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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 0-19591

EPIMMUNE INC.

5820 Nancy Ridge Drive
San Diego, California 92121

(858) 860-2500

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

Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934. Yes [  ] No [X]

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

Common Stock: $.01 par value 13,475,624 shares outstanding as of November 10, 2003.

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EPIMMUNE INC.
QUARTERLY REPORT
FORM 10-Q

*

No information provided due to inapplicability of item.

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PART I. FINANCIAL INFORMATION

EPIMMUNE INC.
CONDENSED BALANCE SHEETS
(in thousands, except share data)

See accompanying notes.

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EPIMMUNE INC.
CONDENSED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except per share data)

See accompanying notes.

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EPIMMUNE INC.
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)

See accompanying notes.

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EPIMMUNE INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003

1. Basis of Presentation

The interim unaudited condensed financial statements contained herein have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In management’s opinion, the unaudited information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. Interim results are not necessarily indicative of results to be expected for the full year. The financial statements should be read in conjunction with the audited consolidated financial statements and disclosures thereto included in the Company’s Form 10-K for the year ended December 31, 2002.

The Company has an accumulated deficit of $156.7 million as of September 30, 2003. The Company’s ability to attain profitable operations is dependent upon obtaining sufficient working capital to complete the successful development of its products, the Food and Drug Administration (“FDA”) approval of its products, achieving market acceptance of such products and achievement of sufficient levels of revenue to support the Company’s cost structure. Management believes that the Company’s existing capital resources will enable the Company to fund its operations through 2004 and into the second quarter of 2005. If the Company is unable to obtain additional funding, it will be required to delay, reduce the scope of or eliminate one or more of its research and development projects, sell the Company or certain of its assets or technologies, or dissolve and liquidate all of its assets.

Earnings per share (“EPS”) is computed in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share (“SFAS No. 128”). SFAS No. 128 requires dual presentation of basic and diluted earnings per share. Basic EPS includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period, excluding owned but unvested shares. There were 92,172 and 605,872 owned but unvested shares as of September 30, 2003 and September 30, 2002, respectively. Diluted EPS reflects the potential dilution of securities that could share in our earnings, such as common stock equivalents that may be issuable upon exercise of outstanding common stock options or warrants as well as all shares of preferred stock, which may be converted into common stock. Prior to the application of the treasury stock method for options and warrants, common stock equivalents of 4,640,801 and 3,564,253 for the nine months ended September 30, 2003 and 2002, respectively, have been excluded from EPS as the effect is antidilutive. On a fully diluted basis, assuming full vesting and conversion of all common stock equivalents upon exercise of outstanding common stock options and warrants as well as conversion of all shares of preferred stock, there were 18,095,275 and 15,698,673 shares outstanding as of September 30, 2003 and September 30, 2002, respectively.

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), the Company elected to follow the Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”), and related interpretations in accounting for its employee stock options. Under APB Opinion No. 25, among other things, when the exercise price of its employee stock options is not less than the market price of the underlying stock on the date of grant, no compensation expense is recognized.

As required under SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure- an amendment of FASB Statement No. 123 (“SFAS No. 148”), the pro forma effects of stock-based compensation on net income and net earnings per common share have been

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estimated at the date of grant using the Black-Scholes option pricing model based on the following weighted-average assumptions: risk-free interest rates of 6%; dividend yield of 0; and a weighted average expected life for all options of six years. The volatility factor assumptions of the expected market price of the Company’s common stock were 128% and 94% for September 30, 2003 and 2002, respectively.

For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period. The effect of applying SFAS No. 123 for purposes of providing pro forma disclosures is not likely to be representative of the effects on the Company’s operating results for future years because changes in the subjective input assumptions can materially affect future value estimates. Pro forma information for the three and nine months ended September 30, 2003 and 2002 is as follows:

2. New Accounting Standards

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148. This statement amends SFAS No. 123 to provide alternative methods of voluntarily transitioning to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require disclosure of the method used to account for stock-based employee compensation and the effect of the method on reported results in both annual and interim financial statements. The annual disclosure provisions are effective for the Company beginning with its year ended December 31, 2002. The interim disclosure requirements are currently effective. The adoption of SFAS No. 148 did not have a material effect on our results of operations or financial condition.

3. Termination of Merger Agreement with Anosys, Inc.

On August 12, 2003, the Company announced that the merger agreement between the Company and Anosys, Inc., entered into on May 9, 2003, was terminated. In connection with the termination of the merger agreement, the Company recorded a charge of $0.5 million during the second quarter ended June 30, 2003, which is included in general and administrative costs, to write-off costs it had previously capitalized in connection with the proposed merger.

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4. Note Receivable from Stockholder

In January 2001, the Company sold Dr. Emile Loria, President and CEO, 1,056,301 shares of its common stock at the closing price of such common stock as reported by the Nasdaq National Market on the date of purchase, which was $2.50 per share. These shares vested in equal daily installments over the four-year period following the purchase date and the Company had a right to purchase any unvested shares at the purchase price paid by Dr. Loria in the event of termination of Dr. Loria’s service to the Company. Dr. Loria purchased the shares with a promissory note in the principal amount of $2,641,000, which was secured by a pledge of the shares. The note bore interest at the rate of 5.61% per year, compounded annually.

On September 29, 2003, Dr. Loria surrendered an aggregate of 963,740 shares of the Company’s common stock, including 250,139 unvested shares, at the fair market value of $3.17 per share, in exchange for the prepayment of the outstanding principal and interest under the promissory note, an aggregate amount of $3,055,000. The remaining 92,561 unvested shares will vest in equal daily installments between September 29, 2003 and January 15, 2005. The Company continues to have the right to purchase any unvested shares at the purchase price paid by Dr. Loria in the event of termination of Dr. Loria’s service to the Company.

In connection with this transaction, the Company recorded a non-cash, stock-based compensation charge of approximately $646,000 in the third quarter ended September 30, 2003 based on the difference between the fair market price on September 29, 2003 and the exercise price of the shares surrendered by Dr. Loria. The Company will also recognize an additional $62,000 in non-cash, stock-based compensation charges ratably over the period from September 29, 2003 to January 15, 2005 as the remaining 92,561 unvested shares vest.

The Company has included $230,000 associated with the remaining unvested shares in accrued liabilities because the Company has a repurchase option on the 92,561 unvested shares at the original exercise price. As the remaining 92,561 unvested shares vest between September 29, 2003 and January 15, 2005, the liability will be reclassified into equity in equal installments.

The Company has also been recording non-cash compensation expense related to the below market interest rate the promissory note bore. The Company recorded $25,000 in such compensation expense for the three months ended September 30, 2003 and 2002. Due to the prepayment of the note, the Company reversed the unamortized portion of $137,000 of deferred compensation related to the below market interest rate on the note during the quarter ended September 30, 2003.

5. CEO Performance Bonus

In June 2003, in consideration for continued employment at Epimmune, the Company entered into an agreement with Dr. Loria, whereby Dr. Loria was eligible to earn a performance bonus equal to 2% of any proceeds received by the Company from any private or public equity financing completed through December 31, 2004. Payment of such bonus was to be automatic up to $1.0 million and thereafter was at the discretion of the Company’s Board of Directors.

In September 2003, in consideration for an option grant to purchase 500,000 shares of Common Stock of Epimmune at the then fair market value, Dr. Loria agreed to terminate the June 2003 letter agreement and his right to receive a performance bonus from any private or public equity financing.

