug resistance.
HE2000 appears to work independently of the viral structure by inhibiting
human cellular energy producing enzymes, which are necessary for retroviral
replication. The Company's research affiliates, headed by Dr. Patrick
Prendergast, discovered that HIV deprives the host cell of a natural human
molecule that regulates cellular energy. The result of this action causes the
cell to increase the activity of the known energy producing enzymes necessary
for retroviral (HIV) replication. The Company believes that HE2000 decreases
the activity of the energy producing enzymes the cell requires to replicate
HIV and therefore prohibits viral replication. The Company believes that
HE2000 will inhibit viral replication on a sustained basis and will not
develop drug resistance. The Company intends to advance HE2000 into safety and
efficacy clinical trials this year.
TECHNOLOGY PLATFORM II - IMMUNE SYSTEM REGULATORS
The Company's second technology platform focuses on ways to up regulate and
down regulate the immune system of the body to treat various disorders.
HE317, the Company's drug candidate for up regulation of the immune system,
is intended to be tested in immune suppressed patients suffering from HIV/AIDS
either as monotherapy or adjunctive therapy with HE2000 or other
antiretroviral HIV/AIDS drugs. IDPS, the Company's drug candidate for down
regulating the immune system, will be tested in accepted animal models to
treat organ transplant rejection. In addition to working on products for organ
transplant rejection, the Company is exploring agents using IDPS technology to
treat other immune system disorders such as lupus, multiple sclerosis,
psoriasis, rheumatoid arthritis and scleroderma.
TECHNOLOGY PLATFORM III - SYNTHESIS REGULATORS
The Company's third platform is based on the regulation of biochemical
synthesis in the cell.
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The Company has discovered, developed and patented a range of modified
nucleosides, which are generally classified as cytokinins, and used as
antibacterial, antiparasitic, antifungal and antiviral agents to treat
diseases such as cytomegalovirus, tuberculosis, malaria, toxoplasmosis and
leishmania. The Company's drug candidates are directly involved with the
control of protein RNA and DNA synthesis and have demonstrated the ability to
selectively inhibit RNA synthesis and protein synthesis of a variety of intra-
cellular infective organisms.
The Company's drug candidates interact with a very important high-energy
signal molecule called cyclic nucleotide adenosine monophosphate (cAMP), and
because of its unique multi-targeted approach it may be universally effective
at inhibiting a wide array of infectious organisms and viruses in very small
concentrations. Furthermore, the Company has demonstrated in vitro and in vivo
that, with very low levels of these drug candidates, it may be possible to
inhibit both RNA and DNA viruses. This approach has been shown to be non-toxic
to normal body cells.
MARKET OPPORTUNITIES
The number of people suffering from diseases caused by microorganisms, such
as viruses, bacteria, fungi and parasites, is growing at an alarming rate
worldwide. At the same time, medical conditions involving immune system
disorders are being reported constantly in clinical journals, and new diseases
for which there are no known cures or treatments are becoming more prevalent.
Today, AIDS is the number one killer of Americans between the ages of 25 and
44. It is estimated by the Centers for Disease Control that approximately 1.1
million Americans are infected with HIV. Globally, the World Health
Organization ("WHO") and the Joint United Nations Programme on HIV/AIDS
reported as of December 1998 that approximately 33.4 million adults and
children are living with HIV/AIDS, a 10% increase from 1997. It is also
estimated that there were 5.8 million newly infected people and 2.5 million
deaths related to HIV/AIDS in 1998. That equates to 11 newly infected people
per minute and 16,000 per day in 1998.
WHO reports, that of the 170 million chronic carriers of hepatitis C in the
world, 20% are at risk of developing cirrhosis of the liver and 1% to 5% may
develop liver cancer. Today, the disease often is treated with Interferon,
which is only 20% effective, has significant side effects and is relatively
expensive to use.
According to the United Network of Organ Sharing, each year approximately
20,000 organ transplants are performed in the U.S., while more than 60,000
people remain on waiting lists and more than 6% of those die waiting.
According to Frost and Sullivan, this has created a $1.2 billion U.S. market
for drugs that suppress the body's immune system so as not to reject the
implanted organs. Hollis-Eden Pharmaceuticals, Inc., is conducting research
with drug candidates that may down regulate the immune system, potentially
allowing the body to better tolerate a mismatched transplanted organ or
tissue. The Company believes this new drug development discovery could
dramatically increase the number of transplants each year and result in rapid
market expansion in the U.S. and throughout the world.
Hollis-Eden Pharmaceutical's technology platforms enable the Company to
target multiple diseases and disorders. These technology platforms have
already identified molecules for drug candidates and have been tested both in
vitro and in vivo. According to the Pharmaceutical Manufacturers Association,
3,995 of every 4,000 compounds screened in preclinical animal testing never
make it to human clinicals. Earlier versions of HE2000 and HE317 have been
used in human clinical tests and appear to be well tolerated with no
significant side effects. Furthermore, the product significantly showed
efficacy by reducing the viral load in infected HIV/AIDS patients. Such safety
and efficacy results, coupled with the drugs' non-pathogenic mechanism of
action, indicate that they can also be used in several other diseases and
disorders. Another advantage of the Company's products is the fact that
extensive research has been completed, thereby reducing the time required for
final development and commercialization. Additionally, the Company is
strategically pursuing its initial indications in terminal or fatal diseases,
such as HIV/AIDS, where the Company's FDA approval process may be dramatically
shorter if the Company's products qualify for the FDA accelerated drug
approval program. See "FDA Overview--Accelerated Drug Approval."
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COMPETITION
Hollis-Eden Pharmaceuticals believes that its scientific approaches to
infectious diseases, which have led to multiple platform technologies, enable
the Company to develop products for multiple disease states. The Company
believes that certain of its initial products under development that are
focused on HIV/AIDS may realize more effective treatments than drugs currently
being used or developed by the competition. The principal drugs currently used
to treat HIV and AIDS (e.g., AZT, ddI, ddc, d4T and 3TC) are nucleoside analog
reverse transcriptase drugs. Additionally, most newer drugs being developed
and recently being introduced are protease inhibitors; e.g., Invirase
(Saquinavir), Crixivan (Indinavir sulfate), Viracept (Nelfinavir) and Novir
(Ritonavir). Hollis-Eden Pharmaceuticals believes that the effectiveness of
these types of drugs may prove to be short-lived since HIV rapidly mutates and
develops resistance to the effectiveness of these drugs. Development of drug
resistance occurs when the virus can mutate its coat protein or enzyme
structure so that its interaction with the drug is altered. Another
disadvantage of currently used treatments is that nucleoside analogues and
protease inhibitors are toxic and can cause severe and intolerable side
effects. HE2000 and HE317 are not reverse transcriptase or protease
inhibitors, but are derived from naturally occurring substances and are
expected to be well-tolerated by humans with minimal side effects.
Furthermore, Hollis-Eden Pharmaceuticals believes that its drug candidates
will have a longer duration of effectiveness, be more affordable and require
smaller doses and fewer pills to be taken than the drugs and combinations
currently being used.
Because HE2000's antiviral effectiveness is not reliant on a direct
structural interaction with the virus itself, Hollis-Eden Pharmaceuticals
believes that HE2000 will inhibit replication of the virus regardless of its
mutation rates. By decreasing the synthesis of the viral raw materials in the
cell, HE2000 effectively slows and may eventually stop the virus' production
line. The Company further expects that HE2000 will decrease the energy supply
for viral synthesis regardless of the viral type or strain.
FDA OVERVIEW
GENERAL
The manufacturing and marketing of Hollis-Eden Pharmaceuticals' proposed
products and its research and development activities are and will continue to
be subject to regulation by federal, state and local governmental authorities
in the United States and other countries. In the United States,
pharmaceuticals are subject to rigorous regulation by the FDA's Center for
Drug Evaluation and Research, which reviews and approves marketing of drugs.
The Federal Food, Drug and Cosmetic Act, the regulations promulgated
thereunder, and other federal and state statutes and regulations govern, among
other things, the testing, manufacturing, labeling, storage, record keeping,
advertising and promotion of Hollis-Eden Pharmaceuticals' potential products.
APPROVAL PROCESS
The process of obtaining FDA approval for a new drug may take several years
and generally involves the expenditure of substantial resources. Hollis-Eden
Pharmaceuticals will try to accelerate the drug approval process because of
the priority status of HIV/AIDS drugs. See "Accelerated Drug Approval." The
steps required before a new drug can be produced and marketed for human use
include clinical trials and the approval of a New Drug Application.
Preclinical Testing. The promising compound is subjected to extensive
laboratory and animal testing to determine if the compound is biologically
active and safe.
Investigational New Drug (IND). Before human tests can start, the drug
sponsor must file an IND application with the FDA, showing how the drug is
made and the results of animal testing. If the FDA does not reject the
application within 30 days, IND status allows initiation of clinical
investigation.
Human Testing (Clinical). The human clinical testing program usually
involves three phases which generally are conducted sequentially, but which,
particularly in the case of anti-cancer and other life saving
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drugs, may overlap or be combined. Clinical trials are conducted in accordance
with protocols that detail the objectives of the study, the parameters to be
used to monitor safety and the efficacy criteria to be evaluated. Each
protocol is submitted to the FDA as part of the IND filing. Each clinical
study is conducted under the auspices of an independent Institutional Review
Board ("IRB") for each institution at which the study will be conducted. The
IRB will consider, among other things, all existing pharmacology and
toxicology information on the product, ethical factors, the risk to human
subjects and the potential benefits of therapy relative to risk.
In Phase I clinical trials, studies usually are conducted on healthy
volunteers but, in the case of certain terminal illnesses such as AIDS, are
conducted on patients with disease that usually has failed to respond to other
treatment to determine the maximum tolerated dose, side effects and
pharmacokinetics of a product. Phase II studies are conducted on a small
number of patients having a specific disease to determine initial efficacy in
humans for that specific disease, the most effective doses and schedules of
administration, and possible adverse effects and safety risks. Phase II/III
differs from Phase II in that the trials involved may include more patients
and, at the sole discretion of the FDA, be considered the pivotal trial or
trials for FDA approval (see below). Phase III normally involves the pivotal
trials of a drug, consisting of wide-scale studies on patients with the same
disease, in order to evaluate the overall benefits and risks of the drug for
the treated disease compared with other available therapies. The FDA
continually reviews the clinical trial plans and results and may suggest
design changes or may discontinue the trials at any time if significant safety
or other issues arise.
New Drug Application (NDA). Upon completion of Phase III, the drug sponsor
must file an NDA containing all information that has been gathered. The
information must include the chemical composition of the drug, scientific
rationale, purpose, animal and laboratory studies, results of human tests,
formation and production details, and proposed labeling.
Approval. Once an NDA is approved, the drug sponsor is required to submit
reports periodically to the FDA containing adverse reactions, production,
quality control and distribution records. The FDA may also require post-
marketing testing to support the conclusion of efficacy and safety of the
product, which can involve significant expense. After FDA approval is obtained
for initial indications, further clinical trials may be necessary to gain
approval for the use of the product for additional indications.
The testing and approval process is likely to require substantial time and
effort, and there can be no assurance that any FDA approval will be granted on
a timely basis, if at all. The approval process is affected by a number of
factors, primarily the side effects of the drug (safety) and its therapeutic
benefits (efficacy). Additional preclinical or clinical trials may be required
during the FDA review period and may delay marketing approval. The FDA may
also deny an NDA if applicable regulatory criteria are not met.
Outside the United States, Hollis-Eden Pharmaceuticals will be subject to
foreign regulatory requirements governing human clinical trials and marketing
approval for its products. The requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursements vary widely from country
to country.
ACCELERATED DRUG APPROVAL
In December 1992, the FDA formalized procedures for accelerating the
approval of drugs to be marketed for the treatment of certain serious
diseases. To be eligible for this program, the products must treat serious or
life-threatening illnesses and provide meaningful therapeutic benefits beyond
existing treatments. Under these regulations, a significant new therapy could
be approved for marketing at the earliest possible point at which safety and
effectiveness are reasonably established under existing law. For example, the
approval of a drug could be accelerated by demonstrating a favorable effect on
a well-documented surrogate endpoint to predict clinical benefit, instead of
requiring that the drug demonstrate actual clinical benefit.
An important and unique element of these regulations is that approval would
be granted only if the sponsor agrees to conduct additional post-marketing
studies to confirm the product's effectiveness and/or agrees to restrict
distribution of the product. In addition, if the further clinical trials do
not bear out the product's effectiveness or if restricted distribution is
inadequate to assure safe use, approval of the product would be withdrawn.
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MANUFACTURING
Hollis-Eden Pharmaceuticals does not have, and does not intend to establish,
manufacturing facilities to produce its products. Hollis-Eden Pharmaceuticals
plans to control its initial capital expenditures by using contract
manufacturers to make its products. Hollis-Eden Pharmaceuticals believes that
there are a sufficient number of high quality FDA approved contract
manufacturers available, and management has had discussions and established
relationships with several of them, to fulfill its near-term production needs
for both clinical and commercial use.
The manufacture of Hollis-Eden Pharmaceuticals' products, whether done by
outside contractors (as planned) or Hollis-Eden Pharmaceuticals, will be
subject to rigorous regulations, including the need to comply with the FDA's
current Good Manufacturing Practice standards. As part of obtaining FDA
approval for each product, each of the manufacturing facilities must be
inspected, approved by and registered with the FDA. In addition to obtaining
FDA approval of the prospective manufacturer's quality control and
manufacturing procedures, domestic and foreign manufacturing facilities are
subject to periodic inspection by the FDA and/or foreign regulatory
authorities.
PATENTS
Hollis-Eden Pharmaceuticals considers the protection of its products,
whether owned or licensed, to the exclusion of use by others, to be vital to
its business. While the Company intends to focus primarily on patented or
patentable technology, it may also rely on trade secrets, unpatented property,
know-how, regulatory exclusivity, patent extensions and continuing
technological innovation to develop its competitive position. In the United
States and certain foreign countries, the exclusivity period provided by
patents covering pharmaceutical products may be extended by a portion of the
time required to obtain regulatory approval for a product.
In certain countries, pharmaceuticals are not patentable or only recently
have become patentable, and enforcement of intellectual property rights in
many countries has been limited or non-existent. Future enforcement of patents
and proprietary rights in many countries can be expected to be problematic or
unpredictable. There can be no assurance that any patents issued or licensed
to Hollis-Eden Pharmaceuticals will provide it with competitive advantages or
will not be challenged by others. Furthermore, there can be no assurance that
others will not independently develop similar products or will not design
around patents issued or licensed to Hollis-Eden Pharmaceuticals.
