LIPID SCIENCES INC/ - 10-Q Quarterly Report

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7068 Koll Center Parkway, Suite 401, Pleasanton, California 94566
(Address of principal executive offices) (Zip 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 Noo

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.

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

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

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

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

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 June 30, 2003, the remaining available cash and investments balance is $17.4 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 at least through the end of the 2004 fiscal year. We expect additional capital will be required in the future. We intend to seek capital needed to fund our operations through new collaborations, such as licensing or other arrangements, through pursuit of research and development grants or through 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 normal recurring adjustments, which the Company considers necessary 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 2002 Annual Report on Form 10-K.

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

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.

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 aggregate purchase price equals the fair value of NZ’s net assets. 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 stock rights, 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 perfect their rights and must continue to hold their shares in direct registered form through November 28, 2003 to continue to qualify for the right. Transfer of shares before November 29, 2003 will disqualify the right attached to the transferred shares. If additional shares are issued pursuant to the rights, the issuance of additional shares of common stock 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 June 30, 2003, 2,956,239 rights were perfected with an additional 104,251 rights pending determination. If all of the holders of perfected rights remain qualified to receive the additional shares on November 28, 2003, the issuance will dilute ownership of stockholders not holding rights by up to 12.6%, based on 21,141,455 shares outstanding as of June 30, 2003.

The unaudited condensed consolidated results of operations from continuing operations on a pro forma basis as if the merger had occurred as of the beginning of the periods presented would be consistent with the results of continuing operations presented in the consolidated statements of operations.

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:

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:

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company adopted the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

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. The adoption of this statement is not expected to 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 and for hedging relationships designated after June 30, 2003. The adoption of this statement is not expected to have an impact on Lipid’s financial position, results of operations or cash flows.

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.

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.

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 $325,000 and $1,644,000 for the three month periods ended June 30, 2003 and June 30, 2002, respectively, and $846,000 and $3,235,000 for the six month periods ended June 30, 2003 and June 30, 2002, respectively, were charged to operations for fees related to Phase II.

As of June 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 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 June 30, 2003 and June 30, 2002 we have expensed $125,000 and $375,000, respectively, and for the six month periods ended June 30, 2003 and June 30, 2002 we have expensed $250,000 and $500,000, 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. On July 30, 2003, the required 30 days written notice was given of our intent to terminate this agreement effective August 31, 2003. At termination of this agreement, we will be required to pay Karuba an amount equal to one third of the annual fee, payable in equal monthly installments through December 2003. Approximately $72,000 and $73,000 for the three month periods ended June 30, 2003 and June 30, 2002, respectively, and $143,000 and $115,000 for the six month periods ended June 30, 2003 and June 30, 2002, respectively, were expensed to research and development under this agreement of which $6,500 is included in accounts payable at June 30, 2003.

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 six month period ended June 30, 2003. During the three month period ended June 30, 2003, we expensed an additional $200,000 as a selling, general and administrative expense related to this agreement.

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

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 June 30, 2003, we have utilized approximately $450,000 of the accrual set up for real estate restructuring purposes and $882,000 of the accrual related to the implementation of our new strategic plan.

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 June 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 and March 31, 2003 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, have been reclassified and included in interest and other income for all periods presented. Income of $320,000, $172,000 and $1,237,000 for the three months ended June 30, 2003, June 30, 2002 and the period from Inception (May 21, 1999) to June 30, 2003, respectively, have been reclassified to interest and other income. Additionally, all related income tax expenses/benefits and accrued interest have been reclassified accordingly.

The Company’s effective tax rate was 0.77% in the second quarter of 2003 and effective tax benefit rate was 27.33% 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. The company has established a valuation allowance against its net operating loss carry-forward and credits due to the uncertainty of realizing future tax benefits.

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).

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

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.

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 from the blood stream. Examples of viruses with lipid envelopes that 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.

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 stock rights, 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 perfect their rights and must continue to hold their shares in direct registered form through November 29, 2003 to qualify to receive the additional stock with respect to each perfected right. Transfer of shares before November 29, 2003 will disqualify the right with respect to each of the transferred shares. If additional shares are issued pursuant to the rights, the issuance of additional shares of common stock 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 June 30, 2003, 2,956,239 rights were perfected with an additional 104,251 rights pending determination. If all of the holders of perfected rights remain qualified to receive the additional shares on November 28, 2003, the issuance will dilute ownership of stockholders not holding rights by up to 12.6%, based on 21,141,455 shares outstanding as of June 30, 2003.