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6. Work Force Reduction

On September 3, 2003, the Company announced a reduction of its work force aimed at focusing the Company’s efforts on its most advanced clinical programs and its sponsored and partnered programs. The Company reduced its research and administrative staff by 11 individuals or 23%, which resulted in a one-time restructuring charge of approximately $344,000 in the third quarter ended September 30, 2003. The Company paid $329,000 during the three months ended September 30, 2003 remaining liability of $15,000 included in Accrued Liabilities as of September 30, 2003. The Company expects the remaining liability to be paid in the fourth quarter of 2003.

7. Private Placement

In September 2003, the Company completed a private placement of 2,168,961 shares of common stock and warrants to purchase up to 542,238 shares of common stock to selected institutional and accredited investors, including current shareholders, for a total purchase price of $4.05 million. The Company received net proceeds of $3.6 million. The purchase price of each security, which is the combination of one share of common stock and a warrant to purchase 25% of one share of common stock, was priced at the market value of $1.86725, which was the sum of the average of the closing bid price of Epimmune common stock as quoted on the Nasdaq National Market for the five days up to and including September 17, 2003, and $0.03125, the imputed value of a warrant to purchase 25% of one share of common stock. In addition, we issued warrants to purchase an aggregate of 250,000 shares of our common stock to a placement agent for services rendered in connection with the private placement. Each warrant, including the warrant issued to the placement agent, has a three-year term and an exercise price equal to 125% of $1.86725 or $2.33406 per share. The Company filed a registration statement to permit registered resales of the common stock and the common stock issuable upon exercise of the warrants sold in the transaction. The registration statement was declared effective on October 21, 2003.

8. Beckman Coulter

In January 2003, the Company entered into an option and license agreement with Beckman Coulter, Inc. under which Beckman Coulter may acquire a non-exclusive license to certain Epimmune epitopes. Beckman Coulter may use these epitopes for research and diagnostic applications in connection with their MHC Tetramer and other immune response monitoring technologies. Under the terms of the agreement, Epimmune is entitled to annual option fees. Each annual option fee will be amortized into revenue over twelve months. Beckman Coulter may acquire non-exclusive, worldwide licenses to specific epitopes covered by Epimmune patent rights or know-how in certain infectious disease and cancer indications. In the event that Beckman Coulter exercises its option to acquire a license to any specific epitope, Epimmune will be entitled to additional license fees for each epitope and royalties on product sales in the event any products are commercialized using the Company’s technology.

9. Immuno-Designed Molecules, S.A.

In October 2002, the Company entered into an evaluation and license option agreement with Immuno-Designed Molecules, S.A., or IDM, for certain cancer antigens for use in IDM’s ex vivo cancer therapy program. Under the terms of the agreement, IDM had 120 days from the date of the option agreement to evaluate the epitopes and exercise its option to license certain patented and non-patented rights to Epimmune’s universal cancer epitope packages for use in ex vivo cancer therapy. In February 2003, IDM exercised its option and in July 2003, the Company entered into a license agreement with IDM pursuant to which IDM was granted a non-exclusive license to use the epitopes in connection with its Dendritophage^TM ex vivo technology. The Company received an evaluation license fee when it entered into the evaluation and license option agreement, which was amortized into revenue over the evaluation period. The Company received a license fee in February 2003 when IDM exercised its option. The Company is amortizing the license fee over the estimated four-year life of the license. The Company also received a non-recurring milestone payment in June 2003, which it will recognize as revenue over the remaining estimated life of the license.

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10. Merck & Co., Inc.

In April 2003, the Company entered into an agreement with Merck & Co., Inc. under which Merck will evaluate select Epimmune epitopes in connection with technology controlled by Merck for the development of certain vaccines. Under the terms of the agreement, the Company will provide Merck a limited number of its proprietary analog, or modified, epitopes, which will then be evaluated in connection with delivery technologies owned or controlled by Merck to determine the activity of the Epimmune epitopes. The Company received an evaluation license fee in connection with the agreement, which will be amortized into revenue over the term of the agreement. Merck has an option to enter into licensing discussions with Epimmune for the development of the Epimmune epitopes for use in vaccines for the treatment of certain diseases.

11. Aventis Pasteur

The Company entered into an evaluation and license option agreement with Aventis Pasteur Limited in July 2002, which gave Aventis, for twelve months, the right to exercise its option to license from Epimmune certain epitopes from two cancer associated antigens for use in connection with its pox virus therapeutic cancer vaccine program. Epimmune received an evaluation license fee, which was amortized into revenue over the evaluation period. In June 2003, the end of the evaluation period, Aventis Pasteur chose to not exercise its rights under the agreement.

12. Amgen

In September 2003, the Company entered into an agreement with Amgen Inc. under which Amgen acquired a non-exclusive license to Epimmune’s PADRE^® technology for research use. Under the terms of the agreement, Epimmune received a license fee that will be amortized into revenue over the term of the agreement.

13. Milestone Payment under Anosys License Agreement

In September 2003, the Company earned and received a milestone payment from Anosys Inc. as a result of Anosys’ filing of an Investigational New Drug application for a product incorporating Epimmune technology under a license granted to Anosys in August 2001. In addition, the Company announced that it had received payment of an additional license fee under the terms of the original agreement as a result of Epimmune regaining all rights to the technology covered by the agreement in Japan. Both the milestone payment and the additional license fee were recognized as revenue in the third quarter ended September 30, 2003. In the event Anosys elects to exercise its rights to include Japan in the territory covered by the agreement, Epimmune will be entitled to an additional license fee payment.

14. National Institutes of Health Contract for HIV Vaccine

In September 2003, the Company received a five-year, $16.7 million contract from the National Institute of Allergy and Infectious Diseases (NIAID) at the National Institutes of Health (NIH) for the design and development of prophylactic HIV vaccines for clinical evaluation. The Company will recognize revenue under the contract as reimbursable expenses under the contract are incurred.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, without limitation, those discussed below and in the section entitled “Risk Factors.”

Epimmune^® and PADRE^® are our trademarks and EIS, ImmunoStealth and ImmunoSense are our service marks.

Since 1997, we have devoted substantially all of our resources to the discovery and development of potential therapeutic and prophylactic products. To date, we have not received any revenues from the sale of products. We began a Phase I/II clinical trial targeting HIV in September 2002 and two Phase I/II clinical trials targeting lung and colorectal cancer in February 2003. We have funded our research and development primarily from equity-derived working capital, through licensing transactions and collaborations with other companies and through government grants and contracts. We have not been profitable since our inception and expect to incur substantial operating losses for at least the next several years. As of September 30, 2003, our accumulated deficit was approximately $156.7 million.

In July 2001, we entered into a collaboration agreement with Genencor. The revenue that we recognize from Genencor includes milestone payments, recognition of upfront license fees over the term of the contract and contract research and development funding to support our research over the term of the collaboration. As of September 30, 2003, Genencor owned 8.9% of our common stock and is therefore considered a “related party” for financial reporting purposes. Therefore, all payments that we receive under this agreement are included in the category, “Related Party Revenue.”

On August 12, 2003, we announced that the merger agreement between us and Anosys, Inc., entered into on May 9, 2003, was terminated.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, patents and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our financial statements (see Note 1 to our financial statements on page F-7 of the Form 10-K filed for the year ended December 31, 2002).

