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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the Quarterly Period Ended September 30, 2003.
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from                  to

Commission File Number: 0-497

Lipid Sciences, Inc.

7068 Koll Center Parkway, Suite 401, Pleasanton, California 94566

(925) 249-4000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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LIPID SCIENCES, INC.

FORM 10-Q

For the Period Ended September 30, 2003

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PART I

ITEM 1. FINANCIAL STATEMENTS

Lipid Sciences, Inc. (A Development Stage Company) Condensed Consolidated Balance Sheet (Unaudited)

See accompanying notes to Condensed Consolidated Financial Statements

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Lipid Sciences, Inc.
(A Development Stage Company)
Condensed Consolidated Statements of Operations (Unaudited)

See accompanying notes to Condensed Consolidated Financial Statements

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Lipid Sciences, Inc.
(A Development Stage Company)
Condensed Consolidated Statements of Cash Flows (Unaudited)

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See accompanying notes to Condensed Consolidated Financial Statements

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Lipid Sciences, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1: ORGANIZATION AND BASIS OF PRESENTATION

     On November 29, 2001, Lipid Sciences, Inc., a privately-held corporation, merged with and into NZ Corporation. NZ Corporation survived the merger and changed its name to Lipid Sciences, Inc. In this report, unless the context otherwise requires, the current company, Lipid Sciences, Inc., is referred to as “we,” “the Company” or “Lipid Sciences” with respect to periods of time from the effective date of the merger to the date of this report; the merged company, Lipid Sciences, Inc., a privately-held corporation, is referred to as “we” or “Pre-Merger Lipid” with respect to periods prior to the effective date of the merger; and NZ Corporation is referred to as “NZ,” with respect to periods prior to the effective date of the merger.

     On June 26, 2002, the Company changed its state of incorporation from Arizona to Delaware. The reincorporation was accomplished through a statutory merger of Lipid Sciences, Inc., an Arizona corporation (“Lipid Arizona”), into a newly formed Delaware corporation of the same name (“Lipid Delaware”). As a result of the merger, each outstanding share of Lipid Arizona Common Stock, no par value, was automatically converted into one share of Lipid Delaware Common Stock, par value $0.001. This change in the Company’s state of incorporation was approved by the holders of a majority of the Company’s outstanding shares of Common Stock at the Company’s Annual Meeting of Stockholders on June 18, 2002. There was no impact on the Company’s financial condition or results of operations as a result of the reincorporation.

     The Company is engaged in the research and development of products and processes intended to treat major medical conditions in which lipids, or fat components, play a key role. Our primary activities since incorporation have been conducting research and development, performing business, strategic and financial planning, and raising capital. Accordingly, the Company is considered to be in the development stage.

     Historically, NZ engaged in various real estate and commercial real estate lending activities. On March 22, 2002, we formalized a plan to discontinue the operations of our real estate and real estate lending business, including commercial real estate loans, to fund the ongoing operations of Lipid Sciences’ biotechnology business. As a result, we have reclassified the results of operations and the assets and liabilities of the discontinued operations for all periods presented.

     In the course of our research and development activities, we have sustained continued operating losses and expect those losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources for clinical testing and related activities. We continue to expend significant cash resources in pursuit of our primary objectives, and at September 30, 2003, the remaining available cash and investments balance is $14.7 million. We anticipate that these assets and the cash raised from the disposal of remaining real estate and other assets held by the Company before the merger will provide sufficient working capital for our research and development activities through mid-2005. We expect additional capital will be required in the future and our Board is evaluating various alternatives for funding our operations. These alternatives may include new collaborations, such as licensing or other arrangements, the pursuit of research and development grants, or public or private equity or debt financings.

     The Condensed Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated.

     The Condensed Consolidated Financial Statements presented are unaudited and in the opinion of management reflect all adjustments necessary (consisting only of normal recurring adjustments) for a fair presentation of the financial condition and results of operations as of, and for, the interim periods presented. The results for interim periods are not necessarily indicative of the results to be expected for the full year. The December 31, 2002 balance sheet, as presented, was derived from the audited Consolidated Financial Statements as of December 31, 2002. These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2003.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date

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of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates and assumptions.

     Certain prior period amounts have been reclassified to conform to the current period’s presentation. Such reclassifications had no material effect on the Company’s previously reported consolidated financial position, results of operations or cash flows.

NOTE 2: ACQUISITION

     On November 29, 2001, we completed our merger with Pre-Merger Lipid. As a result of the merger, the Company was renamed Lipid Sciences, Inc. Pre-Merger Lipid ceased to exist as a separate corporation, and the shareholders of Pre-Merger Lipid became shareholders of the Company. In connection with the merger, Pre-Merger Lipid shareholders received 1.55902 shares of our common stock for each share of Pre-Merger Lipid common stock they held at the time the merger was completed. After the transaction, the Pre-Merger Lipid shareholders owned approximately 75% of the then outstanding stock of the Company and the NZ shareholders owned the remaining shares of the Company’s common stock.

     The merger was accounted for under the purchase method of accounting and was treated as a reverse acquisition because the shareholders of Pre-Merger Lipid owned the majority of the Company’s common stock after the merger. Pre-Merger Lipid was considered the acquiror for accounting and financial reporting purposes. The results of operations from NZ have been included only from November 29, 2001, the date of acquisition. The historical financial statements prior to November 29, 2001 are those of Pre-Merger Lipid.