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 Six Months Ended June 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 June 30, 2003 we have utilized approximately $450,000 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 on our proprietary VPI platform, while we continue to strengthen our intellectual property base related to both our viral and cardiovascular technology platforms. The first indication being pursued by the Company to demonstrate the efficacy of our VPI platform technology is HIV. 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 have been eliminated. Sandra Gardiner, the Company’s Vice President, Controller and Corporate Secretary, has assumed the newly created position of Chief Accounting Officer. In related appointments, Marc Bellotti, who was Vice President of Product Development, has assumed the position of Vice President, Research and Development. Dale Richardson, who was Vice President of Marketing and Sales, has assumed the position of Vice President, Business Development. In the six month period ended June 30, 2003, we recorded and utilized restructuring charges of approximately $1,120,000 and $882,000, 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.

On April 14, 2003, S. Lewis Meyer, Ph.D. was elected President and Chief Executive Officer of Lipid Sciences, Inc. Dr. Meyer replaces Phil Radlick, Ph.D., who resigned in October 2002 and served as an advisor to the Company through February 2003. Dr. Meyer will continue to serve as a Director and member of the Executive Committee. Dr. Meyer has stepped down as Chairman of the Audit and Compensation Committees and is no longer serving on the Nominating Committee. Mr. Babbitt replaced Dr. Meyer as Chairman of the Audit Committee and H. Bryan Brewer, Jr., M.D., was elected to serve on the Nominating Committee.

On May 1, 2003, Nasdaq informed us that for the prior 30 consecutive trading days the bid price of our common stock had closed below the minimum $1.00 per share requirement for continued inclusion in the Nasdaq National Market. Therefore, in accordance with Nasdaq Rules, we were provided 180 days, or until October 28, 2003, to regain compliance. Compliance is achieved if, at any time before October 28, 2003, the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive trading days. On June 12, 2003, we received written notification from Nasdaq confirming that we have regained compliance with Nasdaq Rules.

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:

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.

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.

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.

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.

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.

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

Net Revenue. We had no revenues from continuing operations from Inception (May 21, 1999) through June 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 $2,417,000, or 62%, to $1,477,000 in the second quarter of 2003 from $3,894,000 for the same period in 2002. The decrease is due primarily to reduced external development services, 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. 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 will be significantly reduced.

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 June 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 $711,000, or 38%, to $1,157,000 in the second quarter of 2003 from $1,868,000 for the same period in 2002. The decrease is due primarily to reduced public company related expenses, including legal and accounting fees, as well as reduced employee related expenses as a result of our recent restructuring. During the three months ended June 30, 2003, the reduction in general and administrative expenses was partially offset by the additional accrual of advisory fees expected to be paid to MDB Capital Group, LLC related to the merger between NZ and Pre-Merger Lipid (see Note 8 of the Condensed Consolidated Financial Statements).

Interest and Other Income. Interest and other income for the second quarter of 2003 increased approximately $158,000, or 77%, to $364,000 from $206,000 for the same period in 2002. The increase is due primarily to a gain recognized 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 (see Note 10 of the Condensed Consolidated Financial Statements).

Results of Continuing Operations – Six Months Ended June 30, 2003 and 2002

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

Research and Development Expenses. Research and development expenses decreased approximately $3,134,000, or 45%, to $3,779,000 for the six month period ended June 30, 2003 from $6,913,000 for the same period in 2002. The decrease is due primarily to reduced external development services, 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 six months ended June 30, 2003, the reduction in research and development expense was partially offset by approximately $600,000 of restructuring charges incurred during the first quarter 2003 related to the implementation of our new strategic direction. Research and development expenses account for approximately 58% of total operating expenses for the six months ended June 30, 2003.

Selling, General and Administrative Expenses. General and administrative expenses decreased approximately $115,000, or 4%, to $2,720,000 for the six month period ended June 30, 2003 from $2,835,000 for the same period in 2002. The decrease is due primarily to reduced public company related expenses, including legal and accounting fees, and reduced employee related expenses as a result of our recent restructuring. During the six months ended June 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 42% of total operating expenses for the six months ended June 30, 2003.

Interest and Other Income. Interest and other income for the six month period ended June 30, 2003 increased approximately $193,000, or 49%, to $583,000 from $390,000 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.

Results of Discontinued Operations – Three and Six Months Ended June 30, 2003

During the three months ended June 30, 2003, we disposed of certain residential and industrial lots in New Mexico, in multiple transactions, for an aggregate sales price of approximately $1,380,000. In these transactions, we received cash of approximately $1,272,000, net of commissions, title fees, closing costs and pro-rations of property taxes. Additionally, we collected approximately $934,000 in principal payments from other notes receivable during this same period and invested approximately $160,000 of cash in the improvement of fifteen residential lots in San Diego County, California, which we obtained through a foreclosure in 2002.