Patent applications in the United States are maintained in secrecy until
patents issue. Publication of discoveries in the scientific or patent
literature, if made, tends to lag behind actual discoveries by several months.
Consequently, the Company cannot be certain that a licensor of its
intellectual property was the first to invent certain technology or compounds
covered by pending patent applications or issued patents or that it was the
first to file patent applications for such inventions. In addition, the patent
positions of pharmaceutical companies, including those of Hollis-Eden
Pharmaceuticals, are generally uncertain, partly because they involve complex
legal and factual questions.
In addition to the considerations discussed above, companies that obtain
patents claiming products, uses or processes that are necessary for or useful
to the development of Hollis-Eden Pharmaceuticals' products could bring legal
actions against the Company claiming infringement. Patent litigation is
typically costly and time-consuming, and if such an action were brought
against Hollis-Eden Pharmaceuticals, it could result in significant cost and
diversion of management time. The Company may be required to obtain licenses
to other patents or proprietary rights, and there can be no assurance that
licenses would be made available on terms acceptable to the Company. If
Hollis-Eden Pharmaceuticals does not obtain such licenses, it could encounter
delays in product market introductions while it attempts to license technology
designed around such patents or could find that the development, manufacture
or sale of products requiring such licenses is foreclosed.
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Further, there can be no assurance that patents that are issued will not be
challenged, invalidated or infringed upon or designed around by others, or
that the claims contained in such patents will not infringe the patent claims
of others, or provide Hollis-Eden Pharmaceuticals with significant protection
against competitive products, or otherwise be commercially valuable. There can
be no assurance that the Company will not need to acquire licenses under
patents belonging to others for technology potentially useful or necessary to
the Company or, if any such licenses are required, that they will be available
on terms acceptable to the Company, if at all. To the extent that Hollis-Eden
Pharmaceuticals is unable to obtain patent protection for its products or
technology, Hollis-Eden Pharmaceuticals' business may be adversely affected by
competitors who develop substantially equivalent technology.
LICENSE AGREEMENTS
Certain provisions of agreements relating to the products have been
renegotiated and amended from time to time, primarily to defer cash payments
due under the agreements. The amendments have streamlined Hollis-Eden
Pharmaceuticals' commitments and contingencies. The discussion below reflects
the nature of its agreements as in effect at the current time. Although the
Company believes the following summaries to be accurate, such summaries are
qualified in their entirety by reference to their original documents.
COLTHURST LICENSE AGREEMENT
In May 1994, Hollis-Eden Pharmaceuticals entered into a license agreement,
as amended in August 1995 and October 1996, with Colthurst Limited
("Colthurst") and Patrick T. Prendergast, Ph.D., pursuant to which Hollis-Eden
Pharmaceuticals was granted exclusive worldwide rights to all present and
future patent rights, know-how and background technology of Colthurst and Dr.
Prendergast relating to the treatment of retroviral infections for all uses
thereunder to develop and commercialize products based on the licensed rights.
The Company also has the right to sublicense any such rights.
Hollis-Eden Pharmaceuticals paid a license fee of $100,000 to Colthurst upon
execution of the agreement and was required to pay an additional license fee
of $250,000, of which Hollis-Eden Pharmaceuticals paid $125,000 to Colthurst
in March 1995. The remainder of such fee becomes due according to the terms of
the agreement. The Company issued 37,736 shares of Common Stock to Colthurst
and, beginning August 1995, the Company agreed to make monthly payments of
$5,000 to the licensors. Hollis-Eden Pharmaceuticals is also obligated to pay
to Colthurst royalties on revenues from products covered by the licensed
rights and on revenues received by the Company in connection with sublicenses
granted by the Company to third parties. Hollis-Eden Pharmaceuticals must pay
a renewable annual license fee, which fee is deductible from royalty fees due
to Colthurst during a certain period following renewal of the license. There
can be no assurance that the Company will be able to pay such annual fees in
the future, in which event the termination of the agreement and the licensing
of such rights to a third party would have a material adverse effect on the
Company's business.
EDENLAND LICENSE AGREEMENT
In August 1994, Hollis-Eden Pharmaceuticals entered into a license
agreement, as amended in August 1995, with Edenland, Inc. ("Edenland") and Dr.
Prendergast pursuant to which Hollis-Eden Pharmaceuticals was granted
exclusive worldwide rights to all present and future patent rights, know-how
and background technology of Edenland and Dr. Prendergast relating to the
anti-serum/vaccine for all uses thereunder to develop and commercialize
products based on the licensed rights. The Company also has the right to
sublicense any such rights.
Hollis-Eden Pharmaceuticals paid a license fee of $25,000 upon execution of
the agreement and an additional license fee in the aggregate of $100,000 over
a six-month period ending February 28, 1995. The Company issued to Edenland
and Dr. Prendergast an aggregate of 543,396 shares of the Company Common Stock
and agreed that either Dr. Prendergast or his brother, Leo Prendergast, at
Edenland's election, has the right to serve on Hollis-Eden Pharmaceuticals'
Board of Directors for three years. The Company is also obligated to
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pay Edenland a license fee of $572,000, of which the Company paid $125,000 to
Edenland in March 1995. The remainder of such fee becomes due according to the
terms of the agreement. Hollis-Eden Pharmaceuticals issued to Edenland a
warrant to purchase 37,736 shares of Common Stock at an exercise price of
$15.90 per share, 37,736 shares of Common Stock and registration rights pari
passu with certain other investors of Hollis-Eden Pharmaceuticals. In
addition, beginning August 1995, the Company agreed to make monthly payments
of $5,000 to the licensors. The Company is obligated to pay to Edenland
royalties on revenues from products covered by the licensed rights and on
revenues received by the Company in connection with sublicenses granted by the
Company to third parties. Pursuant to the terms of the agreement, with certain
limitations, Edenland has the option to receive such royalties in the form of
Common Stock. Furthermore, as a condition to the Company's commercialization
rights to any product for which regulatory approval is obtained and a certain
revenue milestone is achieved, the Company is obligated to pay Edenland a
renewable annual license fee for such product for a period of six years. Such
annual fee, however, is deductible from royalty fees due to Edenland,
including royalty payments due to Edenland in connection with sublicenses
granted by Hollis-Eden Pharmaceuticals, during the term of the agreement.
HE317 will cease to be a product covered by the license agreement if Hollis-
Eden Pharmaceuticals has not contributed a certain amount of funding to the
development of HE317 in accordance with the terms and conditions of the
related Research and Development Agreement (described below). There can be no
assurance that the Company will be able to pay such annual fees in the future,
in which event the termination of certain rights and the licensing of such
rights to a third party would have a material adverse effect on the Company's
business.
RESEARCH AND DEVELOPMENT AGREEMENT
In August 1994, Hollis-Eden Pharmaceuticals entered into a research,
development and option agreement, as amended in August 1995 and October 1996,
with Edenland and Dr. Prendergast, pursuant to which Edenland agreed to obtain
an open IND for HE317 from the FDA and to commence a patient Phase I IND study
under the guidelines and regulations of the FDA. The Company is obligated to
pay Edenland the development costs associated with such Phase I study, for
which the Company has agreed to commit a certain minimum amount from its
annual research and development budget. After the payment of such development
costs and upon the determination that the new product will not meet regulatory
approval, Hollis-Eden Pharmaceuticals has the right to terminate its
obligation to pay any further development costs of HE317.
Edenland granted Hollis-Eden Pharmaceuticals the exclusive option to acquire
exclusive worldwide rights to all new products of Edenland relating to the
modulating of the immune system and all patent rights, know-how and background
technology from which such new products were derived, which rights, upon
exercise of the option by Hollis-Eden Pharmaceuticals, are governed by the
terms and conditions of the Edenland license agreement. The research and
development agreement terminates concurrently with the termination of the
Edenland license agreement.
RECAPITALIZATION
On March 26, 1997, Hollis-Eden was merged with and into IAC pursuant to an
Agreement and Plan of Merger, dated November 1, 1996, among IAC, Hollis-Eden,
Mr. Salvatore J. Zizza and Mr. Richard B. Hollis (the "Merger Agreement").
Upon consummation of the merger of Hollis-Eden with IAC (the "Merger"),
Hollis-Eden ceased to exist, and IAC changed its name to Hollis-Eden
Pharmaceuticals, Inc. IAC (now called Hollis-Eden Pharmaceuticals, Inc.)
remains the continuing legal entity and registrant for Securities and Exchange
Commission reporting purposes. The Merger was intended to be a tax-free
reorganization for federal income tax purposes and was accounted for as a
recapitalization of Hollis-Eden by an exchange of Common Stock of Hollis-Eden
for the net assets of IAC, consisting primarily of cash. IAC was formed to
serve as a vehicle to effect a merger, exchange of capital stock, asset
acquisition or other business combination with a target business, which IAC
believed has significant growth potential.
Under the terms of the Merger Agreement, each share of Hollis-Eden Common
Stock outstanding immediately prior to the closing of the Merger converted
into one share of Common Stock of Hollis-Eden
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<PAGE>
Pharmaceuticals, Inc. Common Stock ("Company Common Stock"), and all warrants
and options to purchase Hollis-Eden Common Stock outstanding immediately prior
to the Merger converted into the right to receive the same number of shares of
Company Common Stock. At the closing of the Merger, 4,911,004 shares of
Company Common Stock were issued, which represented approximately 85% of the
shares of Company Common Stock outstanding immediately after consummation of
the Merger.
EMPLOYEES
As of March 15, 1999, the Company had 14 full-time employees. The Company
believes that its relations with its employees are good.
FOUNDERS
The Company was founded by Richard B. Hollis (see "Executive Officers") and
Patrick T. Prendergast, Ph.D. Dr. Prendergast, whose specialty is in anti-
viral drug screening and assessment, developed the drug candidates licensed to
Hollis-Eden Pharmaceuticals. His research interests are virology, molecular
immunological and genetic analysis of animal and human lentiviruses, human
herpes virology and immunology, anti-viral agent isolation and retroviral
diagnostics. Dr. Prendergast has been primarily engaged in medical research
and development activities through two research and development companies
controlled by him, Colthurst and Edenland, since 1985 and 1987, respectively.
These companies investigated and screened human hormones and proteins as anti-
HIV drugs. Dr. Prendergast filed foreign patents on the use of these agents
for the treatment of viral caused immune disorders. Dr. Prendergast received
his Ph.D. in microbiology from the University College of Galway, Ireland in
1982.
EXECUTIVE OFFICERS
The executive officers of the Company and their ages as of March 15, 1999
are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Richard B. Hollis.............. 46 Chairman of the Board, President and Chief Executive Officer
James M. Frincke, Ph.D. ....... 48 Executive Vice President, Research and Development
Robert L. Marsella............. 46 Vice President, Business Development and Marketing
Thomas C. Merigan, Jr., M.D. .. 65 Medical Director, Infectious Diseases
Robert W. Weber................ 48 Vice President - Controller
</TABLE>
RICHARD B. HOLLIS, age 46, has served as Chairman of the Board and Chief
Executive Officer of the Company since March 1997 (since August 1994 including
Hollis-Eden, Inc.) and as President of the Company since February 1999. Mr.
Hollis was the founder of Hollis-Eden, Inc. and also served as Hollis-Eden,
Inc.'s President from August 1994 to February 1997. Mr. Hollis has over 20
years of experience in the health care industry in positions ranging from
sales to Chief Executive Officer. Mr. Hollis served as Chief Operating Officer
of Bioject Medical from 1991 to 1994 and as Vice President, Marketing and
Sales/General Manager for Instromedix from 1989 to 1991. From 1986 to 1989,
Mr. Hollis served as a general manager of the Western business unit of
Genentech, Inc., a manufacturer of biopharmaceuticals. Prior to joining
Genentech, Inc., Mr. Hollis served as a divisional manager of Imed
Corporation, Inc., a manufacturer of drug delivery systems, intravenous
infusion pumps and controllers. Mr. Hollis began his career in the health care
industry with Baxter Travenol from 1974 to 1977. Mr. Hollis received his B.A.
in Psychology from San Francisco State University in 1974.
JAMES M. FRINCKE, PH.D. became Executive Vice President, Research and
Development, of the Company in November 1997. During his 17 years in the
industry, Dr. Frincke has managed major programs for research and development
of drugs, biologicals, cellular and gene therapeutics that are aimed at the
treatment of cancer, infectious diseases and tissue transplantation. Since
joining the biotechnology industry, Dr. Frincke has held vice president,
research and development positions, in several biotechnology companies
including Hybritech/Eli Lilly. Most recently, he served as Vice President of
Therapeutics Research and Development at Prolinx, from 1995 to
11
<PAGE>
1997, Vice President of Bio-Organic Chemistry and Vice President of Research
and Development for Systemix from 1991 to 1995. In various capacities, he has
been responsible for all aspects of pharmaceutical development, including
early stage research programs, product evaluation, pharmacology,
manufacturing, and the management of the regulatory and clinical matters of
lead product opportunities. Dr. Frincke has authored and co-authored more than
100 scientific articles, abstracts and regulatory filings. Dr. Frincke
received his Ph.D. in chemistry at the University of California, Davis in
1978. In 1981, Dr. Frincke completed his postdoctoral work at the University
of California, San Diego.
ROBERT L. MARSELLA became Vice President, Business Development and
Marketing, of the Company in September 1997. Mr. Marsella has over 18 years of
medical sales, marketing and distribution experience. Since 1994 Mr. Marsella
has been President of RLM Cardiac Products, an exclusive distributor in the
Southwestern United States of various cardiac related hospital products. From
1990 to 1994, Mr. Marsella marketed and distributed implantable pacemakers and
defibrillators for Telectronics Pacing Systems. From 1987 to 1990,
Mr. Marsella served as Regional Manager for Genentech, Inc. and launched
ACTIVASE t-PA(TM) (a Biopharmaceutical drug) in the Western United States.
From 1983 to 1987, Mr. Marsella marketed intravenous infusion pumps for Imed
Corporation. Mr. Marsella began his career in 1980, as a field sales
representative, and was quickly promoted to regional sales manager for U.S.
Surgical Corporation, auto suture division. Mr. Marsella received his B.A.
degree from San Diego State University in 1975.