     Pre-Merger Lipid acquired NZ for the aggregate purchase price of $60,952,000. The following table summarizes the fair values of the assets acquired and the liabilities assumed at the date of acquisition:

     In connection with the merger, the Company is obligated to issue additional shares of common stock to those individuals and entities who were stockholders of NZ on the day prior to the completion of the merger and who perfected their rights to receive additional shares of the Company’s common stock, unless during the 24-month period immediately following the merger, the closing price per share of the Company’s common stock equals or exceeds $12.00 per share throughout any period of 20 consecutive trading days, in which the aggregate volume of shares traded equals or exceeds 1,500,000 shares. Each perfected right entitles the holder to receive up to one additional share of the Company’s common stock. Stockholders had until April 30, 2002 to become the direct registered holder of their shares of common stock and must continue to hold their shares through November 29, 2003 to receive the common stock associated with each right. Any transfer of shares before November 29, 2003 will disqualify the right attached to such transferred shares. The issuance of additional shares of common stock pursuant to the rights will have the effect of diluting the ownership of stockholders not holding rights and increasing the proportionate ownership of the stockholders holding rights. The number of outstanding shares of common stock would increase, having the effect of diluting earnings per share. As of September 30, 2003, 3,340,344 rights were perfected with an additional 120,751 rights pending determination. If all of the holders of rights remain qualified to receive the additional shares on November 29, 2003, the issuance will dilute ownership of stockholders not holding rights by up to 14.1%, based on 21,141,455 shares outstanding as of September 30, 2003.

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NOTE 3: NET LOSS PER SHARE

     The merger between the Company and Pre-Merger Lipid was accounted for under the purchase method of accounting and was treated as a reverse acquisition because the stockholders of Pre-Merger Lipid owned the majority of the Company’s common stock after the merger. Pre-Merger Lipid was considered the acquiror for accounting and financial reporting purposes. The weighted average number of common shares has been adjusted for all periods to reflect the exchange ratio of 1.55902 to 1.

     The Company computes its net loss per share under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share”. Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company had securities outstanding, which could potentially dilute basic earnings per share, but because the Company incurred a net loss for all periods presented, such securities were excluded from the computation of diluted net loss per share as their effect would have been antidilutive. The securities excluded from diluted loss per share consist of the following:

NOTE 4: STOCK COMPENSATION

     The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (“APB”) No. 25, Accounting for Stock Issued to Employees, as interpreted by Financial Accounting Standards Board (“FASB”) Interpretation No. 44, “Accounting for Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25.” The Company accounts for stock-based awards to non-employees in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation and Emerging Issues Task Force (“EITF”) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

     Because the Company grants stock option awards at market value, there is no compensation expense recorded. Had compensation expense for the Company’s stock option awards been determined based on the Black-Scholes fair value at the grant dates for awards under those plans consistent with the fair value method of SFAS No. 123—Accounting for Stock-Based Compensation, the Company would have recorded additional compensation expense and its net income and earnings per share (EPS) would have been reduced to the pro forma amounts presented in the following table:

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NOTE 5: RECENTLY ISSUED ACCOUNTING STANDARDS

     In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Lipid adopted the disclosure requirements of FIN 45 on December 31, 2002. Adoption of the recognition provision of FIN 45 did not have an impact on Lipid’s financial position, results of operations or cash flows.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the annual and quarterly disclosure requirements of SFAS No. 148 as of December 31, 2002 and March 31, 2003, respectively. The transitional provisions of SFAS No. 148 did not have an impact on the Company’s financial position, results of operations, EPS, or cash flows, as the fair value method has not been adopted.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement did not have an impact on Lipid’s financial position, results of operations or cash flows.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” . This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003. The adoption of this statement did not have an impact on Lipid’s financial position, results of operations or cash flows.

NOTE 6: PROPERTY AND EQUIPMENT

     Property and equipment are carried at cost less accumulated depreciation and amortization. Property and equipment are depreciated using the straight-line method over the estimated useful lives, generally three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the remaining term of the lease.

      Property and equipment consist of the following (in thousands):

NOTE 7: DEVELOPMENT AGREEMENT

     In October 2000, we entered into a Development Agreement with SRI International, a California nonprofit public benefit corporation, pursuant to which SRI provides us with various consulting and development services. SRI will assign to us all intellectual property developed during the term of the Development Agreement. The Development Agreement calls for SRI to complete two development phases (as defined in the Development Agreement, “Phase I” and “Phase II”) during which time SRI will work to develop a medical device to enable us to further develop and commercialize our lipid removal technology. In addition, we have entered into a number of amendments with SRI to address work performed by SRI, which are both within and outside of the scope of work of Phase II development. Certain of the amendments have been in support of product development and certain of the amendments relate to supplemental testing and analysis performed by SRI.

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     We also issued SRI a warrant to purchase 779,510 shares of common stock at an exercise price of $3.21 per share. The warrant vested with respect to 233,853 shares upon completion of Phase I, with the remaining 545,657 shares vesting upon completion of Phase II. On May 12, 2001, the Development Agreement was amended with respect to the remaining unvested warrant shares to purchase 545,657 shares of common stock related to Phase II. This amendment splits Phase II into two development milestones with 272,829 warrant shares vesting at the completion of each milestone. If either development milestone is discontinued at the option of the Company, all 545,657 remaining warrant shares will vest at the completion of the remaining milestone.

     Phase I was completed on March 28, 2001. Fees for services performed by SRI for Phase I totaled $1,517,000. The completion of Phase I resulted in the vesting of 233,853 warrant shares to purchase our common stock becoming fully vested. On this date, we recognized an expense of $847,000, based upon the fair market value of the warrant shares on the date of vesting, using the Black-Scholes method with the following assumptions: a volatility of 80%, a dividend yield of 0%, a risk-free interest rate of 6%, and a life of seven years.

     Phase II was initiated upon completion of Phase I. Fees for Phase II of the development program were limited to $6,300,000. On July 26, 2002, funding to SRI for the continued development of Phase II was increased to $9,500,000. On July 1, 2003, consistent with our new strategic direction, the scope of the Development Agreement was amended to focus on providing applied research and development services in support of advancing our VPI platform. Approximately $147,000 and $1,334,000 for the three month periods ended September 30, 2003 and September 30, 2002, respectively, and $993,000 and $3,638,000 for the nine month periods ended September 30, 2003 and September 30, 2002, respectively, were charged to operations for fees related to Phase II. As of September 30, 2003, neither milestone related to Phase II was completed. Consequently no value has been assigned to the remaining 545,657 warrant shares which vest upon completion of such milestones.