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

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 and March 31, 2003 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, have been reclassified and included in interest and other income for all periods presented. Income of $170,000, $170,000 and $917,000 for the three months ended June 30, 2003 and June 30, 2002, and the period from Inception (May 21, 1999) to June 30, 2003, respectively, have been reclassified to interest and other income. Additionally, all related income tax expenses/benefits have been reclassified accordingly.

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 June 30, 2003.

The net cash used in continuing operating activities was approximately $5,300,000, $1,100,000, and $30,800,000 for the six months ended June 30, 2003, June 30, 2002, and the period from Inception (May 21, 1999) to June 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 $3,700,000, $200,000 and $7,100,000 for the six months ended June 30, 2003, June 30, 2002, and the period from Inception (May 21, 1999) to June 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 six months ended June 30, 2003 and $23,800,000 for the period from Inception (May 21, 1999) to June 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 $500,000 for the six months ended June 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 $2,200,000, $14,300,000, and $25,900,000 for the six months ended June 30, 2003, June 30, 2002, and the period from Inception (May 21, 1999) to June 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 June 30, 2003 and June 30, 2002 we have expensed $125,000 and $375,000, respectively, and for the six month periods ended June 30, 2003 and June 30, 2002 we have expensed $250,000 and $500,000, 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.

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.

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 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. On July 30, 2003, the required 30 days written notice was given of our intent to terminate this agreement effective August 31, 2003. At termination of this agreement, we will be required to pay Karuba an amount equal to one third of the annual fee, payable in equal monthly installments through December 2003. Approximately $72,000 and $73,000 for the three month periods ended June 30, 2003 and June 30, 2002, respectively, and $143,000 and $115,000 for the six month periods ended June 30, 2003 and June 30, 2002, respectively, were expensed to research and development under this agreement of which $6,500 is included in accounts payable at June 30, 2003.

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 June 30, 2003, the remaining available cash and investments balance is $17.4 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 at least through the end of the 2004 fiscal year. We expect additional capital will be required in the future. We intend to seek capital needed to fund our operations through new collaborations, such as licensing or other arrangements, 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.

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

For the six months ended June 30, 2003, we incurred a net loss of approximately $5,619,000 and since Inception through June 30, 2003, we have incurred an accumulated deficit of approximately $37,083,000. 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 June 30, 2003, we had cash, cash equivalents and short-term investments equal to approximately $17.4 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 at least through the end of the 2004 fiscal year. As of June 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.

Our technology, and hence, our business, at present is limited to addressing two medical applications: the removal of lipid from lipid-enveloped viruses, bacteria and other lipid-enveloped infectious agents such as HIV, Hepatitis B and Hepatitis C, SARS Coronavirus, West Nile Virus, and Influenza, among others, and the reversal of cardiovascular and cerebrovascular disease. If our technology does not prove to be safe or effective, if we otherwise fail to receive regulatory approval for our potential product indications, or if we fail to successfully commercialize any product that may receive regulatory approval, our business prospects would be significantly harmed and possibly it could cause us to cease operations.

Our future success depends in large part upon the results of clinical trials designed to assess the safety and efficacy of our potential product indications. The ultimate results of clinical studies cannot be predicted with accuracy and can be impacted by many variables. We cannot be sure whether planned clinical trials will begin on time or will be completed on schedule or at all. Delay or failure to complete clinical studies may delay or prevent us from bringing products to market, which would materially harm our business. For example, any of our future clinical studies might be delayed in their initiation or performance, or even halted after initiation because:

	•		extensive and time-consuming pre-clinical animal studies are required by the regulatory authorities to demonstrate the safety of the process technology;

	•		the data generated by the pre-clinical animal studies does not indicate to the regulatory authorities that there is a sufficient margin of safety;

	•		the potential clinical benefit from the delipidation process cannot be effectively demonstrated through the pre-clinical animal studies;

	•		the relevant regulatory requirements for initiating and maintaining an application for a clinical study cannot be met;

	•		the product or process is not effective, or physicians perceive that the product is not effective;

	•		patients experience severe side effects during treatment or possibly even death as a result of the treatment;

	•		patients die during a clinical study because their disease is too advanced or because they experience medical problems that are not related to the product being studied;

	•		patients do not enroll in the studies at the rate we expect; or

•

the discovery by the sponsor, during the study, of deficiencies in the way the study is being conducted by the study investigators that raise questions as to whether the study is being conducted in conformity with the relevant regulatory authorities’ regulations or Good Clinical Practice.

In the third quarter of 2002, we voluntarily paused our Phase 1 human clinical trial which was being conducted in Australia to determine the safety of our plasma delipidation process. For strategic reasons, we discontinued our Phase 1 human clinical trial and ceased all operations in Australia in January 2003 to align our clinical trial efforts toward the development of our VPI platform and U.S.-based clinical trials.