THOMAS CHARLES MERIGAN, JR., M.D., age 65, has served as a director and as
Chairman of the Scientific Advisory Board of the Company since March 1997
(since March 1996 including Hollis-Eden, Inc.). Dr. Merigan has been George E.
and Lucy Becker Professor of Medicine at Stanford University School of
Medicine from 1980 to the present. Dr. Merigan has also been the Principal
Investigator, NIAID Sponsored AIDS Clinical Trials Unit, from 1986 to the
present and has been Director of Stanford University's Center For AIDS
Research from 1988 to the present. Dr. Merigan is a member of various medical
and honorary societies, has lectured extensively within and outside the United
States, has authored numerous books and articles and has chaired and edited
symposia relating to viruses, infectious diseases, anti-viral agents, HIV and
other retroviruses and AIDS. From 1990 to the present, Dr. Merigan has been
Chairman, Editorial Board of "HIV: Advances in Research and Therapy". He is
also a member of the editorial boards of "Aids Research and Human
Retroviruses" (since 1983), "International Journal of Anti-Microbial Agents"
(since 1990), and "The Aids Reader" (since 1991), among others. He is a co-
recipient of eight patents which, among other things, relate to synthetic
polynucleotides, modification of hepatitis B virus infection, treatment of HIV
infection, purified cytomegalovirus protein and composition and treatment for
herpes simplex. Dr. Merigan has been Chair, Immunology Advisory Board, Bristol
Myers Squibb Corporation (1989--1995) and Chair, Scientific Advisory Board,
Sequel Corp. (1993--1996). In 1994, Stanford University School of Medicine
honored him with the establishment of the Annual Thomas C. Merigan Jr. Endowed
Lectureship in Infectious Diseases, and, in 1996, Dr. Merigan was elected
Fellow, American Association for the Advancement of Science. From 1966 to
1992, Dr. Merigan was Head, Division of Infectious Diseases, at Stanford
School of Medicine. Dr. Merigan received his B.A. (with honors) from the
University of California at Berkeley in 1954 and his M.D. from the University
of California at San Francisco in 1958.
ROBERT W. WEBER was appointed Vice President - Controller of the Company in
March 1996. Mr. Weber has over twenty years of experience in financial
management and has been employed at executive levels by multiple start-up
companies and contributed to the success of several turnaround situations.
Most recently he served as Vice President of Finance at Prometheus Products, a
subsidiary of Sierra Semiconductor, and Vice President Finance and Chief
Financial Officer for Amercom. From 1988 to 1993, Mr. Weber served as Vice
President Finance and Chief Financial Officer of Instromedix, which designs,
manufactures and markets medical electronic devices and software. Mr. Weber
received a B.S. from GMI Institute of Technology in 1975 and a MBA from
Stanford Graduate School of Business in 1977.
12
<PAGE>
RISK FACTORS
An investment in the shares being offered hereby involves a high degree of
risk. In deciding whether to purchase shares of our common stock, you should
carefully consider the following risk factors, in addition to other
information contained in this Annual Report on Form 10-K.
Dependence on New Products and FDA Approval. Our principal development
efforts are currently centered around two drug candidates licensed to us which
we believe show promise for the treatment and prevention of HIV/AIDS. However,
all of our drug candidates will require FDA and foreign government approvals
before they can be commercialized. Neither HE2000 nor any of our other drug
candidates have been approved for commercial sale. While limited clinical
trials of HE2000 have to date produced favorable results, significant
additional trials are required, and we may not be able to demonstrate that
this drug candidate is safe or effective. We have never commercially
introduced a product, and we cannot guarantee that any of our product
candidates will obtain required governmental approvals or that we can
successfully commercialize any products.
Early Stage of Product Development and Substantial Operating Losses. We have
experienced significant operating losses to date because of the substantial
expenses we have incurred to acquire and fund development of our drug
candidates. We have never had operating revenues. Our accumulated deficit was
approximately $13.3 million through December 31, 1998. We expect to incur
significant additional operating losses over the next several years as we fund
development, clinical testing and other expenses of seeking FDA approval. Many
of our research and development programs are at an early stage. Potential drug
candidates are subject to inherent risks of failure. These risks include the
possibilities that no drug candidate will be found safe or effective, meet
applicable regulatory standards or receive the necessary regulatory
clearances. Even safe and effective drug candidates may never be developed
into commercially successful drugs. There may be delays in receipt of
regulatory approvals. The drugs could be uneconomical to manufacture or
produce on a large scale. The drugs may not achieve customer acceptance. The
proprietary rights of others could stop us from being able to market the
drugs, or third parties could market superior or equivalent drugs. If we were
unable to develop safe, commercially viable drugs, it would have a material
adverse effect on our business, financial condition and results of operations.
Our ability to achieve profitable operations will depend on our ability to
obtain regulatory approvals for our drug candidates, our ability to enter into
collaboration agreements, and our ability to commercialize a drug candidate.
We cannot assure you that we will ever operate profitably.
Patents and Proprietary Rights. Our success will depend in part on our
ability to obtain United States and foreign patent protection for our drug
candidates and processes, preserve our trade secrets and operate without
infringing the proprietary rights of third parties. We place considerable
importance on obtaining patent protection for significant new technologies,
products and processes. Legal standards relating to the validity of patents
covering pharmaceutical and biotechnological inventions and the scope of
claims made under such patents are still developing. Our patent position is
highly uncertain and involves complex legal and factual questions. We cannot
be certain that the applicant or inventors of subject matter covered by patent
applications or patents owned by or licensed to us were the first to invent or
the first to file patent applications for such inventions. We cannot guarantee
that any patents will issue from any of the pending or future patent
applications we own or have licensed. Existing or future patents owned by or
licensed to us may be challenged, infringed upon, invalidated, found to be
unenforceable or circumvented by others. Further, we cannot guarantee that any
rights we may have under any issued patents will provide us with sufficient
protection against competitive products or otherwise cover commercially
valuable products or processes.
If another party claims the same subject matter or subject matter
overlapping with the subject matter that we have claimed in a United States
patent application or patent, we may decide or be required to participate in
interference proceedings in the United States Patent and Trademark Office in
order to determine the priority of invention. Loss of such an interference
proceeding would deprive us of patent protection sought or previously
obtained. Participation in such proceedings could result in substantial costs,
whether or not the eventual outcome is favorable.
13
<PAGE>
Government Regulation and Product Approvals. Our drug candidates under
development are subject to regulation by the federal government, including the
FDA, and by state and local governments. If our products are marketed abroad,
they will also need to comply with export requirements and regulation by
foreign governments. The applicable regulatory approval process is lengthy and
expensive and must be completed prior to the commercialization of a product.
We cannot guarantee that we will be able to obtain necessary regulatory
approvals on a timely basis, if at all, for any of our products under
development. Delays in receiving such approvals, failure to receive such
approvals at all or failure to comply with existing or future regulatory
requirements could have a material adverse effect on our business, financial
condition and results of operations.
Product development and approval to meet FDA regulatory requirements takes a
number of years, involves the expenditure of substantial resources and is
uncertain. Many products that initially appear promising ultimately do not
reach the market because they are not found to be safe or effective. In
addition, the current regulatory framework could change and additional
regulations may arise at any stage of product development that may affect
approval, delay the submission or review of an application or require
additional expenditures.
Substantial Capital Needs. We will require substantial additional funds in
order to finance our drug discovery and development programs, fund operating
expenses, pursue regulatory clearances, develop manufacturing, marketing and
sales capabilities, and prosecute and defend our intellectual property rights.
We intend to seek additional funding through public or private financing or
through collaboration arrangements with collaborative partners. If we raise
funds by selling equity securities, sales may dilute your share ownership and
future investors may be granted rights superior to yours. We cannot guarantee,
however, that we will be able to obtain additional financing on acceptable
terms, if at all.
Technological Change and Competition. Biotechnology and related
pharmaceutical technology have undergone rapid and significant change. We
expect that the technologies associated with biotechnology research and
development will continue to develop rapidly. Our future will depend in large
part on our ability to maintain a competitive position with respect to these
technologies. Any compounds, products or processes that we develop may become
obsolete before we recover any expenses we have incurred in connection with
developing these products.
The biotechnology and pharmaceutical industries are intensely competitive.
We have numerous competitors in the United States and elsewhere. Our
competitors include major, multinational pharmaceutical and chemical
companies, specialized biotechnology firms and universities and other research
institutions. Many of these competitors have greater financial and other
resources, larger research and development staffs and more effective marketing
and manufacturing organizations than we do. In addition, academic and
government institutions have become increasingly aware of the commercial value
of their research findings. These institutions are now more likely to enter
into exclusive licensing agreements with commercial enterprises, including our
competitors, to market commercial products.
Our competitors may succeed in developing or licensing technologies and
drugs that are more effective or less costly than any we are developing. Our
competitors may succeed in obtaining FDA or other regulatory approvals for
drug candidates before we do. We cannot guarantee that our drug candidates, if
approved for sale, will be able to compete successfully with our competitors'
existing products under development.
No Sales and Marketing Experience. Our efforts to date have focused on the
development and evaluation of our drug candidates. As we continue clinical
studies and prepare for commercialization of our drug candidates, we need to
build a sales and marketing infrastructure. We have no experience in the sales
and marketing of our drug candidates. We may not be able to attract and retain
the skilled personnel necessary to effectively market our drug candidates.
Dependence on License Agreements. We license our drug candidates from Dr.
Patrick T. Prendergast and from Edenland, Inc. and Colthurst Limited, two
organizations Dr. Prendergast controls. Our license agreements can be
terminated if we materially breach our obligations under the agreements.
Termination of our license
14
<PAGE>
agreements would cause us to lose our rights to our existing drug candidates.
If we lost our licensed rights to one or more of our drug candidates or if our
rights were materially limited, it would have a material adverse effect on our
business, operating results and financial condition.
Dependence on Officers and Future Employees. Our ability to successfully
implement our business strategy depends highly upon our Chief Executive
Officer, Richard B. Hollis. The loss of Mr. Hollis' services could impede the
achievement of our research and development objectives. We also highly depend
on our ability to hire and retain qualified scientific and technical
personnel. The competition for these employees is intense. We cannot guarantee
that we will continue to be able to hire and retain the qualified personnel
needed for our business. Loss of the services of or the failure to recruit key
scientific and technical personnel could adversely affect our business,
operating results and financial condition.
Technological Uncertainties. Our product development efforts are based upon
technologies and therapeutic approaches that have not been widely used in
humans for therapeutic purposes. There is significant risk that these
approaches will not prove to be successful. Although we believe that the
positive results obtained to date in preclinical and limited clinical human
studies support further research and development, the positive results
obtained to date do not necessarily reflect results that we may obtain in
further human clinical testing.
Pharmaceutical Pricing and Pending Health Care Reforms. Government health
administration authorities, together with private health insurers,
increasingly are attempting to contain health care costs by limiting the price
or reimbursement levels for medical products and services. In certain foreign
markets, pricing or profitability of prescriptive pharmaceuticals is subject
to government control. In the United States, there have been a number of
federal and state proposals to implement similar government controls or
otherwise significantly reform the existing health care system. We cannot
predict if any of these reform proposals will be adopted, when they may be
adopted, or what impact they may have on Hollis-Eden. Any enacted legislation
may include provisions resulting in price limits, utilization controls or
other consequences that may adversely affect our business, operating results
and financial condition.
Manufacturing Limitations and Uncertainties. Outside manufacturers currently
produce our drug candidates and supply us with sufficient quantities to
conduct clinical trials. If we have difficulty in the future obtaining our
required quantity or quality of supply, we could experience significant delays
in our development programs or regulatory approval process. If we have
difficulties establishing relationships with manufacturers to produce and
distribute our finished pharmaceutical products, market introduction and sales
of our products would be adversely affected. Manufacturers producing our
products must also follow current Good Manufacturing Practices regulations
enforced by the FDA through its facilities inspection program. We may not be
able to commercialize pharmaceutical products as planned if we cannot obtain
or retain qualified third party manufacturing on commercially acceptable
terms.
We currently do not intend to manufacture any pharmaceutical products
ourselves. If we determine to manufacture products ourselves in the future, we
would be subject to the regulatory requirements described above and would be
subject to the same risks regarding difficulties encountered in manufacturing
pharmaceutical products. We also would require substantial additional capital.
We have no experience manufacturing pharmaceutical products for commercial
purposes, so we cannot guarantee that we would be able to manufacture any
products successfully or in a cost-effective manner.
Management of Growth. We will need to continue to improve and expand our
management, operational and financial systems and controls to support future
growth. Our business, operating results and financial condition will be
adversely affected if we cannot do so.
Product Liability and Lack of Adequate Insurance. Our business exposes us to
potential product liability risks associated with the testing, manufacturing,
marketing and sale of pharmaceutical products. Therefore, product liability
claims may be asserted against us. Product liability insurance for the
pharmaceutical industry
15
<PAGE>
generally is expensive, if it is available at all. Adequate insurance coverage
may not be available at an acceptable cost. A product liability claim could
adversely affect our business, operating results and financial condition.
Authorized Preferred Stock. Our Board of Directors is authorized, without
further action required on the part of stockholders, to issue one or more
classes of preferred stock and to designate the rights, preferences and
privileges of such preferred stock including voting, dividend and liquidation
rights which may be superior to those of the holders of Common Stock. The
issuance of one or more classes of preferred stock could materially adversely
affect the rights of holders of Common Stock.
Indemnification and Limited Monetary Damages. Our Certificate of
Incorporation provides that our directors shall not be liable for monetary
damages to our stockholders except as required by law. In addition, our Bylaws
provide indemnification of its officers and directors to the fullest extent
permitted by Delaware law. To the extent that stockholders are unable to
prevail in actions for monetary damages against our directors, such
stockholders' rights in this regard are limited in comparison to rights of
stockholders of a corporation that has not adopted such provisions. In
addition, to the extent that the officers and directors may obtain
indemnification from us, we, may incur substantial financial losses.
Dividends Unlikely. We have never paid dividends on our shares of Common
Stock. The payment of dividends in the future, if any, will be contingent upon
our revenues and earnings, if any, capital requirements and general financial
condition. The payment of any dividends in the future will be within the
discretion of our Board of Directors. We intend to retain all earnings, if
any, for use in our business operations and, accordingly, the Board of
Directors does not anticipate declaring any dividends in the foreseeable
future.
Concentration of Ownership. As of March 1, 1999, Richard B. Hollis, our
President and Chief Executive Officer, owned approximately 29.3% of the
outstanding shares of Common Stock (without giving effect to the exercise of
any warrants or options). Accordingly, Mr. Hollis will control our business,
policies and affairs, including the election of members of our Board of
Directors. Assuming the exercise of our outstanding warrants and options, Mr.
Hollis would own approximately 15.5% of the then outstanding shares of Common
Stock.
Classified Board of Directors; Possible Deterrent to Takeovers, Changes in
Board and Other Changes in Control. Our Board of Directors is a "classified
board," with approximately one-third of its directors coming up for election
each year. This provision is applicable to every election of directors. As a
result of having a classified board, two annual meetings will be necessary to
change a majority of the directors. The existence of a classified board may,
in certain circumstances, deter or delay mergers, tender offers, other
possible takeover attempts or changes in management of the Board of Directors
which may be favored by some or a majority of our stockholders.
