HARBOR DIVERSIFIED, INC. - Quarter Report: 2002 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark one)

For Quarterly Period Ended September 30, 2002

For the period from __________ to __________.

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.

As of November 11, 2002 there were 12,972,443 shares of registrant’s Common Stock, $.01 par value, outstanding.

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HOLLIS-EDEN PHARMACEUTICALS, INC.
Form 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002

INDEX

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Part I.            Financial Information

Item I.            Financial Statements

Hollis-Eden Pharmaceuticals, Inc.
(A Development Stage Company)
Balance Sheets

The accompanying notes are an integral part of these financial statements.

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Hollis-Eden Pharmaceuticals, Inc.
(A Development Stage Company)
Statements of Operations
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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Hollis-Eden Pharmaceuticals, Inc.
(A Development Stage Company)
Statements of Cash Flows
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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HOLLIS-EDEN PHARMACEUTICALS, INC.
(A Development Stage Company)

NOTES TO FINANCIAL STATEMENTS

(UNAUDITED)

1.          Basis of Presentation

             The information at September 30, 2002, and for the three-month and nine-month periods ended September 30, 2002 and 2001, is unaudited.  In the opinion of management, these financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented.  Interim results are not necessarily indicative of results for a full year.  These financial statements should be read in conjunction with the Hollis-Eden Pharmaceuticals, Inc. (“Hollis-Eden”) Annual Report on Form 10-K for the year ended December 31, 2001, which was filed with the United States Securities and Exchange Commission on March 1, 2002.

             While management believes that the discussion and analysis in this report is adequate for a fair presentation of the information, management recommends that this discussion and analysis be read in conjunction with Management’s Discussion and Analysis of Results of Operations and Financial Condition included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.

2.          Other Agreements and Commitments

   Aeson Therapeutics

             In March 2002, we amended certain of our agreements with Aeson Therapeutics, Inc. (“Aeson”).  Under the amendments, we paid Aeson $1.0 million for further clinical development of HE2500.  The payment extended the initial date by which we could exercise our option to acquire the remainder of Aeson to September 30, 2002.  We also received additional equity securities as a result of our $1.0 million payment and now have approximately a 25% equity stake in Aeson.  The $1.0 million payment was expensed as in-process R&D during the second quarter of 2002.  The amendments also provided that if we did not exercise our initial option to acquire the remainder of Aeson then we, at our sole option, could make an additional payment of $1.0 million to allow us to extend the date by which we may exercise our option to acquire the remainder of Aeson through April 11, 2003.

             We elected not to exercise our option to acquire the remainder of Aeson by September 30, 2002 or to make the additional payment required to extend our option until April 2003.  Accordingly, our option to acquire Aeson has now expired.  We continue to hold a 25% equity interest in Aeson.

   Pharmadigm

             In August 2002, we entered into a Sublicense Agreement with Pharmadigm, Inc.  Under the agreement, we obtained exclusive worldwide rights to certain intellectual property of Pharmadigm and the University of Utah and we agreed to make aggregate payments of $0.9 million in cash or in shares of our common stock, at our option, over the next year.  The $0.9 million payment to Pharmadigm is comprised of a $50,000 sublicense issue fee and the remainder as payments related to reimbursement of costs incurred and technology transfer, to be paid over the next year in cash or in shares of our common stock, at our option. The $0.9 million payment was expensed as in-process R&D during the third quarter 2002.  We will also make additional milestone and royalty payments to Pharmadigm if we meet specified development and commercialization milestones for products covered by the patents that we licensed under the agreement.  The principal patents licensed under the agreement, originally licensed to Pharmadigm from the University of Utah, relate to inventions by Dr. Raymond Daynes and Dr. Barbara A. Araneo.  Dr. Daynes is currently a scientific consultant to Hollis-Eden.

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             The forward-looking comments contained in the following discussion involve risks and uncertainties.  Our actual results may differ materially from those discussed here due to factors such as the timing, success and cost of preclinical research and clinical studies, the timing, acceptability and review periods for regulatory filings, the ability to obtain regulatory approval of products, our ability to obtain additional funding and the development of competitive products by others.  Additional factors that could cause or contribute to such differences can be found in the following discussion, as well as in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.