NOTE 8: RELATED PARTY TRANSACTIONS

     In December 1999, we entered into an Intellectual Property License Agreement to obtain the exclusive worldwide rights to certain patents, trademarks, and technology with Aruba International Pty. Ltd., an Australian company, controlled by Bill E. Cham, Ph.D., a founding stockholder of Pre-Merger Lipid and a former Director. Under this agreement, we are obligated to pay Aruba a continuing royalty on revenue in future years, subject to a minimum annual royalty amount of $500,000, 10% of any External Research Funding received by us to further this technology, as defined in the agreement, and $250,000 upon commencement of our initial human clinical trial utilizing the technology under the patents. Our initial human clinical trial commenced during the three month period ended June 30, 2002. For the three month periods ended September 30, 2003 and September 30, 2002 we have expensed $125,000 and $125,000, respectively, and for the nine month periods ended September 30, 2003 and September 30, 2002 we have expensed $375,000 and $625,000, respectively, related to this agreement. Amounts for 2003 and 2002 were charged to research and development expense.

     Additionally, in the normal course of business, we have consulted with Dr. Cham, and companies with which he is affiliated, regarding various matters relating to research and development. In November 2001, we entered into a Service Agreement with Karuba International Pty. Ltd., a company controlled by Dr. Cham, in order to consolidate such consulting services. We were required to pay approximately $191,000 a year for Karuba’s consulting services, as well as out-of-pocket expenses incurred in the performance of such services. Under the terms of the agreement, the annual obligation to Karuba increased to approximately $198,000 per year in May 2002. Haven given 30 days written termination notice to Karuba on July 30, 2003, the agreement was terminated effective August 31, 2003. As a result of such termination, we are required to pay Karuba a termination amount equal to one third of the annual fee, payable in equal monthly installments through December 2003. During the three month period ended September 30, 2003, we recorded a provision for approximately $80,000, reflecting the remaining termination liability to Karuba. Approximately $140,000 and $65,000 for the three month periods ended September 30, 2003 and September 30, 2002, respectively, and $273,000 and $180,000 for the nine month periods ended September 30, 2003 and September 30, 2002, respectively, were expensed to research and development under this agreement, of which approximately $80,000 is included in accounts payable and accrued liabilities at September 30, 2003.

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     In June 2001, Pre-Merger Lipid engaged MDB Capital Group, LLC as its financial advisor in the merger between NZ and Pre-Merger Lipid. The engagement letter commits the Company to pay MDB Capital Group an advisory fee. In December 2001, we paid MDB Capital Group approximately $446,000, which represents a portion of the advisory fee and is based on 5% of the cash and cash equivalents of the Company immediately after the merger, as compared to Pre-Merger Lipid’s cash and cash equivalents immediately prior to the merger. The remainder of the advisory fee is based on 5% of the gross sales of the Company’s pre-merger assets during the two-year period after the closing of the merger, the Company’s assets on the two-year anniversary of the merger and the net operating income of the Company derived from the Company’s pre-merger assets during the two-year period after the closing of the merger. Approximately $1,400,000 of the advisory fee was paid during the twelve months ended December 31, 2002 and $432,000 during the nine month period ended September 30, 2003.

NOTE 9: RESTRUCTURING

     In December 31, 2001, we recorded restructuring charges of approximately $885,000, which were charged to general and administrative expense. Our restructuring initiatives involved strategic decisions to exit the real estate market through the orderly disposition of substantially all of NZ’s assets.

     On January 28, 2003, we announced a new strategic direction for the Company and the application and development of our novel technology of plasma delipidation. As a result, we are focusing our research and development efforts with respect to our proprietary Viral Pathogen Inactivation (VPI™) platform on HIV, while continuing to undertake research and development with respect to our proprietary Vascular Lipid Removal (VLR™) platform. In addition, we are continuing to strengthen our intellectual property position with respect to both of our technology platforms. In connection with this new strategic direction, we have discontinued our Phase 1 human clinical trial in Australia, which was paused in the third quarter of 2002, and ceased all operations in Australia. In the nine month period ended September 30, 2003, we recorded restructuring charges of approximately $1,120,000 related to this restructuring.

     In connection with these restructuring initiatives, we have recorded the following:

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     The restructuring related to NZ was completed in April 2003. All accrued amounts will be paid within twelve months of the restructuring completion. The restructuring related to our new strategic direction was completed during the first quarter of 2003 with all accrued amounts to be paid by the end of the first quarter 2004. As of September 30, 2003, we have utilized approximately $611,000 of the accrual set up for real estate restructuring purposes and $995,000 of the accrual related to the implementation of our new strategic plan.

NOTE 10: DISCONTINUED OPERATIONS

     As a result of the merger between Pre-Merger Lipid and NZ on November 29, 2001, certain real estate assets, including commercial real estate loans were acquired. As part of the merger, we announced our intent to conduct an orderly disposition of those assets to fund the ongoing operations of Lipid Sciences’ biotechnology business. On March 22, 2002, we formalized a plan to discontinue the operations of our real estate business, including commercial real estate loans. All of those assets were included in the Real Estate segment. The plan identified the major assets to be disposed of, the method of disposal, and the period required for completion of the disposal. As a result, we have reclassified the results of operations and the assets and liabilities of the discontinued operations for all periods presented. The carrying amounts of the major classes of assets and liabilities included as part of the disposal group as of September 30, 2003, are as follows:

     During the three months ended March 31, 2003, the Company reclassified the remaining assets of a component of the real estate business from discontinued operations to assets held for use. As a result, notes receivable with a carrying value of $6,569,000 at December 31, 2002 were reclassified from current assets of discontinued operations to notes receivable. Although we may dispose of these assets prior to their maturities, they may also be held to term if we cannot obtain favorable terms for disposal. The results of operations of this component, previously reported in discontinued operations through December 31, 2002, have been reclassified and included in interest and other income for all periods presented. Income of $173,000, $515,000 and $747,000 for the three months ended September 30, 2002, the nine months ended September 30, 2002 and the period from Inception (May 21, 1999) to December 31, 2002, respectively, have been reclassified to interest and other income. Additionally, all related income tax expenses/benefits and accrued interest have been reclassified accordingly.