Possible Volatility in Stock Price. There is no assurance that a market for
our common stock will continue to exist. The prices at which Common Stock
trades will depend on many factors, including prevailing interest rates,
markets for similar securities, industry conditions, and the performance of,
and investor expectations for, our prospects.
YEAR 2000
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish the 21st century dates from 20th century dates. As a result, in
less than two years, computer systems and/or software used by many companies
may need to be upgraded to comply with such "Year 2000" requirements.
We upgraded our accounting software during 1998 with a version that is Year
2000 compliant. In addition, we have upgraded all of our computer operating
systems. We believe that our computer systems and applications are Year 2000
compliant.
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<PAGE>
We recently completed the process of reviewing our communications systems
and other non-information technology systems to ascertain whether they are
Year 2000 compliant. We expect to complete upgrading these systems by the
second quarter of 1999.
We do not expect that the costs associated with achieving Year 2000
compliance will have a material adverse effect on our future results of
operations, liquidity or capital resources. We have spent less than three
thousand dollars in connection with our Year 2000 compliance efforts to date.
We believe that the costs to be incurred in upgrading our non-information
technology systems will be immaterial.
We have begun contacting our material suppliers and third party service
providers to identify Year 2000 problems and provide solutions to prevent the
disruption of business activities. At present, we have very little information
regarding the extent of Year 2000 compliance by our suppliers and third party
service providers. We expect to complete our review of the compliance efforts
by these parties in during the second quarter of 1999.
There can be no assurance, however, that the computer systems and
applications of other companies on which our operations rely, will be timely
converted, or that any such failure to convert by another company will not
have a material adverse effect on us. Moreover, the following could have a
material adverse effect on our business or financial condition: (i) failure of
suppliers and third-party service providers equipment to operate or to operate
accurately, (ii) failure of clinical trial site medical equipment to perform
properly, (iii) failure of necessary materials or supplies to be available to
us when needed, or (iv) failure of other equipment, software, or systems as a
result of Year 2000 problems. At the completion of our review of our material
suppliers and third-party service providers, we intend to assess worst case
scenarios and to develop one or more contingency plans that may be necessary,
such as securing alternative vendors.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located at 9333 Genesee Avenue,
Suites 110 and 200, San Diego, California 92121, where the Company leases
approximately 17,000 square feet. The leases expires in August 2000 and August
2002, respectively. The Company believes that its facilities are adequate for
its current operations.
ITEM 3. LEGAL PROCEEDINGS
The Company currently is not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.
17
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market System
under the symbol HEPH. Prior to September 1997, the Company's common stock was
traded on the OTC Electronic Bulletin Board (the "OTC") under the symbol HEPH
and prior to the merger under the symbols IACQ.
The following table sets forth the quarterly high and low bid quotations
and/or selling prices for the securities of the Company on the OTC Electronic
Bulletin Board and Nasdaq Market since September 1997.
<TABLE>
<CAPTION>
COMMON STOCK HIGH LOW
------------ ------- ------
<S> <C> <C>
1997
First Quarter............................................... $12.000 $9.000
Second Quarter.............................................. 11.750 4.125
Third Quarter............................................... 8.440 4.500
Fourth Quarter.............................................. 8.875 5.000
1998
First Quarter............................................... $19.750 $6.125
Second Quarter.............................................. 18.000 14.000
Third Quarter............................................... 16.938 7.875
Fourth Quarter.............................................. 18.500 10.094
</TABLE>
On March 15, 1999, the closing price of the Company's common stock as
reported by the Nasdaq National Market System was $21.00 per share. There were
approximately 3,400 shareholders of record plus beneficial stockholders of the
Company's common stock as of such date. The Company has not paid cash
dividends on its common stock and does not intend to do so in the foreseeable
future.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated by reference to page
13 of the Annual Report to Stockholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The information required by this item is incorporated by reference to pages
10-13 of the Annual Report to Stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to pages
15-24 of the Annual Report to Stockholders.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
18
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See the section entitled "Executive Officers" in Part I, Item 1 hereof for
information regarding executive officers.
The information required by this item with respect to directors is
incorporated by reference from the information under the caption of "Election
of Directors," contained in the Company's definitive Proxy Statement to be
filed with the Commission pursuant to Regulation 14A in connection with the
1999 Annual Meeting (the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information concerning executive compensation is set forth in the Proxy
Statement under the heading "Executive Compensation," which information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning security ownership of certain beneficial owners
and management is set forth in the Proxy Statement under the heading "Security
Ownership of Certain Beneficial Owners and Management," which information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related transactions is
set forth in the Proxy Statement under the heading "Certain Transactions,"
which information is incorporated herein by reference.
19
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this Annual Report to Stockholders on
Form 10-K:
1. Financial Statements: The financial statements of Hollis-Eden
Pharmaceuticals are included in the Annual Report, Exhibit 13.1
2. Financial Statement Schedules: Financial statement schedules required
under the related instructions are not applicable for the three years
ended December 31, 1998, and have therefore been omitted.
3. Exhibits: The exhibits which are filed with this Report or which are
incorporated herein by reference are set forth in the Exhibit Index on
page E-1.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of fiscal
1998.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on March 29, 1999.
HOLLIS-EDEN PHARMACEUTICALS, INC.
By:/s/ Richard B. Hollis
----------------------------------
RICHARD B. HOLLIS,
CHAIRMAN OF THE BOARD OF DIRECTORS,
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints RICHARD B. HOLLIS and ROBERT W. WEBER, and each
of them, as his true and lawful attorneys-in-fact and agents, with full power
of substitution and resubstitution, for him and in his name, place, and stead,
in any and all capacities, to sign any and all amendments to this Report, and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming that all said attorneys-
in-fact and agents, or any of them or their or his substitute or substituted,
may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Richard B. Hollis Chairman of the Board of March 29, 1999
____________________________________ Directors, President and
RICHARD B. HOLLIS Chief Executive Officer
/s/ Robert W. Weber Vice President - Controller March 29, 1999
____________________________________ and Secretary (Principal
ROBERT W. WEBER Financial and Accounting
Officer)
/s/ Paul Bagley Director March 5, 1999
____________________________________
PAUL BAGLEY
/s/ Leonard Makowka Director March 11, 1999
____________________________________
LEONARD MAKOWKA
/s/ Brendan R. McDonnell Director March 5, 1999
____________________________________
BRENDAN R. MCDONNELL
/s/ Thomas C. Merigan, Jr. M.D. Chairman of the Scientific March 10, 1999
____________________________________ Advisory Board and Director
THOMAS C. MERIGAN, JR. M.D.
/s/ William H. Tilley Director March 19, 1999
____________________________________
WILLIAM H. TILLEY
/s/ Salvatore J. Zizza Director March 12, 1999
____________________________________
SALVATORE J. ZIZZA
</TABLE>
21
<PAGE>
APPENDIX E
HOLLIS-EDEN PHARMACEUTICALS, INC.
ANNUAL REPORT ON FORM 10-K
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 4.1 to Registrant's Registration
Statement on Form S-4 (No. 333-18725), as amended (the "Form S-4" )).
3.2 Bylaws of Registrant (incorporated by reference to Exhibit 4.2 to the
Form S-4).
10.1 Registrant's 1997 Incentive Stock Option Plan (the "Option Plan")
(incorporated by reference to Exhibit 10.3 to the Form S-4).
10.2 Forms of Incentive Stock Options and Nonstatutory Stock Options under
the Option Plan (incorporated by reference to Exhibit 10.5 to the Form
S-4).
10.3 Employment Agreement by and between Registrant and Richard B. Hollis
dated November 1, 1996 (incorporated by reference to Exhibit 10.6 to
the Form S-4).
10.4 Employment Agreement by and between Registrant and Terren S. Peizer
dated February 5, 1997 (incorporated by reference to Exhibit 10.11 to
the Form S-4).
10.5 Amendment to Employment Agreement by and between Registrant and Terren
S. Peizer dated April 1, 1997 (incorporated by reference to Exhibit
10.1 to Registrant's Current Report on Form 8-K dated March 26, 1997).
10.6 License Agreement by and among Registrant, Colthurst Limited and
Patrick T. Prendergast, Ph.D. dated May 18, 1994, including all
amendments thereto (incorporated by reference to Exhibit 10.7 to the
Form S-4).
10.7 License Agreement by and among Registrant, Edenland, Inc. and Patrick
T. Prendergast, Ph.D. dated August 25, 1994, including all amendments
thereto (incorporated by reference to Exhibit 10.8 to the Form S-4).
10.8 Research, Development and Option Agreement by and among Registrant,
Edenland, Inc. and Patrick T. Prendergast, Ph.D. dated August 25,
1994, including all amendments thereto (incorporated by reference to
Exhibit 10.9 to the Form S-4).
10.9 Employment Agreement by and between Registrant and Robert W. Weber
dated March 16, 1996.
13.1 The excerpts from the Annual Report to the Stockholders for the fiscal
year ended December 31, 1998.
23.1 Consent of BDO Seidman, LLP.
24.1 Power of Attorney. Reference is made to signature page.
27 Financial Data Schedule (filed electronically only).
</TABLE>
E-1
<PAGE>
EXHIBIT 10.9
EMPLOYMENT AGREEMENT
March 16, 1996
Robert Weber
6552 Palomino Way
West Linn, OR 97068
Dear Bob:
I want to welcome you aboard and put into writing the employment opportunity we
have agreed to during our phone conversations. Your initial position will be
Vice President-Controller reporting to me and as a member of the Executive team.
Your initial salary will be $85,000 per year, with 50% deferred until the
company is public. At the time the company is public, your salary will be
increased to $100,000 per year plus you and your family will be provided with
medical and other such benefits the company offers its employees. The company
will provide at least three weeks of paid vacation per year, which will continue
to accrue during your employment.
If the company relocates to California, your salary will be increased an
additional 20% as a minimum. In addition, the company will pay for all
reasonable relocation and moving expenses.
If your employment is terminated for any reason other than cause, the company
will pay you one year of severance pay, at your highest salary and prior year's
bonus, plus benefits. In addition, all unvested stock options will immediately
vest and the exercise period will continue until the final expiration of the
original term of such stock options. Voluntary termination due to change in
duties or change in control of the company will be considered the same as
termination for any reason other than cause.
Stock options will be handled separately as we've discussed.
I'm excited that you've agreed to join the company and will be part of the team
that has an opportunity to build a great pharmaceutical company.
Sincerely,
/s/ RICHARD B. HOLLIS
Richard B. Hollis
Chairman, President and CEO
<PAGE>
EXHIBIT 13.1
ANNUAL REPORT ON FORM 10-K
ITEM 6, ITEM 7, ITEM 8, ITEM 14 (a)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 1998
HOLLIS-EDEN PHARMACEUTICALS
SAN DIEGO, CA 92121
Form 10-K - Item 14 (a)
Hollis-Eden Pharmaceuticals
List of Financial Statements and Financial Statement Schedules
Statements of operations - from Inception (August 15, 1994) to December 31, 1998
Report of independent certified public accountants
Balance sheets as of December 31, 1998 and 1997
Statements of operations for the years ended December 31, 1998, 1997 and 1996
and the period from Inception (August 15, 1994) to December 31, 1998
Statements of stockholders' equity from Inception (August 15, 1994) to
December 31, 1998
Statements of cash flows for the years ended December 31, 1998, 1997, 1996
and 1995 and the period from Inception (August 15, 1994) to December 31, 1998
Notes to financial statements
The following financial statements schedules of Hollis-Eden Pharmaceuticals are
included in Item 14 (d):
None
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
The forward-looking comments contained in the following discussion involve
risks and uncertainties. The Company's actual results may differ materially
from those discussed here. Factors that could cause or contribute to such
differences can be found in the following discussion and in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1998.
GENERAL
Hollis-Eden Pharmaceuticals, a development-stage pharmaceutical company, is
engaged in the discovery, development and commercialization of products for the
treatment of a number of targeted disease states caused by viral, bacterial,
parasitic or fungal infections, including HIV/AIDS, hepatitis B and C, and
malaria. The Company has three technology platforms, one based on cellular
energy regulation, the second on a unique immune system modulation technology,
and the third on biochemical synthesis regulators. The Company believes that
certain of its drug candidates may provide the first long-term treatment for HIV
without the development of viral strain resistance to the drugs' effectiveness,
significant toxicity or severe side effects. The Company has not yet generated
any operating revenues. The Company has experienced significant operating
losses due to substantial expenses incurred to acquire and fund development of
its drug candidates and, as of December 31, 1998, had an accumulated deficit of
approximately $13.3 million.
When and if any of the Company's drug candidates have been approved for
commercial sale, the Company plans to market them in the United States. For
international markets, the Company intends to develop strategic alliances with
major pharmaceutical companies that have foreign regulatory expertise and
established distribution channels, and will also consider corporate strategic
partnerships and co-marketing agreements. No assurances can be given that any
of the Company's drug candidates will be approved for commercial sale or that
any of the foregoing proposed arrangements will be implemented or prove to be
successful.
The Company has been unprofitable since inception and expects to incur
substantial additional operating losses for at least the next few years as it
increases expenditures on research and development and begins to allocate
significant and increasing resources to its clinical testing and other
activities. In addition, during the next few years, the Company will have to
meet the substantial new challenge of developing the capability to market
products. Accordingly, the Company's activities to date are not as broad in
depth or scope as the activities it must undertake in the future, and the
Company's historical operations and financial information are not indicative of
the Company's future operating results or financial condition or its ability to
operate profitably as a commercial enterprise when and if it succeeds in
bringing any drug candidate to market.
On March 26, 1997, Hollis-Eden, Inc. ("Hollis-Eden"), a Delaware
corporation, was merged with and into the Company (then known as Initial
Acquisition Corp. ("IAC")), a Delaware corporation, pursuant to an Agreement and
Plan of Merger, dated November 1, 1996, (the "Merger Agreement"). Upon
consummation of the merger of Hollis-Eden with IAC (the "Merger"), Hollis-Eden
ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals, Inc.
RESULTS OF OPERATIONS
The Company has not generated any revenues for the period from August 15,
1994 (inception of Hollis-Eden) through December 31, 1998. The Company has
devoted substantially all its resources to the payment of licensing fees and
research and development fees plus expenses related to the startup of its
business. From inception until December 31, 1998, the Company incurred expenses
of approximately $8.1 million in research and development fees, $6.4 million in
general and administrative expenses, and $1.2 million in net interest income
resulting in a loss of $13.3 million for the period.