General

             Hollis-Eden Pharmaceuticals, Inc., a development-stage pharmaceutical company, is engaged in the discovery, development and commercialization of products for the treatment of infectious diseases and other conditions resulting from immune system disorders and hormonal imbalances.  Our initial technology development efforts are focused on a series of potent hormones and hormone analogs that we believe are key components of the body’s natural regulatory system. We believe these compounds can be used to reestablish balance to the immune and metabolic systems in situations of dysregulation. 

             We have been unprofitable since our inception and we expect to incur substantial additional operating losses for at least the next few years as a result of the continuing development activities necessary to bring our potential products to market. In addition, during the next few years, we may have to meet the substantial new challenge of developing the capability to market products. Accordingly, our activities to date are not as broad in depth or scope as the activities we must undertake in the future, and our historical operations and financial information are not indicative of the future operating results or financial condition or ability to operate profitably as a commercial enterprise when and if we succeed in bringing any drug candidates to market.

             On March 26, 1997, Hollis-Eden, Inc., a Delaware corporation, was merged with and into us, then known as Initial Acquisition Corp. (“IAC”), a Delaware corporation.  Upon consummation of the merger of Hollis-Eden, Inc. with IAC, Hollis-Eden, Inc. ceased to exist, and IAC changed its name to Hollis-Eden Pharmaceuticals, Inc.

Results of Operations

             We have not generated any revenues for the period from August 15, 1994 (inception of Hollis-Eden) through September 30, 2002. We have devoted substantially all of our resources to the payment of licensing fees and research and development expenses plus expenses related to the startup of our business. From inception until September 30, 2002, we have incurred expenses of approximately $54.6 million in research and development, of which $5.3 million are non-cash expenses, and $31.2 million in general and administrative expenses, of which $10.0 million are non-cash expenses.  Our expenses have been partially offset by $7.6 million in net interest income, resulting in a loss of $78.2 million for the period.

             Research and development expenses were approximately $3.5 million and $11.0 million for the three- and nine-month periods ended September 30, 2002, compared to $2.7 million and $8.4 million for the same periods in 2001.  Research and development expenses relate primarily to the ongoing development, preclinical testing, and clinical trials for our investigational drug candidates.  The increase in research and development expenses for the three-month period ended September 30, 2002, compared to the same period in 2001, was due mainly to our obligation of $0.9 million for fees payable to Pharmadigm, Inc. under a license agreement that we entered into in August 2002.  The $0.9 million payment to Pharmadigm is comprised of a $50,000 sublicense issue fee and the remainder as payments related to reimbursement of costs incurred and technology transfer, to be paid over the next year in cash or in shares of our common stock, at our option. If we choose to pay in common stock, the number of shares of common stock will be calculated using a formula set forth in the license agreement. The increase in research and development expenses in the nine-month period ended September 30, 2002, compared to the same period in 2001, was due mainly to the $0.9 million in fees payable

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to Pharmadigm, Inc. in September 2002, a $1.0 million investment in Aeson Therapeutics for in-process R&D in April 2002, a $1.0 million increase in salaries and benefits during the period in 2002, and a $1.1 million increase in clinical activities during the period in 2002.  The increase in expenses during the first nine months of 2002 were offset by a $0.6 million decrease in preclinical expenses, $0.3 million decrease in patent fees and $0.2 million decrease in consulting expenses during the period in 2002. 

             General and administrative expenses were $1.0 million and $3.6 million for the three- and nine-month periods ended September 30, 2002, compared to $1.2 million and $3.7 million for the same periods in 2001.  General and administrative expenses relate to salaries and benefits, facilities, legal, investor relations, insurance and travel.

             Net interest income was $0.1 million and $0.3 million for the three- and nine-month periods ended September 30, 2002, compared to $0.2 million and $1.0 million for the same periods in 2001.  The decline in interest income in both the three- and nine-month periods ended September 30, 2002, compared to the same periods in 2001, is due to lower interest rates and to lower average balances of cash and cash equivalents as a result of ongoing operating losses.