NOTE 11: INCOME TAXES

     The Company’s effective tax rate was 0.77% in the third quarter of 2003 and effective tax benefit rate was 27.87% in 2002. The effective tax rate was calculated using an estimate of our expected annual pretax income for 2003. The effective tax rate for 2003 differed from the statutory federal income tax rate primarily due to additional valuation allowance provided.

     A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. We established a valuation allowance at September 30, 2003 due to the uncertainty of realizing future tax benefits from certain of its operating loss carryforwards and credits.

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NOTE 12: SEGMENTS

     As a result of the merger between Pre-Merger Lipid and NZ, the Company was previously organized into two segments, Biotechnology and Real Estate. The Biotechnology segment is primarily engaged in the research and development of products and processes focused on treating major medical indications in which lipids, or fat components, play a key role. As part of the merger we announced our intent to conduct an orderly disposition of the real estate assets, including commercial real estate loans, acquired to fund the ongoing operations of Lipid Sciences. On March 22, 2002, we approved a plan to dispose of the Real Estate segment and intend to focus on Biotechnology in the future. Substantially all of the assets and liabilities of the Real Estate segment are included in the discontinued operations plan formalized by the Company on March 22, 2002 (see Note 10 of the Condensed Consolidated Financial Statements).

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     This Form 10-Q contains forward-looking statements concerning plans, objectives, goals, strategies, future events or performance as well as all other statements which are not statements of historical fact. These statements contain words such as, but not limited to, “believes,” “anticipates,” “expects,” “estimates,” “projects,” “will,” “may” and “might.” The forward-looking statements contained in this Form 10-Q reflect our current beliefs and expectations on the date of this Form 10-Q. Actual results, performance or outcomes may differ materially from what is expressed in the forward-looking statements. We have discussed the important factors, which we believe could cause actual results, performance or outcomes to differ materially from what is expressed in the forward-looking statements, under the caption “Factors That May Affect Future Results and Financial Condition.” We are not obligated to publicly announce any revisions to these forward-looking statements to reflect a change in facts or circumstances.

     You should read the discussion below in conjunction with Part I, Item 1, “Financial Statements,” of this Form 10-Q and Part II, Items 7, 7A and 8, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and “Financial Statements and Supplementary Data,” respectively, of our Annual Report on Form 10-K for the year ended December 31, 2002.

Overview

     We are a development-stage biotechnology company that is conducting research and developing products and processes intended to treat major medical conditions in which lipids, or fat components, play a key role. Our technologies are based on a patented process that selectively removes lipids from proteins. We believe that this unique delipidation process has the potential for far-reaching implications related to human health. It may provide an effective therapeutic effect against viral infections, including HIV, Hepatitis B and Hepatitis C, SARS and West Nile, among others, as well as reverse cardiovascular and cerebrovascular disease.

     We are developing our basic delipidation technology as two complementary technology platforms. The first platform, Viral Pathogen Inactivation (VPI™), relates to the removal of lipid from lipid-enveloped viruses, bacteria and other lipid-enveloped infectious agents in the blood stream. Examples of viruses with lipid envelopes that potentially may be treated by our VPI system include: HIV, Hepatitis B and Hepatitis C, SARS Coronavirus, West Nile virus, and Influenza, among others. The second platform, Vascular Lipid Removal (VLR™), is focused on treating atherosclerosis, which results from the buildup of fatty plaque in the vascular system and, most critically, in the coronary arteries. Conditions such as heart disease, stroke and peripheral vascular disease are targets for our VLR platform.

     Our primary activities since incorporation have been conducting research and development, performing business, strategic and financial planning, and raising capital. Accordingly, the Company is considered to be in the development stage.

     On November 29, 2001, we completed our merger with Pre-Merger Lipid. As a result of the merger, the Company was renamed Lipid Sciences, Inc. Pre-Merger Lipid ceased to exist as a separate corporation, and the shareholders of Pre-Merger Lipid became shareholders of the Company. In connection with the merger, Pre-Merger Lipid shareholders received 1.55902 shares of our common stock for each share of Pre-Merger Lipid common stock they held at the time the merger was completed. After the transaction, the Pre-Merger Lipid shareholders owned approximately 75% of the then outstanding stock of the Company and the NZ shareholders owned the remaining shares of the Company’s common stock.

     The merger with NZ was accounted for under the purchase method of accounting and was treated as a reverse acquisition because the stockholders of Pre-Merger Lipid owned the majority of our common stock immediately after the merger. Pre-Merger Lipid was considered the acquiror for accounting and financial reporting purposes. Accordingly, all financial information prior to November 29, 2001 included in this report reflects Pre-Merger Lipid results.

     In connection with the merger, the Company is obligated to issue additional shares of common stock to those individuals and entities who were stockholders of NZ on the day prior to the completion of the merger and who perfected their rights to receive additional shares of the Company’s stock, unless during the 24-month period immediately following the merger, the closing price per share of the Company’s common stock equals or exceeds $12.00 per share throughout any period of 20 consecutive trading days, in which the aggregate volume of shares traded equals or exceeds 1,500,000 shares. Each perfected right entitles the holder to receive up to one additional share of the Company’s common stock. Stockholders had until April 30, 2002 to become the direct registered holder of their shares of common stock and must continue to hold their shares through November 29, 2003 to qualify to receive the additional stock with respect to each perfected right. Any transfer of shares before November 29, 2003 will disqualify the right with respect to each of such transferred shares. The issuance of additional shares of common stock pursuant to the rights, will have the effect of diluting the ownership of stockholders not holding rights and increasing the proportionate ownership of the stockholders holding rights. As of September 30, 2003, 3,340,344 rights were perfected with an additional 120,751 rights pending determination. If all of the holders of perfected rights remain qualified to receive the additional shares on November 29, 2003, the issuance will dilute ownership of stockholders not holding rights by up to 14.1%, based on 21,141,455 shares outstanding as of September 30, 2003.