Revenue Recognition

     We recognize revenues pursuant to Staff Accounting Bulletin No. 101, Revenue Recognition. License fees are earned and recognized in accordance with the provisions of each agreement. Upfront license fees for perpetual licenses where we have no performance obligations are recognized when received. License fees under agreements in which we have ongoing involvement or performance obligations are recognized over the term of the agreement. For example, in connection with our Genencor collaboration, because we received an upfront license fee, it is being amortized into revenue over the collaboration

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term. Milestone payments are recognized as revenue upon the completion of the milestone as long as the milestone event was substantive, and its achievability was not reasonably assured at inception and the Company’s performance obligations after milestone achievement will continue to be funded at a comparable level before the milestone achievement. Contract research and development funding is recognized as revenue in the same period as reimbursable expenses under a contract are incurred and in an amount or at a rate billable under each contract’s terms. Revenues from grants are recognized on a percentage-of-completion basis as related costs are incurred. We defer revenue recognition until performance obligations have been completed and collectibility is reasonably assured.

Patents

We capitalize the costs incurred to file patent applications when we believe there is a high likelihood that the patent will issue and there will be future economic benefit associated with the patent. These costs are amortized over a ten-year life from the date of patent filing. We expense all costs related to abandoned patent applications. In addition, we review the carrying value of patents for indicators of impairment on a periodic basis. If we elect to abandon any of our currently issued or unissued patents or we determine that the carrying value is impaired, the related expense could be material to our results of operations for the period of the abandonment.

Investment Policy

The primary objective of our investment activities is to preserve principal while at the same time achieving competitive yields, without significantly increasing risk. To achieve this objective, we primarily invest in cash and money market accounts as well as A1 or P1 or higher rated debt securities with maturities of less than two years, with the weighted average maturity not to exceed eighteen months. We also attempt to minimize our portfolio risk by placing constraints on how much of our portfolio may be held in a specific type of investment such as asset-backed securities or collateralized mortgage obligations as well as limiting our holdings in any one issuer. At September 30, 2003, our investment portfolio included only cash and money market accounts and had no fixed-income securities.

Results of Operations

Three months ended September 30, 2003, as compared with three months ended September 30, 2002.

We had total revenues of $2.0 million in the three months ended September 30, 2003, as compared to $1.7 million in the three months ended September 30, 2002. In the three months ended September 30, 2003, a $0.4 million increase in license fees and milestone revenue and a $0.2 million increase in grant and contract revenue was offset by a $0.4 million decrease in related party revenue. The increase in license fees and milestone revenue was primarily the result of the receipt of one-time payments for license fees and milestones during the three months ended September 30, 2003 under the terms of our agreement with Anosys, compared to the three months ended September 30, 2002. The increase in grant and contract revenue in the third quarter of 2003, as compared to the third quarter of 2002, was the result of an increase in the number of active grants and contracts from the NIH and the timing of costs included for reimbursement on those grants and contracts, partially offset by the completion of work on certain grants. Related party revenue includes milestone payments, amortization of license fees and contract research and development funding, as a result of our collaboration with Genencor. The reduction in related party revenue during the three months ended September 30, 2003, compared to the three months ended September 30, 2002, was primarily due to the shift in focus from scientific research activities, the part of the collaboration in which we are most involved, to preclinical development on the lead program in support of a late 2003 or early 2004 IND filing, as announced by Genencor, and an increase in the time period during which the license fees previously paid by Genencor are being amortized due to the extension of the agreement. The change in the estimated life of the license occurred due to the extension of the agreement term from September 1, 2003 to September 1, 2004. The agreement term was extended in October of 2002.

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Research and development expenses decreased to $2.3 million in the three months ended September 30, 2003 from $2.7 million in the three months ended September 30, 2002. The decrease in the three months ended September 30, 2003 relates primarily to reduced labor and related costs due to the work force reduction, lower outside costs related to preclinical activities such as formulation and toxicology studies for our HIV and lung and colorectal cancer programs which are now in clinical trials, lower scientific supplies costs related to completion of preclinical activities, and lower patent and intellectual property related expenses, partially offset by higher costs associated with outside research support from the La Jolla Institute for Allergy and Immunology with whom we contracted on our High Throughput Screening, or HTS, contract with the NIH.

General and administrative costs were approximately $1.5 million in the three months ended September 30, 2003 and $0.6 million in the three months ended September 30, 2002. The increase in the third quarter of 2003 was primarily due to the recognition of non-cash, stock-based compensation charges in connection with the prepayment of a promissory note by our CEO in September 2003, other non-cash, stock-based compensation expenses as a result of recent increases in our stock price, and legal, investment banking, accounting and other expenses related to our previously proposed merger with Anosys, which has now been terminated, partially offset by lower consulting and travel expenses.

On September 3, 2003, we announced a reduction of our work force aimed at reducing our cash burn and focusing our efforts on our most advanced clinical programs and our sponsored and partnered programs. We reduced our research and administrative staff by 11 individuals or 23%, which resulted in a one-time restructuring charge of approximately $344,000 in the three months ended September 30, 2003. We had no restructuring charges in the corresponding period ended September 30, 2002.

Net interest income was approximately $0.1 million in the three months ended September 30, 2003 and in the three months ended September 30, 2002.

Nine months ended September 30, 2003 as compared with nine months ended September 30, 2002.

In the nine months ended September 30, 2003, we had total revenues of $5.2 million, as compared to $5.5 million in revenue in the nine months ended September 30, 2002. The decrease in the nine months ended September 30, 2003 relates primarily to a $0.9 million decrease in related party revenue and a $0.1 million decrease in research grants and contract revenue, offset by a $0.8 million increase in licensing and milestone revenue. The decrease in related party revenue in the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002, was primarily due to the shift in focus from scientific research activities, the part of the collaboration in which we are most involved, to preclinical development on the lead program in support of a late 2003 or early 2004 IND filing, as announced by Genencor, lower non-recurring milestone payments received in 2003 and an increase in the time period during which the license fees previously paid by Genencor are being amortized due to the extension of the agreement. The change in the estimated life of the license occurred due to the extension of the agreement term from September 1, 2003 to September 1, 2004. The agreement term was extended in October of 2002. The decrease in grant and contract revenue in the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, was a result of completion of work on certain grants and the timing of costs to be included for reimbursement on others. The increase in licensing and milestone revenue in the nine months ended September 30, 2003 was due to the receipt of one-time payments for license fees and milestones during the third quarter of 2003 under the terms of our agreement with Anosys, and an increase in licensing revenue as a result of amortization of evaluation fees and license fees received from Aventis, IDM, Beckman Coulter, Merck and Amgen in the current period, compared to the same period in 2002.

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Research and development expenses decreased to $7.7 million in the nine months ended September 30, 2003, from $8.7 million in the nine months ended September 30, 2002. The decrease in the nine months ended September 30, 2003 relates primarily to lower outside costs related to preclinical activities such as formulation and toxicology studies for our HIV and lung and colorectal cancer programs, which are now in clinical trials, lower scientific supplies costs related to completion of preclinical activities, lower patent and intellectual property related expenses, and reduced labor costs related to the work force reduction, partially offset by higher costs associated with outside research support related to our HTS contract with the NIH.

General and administrative costs were approximately $3.2 million in the nine months ended September 30, 2003 and $2.0 million in the nine months ended September 30, 2002. The increase in the nine months ended September 30, 2003 was primarily due to the recognition of non-cash, stock-based compensation charges in connection with the prepayment of a promissory note by our CEO in September 2003, other non-cash, stock-based compensation expenses as a result of recent increases in our stock price, and the write off of legal, investment banking, accounting and other expenses related to our previously proposed merger with Anosys, which has now been terminated. The increases were partially offset by a reduction in legal, consulting and other outside costs, decreases in recruiting and relocation expenses, the timing of accounting fees, and the reclassification of internal, intellectual property related salaries to research and development expense.