Liquidity and Capital Resources

             We have financed our operations since inception primarily through the sale of shares of common stock.  During the year ended December 31, 1995, we received cash proceeds of $250,000 from the sale of securities. In May 1996, we completed a private placement of shares of common stock, from which we received aggregate gross proceeds of $1.3 million.  In March 1997, the merger of IAC and Hollis-Eden, Inc. provided us with $6.5 million in cash and other receivables.  In May 1998, we completed a private placement of common stock and preferred stock and warrants to purchase common stock, from which we received gross proceeds of $20 million.  During January 1999, we completed two private placements from which we received aggregate gross proceeds of approximately $25 million.  In December 2001, we completed a private placement of common stock and warrants, from which we received gross proceeds of $11.5 million.  In addition, we have received a total of $13 million from the exercise of warrants and stock options from inception.

             As of September 30, 2002, our cash, cash equivalents and short-term investments were $16.4 million compared to $30.5 million at December 31, 2001.  The decrease was primarily due to $14.1 million of cash used for operations.  We expect to continue to use our cash, cash equivalents and short-term investments to fund our ongoing research and development programs.

             Our operations to date have consumed substantial capital without generating any revenues, and we will continue to require substantial and increasing amounts of funds to conduct necessary research and development and preclinical and clinical testing of our drug candidates, and to market any drug candidates that receive regulatory approval.  We do not expect to generate revenue from operations for the foreseeable future, and our ability to meet our cash obligations as they become due and payable is expected to depend for at least the next several years on our ability to sell securities, borrow funds or some combination thereof.  We may not be successful in raising necessary additional capital resources to fund our ongoing operations.  We may also seek additional funding through collaborative arrangements with strategic partners or with governmental entities.  If adequate funds are not available we may be required to delay, scale back or eliminate one or more of our drug discovery or development programs or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or product candidates that we would not otherwise relinquish. 

             Based upon our current plans, we believe that our existing capital resources, together with interest thereon, will be sufficient to meet our operating expenses and capital requirements at least into the second half of 2003.  We have recently streamlined our operations and focused our research and development expenditures, and we are developing further contingency plans that we believe will allow our existing resources to meet our needs into 2004 in the event we are unable to raise additional funds before that time. However, changes in our research and development plans or other events affecting our operating expenses may result in the expenditure of our available capital resources earlier than expected.  Our future capital requirements will

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depend upon many factors, including progress with preclinical testing and clinical trials, the number and breadth of our programs, the time and costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other proprietary rights, the time and costs involved in obtaining regulatory approvals, competing technological and market developments, and our ability to establish collaborative arrangements for the development of our drug candidates or for the effective commercialization and marketing of any drug candidate approved by regulatory authorities.  We expect to continue to incur increasing negative cash flows and net losses for the foreseeable future.

                           At September 30, 2002, our investment portfolio included only cash and money market accounts and had no fixed-income securities.  There would be no material impact to our investment portfolio, in the short term, associated with any change in interest rates, and any decline in interest rates over time will reduce our interest income, while increases in interest rates over time will increase our interest income.

                            An evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Operating Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures within 90 days before the filing date of this quarterly report.  Based on that evaluation, the Company’s management, including the Company’s Chief Executive Officer and Chief Operating Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.  There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

PART II              Other Information

Item 1.                 Legal Proceedings

                            From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business.  As of the date of this quarterly report, we are not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition or operating results.

Item 2.                 Changes in Securities

                            On October 15, 2002, we issued 50,000 shares of unregistered Common Stock to Pharmadigm, Inc. as a contractual obligation and as consideration, in part, for the sublicense granted to us pursuant to the sublicense agreement entered into in August 2002 with Pharmadigm.

                           The issuance of these securities was deemed to be exempt from registration under the Securities Act of 1933, as amended, by virtue of Section 4(2) and/or Regulation D promulgated under such Act. The recipients represented their intention to acquire the securities for investment only and not with a view to distribution thereof. Appropriate legends are affixed to the securities issued in such transaction.

Item 3.                 Defaults upon Senior Securities

                            None

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Item 6.                Exhibits and Reports on Form 8-K

(a) The following exhibits are included as part of this report:

(b) Reports on Form 8-K:

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Signatures

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 hereunto duly authorized.

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