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     In the course of our research and development activities, we have sustained continued operating losses and we expect these losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources to clinical testing and other activities related to seeking approval to market our products. We approved a discontinued operations plan on March 22, 2002, to dispose of substantially all of the real estate and other assets held by the Company before the merger. During 2002, we disposed of most of these assets. As described under “Results of Discontinued Operations – Three and Nine Months Ended September 30, 2003”, we reclassified certain of these assets to assets held for use (see Note 10 of the Condensed Consolidated Financial Statements). We intend to finance our operations through the disposition of the remaining real estate and other assets held by the Company before the merger, through public or private equity or debt financings, the pursuit of research and development grants, and cash on hand. In the longer term, we expect to additionally finance our operations through revenues from product sales and licenses upon receiving all relevant approvals. If adequate funds are not available to satisfy our requirements we may have to substantially reduce, or eliminate, certain areas of our product development activities, significantly limit our operations, or otherwise modify our business strategy.

     Our business was organized into two segments: Biotechnology and Real Estate. Our Biotechnology segment is focused on research and development of products and processes intended to treat major medical conditions in which lipid, or fat components, play a key role. As a result of the merger with NZ on November 29, 2001, certain real estate assets, including commercial real estate loans were acquired. As part of the merger we announced our intent to conduct an orderly disposition of these assets and on March 22, 2002, we formalized a plan to discontinue the operations of our Real Estate segment. The plan identified the major assets to be disposed of, the expected method of disposal, and the period expected to be required for completion of the disposal.

     In December 31, 2001, we recorded restructuring charges of approximately $885,000, which were charged to general and administrative expense. Our restructuring initiatives involved strategic decisions to exit the real estate market through the orderly disposition of substantially all of NZ’s assets. As of September 30, 2003 we have utilized approximately $611,000 of the accruals set up for the real estate restructuring purposes. This restructuring was completed in April 2003. All accrued amounts will be paid within twelve months of the restructuring completion (see Note 9 of the Condensed Consolidated Financial Statements).

     On January 28, 2003, we announced a new strategic direction for the Company and the application and development of our novel technology of plasma delipidation. As a result, we are focusing our research and development efforts with respect to our proprietary VPI platform on HIV, while continuing to undertake research and development with respect to our proprietary VLR platform. In addition, we are continuing to strengthen our intellectual property position with respect to both of our technology platforms. In connection with this new strategic direction we have discontinued our Phase 1 human clinical trial in Australia, which was paused in the third quarter of 2002, and ceased all operations in Australia. The preliminary results from the clinical trial in Australia, and the associated most probable cause analysis, have advanced the science and improved the safety of our proprietary delipidation process through the development of a modified plasma delipidation process. The new process removed the steps responsible for the creation of the adverse events observed in the clinical trial and replaced them with a novel approach to solvent removal. In addition, alterations to the methods of mixing, ratios of solvents, and solvent combinations have led to specifically tailored processes for both viral and cardiovascular delipidation. Although our strategic plan is projected to reduce operating expenses in the second half of 2003 by approximately 30% to 40% when measured against the second half of 2002, we cannot assure you that such reduction will be realized, nor that such reduction, if realized, would be sufficient to permit the Company to succeed in its development efforts with currently available funds.

     The new direction is part of a comprehensive strategic plan being implemented by the Company. In connection with the adoption of that plan, we also have restructured our business operations. The strategic plan was recommended by the management team and approved by the Board of Directors. As part of the cost-savings goal of the strategic plan, Barry D. Michaels resigned as Chief Financial Officer and certain other management and other staff positions were eliminated. Sandra Gardiner, the Company’s Vice President, Controller and Corporate Secretary, assumed the newly created position of Chief Accounting Officer. In related appointments, Marc Bellotti, who was Vice President of Product Development, assumed the position of Vice President, Research and Development. Dale Richardson, who was Vice President of Marketing and Sales, assumed the position of Vice President, Business Development. In the nine month period ended September 30, 2003, we recorded and utilized restructuring charges of approximately $1,120,000 and $995,000, respectively, related to the implementation of the strategic plan. The restructuring associated with the implementation of the strategic plan was completed during the first quarter of 2003 with all accrued amounts to be paid by the end of the first quarter 2004.

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Critical Accounting Policies

     In December 2001, the Securities and Exchange Commission, or SEC, required that all registrants disclose and describe their “critical accounting policies” in MD&A. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry and information available from other outside sources, as appropriate. We believe that our following accounting policies fit this definition:

Property and Equipment

     Real estate properties are stated at the lower of cost or estimated fair value. All properties are held for sale and are written down to estimated fair value when the Company determines the carrying cost exceeds the estimated selling price, less costs to sell. Management makes this evaluation on a property-by-property basis. The evaluation of fair value and future cash flows from individual properties requires significant judgment. Our estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. Our estimates of fair value represent our best estimate based on industry trends and reference to market rates and transactions. It is reasonably possible that a change in economic or market conditions could result in a change in management’s estimate of fair value.

Loans and Notes Receivable

     All loans and notes receivable are written down to estimated fair value when the Company determines that the loan is impaired. Among the factors used to determine whether a loan is impaired are creditworthiness of the borrower, whether or not the loan is performing, the value of any collateral for the loan, collectibility of the loan, and general economic and market conditions. The determination of whether a loan is impaired requires significant judgment. Our estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. Our conclusions are based on factors that are inherently uncertain. It is reasonably possible that a change in economic or market conditions could result in a change in management’s estimate of fair value.

Income Taxes

     The Company follows SFAS No.109, “Accounting for Income Taxes.” Under the asset and liability method of SFAS No.109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

     In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

Restructuring Activities

     We record restructuring reserves for certain costs associated with disposition of assets and business restructuring activities. Such costs are recorded as a current liability and primarily include severance and related benefits, lease terminations, cessation of operations and facility contract obligations. Inherent in the estimation of these costs are assessments related to the most likely or expected outcome of the significant actions to accomplish the restructuring. We review the status of restructuring activities on a quarterly basis and, if appropriate, record charges or adjustments based on updated estimates.