<PAGE>
Research and development expenses were $2.8 million, $3.5 million and
$184,000 in 1998, 1997 and 1996 respectively. 1998 research and development
expenses were focused on the development of HE2000 and HE317. A substantial
portion of the 1997 research and development expenses were incurred after the
completion of the Merger on March 26, 1997 as described below.
General and administrative expenses increased to $3.6 million in 1998 from
$2.0 million and $510,000 in 1997 and 1996, respectively. These increases in
1998 and 1997 are due primarily to (i) the issuance of warrants and stock for
services in lieu of cash (described below), (ii) the amortization of the
unearned compensation charge of certain stock options, (iii) increased expenses
as a public company such as legal fees, filing fees, and directors and officers
insurance, and (iv) increased staffing.
In 1998, the Company incurred significant non-cash, non-recurring charges.
A total of $716,000 was amortized throughout 1998 for services in lieu of cash
and non-cash compensation. Additionally, $240,000 was expensed for options
granted to certain directors and consultants.
Upon the completion of the Merger and the exercise of warrants, the Company
incurred significant non-recurring charges to operations that have been recorded
as expenses during 1997. In particular, the Company incurred (i) a $1.5 million
and a $1.2 million expense for research and development fees during the first
and second quarters, respectively, and (ii) a $570,000 non-cash charge relating
to the issuance of warrants to a certain director and former officer during the
first quarter. The $2.7 million research and development fees are being used by
Edenland, a related party, as funding to continue the development of the
Company's second drug candidate, HE317.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception through the sale of
shares of Common Stock and with loans from the Company's founder, Richard B.
Hollis. The Company repaid Mr. Hollis in January 1996.
During the year ended December 31, 1995, the Company received cash proceeds
of $250,000 from the sale of its securities. In May 1996, the Company completed
a private placement of shares of Common Stock, from which it received aggregate
gross proceeds of $1.3 million. In March 1997, the Merger of IAC and Hollis-
Eden provided the Company with $6.5 million in cash and other receivables. In
May 1998, the Company completed a private placement of shares and warrants, from
which it received gross proceeds of $20 million. During January 1999, the
Company completed two private placements raising approximately $25 million.
Under its license agreements with Dr. Patrick T. Prendergast, Colthurst and
Edenland, the Company is obligated to pay certain minimum license fees to
maintain its rights to its drug candidates. An annual renewable license fee of
$500,000 was due and paid in May 1998. As of December 31, 1998, the Company is
current on all license fee obligations under these agreements.
Under its Research and Development Agreement with Edenland and Dr. Patrick
T. Prendergast, the Company is committed to pay $3.0 million for the development
costs related to HE317. An amount of $1.5 million was recorded as a charge to
operations upon the closing of the Merger and was paid in April 1997. An
additional $1.2 million was recorded as a charge to operations and paid in May
1997. The remaining $300,000 was accrued as an expense during the fourth
quarter of 1997 and was paid during the first quarter of 1998.
<PAGE>
The Company's operations to date have consumed substantial capital without
generating any revenues, and the Company will continue to require substantial
and increasing amounts of funds to conduct necessary research and development
and preclinical and clinical testing of its drug candidates, and to market any
drug candidates that receive regulatory approval. The Company does not expect
to generate revenue from operations for the foreseeable future, and the
Company's ability to meet its cash obligations as they become due and payable is
expected to depend for at least the next several years on its ability to sell
securities, borrow funds or some combination thereof. Based upon its current
plans, the Company's management believes that its existing capital resources,
together with interest thereon, will be sufficient to meet the Company's
operating expenses and capital requirements through at least the end of 1999.
There can be no assurance, however, that changes in the Company's research and
development plans or other events affecting the Company's operating expenses
will not result in the expenditure of such cash before that time. No assurance
can be given that the Company will be successful in raising necessary funds.
The Company's future capital requirements will depend upon many factors,
including progress with preclinical testing and clinical trials, the number and
breadth of the Company's programs, the time and costs involved in preparing,
filing, prosecuting, maintaining and enforcing patent claims and other
proprietary rights, the time and costs involved in obtaining regulatory
approvals, competing technological and market developments, the ability of the
Company to establish collaborative arrangements and effective commercialization
and marketing activities and other arrangements. In any event, the Company will
continue to incur increasing negative cash flows and net losses for the
foreseeable future.
YEAR 2000
Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish the 21st century dates from 20th century dates. As a result, in
less than one year, computer systems and/or software used by many companies may
need to be upgraded to comply with such "Year 2000" requirements.
The Company upgraded its accounting software during 1998 with a version
that is Year 2000 compliant. In addition, the Company has upgraded all of its
computer operating systems. The Company believes that its computer systems and
applications are Year 2000 compliant.
The Company recently completed the process of reviewing its communications
systems and other non-information technology systems to ascertain whether they
are Year 2000 compliant. The Company expects to complete upgrading these
systems by the second quarter of 1999.
The Company does not expect that the costs associated with achieving Year
2000 compliance will have a material adverse effect on its future results of
operations, liquidity or capital resources. The Company has spent less than
three thousand dollars in connection with its Year 2000 compliance efforts to
date. The Company believes that the costs to be incurred in upgrading its non-
information technology systems will be immaterial.
The Company has begun contacting its material suppliers and third party
service providers to identify Year 2000 problems and provide solutions to
prevent the disruption of business activities. At present, the Company has very
little information regarding the extent of Year 2000 compliance by its suppliers
and third party service providers. The Company expects to complete its review
of the compliance efforts by these parties during the second quarter of 1999.
There can be no assurance, however, that the computer systems and
applications of other companies on which the Company's operations rely, will be
timely converted, or that any such failure to convert by another company will
not have a material adverse effect on the Company. Moreover, the following
could have a material adverse effect on the Company's business or financial
condition:
<PAGE>
(i) failure of suppliers and third-party service providers equipment to operate
or to operate accurately, (ii) failure of clinical trial site medical equipment
to perform properly, (iii) failure of necessary materials or supplies to be
available to the Company when needed, or (iv) failure of other equipment,
software, or systems as a result of Year 2000 problems. At the completion of its
review of its material suppliers and third-party service providers, the Company
intends to assess worst case scenarios and to develop one or more contingency
plans that may be necessary, such as securing alternative vendors.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 133 "Accounting for Derivatives Instrument and Hedging Activities"
establishes accounting and reporting standards for derivative instruments. The
Company has not in the past nor does it anticipate, that it will engage in
transactions involving derivative instruments which will impact the financial
statements.
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," requires an entity to expense all
software development costs incurred in the preliminary project stage, training
costs and data conversion costs for fiscal years beginning after December 15,
1998. The Company believes that this statement will not have a material effect
on the Company's accounting for computer software costs.
Statement of Position 98-5 "Accounting for Start-up Costs," requires an
entity to expense all start-up related costs as incurred for the fiscal years
beginning after December 15, 1998. The Company believes that this statement
will not have a material effect on the Company's accounting for start-up costs.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in a separate section of this
report. See Financial Statements on pages 15-24.
<PAGE>
SELECTED FINANCIAL DATA
The following data summarizes certain selected financial data for each of
the five years ended December 31, 1998 and the period from inception (August 15,
1994) to December 31, 1998. The information presented should be read in
conjunction with the financial statements and related notes included elsewhere
in this annual report.
<TABLE>
<CAPTION>
Period from
Inception
As of or for the Year Ended December 31, (Aug. 15, 1994)
($000), Except Per Share to
-------------------------------------------------------------------- December 31,
1998 1997 1996 1995 1994 1998
---------- ---------- ---------- ---------- ----------- -------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Research and development ................. $ 2,777 $ 3,488 $ 184 $ 463 $ 1,167 $ 8,080
General and administrative................ 3,577 2,044 511 171 104 6,406
---------- ---------- ---------- ---------- ----------- --------
Total operating expenses.................. 6,355 5,532 695 634 1,270 14,486
Other income (expense), net............... 927 280 3 (38) (7) 1,165
---------- ---------- ---------- ---------- ----------- --------
Net loss.................................. $ 5,427 $ 5,253 $ 692 $ 672 $ 1,277 $ 13,321
========== ========== ========== ========== =========== ========
Net loss per share, basic and diluted..... $ (0.69) $ (0.85) $ (0.15) $ (0.17) $ (0.38)
Weighted average number
of common shares outstanding............. 7,850,854 6,192,764 4,657,650 3,867,924 3,396,226
BALANCE SHEET DATA:
Total assets.............................. $ 24,524 $ 7,400 $ 241 $ - $ -
Notes and accounts payable and
accrued interest to related party........ - - - 368 217
License fees payable...................... - - 500 928 927
Stockholders' equity (deficit)............ $ 24,303 $ 6,933 $ (566) $ (1,538) $ (1,144)
</TABLE>
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Hollis-Eden Pharmaceuticals, Inc.
San Diego, CA
We have audited the accompanying balance sheets of Hollis-Eden Pharmaceuticals,
Inc. (a development stage company) as of December 31, 1998 and 1997 and the
related statements of operations, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998 and for the period from
inception (August 15, 1994) to December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly in all
material respects, the financial position of Hollis-Eden Pharmaceuticals, Inc.
as of December 31, 1998 and 1997 and the results its operations and its cash
flows for each of the three years in the period ended December 31, 1998 and for
the period from inception (August 15, 1994) to December 31, 1998, in conformity
with generally accepted accounting principles.
BDO Seidman, LLP
New York, NY
January 26, 1999
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
1998 1997
------------ -----------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents........................................... $ 24,189,806 $ 7,102,620
Prepaid expenses..................................................... 26,250 53,009
Deposits............................................................. 9,163 9,163
Receivable - tax refund (Note 8)..................................... 0 105,436
Receivable from related party (Note 7)............................... 206,663 46,679
------------ -----------
Total current assets................................................. 24,431,882 7,316,907
Property and equipment, net of accumulated
depreciation of $28,201 and $6,602............................... 92,343 82,941
------------ -----------
Total assets......................................................... $ 24,524,225 $ 7,399,848
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable and accrued expenses................................ $ 221,670 $ 128,631
R & D fees payable to related party (Note 10)........................ - 338,000
------------ -----------
Total current liabilities............................................ 221,670 466,631
Commitments and contingencies (see Note 10, 15, 16)
Stockholders' equity: (Notes 3, 4, 5, 6, 9, 11, 12, 13, 14)
Preferred stock, convertible into common stock,
$.01 par value, 10,000,000 shares authorized;
4,000 and 0 shares issued or outstanding, respectively........... 40 -
Common stock, $.01 par value,
30,000,000 shares authorized; 8,592,202 and
6,772,023 shares issued and outstanding, respectively............ 85,922 67,720
Paid-in capital...................................................... 38,795,887 16,325,338
Deferred compensation-stock options, net of accumulated
amortization of $590,000 and $282,000, respectively.............. (1,258,000) (1,566,000)
Deficit accumulated during development stage......................... (13,321,294) (7,893,841)
------------ -----------
Total stockholders' equity........................................... 24,302,555 6,933,217
------------ -----------
Total liabilities and stockholders' equity............................ $ 24,524,225 $ 7,399,848
============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Period from
Inception
(Aug.15,1994)
For the year ended December 31, to
------------------------------------------------------ December 31,
1998 1997 1996 1998
------------ ------------ ---------- ------------
<S> <C> <C> <C> <C>
Operating expenses:
Research and development....................... $ 2,777,460 $ 3,488,358 $ 184,276 $ 8,079,856
General and administrative..................... 3,577,183 2,044,139 510,534 6,406,349
------------ ------------ ---------- ------------
Total operating expenses........................ 6,354,643 5,532,497 694,810 14,486,205
Other income (expense):
Interest income................................ 928,916 279,812 5,732 1,214,460
Interest expense............................... (1,726) (199) (3,142) (49,549)
------------ ------------ ---------- ------------
Total other income.............................. 927,190 279,613 2,590 1,164,911
------------ ------------ ---------- ------------
Net loss........................................ $ 5,427,453 $ 5,252,884 $ 692,220 $ 13,321,294
============ ============ ========== ============
Net loss per share, basic and diluted........... $ (0.69) $ (0.85) $ (0.15)
Weighted average number of
common shares outstanding...................... 7,850,854 6,192,764 4,657,650
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Preferred stock Common stock
at par value at par value
-------------------------------------------------------
shares amount shares amount
-------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Contribution by stockholder - $ - - $ -
Common stock issued for cash - - 2,852,830 285
Common stock issued as consideration for
amendments to the license agreements (Note 10) - - 543,396 55
Net loss - - - -
----- ---- --------- --------
Balance at December 31, 1994 - - 3,396,226 340
Common stock issued for cash - - 679,245 68
Common stock issued as consideration for
amendments to the license agreements (Note 10) - - 75,472 7
Net loss - - - -
----- ---- --------- --------
Balance at December 31, 1995 - - 4,150,943 415
Common stock issued in conversion of debt (Note 12) - - 164,962 16
Common stock issued for cash, net of
issuance costs of $203,622 (Note 12) - - 580,005 58
Common stock issued as consideration
for termination of a finance agreement - - 15,094 2
Warrants issued to consultants
for services rendered - - - -
Net loss - - - -
----- ---- --------- --------
Balance at December 31, 1996 - - 4,911,004 491
Recapitalization of Company upon the merger
with Initial Acquisition Corp. (Note 3) - - 883,250 57,453
Warrants issued to a certain director
upon the successful closure of the merger - - - -
Exercise of warrants, net of expenses (Note 5) - - 977,593 9,775
Deferred compensation - stock options (Note 14) - - - -
Amortization of deferred compensation - - - -
Exercise of stock options - - 166 1
Net loss - - - -
----- ---- --------- --------
Balance at December 31, 1997 - - 6,772,013 $ 67,720
Exercise of warrants - - 398,359 3,984
Exercise of stock options - - 53,302 533
Private Placement, net of expenses (Note 6, 13) 4,000 40 1,329,201 13,292