On September 3, 2003, we announced a reduction of our work force aimed at reducing our cash burn and focusing our efforts on our most advanced clinical programs and our sponsored and partnered programs. We reduced our research and administrative staff by 11 individuals or 23%, which resulted in a one-time restructuring charge of approximately $344,000 in the nine months ended September 30, 2003. We had no restructuring charges in the nine months ended September 30, 2002.

Net interest income was approximately $0.2 million in the nine months ended September 30, 2003 and $0.5 million in the nine months ended September 30, 2002. Interest income during the nine months ended September 30, 2003 includes $0.1 million of interest accrued on the note issued for the purchase of shares by Dr. Loria, our president and chief executive officer, in January 2001, compared to $0.3 million of interest on the note for the nine months ended September 30, 2002. We also had lower average cash balances and rates of return in the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002.

We expect to incur significant operating losses over the next several years due to continuing expenses associated with our research and development programs, including preclinical testing and clinical trials. Operating losses may fluctuate from quarter to quarter as a result of differences in the timing of revenues received and expenses incurred, and such fluctuations may be substantial.

Liquidity and Capital Resources

We have financed operations since inception primarily through private placements of equity securities, two public common stock offerings, revenues under collaborative research and development agreements, grant revenues, certain asset divestitures and interest income. Through September 30, 2003, we had raised approximately $168.0 million in cash from the sale of equity securities. As of September 30, 2003, we had 15,157,772 shares outstanding on an as converted to common stock basis, assuming conversion of preferred shares.

As of September 30, 2003, our cash and cash equivalents were $8.1 million compared to $9.7 million at December 31, 2002. The decrease was primarily due to cash used for operations. Approximately $0.5 million was used for legal, investment banking, accounting and other expenses related to our previously proposed merger with Anosys, which has now been terminated. In addition, we used approximately $0.4 million for costs related to our work force reduction, which included payment of severance, accrued vacation and outplacement services. We expect to continue to use our cash and cash equivalents to fund our ongoing clinical trials and drug research and development programs.

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Capital expenditures were approximately $0.1 million for the nine months ended September 30, 2003 compared to $0.7 million for the nine months ended September 30, 2002. The expenditures for the first nine months of 2002 were primarily for laboratory equipment to increase and improve immunological screening throughput and to build out additional laboratory space to accommodate additional employees. In the past, we have financed our laboratory equipment and research and office facilities primarily through operating lease arrangements and a note payable. We fully paid off our note payable in the first quarter of 2003, resulting in payments of approximately $43,000 in the nine months ended September 30, 2003, as compared to $0.3 million in the nine months ended September 30, 2002. During 2003, payments related to leasehold improvements and capital expenditures will decrease compared to 2002 levels to approximately $0.2 million. We will also pay approximately $0.6 million in rent on our lease commitments during 2003.

Payments related to capitalized patent expenses were approximately $0.6 million during the nine months ended September 30, 2003, as compared to $0.7 million during the same period in 2002. The decrease in the nine months ended September 30, 2003 is due to consolidation of our patent portfolio to limit administrative redundancies. We expect payments related to patents to decrease by approximately $0.2 million over the remainder of 2003 compared to 2002 for similar reasons.

We now expect, as a result of the recent reduction in our work force, to incur research and development expenditures in 2003 at comparative levels to 2002 in connection with our ongoing drug research and development programs, including costs related to preclinical testing, our three Phase I/II clinical trials and manufacturing. We intend to seek collaborative research and development relationships with suitable corporate partners and U.S. government agencies (including seeking grants to fund our research). We continue to attempt to license to third parties some of our technology in markets that we are not pursuing ourselves or through our collaborations. In the event these agreements relate to markets we are not pursuing, any agreements that may result from these discussions may not successfully reduce our funding requirements or, if entered into, may be terminated.

In September 2003, we completed a private placement of common stock and warrants to selected institutional and accredited investors, including current shareholders. We sold 2,168,961 shares of common stock and warrants to purchase up to 542,238 shares of common stock, for gross proceeds of $4.05 million.

We also anticipate that costs and expenses for the full year 2003 will be comparable to 2002 levels. We anticipate using some of our cash in 2003 and beyond to fund our collaboration with Bavarian Nordic. We will share equally with Bavarian Nordic in all research related expenses and have included these anticipated expenditures in our operating expense forecast for 2003 and beyond. A significant portion of our expenses as well as those of Bavarian Nordic will be reimbursed under our recently awarded HIV contract from NIH. We will also become liable in 2003 for payment of license fees of up to $0.1 million.

We anticipate that our existing cash and investments and interest earned thereon, along with the cash receipts related to existing contracts will enable us to maintain our current and planned operations through 2004 and into the second quarter of 2005. We will continue to spend substantial amounts on research and development, including amounts spent for manufacturing clinical supplies, conducting clinical trials for our product candidates and advancing development of certain sponsored and partnered programs. Therefore, we will need to obtain additional funding. We do not have committed external sources of funding and may not be able to obtain any additional funding, especially if volatile market conditions persist for biotechnology companies. If we are unable to obtain additional funding, we will be required to delay, further reduce the scope of or eliminate one or more of our research and development projects, sell the Company or certain of its assets or technologies, or dissolve and liquidate all of its assets. As of September 30, 2003, we had approximately $8.1 million in cash and cash equivalents.

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Our future operational and capital requirements will depend on many factors, including:

	•		whether we are able to secure additional financing on favorable terms, or at all;
	•		the costs associated with our clinical trials for our vaccine targeting HIV, which began in September of 2003, including the status of our contract with the NIH;
	•		the costs associated with our clinical trials for our vaccine targeting lung and colorectal cancer, which began in February 2003;
	•		progress with other preclinical testing and clinical trials in the future;
	•		our ability to establish and maintain collaboration and license agreements and any government grants;
	•		the actual revenue we receive under our collaboration and license agreements;
	•		the actual costs we incur under our research collaboration with Bavarian Nordic;
	•		the actual payment of license fees which may become payable at the option of the licensor;
	•		the time and costs involved in obtaining regulatory approvals;
	•		the costs involved in filing, prosecuting, enforcing and defending patent claims and any other proprietary rights;
	•		competing technological and market developments;
	•		changes in our existing research relationships;
	•		continued scientific progress in our drug discovery programs; and
	•		the magnitude of our drug discovery and development programs.

As is typical in the biotechnology industry, our commercial success will depend in part on not infringing upon the patent or other proprietary rights of others and maintaining the technology licenses upon which our products might be based. Our business is also subject to other significant risks, including the uncertainties associated with our ability to enter into and maintain new collaborations, the lengthy regulatory approval process, and potential competition from other products. Even if our products appear promising at an early stage of development, they may not reach the market for a number of reasons. Such reasons include, but are not limited to, our inability to fund clinical development of such products, or the possibilities that the potential products will be found ineffective or unsafe during clinical trials, fail to receive necessary regulatory approvals, be difficult to manufacture on a large scale or be uneconomical to market.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At September 30, 2003, our investment portfolio included only cash and money market accounts and had no fixed-income securities. There would be no material impact to our investment portfolio, in the short term, associated with any change in interest rates and any decline in interest rates over time will reduce our interest income, while increases in interest rates over time will increase our interest income.

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RISK FACTORS

We wish to caution readers that the following important factors, among others, in some cases have affected our results and in the future could cause our actual results and needs to vary materially from forward-looking statements made from time to time by us on the basis of management’s then-current expectations. The business in which we are engaged is in rapidly changing and competitive markets and involves a high degree of risk, and accuracy with respect to forward-looking projections is difficult.