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     The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. Our significant accounting policies are more fully described in our audited Consolidated Financial Statements and notes thereto for the year ended December 31, 2002, which appear in the Company’s Annual Report on Form 10-K filed with the SEC on March 28, 2003.

Recently Issued Accounting Standards

     In November 2002, the FASB issued FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Lipid adopted the disclosure requirements of FIN 45 on December 31, 2002. Adoption of the recognition provision of FIN 45 did not have an impact on Lipid’s financial position, results of operations or cash flows.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the annual and quarterly disclosure requirements of SFAS No. 148 as of December 31, 2002 and March 31, 2003, respectively. The transitional provisions of SFAS No. 148 did not have an impact on the Company’s financial position, results of operations, EPS, or cash flows, as the fair value method has not been adopted.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement did not have an impact on Lipid’s financial position, results of operations or cash flows.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003. The adoption of this statement did not have an impact on Lipid’s financial position, results of operations or cash flows.

Results of Continuing Operations – Three Months Ended September 30, 2003 and 2002

     Net Revenue. We had no revenues from continuing operations from Inception (May 21, 1999) through September 30, 2003. Future revenues will depend on our ability to develop and commercialize our two primary platforms for the treatment of lipid-enveloped viruses (Viral Pathogen Inactivation) and cardiovascular disease (Vascular Lipid Removal).

     Research and Development Expenses. Research and development expenses include applied research, product development, clinical testing, and regulatory expenses. Research and development expenses decreased approximately $2,827,000, or 66%, to $1,487,000 in the third quarter of 2003 from $4,314,000 for the same period in 2002. The decrease is due primarily to reduced external development services and employee related expenses as a result of our recent restructuring, as well as the cessation of all operations in Australia in January 2003. These decreases were partially offset by an increase in consulting fees, resulting from a provision recorded for the termination of the Karuba agreement effective August 31, 2003. On July 1, 2003, consistent with our new strategic direction, the scope of the Development Agreement with SRI International was amended to focus on providing applied research and development services in support of advancing our VPI platform and spending has been significantly reduced.

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     While we allocate and track resources when required pursuant to the terms of development arrangements, our research team typically works on different products concurrently, and our equipment and intellectual property resources often are deployed over a range of potential indications with a view to maximize the benefit of our investment. Accordingly, we have not, and do not intend to, separately track the costs for each of our research projects on a platform-by-platform basis. For the three months ended September 30, 2003, however, we estimate that the majority of our research and development expense was associated with our primary platform, Viral Pathogen Inactivation.

     Selling, General and Administrative Expenses. General and administrative expenses decreased approximately $891,000, or 51%, to $853,000 in the third quarter of 2003 from $1,744,000 for the same period in 2002. The decrease is due primarily to reduced investor and public relations related expenses, consulting, legal and accounting fees.

     Interest and Other Income. Interest and other income for the third quarter of 2003 decreased approximately $75,000, or 27%, to $203,000 from $278,000 for the same period in 2002. The decrease is due primarily to lower average money market balances coupled with lower interest rates compared to the same period in 2002.

Results of Continuing Operations – Nine Months Ended September 30, 2003 and 2002

     Net Revenue. We had no revenues from continuing operations from Inception (May 21, 1999) through September 30, 2003.

     Research and Development Expenses. Research and development expenses decreased approximately $5,960,000, or 53%, to $5,267,000 for the nine month period ended September 30, 2003 from $11,227,000 for the same period in 2002. The decrease is due primarily to reduced external development services and laboratory materials, royalty expenses incurred related to the initiation of our human clinical trial during the three months ended June 30, 2002, reduced employee related expenses as a result of our recent restructuring, and the cessation of all operations in Australia in January 2003. During the nine months ended September 30, 2003, the reduction in research and development expense was partially offset by approximately $600,000 of restructuring charges incurred during the first quarter of 2003 related to the implementation of our new strategic direction and an increase in consulting fees, resulting from a provision recorded for the termination of the Karuba agreement effective August 31, 2003. Research and development expenses account for approximately 60% of total operating expenses for the nine months ended September 30, 2003.

     Selling, General and Administrative Expenses. General and administrative expenses decreased approximately $1,006,000, or 22%, to $3,573,000 for the nine month period ended September 30, 2003 from $4,579,000 for the same period in 2002. The decrease is due primarily to a reduction in investor and public relations related expenses, consulting, legal, and accounting fees, and employee related expenses as a result of our recent restructuring. During the nine months ended September 30, 2003, the reduction in general and administrative expenses was partially offset by approximately $500,000 of restructuring charges incurred during the first quarter 2003 related to the implementation of our new strategic direction and the additional accrual of approximately $200,000 of advisory fees expected to be paid to MDB Capital Group, LLC related to the merger between NZ and Pre-Merger Lipid. General and administrative expenses account for approximately 40% of total operating expenses for the nine months ended September 30, 2003.

     Interest and Other Income. Interest and other income for the nine month period ended September 30, 2003 increased approximately $118,000, or 18%, to $786,000 from $668,000 for the same period in 2002. The increase is due primarily to a gain recognized in the second quarter 2003 from the payoff of a note receivable reclassified from discontinued operations to assets held for use during the three month period ended March 31, 2003. This increase was partially offset by lower average money market balances coupled with lower interest rates compared to the same period in 2002.

Results of Discontinued Operations – Three and Nine Months Ended September 30, 2003

     During the three months ended September 30, 2003, we invested approximately $105,000 of cash in the improvement of 15 residential lots in San Diego County, California, which we obtained through a foreclosure in 2002.

     During the nine months ended September 30, 2003, the disposal of real estate assets generated net cash proceeds of approximately $1,480,000. Additionally, we collected approximately $1,000,000 in principal payments from other notes receivable.