We depend on our license agreement with Aruba International Pty. Ltd. that may, if terminated, significantly harm our business.

We have entered into an agreement for an exclusive license to patents, know-how and other intellectual property relating to our foundation technology for removal of lipids from proteins and our continued operations at present are dependent upon such license. The licensor is Aruba International Pty. Ltd., a company controlled by Dr. Bill E. Cham, a founding stockholder of Pre-Merger Lipid and a former Director of the Company. Dr. Cham also controls KAI International, LLC, our largest stockholder. The technology licensed from Aruba currently represents an important part of the technology owned or licensed by us. Aruba may terminate the license agreement if we fail to perform and fail to remedy following written notice of default with respect to our material obligations under the agreement, including our obligations to make royalty payments, or if we cease, without intention to resume, all efforts to commercialize the subject matter of the licensed intellectual property. If our license with Aruba terminates, our business would be significantly harmed and may cause us to cease operations.

We intend to rely on collaborations in order to further develop our products and processes. If these collaborations are unsuccessful, the development of our products could be adversely affected and we may incur significant unexpected costs.

We intend to enter into collaborations with strategic partners, licensors, licensees and others. We may be unable to maintain or expand our existing collaborations or establish additional collaborations or licensing arrangements necessary to develop our technology or on favorable terms. Any current or future collaborations or licensing arrangements may not be successful. In addition, parties we collaborate with may develop products or processes that compete with ours, and we cannot be certain that they will perform their contractual obligations or that any revenues will be derived from such arrangements. If one or more of these parties fails to achieve product development objectives, this failure could harm our ability to fund related programs and develop or commercialize products.

The biotechnology industry is intensely competitive and we may not be able to develop, perfect or acquire rights to new products with commercial potential. We compete with biotechnology and pharmaceutical companies that have been established longer than we have, have a greater number of products on the market, have greater financial and other resources and have other technological or competitive advantages. We also compete in the development of technologies and processes and in acquiring personnel and technology from academic institutions, governmental agencies, and other private and public research organizations. We cannot be certain that one or more of our competitors will not receive patent protection that dominates, blocks or adversely affects our clinical studies, product development or business; will benefit from significantly greater sales and marketing capabilities; or will not develop products that are accepted more widely than ours.

If we fail to secure and then enforce patents and other intellectual property rights underlying our technologies, we may be unable to compete effectively.

Our future success will depend in part on our ability to obtain patent protection, defend patents once obtained, maintain trade secrets and operate without infringing upon the patents and proprietary rights of others, and if needed, obtain appropriate licenses to patents or proprietary rights held by third parties with respect to its technology, both in the United States and in foreign countries. We currently have an exclusive license from Aruba International Pty. Ltd. with respect to three issued US patents (and three issued Australian counterpart patents) and counterpart applications as well as independent pending patent applications. The issued patents will expire in July 2005, July 2014 and December 2014. There are additional pending applications assigned to us. Each of the patents and pending applications relates to different aspects of our technology platforms. However, these patent applications may not be approved and, even if approved, our patent rights may not be upheld in a court of law or may be narrowed if challenged. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Our patent rights may not provide competitive advantages for our products and may be challenged, infringed upon or circumvented by our competitors.

In addition to patents, we rely on trade secrets, know-how, continuing technological innovations, and licensing opportunities to develop and maintain our competitive position. It is our policy to require our employees, certain contractors, consultants, members of our scientific and viral advisory boards and parties to collaborative agreements to execute confidentiality agreements upon the commencement of a business relationship with us. We cannot assure you that these agreements will not be breached, that they will provide meaningful protection of our trade secrets or know-how or adequate remedies if there is unauthorized use or disclosure of this information or that our trade secrets or know-how will not otherwise become known or be independently discovered by our competitors.

If it were ultimately determined that our intellectual property rights are unenforceable, or that our use of our technology infringes on the intellectual property rights of others, we may be required or may desire to obtain licenses to patents and other intellectual property held by third parties to develop, manufacture and market products using our technology. We may not be able to obtain these licenses on commercially reasonable terms, if at all, and any licensed patents or intellectual property that we may obtain may not be valid or enforceable. In addition, the scope of intellectual property protection is subject to scrutiny and challenge by courts and other governmental bodies. Litigation and other proceedings concerning patents and proprietary technologies can be protracted, expensive and distracting to management and companies may sue competitors as a way of delaying the introduction of competitors’ products. Any litigation, including any interference proceedings to determine priority of inventions, oppositions to patents in foreign countries or litigation against our partners, may be costly and time-consuming and could significantly harm our business.