Our substantial additional financing requirements and limited access to financing may adversely affect our ability to develop products and fund our operations.

We will continue to spend substantial amounts on research and development, including amounts spent for manufacturing clinical supplies, conducting clinical trials for our product candidates and advancing development of certain sponsored and partnered programs. Therefore, we will need to obtain additional funding. We do not have committed external sources of funding and may not be able to obtain any additional funding, especially if volatile market conditions persist for biotechnology companies. If we are unable to obtain additional funding, we will be required to delay, further reduce the scope of or eliminate one or more of our research and development projects, sell the Company or certain of its assets or technologies, or dissolve and liquidate all of its assets. As of September 30, 2003, we had approximately $8.1 million in cash and cash equivalents. Our future operational and capital requirements will depend on many factors, including:

	•		whether we are able to secure additional financing on favorable terms, or at all;
	•		the costs associated with our clinical trials for our vaccine targeting HIV, which began in September of 2003, including the status of our contract with the NIH;
	•		the costs associated with our clinical trials for our vaccine targeting lung and colorectal cancer, which began in February 2003;
	•		progress with other preclinical testing and clinical trials in the future;
	•		our ability to establish and maintain collaboration and license agreements and any government grants;
	•		the actual revenue we receive under our collaboration and license agreements;
	•		the actual costs we incur under our research collaboration with Bavarian Nordic;
	•		the actual payment of license fees which may become payable at the option of the licensor;
	•		the time and costs involved in obtaining regulatory approvals;
	•		the costs involved in filing, prosecuting, enforcing and defending patent claims and any other proprietary rights;
	•		competing technological and market developments;
	•		changes in our existing research relationships;
	•		continued scientific progress in our drug discovery programs; and
	•		the magnitude of our drug discovery and development programs.

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We intend to seek additional funding through collaboration and license agreements, government research grants or equity or debt financings. In the event we are able to obtain financing, it may not be on favorable terms. In addition, we may not be able to enter into additional collaborations to reduce our funding requirements. If we acquire funds by issuing securities, dilution to existing stockholders will result, in addition to the dilution that occurred as a result of our September 2003 financing,. If we raise funds through additional collaborations and license agreements, we will likely have to relinquish some or all of the rights to product candidates or technologies that we may have otherwise developed ourselves. If we are unable to obtain funding, we may be required to engage in another restructuring, cease development of some product candidates, further reduce the scope of our operations, sell the Company or certain of its assets or technologies or cease operations.

We may not meet all of The NASDAQ National Market’s continued listing requirements and we may be delisted, which could reduce the liquidity of our common stock and adversely affect our ability to raise additional necessary capital.

In order to continue trading on The NASDAQ National Market, we must comply with The NASDAQ National Market’s continued listing requirements, which require that we maintain a minimum stockholders’ equity of $10.0 million and a minimum closing bid price of $1.00 per share. If we fail to satisfy The NASDAQ National Market’s continued listing requirements, our common stock may be delisted from The NASDAQ National Market. The delisting of our common stock may result in the trading of the stock on The NASDAQ SmallCap Market or the OTC Bulletin Board. Consequently, a delisting of our common stock from The NASDAQ National Market may reduce the liquidity of our common stock and adversely affect our ability to raise additional necessary capital.

The process of developing therapeutic products requires significant research and development, preclinical testing and clinical trials, all of which are extremely expensive and time-consuming and may not result in a commercial product.

Except for our HIV and lung and colorectal cancer vaccine candidates, for which we began clinical trials in September 2002 and February 2003 respectively, all of our potential vaccine products are in research or preclinical development, the results of which do not necessarily predict or prove safety or efficacy in humans. We must demonstrate for each vaccine, safety and efficacy in humans through extensive clinical testing, which is very expensive, can take many years, and has an uncertain outcome. We may experience numerous unforeseen events during or as a result of the testing process that could delay or prevent testing or commercialization of our products, including the following:

	•		the results of preclinical studies may be inconclusive, or they may not be indicative of results that will be obtained in human clinical trials;
	•		after reviewing test results, we or our collaborators may abandon projects that we might previously have believed to be promising;
	•		we, our collaborators or regulators may suspend or terminate clinical trials if the participating subjects or patients are being exposed to unacceptable health risks;
	•		we may have to delay clinical trials as a result of scheduling conflicts with participating clinicians and clinical institutions, or difficulties in identifying and enrolling patients who meet trial eligibility criteria;
	•		safety and efficacy results attained in early human clinical trials may not be indicative of results that are obtained in later clinical trials; and

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•

the effects our vaccine candidates have may not be the desired effects or may include undesirable side effects or other characteristics that preclude regulatory approval or limit their commercial use if ever approved.

The data collected from clinical trials may not be sufficient to support regulatory approval of any of our products, and the Food and Drug Administration, or the FDA, may not ultimately approve any of our therapeutic products for commercial sale, which will adversely affect our revenues and prospects. If we fail to commence or complete, or experience delays in, any of our planned clinical trials, our operating income, our stock price and our ability to conduct our business as currently planned could be harmed.

Some of our programs are funded by the government and the government may not allocate funds for these programs in future fiscal years.

We fund certain of our research and development related to our HIV, cancer and malaria programs pursuant to multi-year grants and contracts from the government. The government is under no obligation to and may not fund these programs over their full term which would have a significant impact on our ability to continue development of our HIV, cancer and malaria programs.

Our history of operating losses and our expectations of continuing losses may hurt our ability to reach profitability or continue operations.

We have experienced significant operating losses since our inception in 1987. As of September 30, 2003, we had an accumulated deficit of $156.7 million. We expect to continue to incur substantial operating expenses and net operating losses for the foreseeable future, which may hurt our ability to continue operations. We have not generated revenues from the commercialization of any product. All of our revenues to date have consisted of contract research and development revenues, license and milestone payments, research grants, certain asset divestitures and interest income. We expect that substantially all of our revenues for the foreseeable future will result from similar sources. To achieve profitable operations, we, alone or with collaborators, must successfully identify, develop, register and market proprietary products. We do not expect to generate revenues from the commercialization of any product for at least six years (and this would assume approval of either our HIV or lung and colorectal product candidates, which may not occur). We may not be able to generate sufficient product revenue to become profitable. Even if we do achieve profitability, we may not be able to sustain or increase our profitability on a quarterly or yearly basis.

The subordination of our common stock to our preferred stock could hurt common stockholders and, upon conversion, our preferred stock will further dilute our holders of common stock.

Our common stock is expressly subordinate to our series S and series S-1 preferred stock in the event of our liquidation, dissolution or winding up. With respect to our series S preferred, any merger or sale of substantially all of our assets shall be considered a deemed liquidation. If we were to cease operations and liquidate our assets, we would first be required to pay $10 million to our holders of preferred stock and there may not be any remaining value available for distribution to the holders of common stock after providing for the series S and series S-1 preferred stock liquidation preference. In addition, due to adjustments to the conversion price of our series S preferred stock, in the event our series S preferred stock is converted to common stock, it will further dilute our holders of common stock.

We are at an early stage of development, and we may experience delays and other problems in entering clinical trials.

We are an early stage research and development company, and only commenced our first Phase I/II clinical trials for two of our vaccines within the past year. There are many factors outside of our control that may affect the timing of completion of our current clinical trials, and any future clinical trials may

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not commence when planned or be completed within any anticipated time frame. We have already experienced unexpected delays in filing an IND for our therapeutic vaccine candidate targeting HIV, due to additional time necessary to complete all of the animal safety studies that were contemplated in our pre-IND discussions with the FDA. We may experience unexpected delays in our research and development efforts that would require us to postpone the commencement or completion of clinical trials of other vaccine candidates. The FDA may comment or raise concerns or questions with respect to any IND that we file and, therefore, clinical trials may not begin when planned, if at all.