Warrants issued for services in lieu of cash (Note 11) - - - -
Stock issued for license fee (Note 10) - - 33,058 330
Stock issued for services in lieu of cash (Note 11) - - 6,269 63
Options issued for services in lieu of cash (Note 14) - - - -
Amortization of deferred compensation - - - -
Net loss - - - -
----- ---- --------- --------
Balance at December 31, 1998 4,000 $ 40 8,592,202 $ 85,922
----- ---- --------- --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Deficit
accumulated
Capital in during
excess of Deferred development
par value compensation stage
----------- ------------ -------------
<S> <C> <C> <C>
Contribution by stockholder $ 103,564 $ - $ -
Common stock issued for cash 24,715 - -
Common stock issued as consideration for
amendments to the license agreements (Note 10) 4,707 - -
Net loss - - (1,277,046)
----------- ------------ -------------
Balance at December 31, 1994 132,986 - (1,277,046)
Common stock issued for cash 249,932 - -
Common stock issued as consideration for
amendments to the license agreements (Note 10) 27,771 - -
Net loss - - (671,691)
----------- ------------ -------------
Balance at December 31, 1995 410,689 - (1,948,737)
Common stock issued in conversion of debt (Note 12) 371,148 - -
Common stock issued for cash, net of
issuance costs of $203,622 (Note 12) 1,234,441 - -
Common stock issued as consideration
for termination of a finance agreement 33,960 - -
Warrants issued to consultants
for services rendered 24,069 - -
Net loss - - (692,220)
----------- ------------ -------------
Balance at December 31, 1996 2,074,307 - (2,640,957)
Recapitalization of Company upon the merger
with Initial Acquisition Corp. (Note 3) 6,213,329 - -
Warrants issued to a certain director
upon the successful closure of the merger 570,000 - -
Exercise of warrants, net of expenses (Note 5) 5,619,330 - -
Deferred compensation - stock options (Note 14) 1,848,000 (1,848,000) -
Amortization of deferred compensation - 282,000 -
Exercise of stock options 372 - -
Net loss - - (5,252,884)
----------- ------------ -------------
Balance at December 31, 1997 $16,325,338 (1,566,000) (7,893,841)
Exercise of warrants 1,195,728 - -
Exercise of stock options 155,717 - -
Private Placement, net of expenses (Note 6, 13) 19,876,497 - -
Warrants issued for services in lieu of cash (Note 11) 408,000 - -
Stock issued for license fee (Note 10) 499,670 - -
Stock issued for services in lieu of cash (Note 11) 94,937 - -
Options issued for services in lieu of cash (Note 14) 240,000 - -
Amortization of deferred compensation - 308,000 -
Net loss - - (5,427,453)
----------- ------------ -------------
Balance at December 31, 1998 $38,795,887 $ (1,258,000) $ (13,321,294)
----------- ------------ -------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Total
------------
<S> <C>
Contribution by stockholder $ 103,564
Common stock issued for cash 25,000
Common stock issued as consideration for
amendments to the license agreements (Note 10) 4,762
Net loss (1,277,046)
------------
Balance at December 31, 1994 (1,143,720)
Common stock issued for cash 250,000
Common stock issued as consideration for
amendments to the license agreements (Note 10) 27,778
Net loss (671,691)
------------
Balance at December 31, 1995 (1,537,633)
Common stock issued in conversion of debt (Note 12) 371,164
Common stock issued for cash, net of
issuance costs of $203,622 (Note 12) 1,234,499
Common stock issued as consideration
for termination of a finance agreement 33,962
Warrants issued to consultants
for services rendered 24,069
Net loss (692,220)
------------
Balance at December 31, 1996 (566,159)
Recapitalization of Company upon the merger
with Initial Acquisition Corp. (Note 3) 6,270,782
Warrants issued to a certain director
upon the successful closure of the merger 570,000
Exercise of warrants, net of expenses (Note 5) 5,629,105
Deferred compensation - stock options (Note 14) -
Amortization of deferred compensation 282,000
Exercise of stock options 373
Net loss (5,252,884)
------------
Balance at December 31, 1997 6,933,217
Exercise of warrants 1,199,712
Exercise of stock options 156,250
Private Placement, net of expenses (Note 6, 13) 19,889,829
Warrants issued for services in lieu of cash (Note 11) 408,000
Stock issued for license fee (Note 10) 500,000
Stock issued for services in lieu of cash (Note 11) 95,000
Options issued for services in lieu of cash (Note 14) 240,000
Amortization of deferred compensation 308,000
Net loss (5,427,453)
------------
Balance at December 31, 1998 $ 24,302,555
------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
Period from
Inception
(Aug. 15, 1994)
to
For the year ended December 31, December 31,
1998 1997 1996 1995 1998
------------ ------------- ------------ ----------- --------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.......................................... $ (5,427,453) $ (5,252,884) $ (692,220) $ (671,691) $ (13,321,294)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation.................................. 21,599 6,008 594 - 28,201
Common stock issued as consideration
for amendments to the license agreements..... - - - 27,778 32,540
Common stock issued as consideration
for termination of a finance agreement....... - - 33,962 - 33,962
Common stock issued as consideration
for license fees and services 595,000 - - - 595,000
Expense related to warrants issued as
consideration to consultants................. 408,000 8,024 6,017 - 422,041
Expense related to warrants issued to a
director for successful closure of merger.... - 570,000 - - 570,000
Expense related to stock options
issued to non-employees...................... 240,000 - - - 240,000
Deferred compensation expense related
to options issued............................ 308,000 282,000 - - 590,000
Changes in assets and liabilities:
Prepaid expenses.................................. 16,731 55,852 (98,833) - (26,250)
Deposits.......................................... - 90,837 (100,000) - (9,163)
Receivable - tax refund........................... 105,436 (105,436) - - -
Receivable from related party..................... 46,679 (46,679) - - -
Loan receivable from related party................ (206,663) - - - (206,663)
Accounts payable and accrued expenses............. 103,067 (82,263) 118,783 92,111 231,698
Accrued expenses for clinical trials.............. - - (150,000) 150,000 -
Wages payable..................................... - (96,771) 96,771 - -
Accounts payable to related party................. - - (73,040) 73,040 -
License fees payable to related party............. - (499,700) (428,300) 1,000 -
R & D fees payable to related party............... (338,000) 338,000 - - -
Accrued interest expense.......................... - - (44,482) 37,762 -
----------- ----------- ----------- ---------- -------------
Net cash used in operating activities......... (4,127,604) (4,733,012) (1,330,748) (290,000) (10,819,928)
Cash flows provided by investing activities:
Purchase of property and equipment................ (31,001) (82,542) (7,001) - (120,544)
----------- ----------- ----------- ---------- -------------
Net cash used in investing activities......... (31,001) (82,542) (7,001) - (120,544)
Cash flows from financing activities:
Borrowings from related party..................... - 92,000 - 40,000 342,000
Payments on note payable to related party......... - (92,000) (250,000) - (342,000)
Contributions from stockholder ................... - - - - 103,564
Net proceeds from sale of preferred stock......... 4,000,000 - - - 4,000,000
Net proceeds from sale of common stock............ 15,889,829 - 1,234,499 250,000 17,399,328
Proceeds from issuance of debt.................... - - 371,164 - 371,164
Net proceeds from recapitalization................ - 6,270,782 - - 6,270,782
Net proceeds from warrants exercised.............. 1,355,962 5,629,478 - - 6,985,440
----------- ------------ ----------- ---------- ------------
Net cash from financing activities............ 21,245,791 11,900,260 1,355,663 290,000 35,130,278
Net increase in cash................................ 17,087,186 7,084,706 17,914 - 24,189,806
Cash at beginning of period......................... 7,102,620 17,914 - - -
----------- ------------ ----------- ---------- ------------
Cash at end of period............................... $ 24,189,806 $ 7,102,620 $ 17,914 $ - $ 24,189,806
============ ============ =========== ========== ============
</TABLE>
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF CASH FLOWS (CONT.)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Period from
Inception
(Aug. 15, 1994)
to
For the year ended December 31, December 31,
1998 1997 1996 1995 1998
--------------------------------------- -------------
<S> <C> <C> <C> <C> <C>
Supplemental disclosure of cash
flow information:
Interest paid............................. $ 1,726 $ 199 $ 44,482 - $ 49,549
Conversion of debt to equity.............. - - 371,164 - 371,164
Options issued to consultants in
lieu of cash, no vesting................ - - 24,069 - 24,069
Options issued in lieu of cash,
commissions on private placement........ - - 133,110 - 133,110
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY
Hollis-Eden Pharmaceuticals, Inc. (the Company) was formed on August 15,
1994 and is engaged in developing therapeutic and/or preventative pharmaceutical
agents for the treatment of a number of targeted disease states caused by viral,
bacterial, parasitic or fungal infections, including HIV and AIDS. The Company
believes that certain of its drug candidates may provide the first long-term
treatment for HIV without the development of viral strain resistance to the
drugs' effectiveness, significant toxicity or severe side effects. The Company's
development efforts are based upon the pioneering research conducted by Dr.
Patrick T. Prendergast through his research and development organization,
Edenland, Inc. The Company has extensive business arrangements with Edenland,
Inc. (See Note 10) and both Edenland, Inc. and Dr. Prendergast are significant
stockholders of the Company. The Company is a development stage company that was
organized under the laws of the State of Delaware. Since its inception (August
15, 1994) through March 1997, the Company's efforts have been directed toward
organizing, research and development and preparing for offerings of shares of
its common stock. As a result, the Company has not developed commercial products
or generated sales for the period August 15, 1994 through December 31, 1998.
On March 26, 1997, Hollis-Eden, Inc. ("Hollis-Eden"), a Delaware
corporation, was merged with and into the Company (then known as Initial
Acquisition Corp. ("IAC")), a Delaware corporation, pursuant to an Agreement and
Plan of Merger, dated November 1, 1996. Upon consummation of the merger of
Hollis-Eden with IAC (the "Merger"), Hollis-Eden ceased to exist, and IAC
changed its name to Hollis-Eden Pharmaceuticals, Inc. (See Note 3).
2. SUMMARY OF ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers any liquid investments with a maturity of three months or
less when purchased to be cash equivalents. Because of the short maturities of
these investments, the carrying amount is a reasonable estimate of fair value.
At December 31, 1998, the Company's cash equivalents totaling $23,720,000 are
deposited in a money market mutual fund with a large financial institution.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated over the estimated
useful lives of the assets (five and seven years) using the straight-line
method.
RESEARCH AND DEVELOPMENT
Research and development costs consist of license fee expenses related to
license agreements as well as research and development expenses with related
parties and clinical trial expenses. Such amounts paid or payable to related
parties aggregated $1,267,259, $3,068,000, and $20,000 for the years ended
December 31, 1998, 1997 and 1996, respectively, and $5,835,021 for the period
from inception (August 15, 1994) to December 31, 1998. Such expenses are
recognized as research and development, as incurred.
INCOME TAXES
The Company provides for income taxes under the principles of Statement of
Financial Accounting Standards No. 109 (SFAS 109) which requires that provision
be made for taxes currently due and for the expected future tax effects of
temporary differences between book and tax bases of assets and liabilities.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash, other
receivables, accounts payable, accrued expenses and license fees payable. These
financial instruments are stated at their respective carrying values, which
approximate their fair values.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
NET LOSS PER SHARE
Net loss per share is presented as basic earnings based upon the weighted
average number of common shares. Diluted earnings per share have not been
presented as the common stock equivalents and their effect on earnings per share
is anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133 "Accounting for Derivatives Instrument and Hedging
Activities" establishes accounting and reporting standards for derivative
instruments. The Company has not in the past nor does it anticipate, that it
will engage in transactions involving derivative instruments which will impact
the financial statements.
Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," requires an entity to expense
all software development costs incurred in the preliminary project stage,
training costs and data conversion costs for fiscal years beginning after
December 15, 1998. The Company believes that this statement will not have a
material effect on the Company's accounting for computer software costs.
Statement of Position 98-5 "Accounting for Start-up Costs," requires an
entity to expense all start-up related costs as incurred for the fiscal years
beginning after December 15, 1998. The Company believes that this statement will
not have a material effect on the Company's accounting for start-up costs.
3. RECAPITALIZATION
On March 26, 1997, Hollis-Eden , was merged with and into the Company
(then known as IAC), pursuant to an Agreement and Plan of Merger, dated November
1, 1996, among IAC, Hollis-Eden, Mr. Salvatore J. Zizza and Mr. Richard B.
Hollis (the "Merger Agreement"). Upon consummation of the Merger, Hollis-Eden
ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals, Inc.
IAC (now called Hollis-Eden Pharmaceuticals, Inc.) remains the continuing legal
entity and registrant for Securities and Exchange Commission reporting purposes.
The Merger was intended to be a tax-free reorganization for federal income tax
purposes and was accounted for as a recapitalization of Hollis-Eden by an
exchange of Common Stock of Hollis-Eden, $.0001 par value ("Hollis-Eden Common
Stock"), for the net assets of IAC, consisting primarily of cash.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
Under the terms of the Merger Agreement, each share of Hollis-Eden Common
Stock outstanding immediately prior to the closing of the Merger converted into
one share of Common Stock, $.01 par value, of Hollis-Eden Pharmaceuticals, Inc.
Common Stock ("Company Common Stock"), and all warrants and options to purchase
Hollis-Eden Common Stock outstanding immediately prior to the Merger converted
into the right to receive the same number of shares of Company Common Stock. At
the closing of the Merger, 4,911,004 shares of Company Common Stock were issued,
which represented approximately 85% of the shares of Company Common Stock
outstanding immediately after consummation of the Merger.
For accounting and financial reporting purposes, the Merger was treated
as a recapitalization of Hollis-Eden. Since IAC had no business operations other
than the search for a suitable target business, IAC's assets were recorded in
the balance sheet of the Company at book value. Upon the consummation of the
Merger, the Company had $6.5 million in cash and other receivables, and incurred
transaction costs of approximately $230,000 associated with the Merger for net
proceeds totaling $6.3 million which was recorded as equity. Additional
transaction costs totaling $4.7 million represent a charge for (i) warrants to
purchase an aggregate of 452,830 shares of Company Common Stock at an exercise
price of $2.475 issued to the placement agent (Note 11) upon the closing of the
Merger pursuant to an agreement and (ii) an aggregate of 50,000 shares of
Company Common Stock issued for legal and consulting services upon the closing
of the Merger. An estimate of $11.50 per share was used to calculate the charges
which approximates fair market value on the date of the Merger. These charges
constitute transaction fees and accordingly have been recorded as a charge and
an offsetting credit to additional paid-in capital.
Upon the consummation of the Merger, pursuant to an agreement, the
Company issued warrants to purchase an aggregate of 50,000 shares of Company
Common Stock at an exercise price of $0.10 per share to a director and former
officer. Additional paid-in capital was increased by $570,000 with an offsetting
$570,000 charge recorded to operations during the three months ended March 31,
1997.
At the IAC annual and special meeting of shareholders (IAC Special
Meeting), none of the stockholders who held shares of IAC common stock that was
sold during IAC's initial public offering (IAC Non-Affiliate Stockholders)
elected to redeem their shares of IAC Common Stock and therefore were eligible
for Additional Merger Shares. (See Note 4).