Because of the large number of patent filings in the biopharmaceutical field, our competitors may have filed applications or been issued patents and may obtain additional patents and proprietary intellectual property rights relating to products or processes competitive with or similar to ours. We cannot be certain that U.S. or foreign patents do not exist or will be issued that would harm our ability to commercialize our products and product candidates.

If we use biological and hazardous materials in a manner that causes injury, we may be liable for damages.

Our research and development activities involve the controlled use of potentially harmful biological materials, such as blood products, organic solvents and other hazardous materials. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result, and any liability could be significant. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.

Our design, testing, development, manufacture and marketing of products involve an inherent risk of exposure to product liability claims and related adverse publicity. Insurance coverage is expensive and difficult to obtain, and we may be unable to obtain coverage in the future on acceptable terms, if at all. Although we currently maintain product liability insurance for our products in the amounts we believe to be commercially reasonable, we cannot be certain that the coverage limits of our insurance policies or those of our strategic partners will be adequate. If we are unable to obtain sufficient insurance at an acceptable cost or if a successful product liability claim is made against us, whether fully covered by insurance or not, our business could be harmed.

We depend on key personnel and will need to hire additional key personnel in the future.

Our ability to operate successfully depends in significant part upon the experience, abilities and continued service of certain key scientific, technical and managerial personnel. If we lose the services of any of these personnel and we are unable to hire qualified replacements, our business could be harmed. Our future success also depends upon our ability to attract and retain additional highly qualified personnel in these areas and our ability to develop and maintain relationships with qualified clinical researchers. Our Chief Financial Officer resigned in January 2003. We currently do not plan to fill that position. Competition for such personnel and relationships is intense, especially in the San Francisco Bay Area. There can be no assurance that we can retain such personnel or that we can attract or retain other highly qualified scientific, technical and managerial personnel or develop and maintain relationships with clinical researchers in the future.

An economic downturn in the real estate market could adversely affect our ability to complete the disposal of real estate and other assets held by the Company before the merger and generate funds for our continuing operations.

While we have disposed of most of our real estate and other assets held by the Company before the merger, we plan to use the proceeds from sales of the remainder of these assets to partially fund our continuing operations. While the current real estate markets are generally healthy, there is no assurance that the markets will continue to be favorable to support the disposal of these assets. A downturn in the real estate market could adversely affect our ability to sell these real estate assets. Additionally, a downturn in the real estate market could adversely affect the ability of our borrowers to repay their loans according to the terms of the loans and/or could adversely affect the value of the collateral for those loans. Either of these outcomes would impair our ability to generate funds for our continuing operations.

Our stock price may be volatile and there may not be an active trading market for our common stock.

There can be no assurance that there will be an active trading market for our common stock or that the market price of the common stock will not decline below its present market price. The market prices for securities of biotechnology companies have been, and are likely to continue to be, highly volatile. Factors that have had, and are expected to continue to have, a significant impact on the market price of our common stock include:

	•		material public announcements;

	•		actual or potential clinical results with respect to our products under development or those of our competitors;

	•		the announcement and timing of any new product introductions by us or others;

	•		technical innovations or product development by us or our competitors;

	•		regulatory approvals or regulatory issues;

	•		developments relating to patents and proprietary rights;

	•		political developments or proposed legislation in the medical device or healthcare industry;

	•		economic and other external factors, disaster or crisis;

	•		changes to our management;

	•		period-to-period fluctuations in our financial results or results which do not meet or exceed analyst expectations; and

	•		market trends relating to or affecting stock prices throughout our industry, whether or not related to results or news regarding us or our competitors.

In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Regardless of its outcome, securities litigation may result in substantial costs and divert management’s attention and resources, which could harm our business and results of operations.

The future sale of substantial number of shares of our common stock, or the perception that such sales could occur, would impact the market price of our common stock. In connection with the merger of the privately-held Lipid Sciences, Inc. with and into NZ Corporation in November 2001, (i) certain of our stockholders beneficially owning 5,451,772 shares of our common stock have agreed for one year, and (ii) certain of our other stockholders beneficially owning 9,622,803 shares of our common stock have agreed for two years, pursuant to executed lock-up agreements, not to sell any shares of common stock. The shares subject to such one-year lock-up agreements became available for sale in the public market on November 29, 2002 and the shares subject to such two-year lock-up agreements will be available for sale in the public market on November 29, 2003. If a substantial number of shares of common stock that have become available for sale or will be available for sale in the near future are sold, the market price of our common stock may be negatively impacted.