Our failure to obtain issued patents and, consequently, to protect our proprietary technology, could hurt our competitive position.

Our success will depend in part on our ability to obtain and enforce claims in our patents directed to our products, technologies and processes, both in the United States and other countries. Although we have filed various patent applications, our patent position is highly uncertain and involves complex legal and factual questions. Legal standards relating to patentability, validity and scope of patent claims in epitope identification and other aspects of our technology field are still evolving. Patents may not issue from any of the patent applications that we own or license and, if patents do issue, claims issued in the patents may not be sufficiently broad to protect our vaccines, technologies and processes. For example, even though our patent portfolio includes patent applications with claims directed to peptide epitopes and methods of utilizing sequence motifs to identify peptide epitopes, we cannot assure you of the breadth of claims that will be allowed or that may issue in future patents. Other risks and uncertainties that we face with respect to our patents and patent applications include the following:

	•		the pending patent applications we have filed or to which we have exclusive rights may not result in issued patents or may take longer than we expect to result in issued patents;
	•		the allowed claims of any patents that issue may not provide meaningful protection;
	•		we may be unable to develop additional proprietary technologies that are patentable;
	•		the patents licensed or issued to us may not provide a competitive advantage;
	•		other companies may challenge patents licensed or issued to us;
	•		disputes may arise regarding inventions and corresponding ownership rights in inventions and know-how resulting from the joint creation or use of intellectual property by us, our licensors, or collaborators; and
	•		other companies may design around our patented technologies.

Our competitors may develop products that are more effective and that render our potential products obsolete.

The biotechnology industry continues to undergo rapid change, and competition is intense and is expected to increase. Our competitors may succeed in developing technologies, vaccines or other therapeutic products that are more effective than any of the products we are developing, which would render our technology and products obsolete and noncompetitive.

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If we are unable to compete effectively in the highly competitive biotechnology industry, our business will fail.

Many companies and institutions compete with us in developing vaccines and other therapies to activate the body’s immune system or to otherwise treat or more effectively manage infectious diseases and cancer, including:

	•		pharmaceutical companies;
	•		chemical companies;
	•		specialized biotechnology companies;
	•		academic institutions; and
	•		research organizations.

Many of the companies developing competing technologies and products have significantly greater financial resources and expertise in research and development, manufacturing, preclinical and clinical development, obtaining regulatory approvals and marketing than we do, and we may not be able to compete effectively against them.

Our vaccines under development address a range of cancer and infectious disease markets. The competition in these markets is extremely formidable. There are 74 drugs currently approved in the United States for HIV, and according to a PhRMA 2002 report on pharmaceutical drug development, there were 83 new product candidates in clinical development for HIV and related conditions, including 14 HIV vaccines. In addition, according to a PhRMA 2003 report on pharmaceutical drug development, there were 395 new product candidates in clinical development for the treatment of cancer, and at least 33 companies were developing more than 50 vaccines against various cancers. An important factor in competition may be the timing of market introduction of our vaccines and competitive products. Accordingly, the relative speed with which we can develop vaccines, complete the clinical trials and approval processes and supply commercial quantities of the vaccines to the market are expected to be important competitive factors. We expect that competition among products approved for sale will be based, among other things, on product effectiveness, safety, reliability, availability, price and patent position.

Litigation regarding intellectual property rights owned or used by us may be costly and time-consuming.

Litigation may be necessary to enforce the claims in any patents issued to us, to defend ourselves against any patents owned by third parties that are asserted against us, or to determine the scope and validity of others’ proprietary rights. In addition, we may have to participate in one or more interference proceedings declared by the United States Patent and Trademark Office, which could result in substantial costs to determine the priority of inventions.

If we become involved in litigation or interference proceedings, we may incur substantial expense, and the proceedings may divert the attention of our technical and management personnel, even if we ultimately prevail. An adverse determination in proceedings of this type could subject us to significant liabilities, allow our competitors to market competitive products without obtaining a license from us, prohibit us from marketing vaccines or other products or require us to seek licenses from third parties that may not be available on commercially reasonable terms, if at all. If we cannot obtain such licenses, we may be restricted or prevented from developing and commercializing our product candidates.

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The enforcement, defense and prosecution of intellectual property rights, United States Patent and Trademark Office interference proceedings and related legal and administrative proceedings in the United States and elsewhere involve complex legal and factual questions. As a result, these proceedings are costly and time-consuming, and their outcome is uncertain. Litigation may be necessary to:

	•		assert against others or defend ourselves against claims of infringement;
	•		enforce patents in our portfolio owned by us or licensed from another party;
	•		protect our trade secrets or know-how; or
	•		determine the enforceability, scope and validity of the proprietary rights of ours or others.

Unexpected side effects or other characteristics of our technology may delay or otherwise hurt the development of our vaccine candidates.

There may be side effects in our current or future clinical trials that we may discover, including side effects that become apparent only after long-term exposure, even though our safety tests may indicate favorable results. We may also encounter technological challenges relating to these technologies and applications in our research and development programs that we may not be able to resolve. Any such unexpected side effects or technological challenges may delay or otherwise adversely affect the development, regulatory approval or commercialization of our drug candidates.

There are no therapeutic vaccines that have been approved for use by the FDA and our vaccines may not work, which would prevent us from ever becoming profitable.

Because there are not yet any therapeutic vaccines that have undergone the complete clinical development process and FDA review, there is still insufficient evidence that therapeutic vaccines will become products. Our business is dependent upon the concept of a therapeutic vaccine and, therefore, if therapeutic vaccines were found not to be safe or effective, we would never commercialize a product candidate and would never make a profit.

Adverse publicity regarding the safety or side effects of the technology approach or products of others could reduce our revenues and cause our stock price to fall.

Despite any favorable safety tests that may be completed with respect to our product candidates, adverse publicity regarding vaccines or products being developed or marketed by others could negatively affect us. If other researchers’ studies raise or substantiate concerns over the safety or side effects of vaccines or our technology approach or product development efforts generally, our reputation and public support for our clinical trials or products could be harmed, which would harm our business and could cause our stock price to fall.

Our research and development programs may not yield effective product candidates, which could prevent us from developing our products.

We cannot guarantee that our research and development programs will be successful in identifying vaccine candidates for clinical trials. Even if we do receive positive data during preclinical testing and during Phase I/II clinical trials for our therapeutic vaccine candidates targeting HIV, and lung and colorectal cancer or any other candidates we may develop, this data cannot be relied upon as evidence that the clinical candidate will be safe and effective in humans, and assuming we initiate any Phase III trials, data from Phase III or other pivotal clinical trials may not be consistent with earlier data or be sufficient to support regulatory approval.

We may not identify the correct epitopes and, therefore, not develop a safe or effective vaccine.

Our strategy involves identifying multiple epitopes in order to create our vaccines. If we are unable to identify the correct epitopes, or if we are unable to combine them in the correct manner, to stimulate desired immune responses we may never develop a vaccine that is safe or effective in any of the indications that we are pursuing.

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Our business is based on a novel technology, which has not been used in any commercial drugs, and may not work.

Our vaccine candidates use epitopes to stimulate specific T cell immune responses, but we are not aware of any commercial drugs that are based on this technology. Our technology related to T cell stimulation is unproven and may not produce any commercial vaccines.