The Company's 1997 Stock Incentive Stock Option Plan became effective on
February 5, 1997 and was approved by the stockholders on March 26, 1997. A total
of 1,250,000 shares of Company Common Stock have been authorized for issuance
under the plan (see Note 14).
4. ADDITIONAL MERGER SHARES
Pursuant to IAC's prospectus dated May 15, 1995, each of the IAC Non-
Affiliate Stockholders (and each IAC stockholder prior to IAC's initial public
offering who (i) participated in the February 1993 private placement of IAC
securities and (ii) purchased shares of IAC common stock in the open market
after May 15, 1995 (the "After Acquired Stock"), but only to the extent of the
After Acquired Stock)) had the right (the "Redemption Right") to elect to have
any or all of his or her shares of IAC common stock redeemed for approximately
$11.00 per share (the "Redemption Value"). At the IAC special meeting, none of
the IAC Non-Affiliate Stockholders elected to redeem their shares of IAC common
stock. In connection with the Merger, IAC offered each IAC Non-Affiliate
Stockholder the opportunity to exchange his or her Redemption Right for the
right to receive additional shares of Company common stock ("Additional Merger
Shares"), should any be issued.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
In order to perfect the right to receive Additional Merger Shares, if
any, an IAC Non-Affiliate Stockholder must (i) not have exercised his or her
Redemption Right in connection with the Merger and (ii) prior to May 25, 1997
(60 days following March 26, 1997, the effective time of the Merger (the
"Effective Time")), have taken whatever action necessary to cause such IAC Non-
Affiliate Stockholder to become the registered owner of his shares of Company
Common Stock (each, a "Rights Share" and, collectively, the "Rights Shares"). By
not exercising his or her Redemption Right in connection with the Merger, an IAC
Non-Affiliate Stockholder was deemed to have waived his or her Redemption Right
and accepted IAC's offer to receive the right to receive Additional Merger
Shares, if any are issued (provided such IAC Non-Affiliate Stockholder was not a
dissenting stockholder and became the registered owner of his or her shares of
Company Common Stock as provided above). The Company will cause to be issued to
each IAC Non-Affiliate Stockholder who shall have perfected his or her right to
receive Additional Merger Shares, if any, certificates evidencing one right
(each, a "Right" and, collectively, the "Rights") for each Rights Share held by
such IAC Non-Affiliate Stockholder (the "Rights Certificates"). The Rights
Certificates shall not be transferable, assignable, subject to pledge or
otherwise alienable, and the registered holder of such Rights Certificates shall
forfeit the number of Rights (the "Forfeited Rights") equal to the number of
shares of Company Common Stock sold or otherwise transferred by such holder
during the period commencing at the Effective Time and ending on the date that a
final determination of whether any Additional Merger Shares will be issued is
made (i.e., the second anniversary of the Effective Time) (the "Holding
Period"). The Forfeited Rights, at the moment of such sale or transfer, shall be
null and void and have no further force or effect.
Additional Merger Shares, if any, shall be issued to the holders of
Rights Certificates who have not otherwise forfeited their Rights as a result of
their selling or otherwise transferring shares of Company Common Stock during
the Holding Period if, at no time during the 24-month period immediately
following the Effective Time, the average closing price per share of Company
Common Stock over a period of 20 consecutive trading days equals or exceeds
$20.00 per share (subject to adjustment as set forth below). The Additional
Merger Shares shall be issued in accordance with the records of the Company as
promptly as practicable following the second anniversary of the Effective Time
to those holders of Rights Certificates who have not otherwise forfeited their
Rights. The number of Additional Merger Shares, if any, to be issued to the
holders of the Rights Certificates shall be calculated as follows: each
outstanding Right (i.e., any Right other than a Forfeited Right) shall entitle
the holder thereof to the number of Additional Merger Shares equal to (a) the
difference between (i) $20.00 (subject to adjustment as set forth below) and
(ii) the average of the highest 60 closing prices per share of Company Common
Stock during the one-year period immediately prior to the second anniversary of
the Effective Time (the "Sixty Day Average Price"), divided by (b) the Sixty Day
Average Price. No fractional Additional Merger Shares shall be issued. In lieu
thereof, any fractional shares shall be rounded to the nearest whole share of
Company Common Stock. The amount of Additional Merger Shares, if any, to be
issued shall be computed by the Company's independent public accountants as soon
as practicable following the second anniversary of the Effective Time. The
determination by such independent public accountants shall be final and binding
on the Company and the holders of the Rights. Notwithstanding the foregoing, the
Sixty Day Average Price shall in no event be less than $5.00 per share (subject
to adjustment as set forth below).
In the event of a stock dividend, stock split, share combination,
exchange of shares, recapitalization, merger, consolidation, acquisition or
disposition of property or shares, reorganization, liquidation or other similar
change or transaction of or by the Company following the Effective Time, the
closing price per share of Company Common Stock and the Sixty Day Average Price
shall be adjusted as appropriate to give proper effect to the event.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
Notwithstanding the foregoing, the Company shall have the unilateral
right to redeem and cancel all, but not less than all, of the Rights evidenced
by the Rights Certificates, at a redemption price of $.001 per Right, if the
Company, at any time during the Holding Period, closes an equity offering
pursuant to which the Company (i) issues shares of Company Common Stock at a per
share price of not less than $15.00 per share and (ii) raises net proceeds to
the Company of not less than $10 million. These rights were terminated in
January 1999.
5. NOTICE OF REDEMPTION AND EXERCISE OF WARRANTS
On March 27, 1997, the Company sent a Notice of Redemption to holders of
its Class A Common Stock Purchase Warrants and Class B Unit Purchase Warrants,
stating that it would redeem all of such outstanding warrants on April 28, 1997
at a redemption price of $0.05. The right to exercise such Warrants terminated
on April 25, 1997. 603,415 of the Class A Common Stock Purchase Warrants and
254,950 Class B Unit Purchase Warrants were exercised into an aggregate of
858,365 shares of Company Common Stock. The gross proceeds to the Company were
$5.5 million. The Company incurred approximately $42,000 in transaction costs
associated with the exercise and redemption of the warrants which was recorded
against equity.
6. FINANCING
During May 1998, the Company completed a private financing totaling $20.6
million in gross proceeds. The Company issued 1,329,201 shares of Common Stock
(of which 192,061 shares are subject to adjustment based on future average stock
price ("Adjustable Common Stock")), 4,000 shares of 5% Series A Convertible
Preferred Stock and Warrants to purchase 1,437,475 shares of Common Stock in the
financing.
The Convertible Preferred Stock had an initial conversion price of $20.30
for the first seven months, after which it can be adjusted, either up or down,
based on the future stock prices of the Company's Common Stock. The Convertible
Preferred Stock was converted to Common Stock in January 1999 (See Note 17).
The Warrants are exercisable for three years and entitle the holders to
purchase up to a total of 1,437,475 shares of Common Stock at a price of $17.00
per share.
7. NOTES PAYABLE/RECEIVABLE TO/FROM RELATED PARTY
During the first quarter of 1997, the Company borrowed $92,000 from a
stockholder/officer of the Company. The loaned amount plus accrued interest was
due on the earlier of the effective date of the merger of Hollis-Eden with IAC
or December 31, 1997. The loan was fully paid on March 27, 1997.
On May 22, 1998, the Company entered into a promissory note with a
stockholder/officer in the amount of $200,000. Interest is at 5.5% per annum.
The note is due and payable in full on May 22, 2001.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
8. INCOME TAXES
The Company has available a net operating loss carryforward of
approximately $10 million at December 31, 1998 which may be carried forward as
an offset to taxable income, if any, in future years through its expiration in
2012 to 2013. The Company has a net deferred tax asset of approximately $5
million at December 31, 1998 comprised of capitalized start-up costs, research
and development credits, and the net operating loss carryforward. The net
deferred tax asset has been fully reserved due to the uncertainty of the Company
being able to generate net operating income under the more likely than not
criteria of SFAS 109. If certain substantial changes in the Company's ownership
should occur, there would potentially be an annual limitation on the amount of
the carryforwards, which could be utilized in a tax year.
The Company carried back an operating loss to recover $105,436 in taxes
paid by IAC for the year ending 1996. The refund was received during the second
quarter 1998.
9. REVERSE STOCK SPLITS
In March 1996, a 1 for 2.65 split of the Company's common stock was
effected. Also, on February 13, 1995 there was a 3 for 5 split of the Company's
common stock. All stock splits have been retroactively restated for all periods
presented.
10. RELATED PARTY LICENSES AND OTHER AGREEMENTS AND COMMITMENTS AND
CONTINGENCIES
The Company entered into two license agreements and one research,
development and option agreement as discussed in the following paragraphs.
Pursuant to a license agreement dated May 18, 1994 (Colthurst License
Agreement) with related parties Patrick T. Prendergast, a significant
stockholder, and with Colthurst Limited, a company controlled by Patrick T.
Prendergast, the Company acquired the exclusive worldwide rights of Patrick T.
Prendergast's patent rights, know-how and background technology relating to the
treatment of human/animal immunodeficiency as disclosed in U.S. patent No.
4,956,355 entitled "Agents for the Arrest and Therapy of Retroviral Infections."
Upon execution of this agreement, the Company paid a license fee of $100,000 and
was contractually obligated to pay $250,000 no later than November 18, 1994. The
payment of this obligation was delinquent at December 31, 1994 and was included
in license fees payable on the balance sheet at December 31, 1994. The agreement
was amended on August 11, 1995 to change the license fee payment terms as
discussed below in paragraph five of this Note. Also, per the Colthurst License
Agreement, if the Company obtained financing of at least $10,000,000 by December
31, 1995, payments of $15,000 per month for services commencing on June 1, 1994
through the completion of FDA Phase II would have been payable to Patrick T.
Prendergast ($105,000 was included in license fees payable on the balance sheet
at December 31, 1994 based on a pending financing agreement). These monthly
service fees were eliminated entirely pursuant to an amendment to the agreement
on March 17, 1995 and the previously accrued amount of $105,000 was restructured
as discussed in paragraph five of this Note. Per the amended license agreement,
a renewal annual license fee of $500,000 is payable commencing 18 months after
the $350,000 license fee, as discussed below in paragraph five of this Note, is
paid. In 1998, the Company paid this fee by issuing 33,058 shares of its common
stock.
Also, the Company has agreed to pay royalties of 6% on product revenues.
In the event of a sale of sublicenses or any other third-party agreements, 25%
of any fees are payable to Colthurst Limited.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
On August 25, 1994, the Company entered into a license agreement
(Edenland License Agreement) with a related party, Edenland Inc., a company
controlled by Patrick T. Prendergast, for the exclusive worldwide rights of
Patrick T. Prendergast's patent rights, know-how and background technology
related to the substance trade named HE317 and to any other pharmaceutical
product that becomes subject to the license agreement under the research,
development and option agreement discussed below. Upon execution of this
agreement, the Company paid a license fee of $25,000. The agreement was amended
in August 1994 and required the Company to pay a license fee of $572,000 as
follows: $150,000 payable no later than February 28, 1995, $300,000 on February
28, 1995, and $122,000 payable no later than March 31, 1995. These amounts were
included in license fees payable on the balance sheet at December 31, 1994. The
agreement was again amended on August 11, 1995 to change the license fee payment
terms as discussed below in paragraph five of this Note. Per the Edenland
License Agreement, the Company has agreed to pay royalties of 4% of product
revenues. In the event of a sale of sublicenses or any other third-party
agreements, 25% of any fees are payable to Edenland, Inc. Additionally, the
Company granted Edenland, Inc. the option to receive payment of its royalties
under the license agreement in the form of shares of the Company's stock. The
option is limited to a maximum of 5% of the Company's outstanding shares at
August 25, 1994. The option is subject to the products and/or vaccine developed
therefrom receiving approval and generating product revenues to the Company of
at least $200,000,000. The option exercise price per share is the fair market
value on the date when and if such revenue milestone is achieved, and the option
has a term of five years beginning from such date.
Effective August 11, 1995, Edenland, Inc., Colthurst Limited and the
Company entered into amendments concerning the license fee payment terms to the
two agreements described above. Under the August 11, 1995 amendment, the Company
was obligated to pay $350,000 by April 28, 1996 and up to an additional $600,000
within 24 months of the $350,000 payment. The $600,000 fee will be payable by
way of a five percent payment of the first $12,000,000 of net proceeds or funds
or investments acquired by or expended on behalf of the Company by way of equity
sale, partnership agreement, loan or other means. At the end of the 24 month
period, any unpaid portion of the $600,000 fee is due immediately. If during the
24 month period the net proceeds exceed $12,000,000, then an additional fee is
due by way of two and one-half percent of all such proceeds. As of December 31,
1995, the Company had paid $22,000 of the $350,000 fee, and the remaining
$328,000 and the $600,000 fee were included in license fees payable as of
December 31, 1995 on the balance sheet. During April 1996, the $328,000 balance
was paid in full. During 1996, the Company advanced license fees of $100,300
related to the $600,000 owed to Edenland upon obtaining additional funding.
During April and May 1997, the balance of the $600,000 fee was paid in full. As
consideration for entering into certain amendments, the Company issued 75,472
shares of the Company's common stock at fair market value to Edenland, Inc. and
Colthurst Limited. Such valuation was determined by the Board of Directors and
was charged to general and administration expense for the year ended December
31, 1995.
In August 1994, the Company entered into a contingent research
development and option agreement, as amended, with Edenland, Inc. and Patrick T.
Prendergast. The agreement provides for the development of HE317 to a stage of
development that demonstrates the toxicity and safety profile and also indicates
potential efficacy in Phase II (FDA) patient studies, and grants the Company the
right of first option on new products developed by Edenland, Inc. The agreement
commits the Company to pay for the development costs related to HE317 up to the
amount of $3,000,000 contingent upon the Company's receipt of funds realized by
way of equity sale, sublicense, partnership agreements, loans, private
placements and public offerings which take place following April 28, 1996 but
not later than 24 months from 7 days following a private offering. Additionally,
the Company has agreed to pay a maximum of $250,000 per year to fund off-budget
projects to commence if and on the date the Company obtains $10,000,000 in
financing.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
In October 1996, the Company and Colthurst Limited entered into an
amendment to the existing agreement. The amendment changes the due date of the
renewable annual license of $500,000 from October 1997 to the first date that
one of the following events occurs: the Company raises a predetermined amount of
capital occurring after May 18, 1994; the Company sublicenses the technology
received under the Colthurst License Agreement; the Company generates sales; the
Company licenses or funds new technologies not covered under the existing
agreements; or, February 10, 1999. The amendment also requires an additional
license fee of $10,000 per month beginning November 5, 1996 through the earlier
of the effective date of the Merger or May 5, 1997. This amendment was
contingent upon the successful closure of the Merger. The renewable annual
license fee of $500,000 became due and was paid in May, 1998.