In connection with the merger of the privately-held Lipid Sciences, Inc. with and into NZ Corporation, we are obligated to issue additional shares of common stock on November 29, 2003 to those individuals and entities who were stockholders of NZ Corporation on the day prior to the completion of the merger and who perfected their stock rights, subject to certain exceptions. Each perfected right entitles the holder to receive up to one additional share of our common stock. If additional shares are issued pursuant to the rights, the issuance of additional shares of common stock 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 June 30, 2003, 2,956,239 rights were perfected with an additional 104,251 rights pending determination. If all of the holders of perfected rights remain qualified to receive the additional shares on November 28, 2003, the issuance will dilute ownership of stockholders not holding rights by up to 12.6%, based on 21,141,455 shares outstanding as of June 30, 2003. In addition, if we seek funding through equity financings, there would be further dilution to existing stockholders.

We have taken a number of actions that could discourage a takeover attempt that might be beneficial to stockholders who wish to receive a premium for their shares from a potential bidder. For example:

	•		our Board of Directors has the authority to issue, without vote or action of stockholders, up to 10,000,000 shares of preferred stock and to fix the price, rights, preferences and privileges of those shares. Any series of preferred stock could contain dividend rights, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences or other rights superior to the rights of holders of common stock;

	•		our Directors are elected to staggered terms, which prevents the entire Board from being replaced in any single year;

	•		our Certificate of Incorporation and Bylaws require the affirmative vote of the holders of sixty-six and two-thirds percent (66 2/3%) of the voting power of all of the then outstanding shares entitled to vote generally in the election of Directors, voting together as a single class, to make, alter, amend or repeal our Bylaws;

	•		our Certificate of Incorporation does not permit stockholders to take an action by written consent;

	•		our Certificate of Incorporation and the Bylaws provide that special meetings of the stockholders may be called only by the Chairman of the Board, the President, or the Board of Directors by a resolution approved by a majority of the total number of Directors we would have if there were no vacancies; and

	•		under our Bylaws, notice regarding stockholder proposals and Director nominations must have been delivered not less than 45 days nor more than 75 days prior to the first anniversary of the date on which we first mailed our proxy materials for the preceding year’s annual meeting.

Our exposure to market risk associated with changes in interest rates relates to our investment portfolio. We maintain a non-trading investment portfolio consisting of government issued securities. These investments are classified as held-to-maturity and are accounted for at their amortized cost, as per FASB Statement No. 115. Due to the conservative nature of our investment portfolio, we do not believe that short-term fluctuations in interest rates would materially affect the value of our securities.

The operating expenses, assets and liabilities of our Australian subsidiary are denominated in a foreign currency, thereby creating exposures to changes in exchange rates. However, the risks related to foreign currency exchange rates are not material to our consolidated financial position or results of operations.

(a)		Evaluation of Disclosure Controls and Procedures. The Company’s Chief Executive Officer and Chief Accounting Officer have conducted an evaluation of the effectiveness of the disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2003. Based on such evaluation, such officers have concluded that the Company’s disclosure controls and procedures are effective in alerting them, on a timely basis, to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings under the Exchange Act.

(b)		Changes in Internal Controls Over Financial Reporting. In connection with the evaluation of our internal control over financial reporting, pursuant to Rule 13a-15(d) of the Exchange Act, no changes during the quarter ended June 30, 2003 were identified that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are from time to time a party to legal proceedings. All of the legal proceedings we are currently involved in are ordinary and routine. The outcomes of the legal proceedings are uncertain until they are completed. We believe that the results of the current proceedings will not have a material adverse effect on our business or financial condition or results of operations.

On May 29, 2003, the Company held its annual meeting of stockholders. The following items were submitted to a vote of the stockholders:

(a)

To elect two Class I members currently serving on the Board of Directors to three-year terms.

As a result, Messrs. Pope and Meyer were elected as Directors of the Company. The following incumbent members continue to serve on the Board of Directors: Richard G. Babbitt, H. Bryan Brewer, Jr., M.D., Frank M. Placenti and Gary S. Roubin, M.D., Ph.D.

(a)		Exhibits - See Index to Exhibits.

(b)		Reports on Form 8-K

		During the quarter for which this report is filed, the Company filed the following reports on Form 8-K:

	(i)		Report on Form 8-K filed April 15, 2003 under “Item 5. Other Events and Regulation FD Disclosure” and “Item 7. Financial Statements and Exhibits” containing Lipid Sciences, Inc.’s news release dated April 15, 2003 with respect to the announcement of S. Lewis Meyer, Ph.D. as President and CEO.

	(ii)		Report on Form 8-K filed June 4, 2003 under “Item 7. Financial Statements and Exhibits” containing Lipid Sciences, Inc.’s news release dated June 4, 2003 with respect to the announcement of the re-election of two Directors, actions taken by the Board of Directors to appoint Deloitte and Touche as Auditors, and viral projects and new patents being pursued.