If we cannot obtain and maintain strategic collaborations on acceptable terms in the future, we may not be able to develop products in markets where it would be too costly or complex to do so on our own.

We will need to enter into and maintain collaborative arrangements with pharmaceutical companies or other strategic partners both for development and commercialization of potential vaccine products in markets where it would be too costly or complex to do so on our own. Currently, our only collaborations are with Genencor and Bavarian Nordic. If we are not able to enter into and maintain additional research and development collaborations or other collaborations in the future on acceptable terms, we may be forced to abandon development and commercialization of some vaccine product candidates.

If our collaboration or license arrangements are unsuccessful, our revenues and product development may be limited.

Our collaborations and license arrangements generally pose the following risks:

	•		collaborators and licensees may not pursue further development and commercialization of potential products resulting from our collaborations or may elect not to renew research and development programs;
	•		collaborators and licensees may delay clinical trials, under fund a clinical trial program, stop a clinical trial or abandon a product candidate, repeat or conduct new clinical trials or require new formulation of a product candidate for clinical testing;
	•		expected revenue might not be generated because milestones may not be achieved and product candidates may not be developed;
	•		collaborators and licensees could independently develop, or develop with third parties, products that could compete with our future products;
	•		the terms of our contracts with our current or future collaborators and licensees may not be favorable to us in the future;
	•		a collaborator or licensee with marketing and distribution rights to one or more of our products may not commit enough resources to the marketing and distribution of our products, limiting our potential revenues from the commercialization of a product;
	•		disputes may arise delaying or terminating the research, development or commercialization of our product candidates, or result in significant and costly litigation or arbitration; and
	•		collaborations and licensee arrangements may be terminated and we will experience increased operating expenses and capital requirements if we elect to pursue further development of the product candidate.

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We may not be able to obtain licenses to technology that is necessary for us to develop products.

We may be required to enter into licenses or other collaborations with third parties in order to access technology that is necessary to successfully develop certain of our products. We may not successfully negotiate acceptable licenses or other collaborative arrangements that will allow us to access such technologies. If we cannot obtain and maintain license rights on acceptable terms to access necessary technologies, we may be prevented from developing some product candidates. In addition, any technologies accessed through such licenses or other collaborations may not help us achieve our product development goals.

We may not be able to commercialize our products under development if they infringe claims in existing patents or patents that have not yet issued, and this would materially harm our ability to operate.

As is typical in the biotechnology industry, our commercial success will depend in part on our ability to avoid infringing patents issued to others or breaching the technology licenses upon which we might base our vaccines or other products. We are aware of patents issued to others that contain claims that may cover certain aspects of our or our collaborators’ technologies, including cancer vaccine epitopes, HIV vaccine epitopes, and methods for delivering DNA vaccines to patients. We do not believe that any of these known patents are likely to require us to obtain a license in order to pursue the development or commercialization of our vaccine product candidates. However, we may be required to take a license under one or more of these patents to practice certain aspects of our vaccine technologies in the United States, and such a license may not be available on commercially reasonable terms, if at all. If we fail to obtain a license on acceptable terms to any technology that we need in order to develop or commercialize our vaccines or other products, or to develop an alternative vaccine or other product that does not infringe on the patent rights of others, we would be prevented from commercializing our vaccine, and our business would be harmed.

If we or our collaborators cannot cost-effectively manufacture vaccines in commercial quantities and for clinical trials in compliance with regulatory requirements, we or our collaborators may not be able to successfully commercialize the products.

We have not commercialized any products, and we do not have the experience, resources or facilities to manufacture vaccines on a commercial scale. We will not be able to commercialize any vaccines and earn product revenues unless we or our collaborators demonstrate that we can manufacture commercial quantities of vaccines in accordance with regulatory requirements. Among the other requirements for regulatory approval is the requirement that prospective manufacturers conform to the FDA’s Good Manufacturing Practices, or GMP, requirements specifically for biological drugs, as well as for other drugs. In complying with the FDA’s GMP requirements, manufacturers must continue to expend time, money and effort in production, record keeping and quality control to assure that the product meets applicable specifications and other requirements.

We currently rely and intend to continue to rely on third-party contract manufacturers to produce materials needed for clinical trials and, ultimately, for product commercialization. Third-party manufacturers may not be able to meet our needs with respect to timing, quantity or quality. If we are unable to contract for a sufficient supply of needed materials on acceptable terms, or if we encounter delays or difficulties in our relationships with manufacturers, it may delay clinical trials, regulatory approvals and marketing efforts for our vaccines. Such delays could adversely affect our ability to earn revenues and our chances of achieving profitability. We cannot be sure that we can manufacture, either on our own our through contracts with outside parties, vaccines at a cost or in quantities that are commercially viable.

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If we do not successfully develop and commercialize our products, we may never generate significant revenues or become profitable.

We have not completed the development of any product and, accordingly, have not begun to market or generate revenues from the commercialization of any product. We do not expect to market any of our therapeutic or prophylactic vaccines or any other products for at least six years (and this would assume approval of either our HIV or lung and colorectal product candidate, which may not occur). If we do not successfully develop and commercialize products, we will never generate revenues that would allow us to become profitable.

The lengthy approval process and uncertainty of government regulatory requirements may impair our ability to develop, manufacture and sell any vaccines.

We and our collaborators cannot commercialize our vaccines or other products if we do not receive FDA or state regulatory approval to market our products. The regulatory process for new therapeutic drug products, including the required preclinical studies and clinical testing, is lengthy, uncertain and expensive. We and our collaborators may not receive necessary FDA clearances for any of our vaccines or other potential products in a timely manner, or at all. Once approved, we are subject to the continuing requirements of the FDA. Noncompliance with initial or continuing requirements can result in, among other things:

	•		fines and penalties;
	•		injunctions;
	•		seizure of products;
	•		total or partial suspension of product marketing;
	•		failure of the government to grant a new drug application;
	•		withdrawal of marketing approvals; and
	•		criminal prosecution.

The length of the clinical trial process and the number of patients the FDA will require to be enrolled in clinical trials in order to establish the safety and efficacy of our products is uncertain. In addition, our clinical studies may not provide the FDA with sufficient clinical data to permit approval of a new drug application, or NDA, or a biologic license application, or BLA, even though we or our collaborators believe we are doing the right studies based on the protocol. The FDA or we and our collaborators may decide to discontinue or suspend clinical trials at any time if the subjects or patients who are participating in such trials are being exposed to unacceptable health risks or if the results show no or limited benefit in patients treated with the vaccine compared to patients in the control group.

Regulatory requirements are evolving and uncertain. Future United States or state legislative or administrative acts could also prevent or delay regulatory approval of our products. Even if we obtain commercial regulatory approvals, the approvals may significantly limit the indicated uses for which we may market our products.

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The approval process outside the United States is also uncertain and may limit our ability to develop, manufacture and sell our products internationally.

To market any drug products outside of the United States, we and our collaborators are also subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval for vaccines or other drug products. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country, nor does the approval by foreign health authorities ensure approval by the FDA.

Even if we obtain regulatory approval, we may be required to perform additional clinical trials or change the labeling of our products if we or others identify side effects after our products are on the market, which could harm sales of the affected products.

If we or others identify adverse side effects after any of our vaccines or other drug products are on the market, or if manufacturing problems occur:

	•		regulatory approval may be withdrawn;
	•		reformulation of our products, additional clinical trials, changes in labeling of our products or changes to or re-approvals of our manufacturing facilities may be required;
	•		sales of the affected products may drop significantly;
	•		our reputation in the marketplace may suffer; and
	•		lawsuits, including costly and lengthy class action suits, may be brought against us.