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     As of September 30, 2003, the remaining assets in the disposal group were one other note receivable, one commercial real estate loan, mineral rights, vacant industrial land in New Mexico, and residential lots in New Mexico and California. During the three month period ended September 30, 2003, we wrote down the value of an asset in the disposal group in the aggregate amount of $625,000. The write down is a result of our analysis of the market value and likely sales price of this asset adjusted for anticipated costs of development, sales, and holding, compared to the amount at which the asset was recorded.

     During the three months ended March 31, 2003, the Company reclassified the remaining assets of a component of the real estate business from discontinued operations to assets held for use. As a result, notes receivable with a carrying value of $6,569,000 at December 31, 2002 were reclassified from current assets of discontinued operations to notes receivable. Although we may dispose of these assets prior to their maturities, they may also be held to term if we cannot obtain favorable terms for disposal. The results of operations of this component, previously reported in discontinued operations through December 31, 2002, have been reclassified and included in interest and other income for all periods presented. Income of $173,000, $515,000 and $747,000 for the three months ended September 30, 2002, the nine months ended September 30, 2002 and the period from Inception (May 21, 1999) to December 31, 2002, respectively, have been reclassified to interest and other income. Additionally, all related income tax expenses/benefits have been reclassified accordingly.

Liquidity and Capital Resources

     Pre-Merger Lipid financed its operations principally through two private placements of equity securities, which yielded net proceeds of approximately $16,900,000, and the sale of common stock to one of its founders. The merger with NZ resulted in the acquisition of net assets of approximately $45,000,000, net of repurchase of stock and acquisition costs, through September 30, 2003.

     The net cash used in continuing operating activities was approximately $7,800,000, $6,700,000, and $33,300,000 for the nine months ended September 30, 2003, September 30, 2002, and the period from Inception (May 21, 1999) to September 30, 2003, respectively, resulting primarily from operating losses incurred as adjusted for income taxes and non-cash stock compensation charges. The net cash used in investing activities was approximately $5,700,000, $400,000 and $9,100,000 for the nine months ended September 30, 2003, September 30, 2002, and the period from Inception (May 21, 1999) to September 30, 2003, respectively, primarily attributable to the purchase, maturities and sales of short-term investments and the purchase of capital equipment. Net cash provided by financing activities was zero for the nine months ended September 30, 2003 and $23,800,000 for the period from Inception (May 21, 1999) to September 30, 2003, which was primarily due to the acquisition of NZ Corporation and the sale of equity securities in private placement transactions. Net cash used in financing activities of approximately $700,000 for the nine months ended September 30, 2002 was primarily attributable to the repurchase of common stock from dissenting stockholders and additional accrued merger costs. Net cash provided by discontinued operations of approximately $1,900,000, $21,700,000, and $25,600,000 for the nine months ended September 30, 2003, September 30, 2002, and the period from Inception (May 21, 1999) to September 30, 2003, respectively, was primarily due to the sale of real estate assets and collection of principal payments on commercial real estate loans and other notes receivable.

     In December 1999, we entered into an Intellectual Property License Agreement to obtain the exclusive worldwide rights to certain patents, trademarks, and technology with Aruba International Pty. Ltd., an Australian company, controlled by Bill E. Cham, Ph.D., a founding stockholder of Pre-Merger Lipid and a former Director. As consideration for the license, we issued 4,677,060 shares of our common stock valued at $250,000 to Aruba. Under this agreement, we are obligated to pay Aruba a continuing royalty on revenue in future years, subject to a minimum annual royalty amount of $500,000, 10% of any External Research Funding received by us to further this technology, as defined in the agreement, and $250,000 upon commencement of our initial human clinical trial utilizing the technology under the patents. Our initial human clinical trial commenced during the three month period ended June 30, 2002. For the three month periods ended September 30, 2003 and September 30, 2002 we have expensed $125,000 and $125,000, respectively, and for the nine month periods ended September 30, 2003 and September 30, 2002 we have expensed $375,000 and $625,000, respectively, related to this agreement. Amounts for 2003 and 2002 were charged to research and development expense.

     In May 2000, we sold a total of 4,925,300 shares of common stock at $2.25 per share in a private placement to accredited investors. Net cash proceeds, after expenses of the placement, were approximately $11,000,000.

     In October 2000, we entered into a Development Agreement with SRI International, a California nonprofit public benefit corporation, pursuant to which SRI provides us with various consulting and development services. SRI will assign to us all intellectual property developed during the term of the Development Agreement. The Development Agreement calls for SRI to complete two development phases (as defined in the Development Agreement) during which time SRI will work to develop a medical device to enable us to further develop and commercialize our lipid removal technology. In addition, we have entered into a number of amendments with SRI to address work performed by SRI, which are both within and outside of the scope of work of Phase II development. Certain of the amendments have been in support of product development and certain of the amendments relate to supplemental testing and analysis performed by SRI.

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     We also issued SRI a warrant to purchase 779,510 shares of common stock at an exercise price of $3.21 per share. The warrant vested with respect to 233,853 shares upon completion of Phase I, with the remaining 545,657 shares vesting upon completion of Phase II. On May 12, 2001, the Development Agreement was amended with respect to the remaining unvested warrant shares to purchase 545,657 shares of common stock related to Phase II. This amendment splits Phase II into two development milestones with 272,829 warrant shares vesting at the completion of each milestone. If either development milestone is discontinued at the option of the Company, all 545,657 remaining warrant shares will vest at the completion of the remaining milestone.

     Phase I was completed on March 28, 2001. Fees for services performed by SRI for Phase I totaled $1,517,000. The completion of Phase I resulted in the vesting of 233,853 warrant shares to purchase our common stock becoming fully vested. On this date, we recognized an expense of $847,500, based upon the fair market value of the warrants on the date of vesting, using the Black-Scholes method with the following assumptions: a volatility of 80%, a dividend yield of 0%, a risk-free interest rate of 6%, and a life of seven years.