In October 1996, the Company and Edenland, Inc. entered into an amendment
to the existing Research, Development and Option agreement. This amendment
accelerated the date that the $3,000,000 payment for HE317 or other product
development costs is to be made. A payment of $1,500,000 was payable upon the
closure of the Merger and the balance is contingent upon future funding events
by allocating 22% of the funds raised to the Research, Development and Option
agreement until the $3,000,000 has been paid in full. $2,700,000 of the
$3,000,000 was paid in 1997 with the remaining $300,000 accrued as an expense in
1997 and paid in April 1998.
11. COMMON STOCK PURCHASE WARRANTS
SERIES A WARRANTS
During April 1996, in accordance with anti-dilution privileges triggered by an
offering in March 1995, the Company issued 1,018,867 Series A Warrants to all
stockholders of record as of March 1995 to purchase the same number of shares of
common stock at a price of $11.02 per share, exercisable until January 7, 2002.
SERIES B WARRANTS
During February 1995, the Company issued 37,736 Series B Warrants to Edenland,
Inc. in consideration for an amendment to the Edenland License Agreement. The
warrants are exercisable until February 5, 2000, to purchase the same number of
shares of common stock at a price of $15.90 per share.
CONSULTANT'S OPTIONS
On July 12, 1995, as payment for investor relations counseling and consulting
services, the Company issued an option, exercisable until July 12, 2000, to
purchase 18,868 shares of common stock at a price of $2.65 per share, 9,434
shares at a price of $5.30 per share, and 9,434 shares at a price of $7.95 per
share.
PLACEMENT AGENT WARRANTS
During May 1996, the Company issued to the placement agent, for the completion
of the private placement in April 1996 (see Note 12), a warrant to purchase an
aggregate of up to 445,000 shares of common stock, at an exercise price of
$2.475 per share. The fair value of the 445,000 options is deducted from the
net proceeds of the private placement as a cost of raising capital and totaled
approximately $133,000.
Upon the successful closure of the Merger and Redemption of the Class A Common
Stock Purchase Warrants (the "Class A Warrants") and Class B Unit Purchase
Warrants (the "Class B Warrants"), the Company issued additional placement agent
warrants to purchase 452,830 shares of common stock at an exercise price of
$2.475 per share.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
IAC MANAGEMENT WARRANTS
During April 1994, the Company issued warrants, to existing shareholders and
management, to purchase 160,000 units (the "Units") at $10.00 per Unit, each
unit to be identical to the Units issued as part of its initial public offering,
exercisable until May 15, 2000. Each Unit consists of (i) one share of common
stock, $.01 par value per share and (ii) one Class A Warrants entitling the
holder to purchase one share of common stock at a price of $9.00 per share.
REPRESENTATIVES WARRANTS
In connection with the Company's initial public offering, the Company issued
warrants to the underwriters for 60,000 Units at an exercise price of $11.00 per
Unit and 24,000 Class B Warrants at an exercise price of $5.775 per warrant and
exercisable until May 15, 2000. Each Class B Warrant entitles the holder to
purchase one Unit (i.e. one share of common stock and one Class A Warrant).
INVESTOR RELATIONS WARRANTS
During February 1998, as part of payment for investor relations, the Company
issued 150,000 warrants with an exercise price of $14.75 per share and an
expiration date of February 4, 1999. The warrants were estimated to have a value
of $408,000, which was expensed in 1998.
1998 PRIVATE PLACEMENT WARRANTS
In connection with the May 1998 private placement, the company issued warrants
to purchase 1,437,475 shares of common stock at an exercise price of $17.00 per
share. The warrants are exercisable until April 15, 2001. Of the warrants
issued, 157,000 were issued as finder fees, and 1,280,475 were issued to the
private placement investors.
As of December 31, 1998, the Company has 3,732,130 warrants outstanding.
12. COMMON STOCK
On January 21, 1996, the Company completed a $367,522 round of debt
financing with a group of private investors (Bridge Finance Offering). These
notes were due on or before the earlier of (i) January 21, 1997 or (ii) the
closing of a private or public offering of securities. These notes bear interest
at 8% per annum. The Company had the option to repay these notes with common
stock of the Company valued at a price of $2.25 per share or such price at which
shares were sold to investors in the Bridge Finance Offering. Proceeds from this
debt financing were used to repay the note and accounts payable to related
party, and accrued interest totaling $367,522. During April 1996, the debt
financing, plus accrued interest, were converted into 164,962 shares of common
stock at a price of $2.25 per share. From March 19, 1996 through April 19, 1996,
the Company privately issued 580,005 shares of the Company's common stock at an
offering price of $2.25 per share. Total proceeds from this offering aggregated
$1,234,499.
13. PREFERRED STOCK
During May 1998, as part of the private placement, the Company issued
4,000 shares of convertible preferred stock for proceeds of $4,000,000. During
January, 1999, all of the Preferred Stock was converted to Common Stock (See
Note 17).
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
14. STOCK OPTIONS
The 1997 Stock Option Plan (the "Plan") was approved by the shareholders
in 1997. Under the Plan, 1,250,000 shares of common stock have been reserved for
issuance to employees, officers, directors, and consultants of the Company and
provides for the grant of incentive and nonstatutory stock options. Terms of the
stock option agreements, including vesting requirements, are determined by the
Board of Directors. The exercise price of incentive stock options must equal at
least the fair market value on the date of grant. The options expire not later
than ten years from the date of the grant and become exercisable immediately or
generally are exercisable ratably over a three-year period beginning one year
from the date of the grant. The following table summarizes stock option activity
under the Plan for 1997 and 1998:
Price Per Share
-----------------------
Weighted
Shares Range Average
------- ----------- --------
1997
Granted 518,500 $ 2.25-8.70 $ 7.12
Exercised 166 2.25 2.25
Canceled 334 2.25 2.25
Outstanding, December 31, 1997 518,000 2.25-8.70 7.13
1998
Granted 340,800 13.25-16.75 14.52
Exercised 0 0 0
Canceled 100,000 8.70 8.70
Outstanding, December 31, 1998 758,800 $ 2.25-16.75 $ 10.24
The Company entered into stock options agreements not pursuant to the
Plan with certain directors, officers and consultants. These options become
exercisable according to a schedule of vesting as determined by the Board of
Directors. The options become exercisable immediately or over a period of years.
During 1996, the Company recognized a prepaid expense related to the options
issued to consultants. The Company recognized the expense of approximately
$24,000 related to these options ratably over the three-year vesting period.
During 1998, the Company granted options to certain consultants and directors,
and will recognize $900,000 in expense related to these options ratably over the
three-year vesting period, $240,000 was expensed in 1998.
In February, 1997, as part of an employment agreement,the Company granted
a non-statutory stock option to a certain officer to purchase 2,400,000 shares
of the Company's common stock at a price of $5.00 per share, which option vests
ratably over a six-year period. The Company engaged an independent appraiser to
prepare several financial and valuation analyses to estimate the fair value for
accounting purposes. The appraiser estimated the intrinsic value of the options
to be $1,848,000. As a result, the Company recorded as deferred compensation a
non-cash charge of $1,848,000, which is being amortized ratably over the six-
year vesting period. Through December 31, 1998 the Company has amortized a total
of $590,000, (See Note 17).
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
The following table summarizes stock option activity not pursuant to the
Plan for 1995 through 1998:
Price Per Share
---------------------
Weighted
Shares Range Average
--------- ---------- --------
Outstanding, January 1, 1995 - $ - $ -
Granted 37,736 2.65-7.95 4.64
Exercised - - -
Canceled - - -
Outstanding, December 31, 1995 37,736 2.65-7.95 4.64
Granted 570,000 2.25 2.25
Exercised - - -
Canceled - - -
Outstanding, December 31, 1996 607,736 2.25-7.95 2.40
Granted 2,400,000 5.00 5.00
Exercised - - -
Canceled - - -
Outstanding, December 31, 1997 3,007,736 2.25-7.95 4.47
Granted - - -
Exercised 53,302 2.25-5.30 2.93
Canceled 50,000 2.25 2.25
Outstanding, December 31, 1998 2,904,434 $2.25-7.95 $ 4.54
For various price ranges, weighted average characteristics of outstanding stock
options at December 31, 1998 were as follows:
Outstanding Options Exercisable options
------------------------------------- -----------------------
Range of Remaining life Weighted Weighted
Exercise Prices Shares (years) average price Shares average price
- --------------- --------- ------- ------------- -------- -------------
$2.25-$4.99 495,000 6 $ 2.25 458,333 $2.25
$5.00-$8.99 2,827,434 10.9 5.27 560,378 5.52
$9.00-$12.99 - - - - -
$13.00-$16.99 340,800 9.4 $14.52 - -
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 ("SFAS 123")
During 1995, the Financial Accounting Standards Board issued SFAS 123,
Accounting for Stock-Based Compensation, which defines a fair-value-based method
of accounting for stock compensation plans. However, it also allows an entity to
continue to measure compensation cost related to stock compensation plans using
the method of accounting prescribed by the Accounting Principles Board Opinion
No. 25 (APB 25), Accounting for Stock Issued to Employees. Entities electing to
follow APB 25 must make pro forma disclosures of net income, as if the fair-
value-based method of accounting defined in SFAS had been applied.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
The Company has elected to account for its stock-based compensation plans under
APB 25; however, for pro forma disclosure purposes, the Company has computed the
value of all options granted to employees during 1996 through 1998, using the
minimum value pricing model as prescribed by SFAS 123 for 1996 and the Black-
Scholes option pricing model for 1997 and 1998 with the following weighted
average assumptions:
1998 1997 1996
------- ------- -------
Risk free interest rate 5.55% 5.90% 6.09%
Expected dividend yield 0% 0% 0%
Expected lives 5 years 5 years 5 years
Expected volatility 46.5% 46.5% N/A
The warrants were assumed to be exercised at maturities of four and five years,
while the stock options were assumed to be exercised in five to seven years.
Adjustments are made for options forfeited prior to vesting. The total value of
warrants and options was computed to be the following approximate amounts, which
would be amortized on the straight-line basis over the vesting period of the
options:
Year ended December 31, 1996 $ 385,042
Year ended December 31, 1997 $1,777,270
Year ended December 31, 1998 $1,435,510
If the Company had accounted for stock options issued to employees and directors
in accordance with SFAS 123, the Company's net loss would have been reported as
follows:
Net loss
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------- ---------- ----------
As reported $5,427,453 $5,252,884 $ 692,220
Pro forma $6,862,963 $7,030,154 $1,077,262
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options. The weighted average, estimated
fair values of employee stock options granted during fiscal 1998, 1997 and 1996
were $14.52, $5.38 and $2.25 per share, respectively.
<PAGE>
HOLLIS-EDEN PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
15. EMPLOYMENT AGREEMENTS
Pursuant to an employment agreement between Hollis-Eden and Mr. Richard
B. Hollis entered into in November 1996 (the "Hollis Employment Agreement"), Mr.
Hollis' annual base salary was increased to $225,000 upon the consummation of
the Merger, with bonuses and equity compensation as determined by the Hollis-
Eden Pharmaceuticals Board of Directors. As of September 1, 1998, Mr. Hollis'
base salary was increased to $300,000. If Mr. Hollis' employment is terminated
"without cause," "for insufficient reason" or pursuant to a "change in control"
(as such terms are defined in the Hollis Employment Agreement), Mr. Hollis will
receive as severance (i) an amount equal to five times his then current annual
base salary plus five times the amount of the bonus awarded to him in the prior
calendar year, (ii) immediate vesting of all unvested stock options of Hollis-
Eden Pharmaceuticals (or the Surviving Corporation, if applicable) held by him
and (iii) continued benefits under all employee benefit plans and programs for a
period of three years. All of such payments are to be made in one lump sum
within 30 days of termination. If Mr. Hollis' employment is terminated "with
cause" or if Mr. Hollis resigns other than for "sufficient reason," Mr. Hollis'
compensation and benefits will cease immediately and Mr. Hollis will not be
entitled to severance benefits.
16. LEASES
Rental expenses for principally leased facilities under operating leases
were $17,000, $69,000 and $115,000 for 1996, 1997 and 1998, respectively. Future
minimum payments for operating leases are as follows:
Operating Leases
----------------
1999 $120,000
2000 83,000
2001 4,000
2002 4,000
--------
Total minimum lease payments $211,000
17. SUBSEQUENT EVENTS
In January 1999, the Company issued 346,217 shares of common stock in
connection with the conversion of the Series A convertible preferred stock and
additional shares relating to the Adjustable Common Stock as described in Note
6.
During January 1999, the Company completed two private placements of
1,367,686 shares of common stock and 90,000 warrants as a finders fee. The
Company raised approximately $25 million. The pricing ranged from $18.00 to
$18.50 per share.
During January 1999, the Company terminated the additional merger share
rights (See Note 4) as a result of the above mentioned private placement and the
Company's average closing stock price.
On March 1, 1999, the Company announced the resignation of it's
president. Concurrent therewith, the Company accelerated the vesting of 300,000
stock options previously granted to the President. This acceleration is
considered to be a new grant of options, and as such, the Company will take a
one time non-cash charge of approximately $5 million during the first quarter of
1999.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Hollis-Eden Pharmaceuticals, Inc.
San Diego, CA
We hereby consent to the incorporation by reference of our report dated January
26, 1999 relating to the financial statements of Hollis-Eden Pharmaceuticals,
Inc., incorporated by reference into the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, into the prospectuses constituting a part
of the following registration statements: No. 333-18725 on Form S-8 to Form S-4,
No. 333-18725 on Form S-3 to Form S-4, No. 333-56155 on Form S-3, No. 333-56157
on Form S-3, and No. 333-69727 on Form S-3.
We also consent to the references to us under the caption "Experts" in the
Prospectuses.
BDO Seidman, LLP
New York, NY
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE TWELVE MONTH PERIOD ENDED DECEMBER
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 24,189,806
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 24,431,882
<PP&E> 120,544
<DEPRECIATION> 28,201
<TOTAL-ASSETS> 24,524,225
<CURRENT-LIABILITIES> 221,670
<BONDS> 0
0
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<COMMON> 85,922
<OTHER-SE> 24,216,593
<TOTAL-LIABILITY-AND-EQUITY> 24,524,225
<SALES> 0
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<CGS> 0
<TOTAL-COSTS> 6,354,643
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1726
<INCOME-PRETAX> (5,427,453)
<INCOME-TAX> 0
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