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


PART I
	ITEM 1. FINANCIAL STATEMENTS
		Condensed Consolidated Balance Sheet
		Condensed Consolidated Statements of Operations
		Condensed Consolidated Statements of Cash Flows
		Notes to Condensed Consolidated Financial Statements
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II.
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT INDEX
EX-31.1
EX-31.2
EX-32.1
EX-32.2


			Page No.

PART I
	Item 1.	Financial Statements	3
		Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002	3
		Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002, and cumulative period from Inception (May 21, 1999) to June 30, 2003	4
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002, and cumulative period from Inception (May 21, 1999) to June 30, 2003	5
		Notes to Condensed Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
	Item 4.	Controls and Procedures	28
PART II
	Item 1.	Legal Proceedings	29
	Item 2.	Changes in Securities and Use of Proceeds	29
	Item 3.	Defaults upon Senior Securities	29
	Item 4.	Submission of Matters to a Vote of Security Holders	29
	Item 5.	Other Information	29
	Item 6.	Exhibits and Reports on Form 8-K	29
SIGNATURES			30
INDEX TO EXHIBITS FOR FORM 10-Q			31


(In thousands, except share amounts)			June 30, 2003			December 31, 2002

ASSETS
Current assets:
	Cash and cash equivalents		$	11,744		$	18,552
	Short-term investments			5,682			2,000
	Prepaid expenses and other current assets			297			537
	Other current assets			34			138
	Current assets of discontinued operations			8,375			10,237

Total current assets				26,132			31,464

	Property and equipment			790			1,175
	Notes receivable			5,850			6,569
	Restricted cash			317			316

Total assets			$	33,089		$	39,524

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable and accrued liabilities		$	1,435		$	2,226
	Related party payables			593			825
	Accrued royalties			500			250
	Accrued compensation			355			370
	Income taxes payable			58			39
	Current liabilities of discontinued operations			76			172

Total current liabilities				3,017			3,882

	Deferred rent			37			36

Total long-term liabilities				37			36

Commitments and contingencies (Notes 7, 8, 9, 10)
Stockholders’ equity:
	Preferred stock, $0.001 par value; 10,000,000 shares authorized and issuable; no shares outstanding			—			—
	Common stock, $0.001 par value; 75,000,000 shares authorized; 21,141,455 shares issued and outstanding at December 31, 2002 and June 30, 2003			21			21
	Additional paid in capital			67,097			67,049
	Deficit accumulated in the development stage			(37,083	)		(31,464	)

		Total stockholders’ equity		30,035			35,606

Total liabilities and stockholders’ equity			$	33,089		$	39,524


													Period
													from
													Inception
													(May 21,
	Three Months Ended						Six Months Ended						1999) to
	June 30,						June 30,						June 30,
(In thousands, except per share amounts)	2003			2002			2003			2002			2003

Revenue	$	—		$	—		$	—		$	—		$	—
Operating expenses:
Research and development		1,477			3,894			3,779			6,913			32,884
Selling, general and administrative		1,157			1,868			2,720			2,835			14,943

Total operating expenses		2,634			5,762			6,499			9,748			47,827

Operating loss		(2,634	)		(5,762	)		(6,499	)		(9,748	)		(47,827	)
Interest and other income		364			206			583			390			2,333

Loss from continuing operations		(2,270	)		(5,556	)		(5,916	)		(9,358	)		(45,494	)
Income tax (expense)/benefit		—			1,704			(95	)		2,765			7,974

Net loss from continuing operations		(2,270	)		(3,852	)		(6,011	)		(6,593	)		(37,520	)

Discontinued operations:
Income from discontinued operations		238			280			392			619			616
Income tax (expense)/benefit		—			(130	)		—			(284	)		(179	)

Income from discontinued operations – net		238			150			392			335			437

Net loss	$	(2,032	)	$	(3,702	)	$	(5,619	)	$	(6,258	)	$	(37,083	)

Earnings/(loss) per share – basic and diluted:
Net (loss) per share continuing operations	$	(0.11	)	$	(0.18	)	$	(0.28	)	$	(0.31	)
Earnings per share discontinued operations	$	0.01		$	0.00		$	0.01		$	0.01
Net loss per share	$	(0.10	)	$	(0.18	)	$	(0.27	)	$	(0.30	)
Weighted average number of common shares outstanding – basic and diluted		21,141			21,141			21,141			21,163


								Period from
								Inception (May
		Six Months Ended						21, 1999) to
		June 30,						June 30,
(In thousands)		2003			2002			2003