Any of the above occurrences could halt or reduce sales of the affected vaccines or other products or could increase the costs and expenses of commercializing and marketing these vaccines or other products.

If we are unable to protect our trade secrets, we may be unable to protect from competitors our interests in proprietary know-how that is not patentable or for which we have elected not to seek patent protection.

Our competitive position depends in part on our ability to protect trade secrets that are not patentable or for which we have elected not to seek patent protection. To protect our trade secrets, we rely primarily on confidentiality agreements with our collaborative partners, employees and consultants. Nevertheless, our collaborative partners, employees and consultants may breach these agreements and we may be unable to enforce these agreements. In addition, other companies may develop similar or alternative technologies, methods or products or duplicate our technologies, methods or vaccines that are not protected by our patents or otherwise obtain and use information that we regard as proprietary, and we may not have adequate remedies in such event. Any material leak of our confidential information into the public domain or to third parties could harm our competitive position.

If we lose our key scientific and management personnel or are unable to attract and retain qualified personnel, it could delay or hurt our epitope identification and vaccine development efforts.

We are highly dependent on the principal members of our scientific and management staff. We do not maintain key person life insurance on the life of any employee and, although we have an employment contract with Dr. Emile Loria, he may terminate his employment at any time. Our ability to identify epitopes, develop vaccines and achieve our other business objectives also will depend in part on the continued service of our key scientific and management personnel and our ability to identify, hire and

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retain additional qualified personnel. There is intense competition for qualified personnel in biochemistry, molecular biology, immunology and other areas of our activities, and we may not be able to continue to attract and retain such personnel necessary for the development of our business. Because of the intense competition for qualified personnel among technology-based businesses, particularly in the San Diego area, we may not be successful in adding technical personnel as needed to meet the staffing requirements of additional collaborative relationships. Our failure to attract and retain key personnel could delay or be significantly detrimental to our product development programs and could cause our stock price to decline.

We out-license technology outside of our core area of focus, and these licensees may not develop any products using our technology, which may limit our revenue.

We have licensed to third parties some of our technology in markets that we are not pursuing ourselves or with our collaborators. If these licensees are not successful in developing and commercializing products using our technology, our revenues would be limited. Our licensees may pursue alternative technologies or develop alternative products either on their own or in collaboration with others in competition with products developed under licenses or collaborations with us.

Some of our programs are funded by the government and, therefore, the government may have rights to certain of our technology and could require us to grant licenses of our technology to third parties.

We fund certain of our research and development related to our HIV, cancer and malaria programs pursuant to grants from the government. As a result of these grants, the government may have rights in the technology, including inventions developed with government funding. In addition, the government may require us to grant to a third party an exclusive license to any inventions resulting from the grant if the government determines that we have not taken adequate steps to commercialize inventions, or for public health or safety needs.

Adverse determinations concerning product pricing, reimbursement and related matters could prevent us from successfully commercializing products and impair our ability to generate revenues.

Our ability to successfully commercialize our vaccines or other products may depend in part on the extent to which reimbursement for the cost of such products and related treatment will be available from government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and adequate third-party coverage may not be available to enable us to maintain price levels sufficient to realize an appropriate return on our investment in product development.

Product liability risks may expose us to significant liability that could cause us to incur significant costs or cease developing our products.

Our business exposes us to potential product liability risks that are inherent in the testing, manufacturing and marketing of human therapeutic products. While we currently have product liability insurance for an early stage clinical trial, we cannot be sure that we can maintain such insurance on acceptable terms or obtain acceptable insurance as we progress through product development and commercialization, or that our insurance will provide adequate coverage against potential liabilities, either in human clinical trials or following commercialization of any vaccines we may develop.

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Our use of hazardous materials could expose us to significant costs.

Our research and development processes involve the controlled storage, use and disposal of hazardous materials, chemicals and radioactive compounds. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and some waste products. The risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed our resources. We cannot be sure that compliance with environmental laws and regulations in the future will not entail significant costs, or that our ability to conduct research and development activities will not be harmed by current or future environmental laws or regulations.

The volatility of the price of our common stock may hurt our stockholders.

The market prices for securities of biotechnology companies, including our common stock, have historically been highly volatile, and the market from time to time has experienced significant price and volume fluctuations that are not necessarily related to the operating performance of such companies. In the year 2003, our closing stock price has ranged from $0.760 to $3.166 and has been and will continue to be influenced by general market and industry conditions. In addition, the following factors may have a significant effect on the market price of our common stock:

	•		whether we are able to secure additional financing on favorable terms, or at all;
	•		announcements of technological innovations or new commercial vaccines or other therapeutic products by us or others;
	•		governmental regulation that affects the biotechnology and pharmaceutical industries;
	•		developments in patent or other proprietary rights;
	•		receipt of funding under collaboration and license agreements and government grants;
	•		developments in, or termination of, our relationships with our collaborators and licensees;
	•		public concern as to the clinical results and/or the safety of drugs developed by us or others; and
	•		announcements related to the sale of our stock.

Fluctuations in our financial performance from period to period also may have a significant impact on the market price of our common stock.

Concentration of ownership among our existing officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate decisions and depress our stock price.

As of September 30, 2003, our officers, directors and those stockholders owning at least five percent of our outstanding stock together control approximately 57.2% of our outstanding common stock as converted and Pharmacia, now part of Pfizer, holds 100% of our preferred stock. If some or all of these officers, directors and principal stockholders act together, they will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval or disapproval of any proposed merger or financing or other business combination transaction. The interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders. For instance, officers, directors and principal stockholders, acting together, could cause us to enter into transactions or agreements that we would not otherwise consider. Similarly, this concentration of ownership may have the effect of delaying or preventing a change in control of our company otherwise favored by our other stockholders. This concentration of ownership also could depress our stock price.

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ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, as of September 30, 2003. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective as of the evaluation date.

(b) Changes in Internal Controls

There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time we are involved in certain litigation arising out of our operations. We are not currently engaged in any legal proceedings.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On September 18, 2003, pursuant to a Unit Purchase Agreement dated September 18, 2003, we completed a private placement of common stock and warrants to selected institutional and accredited investors, including current shareholders. We sold 2,168,961 shares of our common stock and warrants to purchase 542,238 shares of our common stock at a combined unit price of $1.86725 per unit. Each unit consisted of one share of common stock and a warrant to purchase 25% of one share of our common stock. In addition, we issued warrants to purchase an aggregate of 250,000 shares of our common stock to a placement agent, Jefferies & Company, Inc., for services rendered in connection with the private placement. The warrants issued in the private placement, including the warrant issued to the placement agent, are exercisable at any time in whole or in part until September 17, 2006 at an exercise price of $2.33406 per share. The exercise price of the warrants and the number of shares issuable upon exercise of the warrants are subject to adjustment upon the subdivision, split or combination of shares of our common stock and the issuance of dividends in the form of common stock. We issued the common stock and the warrants to the purchasers in the private placement and the warrants to the placement agent in reliance on the exemption from registration permitted under Section 4(2) or Regulation D of the Securities Act of 1933, as amended, based on investment representations made by each such purchaser and the placement agent. We have filed a registration statement under the Securities Act to permit registered resales of the common stock and the common stock issuable upon exercise of the warrants issued to the purchasers and to the placement agent, which became effective on October 21, 2003.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

(b)

Reports on Form 8-K during the second quarter ended September 30, 2003

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EPIMMUNE INC.

SIGNATURES

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

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