     Phase II was initiated upon completion of Phase I. Fees for Phase II of the development program were limited to $6,300,000. On July 26, 2002, funding to SRI for the continued development of Phase II was increased to $9,500,000. On July 1, 2003, consistent with our new strategic direction, the scope of the Development Agreement was amended to focus on providing applied research and development services in support of advancing our VPI platform. Approximately $147,000 and $1,334,000 for the three month periods ended September 30, 2003 and September 30, 2002, respectively, and $993,000 and $3,638,000 for the nine month periods ended September 30, 2003 and September 30, 2002, respectively, were charged to operations for fees related to Phase II. As of September 30, 2003, neither milestone related to Phase II was completed. Consequently no value has been assigned to the remaining 545,657 warrant shares which vest upon completion of such milestones.

     In March 2001, we closed a private placement of 1,375,282 shares of common stock at $4.49 per share for gross proceeds of $6,175,000. In connection with the private placement, we paid a commission to MDB Capital Group, LLC of approximately 7% of the gross proceeds, payable in shares of common stock, for services rendered in the private placement. Accordingly, 95,491 shares of common stock at $4.49 per share were issued as commission for the transaction.

     In June 2001, Pre-Merger Lipid engaged MDB Capital Group, LLC as its financial advisor in the merger between NZ and Pre-Merger Lipid. The engagement letter commits the Company to pay MDB Capital Group an advisory fee. In December 2001, we paid MDB Capital Group approximately $446,000, which represents a portion of the advisory fee and is based on 5% of the cash and cash equivalents of the Company immediately after the merger, as compared to Pre-Merger Lipid’s cash and cash equivalents immediately prior to the merger. The remainder of the advisory fee is based on 5% of the gross sales of the Company’s pre-merger assets during the two-year period after the closing of the merger, the Company’s assets on the two-year anniversary of the merger and the net operating income of the Company derived from the Company’s pre-merger assets during the two-year period after the closing of the merger. Approximately $1,400,000 of the advisory fee was paid during the twelve months ended December 31, 2002 and $432,000 during the nine month period ended September 30, 2003.

     In the normal course of business, we have consulted with Dr. Cham, and companies with which he is affiliated, regarding various matters relating to research and development. In November 2001, we entered into a Service Agreement with Karuba International Pty. Ltd., a company controlled by Dr. Cham, in order to consolidate such consulting services. We were required to pay approximately $191,000 a year for Karuba’s consulting services, as well as out-of-pocket expenses incurred in the performance of such services. Under the terms of the agreement, the annual obligation to Karuba increased to approximately $198,000 per year in May 2002. Haven given 30 days written termination notice to Karuba on July 30, 2003, the agreement was terminated effective August 31, 2003. As a result of such termination, we are required to pay Karuba a termination amount equal to one third of the annual fee, payable in equal monthly installments through December 2003. During the three month period ended September 30, 2003, we recorded a provision for approximately $80,000, reflecting the remaining termination liability to Karuba. Approximately $140,000 and $65,000 for the three month periods ended September 30, 2003 and September 30, 2002, respectively, and $273,000 and $180,000 for the nine month periods ended September 30, 2003 and September 30, 2002, respectively, were expensed to research and development under this agreement of which approximately $80,000 is included in accounts payable and accrued liabilities at September 30, 2003.

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     In the course of its research and development activities, the Company has sustained continued operating losses and expects those losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources for clinical testing and related activities. As of September 30, 2003, the remaining available cash and investments balance is $14.7 million. We anticipate that these assets and the cash raised from the disposal of remaining real estate and other assets held by the Company before the merger will provide sufficient working capital for our research and development activities through mid-2005. We expect additional capital will be required in the future and our Board is evaluating various alternatives for funding our operations. These alternatives may include new collaborations, such as licensing or other arrangements, the pursuit of research and development grants, or public or private equity or debt financings. Additional financing may not be available on terms favorable to us, or at all. If we are unable to obtain financing on acceptable terms, our ability to continue our business as planned will be significantly harmed.

Factors That May Affect Future Results and Financial Condition

If we are unable to obtain adequate funds, we may not be able to develop and market our potential products.

     For the nine months ended September 30, 2003, we incurred a net loss of approximately $8,493,000 and since Inception through September 30, 2003, we have incurred an accumulated deficit of approximately $39,956,000. We expect to continue to incur losses for the foreseeable future as we continue funding for clinical testing and other activities related to seeking approval to market our products. Conducting clinical trials necessary to apply for regulatory approval to sell our products will take a number of years and will require significant amounts of capital.

     As of September 30, 2003, we had cash, cash equivalents and short-term investments equal to approximately $14.7 million. We anticipate that these assets and the cash raised from the disposal of remaining real estate and other assets held by the Company before the merger will provide sufficient working capital for our research and development activities through mid-2005. As of September 30, 2003, we have disposed of a substantial portion of our real estate and other assets held by the Company before the merger. In the near future, we will require additional capital in amounts that cannot be quantified, but are expected to be significant. Although we announced a plan to restructure our business operations in the first quarter of 2003, in part to reduce operating expenses through staff reductions and cessation of all operations in Australia, we cannot assure you that any such reduction in operating expenses will be realized. We intend to seek capital needed to fund our operations through new collaborations, through pursuit of research and development grants, or through public or private equity or debt financings. Additional financing may not be available on terms favorable to us, or at all. If we are unable to obtain financing on acceptable terms, our ability to continue our business as planned will be significantly harmed.

Our technology is only in the clinical development stage, may not prove to be safe or effective, and may never receive regulatory approval or achieve wide-spread use, which would significantly harm our business prospects.

     Before obtaining required regulatory approvals for the commercial sale of any of our potential products, we must demonstrate, through pre-clinical studies and clinical trials, that our technology is safe and effective for use in at least one medical indication. These studies and clinical trials are expected to take a number of years and may fail to show that our technology is sufficiently safe and effective, in which case our technology will not receive regulatory approval, and we will not be able to develop and commercialize our products. In the third quarter of 2002, we paused our Phase 1 human clinical trial being conducted in Australia. In connection with our restructuring plan, we have discontinued our Phase 1 human clinical trial and ceased all operations in Australia in January 2003.