Cash flows used in operating activities:
Net loss from continuing operations		$	(6,011	)	$	(6,593	)	$	(37,520	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization			167			116			473
Loss on disposal of assets			203			—			203
Accretion of discount on investments			(11	)		—			(91	)
Issuance of common stock to consultants and advisors			48			(399	)		4,060
Issuance of warrants to consultants			—			—			1,044
Deferred income taxes			—			971			—
Changes in operating assets and liabilities:
	Prepaid expenses and other current assets		344			(183	)		(332	)
	Notes receivable		719			—			719
	Restricted cash		—			107			(316	)
	Income taxes		19			4,621			58
	Accounts payable and other current liabilities		(1,023	)		(204	)		(24	)
	Accrued royalties		250			250			500
	Accrued compensation		(15	)		174			356
	Deferred rent		1			5			37

Net cash used in operating activities			(5,309	)		(1,135	)		(30,833	)

Cash flows used in investing activities:
	Capital expenditures		—			(207	)		(1,479	)
	Proceeds from disposal of assets		14			—			14
	Purchases of investments		(6,671	)		—			(16,716	)
	Maturities and sales of investments		3,000			—			11,125

Net cash used in investing activities			(3,657	)		(207	)		(7,056	)

Cash flows (used in)/provided by financing activities:
	Acquisition of NZ Corporation - cash acquired		—			—			20,666
	Payment of acquisition costs		—			—			(1,863	)
	Payment to repurchase stock		—			(470	)		(12,513	)
	Proceeds from sale of common stock, net of issuance costs		—			(19	)		17,448
	Proceeds from issuance of warrants		—			—			40

Net cash (used in)/provided by financing activities			—			(489	)		23,778

Net decrease in cash and cash equivalents from continuing operations			(8,966	)		(1,831	)		(14,111	)
Net cash provided by operating, investing, and financing activities of discontinued operations			2,158			14,344			25,855
Cash and cash equivalents at beginning of period			18,552			12,811			—

Cash and cash equivalents at end of period		$	11,744		$	25,324			$11,744

Date: August 12, 2003

/s/ Sandra Gardiner

Sandra Gardiner

Chief Accounting Officer
(Principal Financial Officer
and Duly Authorized Officer)


x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 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 _____________


Delaware (State or other jurisdiction of incorporation or organization)		43-0433090 (I.R.S. Employer Identification No.)


Common Stock $0.001 par value		21,141,455 shares outstanding at July 31, 2003


		(In thousands)

Current assets		$	21,706
Property and equipment			30,193
Commercial real estate loans			16,335
Notes and notes receivables			15,166
Investments in joint ventures			2,343

	Total assets acquired		85,743

Current liabilities			1,947
Long-term debt			14,908
Long-term deferred taxes			7,936

	Total liabilities assumed		24,791

	Net assets acquired	$	60,952


	At June 30,

	2003		2002

Stock options		5,547,086		5,445,711
Warrants to purchase common stock		1,091,314		1,091,314
Contingently issuable shares pursuant to stock rights		3,060,707		3,060,340

		9,699,107		9,597,365


	June 30,			December 31,
	2003			2002

Equipment	$	999		$	1,112
Leasehold improvements		237			368

		1,236			1,480
Less accumulated depreciation and amortization		(446	)		(305	)

Total property and equipment, net	$	790		$	1,175


		Real Estate Restructuring					Strategic Restructuring

		Severance					Severance		Cessation
		& Related			Lease		& Related		Australian		Facility
		Benefits			Termination		Benefits		Operations		Related		Total

Accrual as of December 2001		$	705,000		$	180,000	$	—	$	—	$	—	$	885,000
Amount utilized during the three months ended March 31, 2002			—			—		—		—		—		—
Amount utilized during the three months ended June 30, 2002			—			—		—		—		—		—
Amount utilized during the three months ended September 30, 2002			(34,000	)		—		—		—		—		(34,000	)
Amount utilized during the three months ended December 31, 2002			(52,000	)		—		—		—		—		(52,000	)

	Accrued balance as of December 31, 2002		619,000			180,000		—		—		—		799,000


		(In thousands)

Prepaid assets		$	30
Property and equipment			6,941
Commercial real estate loans			1,285
Notes and receivables			118

	Total assets held for disposal		8,374

Current liabilities			75

	Total liabilities held for disposal		75

Net assets held for disposal		$	8,299


Election of Directors	Votes For		Votes Withheld

William A. Pope		14,893,103		61,535
S. Lewis Meyer, Ph.D.		14,893,103		61,535


Exhibit Number		Description

3.1		Certificate of Incorporation. Previously filed as Exhibit 3.1 to registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 13, 2002.

3.2		Bylaws. Previously filed as Exhibit 3.2 to registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 13, 2002.

31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.